Enforcement

Because COI’s are often willful, the “hard edge” of compliance – encouraging internal reports of violations, investigations and discipline – can be key to successful mitigation for this risk area, as addressed in the sub-categories below.

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.

 

 

Independent Investigations (Part Four): Motivated Blindness

In the first posting in this series we described two types of independence criteria in investigations – one having to do with an attorney’s relationships with the company and the other  her involvement in the subject matter being investigated. The second posting discussed independence issues regarding board members supervising investigations and the third reported on the then-just-breaking story about the Wal-Mart FCPA matter – and particularly the role of an apparently un-independent investigation in those unfortunate events.  In this fourth post we return to the issue of attorney independence to make a seemingly small but – at least for some cases – potentially important point that is based in part on behavioral ethics.

Balzac famously said, “Behind every great fortune there is a crime,” and, less famously, many C&E professionals have noted that behind many crimes in companies there is a supervisor asleep at the switch. (Indeed, our most recent prior post was about a case of this sort – where the “supervisors” were the members of the board.) What does this (meaning the part about supervisors – not Balzac) have to do with independent internal investigations?

In assessing an attorney’s independence vis a vis a contemplated investigation it is obvious that one should weigh her relationship with the target(s) of the inquiry. Less obvious, one should consider her relationships with anyone else at the company whose interests could be adversely affected by the outcome of the matter – including by the possibility of an investigative showing that a target’s supervisor was negligent in her supervision.

In an earlier post on behavioral ethics,  I observed that the phenomenon of “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).”   Given the difficulty that many organizations have traditionally faced in imposing this sort of discipline, they should do whatever is reasonably possible to maximize the likelihood of success.  And in some situations, that includes selecting a lawyer for an investigation who is sufficiently independent not only of the target but also of those who could be reasonably faulted for not having prevented or detected the target’s misdeeds.

 

Independence and internal investigations (Part Three): Wal-Mart

The first two posts in this series    gave an overview of the legal landscape regarding independence expectations for internal investigations. Today, I want to draw readers’ attention to a jaw-dropping piece that has just appeared in today’s NY Times about how Wal-Mart allegedly used an utterly un-independent internal investigation to cover-up bribery by its Mexican operation. 

I won’t try to recount all of what’s in the Times piece, which – in my view – every C&E professional should read.  But this excerpt will give a flavor of it:

In one meeting where the bribery case was discussed, H. Lee Scott Jr., then Wal-Mart’s chief executive, rebuked internal investigators for being overly aggressive. Days later, records show, Wal-Mart’s top lawyer arranged to ship the internal investigators’ files on the case to Mexico City. Primary responsibility for the investigation was then given to the general counsel of Wal-Mart de Mexico — a remarkable choice since the same general counsel was alleged to have authorized bribes.  The general counsel promptly exonerated his fellow Wal-Mart de Mexico executives. When Wal-Mart’s director of corporate investigations — a former top F.B.I. official — read the general counsel’s report, his appraisal was scathing. “Truly lacking,” he wrote in an e-mail to his boss. The report was nonetheless accepted by Wal-Mart’s leaders as the last word on the matter.

Rather, I write to make a general point that might otherwise be missed in what I imagine will be a flood of follow-on stories  about Wal-Mart’s woes, but which should be of keen interest to C&E professionals. That is, engaging in sham compliance measures – investigations and other – can itself be considered a crime, at least in some circumstances.  For more on that, see this prior post in the FCPA Blog, about how “I once represented two lawyers who were suspected by a federal prosecutor of having deliberately conducted a half-measure internal investigation for deceptive purposes. No charges were brought (and, from my perspective, none were even close to being warranted). But with the wrong set of facts the result could be different in a case involving compliance program half-measures – especially if, as I believe will happen, there is a generally decreasing tolerance by prosecutors for Potemkin programs.”

In a somewhat related vein, another commentator has asked whether Wal-Mart’s lawyers violated their S-Ox 307 duties.

Wal-Mart’s statement issued in response to the Times piece can be found here.  And, I should emphasize that I am not suggesting that Wal-Mart personnel engaged in a sham investigation.  Rather, like many posts in this blog, I am using the news of the day to provide what is hopefully helpful general COI-related information to C&E professionals.

Independent Investigations (Part Two): Board Conflicts

Part One of this series provided an overview of the issue of  attorney COIs in internal investigations. In this next posting we consider relationships at the board of directors level that can adversely affect an inquiry’s independence or the perception thereof.

COIs in the context of internal investigations most often involve the attorneys tasked to conduct the inquiry.  But independence can also be at issue with respect board members (or executives) designated to oversee the attorney’s work.

For instance, last year, News Corporation was criticized for tapping an inside board member to oversee the internal investigation of allegations of phone tapping and other questionable practices:  “‘That is not standard practice,’ said Charles M. Elson, an expert on corporate governance at the University of Delaware. ‘You cannot be seen as objective if you are inside.’” More recently, however,  an article by Ben Heineman in The Atlantic  suggests that notwithstanding this unusual reporting relationship the investigation is in fact functioning in an independent manner.  Presumably, once this high-profile inquiry is completed and its results known,  the extent of its actual independence can be more fully assessed.

Another noteworthy matter involving director independence in an internal investigation  arose several years ago in a case brought by the shareholders of Oracle. There, the Delaware Court of Chancery ruled   that a board special litigation committee consisting of two Stanford professors could not be considered independent in an internal investigation concerning alleged insider trading by fellow board members, because the target directors had close ties to that university: “It is no easy task to decide whether to accuse a fellow director of insider trading” the court wrote, and for the company to have compounded “that difficulty by requiring [special litigation committee] members to consider accusing a fellow professor and two large benefactors of their university” of a criminal act was “inconsistent with the concept of independence recognized by our law.” While somewhat unusual, the Oracle case serves as a useful reminder of the need to think broadly when it comes to ensuring that independent investigations are, in fact, free from compromising relationships.

Part three of this series will return to the issue of attorney independence in the investigative context.

 

Conflicts of Interest and Internal Investigations (Part One)

The topic of COIs in the practice of law is largely beyond the scope of this blog, but the area of independent investigations is an exception, since it is as much as much about organizational COIs as those based on professional standards.  In this first post in a series we’ll review some of the history that gave rise to the two main expectations regarding conflict-free investigations.   The second posting will examine board-level independence issues concerning investigations,  the third some important practical considerations in maintaining investigative independence and the fourth a different (from the two principal tests) way to look at independence – which is independence of process.  Finally, we will take up the related issue of seemingly forgotten COI-related mandates of Sarbanes-Oxley Section 307.

First, a page of history – that will likely be familiar to those working in the field since the early part of the immediately preceding decade, but may be less well known to others.

It was an internal investigation at Enron conducted by one of the company’s principal outside law firms that, as much as any other event, gave rise to the modern expectations regarding conflict-free investigations.  The inquiry was criticized due to the larger relationship between the firm and the company and also due to the firm’s claimed involvement in  matters being scrutinized.  In other words, there was said to be two discrete types of conflicts – one relational and the other subject-matter based.  Around the same time, an investigation into allegations of wrongdoing at Global Crossing by a partner at a law firm was strongly criticized in a bankruptcy court proceeding because that lawyer also served as the company’s general counsel. The heightened focus on independence expectations was expressed in a widely read report from this time  – issued in 2003 by the Conference Board’s  Commission on Public Trust and Private Enterprise – which stated:

In the event an independent investigation is reasonably likely to implicate company executives, the board — not management — should retain special counsel for this investigation. Special investigations of company activities that may implicate the conduct of company executives require independence from management.  Typically, lawyers and law firms are in the best position to conduct investigations, and care must be taken that these investigations are conducted thoroughly, vigorously, and objectively. It is important, therefore, that investigative counsel be chosen by, and report directly to, the board. To ensure that special counsel’s interests are not aligned with, or influenced by, management, the Commission believes that special counsel should not be one of the corporation’s regular outside counsel or a firm that receives a material amount of revenue from the company.

Finally from this period, independence expectations regarding internal investigations acquired something akin to the force of law in the mandate of Sarbanes-Oxley § 301 that only corporations with audit committees that have certain characteristics can be publicly listed, including the following: “Each audit committee shall have the authority to engage independent counsel and other advisors as it deems necessary to carry out its duties; and. . . .  [E]ach issuer shall provide for appropriate funding, as determined by the audit committee . . . for payment of compensation . . . to any advisors employed by the audit committee.”   Similar requirements can be found in the New York Stock Exchange and Nasdaq’s corporate governance related listing requirements.

Now, many years after this formative period, independence has become a settled expectation.  Certainly it is expected by the government when issues of serious wrongdoing arise.  And, I believe that employees – who are increasingly sophisticated about C&E matters – may have that expectation, too – particularly those who report suspected wrongdoing.