The hotline as a board safety valve: for years hotlines have worked to reduce run-of-the-mill fraud losses. Connecting them to the board will enable directors to police more serious instances of fraud.

• Author: Malone, Tony
• Position: Disclosure

IT IS TEMPTING to hope that the well-publicized debacles of the past 18 months are the exception, and that the vast majority of companies are ethically and honestly managed. Yet an article in August's CFO magazine suggests otherwise. One in six chief financial officers reported being pressured by chief executives to misrepresent financial results, and 5% said that they have violated accounting rules in the last five years. Still, 93% denied engaging in aggressive accounting practices.

Even if financial misstatements represent only a tiny percentage of total occupational fraud cases, these instances are by far the most damaging and expensive to the corporation. The Association of Certified Fraud Examiners' (ACFE) 2002 Report to the Nation indicates that the median loss for detected fraudulent statements is $4.25 million -- more than 50 times the median loss from much more common offenses like inventory theft or payroll fraud.

The duty of care to shareholders requires that boards implement appropriate measures to detect and prevent fraud. Attention so far has been focused on structural steps, such as the New York Stock Exchange's revisions to its listing standards that tighten the definition of an "in dependent" director, require independent directors to constitute a majority of a board, and mandate that director compensation be the sole remuneration for audit committee members, among other measures. These safeguards (and similar proposals from other stock exchanges and business organizations) are all worthwhile, but they do not address the essential task underlying the director's duty of care: the duty to inform himself or herself about what is going on in the company.

Need for new information sources

In most companies, the primary source of information about the company's operations is senior management. Are carefully prepared reports to the board from, or channeled through, senior executives an adequate communications channel, given the high stakes involved? Evidently not, as the recent accounting scandals demonstrate. Executives engaged in disguising losses or plumping up revenues in mandated public financial disclosures will hardly be challenged by tailoring internal disclosures made to the board. Post-Enron, it is clear that directors will be expected to take more initiative to dig beneath and around the summary information provided to them by management. This will require the creative use of existing communication tools, as well as the development of new information sources.

Many...