Conflict of Interest Blog

More on “reverse conflicts of interest”

In a post several years back I discussed what could be called “reverse conflicts of interest,” starting with an example from my work:

A company enters into a complex business arrangement where one of its managers has a relationship with the other entity.  The relationship is fully disclosed and approved pursuant to company policy on COI waivers.  After time, the arrangement runs into business difficulties.  Although the company has lived up to its contractual obligations, the other entity seems to feel that the company should have done more to make the arrangement work.  Based partly on that, some employees of the company question whether that entity had been promised more than was disclosed by the manager, causing the employees to take various defensive measures which put further strain on the arrangement. Ultimately, the arrangement collapses.

As a general matter, if properly disclosed and approved, some COIs can be waived (although some should not be permitted under any circumstances).  Such approvals can be either a true “green light” or subject to being managed on an ongoing basis, i.e., a “yellow light.”

Like many C&E-related determinations, this type of decision tends to be made based on a balancing of costs versus benefits (hopefully, with a reasonably high burden of showing that the latter outweigh the former).

The case above illustrates what I believe is a factor that should generally be considered by companies deciding whether to grant a COI waiver: whether there will be reasonable possibility of overcompensating for the COI in ways that are harmful to the company.  The potential for such “reverse COIs” could turn on many factors – perhaps most significantly, on the extent to which the contemplated relationship must rely on trust.  (That is, the greater the need for trust, the greater the possibility of suspicion – at least as a general matter.)

Historically, reverse COIs may not have been common.  But as sensitivity to COIs has grown dramatically over the past few years …they seem more likely to occur than ever before, and should be on a company’s radar in making COI waiver determinations.

In the many years since that post I cannot say that I have seen many reverse COIs. But I did find notable the following discussion from the recently published  Conflict of Interest Disclosure With High Quality Advice: The Disclosure Penalty and the Altruistic Signal by Sunita Sah of the Johnson Graduate School of Management, Cornell University and Daniel Feiler of the Tuck School of Business at Dartmouth: “In this paper, we explore whether laws requiring conflict of interest disclosure damage the advisor-advisee relationship more than is intended. Across six experiments (N = 1,766), we examine situations in which advisors give high quality advice but still must disclose a conflict of interest. As predicted, such disclosures yield negative attributions regarding the advisor’s character, even when advice is of high quality (and advisees have full information to judge advice quality), and even when the advisor’s professional responsibility and self-interest are aligned, or the advice runs counter to the advisor’s self-interest. This disclosure penalty decreases trust in honest advisors…” (emphasis added).

In short, a reverse COI experiment, of sorts.

Finally, given the extent to which President Trump’s extraordinary COIs have garnered widespread attention, it will interesting to see if over time the reverse COI phenomenon has a widespread effect on how we view COIs in the government realm generally.

 

 

 

Assessing conflicts of interest risks

Conflicts of interest have long been seen as an area of significant risk. But that does not always translate into the conduct of meaningful risk assessments.

Part of the reason for this disconnect is a widespread belief that COI risks are already well known. Certainly every C&E professional knows that the major types of COI for most business organizations involve employees a) having financial ties to competitors and third parties that do or seek to do business with the organization, and b) hiring family and friends into the organization. Similarly, the basics of the other two major COI categories – organizational and gatekeeper COIs – are generally understood by C&E professionals working in fields where risks of such conflicts are significant.

But understanding the general risks regarding COI may  not be enough to generate the type of information that an effective risk assessment process requires, which is information that will help design or modify all the risk-sensitive elements of a program to mitigate COIs. These are policies, training,  and other communications,  auditing and accountability. (Note the other program elements – e.g., helplines, investigations,  incentives, discipline  – are obviously important too, but tend not to vary by risk area.)

Each assessment will vary in substance. But here are some areas of inquiry that may be useful to companies just starting out.

– Any relevant COI history at the organization – violations, near misses and inquiries.

– Any relevant COI history at competitor or otherwise comparable organizations, to the extent known.

– Same inquiry regarding customers, suppliers and other third parties with which one  does business.

– COI standards that are not fully understood or appreciated.

– Weakness in “inner controls” (where – due to factors described in behavioral ethics research – moral constraints against wrongdoing are of diminished efficacy).

– Instances or prospects of prosocial COIs (“right v. right” risks).

– Industry-related risks.

– Cultural-related factors.

– Efficacy of process controls (particularly around COI disclosure/approval regimes).

Note that in some instances the inquiry can be done on an enterprise-wide basis but for others it should be granular (e.g., region, business line, function) too.

Come to the Navex Global master class on conflicts of interest

Together with Rebecca Walker and Jolene Wall of REI, I will be teaching a master class for Navex Global on conflicts of interest compliance programs.

More information is available here.

Why it is important to know who the victims of corruption are

A new posting on the FCPA Blog.

I hope you find it useful.

Insider trading and conflicts of interest

The Coronavirus is,of  course, creating considerable volatility in the stock market. With such volatility comes opportunity for investors to make profits, either honestly or otherwise. Are companies prepared for what might be an increase in insider trading risk?

In many companies the principal “owner” of insider trading compliance is the corporate secretary or other member of the law department – not the compliance & ethics officer. That is generally fine, as the subject is of a fairly technical nature.

But in my view the CECO should still have  a “line of sight” into insider trading compliance too. This is particularly so given that insider trading laws are – at least in part – conflict-of-interest based, and COIs are within the “heartland” of a CECO’s duties.

The basics

The core of an insider trading compliance program is the policy, which every public company (and some private companies) should have. A typical policy should cover the following

– Explanation of insider trading, including definitions of key terms such as “material” information, non-public information, purchase and sale.

– Procedures to prevent insider trading, including preapprovals and black-out periods.

– Policy and procedures on “tipping.”

– Any additional transactions that are prohibited by the policy, such as trading in options in the company stock or buying on margin,

– Rule 10b5-1 trading plans.

– Penalties and enforcement.

The basics also include:

– Insider trading training and periodic communications.

– Certificates of compliance.

– Avenues for seeking guidance and reporting concerns.

The role of the CECO

Most of these items are, as noted above this is fairly technical. But an insider trading program can also have a broader cultural dimension.

For instance, as noted in an earlier post: insider trading should be seen as a form of private corruption, rather than as a more technical and indeed victimless form of wrongdoing,  which it is sometimes seen as. This can give enforcement and compliance efforts  a degree of moral force that they might otherwise lack.

Can the corporate secretary make the case about insider trading being a form of private sector corruption? Sure – but in all likelihood the CECO can do it better because she will be able to place insider trading within the larger conflict of interest framework. This could make both areas stronger.

Again, I’m not trying to take work from the corporate secretary. But having the insider trading program learning from the CECO could help companies strengthen their compliance in a time of heightened risk.

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You might be interested in this piece about abuses in the gifts and entertainment area  being viewed as “soft-core corruption.”

The gut as accomplice

A review of core behavioral ethics concepts (“Rule-breaking without Crime: Insights from Behavioral Ethics for the Study of  Everyday Deviancy” by Yuval Feldman, Benjamin van Rooij and  Melissa Rorie) noted: “Behavioral Ethics has shown that … people relying on System 1 cognition (characterized by intuitive and emotional decision making, more so than System 2’s deliberation and planning) are more likely to be unethical.”

For the past three years we have seen countless examples of President Trump relying on his gut in making decisions for the country – most recently in saying he would trust his instinct in deciding when to reopen the economy. More generally, as described in an article in The Atlantic ,“Trump’s Most Trusted Adviser Is His Own Gut. The president’s glandular instinct has become a substitute for all expertise and all nuance.”

Even if he loses the election in November, Trump’s triumph of instinct over reason will have caused lasting damage to the moral fabric of our country. To counteract that, we need to strengthen the moral imperative not just to be honest but also to be careful and deliberative, particularly when making decisions that will significantly impact others.  We should heed these words of  Samuel Johnson: “It is more from carelessness about truth than from intentionally lying that there is so much falsehood in the world.” And carelessness is obviously at the root of many other types of wrongdoing too.

One specific  example is suggested by a presentation – “Beyond Agency Theory: The Hidden and Heretofore Inaccessible Power of Integrity,” by Michael Jensen and Werner Erhard – discussed in this earlier post. The authors argue that honesty requires more than sincerity: “When giving their word, most people do not consider fully what it will take to keep that word.  That is, people do not do a cost/benefit analysis on giving their word.  In effect, when giving their word, most people are merely sincere (well-meaning) or placating someone, and don’t even think about what it will take to keep their word. This failure to do a cost/benefit analysis on giving one’s word is irresponsible.”

There are many other examples of how more deliberative thinking can lead to less gut-led actions.   Big picture: ultimately we need to get to a place where being  uncareful is broadly seen as unethical in the same way that being dishonest is. 

Investigation manuals

An article in  C&E Professional on drafting investigations manuals.

I hope you find it useful.

This is a test

In Testing Compliance, (published on the Harvard corporate governance web site, with the full paper available at SSRN), Brandon L. Garrett. Professor of Law at Duke Law School, and Gregory Mitchell, Professor of Law at the University of Virginia School of Law, note that “what makes the compliance enterprise deeply uncertain and problematic is that the information generated by compliance efforts is simultaneously useful and dangerous. However, documenting problematic behaviors creates a record that may be used against the corporation in future administrative, criminal or civil proceedings, or may become the subject of a media exposé. Officers and directors, and the in-house compliance team, may sincerely hope compliance programs are effective, but they may quite rationally avoid testing that hope. The end result will often be rational ignorance with respect to the effectiveness of corporate compliance programs. This dynamic—the hope that greater attention to compliance will reap benefits drives more resources toward compliance efforts, yet fears about what examining the effects of those efforts might reveal hinders validation of compliance programs—creates a ‘compliance trap’ that can ensnare corporations and regulators alike.” The authors  “explore ways out of this trap.”

Among other things:

– They argue for government policies to promote more information sharing by companies about what works and what doesn’t in terms of C&E. While there is already some such sharing via compliance conferences and though various professional organizations there is clearly room for improvement here.

– They also note, based on compliance information published by Fortune 100 companies, that if such companies “are measuring the effectiveness of their compliance programs, they are not sharing it. It is also possible that what we see is what we get: active educational efforts focused on employee training and assessments of that training using employee surveys and reactive compliance efforts relying on whistleblower reporting and investigation of those reports. The public record reveals few active efforts to detect and remedy weaknesses within internal compliance systems.” I agree that sharing of this kind could be a powerful force in promoting strong C&E.

– They propose instituting a “legal mandate that organizations regularly test their compliance systems for effectiveness. But to incentivize companies to put in place strong compliance programs and audit those programs rigorously, the mandated reports should not increase their litigation exposure. ” I think implementing legislation to help companies avoid the “compliance trap” in this way would be very beneficial, though getting to such a safe place would – in my view – be a lengthy and difficult journey.

– They note: “Companies need to proactively test whether their employees, when given the chance to misbehave, really do. Such testing need not involve comprehensive data collection or expensive analytics, although firms increasingly use such tools, and consultants may market AI approaches to compliance. Rather, experiments, relying on blind performance testing of randomly sampled employees, can quite inexpensively measure whether employees comply in realistic work situations.” I note (as do the authors) that some this already happens but think there needs to be more of it. However, one must be careful to avoid the perception that employees are being treated as the subject of experiments.

Finally, there is much more to this piece and I encourage you to read it in its entirety.

 

Assessing compliance incentives

A new post by Rebecca Walker and me in Corporate Compliance Insights.

We hope you find it useful.

Will working at home make us more ethical?

Research we reported on several years ago suggests it could.

In “Truth Telling: A Representative Assessment,” published in October by the Institute for the Study of Labor in Bonn, Johannes Abeler, Anke Becker and Armin Falk report on the results of two recent studies in Germany which suggest that individuals who are given an opportunity and motive to lie/cheat are unlikely to do so where the wrongdoing would take place in their home.  That is, individuals were called in their homes and asked to flip a coin – with the understanding that if they reported tails they would be paid a certain amount of money but they would get nothing if the reported heads.  In one version of the experiment, 56% reported heads, a number which presumably reflects a near zero amount of cheating (and maybe underreporting of the profit maximizing result).   The results of a second version were essentially indistinguishable from the first.

What is noteworthy here is that earlier studies on honesty that were conducted in laboratories showed a substantially higher percentage of cheating.  Thus, comparing those results to the new ones suggests that context may have a significant impact on truth telling – and perhaps other forms of ethical conduct.  This is consistent in a broad way with many other behaviorist studies showing how surprisingly malleable we are with respect to ethical conduct.

But can this information be used to promote compliance and ethics in the workplace, or is it interesting but not especially helpful?  At least as a general matter, I expect that C&E training and other communications could evoke the sense of home that seems to engender honesty, although obviously one would need to take care not to go overboard with such an approach.  (Indeed, some training I developed years ago sought to draw this connection,  and I think it was well received.)

Moreover, building on the apparently well-understood need for being truthful at home may be especially important given the relatively tepid endorsement of truthfulness in the workplace that one finds in many companies, including some with otherwise strong C&E programs.  That is, from what I’ve seen over more than twenty years in the field, one finds far less attention in codes of conduct and other C&E communications to the general importance of truthfulness than one would expect.  This shortfall may reflect the commonly held view that some degree of “bluffing” is appropriate in business, as noted in a famous article in the Harvard Business Review.

The benefit of evoking a “domestic” sensibility regarding ethics is that whatever the apparent logic of the bluffing perspective might be in the business realm (and from my perspective, it was never persuasive) on a gut level we are far less likely to accept it in our home lives, where its unsustainability is self-evident to the point of being intuitive (particularly so for parents, but presumably for any type of family member).  That is, whereas one might be aware of successful business careers built on truth bending it is simply impossible to imagine a healthy family life resting on such a foundation, and, I believe this is something that we not only understand intellectually but feel emotionally.

Of course, C&E professionals can also draw upon some very good data showing that in business honesty really is the best policy, such as this study last year by the Corporate Executive Board.   Appealing to one’s colleagues with a direct case should always be the principal approach to promoting business ethics.  But, as with many behaviorist experiments linked to above, this recent study may provide another, and somewhat less obvious, set of tools for enhancing the ethical performance of organizations.