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The corporate board in an age of collaborative intelligence and complex risk

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Helen Bird and Natania Locke explains how AI advocates define ‘administrative’ and ‘subjective’ governance roles and argue AI would at least replace ‘administrative’ operations to avoid micro governance difficulties.

Image courtesy of interviewee. January 11, 2024

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This video video discusses the integration of artificial intelligence (AI) into corporate governance, particularly in the context of risk management and organizational structure, as highlighted in a case study involving Westpac, an Australian bank. The research was part of the edited book "Technology and Corporate Law" published in 2021, emphasizing how AI can aid in reducing information asymmetry between management and boards of directors.

Key points include:

1. **Corporate Governance and AI:** The work underscores a shift in corporate governance, where AI could assist in oversight functions, facilitating better communication and decision-making between levels of management and boards.

2. **Westpac Case Study:** Westpac faced significant issues regarding compliance with anti-money laundering laws, resulting in a historic fine of $1.3 billion. This video video scenario illustrated the failures in risk management and technology oversight, revealing the inadequacies of both management and board actions.

3. **Human Involvement:** The authors stress that while AI may enhance efficiency, it cannot completely replace human directors. Human judgment is essential, particularly for making value-driven decisions that AI cannot handle effectively.

4. **Operational Challenges:** The case showed that technological tools require skilled personnel for their design, implementation, and oversight. In Westpac's case, inconsistent corporate knowledge and management indifference contributed to its failures.

5. **Future of Governance:** The article predicts a potential flattening of organizational structures as AI reshapes the traditional hierarchies in companies, allowing for improved flow of information. However, it emphasizes that AI's effectiveness hinges on clearly established objectives, ongoing monitoring, and the continued presence of human oversight.

6. **Conclusion:** The authors argue against the concept of a completely AI-driven corporation, positing that human directors are necessary for effective governance. They contend that AI should augment human capabilities rather than replace them, enabling better decision-making and oversight processes.

In summary, the text argues for a balanced approach to implementing AI in corporate governance, suggesting that while AI is beneficial for risk management, human oversight remains critical for making nuanced, ethical, and strategic decisions.

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X-TIMESTAMP-MAP:LOCAL=00:00:00.000,MPEGTS=900000

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This work was published as part

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of an edited book entitled Technology

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and Corporate Law, how Innovation Shapes Corporate Activity,

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and was published in 2021 by Edward Edward Algar.

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And our focus was specifically on the role

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and functions of boards in this time,

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and specifically in the way that risk governance,

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is being influenced and might be influenced

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by the acceptance of artificial intelligence systems.

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Uh, another important thing is there were two articles

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published, more or less this, you know, just

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before, we started this research one by Martin Petrin,

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and published in the Colombian business, review,

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law review, where he postulated that he sees,

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a fusion between management,

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and board over the long run so

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that you don't have the two tier system anymore, right?

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Uh, another, article this time by John Almer

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and host Mueller postulated the possibility

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of fully AI driven corporation, so sort

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of the self-driving corporation.

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So our intention was really to put a little bit

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of reality back in the minds of people in this area,

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and just to emphasize that it's much easier said than done

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to incorporate these systems in already established running

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hierarchical organizations,

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and that there are some practical

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conservations to keep in mind.

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Um, and another thing that happened sort

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of while we were busy

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with this is there was a very important case in Australia,

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the Austrac and Westpac decision, which we use

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as an example to illustrate some

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of these practical difficulties,

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that we wanted to highlight.

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Picking up from where Natan left off,

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I thought I just explained essentially the basics

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of the Austrac litigation.

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Westpac in Australia is one

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of the large four banks that we have.

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Probably at that time it was the second largest spy

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market capitalization.

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But what in, in essence this is about is money laundering,

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which is an issue that's, transatlantic Atlantic,

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and, and, and global.

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And as a problem, AUSTRAC was the regulator in Australia

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of anti-money laundering

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and counter-terrorism financing laws.

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And it sued Westpac for 23 million alleged breaches

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of Australia's money laundering laws.

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And in its particulars of claim, it asserted

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that the failures

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or there were failures by simply not making proper reports.

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But those failures in turn were actually the result

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of some systemic failures inside Westpac,

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that they didn't properly control their risk environment.

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There seemed to be indifference by management as

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to the problems, and the board had inadequate

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oversight of what was going on.

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And in effect, this was the case.

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Therefore, that went really very much to the nature

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of the relationship between the technology that was used

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to operate the money laundering arrangements inside Westpac.

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Um, that is the way they dealt with that.

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Secondly, the governance

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and the risk inside a major corporation

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and these wallets, Australian-based case, is an issue

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for every bank across the world at this time.

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Now, Westpac, it has to be said,

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filed a defense in which they largely denied all

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of these allegations, but they did end up settling it

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after this, article was published

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and paying a fine of $1.3 billion towards austrac,

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which is in fact the largest fine ever paid

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by an Australian corporation

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for breaching money laundering laws.

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Uh, but the, at the heart of it is an argument about

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how the technology inside, Westpac was properly managed

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and itself lends a, a, a conversation

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to a conversation about whether AI is the solution given the

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problems that Westpac, experienced.

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So, having regard to works previously published,

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we agree that, artificial intelligence systems

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has every potential to, to

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as assist in breaching the information asymmetry

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that exists in in organizations

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and thereby reducing that problem where a lot

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of the information that ought

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to reach the board is really housed in different levels

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of management inside of the corporation,

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which is a typical problem for governance,

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of corporations generally.

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Um, and so when that happens, we do foresee

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that there might be, a, a flattening

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of the organizational structures inside of corporations

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because you'll need fewer levels of management in between

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to to lead to, you know, this information being sort

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of trickled up to, to the board of directors.

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However, we make, we very strongly make the point

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that the use of this technology is only as good

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as the technology actually working.

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So being fit for purpose as well as the receivers

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of the information that is the, the human actors,

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the directors at the top, making adequate use

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of the information,

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that they receive from their systems.

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Um, and again, we can illustrate this, by reference to

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that AUSTRAC and Westpac case.

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So taking up that point, really,

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essentially there were various different platforms that,

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Westpac was using in order to,

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get information about transfers overseas

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and also report what as required to austrac.

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Now, those systems were regularly being updated,

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there were constant goals for that work to be done,

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but the people in charge of looking

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after that weren't all were, shifting population

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of staff with the various levels of experience.

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There was no consistent corporate knowledge.

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And so what you saw happen in, in a sense,

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occurred on two levels at Westpac.

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Firstly, you had a management problem within the very large

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organization of Westpac.

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There was, the, the subsidiary in charge

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of money laundering, was the Westpac institutional bank.

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And, what was discovered was

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that when there were problems

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and reports being, given to management, management,

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first off didn't take them seriously.

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And secondly, was rather lax in responding to them,

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partly one suspects

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'cause they didn't fully understand the import

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or the seriousness of what was going on.

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They were updates, there were things wrong with the system,

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there were capability issues.

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These were very technical words that

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unless you are very deeply steeped in this area yourself,

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you don't necessarily appreciate.

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And, you know, you might say, well,

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what would you have done if you became

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aware of some of these issues?

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And what at the very least you would've expected

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to have happened was there would've been an investigation

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and steps taken to remediate the gaps identified in the

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system and to address its risk management processes.

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But it wasn't, as I said, just enough to fail to act.

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It was also a laxness.

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And it took them 18 months even

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after the first of these reports started to be received

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before anyone decided to undertake some kind of review.

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And you could say, I guess

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therefore, that the technology worked in the sense

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that somebody within the organization thought

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to say it's not working.

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But it didn't, it failed in the sense

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that the management didn't appreciate

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or understand its critical nature.

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And that would be the same with ai,

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even if this is perhaps not necessarily strictly speaking

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ai, it was more a machine learning

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based tool that they were using.

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Um, secondly,

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the management problem caused a second role,

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which was the failure of the board to do proper oversight.

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Um, they didn't act urgently, they didn't inform the board.

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It took another year after all of this happened,

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before the board was even made aware of it,

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and they in turn, sat on their response, to that.

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So we see that information came in some forms,

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inadequate forms, uninformed forms to those

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who were making critical decisions,

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but it failed to actually result in action.

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And that is gonna be the case.

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This is just one small component of what Westpac does

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and one small set of technology that it uses

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to manage its money laundering program.

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Um, and how we could see this extrapolate

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to all AI makes you realize the problems are

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ahead for all companies.

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And Westpac in particular is a, a very digitalized business,

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as are all banks, and it is not immune from these problems.

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But when we talk about the collective duties of company

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directors, it can be broadly divided between monitoring

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and oversight duties and the sort of leadership functions,

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those strategic functions that a board

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of directors undertake.

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And as lawyers, we tend to focus very much on,

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on those oversight, the oversight aspects of the role

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of functions of directors.

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And the reason for this is

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because of well established, agency problems

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that you have where there's a separation between ownership

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and control in large organizations, large corporations.

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And the theory behind it is that the board

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of directors must be a check, against,

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the incentives that arise on the side of management

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to basically use the resources available to them

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for self-interest rather than to, you know, see to the,

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the most returns to shareholders.

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Um, and you know, at the heart of this, again,

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is information as symmetry.

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The fact that the, the investors shareholders does not have

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the same access to information as the, the management

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of the corporation, has.

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Um, so it seems that all authors

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that work in this areas is largely agreed

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that the oversight functions over time will be very much

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assisted, if not replaced

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by appropriate artificial intelligence systems,

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because it's the type of functions that really lends itself

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to, to this type of technology.

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Um, and so theoretically this should open up the time

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that boards of directors have,

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that they now spend on oversight

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to spend more time on these strategic things

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that they are also tasked with fulfilling, right?

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So, strategic planning, communications,

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decision making, all of all of the sort

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of softer things perhaps, that is really crucial

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for, boards of directors to fulfill.

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Um, we, we do agree with patron

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that in time you might see a merger between management

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and boards of directors, right?

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Because of the reduced need really

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to have this oversight function of, that,

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that we have at, at present.

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But where we differ from Petrin very strongly is,

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he makes out that the board would be completely replaced

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by its artificial intelligence systems.

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And basically you'll have, as Orman

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and I Mueller refers to as self-driving corporation.

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So everything would basically be done

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by artificial intelligence.

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We don't agree with that.

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Um, we feel very strongly that you do need

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to retain humans in this loop of governance.

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Um, and the other point that Petrin makes is that oversight,

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in time could be fulfilled

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by shareholders of the company.

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And we disagree with this as well.

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And there are two reasons for this.

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Firstly, retail shareholders will not have the expertise to,

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exert oversight, you know, over the money,

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over the operations of a corporation.

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And institutional shareholders, even though, you know,

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theoretically speaking, they could acquire the resources

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to do so that would be very costly.

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And in the end, those costs will be, born

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by the end beneficiaries,

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the investors in those institutions,

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which then has a societal influence as well.

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Um, so it's not ideal

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and we can't really see that practically making sense.

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So we would, we would retain directors at the helm,

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human directors at the helm of an organization.

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But we do realize, we do agree

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that artificial intelligence systems will augment, and,

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and assist in the duties

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that directors will fulfill every day.

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Um, we also strongly suggest that are,

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there are certain realities surrounding the adoption of,

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of artificial intelligence systems

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inside established corporations where they especially need

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to replace existing systems that needs to be brought

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to the forefront when we consider the possibility

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of artificial intelligence replacing some operations

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inside of a corporation.

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Um, the first very important thing is to the adoption.

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The, the planning, the, development

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of these systems take very, technical expertise.

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Um, and in most instances, corporations will need to

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buy in this expertise from outside, either

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through outsourcing or consultancy services.

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Um, and because it's so costly, they'll need

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to make the strategic case for it.

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Um, and they'll need to be really convincing that it's going

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to bring a benefit to the corporation,

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that's not already present, right?

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So that is, that's an obstacle to make out the case.

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Then if the proposal is accepted to adopt these systems for,

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you know, to replace particular operations,

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that it'll have to go hand in hand with detailed planning,

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and decision making to support the process.

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And that includes being very explicit about the objectives

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behind certain systems.

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And we postulate that there are many objectives currently

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inside corporations that management might not want

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to make explicit.

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You know, it's based left onset,

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but there's sort of a general understanding of

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what they actually want to achieve that won't work.

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In the case of implementing artificial intelligence,

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you have to be, you'll have to be very explicit

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and you'll have to reach consensus about these objectives

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beforehand in the development.

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Um, and that would be a hard task in our views.

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Um, then

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after implementation, you'll have to consistently monitor

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that system to make sure that it works as intended,

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and that any human error

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or bias that might have been present in development does not

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creep into the proper functioning of that system

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that will also take money, right and time.

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Um, and you also need high quality data for these systems

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to develop these systems.

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And it might be that in many organizations,

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the historical data needed to develop appropriate systems

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is just not available.

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After all of this, the final accountability

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for the proper functioning of the systems will still,

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it still needs to vest with someone.

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And we say that that needs to be humans, needs to be human

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directors, and that basically implies that those human

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directors will need a, a particular level of expertise

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to fulfill this oversight duty.

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So basically, where current oversight is over human actors,

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the new oversight will be over

15:30.165 --> 15:31.245
artificial intelligence systems.

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They will need to be able to monitor those systems offered

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for purpose and actually do what is intended,

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what it is intended to achieve.

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Um, and this will go, will, will very much,

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very strongly tie in with their duties

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of care and diligence.

15:48.985 --> 15:51.675
When it comes to consultancy firms, I think it's important

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to make the points, some have alleged

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that they think artificial intelligence systems will act

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without any conflict of interest or self-interest,

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but this is of course not true

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because you always have human developers, human actors

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behind these systems.

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And if, as we suspect in most cases consultancy firms will

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be used to implement and develop

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and continue to, monitor these systems,

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they are in these,

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in their own rights competitive corporations that you,

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you know, need to be competitive

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and, gain more, business for themselves.

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And implicit in that is self-interest.

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So it's not necessarily true

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that self-interest could not creep into these systems

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because of the underlying motivations of the people

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who develop it, right?

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So that is also an important point to make.

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So what what's going on is at the moment,

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boards are looking at the operations of companies

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and watching what they're doing

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and making sure that that things are being done in a way

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that people are accountable.

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And now we're going to shift and make that about ai.

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So it's not as though really strictly speaking,

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the monitoring and observation role goes away entirely.

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It doesn't, it just changes its emphasis.

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And so, that isn't necessarily an issue

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that we've focused on a great deal in all the

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discussions that are going on.

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Everyone wants to tell you how they'll save money

17:20.305 --> 17:23.605
by streamlining, but there's just a new infrastructure about

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to be created that we haven't yet really discussed.

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Maybe just to reiterate our main point

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and is that, is that we, we don't think

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that this task will be completely taken

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over by artificial intelligence.

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And even if it could, the point is perhaps

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that it should not, it should not be taken over

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by artificial intelligence systems.

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Um, and that is just

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because artificial intelligence systems are not good at,

17:48.785 --> 17:50.765
at least at the point, they are right now,

17:51.425 --> 17:55.165
at making value-driven decisions in the way

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that human actors are.

17:57.025 --> 18:01.325
And so, you know, recently with the pandemic as well as,

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you know, continuing, challenges

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that the climate crisis presents, there's a lot

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of value driven decisions that need to come from the top

18:11.715 --> 18:15.085
that we just simply do not see artificial intelligence

18:15.085 --> 18:17.365
systems being able to, to do.

18:18.305 --> 18:21.205
Um, that being say, said, we do foresee

18:21.205 --> 18:24.845
that artificial intelligence systems will augment

18:25.625 --> 18:27.925
the capability of boards of directors,

18:28.465 --> 18:31.005
and that you'll find a sort of collaboration

18:31.075 --> 18:32.485
between those systems

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and the functions of the board, basically

18:35.885 --> 18:37.925
enabling a more effective governance

18:37.985 --> 18:39.845
of corporations in the long term.

18:40.985 --> 18:42.725
Um, what we don't see

18:42.725 --> 18:47.565
however, is, you know, a completely self-driven corporation.

18:47.865 --> 18:50.885
And definitely we don't advocate for that.

18:51.065 --> 18:54.565
We advocate very much for keeping humans in the loop.

18:55.545 --> 18:59.565
So our main conclusion is that, the ideas of, you know,

18:59.605 --> 19:01.085
self-driving corporation

19:01.265 --> 19:04.285
or a, a fused board where the board of directors is,

19:04.745 --> 19:07.325
you know, completely overtaken by artificial intelligence,

19:07.325 --> 19:09.285
that's very much blue sky at this point.

19:09.425 --> 19:13.005
The reality is realities of, you know,

19:13.175 --> 19:16.565
where we are currently just does not support that type of,

19:17.225 --> 19:19.805
replacement of humans.

19:20.705 --> 19:24.895
Um, and then we, you know,

19:24.895 --> 19:28.695
support this very much by the, the case study of Westpac,

19:28.955 --> 19:30.375
and I'll leave Helen

19:30.375 --> 19:32.535
to illustrate that a little bit further.

19:33.165 --> 19:35.735
Basically, what in essence the Westpac,

19:35.735 --> 19:38.655
case has shown was how poorly managed its technology was,

19:39.395 --> 19:41.015
particularly for managing

19:41.015 --> 19:43.535
and governing it's, money laundering risks.

19:43.955 --> 19:46.055
And this is just one aspect of running a bank.

19:46.115 --> 19:48.935
As I've said, it's very difficult to see how something

19:49.485 --> 19:50.655
that was so small

19:50.875 --> 19:53.655
and was so badly done could ever be considered

19:53.655 --> 19:56.335
as being something that could run a whole of an organization

19:56.335 --> 19:57.775
with all of its complexity.

19:58.315 --> 20:01.055
But I think there are really four key messages that come out

20:01.055 --> 20:02.095
of the Westpac example.

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The first is the technology,

20:05.095 --> 20:07.815
whatever form it takes is only ever as good at

20:07.915 --> 20:10.615
and effective as the personnel who design it,

20:11.155 --> 20:12.775
who monitor its implementation

20:13.195 --> 20:14.815
and who evaluated its effectiveness.

20:15.915 --> 20:19.695
Uh, westpac's laws, the system

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that they operated under required continuous review,

20:22.825 --> 20:24.975
evaluation and updates the whole time.

20:25.475 --> 20:28.815
So human involvement and expertise was absolutely key,

20:29.115 --> 20:30.655
and it was very inconsistent.

20:31.275 --> 20:33.455
Uh, there was no permanent staff, there was a lack

20:33.455 --> 20:36.615
of corporate knowledge and it played havoc over the years.

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Banks are increasingly type technology and data driven.

20:40.515 --> 20:42.375
In fact, what corporation isn't really,

20:42.955 --> 20:45.815
and yet they remain hierarchical in the way they're

20:45.815 --> 20:46.935
appropriately run

20:47.385 --> 20:49.605
and dependent on information, which at this stage,

20:49.605 --> 20:52.245
because there is an adequate reporting goes

20:52.245 --> 20:55.445
between management and boards, I think AI will assist in

20:55.445 --> 20:57.085
that process in the fullness of time.

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But it is the lack of escalation of the problems

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to management in a way that management understood

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and realize to do something.

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And from management to the board that gave effect to

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what was really a perfect governance storm.

21:10.905 --> 21:13.325
Um, and really finally, the effectiveness

21:13.345 --> 21:16.605
of technology in performing risk oversight,

21:16.995 --> 21:20.445
depends upon core modernization of IT systems

21:21.185 --> 21:22.605
and banks

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and many organizations have been very slow

21:25.945 --> 21:28.725
to undertake the kind of work required to be able

21:28.725 --> 21:30.325
to function with such systems.

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It would require massive shutdowns

21:33.025 --> 21:35.445
and days out where while this work was done

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and no one across the globe appears

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to be prepared to do that.

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I.

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