Litmus surgical supplies was founded 20 years ago by entrepreneur Simon Mwaura who has been the companys chief executive since the outset. Incorporated as a private company, Litmus began by importing small surgical devices such as syringes and bandages, and selling them to hospitals, clinics and medical facilities. But the company began to grow rapidly when Mr Mwaura realised the potential of a growing market in knee and hip joint replacements as the population in many countries was rapidly ageing due to the wider availability of more effective, low cost medicines. Fifteen years ago, he began to manufacture the surgical hip and knee joints used for most joint replacement surgery. As a company operating in the surgical supplies industry, Litmus has always been subject to regulation and must complete compliance reports every year to declare that it is using surgical grade materials for its manufacturing and also that it maintains the requisite level of hygiene in its processes. These reports are a legal compliance matter and must be signed by two directors.

Litmus surgical supplies has been a private family (or insider) company throughout its history owned jointly by Mwaura, his wife and brother. Mr Mwaura owns 51% of the shares, his wife, 20% and his brother 29%; all three are directors of Litmus surgical supplies. As the company grew, they sought to employ members of the extended family as much as possible, partly to provide them with jobs and partly to give a feeling of family in the company. It was often described as a tight-knit culture with family members occupying the senior positions and with few appointments made from outside the company to important roles. When the company grew to a certain size, Mr Mwaura decided that he needed a qualified accountant on the board of directors to help with investment appraisals, costings, cash flow management, compliance issues and financial reporting. He eventually appointed Emmy Sang, a relatively inexperienced but ambitious person to the board. This was her first role as finance director.

Mr Mwaura was known to be a strong and domineering person. Some former employees described him as a bully who was unable to discuss matters in a calm manner. He was described as quick to anger and capable of intimidating even his senior colleagues such that they would feel unable to challenge him at all. This was also the case with Emmy Sang, the new finance director. She found him overbearing and impossible to challenge. She always did as he asked, even when she felt uncomfortable with what she was being asked to do.

When the joint replacement industry became more competitive, Mr Mwaura had the idea that he could reduce the companys unit costs by switching some of the surgical-grade materials used in manufacture for a cheaper industrial grade instead. Such a switch would be undetectable to the surgeons using the artificial joints but did increase the risk of fracture and deterioration once the replacement joints were used in a patient. Mr Mwaura asked Emmy Sang, as an accountant and finance director, to produce detailed costing calculations for the switch and to forecast how this change would affect profits. She also calculated the costs of retooling the factory to allow the industrial grade material to be used. Later, on Mr Mwauras instruction, she approved the investment and oversaw the changes in manufacturing and the purchasing processes, in the full knowledge that such changes were both illegal and unethical. Mr Mwaura assumed that because many of the senior employees were family members, and that he could control Emmy Sang, that the switch to industrial grade material would go undetected.

The problem came to the public attention some time later when joints made from the inferior material began to deteriorate and immobilise previously mobile patients. The industrial grade material used in the joints often caused infection in patients and some vulnerable patients died of the effects of the product failure.

John Ali was the investigative journalist who brought the problems at Litmus to national attention. He thought that the problems arose as a result of a probity risk and that the probity or integrity failure was on the part of Mr Mwaura and Emmy Sang. Mr Alis mother had received a Litmus hip joint and subsequently experienced a great deal of pain and distress when the joint deteriorated, producing some unfortunate side effects including blood poisoning. Although his mother was able to have the joint safely removed and replaced by a better quality artificial joint, John researched further and found other patients who had not been so fortunate. It was Johns investigations into Litmus which alerted the regulatory authorities to the use of the inferior materials in the joints. It soon emerged that the cause of the increased failure of the implants was the use of the inferior industrial-grade material.

When the regulator responsible for the safety of surgical supplies discovered, thanks to Johns research, why the joints degraded, they investigated the use of the inferior materials. The legal officers investigating the case noted that two directors had signed the most recent compliance reports, certifying that the company was fully compliant with material usage and quality standards. These were Mr Mwaura and Emmy Sang.

John was angry with Litmus surgical supplies, because of how his mother and others had suffered. He was particularly angry with Mr Mwaura and Emmy Sang. As a business journalist, he often wrote articles on the behaviour and performance of listed companies. He became convinced that it was in the public interest for producers of surgical supplies, such as Litmus, to be subject to the regulatory requirements of listed companies. In a published article, he wrote:

whenever I look at company failures such as that at Litmus, I become increasingly convinced that robust ways of embedding risk awareness and risk management are essential in all companies and not just in listed companies. It was the fact that Mr Mwaura could get away with his offences that is most worrying. He bullied a young accountant, Miss Sang, into highly unprofessional behaviour, and without the systems in place to enable the offence to be challenged internally, he initially got away with it. Had a whistleblowing system been in place, or a separation of roles at the head of the company, Mr Mwaura could not have done this terrible thing. Someone would have challenged him and told him not to be so unethical and arrogant.

The result is that, with such a high impact business risk having been realised, innocent people working for Litmus may lose their jobs whilst patients may have to suffer the effects of this for many years.

Once the case came to the public attention, Mr Mwaura was arrested and prosecuted for the illegal sale of non-compliant surgical materials. Emmy Sang was also prosecuted and then investigated by her professional accounting body. After an appeal, she was struck off, thereby preventing her from working as an accountant in the future. The company itself was wound up after sales declined, and all 130 employees lost their jobs. Patients continue to suffer the effects of the defective joint replacements and will do for several years into the future.

Required:

(a) Distinguish between the governance of a family-owned company like Litmus and a publicly listed company, and explain how Mr Mwaura may not have committed the offences he did if Litmus had been a publicly listed company. (10 marks)

(b) Criticize Emmy Sangs behaviour as the finance director and a qualified accountant, and explain how she acted against the public interest. (6 marks)

(c) Briefly explain why some risks vary by industry sector and discuss why legal risk might be more relevant to surgical suppliers like Litmus than in some other industry sectors. (4 marks)

(d) Write a short article for the specialist magazine Investors in Companies which covers the following points. You may assume that the magazine has an educated readership.

(i) The potential benefits which an effective non-executive chairman could have brought to Litmus. (5 marks)

(ii) In the context of the case, how risk awareness, might be embedded in a company like Litmus. (5marks)