Conflict of Interest Blog

Compliance program assessments: a “teacher’s guide”

In the May issue of Compliance & Ethics Professional I look at two areas where companies frequently come up short in C&E program assessments.

Can you guess what they are?  Click here (and go to the second page)  to find out.

Can ethics be “unbundled” from business?

Imagine the following: You need to hire a lawyer to advise you on a complex and highly confidential corporate acquisition, but the one you’d most like to have is pretty pricey. You explain this to her and she proposes what she calls a “win-win” solution:  if you sign an engagement letter that broadly states that she need not act in your best interests while performing services for you she’ll discount her hourly rate by 25%.

Or, imagine that 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. Like the lawyer, your doctor is offering to “unbundle” his professional ethical obligations from the other aspects of his service – as a way of saving you money.

You seek clarification from both of them – what will this mean for me?  They both have the same response: while we won’t promise to act in your best interest we will act in ways that are “suitable” for you.

Would you be tempted by either offer?

Note that it is doubtful that either arrangement would be considered lawful – certainly the medical one  wouldn’t be, and I doubt the lawyer one would be either (although professional ethics issues arising from providing unbundled legal services are somewhat complicated – as reflected in this piece in the ABA Journal).    But even if they were permissible it is hard to imagine clients and patients saying yes to such options, where the risk of betrayal is so clear-cut and the adverse impact of such could be so great.

Yet a less obvious but not at all hypothetical version of ethics unbundled from business is already standard operating procedure in large parts of the investment world, where some of those who give advice to investors about retirement accounts have been allowed to operate outside of a best-interests-of-the-client framework. The main argument for this state of affairs is that “Consumers Deserve Choices”,  as described in this recent article in Investment News – including the choice of low-cost/non-fiduciary advice.

Of course, not all business relationships warrant the imposition of fiduciary duties. With some, “the morals of the marketplace” – in the immortal words of Judge Benjamin Cardozo – may well be morality enough.  But the business of providing advice about retirement accounts would not seem to be in this category, given how much is at stake for retirees (and, in a sense, for society as a whole), and the massive conflicts of interest problems that have beset the financial services industry for decades.

However, change is in the air. As described by the director of policy research at Morningstar,  last week “the Department of Labor proposed an amendment to the fiduciary definition under ERISA, the Employee Retirement Income Security Act. In short, the proposal would require any individual receiving compensation for providing investment advice to a plan sponsor, plan participant, or IRA owner making a retirement investment decision to adhere to a series of fiduciary duties–that is, to act in the best interests of their clients. The rule is based, in part, on a Council of Economic Advisors analysis showing that when individuals receive what the White House calls ‘conflicted advice,’ they tend to enjoy lower investment returns.”

Note that the even the proposed rule does have some exceptions built into it. For instance, “you can call a broker to execute a trade without triggering fiduciary duties, you just can’t ask for advice,…” as noted in this article in Forbes.   There are other exceptions too.  But overall it is a big step forward.

At this risk of being repetitive, I definitely recognize that there are times when it may indeed make sense to “unbundle” what would otherwise be an ethical duty from a business relationship.  An example from an earlier post is that joint ventures partners may and sometimes do waive fiduciary duties expected of board members on the JV.

However, one would be hard-pressed to look at instances such as this – where the investors in question tend to be powerful and sophisticated – as being relevant to the reality faced by most individuals struggling to grow/maintain their retirement accounts. Like the lawyer and doctor examples at the beginning of the post, if you take ethics out of the equation for investment advice involving retirement, what’s left might well be worthless …or outright damaging.

 

Is compliance still just “putting on its shoes”?

Mark Twain famously said “A lie can travel half way around the world while the truth is putting on its shoes,” and one might think something similar about risk and C&E. Perhaps it has always been this way and maybe it always will be, at least to some extent.  But forward looking companies should look for ways to narrow or possibly eliminate the gap between the immediacy of the problem and that of the solution.

In a sense, this is much of the point of the “cultural” approach to compliance and ethics, and it can also be seen as part of the promise  – albeit still largely theoretical  – of  “behavioral” C&E.  Both seek to have C&E operate, in effect, as an instinct. (For more on behavioral ethics visit the Ethical Systems web site.) But, at least in part, the idea goes back much earlier  –  to Aristotle’s focus on ethics and habit.

There are various avenues for pursuing this goal but, as a general matter, a valuable though often underutilized approach lies in the realm of incentives. Incentives tend, I believe, to reach employees more deeply than policies and procedures do – and thus can help create instinct-like ethical behavior.

Companies indeed do seem to be more interested than ever in exploring ways to use incentives to promote strong C&E. For instance, one company I know now uses the results of internal controls testing in setting compensation for its senior executives. This kind of measure might not sound particularly exciting, but it could  – at least over time – help make compliance operate as something of a reflex, in that it presumably contributes to  managers being focused on risk on a day-to-day basis (and not just on the far less frequent occasions of responding to cases of possible violations).  More generally, this and other incentive measures could be part of a larger C&E strategy of moving from  a necessary but somewhat limited “culture of honesty” to also include a broader and deeper “culture of care,” as described in this earlier post.

Moreover, C&E incentives need not be solely of the negative type, nor need they be tangible. Appealing to the better angels of our nature through praising pro-social behavior could, to my mind, be a powerful force for helping ethics move at the speed of risk, particularly with the somewhat idealistic generation of younger employees.

But, in some cases traditional economic incentives are indeed called for. That is why  – as discussed in these earlier posts – the notion of “moral hazard” should play a greater part than it currently does in many C&E programs.

Finally, note that incentives are just one type of tool in the C&E “tool box.”  And, whether it be through a cultural/behavioral approach or something else, the risk-reduction discussion should include consideration of all available tools – which is what a C&E risk assessment offers …or, at least, should. (For more on risk assessment generally, please download this complementary e-book, available at CCI.)

 

Compliance programs for the “big people”

Imagine a company where all the senior managers took compliance and ethics as seriously as they do traditional aspects of business (R&D, production, sales & marketing).  In this company, not only would senior managers do whatever was reasonably necessary  to prevent and detect violations in their own business unit or function, they would use their knowledge of and clout within the entity as a whole for making sure their peers were equally committed to promoting law abiding and ethical conduct.  While thought experiments are more art than science, I find it hard to imagine any other single C&E-related factor being as powerful a force for good in organizations as this would likely be.

Leona Helmsley is reported to have said that “only the little people pay taxes” and sometimes it feels like C&E programs are only for the little people – given how often it is the “big people” who engage in the types of unlawful and unethical practices that cause the greatest harm in businesses. Indeed, the “C Suite” seems to be the “final frontier” when it comes to effective ethics and compliance programs. In an article in yesterday’s NY Times, Gretchen Morgenson identifies two recent (and somewhat similar) proposals that offer a path to addressing this area of great weakness in many companies.

One is a proposal to Citigroup shareholders that would “require that top executives at the company contribute a substantial portion of their compensation each year to a pool of money that would be available to pay penalties if legal violations were uncovered at the bank. To ensure that the money would be available for a long enough period — investigations into wrongdoing take years to develop — the proposal would require that the executives keep their pay in the pool for 10 years.”

The other is an article by Greg Zipes in the Michigan State Journal of Business and Securities Law  which “calls for the creation of a contract to be signed by a company’s top executives that could be enforced after a significant corporate governance failure. Executives would agree to pay back 25 percent of their gross compensation for the three years before the beginning of improprieties. The agreement would be in effect whether or not the executives knew about the misdeeds inside their companies.” Its requirements would be triggered if, among other things “a company pleaded guilty to a crime [or]…if an executive signed a financial document filed with the S.E.C. that subsequently proved false and required an earnings restatement of at least $5 million.”

Both of these proposals make sense to me. While a company should, of course, use traditional forms of compliance (e.g., training, auditing, monitoring) to address C-Suite risks, the best mitigant of all may be other “big people” – if they are properly motivated to prevent and detect wrongdoing by their peers.

For further reading:

“Redrawing corporate fault lines using behavioral ethics”

- “Behavioral ethics and C-Suite behavior” (discussion of paper by Scott Killingsworth)

- “Behavioral Ethics and Management Accountability for Compliance and Ethics Failures”

- “Where is the accountability?” (a dialogue with Steve Priest in ECOA Connects).

 

A behavioral ethics and compliance index

While in the more than three years of its existence the COI Blog  has been devoted primarily to examining conflicts of interest it has also run a number (close to fifty) of posts on what behavioral ethics might mean for corporate compliance and ethics programs. Below is an updated version of a topical  index to these latter posts. Note, however, that to keep this list to a reasonable length I’ve put each post under only one topic, but many in fact relate to multiple topics (particularly the risk assessment ones).

INTRODUCTION 

- Business ethics research for your whole company (with Jon Haidt)

Overview of the need for behavioral ethics and compliance

BEHAVIORAL ETHICS AND COMPLIANCE PROGRAM COMPONENTS

Risk assessment

“Inner controls”

Is the Road to Risk Paved with Good Intentions?

Slippery slopes

Senior managers

Long-term relationships

How does your compliance and ethics program deal with “conformity bias”? 

Money and morals: Can behavioral ethics help “Mister Green” behave himself? 

- Risk assessment and “morality science”

Communications and training

- Publishing annual C&E reports

Behavioral ethics and just-in-time communications

Values, culture and effective compliance communications

Behavioral ethics teaching and training

Moral intuitionism and ethics training

Accountability

Behavioral Ethics and Management Accountability for Compliance and Ethics Failures

Redrawing corporate fault lines using behavioral ethics

- The “inner voice” telling us that someone may be watching

Whistle-blowing

Include me out: whistle-blowing and a “larger loyalty”

Incentives/personnel measures

Hiring, promotions and other personnel measures for ethical organizations

Board oversight of compliance

Behavioral ethics and C-Suite behavior

Behavioral ethics and compliance: what the board of directors should ask

Corporate culture

- Is Wall Street a bad ethical neighborhood?

Too close to the line: a convergence of culture, law and behavioral ethics

Values-based approach to C&E

- Values, structural compliance, behavioral ethics …and Dilbert

Appropriate responses to violations

Exemplary ethical recoveries

BEHAVIORAL ETHICS AND SUBSTANTIVE AREAS OF COMPLIANCE RISK

Conflicts of interest/corruption

Does disclosure really mitigate conflicts of interest?

Disclosure and COIs (Part Two)

Other people’s COI standards

Gifts, entertainment and “soft-core” corruption

The science of disclosure gets more interesting – and useful for C&E programs

Gamblers, strippers, loss aversion and conflicts of interest

- COIs and “magical thinking”

Insider trading

Insider trading, behavioral ethics and effective “inner controls” 

Insider trading, private corruption and behavioral ethics

Legal ethics

Using behavioral ethics to reduce legal ethics risks

OTHER POSTS ABOUT BEHAVIORAL ETHICS AND COMPLIANCE

- New proof that good ethics is good business

An ethical duty of open-mindedness?

How many ways can behavioral ethics improve compliance?

Meet “Homo Duplex” – a new ethics super-hero?

- Behavioral ethics and reality-based law

Is corruption a harmless foul?

In a book review published last weekend in the Wall Street Journal titled “Two Cheers for Corruption,”  the prolific scholar Deidre McCloskey argues that while corruption can be harmful to some societies (such as Afghanistan, the subject of one of the books she reviews), “The Great Enrichment that America rode to economic power was hardly slowed by the spoils system.”  In short, she sees much corruption as sort of a harmless foul, and some as even beneficial.

This is a maddening argument, because the fact that growth in the US was strong  for many years does not mean that corruption was a neutral or even positive force in that growth. Additionally, the possibility that corruption may on some level be good for US economic interests is hardly the end of the ethical (or even economic) inquiry.  For instance, even if one assumes that  McCloskey is right from a purely US-centric view that “It can be good for efficiency if, say, bribes are paid to …smooth the course of sales by U.S. businesses to the Egyptian military,” the people of Egypt – who have long suffered from corruption of their officials – would almost certainly disagree.

Indeed, over the years I have tried to capture in this blog stories showing how conflicts of interest – which underpin all cases of corruption – can be harmful.  While just the tip of the iceberg, it is hard to square these and countless other similar stories with McCloskey’s more benign vision of corruption.

One can also conduct a thought experiment about a world filled with conflicts of interest – and indeed I used to do this when I taught ethics in business school.  As noted in an earlier post , my students thought that:   In “Conflict of Interest World,”  Individuals might be reluctant to take the medicines that their doctors recommend for fear that those recommendations are motivated more by the doctors’ financial relationships with pharma companies than by the patients’ well-being.  Individuals and organizations might not use financial advisors for fear that the advice they receive is driven by hidden, adverse interests – and would instead devote otherwise productive time to trying to become their own financial experts, resulting in a significant misallocation of capital as well as time. Organizations could hesitate to take a wide range of everyday actions for which they need to trust their employees and agents to do what’s right by the organizations – or would proceed only with highly intrusive and costly surveillance-like measures in place. In short, Conflict of Interest World is a place of needlessly diminished lives, resources and opportunities.

 Note that McCloskey would probably respond that her review is focused on government corruption whereas the examples above are the private sector type.  But, as Justice Brandeis said, “Our government is the potent, the omnipresent teacher. For good or for ill, it teaches the whole people by its example. Crime is contagious. If the government becomes a lawbreaker, it breeds contempt for law; it invites every man to become a law unto himself; it invites anarchy.”

McCloskey indeed has a broad view of the need for ethical instruction, arguing that “All that works in the end is ethical change, urged from the mother’s knee, the pastor’s pulpit, the judge’s bench, the schoolmaster’s lectern.”  All these do work – or at least can.  But the same can be said for a virtuous government as well.

Finally, note that McCloskey speaks derisively of what might be called a systems approach to promoting ethical conduct: “We should stop thinking, as too many economists do, that we can ‘engineer’ society with ‘incentives.’ Freakonomics doesn’t reign. The blessed Adam Smith wrote that ‘the man of system . . . seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board.’ Nowadays, alas, we are all men (and women, dear Adam) of system.”

While there is an obvious logic to Smith’s critique, there is also much that – in my view – can be accomplished through a systems-based approach to ethics,  particularly systems built not only on economic incentives but also learnings from behavioral sciences. For more on the promising field of behavioral ethics,  please visit the Ethical Systems website. 

Compliance law and compliance culture

In my latest column in Compliance & Ethics Professional (page 2 of PDF) I look at legal mandates for having a pro-compliance culture, and what C&E folk should focus on in helping their companies meet those expectations.

I hope you find it interesting.

Future conflicts of interest

First, a plug: at the upcoming annual conference of the Ethics and Compliance Officer Association , I’ll be speaking on a panel on “A view from the edge: exploring the future of ethics and compliance.”  It is a topic I addressed at the very first ECOA conference – held in 1992, when the organization had a grand total of 19 members and the entire C&E field was so new.  I hope to see you at this year’s event, which will be held next month in Dallas.

Second, the COI story of the week – is also about the future. It concerns the Clinton Global Initiative (CGI) accepting contributions from foreign governments, notwithstanding the prospect that Hillary Clinton will run for President.  When she was Secretary of State, the organization did not take such donations, but they lifted the ban when she resigned from that post.

Of course, since she isn’t president, technically this isn’t an actual conflict.  Rather, it is a potential COI.

What’s the difference? As discussed in this earlier post: Potential conflicts refer, as a general matter, to situations that do not necessarily constitute or appear to constitute a COI but where there is a reasonable possibility of an actual or apparent COI coming into play.

As with the risk analysis of any COI, with potential COIs one should consider the dimensions of likelihood and impact.

On likelihood, there are actually two questions relevant to this inquiry. First, how likely is the COI-triggering event to happen?  Here, that event – Hillary becoming President – seems reasonably likely to occur. (The analysis might be different if we were dealing with a “Bernie Sanders Global Initiative,” or organization associated with another long-shot seeker of the office.)

Second, if the triggering event does occur, can effective mitigation measures then be implemented? That might be difficult in this instance because, if she did win the Presidency, presumably returning the donations to the foreign governments, though not impossible, would be pretty unpalatable – particularly if the money was already spent on the many critically important causes the CGI supports.

Finally, the potential impact of a COI seems high here as well.  That is, the donations from foreign governments could undermine the trust that the American people have in the President, and perhaps cause suspicion in other countries too.

So I agree that CGI should ban foreign government contributions.  But I also applaud the organization for its effective work on climate change (and in other areas), as the actual conflicting interest we have with future generations on that issue may be the greatest COI of all time.

(Some additional reading:

Two conflicts of the apocalypse.

Is the road to risk paved with good intentions?

COI policies for non-profits.)

 

 

The most interesting conflict of interest case of the (still young) year

The most prominent COI story in the past few days comes to us from Mexico where, as described in The Economist, that country’s president Enrique Peña Nieto “announced that he, his wife and his finance minister will become the first subjects of a conflict-of-interest investigation” that was “triggered by revelations that [they] bought houses on credit from affiliates of a building firm that has benefited from government contracts.” But for me the most intriguing story of the week (and indeed the year, at least so far) comes from the ethical wonderland that I call my home – New Jersey.

As reported initially by the Bergen Record:   “Federal prosecutors have [launched a probe] into a flight route initiated by United [Airlines] while [David] Samson was chairman of the [Port Authority, which] operates [Newark Liberty Airport]. The route provided non-stop service between Newark and Columbia Metropolitan Airport in South Carolina — about 50 miles from a home where Samson often spent weekends with his wife. United halted the non-stop route on April 1 of last year, just three days after Samson resigned under a cloud. Samson referred to the twice-a-week route — with a flight leaving Newark on Thursday evenings and another returning on Monday mornings — as ‘the chairman’s flight,’ one source said. Federal aviation records show that during the 19 months United offered the non-stop service, the 50-seat planes that flew the route were, on average, only about half full. United… was in regular negotiations with the Port Authority and the Christie administration during Samson’s tenure over issues that included expansion of the airline’s service to Atlantic City and the extension of the PATH train to Newark…” A story from NJ.Com added that the  flight’s booking rate of 50% was significantly lower than “the rate of 85 percent or higher common among carriers” and also that the Chair of the NJ assembly’s transportation committee said the benefit to United of running this unprofitable route “could be PATH. It could be how much they pay for landing planes. It could be for how flights are dispatched at the airport. It could be a multitude of things. And it could be none of them.”

Assuming for the sake of discussion that it is indeed at least one of those or other financial benefits, the case should be interesting to COI aficionados  for several reasons.

First, the main law enforcement challenges to investigating the matter will likely be (as it is many COI/corruption cases) proving wrongful intent.  Presumably, Samson knew enough not to document what was seemingly happening here (although his comments about the “chairman’s flight” may suggest otherwise),  but what about United?  Given how cost conscious airlines have been in recent years, one imagines that someone at the company would have needed to document why they were running half full planes.  Moreover, for various reasons this seems like the sort of arrangement that would have been known at a reasonably high level in the company (although finding documentation of that may be a taller order).

Second, it will also be interesting to see what role, if any, United’s compliance program played in these events. In light of how many people at the airline could well have had some suspicion about these flights, it would be pretty damning if none of them called the C&E helpline. On the other hand, if the issue was raised internally and buried, that would be even worse.

Third, it may be noteworthy that while the Company’s code of conduct does have a section called “When the government is the customer,” the bribery discussion there is limited to international transactions.   Perhaps like a lot of US companies, United’s compliance team failed to grasp the risks of homegrown corruption generally (and the Jersey variety in particular).  Other companies may wish to revisit their own codes to see if they could be subject to the same criticism.

Two final notes.  First, the facts of this case are just beginning to emerge and the speculations in my post should not be read to suggest that  Samson or United are necessarily guilty of corruption. Seriously.  Second, for an earlier story about a possible COI involving Samson (and his connections to the ethically challenged Christie administration) see this post  and the article linked to therein.

Referral fees and conflicts of interest

The recent indictment of NY State Assembly Speaker Sheldon Silver on corruption charges has – at least for  the moment – focused some  attention on the age-old practice of “referral fees,” under which a lawyer or other professional receives compensation for referring an individual or entity to some other service provider.  In the Silver case, the (now ex-) Speaker received such fees from two different law firms.  As described in this piece in the NY Times , one of these firms -  “a  large personal injury law firm where he has worked for more than a decade” – paid him more than three million dollars based on  client referrals from a doctor whose research center had been given $500,000 in state grants orchestrated by Silver.  Another part of the prosecution’s case involves his receipt of referral fees from a real estate law firm to which he had steered clients and his performing official action to benefit those clients.

In both of these alleged schemes the principal victims were the taxpayers of NY, whose interests were subordinated to Silver’s personal interest. The element of harm to the two firms’ respective clients was less a part of the picture (although some harm could be presumed with the personal injury referral fees). But in a traditional referral fee situation the harm is principally and often entirely to the client.

Of course, it is not only lawyers who pay/receive referral fees – and who face ethical questions involving these practices.  For instance, architects must, as a matter of professional standards, disclose referral fees.  As noted in this Advisory Opinion from the American Institute of Architects: “It makes no difference under the disclosure rules whether the architect is certain that the contractor he recommends is the best one for the job or that he would make the same recommendation even if no referral fee were paid. Though the architect may be confident there is no actual conflict of interest, any referral fee is an interest substantial enough to create an appearance of partiality and is a factor about which the client is entitled to know.”

Legal and ethical issues regarding referral fees are disturbingly common in the medical profession.  For a discussion of the conflicts of interest inherent in such arrangements see this post  from Chris MacDonald’s excellent Business Ethics Blog: “If the person you’re relying on for advice is financially beholden to the person he or she is recommending, you have every reason to doubt that advice.”

Such practices are also common in the financial advisory services realm.  See this discussion of  relevant ethical standards,  and note that – as with doctors – these cases sometimes cross legal, as well as ethical, lines.

Finally, the regulation of referral fees in the legal profession has existed for many years. However, the area is increasingly complicated by the phenomenon of referrals being made by non-attorneys to law firms, as described in this paper by John Dzienkowski of the University of Texas School of Law.

Indeed, in my own practice I have been offered referral fees by vendors selling C&E products and services.  I always say No.  I’d like to think that my steadfastness is the result of being virtuous, but in reality, it is just a matter of common sense. That is, for clients or prospective clients to have to worry about whether my advice was tainted would be devastating to my business.  And no referral fee could ever compensate for that.