CHANGING SUPERVISION

Supervising, or the supervisory function, is becoming increasingly important in the Netherlands. This is due to the financial crisis and the banking crisis. In both crises there is a reference to inadequate supervision. Appropriate or not, this leads to attempts to reform the supervision. There should be more supervision and this should especially be stricter. Thereby, it is implicitly or explicitly assumed that such crises will not recur, or will be contested earlier in the future. I do not believe this at all. Institutional reforming is needed, but is not a panacea.

Are rules not helping?

In the file part of FD Outlook, the quarterly magazine of the Financieele Dagblad, July 2013, Steven de Waal writes, often known by ‘Social Entrepreneurship’, on page 31: “If there is one lesson to draw from the series administration scandals of recent years, it is: rules do not help.”

According to him, we have to go back to square one. Ethics and character building should be high on the agenda of management studies again. Codes of good governance seem to be like a Boy Scout oath in the world of power and greed in the boardroom. With that I mean ‘boardroom dynamics’, where even the seating arrangement matters!

Two types of supervision

In the first place there is Internal Supervision within the enterprise. The Supervisory Board practices this type of supervision. External Supervision is being held on whole sectors. There are many External Supervisors and their number seems to increase. That is causing more and more problems, which I will discuss under the next headline.

There are two possible models of Internal Supervision. Firstly, there is the two-tier model, which is common in continental Europe. In this model there is a Board of Directors, which is the executive of the company, and a Supervisory Board, which supervises the actions of the Board of Directors. These are different responsibilities that are organized separately in this model. Until early 2012, this was the only accepted type of internal supervision in the Netherlands. There is also the one-tier model that used to be the standard in Anglo-Saxon countries, but since last year this model is also permissible for Dutch companies. Both responsibilities are still separated, but less strictly and less separately organized. They are part of the same body, ‘the Board’. Both models have their pros and cons. The one-tier model seems to becoming more popular in recent years in Europe.

In England, where the one-tier model is in practice, there has been a mandatory review of the Boardroom for years. An important conclusion drawn form these evaluations, is that even the seating arrangement within the Board is meaningful! UK members prefer more discussion and less presentation. Particularly when it comes to strategy. They prefer to discuss risk management in the Council as a whole, rather than just in the Audit and Risk Committee. The seating arrangement at meetings of the full Board could be improved. Often the executives and non-executives are facing each other with their two presidents (Chairman and CEO) seated in the middle. One can guess what might happen quickly: both positions are not only seated against each other, but they will also disagree sooner. The metaphorical will become visible! The meeting will become more effective once they will no longer be sitting facing each other, but mixed up, say the non-executives.

Whatever way the Board is organized, two-tiered or one-tiered, the call for further professionalization of the Supervisory Board is increasing: no longer recruiting amateurish from the old boys’ network, but increasingly on the basis of expertise, experience and track record. It increasingly involves financial and legal expertise, but soon also professional and business ethics. In short, supervision is changing rapidly.

An article by the revealing title “Five red flags when you know your CFO is up to no good” circulated a while among Dutch commissioners after the Enron crisis early this century. Geertjan Stoker (Dutch Consultancy Risk Management) identifies the following signs of “big trouble”: (frequent) replacement of the management, underperformance relative to the sector, unclear changes in accounting policies, lawsuits, a lack of strategy, expanding terms of payment and a poor relation with stakeholders and external supervisors. He wrote this on account of his experience with the management crisis of the Amsterdam school group Amarantis.

The business program at the University of Groningen includes classes in ethics as well. Once you have completed such a class, you are able to recognize moral aspects of management decisions and to understand your own responsibility for these decisions, to deal with moral dilemma’s in accounting, management and international business and to appreciate the moral role of the individual within the organisation.

What about external supervision?

There has been a lot more developments regarding external supervision. The number of supervisory bodies is increasing rapidly, but due to that also their duties and responsibilities. Who does not know De Nederlandsche Bank (the Dutch Central Bank) and the Autoriteit Financiële Markten (Financial Market Authority) in the financial world, and the Autoriteit Consumenten en Markten (Authority for Consumers and Markets) in the broader economic perspective, but with specialist focus the Voedsel- en Warenautoriteit (Food Safety Authority), the individual Inspections for Labour, Education and Health.  A seemingly endless series of authorities is supervising. And then I forgot to mention European authorities like the European Central Bank.

De Nederlandsche Bank (DNB) has received much criticism for its performance during the financial crisis. At first they have not recognized the crisis and its potentially large impact on financial markets and financial institutions or have recognized it too late. Then followed lax and inadequate responses. The consequences of the bankruptcy of Lehman Brothers were underestimated, the situation at DSB Bank had gotten out of hand, they did not act at all at ABN AMRO, and so on. At the end of his career Bank President Nout Wellink has been made ​​scapegoat. Wellink was not reappointed and prematurely sent into retirement, rightly or not. Intended successor Lex Hoogduin was written off by politics because he was associated with the failure of DNB as a candidate from within the organization. Former financial top official Klaas Knot may try to better now.

The Autoriteit Financiële Markten (AFM) seems to do better. In any case, it did not get a bad reputation due to its crisis management. Ronald Gerritse has been appointed recently as Director and is also a former top official at the Ministry of Finance. The AFM is also changing its ways. The accounting profession was also quite under attack during the financial crisis. After all, the accountant has an important external supervisory function.

It is the job of the accounting profession to check the financial statements of a company in a correct and unbiased way. In recent years we saw an increasing amount of affairs where the qualified audit is given in a case where it should not have been given. The Financieele Dagblad headlines on June 12: AFM discovers many weak audit firms that could better return their license.

Four of the five smaller firms have got an insufficient score if the supervisor supervises them. The day before this statement could be found in the newspapers, the AFM announced for the third time a report on the quality of auditing in the Netherlands.

Including the group that is now under investigation, small companies with a license for auditing, it is even ​​worse than the large firms that have been checked in the two previous reports. The AFM advises some small companies to consider giving up their license and stop their business. The AFM has done a quality research three times; in all of these cases this did not go well. What’s wrong with this profession? It is a sector that has long remained outside the supervision of a supervisor. Of course there are many accountants who do their job just fine, but the AFM focuses on what is not going well. You can have 99 files that are correct, but the one file that is incorrect breaks up. The main problem is that the companies waited too long to anchor the quality of an audit in the hart of organization. The AFM thinks that these companies have had a bad quality security in the recent years.

Additionally, each company will need to face an increasing number of external regulators, including more tasks and responsibilities. This could lead to an effect where the bad quality is transferred to other sector of the business. It could lead to an increase in gaps, inconsistencies, contradictions and antagonism. There seems to be no supervisor.

With every new social problem, the government is showing its decisiveness by implementing a new law, regulation or supervisor. We call this policy accumulation. It will lead to an increasing call for ‘more’! This also applies to supervision. You will make the entrepreneur and the company crazy for sure. Just ask this the first best cafe owner in the Netherlands. Then we are back at the beginning of this article; more rules alone will not help, that is certainly true for supervision in motion …

Prof. Dr. J.G.A. van Mierlo is Professor of Public Finance at the Faculty of Economics and Business Administration from the University of Maastricht.

This article is translated from Dutch to English by the Editorial Board of Asset | Accounting & Finance.