Share |

Abuse of power

Reports of corruption and fraud in major businesses have filled the first weeks of the new year with some notable family names being sullied. William Boston examines the implications of corruption allegations at a family business

The web of corruption has ensnared many notable businesses in recent years. The US, and indeed the whole financial world, is still feeling the effects of Enron, while Europe has also been rocked by fraud allegations at the German electronics giant Siemens AG and the French bank Société Générale. But it is not just the big publicly-listed firms that are being scrutinised; family-owned business are also coming under the beady eye of the anti-corruption watchdogs.

In Europe and Asia, two corruption cases at family-controlled businesses vital to their respective national economies have been making headlines for all the wrong reasons.

In Germany, the trial of former Volkswagen AG employees charged with misusing company funds has begun to cast a dark shadow across the reputation of Ferdinand Piech, the family patriarch and grandson of the designer of the German automotive icon, the Volkswagen. And in South Korea, Lee Kun-hee, the reclusive chairman of industrial conglomerate Samsung, is embroiled in allegations that his company operated a $215 million slush fund to bribe politicians, civil servants, and judges.
These cases, which are very high profile in their respective countries, raise questions about whether family-owned businesses are more prone to corruption than their publicly-listed and shareholder-controlled counterparts. Some observers are asking whether tightly-knit families in control of large businesses are more likely to abuse their power and influence, especially in cultures that place a premium on personal relationships in doing business.

Nigel Nicholson, professor in the Department of Organisational Behaviour at the London Business School, says there is a lack of academic research that compares corruption in family-owned businesses with public companies. But the differences between them are clear to see.

"There is a lot more informal networking within family lines and business," says Nicholson. "Family businesses tend not to like a lot of rules – they are more informal."

But does this informality – putting more faith in the handshake than the signed contract – make a company or its executives more likely to be corrupt?

Not necessarily, says David Gaukrodger, an official in the Anti-Corruption Division of the Organisation for Economic Cooperation and Development (OECD), in Paris. The capital structure of a company, whether it is private or publicly-owned, does not open the door for corruption, nor does it act a safeguard against such abuse.
The OECD is the leading anti-corruption watchdog, administering the global Anti-Bribery Convention. For the purposes of the OECD's work, says Gaukrodger, the ability to perform external audits and the existence of transparent structures inside the company are key to detect or prevent corruption. Often, closely-held companies are not subject to an external audit, regardless of their size or their capital structure, and it is this gap that concerns the OECD. "But it is not limited to family-owned companies because it applies also to large companies that are taken private by management," says Gaukrodger.
The OECD and anti-corruption initiatives at other organisations, such as the United Nations, the International Chamber of Commerce and the Council of Europe, also make clear that corruption is a global phenomenon that is not more prevalent in the developing world than in the West.
In many developing countries and throughout Asia there is a widespread culture of giving gifts as an expression of social esteem and as a way to guarantee a reciprocal attitude of cooperation. "But paying bribes is always a corrupt act, both here and in China," says Antonio Argandona, professor of economics and la Caixa Chair of Corporate Social Responsibility and Corporate Governance at the University of Navarra in Barcelona.

Argandona also points out that in emerging economies the role of the family is more important than in Western societies. Particularly in regions of conflict, families and extended families are often the only dependable network and can be necessary to ensure survival. The legal and financial systems in such areas of the world are also typically underdeveloped or themselves corrupt, which again reinforces the significance of the family.

"This means that trust is primarily based on family ties, then on close social relationships, and only after these two on legal rights and duties," he says. "This is why Chinese families, for example, develop broad family businesses all over the world."

The examples of VW and Samsung straddle these definitions. Both are huge listed companies but are marked by closely-held shareholder structures with significant family control in the case of Volkswagen and, in Samsung's case, total control.

At VW, another element came into play: the tight relationship between stakeholders, shareholders and management. Under German labour laws, employee representatives have half the seats on the 20-member supervisory board. The other half is made up of shareholder representatives. Piech is the chairman of the board with a tie-breaking double-vote. So, when it emerged that VW had a slush fund to provide entertainment for members of the works council, including luxurious trips abroad and paying for prostitutes, it was not far-fetched for prosecutors to ask whether Piech knew about the scam. Piech has denied any knowledge, but he has been sharply criticised in the German press.

In South Korea, the Samsung case is as much a national political crisis as a corporate scandal. Samsung is the crown jewel of the South Korean economy, making everything from chips to ships. Its 58 subsidiaries have assets estimated to be worth $280 billion last year and its exports accounted for 20% of the country's total.
 last October, alleging that Samsung maintained a slush fund for bribes, and that the group tampered with witnesses in a trial concerning the succession of Lee Kun-hee's son, Lee Jay-yong, to control of the group. Kim also alleged that family members used $59 million of company funds to purchase art works for themselves. Samsung has denied any wrongdoing.

In South Korea, this case has come to symbolise what many people feel is wrong with the country's economic and political systems. Jang Ha-sung, dean of Korea University's business school, is convinced that Kim's allegations are accurate. Jang is also head of South Korea's most respected minority shareholders' group, the People's Solidarity for Parliamentary Democracy, which filed suit against Samsung's inheritance case. Samsung has often been the target of such allegations, but this time, says Jang, the company has the public against it.
"It's not just about corporate governance, or taking assets from the company: they have bribed prosecutors, distorted the legal system, bribed the Blue House [presidential office] – they are influencing every corner of society," Jang was quoted as saying in London's Sunday Times. "If the court gives them a slap on the wrist again, the public will be very angry."

As both the VW and Samsung case show, family businesses may not be more corrupt than other businesses. But when they are corrupt, the scandal has a name and it quickly gets personal.

Comment: why the authorities have got it wrong on corruption
by Nick Kochan

Corruption touches the heart of our economic, political and indeed social institutions. It is a cancer that undermines trust insidiously and it is becoming increasingly widespread. Financial institutions and big
business more generally are not merely victims of corruption; all too often they are also conveyors of it.

In the media, stories of corruption are gold for journalists because they are sensational by nature and have at their core the idea of greed, dishonesty and immorality. If attached to the name of a famous business family, the story inevitably conjures images of the rich and uncontrollable elite operating above the law. But when it comes to corruption, there is not so much difference between the family as an institution and other organisations, such as banks or asset managers.

The implement of corruption is typically, but not exclusively, money. Like a bank, a family's assets or family office are the receptacle of money and this is why they can become the vehicle for the transfer of corrupt money to the person who is corrupted. This role is invidious for banks, as they are required to spot where a payment might be corrupt and seek to intercept it. The difference for families is that they are not
necessarily under such obligations.

For European financial institutions, the authorities have enshrined this obligation in the Third EU Anti-Money Laundering Directive. Banks (and other parties covered by anti-money laundering legislation) are required to supervise the accounts held by so called "politically exposed persons", or PEPs.

The universe of PEPs includes politicians, those who work for politicians and those related to politicians. The net is cast very wide and it is very vague. The goal of such legislation is to make the financial institution a policeman for corruption.

Banks are not, of course, devoid of corruption themselves, so they are not necessarily the best policemen for the corrupt activities of others. The trader who lost €5 billion of Société Générale's money was arguably corrupt, insofar as he abused his position of trust. His activities were no doubt scrutinised by others who had enjoyed his trading success but squealed when the market went the other way.

But the authorities have got it wrong when it comes to controlling corruption. The answer is not more controls, more rules, more training and more supervision. This only creates resentment and scope for legal nitpicking. Corruption has its roots in a cultural failure and it is only rooted out by raising an organisation's cultural awareness. It is the same for the culture of a family.

The family that imbues its members, employees and managers with a sense of pride and conviction has no need to tick the boxes to check that everyone is behaving ethically. Ethics cannot be taught. But nor can the guards of ethical behaviour be policed. The Latin saying, quis custodiet ipsos custodes, (who will guard the guards) holds true in a bank or financial institution or family, as much as it does in a prison.

Nick Kochan is the author of The Washing Machine: Money, Crime and Terror in the Offshore System, an insight into the murky world of money laundering.

Click here >>