Edited by Jeff Kaplan
Conflict of Interest Blog
The notion of reciprocity plays a foundational role in our ethical order. Most prominently, variations of the Golden Rule are evidently found in all of the world’s major religions. Ethics-promoting reciprocity can be negative (“an eye for an eye”) or positive (“the best place for [an Eskimo] to store his surplus is in someone’s else’s stomach.”) But, there are also the less ethically savory types – commonly referred to as “mutual backscratching,” but having other names too (my favorite being “the ledger system”).
This past weekend, the Wall Street Journal reported that the “U.K.’s financial regulator on Friday said it is investigating a banking-industry practice known as ‘reciprocity,’ where investment banks bring rivals into deals in exchange for future business. The Financial Conduct Authority, in a paper detailing the scope of a wide-ranging review into possibly anticompetitive investment-banking practices, said it was investigating whether reciprocity ‘might restrict the entry or expansion of firms which are not party to these arrangements.’ The investigation into reciprocity comes after The Wall Street Journal reported in March on the widespread practice in Europe of investment banks doling out lucrative work to competitors, partly based on how much business they will receive in return.”
Not being a competition law expert, I don’t have a sense of what would need to be involved for this practice to rise to the level of a competition law violation, although I have to believe that occasional acts of “garden variety” reciprocity alone wouldn’t be enough to cross that line. But in many circumstances – particularly involving “other people’s money” – the potential for a conflict of interest arising from reciprocity seems clear enough.
Consider two cases. In the first, a bank needs legal services and a law firm needs banking services – both needs being purely internal – and each agrees to use the services of the other. I see no COI there, as there are no interests for which a duty of loyalty are being compromised.
But in the second case, the law firm is recommending banking services to its clients, in return for the bank recommending the firm to the bank’s clients. In circumstances of this type – of which many exist – there is the potential for a COI.
How much of a COI is presented will depend in part on whether the referring party has a fiduciary duty to the party receiving the referral. Presumably the law firm would, and I imagine the bank would as well. However, in other settings it is more doubtful – e.g., a plumbing supplies store referring a general contractor to a customer to reciprocate for the contractor’s referring her customers to it.
My own view is that there is some kind ethical duty here but not to the same extent as there would be for those who are paid to give unvarnished advice. The ethical analysis might depend on how long the customer has been dealing with the store – and how much trust he has placed in it during the course of those dealings. Another factor might be how harmful a conflicted recommendation could be. (E.g., substitute “safety equipment” for “plumbing supplies” in the store case above, and you might get a different result.) For further reading on what an “informal” fiduciary duty might entail, please see this post.
From a psychological perspective, reciprocity may not feel like a COI because it does not involve the direct receipt of cash or other things of value – just as barter transactions may not feel as much like tax fraud as does not declaring cash income. A behavioral scientist might say that this increases the extent of ethical peril.
Finally, I believe that – whether based on a true fiduciary duty or some lesser obligation – these sorts of COI (like many others) generally can be addressed by disclosure: that is, they are not inherently evil as some COIs are, as there will sometimes be quite legitimate reasons for the referral. This is especially true where the referring party’s knowledge of the abilities of the referred party comes from their having previously worked together. However, in all situations involving reciprocity COIs the burden is on the referring party to make sure that the disclosure is indeed meaningful.
For reading on a related topic, here is a recent post on the issue of “referral fees.”
In a world thick with laws, it is unfortunately to be expected that law would not only make C&E program measures necessary – it would also make them more difficult. The latest instances of this (at least in the U.S.) are decisions/guidance by the National Labor Relations Board which limit the ability of companies to prohibit certain conduct in social media policies – such as disclosing confidential information from the workplace – that is basic to any C&E program. (See this article for more information.)
Over the years another source of “law versus law” tension in the C&E field has concerned the area of defamation. Specifically, the danger is that those investigating and otherwise addressing wrongdoing in the workplace will, for such efforts, find themselves on the wrong end of a defamation suit. (Defamation law also has a chilling effect on doing background checks of prospective hires – another a negative from a C&E perspective.)
Because of this tension, some C&E practitioners have been closely watching the progress of Shell Oil Company v Writt through the Texas state courts. The case involved a defamation suit brought by an employee of Shell regarding the results of an internal investigation into possible FCPA violations that was provided to the Department of Justice. He said that the report falsely accused him of bribery.
The company asserted that in this context its report was absolutely privileged. The trial court agreed, and dismissed the suit. (The employee was allowed to proceed to trial on a wrongful termination claim, but the jury ruled against him on that.) However, an appeals court reversed the trial court’s decision on privilege. Last Friday, the Texas Supreme Court reversed the appeals court, upholding the claim of absolute privilege, on the grounds that Shell’s report was “preliminary to a proposed judicial proceeding”. (The court’s decision can be found here.)
By way of background, Texas and other states have traditionally offered absolute immunity with respect to comments made in judicial proceedings. This is only fair given that participation in judicial proceedings can be compulsory and that complete candor is necessary to the operation of such proceedings
But the question in the Shell case is how does this apply to companies’ theoretically voluntary dealings with DOJ – an important issue for C&E personnel given how much the real action involving the prosecution of companies occurs not in courtrooms but in prosecutors’ offices. Citing the Sentencing Guidelines, DoJ enforcement policy and huge FCPA penalties as establishing powerful incentives for companies to cooperate with the DOJ, the court held that Shell was indeed entitled to absolute privilege in the setting presented by this case.
Finally, note that my brief summary of the decision leaves out the court’s doctrinal analysis of different privileges under Texas law, as I believe what will be most interesting to readers of this blog is the big-picture view of law helping to make compliance less legally risky. At least a little less.
Many years ago a CEO at a client organization was called on to respond to a case of employee misuse of T&E expenses at his company. The CEO was, as best I could tell, an honest individual, and he used the occasion to tell managers in no uncertain terms that he expected them to be that way too. What he didn’t do was to use the occasion to tighten the loose procedures in the T&E area, let alone to consider enhancing risk assessment, monitoring or other C&E measures or improving the company’s culture.
Through employee surveys, board of director reviews and compliance/ethics program assessments, the “tone at the top” at many companies is being measured to an extent never before seen. But what exactly is being measured – and is it all the “right stuff”?
Personal honesty is, of course, foundational to a good tone at the top. So is communicating regularly and sincerely the importance to one’s company about the need to act in an ethical and law abiding way.
But CEOs should, in my view, also aim for something higher than these basics.
An “advanced tone at the top” should include not only maintaining a culture of honesty but also one of care. The importance of a culture of care to promoting ethical and compliant behavior is discussed in this prior post.
More broadly, an advanced tone at the top entails senior management truly understanding why companies need to have strong C&E programs. And while that understanding can come from many sources – including the history of compliance failures and writings about the economics-based phenomenon of “moral hazard” – leaders should be particularly inclined to respond to the psychology-based field of behavioral ethics.
This is indeed a growing field and I won’t try to summarize in this post all the ways that behavioral ethics can strengthen corporate compliance programs. For that I commend you to this index of several dozen behavioral C&E posts and particularly to Scott Killingsworth’s important paper “’C’ Is for Crucible: Behavioral Ethics, Culture, and the Board’s Role in C-suite Compliance.”
Why do I think that senior leaders are likely to respond to this approach? Because behavioral science has become very mainstream in fields such as finance and medicine, and seems to have a lot of momentum behind it generally. Catching that wave could well be attractive to business leaders, as could the idea of advancing to a higher level of performance in an area – C&E – that is increasingly seen as integral to leading a business.
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.
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.
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.)
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).
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).
– 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
– “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
– 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
– Include me out: whistle-blowing and a “larger loyalty”
– 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
– 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, behavioral ethics and effective “inner controls”
– Insider trading, private corruption and behavioral 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
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.
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.