Redrawing corporate fault lines using behavioral ethics
At various points in time – such as 1909, when the Supreme Court held that corporations could be criminal liable for the offenses of their employees; 1943, when the Court developed the “responsible corporate officer” doctrine; and 1991, when the Federal Sentencing Guidelines for Organizations went into effect – U.S. law has changed to meet new or newly appreciated risks of misconduct by or in corporations. Is it now time for a legal rewrite using a behavioral ethics perspective?
In her recently published “Behavioral Science and Scienter in Class Action Securities Fraud Litigation” in the Loyola University Chicago Law Journal, Ann Morales Olazábal of the University of Miami School of Business Administration argues that various behavioral economics/ethics research findings warrant revisiting the intent requirements of securities fraud law. She reviews studies showing that the “systematic cognitive errors and mental biases” of “overconfidence, over-optimism, attribution error and illusion of control, the anchoring and framing effects, and loss aversion” can impact decision making in business contexts, and notes: “In the aggregate, these biases establish a human mental environment that is not perfectly rational, but boundedly so. Like other humans, executives and those who surround and support their decision making are subject to flaws in their thinking—subconscious predispositions to see things in self-serving ways that result in a failure to actively and accurately perceive risks and warning signs.”
These factors can contribute in various ways, she argues, to businesses committing securities fraud – but as currently applied the intent element of that offense is inadequate to address risks of this nature. So, she proposes that courts utilize a more objective approach to proving that defendants were reckless in securities fraud cases. The enhanced accountability brought about by such a change in the law, Olazábal says, should help promote greater honesty in corporate financial disclosures by incenting organizations and executives to overcome the effects of cognitive biases – a danger that was unappreciated until the advent of behavioral studies.
Of course, changing the law is not within the job descriptions of most C&E officers, but setting internal standards of accountability generally is. As discussed in this prior post, behavioral ethics research “underscores the importance of the Sentencing Guidelines expectation that organizations should impose discipline on employees not only for engaging in wrongful conduct but ‘for failing to take reasonable steps to prevent or detect, wrongdoing by others’ – something relatively few companies do well (and some don’t do at all).” The post also describes five steps C&E officers can take to strengthen their programs in this regard: “build the notion of supervisory accountability into their policies – e.g., in the managers’ duties section of a code of conduct; speak forcefully to the issue in C&E training and other communications for managers; train investigators on the notion of managerial accountability and address it in the forms they use so that they are required to determine in all inquiries if a manager’s being asleep at the switch led to the violation in question; publicize (in an appropriate way) that managers have in fact been disciplined for supervisory lapses; [and] have auditors take these requirements into account in their audits of investigative and disciplinary records.” Indeed, at least some of these reflect the types of steps that Olazábal’s suggested change in the law might well inspire companies and executives to take.