Conflict of Interest Blog

Is ethics being short-changed by compliance?

In the beginning of this field there was ethics. But with the advent of the Sentencing Guidelines in 1991 compliance entered the picture and where there were once ethics programs now stand “compliance and ethics” ones.

Has ethics been short-changed in this transition?

In a recent posting in the Harvard Law School Forum on Corporate Governance and Financial Regulation  Veronica Root Martinez of Notre Dame Law School  – based on a forthcoming paper in the University of Chicago Law Review  – writes: “firms should implement specific and explicit ethical infrastructures within their compliance programs, which fall somewhere between the floor set by professional ethics and standards and the hazy ceiling found within moral philosophy as applied to business ethics. By which I mean, firms should attempt to create tangible policies, procedures, and programs that promote ethical behavior within their ranks. In doing so, I suggest firms look to the fields of behavioral ethics, social psychology, and organizational behavior to provide guiding principles when they attempt to craft tangible ethics policies. For my own contribution, I suggest that firms look to commit to adopting policies and procedures that (i) protect the dignity of, (ii) promote the flourishing of, and (iii) advance the interests of the various stakeholders of firms as a baseline to be used for establishing the ethics components of their ethics and compliance programs. Thus, ethics and compliance programs should ensure employees feel valued and are viewed as vested partners within the organizational enterprise and consider the ways the program might impact individuals both within and outside of the firm. Firms might choose to emphasize other attributes as part of their ethics programs, but the thrust of the Essay is that firms should more actively engage in thinking about the implementation of programs that go beyond rote compliance and focus equally on efforts targeted at creating strong ethics programs. That is not to suggest that creating ethical infrastructure will be easy, but the persistent scandals plaguing sophisticated organizations all across the globe suggest that it is time to at least experiment with creating More Meaningful Ethics within ethics and compliance programs at firms.”

I greatly agree with both her analysis and recommendations and think that this is an important article that all within the compliance and ethic field should read. However – and perhaps it is a matter of semantics more than substance – I am a bit concerned that compliance is being given somewhat of a bad rap.  That is, she argues that various prominent business scandals demonstrate that too much compliance and too little ethics can create risks of wrongdoing. That might be so, but these cases might also be examples of bad compliance programs. In that connection the importance of tone at the top is a fundamental ethics precept. But it is a pillar of compliance expectations as well.

She also suggests that firms rely should more on behavioral ethics for risk mitigation. I agree with that, too, but do think that behavioral ethics can support compliance approaches as well, as described in some of the posts collected here.

However, these are small points and there is much more that can be said in support of the author’s basic thesis that “firms should attempt to create tangible policies, procedures, and programs that promote ethical behavior within their ranks.”

In this vein, here are some other thoughts on connections between compliance and ethics in an article from  a few years back in Compliance and Ethics Professional:  Body and Soul: Points of Convergence between Ethics and Compliance (page 2 of PDF).

“First, companies should assess ethics, as well as compliance, risks.” This is extremely rare, and has the potential to be extremely valuable.

“Second, ethics should be prominently featured in training and communications. This means, among other things: providing true ethics training on methods for ethical decision making, using values-based communications, giving real-life (and ideally company-specific) examples that go beyond what the law requires/prohibits, and in otherwise deploying training and other communications to show that ethical action is attainable and desirable in business.”

“Third, following the old adage that what’s measured is what counts, companies should measure ethics-related, as well as compliance-related, conduct. Such conduct should be included in personnel evaluations, employee surveys, and program assessments (self or external).”

 

Sweating the small stuff

In Behavioral Ethics as Compliance  (Cambridge Handbook of Compliance (Van Rooij & Sokol Eds)) Yuval Feldman and Yotam Kaplan write:

“[C]urrent approaches to law enforcement and compliance tend to focus on “smoking guns” and extreme violations of the law as the core case and as the ultimate manifestation of the problem of illegality. This tendency is understandable, as it would seem most important to prevent wrongdoing in those cases where it produces the most harm. However, behavioral ethics findings challenge this prevailing wisdom. While devastating in their effects, extreme violations of the law are relatively rare as they are difficult for most people to ignore or justify. On the other hand, most people can, and very often do, ignore and justify “minor” violations, or acts of “ordinary unethicality:” supposedly small deviations from legal and ethical norms common in day-to-day activities. This means that acts of ordinary unethicality can be by far more common, and therefore by far more harmful in the aggregate. Ordinary unethicality can be found in all areas of the law, from contract breach and disregard for the property of others, to corruption in administrative law, corporate misconduct, or insensitive interpersonal behavior. Behavioral ethics research suggests that ‘minor’ wrongs are endemic, widespread and difficult to regulate and prevent.”

This analysis dovetails to some degree with the notion of “slippery slopes.” As noted in an earlier post :  “One of the most important facets of behavioral ethics research concerns slippery slopes. As described in a paper by Francesca Gino and Max Bazerman: “Four laboratory studies show that people are more likely to accept others’ unethical behavior when ethical degradation occurs slowly rather than in one abrupt shift. Participants served in the role of watchdogs charged with catching instances of cheating. The watchdogs in our studies were less likely to criticize the actions of others when their behavior eroded gradually, over time, rather than in one abrupt shift.”

Of course, the points that Feldman and Kaplan are making go beyond slippery slopes – and apply broadly to the overall approach to risk assessment that companies take. E.g., their article essentially suggests an inverse relationship between risk impact and risk likelihood.

What should C&E officers do with this information? Among other things, it should be used to train employees on the importance of not allowing seemingly trivial unethical acts to go unchecked, a particularly important point when dealing with busy business leaders who may believe that their attention should be saved for only “serious” infractions. This can be part of a general approach to training that presents “heightened ethical awareness” as a core leadership skill.

 

Does ethics training actually affect business conduct?

In “Can Ethics be Taught? Evidence from Securities Exams and Investment Adviser Misconduct,” forthcoming in the Journal of Financial Economics,  Zachary T Kowaleski of University of Notre Dame, Andrew Sutherland of the Massachusetts Institute of Technology, and Felix Vetter of the London School of Economics “study the consequences of a 2010 change in the investment adviser qualification exam that reallocated coverage from the rules and ethics section to the technical material section. Comparing advisers with the same employer in the same location and year, we find those passing the exam with more rules and ethics coverage are one-fourth less likely to commit misconduct. The exam change appears to affect advisers’ perception of acceptable conduct, and not just their awareness of specific rules or selection into the qualification. Those passing the rules and ethics-focused exam are more likely to depart employers experiencing scandals. Such departures also predict future scandals. Our paper offers the first archival evidence on how rules and ethics training affects conduct and labor market activity in the financial sector.”

This seems like a very important study and there are far too many aspects of it to provide a comprehensive summary here. But I was particularly struck by the following:

“[W]e find the misconduct differences across passers of the old and new exam persist for at least three years, which we would not expect if advisers merely memorize rules rather than draw more fundamental lessons about acceptable conduct from the ethics portion of the exam. In sum, this evidence suggests that our main results cannot be explained by compliance alone, and that the exam change altered advisers’ perceptions of acceptable conduct.”

“[T]he behavior of the least experienced advisers is most sensitive to the extent of rules and ethics testing. These results are consistent with the exam playing a ‘priming’ role, where early exposure to rules and ethics material prepares the individual to behave appropriately later.”

“[W]e find the exam’s coverage to be less pertinent to those advisers working at firms where misconduct is prevalent. Thus, the contagion of misconduct behavior appears to limit the effectiveness of training in preventing transgressions.”

“We study turnover among all Wells Fargo advisers, and find those passing the old exam are most likely to leave after the scandal broke.”

There is much more to the study than this and I encourage you to read the original.

 

 

Conflicts of interest and nonprofit organizations

The settlement by President Trump of a lawsuit brought by the NY Attorney General claiming that the Trump Foundation misused funds to benefit his 2016 campaign was attention getting not only because of who was involved in the case but also because he was compelled to pay $2 million to have the matter resolved. But while unique in some ways, the matter is a good reminder of the need for effective COI compliance in the nonprofit world generally.

Writing in a recent issue of Nonprofit Quarterly Vernetta Walker notes: “Just in the past few months, Baltimore’s mayor Catherine Pugh resigned following a scandal that revealed she had profited in the hundreds of thousands of dollars from selling her self-published children’s book to the University of Maryland Medical System, where she served as a board member; the Washington Post exposed eighteen board members of the National Rifle Association who were paid commissions and fees ranging from thousands to over $3 million; and ProPublica’s searing investigation into Memorial Sloan Kettering Cancer Center revealed a nest of self-serving behavior, including top executives who received personal annual compensation in the hundreds of thousands of dollars and in one instance over a million dollars in equity stakes and stock options from the drug and healthcare companies. Meanwhile, dozens of stories have appeared that raise questions in the minds of the public about pharmaceuticals’ funding of patients’ rights groups. These are just the tip of the iceberg of recent examples eroding the public trust.” She also writes that a “closer look at real-life examples reveals three separate but related issues that surface repeatedly: (1) failure to navigate the gray areas of conflicts of interest, including group dynamics within the boardroom; (2) failure to navigate the gray areas of recusal and disclosure; and (3) failure to fully appreciate unintentional reputational damage because, technically, the transaction being considered is not illegal.”

Walker further asks: “So, how should nonprofits navigate the gray areas where relationships are involved, the actions are not illegal, and the organization has complied with the conflict policy (i.e., disclosure and recusal)? Some organizations decide, as a matter of policy, never to enter into paid contractual relationships with any board member, so as to avoid speculation about abuse of position and influence for personal gain. Such organizations, of course, steer well clear of inviting vendors or potential vendors onto their boards. They also tend to be very careful about contracting with other organizations where staff members have an interest in the vendor or hire family members or personal friends, because they are consciously holding an ethical standard that argues against it. Where using a board member as a vendor is concerned, there may be some cases in which such situations emerge and the connection is limited enough, or thought to benefit the organization enough, that it may decide to leave some room in its policy while recognizing the risks it incurs in doing so. In all such cases, the board should make comparisons of alternative options; and it should take a vote on whether the proposal is fair and reasonable and in the financial best interest of the organization, but only if no other acceptable option is available.”

There is much more to Walker’s piece and I encourage those involved in compliance work for non-profits to read all of it.

And, you might find of  interest  this earlier post on nonprofit COI policies.

Behavioral ethics, the board and C&E officers

In Conflicts and Biases in the Boardroom, recently posted on the Harvard Law School Forum on Corporate Governance and Financial Regulation, Frank Glassner, of Veritas identifies five ways that cognitive bias can inhibit great governance:

– A board is reluctant to ask the right questions

– The group is unable to fully and effectively involve new board members

– Excessive deference is afforded to a few board members with a long company history

– Peer pressure and conformance minimize constructive dissent

– Inflexible adherence to tradition limits consideration of new initiatives.

He further writes: “Every board member must acknowledge that implicit biases impact his/her objectivity.”

Not surprisingly (given the focus of the COI Blog), I agree with this. But I also wonder if there is a place for the compliance  and ethics officer in helping to address this daunting area.

In an earlier post  I wrote: Ultimately, for a company to have not only a strong compliance program but also an ethics one, the CEO and other leaders would empower the C&E officer to identify and challenge decisions that may be based on bias. (Note that I don’t mean literally all such decisions, but those that are significant in potential impact and have a meaningful ethics/fairness dimension.) The leaders would do so because they would understand that being fair is not just a matter of good intentions; rather, it can also require expertise and effort – both of which the C&E officer can bring to a challenging set of circumstances.

Here is another prior post addressing the issue:  Behavioral ethics and compliance: what the board should ask..

Finally, here is an index of  behavioral ethics and compliance posts generally.

 

 

Strengthening your C&E program through behavioral ethics

A new post in the FCPA Blog.

I hope you find it useful.

More on conflicts of interest disclosure

“Culture trumps compliance,” the old saying goes. But it still worth being reminded of it, particularly in the conflict of interest area, where the effect of culture may be less manifest than it is for various other types of misconduct (like harassment).

The latest contribution to this body of knowledge is Conflict of Interest Disclosure as a Reminder of Professional Norms: Clients First! by Dr Sunita Sah of Cornell’s business school, to be published in Organizational Behavior and Human Decision Processes. Sah writes:

“Disclosure is a popular solution for managing conflicts of interest (COIs) across a variety of industries and professions. The present work documents how perceived professional norms may influence advisors’ reactions to COI disclosure. In a series of laboratory and framed field experiments, five with monetary stakes, I demonstrate that disclosure can have differing effects on advisors who have a COI. These studies provide evidence that COI disclosure increases the salience of the perceived professional norm (‘clients first’  or ‘self-interest first’) and, correspondingly, the level of bias in advice. I show that in both the medical and financial context COI disclosure can significantly improve the advice quality of professional advisors who have norms to place clients first.” (Note: that a prior post discussed  the other side of the coin: Sah’s research on how disclosure of COIs can in some instances  exacerbate conflicted actions by those making the disclosure.) As stated  by Sah, “If self-interest first norms are prevalent, then the findings in this paper suggest that steps to change the perceived norms may be useful or even necessary as a precursor to implementing disclosure.”

Of course, most companies can’t delay implementing COI disclosure requirements. But, this research may help underscore for decision makers that disclosure alone is not enough, and that they may need to assess and possibly enhance the COI-related aspects of their culture.

Expanding Compliance Liability for Directors?

A post a few weeks ago discussed the issuance of an important recent judicial decision in Delaware regarding board liability for compliance failures, and specifically the fact that the claim against the directors had survived a motion to dismiss.  Given how few decisions  support claims such as this – what are generally called Caremark cases – it is worth noting that  a second such decision  has been issued only a few weeks later.

As noted in a post this week in the Harvard Law School corporate governance blog by attorneys from the Wachtell Lipton law firm:  Further extending the practical reach of the Caremark doctrine, the Delaware Court of Chancery this week upheld claims against directors of a life sciences firm for failing to ensure accurate reporting of drug trial results. In re Clovis Oncology, Inc. Derivative Litig., C.A. No. 2017-0222-JRS (Del. Ch. Oct. 1, 2019)…. The Clovis directors argued, and the court accepted, that duty-to-monitor claims require a showing of scienter—that is, evidence that the directors knew they were violating their duties. But the court did not require the plaintiff to allege particular facts showing such knowledge. Instead, reasoning that Clovis had a board “comprised of experts” and “operates in a highly regulated industry,” the court concluded that the directors “should have understood” the problem and intervened to fix….Clovis thus highlights the widening risk to boards of directors of fiduciary litigation when bad news can be tied to an alleged compliance failure. …A compliance program is no longer enough. Courts now look for engaged board oversight, and directors should consider implementing procedures to ensure that the board itself monitors “mission critical” corporate risks.

Of course, while such procedures are themselves important, equally key is having a boardroom culture that encourages robust monitoring of compliance risks. For this reason (as well as others) board members should have strong relationships with their respective companies’ chief compliance officers, as CCOs  can – by word and deed – help develop and maintain a culture that is up to this task.

 

The big compliance news of 2019

In my latest column in Compliance & Ethics Professional I discuss the Department of Justice’s new policy of rewarding antitrust compliance programs.

I hope you find it interesting.

CECO reporting relationships

Here is a just-published article from Compliance Week on compliance & ethics officer reporting relationships.

I hope you find it useful.