Conflict of Interest Blog

Other people’s risks

As described in a recent issue of The Economist:  “Moral hazard is a problem that crops up often in economics. People behave differently if they do not face the full costs or risks of their actions: deposit insurance makes customers less careful about picking their bank, for example. Moral hazard can also be second-hand. Take medicine. A patient with private insurance may be happy to sit through extra tests, and a doctor may be happy to order them. Doctors might be more reluctant to order tests if they know that the patient would bear the full cost. A newly published paper sets out to test this secondary problem by examining a common-enough situation—taking a taxi ride in a strange city. The authors, a trio of academics at the University of Innsbruck, sent researchers on 400 taxi rides, covering 11 different routes, in Athens, Greece. In all cases, the researchers indicated they were not familiar with the city. But in half the cases, the researchers indicated that their employers would be reimbursing them for the journey. The researchers in the latter group were 17% more likely to be overcharged for their trip and paid a fare that was, on average, 7% higher.”

The verdict: a clear case of “second-degree moral hazard.”

Moral hazard has been a subject of various other posts here.  It is like conflicts of interest and behavioral ethics – the two principal topics in this blog – in that all reflect some type of impairment in ethical decision making. But, each obviously is different from the other; indeed, there is arguably a tension between behavioral ethics and moral hazard, in that the former can be seen as a partial repudiation of the notion of homo economicus (humans as highly rational economic actors) whereas the latter suggests we have not gone far enough to understand how that semi-mythical creature really operates, as further discussed here.

All three frameworks are important in understanding risks.  But, at least in compliance and ethics circles, moral hazard has gotten less attention than have its two related types of impairment, which was why I was happy to see this article.

The taxi overcharging study indeed  seems to be an important contribution to the moral hazard field (although I hasten to add  that I’m relying here entirely on The Economist summary of it). Just as Samuel Johnson once said that a certain individual was not only dull but the cause of dullness in others, so this study has shown that moral hazard can be the cause of unethical action by others beyond the obvious subjects. That is useful knowledge because it helps demonstrate – at least in a general way – the power of moral hazard.

Does this have any practical implications for compliance & ethics programs? Maybe it does in the area of risk assessment, but for the most part, probably not.

Thinking more broadly, however, moral hazard imperils our ability to deal with climate change, debt and various other threats where future generations will bear the consequences of present-day decision making. And, understanding moral hazard – as well as COI and behavioral ethics – can help E&C professionals and others contribute to the crucial dialogue  on those challenges.

What is the opposite of right?

In one of my all-time favorite Doonesbury strips, convicted financier Phil Slackmeyer is asked by a prison minister, as part of ethics training: “What is the opposite of wrong?” His response: “Poor.”

But I wouldn’t say the opposite of right is “rich.” More often, it is “rushed.”

The connection between being rushed and being wrong was powerfully established in a famous experiment conducted in the 1970s, in which seminarians on their way to an appointment for which they were operating under different degrees of supposed time urgency were confronted by an individual seemingly in distress. As described here: “Researchers were interested in determining if their imposed time pressure affected the seminarians’ response to a distressed stranger. Remarkably, only 10% of the students in the high-hurry situation stopped to help the victim. 45% of the students in the intermediate-hurry and 63% of the students in the low-hurry situations helped the victim.”

The notion of rushing a decision to override ethical considerations will be familiar to both  C&E officers and criminal lawyers. It is also part of the realm of political decision making, as is currently being illustrated by the attempt in Congress to push through the passage of health care law revisions so hurriedly that there is no time to consider the impact of these on the well-being of millions of men, women and children.

As citizens, we should resist attempts to rush through legislation that hinders ethical consideration in the way that being in the “high hurry” category did for the seminarians. And as C&E professionals, we should understand and seek to address rush as a form of risk.

Among other things, this entails:

– taking rushed conditions into account when constructing and implementing risk assessments;

– addressing in training and other communications the ethical peril of hurried decision making; and

– attempting to build due deliberation into key decision making structures – which can often be done by making the decisions group, as opposed to individual, matters.

Finally, companies should make sure the C&E officer has a “seat at the table” for important business decisions, from which – to shift metaphors mid-sentence – she can serve as a “brakeman” for situations where ethical considerations are likely to collide with the supposed urgency of the moment.

Recusal on my mind

In a classic Doonesbury strip, an ill-informed character – upon learning that a government official had recused himself from involvement in a particular matter – exclaimed, “Oh, gross!” While most readers of this blog will presumably have a more positive view of recusals than is implied by this (fictional) reaction, the decision this past week by Attorney General Jeff Sessions to recuse himself from any investigation relating to the Trump campaign’s connection with the Russian government provides an opportunity to offer some quick thoughts about this somewhat rarely used form of COI mitigation.

To begin, one must be alert to the danger of a phony recusal. Such a ploy is at the center of one of the plot lines in the Showtime series Billions (I’m a big fan), in which a prosecutor purportedly recuses himself regarding an investigation of his wife’s employer but still secretly calls the shots in that matter.  And a real-life example was reported on several years ago in the NYTimes, and summarized in this blog: “a Port Authority matter came before the chair [of that organization] in which a client of [the chair’s law] firm had a clear interest and, while the chair apparently recused himself from voting on the matter, according to sources in the Times story, he evidently still ‘made his support for the plan [at issue] known to his fellow commissioners and was involved in planning’ relating to the matter.” In short, recusal is a promise – not a condition, and attention must be paid to ensure the promise is kept.

A different issue is what the standard for recusal should be. Fairly obvious are situations where the conduct of the individual is within the scope of the investigation or where the interests of a close friend or family member could be impacted by the inquiry. Both of these would present clear-cut conflicts of interest. But a more nuanced view of the impediments to ethical decision-making would also include situations involving the potential for “motivated blindness,” a key behavioral ethics concept which is discussed in this earlier post.

Of course, the ramifications of applying such a standard are potentially broad. But, unlike various other COI mitigation measures, recusals are typically not costly or disruptive. Indeed, the act of recusal should be seen as making a positive general statement  about the ethical standards of the individuals and organization(s) involved – as well as providing a teachable moment regarding motivated blindness,

A final point, which is that behavioral ethics research has also shown – somewhat paradoxically – that an individual’s disclosing a COI can free  her to make a conflict-driven decision that would not be made if the COI hadn’t been disclosed, as discussed here.  While the research didn’t involve the investigative context, it still suggests a possibly underappreciated danger in forgoing recusal once the issue has been raised.

This research also suggests that those presented with a conflict involving a possible decision maker on a matter might need support in persuading such individual to recuse herself. For this reason it may be useful for organizations that have not already done so to draft a written investigations policy that addresses recusals (among other things).  Such a policy (and related training) can help ensure that a recusal request – should the issue ever arise –  isn’t seen as “gross.”

When NOT lobbying suggests a conflict of interest

“It could probably be shown by facts and figures that there is no distinctly native American criminal class except Congress,” Mark Twain famously wrote. Providing some of those facts and figures, Aaron D. Hill, Jason W. Ridge and Amy Ingram – in an article published yesterday in the Harvard Business Review – describe a growing conflict-of-interest problem in the US Congress, an important topic that these days is largely overshadowed by the COIs involving the President.

The authors set the stage by showing that there is now widespread ownership of stock by members of Congress: “the average S&P 500 firm in [their]  sample has about seven members of Congress holding its stock. Some companies have closer to 100 members holding stock, and many firms have 50 or more in a given year.” They next show that “firms where a greater percentage of lawmakers invest have significantly higher performance in the subsequent year — with each percentage of congressional membership owning stock worth about a 1% improvement in” return on assets. “This suggests  that politicians may be privy to nonpublic information about future regulatory or legislative actions that may prove helpful to these companies. It’s also possible that members of Congress use their influence to benefit the firms in which they invest. This finding dovetails with prior research that shows members of the House and Senate generate abnormally higher returns on their investments.”

Hmmm. Perhaps just a coincidence. (As Twain once noted in a different context: “What a delightful thing a coincidence is.”) But wait, there is more.

The authors also show that “firms are taking note of congressional investments in a couple of ways … paying close attention to public disclosure laws that require members of Congress to report their stock holdings annually… [and] also hiring private companies that specialize in a unique business: identifying who owns firms’ stock (among other political intelligence activities). Firms can use information about which members of Congress own their stock to minimize the intensity of their lobbying activity,… [b]ecause owning stock aligns the interests of the firms with those of their stock-holding lawmakers …companies that have congressional stockholders no longer need to spend as much money on lobbying to influence opinion.” One example of this:  a “nearly three-quarter increase in members of Congress who held Apple stock from 2007 (22 people) to 2008 (38) was followed by a nearly 50% reduction in lobbying intensity the following year (2009).”

This is one of the most interesting use of facts and figures to show COIs that I’ve seen in a long time. Indeed, I think that, as a general matter,  more needs to be done to understand not only the incentives that COIs can create but also the disincentives, as discussed in this recent post.

And, there is more still to what Hill,  Ridge and Ingram have to say about Congressional COIs – both their consequences and also mitigation approaches. But for that you’ll need to read the original article, which I hope you’ll do.

 

Compliance in the service of ethics

Years ago, I was hired to conduct a C&E training “needs analysis” for an investment bank, and ran into an interesting problem with the ethics side of the project: my client contact explained that if I did identify any actual ethics issue at the bank, a new compliance policy would immediately be issued to address it. While I understood the logic of this approach (particularly in the financial services arena, given the degree and impact of regulation there), it certainly didn’t leave much breathing room for an ethics perspective. Since then, I’ve been fascinated by the connections (or lack thereof) between compliance and ethics – and the opportunities often presented to have one help elevate the other.

In a recent article in the Harvard Business Review,  Christopher McLaverty and Annie McKee make a number of important suggestions on “What You Can Do to Improve Ethics at Your Company.” They note that research by McLaverty  shows that “in contrast to what corporate compliance officers would like us to believe, their organizations’ codes of conduct and ethics training wasn’t particularly helpful when it came to managing ethical dilemmas.”

I completely agree that in many business organizations C&E  codes and training often don’t help employees resolve the sort of ethical dilemmas they are likely to face. I concur, too, with the authors’ various suggestions for gauging the ethical well-being of a company and with the finding from McLaverty’s study that “the most useful resource that leaders have when faced with an ethical dilemma is their own personal network. This provides an informal sounding board and can highlight options and choices that the leader may not have considered.”

But I do think more should be said on behalf of the role that compliance can have in promoting ethics in organizations.  A different way to look at the issue is how being exposed to the full range of C&E program measures at a company over the course of years can be helpful preparation for the moment when an ethics-related quandary  is presented.

From my perspective, codes and training aren’t the main story here, and never have been. They are, after all, mere preaching. More likely to be impactful are such measures as risk assessment, monitoring, auditing, use of metrics and various other accountability-related practices and procedures  – at least, when these are done in a serious, results-oriented way.

But what do they have to do with ethics? While each is a  traditional compliance activity, they can also be seen as part of a broader commitment to doing what is right – particularly by the many members of the workforce who don’t distinguish between C and E.  And, I believe that the beneficial habits of mind – i.e., “inner controls” – that should, over time, come with being in a company with a strong approach to  compliance can help lift a company’s ethics performance, including preparing managers for dealing with an ethics issue that is not addressed in the training or code.

I should emphasize that I’m not suggesting that every true ethical quandary is easier to resolve by those who work in companies with rigorous C&E programs. “Right versus right” dilemmas, in particular, may be outside the scope of what I’m describing. However,  there are doubtless many other sorts of workplace ethical challenges – particularly having to do with summoning the will, not finding the way – for which having a well-engrained habit of doing what is right could make a real difference.

A final thought: if what I’m saying is true it should work both ways. That is, a well-engrained habit of acting ethically should make compliance stronger in companies and individuals.

When do you really need best practices?

In my most recent post  I argue for applying a best-interest-of-the-client standard for those who give investment advice.

But – paradoxically or not – when it comes to designing or evaluating compliance & ethics programs, you don’t always need to aim for the maximum.

In my latest column in the SCCE’s Compliance & Ethics Professional (page 2 of PDF) I look at the issue of: How much is enough?

I hope you find it interesting.

Relaxing ethical standards

Imagine the following. Your doctor has two schedules of fees: a “full price” one for patients who want the doctor to prescribe medicine based purely on what’s in their best interests and a lower-cost “value plan” for those who agree that the doctor can receive money from pharma companies for prescribing their medicines. The doctor stresses that under the value plan, while her decisions may not be in your best interests, they will be “suitable” for you. In essence, your doctor is offering to “unbundle” her professional ethical obligations from the other aspects of her service – as a way of saving you money.

Or consider a similar situation involving a company. The head of procurement offers to give up any bonus if his ethical standards can be “relaxed.” Or a member of the board of directors proposes the same with respect to her fees. In both cases, they promise that they would act “suitably” in performing their duties for the company – but not necessarily in its best interests. And, while we are imagining things, how about a political leader who offers to reduce his salary in return for a diminution of his duty of loyalty to the citizenry? Would you find any of these appealing?

Yesterday, as described in this Fox News story, President Trump “signed a memorandum instructing the Labor Department to delay an Obama-era rule that requires financial professionals who charge commissions to put their clients’ best interests first when giving advice on retirement investments.”  The “past administration’s ‘fiduciary rule,’ [was] aimed at blocking consultants from steering clients toward investments with higher commissions and fees that can eat away at retirement savings. The rule was to take effect in April. The financial services industry argues that the rule would limit retirees’ investment choices by forcing asset managers to steer them to low-risk options.” (Note: registered investment advisers are already covered by a best-interests standard – so the rule in question is about extending this requirement to a wide range of others who give financial advice.)

There is a technical side to this debate that I don’t have the expertise to assess. (For instance, if the proposed rule really and truly requires recommending low-risk options for all investors then it is clearly flawed.) But as someone who taught ethics in business school for many years and who studies conflicts generally this does present something of a teachable moment.

To begin, not all business relationships require a “best interests” standard. We each engage regularly in countless transactions where we are content to fend for ourselves (so long as we are not being defrauded). This is true of most things we buy. But for relationships of trust – with doctors, employees, directors … and perhaps political leaders – we do require something beyond a no-lying standard of conduct.

What are relationships of trust? To some extent they are defined by law – such as in Judge Benjamin Cardozo’s famously saying that more is required of trustees than adherence to “the morals of the marketplace.” But beyond this, I think the analysis should be functional, using two dimensions.

The first of these is the likelihood of conflict-driven behavior occurring – which, in turn, is based at least partly on the ability of participants to the transactions in question to recognize such behavior. In each of the examples above the  likelihood of bad conduct seems high, either because the participants might lack necessary technical skill (in the doctor example) to identify it or because the range of conduct at issue is too broad to be efficiently monitored (as in the other examples). Investment-advisor-type relationships would seem to fit into this category, meaning the average investor doesn’t have the time or expertise to monitor her advisor. Indeed, part of the point of purchasing  professional financial advice is to get the benefit of time and expertise that the average person lacks.

The second dimension is, of course,  impact. To my mind, this also argues for a strong – i.e., best interests – set of ethical standards in this setting. That is, for any individual, sub-optimal investment performance could have grave consequences. And, for the nation as a whole – which will increasingly become beset by debts of various kind – the total impact of such a shortfall could exceed the (potentially very high)  sum of such parts. For more on the impact that financial advisor COIs – as well as those in the healthcare, business organization and political realms – can cause see this post.

A Nobel Prize in Compliance & Ethics?

President Trump continues to dominate the C&E news – or at least this blog’s coverage of such news. The story of the week: a team of ethics advisors was named for the White House and a chief compliance counsel was appointed at the Trump Organization.  When taken together, these measures can be viewed as creating a C&E program addressed to the President’s conflicts of interest.

This C&E program raises a number of interesting questions. Perhaps the most significant – as noted by Roy Snell, head of the Society of Corporate Compliance and Ethics – is whether “the new positions [have] enough authority and independence to be effective. [Snell added] compliance officers typically have power to launch investigations on their own and set up programs to educate employees on ethics, assess risks and allow for anonymous reporting of ethics trouble. Lacking that power, Snell said, the new compliance counsel could ‘struggle to prevent, find and fix ethical and regulatory problems.’”

A second area of interest – touched on briefly in Snell’s comments – is risk assessment. The issue here partly concerns process: will the White House Ethics Advisors and Trump Organization Chief Compliance Counsel have a rigorous, structured approach to identifying particular risk areas and using that information to inform key aspects of their program? Deploying  risk assessments of this sort is widely seen as a foundational element of effective C&E programs.

But there is also a substantive dimension to this area, too: what risks will the Ethics Advisors and Chief Compliance Counsel address? In particular, how will they take on the all-important issue of Trump’s avoiding not only actual but also apparent COIs?

The challenge here is that – due to the President’s refusal to release his tax returns – there is some concern that when it comes to business dealings he may not be putting America first. Will this adverse ethical inference drawn from a lack of transparency be part of the risk assessment equation, as logically it should be?

Third, there is the question of culture generally and tone at the top in particular. As all C&E professionals know, culture generally overrides (or “trumps”) policies and procedures when it comes to shaping behavior in organizations.

This is especially true when it comes to giving whistleblowers the courage to report suspected wrongdoing. Providing such comfort  is hard enough even in the best of circumstances, but will be truly daunting with respect to a man who rose to fame telling people “You’re fired.”

How will the new team deal with the culture challenge of promoting C&E in this setting? Honestly, I have a hard time imagining how this can be accomplished. But if they do succeed they should be considered for a Nobel Prize in compliance & ethics.

But, this bit of whimsy notwithstanding,  I should stress that while I’m skeptical about this effort I do hope it will succeed. This would not only be good for the country in a general way – but could be a showcase for the value of effective C&E programs.

 

 

The Trump Conflict-of-Interest Mess

Donald Trump’s announcement last week that his steps to address his conflicts of interest will not include divestiture of his holdings presumably surprised no one. But it is still very big news, which, in my view, has important implications for the country – and not just in the COI realm.

Trump’s apparent reason for this decision is that given the nature of the holdings any divestiture would be very disadvantageous to him financially. I have no reason to doubt that point. Trying to liquidate his interest in the Trump Organization would be, without question, much harder to do than selling publicly traded stock – and would subject him to a very sizable “haircut.”

But, as others have pointed out, as Commander in Chief, he will be asking US military personnel to risk making sacrifices far greater than those he is willing to require of himself.  Indeed, in other contexts – particularly dealing with climate change and the escalating national debt – any meaningful solutions will require some degree of sacrifice by millions of Americans.

The lack of ethical leadership shown by the President Elect on COIs could indeed weaken efforts to deal with a wide range of grave challenges requiring sacrifice that the country faces. To me this is potentially the greatest harm from his decision. (For more on the link between morality-based sacrifice and the success of human societies see Jonathan Haidt’s The Righteous Mind.)

Still, while I disagree with where Trump comes out on divestiture there is at least a logic to it. But the explanation given for the closely related issue of his refusal to release his tax returns – that being under audit prevents him from taking this step – is simply false.

A lesson I learned as a young criminal defense lawyer which has served me well as an older C&E lawyer is that if a good reason can’t be given for something then the real reason is usually a bad one. Of course, this isn’t always the case (as behavioral ethics has demonstrated).  But it is true enough to ask – particularly when viewed in light of his decision to not divest – if Trump is hiding something damaging by not releasing his tax returns.

Regardless of what his reason actually is, a presumption of guilt will  – based on his false explanation –  likely shape the perceptions of his deals, holdings and business partners that are already known and those that emerge from what will doubtless be an endless voyage of discovery by investigative journalists. The loss of trust at risk here will be harmful not only for Trump but also the country as a whole, in the same way that Watergate was harmful.

A gloomy forecast, indeed – particularly given that this condition may well last for four years. But what does it mean for the C&E practitioners who are most of the readers of this blog?

I’d like to think nothing – and to assume that this can all be relegated to the realm of politics, which is far off and distinct from that of the business world, which is largely my focus. But we cannot ignore the warning of Justice Louis Brandeis: “Our government is the potent, the omnipresent teacher. For good or for ill, it teaches the whole people by its example.” While Brandeis was speaking about violations of law (which Trump’s decision on COIs does not involve) the point seems just as applicable to ethics.

Ethics advance…or decoy?

While COI aficionados (not to mention concerned citizens) await the President Elect’s plan to mitigate his conflicts of interest, there is interesting ethics  news regarding his nominee for Secretary of State, Rex Tillerson, CEO of ExxonMobil.  As described in today’s NY Times, in addition to selling ExxonMobil stock he owns outright to avoid a COI, “a more complicated task involved resolving the fate of two million shares of ExxonMobil stock, worth about $180 million, that Mr. Tillerson was set to receive over the next decade. If he held on to this promised future payout from ExxonMobil, he would still have a financial interest in matters that might affect the company and the oil industry. So ExxonMobil agreed to take the unusual step of paying out the value of these sales and putting the money into an independent trust, with the money invested in neutral assets like Treasury bonds and mutual funds. Under the terms of the agreement, if Mr. Tillerson, 64, goes back into the oil industry during the next decade, he will forfeit any money left in the account.”

With respect to this forfeiture provision, Richard W. Painter, a White House ethics lawyer during the administration of President George W. Bush, told the Times that it “was unusual and positive, as it removes the incentive for him to take steps while in government that might benefit an industry he planned to return to work for upon his departure. ‘It gives up something I had never been able to get from other government officials — a promise not to go back to an industry from which you came,’ Mr. Painter said.”

There is, however, a more negative way of looking at the agreement – one that focuses not on the forfeiture provision but rather on the payment for the loss of the restricted stock itself. As noted in  this article by Climate Central: What makes the Tillerson deal unusual is that ExxonMobil has agreed to provide him with benefits it had no legal obligation to provide. ‘This was not a clause in his employment contract that was triggered,’ Stanford law expert Michael Wara said. ‘It’s a special arrangement of massive economic significance to Tillerson that was given to him purely because of his move into government…’ Wara described the arrangement between Tillerson and the ExxonMobil’s board of directors as a legally questionable ‘sweetheart deal.'”

Viewed  through this lens the forfeiture provision is not praiseworthy but should be seen as  an ethics decoy. In this view, it is a clever way of distracting attention – at possibly little real cost to Tillerson  (given that he may have no interest in ever going back to the oil industry) – from a questionable payment of a magnitude that would  engender gratitude in all but the most hard hearted of recipients.

Note, however, I am not 100 % sure that the sweetheart deal analysis is correct. I say that because while I read quite a few press accounts of the Tillerson agreement this article was the only one to make the point.  And, since I’m not an employment lawyer I don’t feel like I know enough to make a judgment on this point based on the agreement documents alone.

But what does seem certain from the Climate Central article is that, in addition to the traditional COI problems, there are other reasons for concern about Tillerson’s impartiality on issues facing oil companies: “‘I want to see some questions at the confirmation hearing about how much those oil companies are going to be coming around and chatting him up,'” ethics attorney Painter said. “‘Are there going to be cognitive biases and personal loyalties?'”

In sum, a mixed bag.  The forfeiture provision does seem like a genuinely important advance in the state of the art regarding forward looking, revolving door conflicts. But the payment for restricted stock could be a powerful backward-looking COI – particularly when coupled with the COI-like bias and loyalty concerns identified by Painter. Rather than passing judgment on which view seems more right to me, I’ll fall back cryptically on  the life philosophy espoused long ago by a Doonesbury character who described himself as cynical but eternally optimistic.

 

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