Is Compliance Positioned for Effectiveness?

At Protiviti, my colleagues and I often receive questions regarding the proper positioning of compliance, often starting with this one: Who does compliance report to? While certainly this is an important question, it’s not the first one to ask.

Positioning the chief compliance officer (CCO) and the independent compliance function for effectiveness is a matter of first understanding the roles and responsibilities executive management and the board want them to play. This understanding provides a strong context for evaluating how to position compliance within the organization, an important point of view because of disparity in practice in positioning compliance and defining the responsibilities expected of it. The lack of a one-size-fits-all solution prompts a question: What is it that the CCO and the independent compliance function are expected to do?

Key Considerations

Generally, a company’s compliance function is responsible for overseeing or coordinating an organization’s compliance efforts and ensuring that the company and its employees understand and are complying with applicable laws, regulations, contracts and internal policies. Some functions may deal with most, if not all, compliance matters. Depending on the organization’s industry, others may deal with specific compliance domains such as environment, health and safety; contracting; product quality; employment and labor; and anti-corruption. Ethical and responsible business behavior may also fall within the scope of a compliance function’s responsibilities – i.e., those of the chief ethics and compliance officer (CECO).

A compliance function may be led by someone designated as the compliance officer or an equivalent title. If responsible for overall compliance, that person may be the CCO or CECO. Below, I use CCO in referring to the function’s leader.

Two Distinct Roles

There are two distinct CCO roles in practice. Although there are variations for sure, let’s focus on these two roles to provide a context for framing the positioning conversation:

“The Champion” advances the framework for identifying the applicable compliance requirements, aligning policies and processes with those requirements, assessing risk of noncompliance and closing gaps to ensure ongoing compliance. The front-line operating units and process owners are responsible for applying the compliance framework; they retain primary ownership of the risks created by their respective units and processes. The champion is independent of these primary risk owners and:

• Enables, coordinates and integrates cross-unit and cross-functional application of the framework by (a) providing tools, guidance and other resource materials to support its application and (b) ensuring sharing of effective practices to address enterprisewide compliance matters and common risks;
• Educates the primary risk owners on the proper use of the framework, provides them with appropriate insights and offers consultation upon request;
• Facilitates risk assessments and formalization of risk mitigation plans and supports executive management in communicating relevant compliance messages;
• Prepares a report on the state of compliance, typically on an annual basis, and either presents it to the board of directors or assists a senior executive who presents it to the board; and/or
• Reports compliance activities with periodic summaries to senior executives and the board, including (a) an assessment of the risks and potential impact of noncompliance against the estimated costs to achieve compliance and (b) recommendations of compliance funding priorities and appropriate corrective actions.

In summary, the Champion CCO is empowered to play a number of roles – framework advancer/enabler, coordinator/integrator (to ensure consistency), educator (to provide insights), facilitator, consultant, communicator and reporter.

“The Line of Defense” undertakes the activities of the champion and, in addition, is authorized to do a combination of the following:

• Evaluate the (1) state of compliance, (2) quality of compliance risk assessments, (3) design and implementation of risk mitigation plans and (4) operating effectiveness of those plans, all in coordination with internal audit and other evaluators;
• Establish standards and implement procedures to ensure that the organization’s compliance programs are cost-effective in preventing, deterring and detecting noncompliance situations and making necessary corrections through enhancement of existing policies and improvement of compliance infrastructure;
• Approve policies and compliance risk mitigation plan design to address identified risks;
• Coordinate internal compliance reviews of lines of business and functions and monitor their activities to ascertain whether compliance programs are working as intended;
• Escalate issues to executive management (including the CEO) and, through appropriate channels, the board of directors;
• Veto activities affecting compliance with the organization’s policies; and/or
• Arbitrate disagreements between operating and functional units that affect compliance.

In summary, the Line of Defense CCO plays a number of roles – evaluator, initiator, approver, escalator, vetoer and arbitrator (plus the various roles of “the champion”). The Line of Defense CCO may not be authorized to perform all of these roles, but his or her responsibilities clearly extend beyond that of the advocate because they include the teeth of escalatory and/or veto authority.

These role descriptions are not necessarily exhaustive, but they clearly differentiate. Using them, we can articulate several principles relating to the positioning of compliance within the organization:

• To be effective, a line of defense CCO must have sufficient stature with business line leaders and across the organization. Stature comes from the authority, the compensation and the direct reporting lines that command respect. The authorities of the Line of Defense CCO enumerated above should convey to the organization as a whole that he or she has a significant role. This positioning is accentuated if the CCO:
  • Reports to someone who has a strong influence on the organization, such as the CEO or the executive committee (with perhaps administrative reporting to another C-level executive) or the Chief Risk Officer (CRO); in any case, the reporting line should establish the CCO’s independence from core business activities;
  • Engages in mandatory and regularly scheduled executive sessions with the board or a standing committee of the board;
  • Has influence on compensation practices incenting the desired compliance behaviors; and
  • Is sufficiently resourced with a support staff commensurate with his or her responsibilities.
• The CCO’s reporting line, as noted above, should position him or her to escalate issues to an executive who has access to and influence with the board; however, there may be circumstances in which the board may want the CCO to have direct access to a standing committee of the board. To that end, a Line of Defense CCO:
  • Needs a formalized escalation process consisting of written procedures and agreements requiring escalation of any significant issues raised by the compliance function that are being challenged by line-of-business executives; and
  • Should be centralized, meaning that all personnel with compliance responsibilities report through the CCO’s line rather than through their respective lines of business.
• Some believe that the authority to hire and fire the CCO should be vested in the board. We are not convinced this is necessary, although there may be circumstances where a board may conclude that it is.
• If the CCO or an equivalent executive plays the role of a champion, he or she may report to a C-level executive (e.g., the Chief Administrative Officer, Chief Operating Officer, or Chief Legal Officer or General Counsel), or to a direct report of a C-level executive, and operate with adequate support staff commensurate with his or her designated responsibilities. Although independence may be desirable, a Champion doesn’t necessarily need to be. In fact, depending on the nature of the designated responsibilities, over time the Champion CCO may not even be a full-time role. In practice, a Champion CCO typically reports to the board of directors or a standing committee of the board only by invitation. One of the prime challenges with a Champion CCO is clarifying how the compliance function interfaces with the lines of business.
• Regulatory settlements that address egregious noncompliance issues sometimes stipulate a particular line of reporting for a company’s CCO. For example, it is not unusual for settlement deals to stipulate that the CCO must not be subordinate to the Chief Legal Officer or the Chief Financial Officer, but must report directly to the CEO and the board.[1]
• In heavily regulated industries, the line of defense CCO is likely the preferred option. If the focus is primarily on understanding and coordinating an organization’s fragmented compliance efforts and reporting on the state of compliance, a Champion CCO might work.

When applying these principles, the key question is, what do the board and the CEO expect from compliance? Effective compliance management starts at the top. If a viable line of defense is intended, it is important to understand that a Champion CCO is not able to deliver.

In summary, if the organization has a compliance function, the board and the executive team are obligated to satisfy themselves that the function’s scope of responsibilities is appropriate to the entity’s operations and is delivering the insights they need. If there isn’t a compliance function, the board and the executive team need to ensure there is a cost-effective plan in place to monitor the top compliance risks and oversee implementation of the compliance program. Finally, if the organization deploys a Champion CCO model, directors and senior executives need to ascertain how they can be sure that compliance programs are updated periodically in light of changes in the company’s needs and in applicable laws and regulations.

[1] “More Compliance Chiefs Get Direct Line to Boss,” by Gregory J. Millman and Ben DiPietro, Wall Street Journal, Jan. 15, 2014: www.wsj.com/articles/SB10001424052702303330204579250723925965180