Continued fallout at Kobe Steel leads to governance overhaul

Kobe Steel’s product quality scandal is far more troubling and widespread than the company originally let on.

In October 2017, Kobe Steel admitted that some employees had falsified inspection data concerning products and parts sold to its top customers, including many automotive and aerospace companies—Ford, GM, Mitsubishi, Toyota, Nissan, Honda, Mazda, Boeing, and Airbus, to name a few. As far back as 2007, Kobe Steel falsified inspection data as if it met customer specifications, or fabricated test data for unmeasured products as if they had been measured.

Such falsified data initially concerned Kobe Steel’s copper and aluminum products, but later engulfed its steel products, as well. From a broader risk and compliance standpoint, Kobe Steel’s actions bring into question the safety and performance of all products with Kobe Steel components, initially believed to have affected 525 global companies.

Once the cover-up was revealed by quality self-inspections on the group’s shipments from September 2016 through August 2017, Kobe Steel established an independent investigation committee (IIC), chaired by Gan Matsui, former superintending prosecutor of the Fukuoka High Public Prosecutors’ Office. That investigation found that some 163 other customers—not originally accounted for—were affected by the misconduct.

The investigation also found that the misconduct took place not only within Kobe Steel’s Aluminum & Copper Business, but also at other divisions and group companies. “We take it very seriously the fact that the misconduct took place at many locations within the Kobe Steel Group,” the company stated.

In its Aluminum & Copper Business, two executives were aware of misconduct taking place, but failed to report it to their superior, the then-head of that unit. “These executive officers did not themselves engage in the misconduct,” Kobe Steel stated.

Another executive who became aware of the misconduct in April 2017 did no more than decide, as a basic policy, “to gradually eliminate the production and shipment of non-conforming products and only instructed his staff to improve manufacturing processes and stop accepting part of the orders,” according to the company.

Of former executive officers, two were found to have been directly involved in the misconduct before taking office as an executive officer. Even after becoming executive officers, they neither reported the misconduct to the board nor took any actions to have the misconduct halted or corrected.

The company’s troubles have only just begun: Kobe Steel CEO Hiroya Kawasaki has resigned, effective April 1. Civil complaints against the company and its subsidiaries are springing up like weeds. Kobe Steel USA, a U.S. subsidiary of Kobe Steel, must now answer to the U.S. Department of Justice, which has requested the production of documents related to non-conforming products sold by the company, subjecting the company to additional legal and financial risk.

And, even though Kobe Steel said as of Feb. 1 that it has not confirmed any cases requiring the immediate suspension of use, or immediate recall of, non-conforming products, Japanese authorities revoked its Japan Industrial Standards (JIS) seal. The company also lost ISO 9001 quality certification for all its major plants.

The number of public apologies the company has made at this point is one for the record books, but even more damning is that this is not the first time Kobe Steel has been caught up in a scandal. To cite just a few examples, Kobe Steel admitted in 2006 to falsifying soot emissions data from blast furnaces at two of its factories and further was found to have exceeded established limits for ground and water pollution that same year. It also failed to report income to tax authorities in 2008, 2011, and 2013.

Collectively, these past and present issues point to systemic problems within the company’s overall culture. In a recent statement, Kobe Steel admitted as much: “Considering the facts relating to the misconduct that were found by the group’s quality self-inspections and the IIC’s investigation, together with multiple compliance incidents in which the company was involved in the past, we must acknowledge that the company is facing deep-seated issues concerning its organizational culture and awareness of its officers and employees, as well as its compliance systems.”

In the process of investigating what caused the misconduct, Kobe Steel said it realized the need to perform a complete overhaul concerning its governance, executive team, and operational processes relating to its quality assurance. It further acknowledged other deep-seated issues that require consideration, including the desirable state of the board, division system, methods of personnel allocation and development, and formulation of management plans.

“We take it very seriously the fact that the misconduct took place at many locations within the Kobe Steel Group.”
Kobe Steel Group

On March 6, in response to the IIC’s findings, Kobe Steel published a report that consisted of an analysis of the causes of the misconduct based on the findings of the investigation, along with the outcomes of discussions at the quality governance restructuring deliberation committee and its quality problem investigation committee and reporting and measures to prevent a recurrence.

Causes of misconduct

Considering the results of the IIC’s investigation and its own internal examination, Kobe Steel attributed the causes of the misconduct to the following three ethics, compliance, and internal audit failures:

Management style that overemphasized profitability and the inadequate corporate governance. “To align with the head office’s emphasis on profitability, each business division felt the need to adopt an attitude that led them to accept purchase orders without reviewing their production capacities,” Kobe Steel stated. Further, it acknowledged, a large-scale transfer of authority from the head office to individual divisions weakened the ability to assume centralized control over the entire Kobe Steel Group.

In turn, the head office could not manage a compliance program that ensured effective quality assurance. Several factors related to corporate governance failures prevented misconduct from being detected at an early stage. For example, even pertaining to past misconduct, “management did not take drastic enough measures to address such issues. Internal audits at each division, moreover, were not sufficiently extensive.”

Imbalanced operation of plants that resulted in the reduced awareness of quality compliance among employees. The following factors created the motive for engaging in, and continuing to engage in, misconduct:

The manufacturing of products based on customer specifications not matched to process capability;

A culture that prioritized winning purchase orders and meeting delivery deadlines over ensuring quality;

An insular organization where personnel were rarely exchanged or transferred between different divisions;

The absence of appropriate quality-related education/training and disciplinary actions;

A false assumption that products falling short of customer specifications could be shipped to the extent that they had no safety issues; and

The employee’s quality compliance awareness dulled by a combination of the situations above.

Insufficient quality control procedures that allowed the misconduct to take place. According to Kobe Steel, the misconduct was provoked by certain issues relating to quality management processes, such as inspection processes enabling data falsification or fabrication, isolated and rigid operational systems, and the establishment of internal standards to which it was impossible to conform.

Governance changes

At Kobe Steel’s board of directors meeting held on March 5, Hiroya Kawasaki submitted a formal request to resign from his position as CEO, president, chairman, and representative director, effective April 1. Consequently, the board at a meeting held March 9 appointed Mitsugu Yamaguchi as the new CEO and president.

Also on March 5, Kobe Steel announced the resignation of Executive Vice President Akira Kaneko, as well as the dismissal of two other executive officers—Takumi Fujii and Nobuaki Isono, managing executive officers in the Aluminum & Copper Business—and an 80 percent reduction in remuneration for four months for Seiji Hirata, assistant to the head of the Aluminum & Copper Business.

Moreover, all directors (excluding independent outside directors and members of the audit and supervisory committee) and all other executive officers will have 10 to 50 percent of their basic remuneration reduced for a period of one to four months.

“These resolutions reflect our company’s taking to heart the substantial troubles we have caused our customers, suppliers, shareholders, and many other people in connection with misconduct that took place within the Kobe Steel Group,” the company stated.

DIVISION RESTRUCTURING

In its “Report on Misconduct,” Kobe Steel describes how it will consider restructuring its organizational structurers, including those across divisions, in order to renovate the Aluminum & Copper Business, where the misconduct occurred.
We will correct the insular nature of each unit in the Aluminum & Copper Business. In the Aluminum & Copper Business, the following four units were granted broad authority to manage the business: the Aluminum Flat-Rolled Products (Moka); the Aluminum Castings and Forgings (Daian); the Aluminum Extrusions(Chofu); and the Copper Flat Rolled Products (Chofu). This management strategy brought negative consequences, such as fixating human resource in one location and weakening the business’s ability to cooperate across different units horizontally. We understand that these have caused a series of quality related incidents to take place. We need to restructure the organization to allow openness and movement of human resources, and develop a system to enable each unit to cooperate with each other, such as holding meetings to make decisions.
We will reform the level of quality control and the corporate culture of the Aluminum & Copper Business. We will promote employees to cultivate their compliance awareness and reform our existing quality control systems in order to renovate the corporate culture which has been built based on the wrong understanding of quality assurance. In order to do this quickly and effectively we will gather those employees from outside our units who have the expertise and experience in building an ideal quality control system and a corporate culture, and include them to our activities for the renovation. To do so, we will reassign them in the units and establish an environment where experts outside the units can support the units.
We will restructure the materials business from the strategic perspective for critical market segments. As part of our strategy to increase our presence in the high value-added industries such as automobiles, aircrafts, and energy, we will shift from our former business structure that corresponded to types of metals to a business structure that corresponds to market segments we serve.
Source: Kobe Steel

Kobe Steel announced its intent to make other governance changes as well, including ensuring that at least one-third of its board members are independent outside directors. Additionally, the new board chairman will also be an independent outside director. “At the same time, we will abolish the Office of Executive Chairman and create a nominating and compensation committee as a voluntary advisory body to the board,” Kobe Steel stated.

Its current structure under which all division heads are directors will be no longer. Instead, one director position will be assigned to each of the following units: the materials business; the machinery business; and the electric power business. Kobe Steel said it will also appoint a director to oversee compliance and another director to oversee quality management.

Other changes announced by Kobe Steel include:

Appointment of a compliance director and establishment of a new compliance management department. To improve its corporate governance further, the company will appoint a director with responsibility for overseeing compliance and risk management activities. Additionally, Kobe Steel’s compliance management section of the legal department and the risk management function of the planning and development department (which manages company-wide risks) will be combined into a single compliance management department. This new department will oversee risk management activities and engage in activities to increase awareness for managing risks across business divisions.

Risk management revisited. Kobe Steel acknowledged that in the past its risk management activities “lacked substance, because over time we did not improve our activities, and even though we were supposed to review our risk management activities by discussing any issues when we held meetings for allocating budgets, we allocated little time to do so.” Moreover, it admitted that management was not provided with substantive information, and further that it failed to develop controls to detect risks in its daily operations.

Through the test of time, Kobe Steel has promised to change its risk management ways. Furthermore, it will evaluate the effectiveness of its risk management activities through a compliance awareness survey.

In the past, risk management activities were dependent on self-governance of each Group company, contributing to its quality problems. Moving forward, Kobe Steel said each of its Group companies will be required to establish its own code of conduct in accordance with Group Practice.

New quality management department. On Jan. 1, 2018, Kobe Steel established a Quality Management Department, with the goal of unifying the divisions’ Quality Assurance Departments, where decisions to ship products are made and audits related to quality are conducted. This department engages in company-wide measures related to strengthening the quality assurance system by collecting information—such as quality management indicators and incidents—related to quality assurance for each business division, determining problems, and reporting such information to and sharing it with the senior management periodically.

Furthermore, Kobe Steel established a Quality Assurance Department directly under each business division. This includes its Machinery Business; Electric Power Business; Technology Administration Department of the Iron & Steel Business; and under the Quality Management Department of the Welding Business.

Improved quality control oversight: Acknowledging its long history of quality problems, Kobe Steel said it will establish an independent quality supervision committee consisting of external experts “as a temporary measure to keep our effort to regularly monitor the status of correcting the misconduct and implementing remedial measures, as well as to provide a platform to discuss appropriate measures to overcome various quality compliance problems that the group may face in the future.”

In addition to issuing new “KOBELCO Quality Guidelines,” a quality assurance representative will be appointed to each head office of the foreign Group companies in each region by the end of fiscal year 2018. “These representatives and the Quality Management Department of the Head Offices will work together to review the audits of quality control and quality assurance conducted by our Group companies, as well as support them to offer education and training of quality control and quality assurance,” Kobe Steel stated. “That way, we will be able to promptly detect any problems which our Group companies experience, and we can strengthen our functions for ensuring and monitoring quality.”

Similar investigations

Kobe Steel’s troubles seemed to have opened a Pandora’s box of other product quality scandals that have dogged several Japanese companies. In October 2017, an internal investigation revealed that certain subsidiaries of Mitsubishi Materials falsified data concerning products used in a wide range of sectors, including the automotive and aerospace industries, believed to have affected more than 300 companies. As the investigation continues, Mitsubishi Materials’ troubles are shaping up to be just as widespread and systemic as those of Kobe Steel.

In another example, Toray Industries, one of Japan’s largest producer of chemicals and advanced materials, admitted in November 2017 that one of its subsidiaries inappropriately overwrote data provided in inspection reports to customers. And in a fourth scandal, Japanese chemical company Ube Industries similarly discovered improprieties in quality checks for certain products at one of its factories.

Based on these recent revelations, risk and compliance officers should be on high alert and do their due diligence when doing business with Japanese companies. Likewise, companies under investigation for falsifying data should take a page from the hard-learned lessons of Kobe Steel.