Analysis: Ethical bind

As it pushes for a greater global presence, BAE Systems is struggling to shake off accusations of unethical business practices.

For a company fighting to restore its good name amid corruption allegations, BAE Systems appeared remarkably naive last year in announcing that it was commissioning its own 'independent' report into its current ethical conduct. However fair and balanced the report's findings would be, they would inevitably attract media accusations of being a whitewash.

Now that the report has been published, however, it is clear that BAE has not been let off lightly. The report, produced by the former Lord Chief Justice of England and Wales, Lord Woolf, came in the wake of allegations that the aerospace and defence group paid bribes to seal a £43bn arms deal with Saudi Arabia in 1985.

Although the report steers clear of the whole Saudi saga - which is the subject of a continuing court case - Woolf's judgment on BAE's current ethical conduct is directly critical. "Despite the progress made, [BAE] has a substantial task ahead if it is to meet higher standards," the report says.

Underlining the importance of high ethical standards in the globalised business world, the report adds: "[BAE] needs to raise its sights above that of becoming a leader in its sector to match the benchmarks set by global companies in other sectors."

The public relations problem for BAE, though, is that the sectors in which it operates are so important to UK plc that central government will always be tempted to treat them as special cases. It therefore came as no great surprise last year when the government halted a Serious Fraud Office (SFO) inquiry into the bribery allegations, claiming the Saudis would withdraw their support on combating terrorism if the investigation continued.

In possibly another PR faux pas, in April this year BAE issued a 60-page document entitled 'The Economic Contribution of BAE Systems to the UK in 2006'. The publication does read like a propaganda sheet, but the facts also speak for themselves - that the company employs around 35,000 people in the UK; that 61 per cent of its UK sales in 2006 were exports; and that its annual spend on research and development, at £1.25bn last year, is five times the UK national average, making it the number three R&D investor in Britain.

It is also far from clear whether BAE's own reactions to the Woolf report will help it with its image problems. The company's response was an odd mixture of mea culpa and belligerent self-defence. BAE chairman Dick Olver appeared to want to clear away the clouds hanging over the company by calling for a full legal review of the SFO inquiry. Such a review, he insisted, would show there was little chance of bringing a successful prosecution over the bribery allegations.

The problem for BAE, however, is the other potential skeletons lurking in its cupboard. The SFO continues to examine the company's dealings in other countries, while governments in the US, Tanzania, Sweden and Switzerland are reported to be looking into other possible bribery allegations. Moreover, the American Justice Department is checking whether funds allegedly paid by BAE to Saudi officials were channelled through US banks, which might be deemed illegal.

The fallout from the Saudi bribery allegations is also embarrassing for the wider aerospace community. The Society of British Aerospace Companies (SBAC) has insisted that the UK industry is ethical, with all leading trade associations across Europe having signed up to the 'aerospace and defence industries common industry standards' on ethical behaviour. But it fails to see the irony of this claim in the light of Woolf's finding that BAE's current practices have not been up to scratch.

As Woolf unequivocally puts it: "The implementation of these [recommendations] will be a considerable challenge for the company over the next three years." The main changes for BAE will involve new "rigorous" selection procedures for hiring "advisers"; forbidding all "facilitation" payments; keeping records on gifts and hospitality spending; and publishing an independent external audit of the company's ethical business conduct and its "reputational risk".

How much long-term damage BAE will suffer remains to be seen - particularly as the continuing court case could result in a reinstatement of the SFO inquiry, alongside those other, overseas investigations. But what's not in doubt is that BAE is a very solid global business that has successfully made US acquisitions in recent years. Its next major challenge, it seems, is to reassure the global business community that it is can get it ethical house in order.

Timeline

1985: UK signs first phase of BAE deal to supply jets and services to Saudi Arabia

May 2004: The Guardian newspaper alleges BAE won deal with "bribes" from slush fund

Nov 2004: BAE confirms it is being investigated by the Serious Fraud Office (SFO) and denies any wrongdoing

Dec 2006: UK government says SFO is to drop its BAE inquiry, in interests of national security

April 2008: High Court rules that SFO acted unlawfully in dropping the inquiry; SFO says it will challenge the ruling

May 2008: Woolf report says BAE faces "considerable challenge" to improve its ethical practices

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