compliance as a competitive advantage september 11-13, 2006 · compliance as a competitive...

Compliance as a Competitive AdvantageSeptember 11-13, 2006

Christopher Myers, PartnerHolland & Knight LLP

Lisa KucaDirector of Ethics & InvestigationsFreddie Mac

Mark S. InzettaVP, AGC & Chief Corporate Compliance OfficerWendy’s International, Inc.

Bad Things Can Happen to

a Good Company

Corporate Misconduct is Not New

• Mid-1800s Railroad Scandals

• 1930s – Securities & Exchange Act to Respond to Stock Market Crash

• 1960s and 1970s – EPA, OSHA and EEOC are Born

• 1980s – Savings and Loan Scandals and Defense Industry Fraud and Abuse

• 1990s – Healthcare Fraud and Abuse

• 2002 – Enron, MCI – Sarbanes Oxley Act

True Costs of Compliance Failures

• The Boeing Case

– 6 Years of Investigation -- $615 million in fines and penalties

– Damages far exceeded out of pocket expenses

– “. . . [Some in prosecutors’ offices believe that Boeing is rotten to the core . . .”

– Lost $1 billion in government contracts; suspended from rocket launch business for 20 months.

– Lost US government tanker market

– Sued by competitor for $1 billion

– Employees fired and indicted

True Cost of Compliance Failures

• Boeing Case Continued

– Forced to recompete other US government contracts

– “Biggest hit” to Boeing’s reputation

– Executive sentenced to prison, fine of $250,000 plus forfeiture of $5 million in equity based compensation

– Denial of export licenses

– Loss of security clearances

– Denial of State Department licenses

– Damage to shareholder value

$800 Billion Loss in Market Cap

• The Last 200 Corporate Scandals Resulted in Permanent Loss of $800 B in Market Cap

Source: OCEG

Market Capitalization Loss

• Merck - Vioxx Product Liability - $40B

• Marsh – Bid Rigging - $10+B

Typical Corporate Views of Compliance Programs

• Compliance is a “Cost Center”

• Our Company is a “good company”

• Compliance is a “once a year activity.”

• We have a program; I just can’t tell you where it is

• “What is the minimum we can do to meet the legal requirements.”

• “We are not like those ‘other companies’ that get into trouble.”

The Impact on the Bottom Line

• Program Benefits Are Not Limited to Avoiding Fines, Penalties and Costly Litigation

• Variety of Ways Good Governance and Robust Compliance Programs Can Improve Production & Profitability

Compliance and Ethics Programs are Good for Business

• Tone at the Top

–Not Just the Lawyers’ and Compliance Officer’s Responsibility

–Integrated into Operations – Not Just a Paper program

• Unintentionally Encouraging Misconduct

Critical to Brand Preservation& Enhancement

• Customer Retention and Growth

• Customer Base Difficult to Rebuild During a Crisis

• Negatively Impact Existing, or Future, Business Relationships (i.e., Vendors, Lenders, regulators, etc.)

Director Retention and Recruitment

• Compliance and Ethics are Critical to Directors –Particularly the Independent Directors

• Directors Have Personal Exposure

• Withdrawal of a Director can Negatively Impact the Company

• Impact D&O Insurance

Avoid Debarment & Suspensionfrom Business

• Ernst & Young Barred from Taking on Any New Audit Business

• Citigroup Barred by Federal Reserve from Major Acquisitions

Additional Impact to Business/Operations

• Denial of Export Licenses

• Loss of Security Clearances

• Prohibition from Trading Company Stock

• Exclusion from Federal Health Care Programs

• Suspension/Debarment

• Denial of FDA Approvals

Unanticipated Change in Business Model

• Change in Profit Models

• Elimination of Products

• Loss of Suppliers and Other Business Partners

Enhance Business Strategy

• Prepare for IPO

• Increase in M&A Opportunities

• Improve Post-Merger Acquisition Efforts

Global Market Opportunities

• Good Corporate Citizenship

• Social Compliance

• Anti-Corruption Efforts Growing Throughout the World; For Example, EU, UN, US

Employee Retention

• Loss of Human Capital

• Loss of Intellectual Property

• Recruiting/Retention Difficult During a Compliance Failure

What is the Proof of All of These Benefits?

• Developing Body of Empirical Studies

• Increasing Use of Compliance and Governance Factors in Evaluations of Companies

Studies of Impact of Strong Governance and Compliance

Programs• GovernanceMetrics International

– Traditional Investor Safeguards (broker research, credit rating agencies, accounting firms) have failed

– Tremendous dollar losses and lost investor confidence

– Investors looking for quality of information and quality of earnings, potential areas of risk, progressive practices

– GMI is “independent corporate governance research and ratings agency”

– Develops ratings database based on metrics measuring governance/compliance criteria

Studies of Impact of Strong Governance and Compliance

Programs• GMI Studies: Benefits of Good Governance

– Lower Cost of Capital

– Lower D&O Insurance Premiums

– Enhanced Reputation Helps Recruiting

– Lower Chance of Shareholder Suits

– Increased Shareholder Returns

– Factored into Credit Risk Models by Commercial Banks

– Used as a Screen by Director and Executive Search Firms

Studies of Impact of Strong Governance and Compliance

Programs• GMI Studies Impact of Poor Governance

– Governance and Compliance Issues as “Early Warning System”

– Studies showed strong correlation between governance and compliance red flags and subsequent problems.

– Interstate Bakeries: 4 red flags in June 2003, filed for bankruptcy in September 2004

– Krispy Kreme Doughnuts: red flags in January 2004, shareholder suits, delayed filings and SEC investigation followed

Corporate Governance and the Cost of Equity Capital

• Universities of Wisconsin and Illinois

• Good Governance = high returns and lower equity costs

• Best governed vs. worst = 88 basis points lower cost of equity on average

Corporate Governance and the Cost of Equity Capital, Hollis Ashbaugh, University of Wisconsin, Daniel Collins, University of Iowa, Ryan LaFond, University of Wisconsin (December 2004)

Corporate Governance and Equity Prices

• Quarterly Journal of Economics – Feb 2003

• “Firms with stronger shareholder rights”

– Higher firm value

– Higher profits

– Higher sales growth

– Lower capital costs

Corporate Governance and Equity Prices, Paul Gompers, Joy Ishii, and Andrew Metrick, The Quarterly Journal of Economics, February 2003

Governance and Compliance Impact on Market Performance

• Good governance and compliance can lead to better market performance in general

• A McKinsey & Co. survey revealed that

– 57% of institutional investors said that good corporate governance determined whether they increased or decreased their holdings in a company

– Investors are willing to pay a premium of up to 41% for good governance

– By moving from worst to best practices in governance, companies can expect a 10-12% gain in market valuation

Well Known Seasoned Issuers

•WKSIs can now gain virtually instant access to the capital markets as their shelf registration statements will become effective automatically and immediately without SEC review

•WKSI status can be lost, however, if the issuer violates the antifraud provisions of the securities laws or enters into an SEC settlement charging such a violation

•WKSIs are thus well advised to revisit corporate compliance programs to make sure that they are as effective as they can be

Benefits of Good Compliance and Governance

“Good governance matters, if for no other reason than bad governance is so costly.”

Buy the Board, Morgan Stanley US Investment Strategy

COMPLIANCE & ETHICS PROGRAMS ARE ESSENTIAL FOR COMPANIES TO AVOID:•Prosecution – (Thompson memo)

•Director and officer civil/criminal liability –(Caremark/COSO)

•Costly penalties in the event of prosecution –(Federal Sentencing Guidelines)

•Increasingly required by regulators (SOX, DRA, etc.) to avoid civil and administrative penalties

THOMPSON MEMO

• Deputy A.G. Larry Thompson

• Directive To All Federal Prosecutors

• In making charging decisions must consider whether company has an effective Compliance Program

CAREMARK CASE

• Delaware Supreme Court in case where Caremark paid $250 million to settle Medicare fraud claims

• Per Se Breach of Fiduciary Duty by Board & Officers not to have compliance program in heavily regulated industries

SENTENCING GUIDELINES

• Recent revisions to sentencing guidelines regarding what is an effective Compliance Program

• Standards not just used in criminal sentencing

• Used in charging decisions and in D&O suits

Compliance & Ethics Programs –New Generation

• Objective of an “Effective Compliance and Ethics Program” is to prevent and detect improper conduct

• Encourages both ethical conduct and full compliance with all applicable laws

• Requires a culture of compliance be established

Critical Components of an “Effective Compliance AND Ethics Program”

• Standards of conduct and Internal Controls• Increase in board involvement• Employee background checks and due diligence• Training and communication• Employee incentives and appropriate discipline• Ongoing auditing, monitoring, review• Helpline• Remedial action • Risk assessment

Standards and Procedures

• Clear and concise standards of conduct that are enforced (i.e. Code of Conduct)

• Internal controls reasonably capable of preventing/detecting misconduct

• Tailored to the organization and its operations

• Document, document, document

Appropriate Personnel

• Hiring and promotion practices should be consistent with the compliance and ethics program

• Conduct background checks and due diligence as appropriate

Training AND Communication

Compliance AND Ethics Training is Required at All Levels of the Organization

• Governing authority

• Officers and other executives

• All employees

• Agents, where appropriate

Performance Incentives AND Disciplinary Actions

Consistent Use at ALL Levels

• Use of both “carrot & stick”

• Incorporate compliance & ethics into performance evaluation

• Consider compliance & ethics in hiring and promotion practices

• Avoid the minefield of tension between operations and compliance

Respond to Improper Conduct AND Take Remedial Action

Failure or Delay in Responding to Problems Could Be Problematic

• Promptly take corrective action to address detected problems

• Report where appropriate

• Amend policies, procedures and program to prevent similar misconduct

The Role of Board of Directors

Authority, Roles and Reporting Relationships

• Governing authority must be knowledgeable about and exercise reasonable oversight over program

• High level personnel responsible for ensuring program is effective (e.g. CEO, audit/compliance committee)

• Senior-level compliance officer responsible for day-to-day operations, has access to Board, adequate resources and credibility

• Directors exercise independent review

• Directors sufficiently informed to exercise independent judgment

Monitoring and Audit Systems: Review and Evaluate

Is the Program Working?

• Ensure company policies and procedures are being followed and that business units are integrating requirements into their operations

• Review the compliance & ethics program for effectiveness

Monitoring and Audit Systems: Review and Evaluate (cont’d…)

Implementation of a Reporting System is Required

• Employees must have a way to report problems and seek guidance

• Establish a “hotline”

Protocol

• Non-retaliation policy is required

• To the extent possible, confidential and anonymous

Components of Risk Assessment

• Determine likelihood of misconduct based on nature of organization’s business

• Analyze current regulatory and enforcement initiatives

• Organization’s prior conduct

• Regular analysis of new regulations and impact on program

• Third-party, or other independent, monitoring of anonymous reporting

Components of Risk Assessment (cont’d)

• Annual risk assessment reports

• Can identify all areas of risk – not just legal and regulatory

• Can apply to business units

• Align program with business objectives

• Show correlations between compliance activities

• Provide benchmark for future activity

• Modify the programs based on data

Factors to Consider for Implementation

• Follow applicable governmental and industry standards in creating the program

• History of similar misconduct within organization

• Size of organization can be a determining factor in allocating resources to be dedicated

Contact Information:

Holland & Knight, LLP1600 Tysons Boulevard, Suite 700

McLean, Virginia 22102

Christopher A. Myers, Partner(703) 720-8038

chris.myers@hklaw.com

Contact Information:

Wendy’s International, Inc.One Dave Thomas Boulevard

Dublin, Ohio 43017

Mark S. InzettaVP, AGC & Chief Corporate

Compliance Officer614-764-6818

mark_inzetta@wendys.com