Edited by Jeff Kaplan
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Conflict of Interest Blog
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The FCPA Blog keeps a list of the costliest FCPA cases in history. Doing something similar for COIs is a bit more of a challenge given that COIs can impact many areas of the law. Still, a COI blog should try to take a stab at developing such a list.
Near the top of a costliest COI list would be some of the prosecutions of pharma companies for making payments to health care providers that caused the latter to have COIs with their patients. These cases included the two largest fines in the history of US criminal law – against Pfizer and Eli Lilly ($1.2 billion and $515 million, respectively) on top of other penalties. (E.g., the Pfizer total was $2.3 billion – a record that is soon to be eclipsed in a case against another pharma company, GSK .) Also near the top would be the prosecution of Boeing in connection employment-related contacts with an Air Force procurement officer in which the company paid a $615 million settlement (most of which was a civil penalty) and suffered the loss of business of many times that amount.
Other big ticket settlements have involved purely civil cases stemming from third-party payments that were undisclosed or insufficiently disclosed to clients in the insurance brokerage industry which cost Marsh $850 million and Aon $190 million. And from a different corner of the financial world, Goldman Sachs’ $550 million fine paid to the SEC in 2010 would also be high up on the list, as would the 1.4 billion dollars total paid in settlements by a number of investment banks in 2003 in connection with the COIs involving research analysts.
And, as the Boeing case shows, COI costs can also include substantial amounts of lost business. Similarly in this respect is the Wal-Mart/ad agency case, discussed previously in the Blog.
Finally, note that I exclude FCPA cases because, although they do involve COIs, their costs are already well chronicled in the FCPA Blog.
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In his comprehensive taxonomy of conflicts of interest in the financial services industry , Professor Ingo Walter of New York University distinguishes between the kind of conflicts that a firm has with its clients (“Type 1” conflicts) and conflicts between a firm’s clients (“Type 2″ COIs). Because the coverage of the COI Blog is not focused on this (or indeed any) industry we have devoted little attention to the latter. However, last week the UK’s Financial Services Authority imposed, in a Type 2 case, what is evidently its largest COI-related fine ever against a firm (Martin Currie), and this seems a good occasion to discuss these sorts of conflicts.
As briefly described in this article the firm “caused one client to enter into an ill-advised transaction which rescued another client from serious liquidity concerns… Both of the two … clients focused on making investments in the China market and were managed by Martin Currie from its Shanghai office. In April 2009, Martin Currie caused the rescued client fund to invest around £15m in an unlisted bond issued by an offshore Chinese firm, the FSA said. Martin Currie failed to ensure that the bond’s valuation or the rationale behind the investment were properly scrutinised at the time of the transaction and it proved to be a poor investment for the client, whose fund halved in value over the next two years. While the investment was detrimental to that fund, it had significant advantages for the other client in question, which was facing serious liquidity concerns due in part to its exposure to illiquid investments in a single offshore Chinese entity.”
Note that Type 2 conflicts pose risks not only for financial services firms. They can also arise in law firms (where such COIs are far more common than are the Type 1 variety), and other contexts, too – e.g., consulting firms that do not fully disclose how commercial relationships with one client can impact the advice given to others (such as in technology procurement).
Indeed, it may be non-obvious Type 2 COIs that create the greatest risk for some organizations precisely because they have not been spotted. And even where these are known they may not be fully appreciated, because the self interest in Type 2 COIs may be less obvious (though no less real) than in Type 1 conflicts; i.e., those faced with the former may be particularly at risk due to the relative absence of “inner controls.” For these reasons, all sorts of organizations should at least consider in their risk assessments whether Type 2 COIs could be an issue for them.
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The fundamental truth about incentives can be found in this classic exchange from Monkey Business: “Groucho: Just how tough are you? Chico: You pay little bit, we’re little bit tough. You pay very much, very much tough. You pay too much, we’re too much tough.”
And the application of that truth to corporate compliance can be found in this recent study from the Ethics Resource Center and an earlier study I co-authored for the Conference Board , both showing that the government doesn’t do a good job in incenting compliance programs. For that reason many C&E programs are only “semi-tough.”
Two weeks ago, however, as with the dawn’s early light, compliance professionals were encouraged by what seemed to be change of direction by Justice – in the Morgan Stanley case, described here. Let’s hope this is indeed the start of a trend, so that many more C&E programs can be “very much tough.”
(Note: this is adapted from a white paper I’ll be presenting next week at a Rand Corporation symposium on Corporate Culture and Ethical Leadership Under the Federal Sentencing Guidelines: What Should Boards, Management and Policymakers Do Now?” It is an invitation only event, but the white paper will be available soon after.)
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In his blog on law and other subjects, Professor Bainbridge recently asked: “Did Wal-Mart lawyers violate their [Sarbanes-Oxley] 307 duties?” It is a good question – among other reasons, because it provides an occasion to reflect on a conflict-of-interest based set of rules that were the subject of much attention when first issued but which have since fallen into semi-obscure status.
Securities and Exchange Commission Rules of Part 205 – which are based upon Section 307 of S-Ox – mandate that lawyers practicing before the SEC take certain actions when faced with evidence of a securities law violation. At the time they were enacted, the rules caused many corporate law departments to issue policies for both their in-house and outside attorneys and to undertake related measures, such as training.
But are law departments still concerned enough about these standards to take even minimal steps to promote compliance with them?
An article published in 2010 in the Georgetown Journal of Legal Ethics (Sonne, “Sarbanes-Oxley Section 307: A Progress Report on How Law Firms and Corporate Legal Departments Are Implementing SEC Attorney Conduct Rules”), indicated a lack of attention to the rules by law departments and also law firms. Inspired by this piece, when speaking at a session later that year on “Legal Ethics for Compliance Lawyers” at the PLI Advanced Compliance and Ethics Institute in New York, I asked the audience: “If you are in a law department, do you regularly send your [Sarbanes Oxley 307/205] policy to newly retained law firms?” Of twenty responses received, nineteen were No.
I know of nothing in the past two years to suggest that the situation is improving. Indeed, the passage of time will likely have made it worse.
Let’s hope Professor Bainbridge’s question – combined with other focus on the role of lawyers and compliance professionals in Wal-Mart’s woes - does the trick. One can imagine how little sympathy the SEC – in the face of a violation – would have for law department or law firm members who failed to take reasonable steps to promote compliance with the rule (which sending out a copy of their policy would surely seem to be). As was said in a very different context (Death of a Salesman), “Attention must be paid…”
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In the first posting in this series we described two types of independence criteria in investigations – one having to do with an attorney’s relationships with the company and the other her involvement in the subject matter being investigated. The second posting discussed independence issues regarding board members supervising investigations and the third reported on the then-just-breaking story about the Wal-Mart FCPA matter – and particularly the role of an apparently un-independent investigation in those unfortunate events. In this fourth post we return to the issue of attorney independence to make a seemingly small but – at least for some cases – potentially important point that is based in part on behavioral ethics.
Balzac famously said, “Behind every great fortune there is a crime,” and, less famously, many C&E professionals have noted that behind many crimes in companies there is a supervisor asleep at the switch. (Indeed, our most recent prior post was about a case of this sort – where the “supervisors” were the members of the board.) What does this (meaning the part about supervisors – not Balzac) have to do with independent internal investigations?
In assessing an attorney’s independence vis a vis a contemplated investigation it is obvious that one should weigh her relationship with the target(s) of the inquiry. Less obvious, one should consider her relationships with anyone else at the company whose interests could be adversely affected by the outcome of the matter – including by the possibility of an investigative showing that a target’s supervisor was negligent in her supervision.
In an earlier post on behavioral ethics, I observed that the phenomenon of “motivated blindness underscores the importance of the Sentencing Guidelines expectation that organizations should impose discipline on employees not only for engaging in wrongful conduct but ‘for failing to take reasonable steps to prevent or detect’ wrongdoing by others – something relatively few companies do well (and some don’t do at all).” Given the difficulty that many organizations have traditionally faced in imposing this sort of discipline, they should do whatever is reasonably possible to maximize the likelihood of success. And in some situations, that includes selecting a lawyer for an investigation who is sufficiently independent not only of the target but also of those who could be reasonably faulted for not having prevented or detected the target’s misdeeds.
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F. Scott Fitzgerald famously said that “The rich are different than you and me,” and, along the same lines, CEO conflicts of interest can be pretty different than those involving people like you and me. Consider this story – which likely would not have taken place with anyone other than a CEO – about what in going on at Chesapeake Energy.
As background, the company permits its CEO, Aubrey McClendon, to take personal stakes in the wells it drills. By itself this arrangement – while unusual and controversial - does not, in my view, inherently involve a COI. Indeed, one could argue that by investing side by side with the company, the CEO aligned his interests with those of the company’s shareholders.
However, “[i]n order to pay for stakes in new wells, McClendon borrowed money — using his stakes in existing wells as collateral — from a group that Chesapeake was trying to sell assets to. Investors complained that the arrangement raised a conflict of interest. They worried that Chesapeake might have sold its assets to the firm because the firm agreed to lend McClendon money, and not because the terms of the deal were the best Chesapeake could have received. The arrangement was not previously disclosed to shareholders.” Or, as noted in another (more bluntly written) account: “The overlapping relationship has led many analysts to say that there was at least the appearance of a conflict of interest since Mr. McClendon could give his lenders a sweetheart deal in exchange for a preferential interest rate on his loans.” (Perhaps some of these analysts recall the harm caused by the tangled personal financial dealings of then CEO Bernard Ebbers at WorldCom.)
Where was the board – which included a former governor of Oklahoma and former US Senator – when this was going on? According to this story, Chesapeake’s general counsel initially claimed that the board “was fully aware of the existence of the loans” but the company soon reversed course on this. As described by Ben Heineman, a former General Electric Co. general counsel who teaches corporate governance and business ethics at Harvard: “the Chesapeake board, in effect, is declaring that it would ‘rather just look ill-informed and negligent than complicit in McClendon’s deals.’”
Adding to this turmoil – a story has now surfaced of an undisclosed financial tie between the CEO and a director (albeit one dating back several years). And, the Securities and Exchange Commission has opened an internal investigation.
What does all this mean for the shareholders (i.e., people like “you and me”)? Many have apparently lost faith in senior management and the board, which has led to a massive loss in their investments in the company. This is, of course, entirely predictable when a CEO creates an apparent COI of this magnitude and the board – the only meaningful check on a CEO - is either negligent or complicit.
CEO conflicts really can be unique, not only in terms of what they are but also the impact they can have.
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By Simon Webley
A day doesn’t seem to go by without a news story about a politician or business person who has failed to recognise that they have is a conflict of interest. When this comes to light, they pay the price with their reputation.
In the Institute of Business Ethic’s ( IBE) 2010 Survey of Corporate Ethics Policies & Programmes (available to download here), ‘managing conflicts of interest’ was identified by 70% of respondents as important to their organisation. Yet guidance provided about managing conflicts of interest seems to be failing to make an impact.
Why do these scandals continue to happen?
The answer I would suggest, is because conflicts of interest are as much about perception, as they are about reality.
Perhaps the most difficult aspect of the topic is where some cultural and regional customs may seem to run contrary to what others perceive as conflicts of interest. For example, the Chinese practice of leveraging guanxi (special relationships) has been a traditionally accepted (and expected) approach for facilitating favourable circumstances for organisations and individuals. In Africa, where family bonds are highly valued, nepotism is a common practice, and an employee may face ostracism for not hiring a relative for a position at the firm. However, most Western-based multinationals actively discourage allowing personal relationships to influence an employee’s business judgment.
It is important not to underestimate the difficulty of this issue. There are some regions where employees feel that hiring a brother, for example, will be in the best interest of the company as well as the right thing to do.
In general, many employees of companies with international operations may be unclear as to what constitutes a conflict of interest. Companies have to be particularly diligent to develop conflict of interest standards and communicate these to their staff throughout the world.
The following list highlights examples that companies should address:
- Participation on boards and panels
- Consulting arrangements
- Gifts and entertainment
- Relatives and friends
- Outside employment
- Personal payment for services (speeches, articles, etc.)
- Personal investments/transactions
- Relations with suppliers/vendors
Guidance on this issue should briefly explain why avoiding conflicts of interest is important for the organisation. For example: an employee’s personal relationships may be perceived to compromise his/her business judgment; and, decisions clouded by personal interests can negatively influence the long-term welfare of the organisation. Good guidance is for an employee to declare the conflict and then remove themselves from the decision-making process. (For further help on this issue, please see the IBE’s Good Practice Guide Globalising a Business Ethics Programme.)
As valuable as codes of ethics and policies are in guiding staff, the example from leadership is the most crucial element when it comes to influencing behaviour. This is where’ tone at the top’, that oft repeated phrase, is so important. If staff see that their leaders (whether they be senior management, board members, or department heads) declare any potential conflict and do so with integrity, then they are likely to follow suit.
Simon Webley is Research Director, Institute of Business Ethics. He can be reached at S.Webley@ibe.org.uk.
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The first two posts in this series gave an overview of the legal landscape regarding independence expectations for internal investigations. Today, I want to draw readers’ attention to a jaw-dropping piece that has just appeared in today’s NY Times about how Wal-Mart allegedly used an utterly un-independent internal investigation to cover-up bribery by its Mexican operation.
I won’t try to recount all of what’s in the Times piece, which – in my view – every C&E professional should read. But this excerpt will give a flavor of it:
In one meeting where the bribery case was discussed, H. Lee Scott Jr., then Wal-Mart’s chief executive, rebuked internal investigators for being overly aggressive. Days later, records show, Wal-Mart’s top lawyer arranged to ship the internal investigators’ files on the case to Mexico City. Primary responsibility for the investigation was then given to the general counsel of Wal-Mart de Mexico — a remarkable choice since the same general counsel was alleged to have authorized bribes. The general counsel promptly exonerated his fellow Wal-Mart de Mexico executives. When Wal-Mart’s director of corporate investigations — a former top F.B.I. official — read the general counsel’s report, his appraisal was scathing. “Truly lacking,” he wrote in an e-mail to his boss. The report was nonetheless accepted by Wal-Mart’s leaders as the last word on the matter.
Rather, I write to make a general point that might otherwise be missed in what I imagine will be a flood of follow-on stories about Wal-Mart’s woes, but which should be of keen interest to C&E professionals. That is, engaging in sham compliance measures – investigations and other – can itself be considered a crime, at least in some circumstances. For more on that, see this prior post in the FCPA Blog, about how “I once represented two lawyers who were suspected by a federal prosecutor of having deliberately conducted a half-measure internal investigation for deceptive purposes. No charges were brought (and, from my perspective, none were even close to being warranted). But with the wrong set of facts the result could be different in a case involving compliance program half-measures – especially if, as I believe will happen, there is a generally decreasing tolerance by prosecutors for Potemkin programs.”
In a somewhat related vein, another commentator has asked whether Wal-Mart’s lawyers violated their S-Ox 307 duties.
Wal-Mart’s statement issued in response to the Times piece can be found here. And, I should emphasize that I am not suggesting that Wal-Mart personnel engaged in a sham investigation. Rather, like many posts in this blog, I am using the news of the day to provide what is hopefully helpful general COI-related information to C&E professionals.
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On May 3, I’ll be speaking on a web cast presented by MetricStream on risk assessment and mitigation, with an emphasis on ways to make sure that identified risks don’t fall through the cracks.
On May 16, I’ll be speaking at a symposium being held by the Rand Center for Corporate Ethics and Governance on how well federal law and policy incents companies to have effective C&E programs. (Based on the following tenet of Marxist economic logic – Groucho: Just how tough are you? Chico: You pay little bit, we’re little bit tough. You pay very much, very much tough. You pay too much, we’re too much tough - I’ll argue that it should be no surprise that many C&E programs are no more than “semi-tough.”)
On May 18, I’ll be speaking on FCPA compliance at the SCCE NE Regional Conference, presenting some of the results of the anti-corruption benchmarking study that Rebecca Walker and I conducted with the FCPA Blog.
On May 31, I’ll be speaking about board oversight of C&E programs at the PLI 2012 C&E Institute.
And, this coming Wednesday I teach the first class in ECOA’s (distance learning) “law school.” (Seats still available!)
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By Patrick J. Egan
COI is at the heart of a myriad of crimes, ranging from insider trading to FCPA violations, but when does a COI alone rise to the level of criminality? Standards differ between the public and private sectors. Congress and State Legislatures have sought to criminalize COI standing alone for public officials as well as for individuals in the private sector who do business with them, but there have been very few attempts to criminalize COI in strictly private enterprise without some related overtly criminal act.
Congress has passed extensive legislation in an attempt to punish public corruption. The most fundamental of these are Bribery, Graft, and Conflicts of Interest: 18 U.S.C. §§ 201,203 and 205. These provisions impose sanctions on public officials who lose sight of whose interests they are expected to serve and the private individuals who help corrupt them. Four federal statutes also address bribery and kickback schemes that do not involve public employees or public funds: 18 U.S.C. §§ 1341, 1343, 1346, and 1952. These impose criminal liability for the exchange an item of value for influence or personal benefit in the private sector.
The above statutes typically require more than just a COI. They require action taken as a result thereof, such as payments or favors. Efforts to criminalize the existence of a COI without more have met with skepticism from legal scholars and in the courts. They have been described as vague and endlessly elastic. The U.S. Supreme Court’s decision in Skilling made clear that there must be more than just a COI to convict on theft of honest services.
The fundamental problem with COI is that they often lead to just such activity. COI are the fertile soil in which the overtly criminal act grows. They also create the appearance of impropriety which can lead to investigation and prosecution. Unfortunately, as a practical matter, the answer to the question, “When does a COI become a crime?” is often “When a prosecutor decides to charge it as one.”
Patrick J. Egan is a partner and co-chair of the White Collar Compliance and defense Group at Fox Rothschild LLP. He is an adjunct professor of Trial Advocacy at the Temple University James Beasley School of Law and author of Avoiding and Defending Government Actions for International Trade Violations. He can be reached at PEgan@foxrothschild.com.
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