Ombudsmen Ease Governance Compliance

Cleaning House

Although many corporations have revised their corporate governance procedures, most have made few or insufficient changes. Many corporations still designate CEOs as board chairmen, few have really independent directors, many put highly paid employee-directors on their audit and compensation committees, and some still try to control the actions of supposedly independent auditors, such as the late Arthur Anderson Co.

Before Sarbox, a CEO or director could claim, usually successfully, that he had no knowledge or did not authorize the irregularities in the company and, thus, was not civilly or criminally liable. Under Sarbox, CEOs and CFOs must swear to the validity of company reports, especially financial reports, under penalty of incarceration if they are wrong. Ignorance is no longer a defense. It is criminally irrelevant if the CEO or director did not know about or authorize the violations. Top officers and directors must find out what is going on below and correct any improper activities. It will not be the CEO's advisors or attorneys who are putting up bail or being assigned cell numbers.

Those who doubt that this is a real danger are referred to the history of the RICO Laws passed 30 years ago, ostensibly to allow civil and criminal prosecution of major Mafiosi, such as the Bonnanos and John Gotti. As too many corporate executives found out too late, ambitious state and federal prosecutors (and later even civil personal injury and plaintiff employment attorneys) saw RICO as the open-sesame to the vault of American corporate wealth. Proving merely two minor "predicate" illegal acts opened the door to not only criminal prosecution, but dismemberment of the businesses themselves through court orders and triple punitive damages. Apply the RICO expansion ratio to Sarbox and you have a national policy that will cover all corporations, public and private, that are involved with any federal program. RICO, Sarbox, and the Federal Sentencing Guidelines all apply to publicly traded insurance companies, as of this writing.

No magic, one-size-fits-all solution is guaranteed to teflonize and immunize corporate leaders. The office of ombudsman, which is informal, neutral, independent and externally confidential, can go a long way to relieve these perils, however. Such offices are cheap to create and maintain when weighed against jail time or ruinous monetary damages for corporate leaders. The costs, with benefits and collateral expenses, rarely exceed six-figures — figurative peanuts to large corporations with cash flows of billions or hundreds of millions. Establishing ombudsman offices actually can provide positive cost-benefit ratios by attracting and retaining valuable employees, preventing lawsuits, reducing administrative filings, and identifying and correcting internal violations out of the public eye, according to research by the Ombudsman Association.

What Does an Ombudsman Do?

Many things, depending on the nature of the business or institution. The official definition is one who provides information, advice, and referrals; investigates complaints; and mediates fair settlements, especially between aggrieved parties, such as employees, departments, supervisors, vendors, or consumers, and organizations. They are navigators with no interest in the outcome. They do not take sides.

First among equals, however, the ombudsman ensures that the organization follows its own rules. Practically speaking, he is a troubleshooter, mediator, and problem-solver of internal disputes and problems. The ombudsman is an internal source to whom information can be reported without fear of retaliation. He can deal with such information confidentially and informally, outside regular channels.

Lastly, ombudsmen address the number-one cause of conflict between employers and employees: ignorance. In general, neither party has complete and accurate information about any given problem. Acting hastily on faulty information frequently triggers all the formal processes: human resources, lawsuits, EEOC filings, union grievances, demotions, terminations, and write-ups.

Although there is no statutory confidentiality, more and more courts are granting confidentiality to information reported to ombudsmen on the basis of either contract or the Federal Rules of Evidence. Alternatives such as anonymous hotlines do not suffice; it can be shown that executives know, or should know, that an answering service is passive and provides no method for easy follow-up. Derivative suits by unhappy stockholders probably can be filed under Sarbox/RICO against executives whose hotlines failed to bring enough detail of correctable bad news. Nor do hotlines help callers explore their options of reporting within the company.

For a corporation, probably the biggest service that an ombudsman can perform is to tell the CEO, CFO, or board of directors what is going on in the branches and precincts below. In the lawsuit-phobic world of corporate America, caution keeps many lips zipped tightly, from the janitors' closet to the human resource offices. An ombudsman cures precisely that situation. The information he receives may be nothing major or, perhaps, it may indicate that equipment, merchandise, or supplies are going out the back door at midnight. The secretary to the CFO may report that the latter has set up front entities to skim off corporate money for personal profit. Line attorneys might reveal that the general counsel has set up partnerships to drain the corporation, itself (perhaps by overpaying for office equipment and getting kickbacks).

Live ombudsmen can do many things for top management. They can hear privately, and try to adjust without litigation, complaints of sexual or racial discrimination or harassment. They can inform CEOs of favorable or unfavorable business trends and customer complaints that otherwise might not come to the attention of the executive offices. They can hear complaints of impropriety, such as those raised by the whistleblower who exposed the Enron scandal.

The ombudsman is only a smoke alarm, however, not a fire extinguisher. He only handles matters informally. If visitors initiate any formal processes, ombudsmen must withdraw their assistance.

With confidential information provided without identifiers, CEOs and their boards of directors have opportunities to take immediate, private, internal measures to correct problems, without having to sign false 10-K, 10-Q, or other accounting reports. Because if the CEO does sign off on inaccurate SEC reports, he could spend a few years in a Club Fed.

Prosecutors are even indicting the spouses of corporate officers. Consider what happened to the wife of Enron's CFO: she will be doing six months while her husband serves 10 years. Sadly, neither had earned any of the federal frequent flyer points available under the new Federal Sentencing Guidelines for having an ombudsman, potentially reducing their sentences and fines by up to 40 percent.

Indeed, the federal courts sometimes are ordering companies to set up ombudsmen's offices, to report to the court until the judge is satisfied that CEOs will receive ombudsman reports without court supervision. Two examples are Coca-Cola Enterprises and Shell Oil, who now praise the benefits of the office, but originally were ordered to establish them as part of settlements in multi-million dollar class-action discrimination suits.

For many corporations, it will be a case of picking their poisons: either set up their own ombudsmen offices, in which they can have input and control, or have a federal court designate ombudsmen and supervise the businesses indefinitely. Certainly, such remedies will be sought by successful plaintiff groups, unions, and U.S. attorneys.

A final and critical point is the status of insurance coverage for corporate malfeasance. D&O policies have been rewritten in recent years to exclude coverage for criminal acts, fines, or intentional statutory violations. Claim committees are denying coverage, and possibly defenses, for their covered corporations relating to costs involved in Sarbox violations, no matter how long or high premiums have been paid. The legal tools to do so are provided by the Contra Proferentem Doctrine, which is being used to off-set the fact that ambiguous language in the policy normally is construed against insurers.

In light of the benefits, low costs, confidentiality, and lack of disadvantages, hiring ombudsman for corporations must be called a no-brainer. Sadly, most CEOs use their advisors as mute buttons for the world around them, despite the fact that Sarbox is setting a price on encircling themselves in the sacred silence of quarterly profit. Yet, the very thing that threatens them can strengthen them: mobilizing positive change by hiring an ombudsman.

Allen Church is a contract ombudsman in San Antonio, Texas. He can be reached at churcha@earthlink.net.