Discipline

In this section of the blog we will examine a) discipline standards and practices involving COIs, and b) independence issues in C&E-related discipline.

Conflict of Interest at Harvard and the Need for Deterrence

We are pleased to have this guest post from Jameson W. Doig, Visiting Research Professor of Government, Dartmouth College  and Professor Emeritus at the Woodrow Wilson School of Public and International Affairs.

On September 12, the Journal of the American Medical Association carried an important story regarding conflict-of-interest in research carried out at Harvard.  In the 1960s, the chairman of Harvard’s Nutrition Department and two of his researchers were given $50,000 (in today’s dollars) to provide a critical review of studies that had identified Sugar as a significant factor in coronary heart disease. Recently discovered files indicate that the Harvard researchers were in close contact with the Sugar Research Foundation, and that they shaped their analysis so it raised doubts about research studies that identified sugar as a causal factor (they suggested that instead “fat” had a key role in causing heart disease). On reviewing a draft, a SRF official said he was pleased with the results. The role of the SRF in financing and partially guiding the study was not revealed in the researchers’ report, which was published in the New England Journal of Medicine in 1967.

The study was completed in 1967 and all three researchers have now died. Even so, the case raises important issues in the field of deterrence. In my view, Harvard should review the evidence described in the JAMA article, and if the integrity of the researchers’ work was compromised significantly by their contacts with the sugar industry, the University should consider public action — formally announcing the negative findings, perhaps removing any Harvard awards given to the three, etc. Action of this kind should help to deter other researchers who may be tempted to carry out research shaped to benefit the funder. (If the allegations in the article are incorrect, the Harvard review should publicly challenge the JAMA implication of unprofessional faculty behavior.)

Although professional rules now ask researchers to reveal their funding sources, it is reasonable to expect that some will not fully comply. More important, revealing funding sources may not be a sufficient deterrent, when large sums to finance research and complex studies are involved. For example, Coca-Cola has recently funded studies on the links between sugary drinks and obesity; and the National Confectioners Association has financed and been actively involved in studies that raise doubts that eating candy is a factor in child obesity. The candy studies were carried out by researchers at two universities, in collaboration with an industry consultant. To protect the reputation of their own institutions, and to improve the quality of research said to benefit the public, university officials should actively monitor apparent conflicts of interest and take punitive action when appropriate.

Risk assessments for office romances

Perhaps the most celebrated story ever about a love affair is Anna Karenina  and the story doesn’t end well – as the distraught heroine throws herself under a train.  Office romances typically don’t end that way, but they are not without risks – particularly those involving senior leaders.

This is indeed an oft-told tale. Here is an earlier post on “frisky executives” discussing one such case from 2012.  Others around that time involved the CEOs of Lockheed Martin and Best Buy. And the latest in this line concerns the CEO of Johnson Controls.

As described in this article of a few weeks ago in the Milwaukee Business Journal, that CEO “failed to inform the corporation’s audit committee about the potential conflict of interest in his extra-marital affair with a consultant hired by the company.”  The net result: a reduction “of his annual incentive performance plan payout to $3.92 million, down nearly $1 million.”

A few thoughts on this case, perhaps of use to any CEO conducting a pre-office affair risk assessment.

First, while the economic hit is high it seems justified for a high ranking official – anything less could be seen as a slap on the wrist. Indeed, one of the cases discussed in the “frisky executives” post also involved a million dollar penalty. So, don’t expect economic leniency.

Second, consider the risk to the other party. In the case of the Johnson Controls executive, she was a consultant in a firm that lost an apparently long standing client in the scandal. No surprise there either.

Finally, while disclosure is necessary it may not be sufficient to prevent harm.  That is because even if an actual COI can be avoided the appearance of a COI might be inescapable – as the natural suspicion among others in the workplace could be that with the relationship comes workplace favoritism. For more on how some  apparent COIs simply can’t be mitigated by disclosure see this post.

(Thanks to COI Blog reader Don Bauer for letting me know about this story.  And, happy new year to all.)

 

“The inner voice that warns us somebody may be looking”

Within the treasure trove of H.L. Mencken’s sayings, this definition of “conscience” may be my favorite.  And, various studies have indeed shown that the sense that somebody may be watching can help promote ethical behavior.  Among these are  experiments exposing individuals to “eyespots” –  drawings which create a vague sense of being watched, even among those who know as a factual matter that they aren’t being seen. (See, e.g., this study, showing that exposure to eyespots can promote generosity.)

While actually deploying eyespots around the workplace is hardly a viable option for most companies, various technological advances offer not only the appearance of being watched but the actuality of it.  Such monitoring technologies can be particularly promising for promoting compliance by parts of a workforce for whom supervision is relatively remote – which is often the case for sales people.

For two other risk-related reasons, sales people can be a logical choice for C&E monitoring:

– Their incentives may not align well with those of their respective companies – a “moral hazard” condition.  (Indeed, in a risk assessment interview I conducted last week, the interviewee responded to a question about conflicts of interest by saying – only somewhat in jest – that the whole company sales force had such conflicts.)

– Sales people tend to be in a position to cause legal/ethical violations – e.g., corruption, collusion and fraud – much more than the average employee at a company.

But, while the case for monitoring sales people is strong as a general matter, obviously not all monitoring strategies are equally effective.  According to a paper published in the September 2014 issue of the Journal of Business Research, “Does transparency influence the ethical behavior of salespeople?” John E. Cicala, Alan J. Bush, Daniel L. Sherrell and George D. Deitz (rentable on Deep Dyve): “it is not the perception of visibility that drives sales persons behavior, but rather the perception of the likelihood of negative consequences resulting from management use of knowledge and information gained from technologically increased visibility.”

Of course, these results – based on an on-line survey which is described in the paper – presumably won’t surprise any C&E professionals. (Nor, likely, would they have impressed Mencken, who also said: “A professor must have a theory as a dog must have fleas” – although I should add that that’s just another chance to quote the great man – not a reflection of my view of this paper.) But, as with much of the social science research discussed in this blog, having data to back up what is intuitively known may be useful, particularly when seeking to make C&E reforms in a company that are being resisted.

Most relevant here is the often-contentious issue of how open a company is with its discipline for violations (meaning not just of sales persons but any employee).  While C&E professionals typically understand that true “public hangings” – i.e., full identification of individual transgressions and transgressors – can be undesirable for all sorts of reasons, there is still a lot that their respective companies can do in a general way to show that   negative consequences do exist for breaches of C&E  standards. Hopefully, this new research can help C&E professionals make such a case.

Liability for faking compliance – a new-fashioned type of deterrence?

I have long felt that C&E programs should do more to appeal to the better angels of our nature. (For more information on how “pro-social” qualities can be built on to promote more ethical workplaces, see this research page from the Ethical Systems web site.) But at the end of the day there will always be a place for good old-fashioned deterrence.

Deterrence, in the business realm, traditionally operates by punishing those who engage in conduct that harms others (e.g., corruption, collusion, pollution). But as C&E program expectations themselves become more central to promoting responsible behavior by companies,  it is inevitable that a more “upstream” form of deterrence should emerge – in which faking compliance is itself the punishable (or otherwise addressable) wrong.  Indeed, this could be considered “new-fashioned” type of deterrence.

The COI Blog has previously discussed two cases of this sort – one involving Goldman Sachs , the other S&P  – both having to do with allegedly false claims by the defendant firms that they had taken strong compliance measures against conflicts of interest.  And at the end of last month, another case was brought in which faking compliance was itself found to be a punishable wrong.

The case – In the Matter of Mark Sherman — can be found here, but readers may find more useful a post about it on the Harvard corporate governance blog by attorneys from the Ropes & Gray law firm.  As they note:

“On July 30, 2014, the Securities and Exchange Commission (“SEC”) advanced a novel theory of fraud against the former CEO (Marc Sherman) and CFO (Edward Cummings) of Quality Services Group, Inc. …, a Florida-based computer equipment company that filed for bankruptcy in 2009. The SEC alleged that the CEO misrepresented the extent of his involvement in evaluating internal controls and that the CEO and CFO knew of significant internal controls issues with the company’s inventory practices that they failed to disclose to investors and internal auditors. This case did not involve any restatement of financial statements or allegations of accounting fraud, merely disclosure issues around internal controls and involvement in a review of the same by senior management. The SEC’s approach has the potential to broaden practical exposure to liability for corporate officers who sign financial statements and certifications required under Section 302 of the Sarbanes-Oxley Act (‘SOX’). By advancing a theory of fraud premised on internal controls issues without establishing an actionable accounting misstatement, the SEC is continuing to demonstrate that it will extend the range of conduct for which it has historically pursued fraud claims against corporate officers.” (Emphasis added.)

Of course, there is much more that could be said about the various connections that the legal systems draws between violations of law and poor compliance than what’s in this and the other two cases mentioned above.  (See, for instance, this prior post about the SAC insider trading case brought last year – where the weakness of the company’s compliance program was used as a basis for finding corporate liability for insider trading by individual employees.) And, the notion of punishing fake (or otherwise weak) compliance efforts has long been part of enforcement strategies in highly regulated areas (e.g., broker-dealer compliance). But the Sherman case seems especially important, as it can be utilized in training corporate officers in public companies of all kinds on the need to be careful in executing their S-Ox certifications which, in turn, should lead them to have a greater appreciation of the value of strong compliance generally.

Finally, the Ropes & Gray post concludes with the following observation: “this case, which includes fraud charges in an accounting case without any restatement of financials, seems to represent an application of SEC’s ‘Broken Windows’ strategy first announced by Robert Khuzami and reiterated by Mary Jo White—to pursue small infractions on the theory that minor violations lead to larger ones—to the public company disclosure and accounting space.”  To this I would add that a “Broken Windows” strategy to preventing wrongdoing is also supported by behavioral ethics research (see this post ), and the Sherman case should also be a reminder for C&E officers to review whether their own companies’ deterrence systems  take this approach into account to a sufficient degree.

 

 

Is your company ethical, or merely compliant?

According to press accounts last week, the Securities and Exchange Commission has decided not to bring insider trading charges against former Berkshire Hathaway executive David Sokol. Last year that company’s CEO, Warren Buffett,  fired Sokol for allegedly violating its internal “insider trading rules by failing to disclose his purchase of Lubrizol shares, less than four weeks after starting talks with Citigroup bankers on acquiring all the shares in the chemicals company that Berkshire Hathaway did not already own.” The value of Sokol’s investment had risen from about $10 million at the time of purchase to about $13 million when Berkshire agreed to the acquisition several months later.  However, the SEC decided that it could not prove that the information – while clearly non-public – was “material,” which is an essential element of any insider trading case.  Nonetheless, according to one story, “Berkshire followers said … the SEC’s decision is unlikely to sway Mr. Buffett, who has long held his top executives to high ethical standards.”

Many companies say that they require that their employees not only abide by the law but also maintain high ethical standards.  But what does that actually mean in practice?

Perhaps the best way to see if ethics – as opposed to narrowly focused compliance – really matters at a company is to ask (as I do when I conduct assessments of  C&E programs) if the company has ever forgone a significant business advantage that would have been legal but not ethical to pursue/maintain. (This can include discrete business  transactions, campaigns, strategies, relations with other organizations or allowing the continued employment of a star performer who has engaged in ethically dubious conduct but has not broken the  law.)  Very often the answer to this inquiry is no.

A second test of whether a company truly promotes ethical, as well as compliance-based, conduct, is checking whether its risk assessment expressly includes an ethics dimension.  For more on what this means see this article from the CCI web site.

A third such test is to see where a company sets the bar for key areas of conduct in its policies – including insider trading (a topic which, because it is mostly conflict-of- interest based, is of particular interest to this blog).  Examples include limitations on short sales, transactions involving options and “churning.”  While not necessarily involving insider trading, each of these entails actions which, when engaged in by insiders, can hurt a company’s reputation or create incentives for the insider to engage in conduct that is not in the company’s interest. And the same is true for the conduct at issue in the Berkshire Hathaway case.

Note – I’m definitely not suggesting that these three tests are the only relevant measurements of ethicality by corporations. There are indeed many others.  But hopefully they will be of use to some organizations which, like Berkshire Hathaway, seek to hold their employees (and particularly their leaders) to a higher standard.

Frisky executives and the extra cookie

As described in this story from the Los Angeles Times, last week the “top executive of insurance giant American International Group Inc.’s airplane leasing unit … had his salary cut by $1 million and was demoted after an affair with an employee… The company said its investigation of [the executive’s] behavior began after AIG received an anonymous complaint that alleged that a personal relationship had started between [the executive], who is married, and an unnamed ILFC employee under his supervision. Both parties acknowledged that they had engaged in a relationship that had since ended…”

Two thoughts occasioned by this story.

First, where a senior executive engages in this sort of conduct, a company that is serious about its compliance and ethics standards really has no choice but to clobber the executive. A weak response could adversely affect the sense of “organizational justice” at the company which, in turn, could imperil its C&E program, as discussed in this earlier post. What AIG did here, to my mind, seems like a model approach. (For more information on appropriate discipline for conflicts of interest please see the prior posts collected here.)

Second, there really do seem to be a lot of these cases. As described in this story from the Wall Street Journal, in the past few months two CEOs of leading US companies lost their jobs due to relationships with employees, as has happened to quite a few others in recent years.  

Is this just human nature at work? And, what do we know about human nature regarding ethics and leadership?

In recent speech at Princeton (which I learned of from this post in Doug Cornelius’ blog) the writer Michael Lewis described the results of an intriguing experiment on how being placed in leadership roles can impact behavior toward others:   

“…… a pair of researchers in the Cal psychology department staged an experiment. They began by grabbing students, as lab rats. Then they broke the students into teams, segregated by sex. Three men, or three women, per team. Then they put these teams of three into a room, and arbitrarily assigned one of the three to act as leader. Then they gave them some complicated moral problem to solve: say what should be done about academic cheating, or how to regulate drinking on campus. Exactly 30 minutes into the problem-solving the researchers interrupted each group. They entered the room bearing a plate of cookies. Four cookies. The team consisted of three people, but there were these four cookies. Every team member obviously got one cookie, but that left a fourth cookie, just sitting there. It should have been awkward. But it wasn’t. With incredible consistency the person arbitrarily appointed leader of the group grabbed the fourth cookie, and ate it. Not only ate it, but ate it with gusto: lips smacking, mouth open, drool at the corners of their mouths. In the end all that was left of the extra cookie were crumbs on the leader’s shirt. This leader had performed no special task. He had no special virtue. He’d been chosen at random, 30 minutes earlier. His status was nothing but luck. But it still left him with the sense that the cookie should be his.”

In our next posting, we will examine other behavioral ethics findings concerning power and ethics.

 

 

Of the 8 million stories in the Big City, here are the ones about conflicts of interest

An area of recurring challenge for many C&E regimes is setting the right level of discipline for a given violation (COI-related or otherwise), a task often complicated by the lack of available precedent for any given case.  For companies, precedent generally means prior internal case decisions that can meaningfully be used for guidance on a given matter.  But small or medium-sized organizations will often lack critical mass of this sort.  Occasionally, one learns of publicly available precedent from other entities in the private sector, although such instances are rare – and are typically limited to instances involving worst-case conduct.

In the public sector, however, more precedent is available. And, in the absence of anything else, public sector cases might be useful to a private sector entity looking for some guidance on meting out justice for COI transgressions.

For instance, the New York City Conflicts of Interest Board publishes a compendium of disciplinary actions concerning:

gifts,

misuse of official position,

misuse of time and resources,  

and many other types of COI-based wrongdoing.

Of course, disciplinary considerations in the public sector can differ from private sector ones in various ways.  But for some companies – particularly those with little else to go on – this information may be useful.

Moreover, for organizations doing business with public sector entities, the data base can be helpful for other purposes, including:

– risk assessment, specifically, identifying situations at the intersection of public and private sectors likely to give rise to COIs;  and

– developing “real-life” communications to employees on the causes and consequences of COIs.

When it comes to COIs, a good story can do a C&E program a world of good.

 

 

Behavioral Ethics and Management Accountability for Compliance and Ethics Failures

As discussed in the initial post in this series, behavioral ethics can help C&E officers prove important things about their programs that they already know anecdotally but which others might not accept in the absence of scientific data.  (The second post addressed what behavioral ethics teaches us about conflicts of interest and  third  described certain behavioral ethics implications for C&E communications.)  In this post we explore what behavioral ethics research can help to prove about what has long been an area of great challenge for many C&E programs: the need to hold managers responsible for the C&E transgressions of their subordinates.

A key tenet of behavioral ethics is “motivated blindness.” As described by Max Bazerman and Ann Tenbrunsel in a piece from the Harvard Business Review Blog Network : “mounting research shows that we often fail to notice others’ unethical behavior if it’s in our interest not to notice. This failure of oversight — called ‘motivated blindness’ — is unconscious and common.”  

Bazerman and Tenbrunsel recount the apparent impact of motivated blindness on what was one of the most jarring business ethics stories of 2011:  how “Warren Buffett, known for his embrace of ethical business practices, failed to understand the unethicality of [an important subordinate’s] actions when he learned of them, and intervene.”  They also argue that motivated blindness may have played a role in “the failure of major accounting firms to see the corruption in the books of the firms that they audit” and “the failure of security rating agencies to accurately gauge the riskiness of the instruments they rate…”

From the perspective of a C&E program, motivated blindness 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).

To meet this important expectation, companies may wish to take the following measures:  

– 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;

– have auditors take these requirements into account in their audits of investigative and disciplinary records.

Taken together, these steps will doubtless be seen as strong medicine – at least by some companies.  But behavioral ethics teaches that motivated blindness is a strong disease.

Our next post in this series  will be on behavioral ethics and C&E risk assessment.  And,  for a discussion of  an important book on behavioral ethics by Bazerman and Tenbrunsel – Blind Spots – please see the initial post in this series.