Moral hazard and the revised DOJ compliance standards

One of the great afflictions of our age is moral hazard. As noted in an earlier post: “The concept of moral hazard was used originally to refer to the phenomenon that providing insurance tended to promote risky behavior by insured parties.  Subsequently, the idea has been applied more generally to mean the provision of incentives that encourage unduly risky conduct by shifting the impact of a bad decision to a party other than the decision maker.”

Another way of thinking about this area is that moral hazard can arise from of lack of appropriate accountability. A notable example of this can be found in an SEC report several years ago on ratings agencies quoting an e-mail between two analysts concerning their plans to give positive ratings to certain financial instruments that were, in fact, unworthy of such ratings: “Let’s hope we are all wealthy and retired by the time this house of cards falters.” A more consequential example is climate change: those who are most likely to be affected by this unparalleled calamity are generally not the same as those who have the power to slow it down (and ultimately reverse it).  And, the Pandemic presents millions of  moral hazard influenced decisions concerning wearing safety masks and other issues.

Moral hazard is not the same thing as conflicts of interest. But they are close enough to each other to be considered “cousins.”   However, the former does not get nearly the attention that the latter does. (See prior posts on moral hazard collected here.)

Moral hazard poses a significant challenge to law enforcement in many types of business crime cases. That is, the Sentencing Guidelines provide for large fines for organizations convicted of federal offenses, but those who bear the brunt of such punishments (mostly the shareholders) are often different than the individuals (usually executives) who benefit from the wrongdoing. The problem, of course, is that their organizations do not hold them to account through the investigation and disciplinary processes.

The history of corporate business crime enforcement is, in part, an effort to close this moral  hazard gap. The latest chapter of this history was released June 1 when the Criminal Division of the Justice Department published its  third iteration of Evaluation of Corporate Compliance Programs.

The prior iterations of the guidance already had included considerably strong approaches to promoting accountability by individual wrongdoers.  In the new version what  most struck me as relevant to the moral hazard issue was the following question: “Does the compliance function monitor its investigations and resulting discipline to ensure consistency?”

I am not suggesting that this is some sort of panacea for moral hazard in companies.  Moreover, adding this to a  compliance program works only if the compliance function is indeed independent and has a sufficient degree of “clout.”  As well, a company needs to publicize that it is doing such monitoring and also that it imposes discipline for violations in a sufficiently rigorous way.

But if taken to heart a corporation’s having the compliance function monitor its investigations and resulting discipline to ensure consistency could be a helpful (albeit only partial) antidote to moral hazard.

For more information about the revisions to the Evaluation of Corporate Compliance Program see this post on the Compliance Program Assessment Blog.



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