Conflict of Interest Blog

Conflicts of interest and “the social nature of humans”

Private supply chain auditing continues to serve an increasingly important role in compliance and ethics efforts worldwide.  A recent working paper from the Harvard Business School  – “Monitoring the Monitors: How Social Factors Influence Supply Chain Auditors,” by  Jodi Short, Professor of Law at the University of California Hastings College of the Law; Michael Toffel of the Technology and Operations Management Unit at the Harvard Business School; and Andrea Hugill of the Strategy Unit at the Harvard Business School – examines various factors that impact the efficacy of such audits.  The paper can be downloaded from SSRN and a summary of it can be found on the Harvard Corporate Governance web site.

For this study, the authors conducted a review of “data for thousands of code-of-conduct audits conducted in over 60 countries between 2004 and 2009 by one of the world’s largest social auditing companies, …”  They found that “auditors’ decisions are shaped not only by the financial conflicts of interest that have been the focus of research to date, but also by social factors, including auditors’ experience, professional training, and gender; the gender diversity of their teams; and their repeated interactions with those whom they audit.”  The authors state that this  “finer-grained picture suggests that audit designers should moderate potential bias and increase audit reliability by considering the auditors’ characteristics and relationships that we found significantly influencing their decisions,” and also that these findings “should likewise inform the broader literature on private gatekeepers such as accountants and credit rating agencies.”

Indeed, and beyond the scope of the paper, a focus on social – and not just economic – ties may be key to assessing various  independence issues regarding boards of directors.  In an important decision from 2003 involving a derivative action brought by shareholders of Oracle Corp., then Vice Chancellor Leo Strine noted: “Delaware law should not be based on a reductionist view of human nature that simplifies human motivations on the lines of the least sophisticated notions of the law and economics movement.  Homo sapiens is not merely homo economicus.  We may be thankful that an array of other motivations exist that influence human behavior; not all are any better than greed or avarice, think of envy, to name just one.  But also think of motives like love, friendship, and collegiality, think of those among us who direct their behavior as best they can on a guiding creed or set of moral values,” adding, “[n]or should our law ignore the social nature of humans.”

Finally, thanks to friend of the blog Scott Killingsworth for recently reminding me of the Oracle decision;  here’s an earlier post about the Oracle case, albeit with a different focus; and here is a post briefly discussing (and linking to) a paper by Jon Haidt and colleagues about business ethics implications of a model of human nature called “Homo Duplex,”  a term coined by the sociologist/psychologist/philosopher Emile Durkheim, which posits that we operate on (or shift between) two levels: a lower one – which he deemed “the profane,” in which we largely pursue individual interests; and a higher – more group-focused – level, which he called “the sacred.”

The Caterpillar criminal investigation: culture, risk and “informal” duties of trust

As described in an article in today’s Wall Street Journal  (which may require a subscription for access): “Ten thousand railcars a month roll into [the] sprawling [Terminal Island] port complex in Los Angeles County. While here, most are inspected by a subsidiary of Caterpillar Inc. [Progress Rail Services]. … When problems are found, the company repairs the railcars and charges the owner. Inspection workers, to hear some tell it, face pressure to produce billable repair work. Some workers have resorted to smashing brake parts with hammers, gouging wheels with chisels or using chains to yank handles loose, according to current and former employees. In a practice called ‘green repairs,’ they added, workers at times have replaced parts that weren’t broken and hid the old parts in their cars out of sight of auditors. One employee said he and others sometimes threw parts into the ocean.”

Caterpillar is being investigated by the US Attorney’s office in Los Angeles, and it should be emphasized that no charges have yet been brought.  Still, the article provides some nourishing food for thought about two key topics in the C&E field, as well as one narrower but, likely for some companies, dangerously under-appreciated risk.

First, there is the issue of culture.  As noted in the article, current and/or former employees told the Journal that while ‘[t]hey weren’t instructed to do [these things], …some managers made clear the workers would be replaced if they didn’t produce enough repair revenue…Current and former employees interviewed said those who found large numbers of parts to replace didn’t receive extra pay, but they tended to be favored by the supervisors and sometimes honored with employee-of-the-month recognition. Employees said newer workers sometimes learned bad habits from veterans. ‘I was trained to do everything the wrong way,’ one current worker said. ‘I basically fell into a bandit’s nest.’”

And then there’s this piece of information: “Three years ago, two workers who were fired from a Progress Rail repair shop in Florida filed lawsuits making allegations similar to what the U.S. attorney is looking into at Terminal Island…. A lawyer who represented the two said the suits were settled on terms that barred them from discussing the case.”

Again it should be emphasized that this is only an article – no charges have yet been brought.  But, if these allegations turn out to be founded, then clearly the culture in Caterpillar’s Progress Rail business will – under current enforcement policy – weigh in favor of bringing criminal charges against the company, meaning, in the first instance, the Progress Rail subsidiary.

But what about Caterpillar itself?  Here, the key issue may turn on whether Caterpillar conducted a meaningful risk assessment after it bought Progress Rail in 2006. I recall, from various conferences at that time, that Caterpillar had a C&E officer and program  – and so if it did not look closely at Progress’s risks (then or since) a prosecutor might well wonder why.

Finally, besides broad lessons about culture and risk assessment, the Caterpillar matter – depending, of course, on how it turns out – may reinforce a narrow but important learning about risk for some companies.  That is, when a company expands its business from just manufacturing goods to providing services it often enters a new realm of risk – because its employees are effectively in a relationship of trust with customers that involves opportunities and motives to cheat beyond those in the context in which it is used to operating.  As described in an earlier post in Corporate Compliance Insights,   risk assessments typically should include “[e]xamining whether a company has any relationships (with customers or others) where the need for good faith and candor might not be sufficiently understood by employees or third parties acting on its behalf. Relationships such as these – which tend to involve a high degree of trust but not necessarily a formal fiduciary duty – may be rife with ethics risk potential.”

Businesses facing this risk typically should consider enhanced C&E mitigation measures, and as the Caterpillar matter progresses (pun not intended) it will be interesting to see what – if anything – the company did on this front. (For further reading on informal fiduciary duties  see this post. )

Compliance risk assessments for the little guy

As a matter of both law and common managerial sense, risk assessment is the foundation for an effective C&E program.  But for many reasons risk assessment can also be the most daunting aspect of developing, implementing and improving programs – and especially so for many small and mid-sized companies.

With this in mind, in my latest column in Corporate Compliance Insights, I outline a (relatively) easy-to-deploy 8-step risk assessment process for companies that don’t have the resources to conduct more elaborate fact gathering and analytic efforts about their C&E risks.

As the saying goes, don’t try this in your own home – but consider trying it out in your company.

Summer C&E movies for the holiday weekend

Well,  perhaps not technically movies, but three short and to-the-point videos from the Ethical Systems website – on effective C&E programs, the cultural approach to C&E and possible collaborations between behavioral ethicists and C&E professionals.

Steven Spielberg – watch out!

Have a happy Fourth.

Friendship – and the ties that blind (directors to conflicts of interest)

King Herod the Great had something of a problem: he had backed the losing side in the contest between Marc Antony and Octavian to rule Rome,  and now fully expected to lose his life for it.  But, as described in Jerusalem: the  Biography, by Simon Sebag Montefiore,  when they met he cleverly asked Octavian “not to consider whose friend he had been but ‘what sort of friend I am.’”  Octavian was evidently persuaded by this, for not only was Herod’s life spared but the size of his kingdom was increased.

Loyalty is, of course, fundamental to friendship.  But, while potentially more physically dangerous in the Roman Empire than it is today, friendship in our world can be ethically treacherous.

In “Will Disclosure of Friendship Ties between Directors and CEOs Yield Perverse Effects?”  (to be published in the July 2014 issue of the Accounting Review), Jacob M. Rose, Anna M. Rose, Carolyn Strand Norman and Cheri R. Mazza  describe how they conducted thought experiments involving both actual corporate directors and MBA students to determine  whether “directors who have  friendship ties with the CEO [are more likely that are directors without such friendships] to manage earnings to benefit the CEO in the short term while potentially sacrificing the welfare of the company in the long term” and also whether “public disclosure of friendship ties mitigate or exacerbate such behavior, and will disclosure of friendship ties influence investors’ perceptions of director decisions.”

Sadly but not surprisingly, their research  found “that friendship ties caused directors to be more willing to approve reductions to research and development (R&D) expenses that cause earnings to rise enough to meet the CEO’s minimum bonus target more often than  when the directors and CEO were not friends.” Seemingly more of a surprise, they also found that “disclosing friendship ties resulted in even greater reductions in R&D expenses and higher CEO bonuses than not disclosing friendship ties.”

But this latter finding is not so surprising – given other  behavioral research showing that disclosure can “morally license” individuals  to act inappropriately when faced with a conflict of interest ( as discussed in this   and other prior posts.) As described in a recent piece in the NY Times  by Gretchen Morgenson, one of the study’s authors explained: “When you disclose things, it may make you feel you’ve met your obligations…They’re not all that worried about doing something to help out the C.E.O. because everyone has had a fair warning.”

Morgenson added: “There are two messages in this study. One is for regulators: Simply disclosing a conflict or friendship does not eliminate its potential to create problems. The other,” again quoting one of the study’s authors (but echoing Herod) “is for investors: ‘Shareholders should take a more active role in finding out what kinds of relationships their boards and C.E.O.s have…and recognize the potential traps created by them’.”

For more on conflicts of interest and directors see the posts collected here .

 

Dead peasants, conflicts of interest and Immanuel Kant

In an unforgettable exchange in Michael Lewis’s wonderful book Liar’s Poker a Wall Street executive tosses a ten-dollar bill to a salesman who is heading for the airport and whom he tells to “take out some crash insurance for yourself in my name.” The salesman asks, “Why,” to which the executive replies:  ”I feel lucky.”

A story in today’s NY Times reported on a growing business in company-owned life insurance – in which a worker’s life is insured with the company as the beneficiary:    “Because so-called company-owned life insurance offers employers generous tax breaks, the market is enormous; hundreds of corporations have taken out policies on thousands of employees.”  There has been some effort to rein this business in: under “a law enacted in 2006 … [which] sought to curb the practice — companies now are restricted to insuring only the highest-paid 35 percent of employees, who must give their consent.”  However, this type of insurance “remains a growing, opaque and legal source of corporate profit” – and something that, understandably, can be unsettling to those whose lives are insured for the benefit of their respective employers.  Indeed, it has even earned a colorful sobriquet:  “’dead peasant’ insurance, an allusion to Nikolai Gogol’s novel ‘Dead Souls,’ in which a con man buys up dead serfs to use them as collateral in a business deal.”

Certainly if an employee was betting against her employer that would be considered a conflict of interest (at least as a general matter).  This is presumably why some companies’ policies prohibit employees’ short selling of company stock, irrespective of insider trading concerns.   However, a COI-based line of analysis is a non-starter here because – at least in the US – employment-based fiduciary duties are largely (and starkly) asymmetric: employees owe duties of loyalty to their employers, but not the other way around.

But that’s  not the end of the ethical inquiry, as deontology  - the school of moral reasoning founded by Immanuel Kant,  which provides much of the foundation for modern business ethics – instructs that you should “[a]ct in such a way that you treat humanity, whether in your own person or in the person of another, always at the same time as an end and never simply as a means.”  And, while in the rough-and-tumble world of modern capitalism there may be many close calls with respect to application of this principle, dead peasant insurance seems pretty far over the line to me. Indeed, I was going to add that this is a practice that almost calls out for a modern-day Gogol to capture fully its moral ghoulishness – except that it might be hard to improve on Lewis’s non-fiction version.

 

More on board oversight of compliance & ethics programs, or….

actually less, meaning  that I recently posted a link to a comprehensive article on board C&E program oversight written by Rebecca Walker and me, and now  - from of The Harvard Law School Forum on Corporate Governance and Financial Regulation – here is a shorter version.

Just the right size for that busy audit committee member on the go!

Values, structural compliance, behavioral ethics and…Dilbert

Back in the mid-1990’s, the incomparable business ethicist Dilbert asked his boss: “Can you explain how the company’s new ‘Statement of Core Values’ will change my behavior? I was planning to poison the town’s water supply. But wait! It’s against our core values!”

The debate over the value of values is nearly as old as the C&E field itself.  Harvard Business School professor Lynn Sharp Paine argued  twenty years ago that commitment to company values and values-supporting systems could  do more to promote responsible conduct than could what she described as a legal compliance model.  But sounding a note of caution then was Win Swenson, the principal draftsperson of the Federal Sentencing Guidelines for Organizations, who wrote in a compliance treatise that while “[t]he legal vs. integrity-based dichotomy helps us think about different approaches companies can take….there is a danger in seeing the actual choice companies confront as a stark ‘either/or’ one,” and with each approach by itself having significant limitations.

The debate continues to this day, and was most recently joined by two other Harvard Business School professors  (Francesca Gino and Max Bazerman) and a graduate student (Ting Zhang) in a paper that posits a somewhat similar – but  certainly not identical – dichotomy between “(1) values-oriented approaches that broadly appeal to individuals’ preferences to be more moral, and (2) structure-oriented approaches that redesign specific incentives, tasks, and decisions to reduce temptations to cheat in the environment.”

With respect to values-oriented approaches, the authors describe a wealth of recent research findings from the field of behavioral ethics that, among many things, demonstrates the strong potential to impact behavior in desirable ways of “reminding individuals of their personal moral self-concept.”  However, the authors note that values-based approaches can have limitations and undesired consequences too: “[f]or instance, organizations that promote ethical mission statements while failing to adjust unrealistic goals that routinely place employees in ethical dilemmas.”

The authors also describe research showing that “structuring the incentives, task, or set of choices to reduce or even eliminate the temptation to act unethically,” can likewise affect behavior in various desirable ways.  But here, as well, the news is mixed – as behavioral ethics studies also suggest, among other things, that “using incentives to highlight the negative side to unethical behavior could lead to even more wrongdoing as doing so may prevent individuals from perceiving their decisions as ethically-relevant.”

Thus, and “[g]iven the strengths and weaknesses of values- and structure-oriented approaches on their own, [the authors argue] …incorporating both approaches can compensate for each approach’s unique set of limitations and dampen the risk of adverse effects.” Their paper describes strategies for doing this – including checking for incompatibilities in implementing either approach; aligning the timing of values-related reminders with that of potentially risky decisions; “evaluating decisions jointly rather than separately”; “encourag[ing] mental and social contemplation”; and “designing a structure-oriented intervention [that] includes implementing changes in the environment to induce self-awareness and highlight the link between behaviors and the moral self.”

I should emphasize that while some of the recommendations can be applied in the context of C&E programs that is not the case with all of them. However, this isn’t intended as a criticism of the paper, which does not purport to be addressed to C&E officers but, rather, mainly to other organizational scholars.  Moreover, because this is one of the few behavioral ethics papers published to date where the focus is on finding ways to prevent – as opposed merely  to identify the causes of – wrongdoing,  it should be welcomed by C&E practitioners.  (As discussed in an earlier blog post, for various reasons behavioral ethicists and C&E practitioners should work more closely together, and this paper is an important step in that direction.)

Another comment from a C&E practitioner’s perspective is that while the two approaches identified in the paper are indeed distinct as a conceptual matter, the perception “on the ground” may be somewhat more of a blend.  That is, regularly seeing one’s company take meaningful steps to promote ethicality and law abidance – through incentives, process controls, discipline for violations and other structure-oriented approaches – may itself serve as a potent reminder to employees of their own moral preferences, and possibly  a more effective one than traditional communications.  Indeed, from my more than twenty years of interviewing employees of client organizations about the perceived ethicality of their respective companies I have been impressed with how much values-oriented individuals appreciate strong compliance/structural approaches.  Like Dilbert (as well as Zhang and her colleagues), they seem to know the difference between preaching and practicing.

___

Some related readings:

- Another best-of-both-worlds approach to values and compliance –specifically on how compliance can bring “body” to ethics and ethics can bring “soul” to compliance.   

- Scott Killingsworth’s paper, ‘C’ is for Crucible: Behavioral Ethics, Culture, and the Board’s Role in C-Suite Compliance.

- An index of posts of what behavioral ethics could mean for C&E programs.  

- An exchange with Steve Priest on C&E “checking,”which includes a discussion of embedding C&E into everyday business operations – an emerging form of structural compliance  which could, I believe, play a powerful  role in reminding employees of their moral preferences on a timely basis.

Fathers and children

With Father’s Day coming up this weekend, it seems like a good time to check in on conflicts of interest that can arise from arise from being a dad. Given the powerful instincts at work, parenthood is indeed fertile ground for COIs, as illustrated by the immortal words of the first Mayor Daley, who, in speaking to colleagues on the  Cook County Democratic Committee, defended his having directed a million dollars of insurance business to an agency on behalf of his son John by saying: “If I can’t help my sons, then [my critics] can kiss my ass. I make no apologies to anyone.”  

In the past year, the biggest COI story involving fathers has been the investigation into hiring of Chinese “princelings” by investment banks – and there is no sign of this story going away any time soon. The most recent addition (just in the past week) to the list of those apparently under scrutiny for such practices is  Deutsche  Bank. And, in what is apparently another recent development relating to this inquiry, the former head of JP Morgan’s  investment bank in China was arrested in late May.  However, one should not paint with too broad a brush here, as when it comes to the legality  and ethicality of hiring relatives the devil will likely be in the details – meaning that while some banks may well have crossed applicable legal/ethical lines  others that hired “princelings” could still have acted appropriately (depending on  a wide variety of relevant factors).

The most troubling of other recent fatherhood COI stories concerns the award of the 2022 World Cup to Qatar, in which football legend Michael Platini – a member of the  FIFA  executive committee – played a role. As noted in The Telegraph: “Mr Platini’s son Laurent became the chief executive of Burrda, a Qatar owned sports company” not long after the father’s vote in favor of Qatar’s candidacy,  although the latter has denied that there is any connection between the two events.

Out of fairness to the Platinis, I need to emphasize, first, that the controversial employment of the son was previously known; what is new is a wide variety of other troublesome facts about the choice of Qatar that have only recently surfaced – that may frame how one looks at this hiring; and, second, that a special investigator hired by FIFA is apparently due to submit his report on the matter by the end of July – after which more definitive ethical judgments can be made.  However, even if the hiring of the son is ultimately found to have been done with the purest of intentions, there is a more general learning  worth noting here – which is that, when gauging the possible appearance of a COI, consider if there may be a broader context (i.e, one that is beyond your control – or even current understanding) that, upon becoming known, might influence how others ultimately see the ethicality of one’s actions. (For more on the difficulty of mitigating apparent COIs see this earlier post.)

Finally, the most recent father-and-son COI issue to surface in the US comes to us courtesy of Fox News:  “Vice President Joe Biden’s visit Saturday to Ukraine in support of the country’s new democratic government is renewing concerns about his youngest son being hired by a Ukraine company promoting energy independence from Moscow. Hunter Biden will be working for the company while his father and others in the Obama administration attempt to influence energy policies and other issues of the new government, which is gripped in a struggle with Russia and pro-Russian separatists to control the county.” The article also points out: “American conflict-of-interest laws and federal ethics rules essentially do not regulate the business activities of adult relatives of those who work in the White House, and there’s no indication that the situation crosses legal or ethical lines.”  Still, there is presumably a little of the late Mayor Daley in all of us fathers, so this bears watching.

Reporting to the board on your C&E program

Rebecca Walker and I have a fairly comprehensive article on this challenging and important topic in the June issue of Compliance & Ethics Professional.

You can get a free download of it here.

We hope you find it interesting.