Conflict of Interest Blog

More on conflicts of interest and corporate boards

Director COIs are in the news again.

First, the Wall Street Journal reported last week: “Generic-drug maker Mylan NV moved into new headquarters in December 2013 after buying vacant land in an office park near Pittsburgh and erecting a five-story building for about 700 employees. The company hasn’t publicly disclosed that the office park’s main developer is Rodney Piatt, Mylan’s vice chairman, lead independent director and compensation-committee chief. The new headquarters was a big boost for the mixed-use real-estate development, called Southpointe II, where all the land has been sold and some of the last buildings are now rising.”  As the article further describes, Piatt sold his interest in two parcels to a business partner for nominal amounts,   who in turn sold the parcels to Mylan for several million dollars each, but that does not mean that Piatt received no benefit from the dealings: “Mylan’s decision to build the new headquarters may have helped boost the value of Mr. Piatt’s other holdings in [the development]. After local officials in 2011 approved permits and rezoning for a plan that included the headquarters, a firm managed by Mr. Piatt sold a nearby hotel for $14.8 million, property records show. Mylan’s plans helped spur interest from retailers to sign leases, says… the business partner of Mr. Piatt. ‘The more people there are in offices, the more demand there is for lunches’ and other services,… .”

While there is presumably more to this story than what appears in the article, it is hard to argue with the take of corporate governance expert Charles Elson: “’The optics are terrible. Pittsburgh is a big town with no shortage of real estate. Either they could have gone somewhere else, or [Mr. Piatt] could have relinquished the directorship and eliminated the conflict.’”

The second article – which appeared this past weekend in the New York Times –  is no less interesting: “Consider a document recently filed in a 2013 shareholder lawsuit against directors of Dish Network, the television provider based in Englewood, Colo., which contends that the company’s co-opted board cost its investors at least $800 million in one recent episode. The document also provides some seriously good, well, dish on personal and family ties between Charles W. Ergen, the company’s co-founder and chief executive, and two Dish directors the company identifies as independent in its regulatory filings. Lawyers for Dish shareholders found, for example, that the family of Tom A. Ortolf, a director who is head of CMC, a private investment firm, has taken numerous hiking trips with Mr. Ergen’s family. Another fun fact unearthed in the case: Four invitees to a 17-person bachelor party for Mr. Ortolf’s son were Ergen family members. Then there’s the note Mr. Ortolf sent after Mr. Ergen offered two Super Bowl tickets. “I love you man!” the director exulted. George Rogers Brokaw, a managing partner at Trafelet Brokaw & Company in New York, is another independent Dish director with personal ties to Mr. Ergen. Mr. Brokaw’s family hosted members of the Ergen clan at their homes in New York City and the Hamptons, the lawsuit says. Mr. Brokaw also provided advice on a job search to one of Mr. Ergen’s children. Cantey Ergen, Mr. Ergen’s wife and a Dish co-founder who is also a director at the company, is godmother to Mr. Brokaw’s son.” The Times piece further describes: “The close relationships between Mr. Ergen and his directors might not have mattered so much if not for a private investment he made in 2012 [which, the shareholders contend in their suit, represents a usurpation of a “corporate opportunity” belonging to the company] “that could generate personal profits for Mr. Ergen of perhaps $800 million. After shareholders sued, contending that the transaction was a breach of the chief executive’s duty to Dish, a special litigation committee of the company’s board was formed to investigate the deal. As it turned out, Mr. Ortolf and Mr. Brokaw were appointed to two of the committee’s three posts.”

There’s lots to be said about director conflicts  (see prior posts collected here ) but perhaps the overarching point is that a big part of the reason that the position of corporate director exists is to ameliorate the conflict-of-interest-like “agency problem” that comes from executives managing other people’s (i.e., shareholders’) money.  Since directors’ COIs can raise questions about the ability of a board to perform this vital function, they can be especially pernicious.  For this reason, it is part of a director’s job,  I believe, to avoid situations that  give governance experts like Charles Elson just cause to berate them publicly for creating terrible optics, as he did the Mylan directors.  Put otherwise,  directors have to be attentive not only to actual COIs but apparent ones too.

Of course, every member of a public company board would swear that they are familiar with this principle.  But what is less well appreciated is just how difficult mitigating an apparent conflict can be – and particularly so for powerful people with complex business dealings. For more on what is involved in mitigating apparent COIs see this earlier post.  On the other hand, maybe the Mylan board did understand how challenging mitigating the apparent COI facing them would be, and so opted for non-disclosure. Of course, once uncovered, non-disclosure itself contributes to the appearance of wrongdoing.

Turning to the other case of the week, while the Dish directors might feel that the various purely social ties described in the Times piece are not the stuff of conflicts, the conception of COIs under Delaware law does indeed encompass non-financial relationships, as established by an important (but sometimes forgotten) case in 2003 involving the directors of Oracle. As  described in this article about fiduciary duties,  the court there  held that “a director must base his or her decision on the merits of the subject matter rather than ‘extraneous considerations or influences’ and that a director may be ‘compromised if he is beholden to an interested person.’ Most importantly, the court stated that ‘[b]eholden in this sense does not mean just owing in the financial sense, it can also flow out of ‘personal or other relationships’ to the interested party.”

The Magna Carta, compliance and ethics

A brief birthday salute to the Great Charter in the July issue of Compliance & Ethics Professional (second page of PDF).

I hope you find it of interest.

Behavioral ethics and compliance – what to do about “framing” risks

Over the past few years, the COI Blog has devoted a fair bit of attention to considering what “behavioral ethics” can mean for corporate compliance programs.  An index of these writings can be found here.  Conspicuously absent from this compilation was anything on the important behavioral concept of “framing.”

But blogs abhor a vacuum, and fortunately this gap has now been filled courtesy of an excellent article by Scott Killingsworth (of the Bryan Cave law firm) in the latest issue of Ethisphere magazine.  As he notes:

Psychologists have much to say about the phenomenon of “framing”—the process by which we decide “What kind of situation is this? What rules and expectations apply?” How we frame a situation affects our thinking and our behavior. We know, for example, that merely framing an issue as a “business matter” can invoke narrow rules of decision that shove non-business considerations, including ethical concerns, out of the picture. Tragic examples of this “strictly business” framing include Ford’s cost/benefit-driven decision to pay damages rather than recall explosion-prone Pintos, and the ill-fated launch of space shuttle Challenger after engineers’ safety objections were overruled with a simple “We have to make a management decision.” We are surprisingly susceptible to external cues about how a situation should be framed. For example, researchers have found that simply renaming “The Community Game” as “The Wall Street Game” cuts cooperation in half: the business frame suggests not only what is expected of us, but what tactics we should expect from our opponent.

There’s much more to this article, but I won’t quote or summarize anything else as I encourage you to read the original. However, I do want to add two thoughts about what framing means from a C&E program perspective.

The first is pretty obvious: framing – and other key behavioral ethics concepts – should be part of C&E training.  In particular, companies should consider including a high-level review of behavioral ethics concepts (with examples) for general employee training and a more detailed version for senior managers and “controls” personnel.

The second is less obvious: these dangers underscore the importance of having a C&E  officer whose “reach” makes it likely that she’ll be at the table when framing risks  first surface.  Moreover, that may be an additional reason to have a CECO who also wears the General Counsel hat (as discussed in this recent post),  since by definition these risks don’t appear to be ethics-based; i.e., the GC in most companies is more likely to be part of what is ostensibly a general business discussion than is a non-GC CECO.

General counsel as chief ethics and compliance officer

Woody Allen once wrote: “Why pork was proscribed by Hebraic law is still unclear, and some scholars believe that the Torah merely suggested not eating pork at certain restaurants.” Something similar can be said about general counsels serving as chief ethics and compliance officers.

The dispute about GCs wearing the CECO hat as well also has porcine-related origins – Senator Charles Grassley’s famously saying: “It doesn’t take a pig farmer from Iowa to smell the stench of conflict in that arrangement.” But based on my experience with hundreds of companies’ C&E programs,  the Senator’s sweeping proclamation doesn’t hold up for all organizations. While  there are indeed certain situations where the CECO should be independent of the GC – e.g., the company is in an industry where the government has voiced a preference for such reporting structures – plenty of times  the opposite is true and the principal effect of  being “independent” is being powerless.

Earlier this month LRN made a significant contribution to this debate with its 2015 Ethics and Compliance Effectiveness Report (which is available for download here). The survey which served as the basis for that report found that: “Among our respondents, 29% are led by CECOs reporting to the CEO, but not all of them get the same-sized seat at the C-Suite table. Roughly half of them also serve as general counsels, and these two-hatted stalwarts run programs significantly more effective than those of their one-capped colleagues.”

I won’t try to summarize the study’s methodology or  all of the specific findings on program efficacy, but one result really stood out for me: “Fully 68% of the GC/CECOs see the primary mandate of their programs as ensuring ethical behaviors and the alignment of decision making and conduct with core values, while that is true of only 41% of the dedicated CECOs. By contrast, 59% of those full-timers see their primary mandate as ensuring compliance rules and regulations, a position taken by only 32% of the GC/ CECOs. As we have previously determined, values based programs outperform rules-based programs by almost every measure.”

There’s plenty more in the study that challenges the orthodox view on this topic, and I encourage you to read it.

 

Inherent conflicts of interest and behavioral ethics

At his trial for Libor rigging, evidence was introduced last week that former trader Tom Hayes had told the Serious Frauds Office that “many of the people responsible for submitting panel banks’ Libor rates also traded products linked to the rate, creating an inherent conflict of interest” and that “’[n]ot even Mother Teresa wouldn’t manipulate Libor if she was trading it,…’”

While obviously somewhat self-serving, this colorful bit of analysis still  helps to underscore the overarching behavioral ethics point that to reduce the risk of ethical transgression often one cannot always count on the characters of those involved.  Rather, the situation will play the decisive role.

Inherent COIs are an instance of that. Granted, they are just one of many such types, but they may also be more common than most others, and hence worth further study.

And beyond an area of interest to behavioral ethicist scholars, seeing some COIs as being inherent (or near to inherent) can be useful to others, too, such as:

– C&E professionals, who should consider the category of inherent COIs in their risk assessments.

– Senior managers and directors, who should – as part of their C&E program oversight – make sure that nothing their company is doing or contemplating doing falls into (or anywhere near) this category of risk.

– Enforcement personnel, who often can find good fishing in the inherent COI waters.

– Individual business people, who – in making career decisions – should steer clear of jobs that could involve inherent conflicts of interest.

On this last point, Mr. Hayes would surely agree.

And on the point about the role of enforcement personnel, in my view the “fishing” shouldn’t be limited to those individuals who succumbed to the pull of the inherent COIs, but should also include the senior managers and directors who allowed the COIs to exist in their respective organizations. (For further reading on how a behavioral understanding of ethics and compliance should inform our approach to liability see this earlier post.)

(Thanks to Scott Killingsworth of the Bryan Cave law firm for letting me know about this story.)

The compliance officer as spy (among other unusual roles)

I was on a conference panel this week discussing compliance officer reporting relationships and the topic of C&E officers reporting to the audit committee came up.  I stated my general view: strong informational reporting by the C&E officer is always a good thing, but with administrative reporting the picture is mixed. (In brief, I think that the latter type of reporting can contribute to C&E office independence and “clout,” but some audit committees might not be able to provide C&E officers with the day-to-day supervision that a general counsel does, resulting in their becoming organizational orphans.) One of my co-panelists then voiced a different reason for being chary of administrative reporting to the audit committee:  other employees might take this to mean that the C&E officer is the board of directors’ “spy.”

In my nearly 25 years in the C&E field I’d never heard this view before.  My initial reaction is that it generally shouldn’t be an issue, but I also see the visceral logic of the concern.  Moreover, the person who made the comment is one of the nation’s most experienced C&E officers, and his saying it underscored for me that compliance professionals may have a view of issues relating to reporting relationships that many employees of their respective companies – who are typically less schooled in the basics of corporate governance  – may not share.

Somewhat similarly, I occasionally encounter companies where the C&E officer’s role includes representing the company in regulatory matters.   My general reaction to this has been that it is a negative with respect to the independence dimension – mostly in terms of how the C&E officer is viewed (as a defender, who might be reluctant to criticize her company) but also possibly how she acts (in ways she may not realize). On the other hand, perhaps dealing with regulators on behalf of their company would be seen as a plus in terms of clout.  As with the C&E officer as “spy,” it would be nice to know what the take of a general employee population – as opposed to C&E professionals – is on this issue.

Finally, what about  C&E officers who call themselves ombudspersons? I’ve always been troubled by this practice, as a true ombuds role requires institutional neutrality of a sort that few C&E officers have – and an employee might feel misled by this designation.  But perhaps none would actually notice or care.

Anyway, I would be interested in the views of readers of the COI Blog on these (or related) issues.

What should your risk assessment do for your compliance program?

On Monday June 1 I’m giving a presentation on risk assessment at PLI’s Compliance & Ethics Institute in NYC.  Here are the slides, which discuss, among other things:

– Fourteen specific things a risk assessment should do for your program – most of which are missed by many companies.

– How an assessment can also educate key people in your company about C&E, set useful boundaries for your program and maintain program momentum.

– The need for assessments to become more granular with time.

– How to develop an initial list of possible risks.

– What “cultural” factors should be considered in an assessment.

– Corruption and competition law assessments.

– A look into the future – the “demand side” of risk assessment.

There’s still time to sign up for the conference – which is also being web cast.
But for those who can be there in spirit only, I hope you find the slides useful.

Ps – this is my 20th year in a row speaking at the PLI compliance conference.  I wish I could say that it makes me feel proud, but mostly it makes me feel old.

The ethics of “backscratching”

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.”

A recent judicial decision helps make compliance a little less risky

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.

“Advanced tone at the top” and the role of behavioral ethics and compliance

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.