Today I begin a series of Star Wars themed blog posts to celebrate the upcoming release of the next entry in the Star Wars franchise, Episode VII – The Force Awakens. Please note that I will only use the first three movies, now known as Episodes IV-VI, for the themes this week. So if you are a millennial and the prequels are your Star Wars sorry but you can write about them as the first three are my Star Wars movies. In conjunction with this series of blog posts, Jay Rosen and I are doing a trilogy of Star Wars themed podcasts this week, monikered May the Podcast Be With You. They were a ton of fun for Jay and I to put together so I hope you will check them out on my podcast site or on iTunes at the FCPA Compliance and Ethics Report.
I will begin with Episode IV – A New Hope. One of the plotlines is that the Galactic Empire has created a Death Star with enough firepower to destroy a planet. The Rebel Alliance is determined to destroy the Death Star and steals a computer program detailing the defensive posture of the Death Star. A computer analysis determines a weakness in the Death Star’s defensive shield. At one point, the Death Star’s commander, Grand Moff Tarkin, played by Peter Cushing, it told there is a ‘risk’ in the Rebel’s plan of attack. Tarkin dismisses this risk as insignificant. Of course, Luke Skywalker then proceeds to exploit this risk and destroy the Death Star.
Tarkin’s incorrect assessment of this risk was lethal. Today I want this part of the story to introduce the subject of how you evaluate anti-corruption compliance risk under the Foreign Corrupt Practices Act (FCPA) or other anti-corruption regime. Mike Volkov has advised that you should prepare a risk matrix detailing the specific risks you have identified and relevant mitigating controls. From this you can create a new control or prepare an enhanced control to remediate the gap between specific risk and control. One way to do so was explored by Tammy Whitehouse, in an article entitled “Improving Risk Assessments and Audit Operations” in which she looked at the risk evaluation process used by Timken Company (Timken).
Once risks are identified, they are then rated according to their significance and likelihood of occurring, and then plotted on a heat map to determine their priority. The most significant risks with the greatest likelihood of occurring are deemed the priority risks, which become the focus of the audit/monitoring plan, she said. A variety of solutions and tools can be used to manage these risks going forward but the key step is to evaluate and rate these risks.
|Likelihood Rating||Assessment||Evaluation Criteria|
|1||Almost Certain||High likely, this event is expected to occur|
|2||Likely||Strong possibility that an event will occur and there is sufficient historical incidence to support it|
|3||Possible||Event may occur at some point, typically there is a history to support it|
|4||Unlikely||Not expected but there’s a slight possibility that it may occur|
|5||Rare||Highly unlikely, but may occur in unique circumstances|
‘Likelihood’ factors to consider: The existence of controls, written policies and procedures designed to mitigate risk capable of leadership to recognize and prevent a compliance breakdown; Compliance failures or near misses; Training and awareness programs.
|Priority Rating||Assessment||Evaluation Criteria|
|1-2||Severe||Immediate action is required to address the risk, in addition to inclusion in training and education and audit and monitoring plans|
|3-4||High||Should be proactively monitored and mitigated through inclusion in training and education and audit and monitoring plans|
|Risks at this level should be monitored but do not necessarily pose any serious threat to the organization at the present time.|
Priority Rating: Product of ‘likelihood’ and significance ratings reflects the significance of particular risk universe. It is not a measure of compliance effectiveness or to compare efforts, controls or programs against peer groups.
The most significant risks with the greatest likelihood of occurring are deemed to be the priority risks. These “Severe” risks become the focus of the audit and monitoring plan going forward. One of the methods used by the compliance group to manage such risk is to provide employees with substantive training to guard against the most significant risks coming to pass and to keep the key messages fresh and top of mind. The company also produces a risk control summary that succinctly documents the nature of the risk and the actions taken to mitigate it.
A second approach to reviewing the results of a risk assessment was detailed in a Harvard Business Review (HBR) article, entitled “Managing Risks: A New Framework”, by Robert Kaplan and Annette Mikes. The authors have separated business risk into three categories: (1) Preventable Risks; (2) Strategy Risks; and (3) External Risks. Companies should design their risk management strategies to each category because what may be an adequate risk management strategy for the management of preventable risks is “wholly inadequate” for the management of strategy or external risks.
Category I: Preventable Risks. These are internal risks, arising from within an organization. The authors believe that “companies should seek to eliminate these risks since they get no strategic benefits for taking them on.” The authors specifically mention anti-corruption and anti-bribery risks as falling in this category. This risk category is best managed through active prevention both through operational processes and training employees’ behaviors and decisions towards a stated goal. The control model to manage preventable risks is to develop an integrated culture and compliance model. Such a system would typically consist of a Code of Conduct or Business Ethics, standard operating procedures, internal controls to spell out the requirement and internal audit to test efficiencies. The role of the Compliance Department in managing Category I risks is to coordinate and oversee the compliance program and then revise the program’s controls as needed on an ongoing basis, all the while acting as independent overseers or the risk management function to the business units.
Category II: Strategy Risks. These risks are those that a company may accept in some form because they are “not inherently undesirable.” In other words, a company may be willing to accept some types of risks in this category so that it may increase profits. This category of risk cannot be managed through the rules based system used for preventable risks, instead the authors believe that “you need a risk management system designed to reduce the probability that the assumed risks actually materialize and to improve the company’s ability to manage or contain the risk events should they occur.”
The authors listed several specific techniques to use as the control model for strategic risks. These include “interactive discussions about risks to strategic objectives drawing on tools” such as heat maps and key risk indicator scorecards. The Compliance Department’s role here is to run risk management workshops and risk review meetings, usually acting as the “devil’s advocate” to the business units involved. Another key role of the Compliance Department is the marshaling and the delivery of resources allocated to mitigate the strategic risk events identified in this process. Finally, the authors believe that the relationship of the Compliance Department to the business units in managing a Category II strategic risk is to act as “independent facilitators, independent experts or embedded experts.”
Category III: External Risks. These are risks that arise outside the company’s control and may even be beyond its influence. This type of risk would be a natural disaster or economic system shutdown, such as a recession or depression. The authors here note that as companies cannot prevent such risks, their risk management strategy must focus on the identification of the risk beforehand so that the company can mitigate the risk as much as possible. Recognizing the maxim that ‘you don’t know what you don’t know’; the authors see the control model for Category III risks as “envisioning risks through: tail-risk assessments and stress testing; scenario planning; and war-gaming” with the management team. Under this Category III risk, the authors believe that the relationship of the Compliance Department to the business units is to either complement the strategy team or to “serve as independent facilitators of envisioning exercises.”
The authors conclude with a discussion of the leadership challenge in managing risks, which they believe is quite different than managing strategy. The reason is that managers “find it antithetical to their culture to champion processes that identify the risks to strategies they helped to formulate.” Nevertheless without such preparation, the authors believe that companies will not be able to weather risks that turn into serious storms under the right conditions. They believe that the key element is that the risk management team must have a direct reporting line to senior management because “a company’s ability to weather [risk] storms depends very much on how seriously executives take their risk-management function when the sun is shining and there are no clouds on the horizon.” I could not have said it better myself.
Whether you utilize one of these approaches or another approach, analyzing the results of your risk assessment is as important as doing the risk assessment. With the recent Department of Justice (DOJ) remarks around how they will review the effectiveness of compliance programs during an enforcement action to determine potential credit or even granting a declination, the stakes have never been higher. Of course for Grand Moff Tarkin, his refusal to analyze the risk assessment presented to him was fatal.
May the force be with you.
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© Thomas R. Fox, 2015