Governance and the HR functionby Peter Bonisch
Risk and tone at the top, OK.  But what would be tone at the ‘bottom’?

The most dangerous untruths are truths moderately distorted.
Georg Christoph Lichtenberg (1742--1799)
The least initial deviation from the truth is multiplied later a thousand-fold. 
Aristotle (384 BC – 322 BC)

The idea that the executive and board of a firm set the ethical tone of a firm is an old one, and it has been highly influential.  In the US, the 1987 National Commission on Fraudulent Financial Reporting (more commonly known as the ‘Treadway Commission’ after its chairman), emphasised the importance of what it described as “tone at the top: . . . the tone set by top management-the corporate environment or culture within which financial reporting occurs”.  This introduced the expression “tone at the top” to the management lexicon.

SEC Chairman William Donaldson, testifying before the House Committee on Financial Services in April 2005 stated that improving companies’ ‘tone at the top’ was one of the six principal groupings of objectives of the Sarbanes-Oxley Act.

And so we have the resurgent importance of the discussion of the ‘tone at the top’.  All US listed companies and other SEC registrants – which includes a lot of major UK companies – have to give explicit and regular consideration to tone at the top. 

In the UK we find that a similar perspective prevails, albeit in more muted tones.  One of the most relevant is the Higgs Review of the Role of Non-executive Directors, which states:
“A culture of openness and constructive dialogue in an environment of trust and mutual respect is . . . a prerequisite for an effective board. The chairman has a central role to play in fostering these conditions through their own actions and through engagement with the members of the board.”

In the revision of Turnbull, the Revised Guidance for Directors on the Combined Code (October 2005) exhorts companies to ask:
“Does senior management demonstrate, through its actions as well as it policies, the necessary commitment to competence, integrity and fostering a climate of trust within the company?”

One of the most persistent and important phenomena in the demography of employment in the UK is ‘churn’ – the rate at which UK employers turn over their workforces.  The latest CIPD survey shows that in professional and financial services sectors, rates of employee turnover are 11.8% and 20.5% respectively.  In the financial services case, this suggests turning over the equivalent of the entire workforce every 5 years.  This represents both an enormous cost, as well as a significant opportunity to UK businesses.  For HR managers, the simplest way of thinking about the issue of churn is illustrated as follows:

 

In deciding the people you want to exit, one of the considerations must be people who do not behave in ways that are compatible with the aspirations or ethical environment of the firm.  The basis for setting these aspirations or the ethical parameters of the firm is a separate topic; however, the fundamental point remains: At some point (unless they were inherited though acquisition) the firm must have made a conscious decision to acquire its people, either through hiring or transfer of another contractual relationship on to a permanent contract of employment.  With 20.5% workforce churn per annum, there are many such decisions going on every day.

People who deceive about their experience, and are nonetheless hired into the firm, create multiple problems for the firm: their lack of veracity creates:
— a functional problem – can they do what their exaggerated experience or qualifications implies they could do?
— an ethical problem – have they consciously committed a deception, and in which circumstances would they be prepared to do so again?
— a social capital problem – is their lack of veracity an isolated incident, or is it endemic in the workforce such that employees’ trust of each other will be eroded by the presumption of lack of veracity?
— the tolerance trap – if lack of veracity is known about and tolerance, does this erode employees’ belief in the ethical soundness of the firm?

Of these, tolerance of unethical behaviour may be the most damaging, at least in the short term.  In his classic Harvard Buisness Review essay ‘Why ‘good’ managers make bad ethical choices,’ Saul Gellerman outlines four commonly-held rationalisations that can lead to misconduct:
1. A belief that the activity is within reasonable ethical and legal limits – that is, that it is not ‘really’ illegal or immoral;
2. A belief that the activity is in the individual’s or the corporation’s best interests – that the individual would somehow be expected to undertake the activity;
3. A belief that the activity is safe because it will never be found out or publicised – the classic crime-and-punishment issue of discovery, and
4. A belief that because the activity helps the company, the company will condone it and even protect the person who engages in it.

Of these bases for subsequent ethical rationalisation, a person who has deliberately and successfully fabricated details of his or her experience or qualifications is at greater risk from rationalisations 1, 2 and 3; the well-spring of these is moral fungibility.  (The fourth has a different origin, more akin to Janis’ Groupthink hypothesis). 

What the data tell us
In light of these challenges, the statistics on lack of veracity in personal details of job applicants in the UK do not make comforting reading.  One study suggests 25% of curricula vitae contain false information (TRAG / BBC).  Powerchex’s own data indicate errors in 36% of CVs referred for validation.  In 15.2% of CVs, more that one error was identified, which presumably implies careless or deceit, or at least the need for an explanation and clarification.

CIPD reports that only 25% of respondents in its 2005 Annual Recruitment survey were aware of a job offer being withdrawn because of false representations in a candidate’s application.  Only 23% reported being aware of an employee being dismissed when such discrepancies came to light (although the frequency of such revelations is not reported).  In the same survey, CIPD reported only 41% of respondents reported ‘always’ checking academic qualifications, and 44% ‘always’ checking professional qualifications;  Only 37 reported ‘always’ checking full employment history.

Worrying trend
These data are as unsurprising as they are worrying.  Although considerable discourse can be observed on tone at the top of firms, a critical opportunity to reinforce the importance of veracity and trustworthiness is routinely being foregone by companies: validating all the veracity of an applicant’s revelations about himself or herself.  This lost opportunity to reinforce ‘tone at the bottom’ right from the candidate’s first experience of the company represents an enormous potential cost, especially in terms of the impact of employees’ perceived trustworthiness of each other.  The specific cost of employees succumbing to one of the rationalisation Gellerman describes is another motivator for enhanced due diligence during the hiring process.

Confirming the bona fides of staff coming in to the organisation is a critical control activity in business that appears routinely to be overlooked.  Nowhere are such controls more important than in financial services.  With turnover rates in UK financial services firms running, on average, in excess of 20%, firms have an ideal opportunity to implement this essential control, and encourage both the reality and the perception of the importance of veracity in the firm.  Revealing to candidates that validation of all revelations of qualifications, professional certifications, and full job history are a routine entry check reinforces the expectation of veracity in the firm, and sends a powerful message about expectations of subsequent employee behaviour. 

The FSA has expressed its support for such arrangements.  In its February 2006 publication Firms’ High-level Management of Fraud Risk, the FSA uses the expression ‘Know Your Employee’.  The link between the employee’s honesty and truthfulness and Gellerman’s rationalisation 3 – the issue of discovery – is drawn clearly in that paper.  Employees who have experienced the firm’s focus on discovery during the employment process may be less inclined to test the quality of discovery of other dishonesty, either through a lower natural inclination or a higher expectation of discovery.

While MiFID is silent on the need for employee validation, the general requirement “to employ personnel with the skills, knowledge and expertise necessary for the discharge of the responsibilities allocated to them,” together with the requirement for effective systems of internal controls should be read as underlining the importance of due diligence during the hiring process.
 
Summary
The question is not why do it, but how, for so long, so many firms have thought they can build viable financial services businesses without the essential trust-reinforcing step of ensuring that the ranks of the truthful and honest – the veracious –  are not corrupted by hiring in those for whom veracity is a matter of expediency or convenience.

As a risk management issue, prophylactic validation of candidates’ revealed history – both from the perspective of technical and ethical competence – is an imperative.