Training and Communications

Training and other forms of communication play can be essential to mitigating any major C&E risk area. In this section of the blog we will explore various COI-specific training and communication issues.

Values, culture and effective compliance communications – the role of behavioral ethics

Compliance-related communications constitute a large part of the day-to-day work of many compliance-and-ethics departments.  But is this work being done in the most effective manner reasonably possible?

“Modeling the Message: Communicating Compliance through Organizational Values and Culture,” – published last fall by attorney  Scott Killingsworth in The Georgetown Journal of Legal Ethics  – provides a thoughtful examination of what we can learn about compliance  communications from various findings of behavioral science.  The article critiques the traditional approach to compliance communications – which focuses on avoidance of personal risks  – as being premised on a  “rational actor” theory that in recent years has been seriously undermined by the results of behavioral economics/ethics research. In this regard, Killingsworth argues: “Instead of conveying the message that compliance is non-negotiable, [the personal risk versus reward approach] implies that it may be negotiable if the price is right.”  An additional source of concern is that this way of communicating may send the implicit message “that management does not trust employees. Potential side effects of this message range from resentment, to an ‘us-versus-them’ attitude towards management, to a reverse-Pygmalion effect in which employees may tend to ‘live down’ to the low expectations that are projected upon them.”

As an alternative, Killingsworth draws upon the behaviorist concept of “framing” to suggest that communications framed in terms of values and ethics are more likely to be effective in reducing wrongdoing than are traditional compliance communications. In that connection, he describes a study showing “that over eighty percent of compliance choices [in the workplace] were motivated by internal perceptions of the legitimacy of the employer’s authority and by a sense of right and wrong, while less than twenty percent were driven by fear of punishment or expectation of reward.” A second benefit to the values-based approach is that it can better serve as “a source of internal guidance in novel situations” than does the traditional alternative.   Third, communications framed from the former perspective may enhance companies’ efforts to promote internal reporting of violations (obviously an important consideration in the Dodd-Frank era),  a contention that he bases on a study which showed that “the reporting of compliance violations encountered dramatically different effects depending on whether the subjects considered a particular infraction morally repugnant or not.”

As well as discussing communications per se, Killingsworth’s piece examines “the messages implicit in key company behaviors, which can either reinforce, undermine, or obliterate explicit compliance messages.”   So, while explicit communications are important, C&E officers must also “reach across functional boundaries to executive management and the human resources group and, if necessary, educate them about the principles of employee engagement and the value of consistent explicit and behavioral messaging that activates the employees’ values and brings out their [employees’] better natures.” The piece concludes with a list of other practical recommendations – concerning, among other things, culture assessments and communications strategies – for making all these good things happen.

Finally, I should emphasize that this posting only scratches the surface of what is in “Modeling the Message: Communicating Compliance through Organizational Values and Culture,” and I strongly encourage both C&E professionals seeking to up their respective companies’ communications efforts and behavioral scientists seeking to learn more about how their work can be put to practical use in compliance programs to read the piece in full.

Catching up on CEO COIs

As noted in a previous post, CEO’s tend to have different COIs than the rest of us. Today’s post will look at a few CEO-related COI stories that have been in the news lately.

Most notably, yesterday the pharma company Novartis dropped a controversial plan to pay outgoing CEO Daniel Vasella up to $78 million over the course of six years. As described by Forbes, “The board had originally justified its decision in order to ‘protect’ the drug maker, since Vasella knows ‘the company’s business intimately, having built the leading R&D organization and personally recruited most of the top executives.’ In other words, the payoff was hush money designed to keep him from telling secrets to competitors.” The notion that a board could even consider paying a CEO something extra for keeping shareholder secrets is – at least on its face – pretty distressing.

Public sector organizations have CEO’s, too – and various press accounts have noted that super-lawyer Mary Jo White, who President Obama has nominated to head the Securities and Exchange Commission,  will need to take conflict avoidance measures if confirmed for that post.  But as noted in this recent story in Bloomberg News , while it is hardly unusual for a lawyer going from private practice to public service to have COIs of this sort, White’s particular contemplated mitigation approach to her potential COIs (which concern not only her law firm partnership but that of her husband, himself a prominent securities lawyer) appears to be of less than optimal efficacy.

I should stress that I don’t think there is any chance that White will personally act in a conflicted way in the discharge of her duties at the SEC.  But individual honesty is presumably not the end of the analysis regarding any leader’s COIs – and that is particularly so where a) the leader leads a government agency whose mandate includes, among other things, addressing COIs (at least in the financial services field);  b) that agency has an uneven record over the years in enforcing that mandate; and c) there is a reasonably strong concern among press and public that the reason for the agency’s shortfall is one of regulatory capture.

And speaking of the SEC, there is this story   from yesterday about a deposition of hedge fund chief Steve Cohen whose firm, SAC Capital, is being investigated for insider trading.  Cohen apparently testified: “I’ve read the compliance manual, but I don’t remember exactly what it says,’’ and, according to John Coffee, a noted securities-law professor at Columbia, “That’s a dangerous statement. The fact that he doesn’t know what’s in his compliance manual is useful to the SEC,” should it decide to pursue the firm on a “control person” theory of liability (which essentially involves supervisory neglect).

But is this really a COI issue?  It is in the sense that under Delaware law compliance oversight failures by directors and officers can be deemed a violation of the duty of loyalty, which – even if not technically involving a conflict – is from the same neck of the woods as COIs.

Finally, just today an internal investigation cleared former Chesapeake Energy CEO Aubrey McClendon of any “intentional wrongdoing” in connection with the controversial borrowing practices that were the subject of the prior post linked to at the top of this one.  But presumably it did not do the same with respect to creating an appearance of a conflict  – given the facts as described in the prior post, that could not be done with a straight face.  And with CEOs, proper appearances can matter just as much as avoiding actual COIs, as evidenced by the great costs and disruption that befell Chesapeake when the borrowing practices became known to the company’s shareholders and others.  Indeed, the company evidently continues to be the subject of an SEC investigation concerning these matters, and COI watchers may be able to look to the outcome of that inquiry for an early view of how seriously that agency will address conflicts in the era of Mary Jo White.

 

 

Breaking news: just-published study shows that COI policies can…work!

One of the sources of frustration of toiling in the C&E field is the relatively small amount of data from the workplace on the efficacy of various program measures in actually reducing wrongdoing and otherwise promoting ethical conduct.   While unfortunate, this dearth of proof is not surprising; after all, what company would allow some or all of its employee population to serve as a control group for an “ethics experiment”?

But, as suggested by this article published yesterday in Science Daily, part of this proof gap has been filled by a recent study:  “Psychiatrists who are exposed to conflict-of-interest (COI) policies during their residency are less likely to prescribe brand-name antidepressants after graduation than those who trained in residency programs without such policies, according to a new study by researchers from the Perelman School of Medicine at the University of Pennsylvania. The study is the first of its kind to show that exposure to COI policies for physicians during residency training — in this case, psychiatrists — is effective in lowering their post-graduation rates of prescriptions for brand medications, including heavily promoted and brand reformulated antidepressants.” The study will be published in the February issue of Medical Care.

Note that while evidently precedent setting in terms of medical COIs, there is other  data – from the behavioral ethics field –  showing that well-timed exposure to a rule or ethical standard can  impact behavior in desirable ways. That research – and the ways in which its teachings might form the basis of effective C&E communications strategies – is discussed here.

Catching up on directors’ conflicts of interest

Directors’ conflicts of interest are one of the favorite topics of this blog.  Among our prior posts on this subject are this one on what to cover when training directors on COIs ,  this one on corporate charitable giving,  this one on board COIs in internal investigations and this one on COIs in connection with service on the board of a joint venture.  We’ve also addressed the need for directors to monitor the COIs of senior executives in their companies – and the dire consequences that can arise from a failure to do so.

So, what’s new in the area?

First, this recent story from Bloomberg news  reported on possible conflicts involving a prominent university’s board: “13.5 percent of Dartmouth’s $3.5 billion endowment is managed by firms that are related to trustees or investment committee members.” Dartmouth is not alone in this respect, but some schools do ban the practice, based on COI concerns: “Trustees shouldn’t manage university money because of the potential for self-dealing and other abuses, says Mark Williams, a former Federal Reserve bank examiner who teaches risk management at Boston University.  ‘Even the appearance of conflicts of interest can create reputational risk and harm the institution,’ Williams says. ‘The perception is almost as bad as the act of conflict. It does damage to that reputation, which has taken many universities centuries to create.’”

On the other side of the coin, the alumni in question have apparently been very generous in their gifts to the school, so it is arguable that on a net basis the practice is worthwhile – although balancing tangible gains against possible intangible losses is hardly an easy calculus to undertake in any meaningful way.  The piece also noted: “The potential conflicts can be thrown into high relief when funds lose money. As chairman of Yeshiva University’s investment committee, J. Ezra Merkin funneled the school’s money via his hedge funds to con man Bernard Madoff in return for fees. The $1.1 billion endowment lost $14.5 million when Madoff’s Ponzi scheme blew up in 2008.”

I don’t know what to add to this except the general comment that many non-profit organizations (i.e., not just universities) could use more rigor in their approaches to COIs. Here is a piece that speaks to that.

Second, this recent post, by Klaus J. Hopt, a professor and director (emeritus) at the Max-Planck-Institute for Comparative and International Private Law, in Hamburg,  on the Harvard Law School Forum for Corporate Governance makes an interesting comparison between the duty of loyalty owed by directors under US and UK law and the prevailing approach under the continental system:  “The duty of loyalty is highly developed in Anglo-American countries, but it has received more hesitant attention in continental European countries.” However, the piece notes: “More recently there are tendencies to more convergence [and] more attention is paid to prevention, remedies and enforcement.”

At the risk of sounding US centric (whereas I’m really just COI-centric), this does sound like a positive development.  Moreover, and beyond the scope of Professor Hopt’s paper (which can be downloaded via the Harvard site), it is interesting to consider that under Delaware law (in particular the Stone v Ritter case) a board’s compliance and ethics oversight duties are  actually based on the duty of loyalty – and perhaps the convergence will extend in that direction, as well.

Conflict of interview review processes

As prior posts have discussed, reviews of disclosed employee conflicts of interest pose a number of challenges. Disclosures may not truly mitigate conflicts.  Indeed, they may actually cause more wrongful COI-based conduct to occur than would be the case absent a disclosure.

Still, very few business organizations opt for a true “zero tolerance” approach to all COIs.  And for those that don’t, COI review processes are necessary for determining when a COI should be permitted to exist and under what conditions.

At a minimum, COI reviews should be conducted by an independent person or body.   Independence for these purposes means more than COI-free in the traditional sense.  It should also encompass the behavioral ethics concept of “motivated blindness,”  i.e., a reviewer should not be someone who may – due to the relationships involved – be inclined to approve a conflict-laden relationship or transaction.

For this reason, companies may wish to have COI reviews conducted by a C&E committee.  One obvious benefit to this approach is that there is “safety in numbers.” Another is that the committee will have or develop expertise (born of experience) in evaluating conflicts, which behavioral ethics research shows can be useful.    Offering less C&E protection – but still more than having COI reviews made by a line supervisor – is tasking a staff function, such as legal or HR,  for this job.

Of course, some companies do permit supervisors to approve COIs.  If this approach is adopted, companies should still seek to have a reasonable degree of rigor in the process by:

– requiring that any approvals be in writing and sought before engaging in a conflict-based transactions;

– providing and publicizing avenues for supervisors to ask questions of the C&E function when performing COI reviews; and

– including the issue of COI reviews in supervisor training – or, if this is impractical, providing written guidance (e.g., FAQs)  regarding such reviews.

Finally, companies should check on the supervisors’  actions in reviewing or approving COIs, such as through audits.

Training Directors on Conflicts of Interest: Six Pillars of Awareness

What do directors need to know about COIs – meaning, for our purposes, what should go into the COI-related training and other communications that they receive?

First, they should be trained on their own personal COI risks, meaning conflicts involving the directors themselves. “Corporate opportunities”  – discussed in this post  – is a kind of COI that a director might face.  Using company confidential information for personal benefit – such as in insider trading (e.g., the allegation in the Gupta/Galleon case)  – would be another, and there are, of course, many others to draw from, as well.

Second, directors should understand the need to monitor COIs of senior executives.  The Chesapeake case – discussed here   – is a pretty compelling vehicle for that sort of discussion. (Note: requirements of disclosure of “related party” transactions   are relevant to both this area of awareness and that concerning board members’ own COIs.)

Third, consistent with their Caremark duty, board members should be made aware of compliance measures regarding any high-risk conflict areas – so that they can ask informed questions about such measures. Here is a discussion of that from the FCPA Blog.

Fourth, training should touch on recent behavioral ethics research showing that disclosure may not mitigate COIs.   This emerging area of social science is relevant not only to the issue of whether to permit a conflict but also to designing COI management/monitoring plans.

Fifth, they should learn about the potentially devastating legal and other costs of COIs.   (On the other hand, one should make clear that not all allegations of COIs are meritorious.)  In addition to the costs imposed by the legal system and the marketplace, this part of the presentation should take note of the negative impact that COIs can have on employees’ larger sense of “organizational justice,” and what that can do to their faith in the company’s C&E program.

Sixth, such training should cover the area of “moral hazard” – a “cousin” of COI – and what it means regarding directors monitoring COIs in their companies.

Cross references: here is a post on the related topics of training senior managers on COIs   and another on service by company employees on other organizations’ boards .

CEOs’ COIs

F. Scott Fitzgerald famously said that “The rich are different than you and me,” and, along the same lines, CEO conflicts of interest can be pretty different than those involving people like you and me.  Consider this story – which likely would not have taken place with anyone other than a CEO – about what in going on at Chesapeake Energy.

As background, the company permits its CEO, Aubrey McClendon, to take personal stakes in the wells it drills.   By itself this arrangement – while unusual and controversial – does not, in my view, inherently involve a COI.  Indeed, one could argue that by investing side by side with the company, the CEO aligned his interests with those of the company’s shareholders.

However, “[i]n order to pay for stakes in new wells, McClendon borrowed money — using his stakes in existing wells as collateral — from a group that Chesapeake was trying to sell assets to. Investors complained that the arrangement raised a conflict of interest. They worried that Chesapeake might have sold its assets to the firm because the firm agreed to lend McClendon money, and not because the terms of the deal were the best Chesapeake could have received.  The arrangement was not previously disclosed to shareholders.” Or, as noted in another (more bluntly written) account:  “The overlapping relationship has led many analysts to say that there was at least the appearance of a conflict of interest since Mr. McClendon could give his lenders a sweetheart deal in exchange for a preferential interest rate on his loans.”  (Perhaps some of these analysts recall the harm caused by the tangled personal financial dealings of then CEO Bernard Ebbers at WorldCom.)

Where was the board – which included a former governor of Oklahoma and former US Senator – when this was going on? According to this story, Chesapeake’s general counsel initially claimed that the board “was fully aware of the existence of the loans” but the company soon reversed course on this.   As described by Ben Heineman, a former General Electric Co. general counsel who teaches corporate governance and business ethics at Harvard: “the Chesapeake board, in effect, is declaring that it would ‘rather just look ill-informed and negligent than complicit in McClendon’s deals.’”

Adding to this turmoil – a story has now surfaced of an undisclosed financial tie between the CEO and a director  (albeit one dating back several years).  And, the Securities and Exchange Commission has opened an internal  investigation.

What does all this mean for the shareholders (i.e.,  people like “you and me”)?  Many have apparently lost faith in senior management and the board, which has led to a massive loss in their investments in the company. This is, of course, entirely predictable when a CEO creates an apparent COI of this magnitude and the board – the only meaningful check on a CEO – is either negligent or complicit.

CEO conflicts really can be unique, not only in terms of what they are but also the impact they can have.

 

 

Conflict of interest compliance quizzes

Good C&E training generally makes use of questions.  Sometimes these are learning questions found in the body of the training.  Sometimes they come in the form of a test at the end of a course.  Both ways, questions can help cement the C&E information from training while they are fresh in employees’ minds.

But, not all companies have a chance to deploy COI training on a regular basis.  And for those that don’t, the possibility of using training techniques in other communications should be considered.

For instance, companies with C&E newsletters could publish a COI issue in which they:

– Describe the importance of appropriate handling of actual or apparent COIs to the company (e.g., how this matters in preserving the trust of shareholders, suppliers, etc.)

– Provide an overview of the company’s COI policies and processes.

– Pose several hypothetical situations to test employees’  knowledge.

Two practice pointers on test questions:

– Consider asking employees to answer not only whether there is (or may be) a COI in a given scenario, but also if they can articulate why.  So, for instance, employees get one point for answering the first question right about a scenario and two if they can also get the second.

– Print the answers upside down in the newsletter, as that should make readers more eager to test their knowledge.

I think this approach should be helpful not only as a way of reinforcing knowledge but also by conveying – given the difficulty that many employees will have in answering the “why” – that maintaining C&E standards (COI and other)  is not as easy as is often assumed to be the case.  And that, in turn, underscores the importance of getting help from the company’s C&E office when COI issues arise.

 

Conflicts of Interest in Joint Ventures – the Rights of “Consenting Adults”

This is the second post this week on COIs involving specific types of business organizations – the first post was on non-profits.  This coming weekend we’ll look at some of the COI stories that have been in the news of late and next week we will resume our series on ways to assess COI risks.

In an earlier post on the murky legal landscape regarding COIs we noted that the fiduciary duty of loyalty operates as a “default” in certain circumstances – imposing various COI-related obligations in the absence of an agreement to the contrary.  But when, one might ask, would anyone give up a duty to be treated in a less than loyal way?  One example lies in the area of joint ventures.

The governance and operation of JVs can certainly raise conflict of interest concerns. For an employee of  a JV’s co-owner who is either on the JV’s board or is seconded to the JV whose interests to be treated paramount?  Given the inherent tension in situations of this sort, those involved have good reason to clearly articulate applicable duties and expectations.

Indeed, as noted in recent Gibson Dunn publication Recent Trends in Joint Venture Governance : “Partners negotiating joint ventures are spending increasing amounts of time developing codes of conduct and policies regarding conflicts of interest.  These codes and policies are intended to legislate how business dealings between the joint venture company and a venture partner or its affiliates will be conducted and define the rights and responsibilities of the joint venture company and the venture partners regarding corporate opportunities.  They often reflect the nature of the industry in which the particular joint venture will operate.  In technical joint ventures, for example, the focus of conflict of interest policies is often the ownership, use and commercialization of intellectual property rights.”

Additionally JV agreements sometimes directly address – and waive – fiduciary duties.  As the Gibson Dunn publication further notes: “The managing boards of joint venture companies also owe fiduciary duties to the venture partners under applicable law.  But venture partners generally have a direct voice on the board.  In addition, when they enter into the venture, they have the opportunity to negotiate specific contractual rights designed to protect their interests.  In fact, in many circumstances, they will waive their common law or statutory fiduciary protections, relying instead on a set of negotiated contractual protections.”

Bottom line: JV owners are considered “consenting adults” who can not only waive individual COIs but the right to be treated in a loyal way by their directors and employees.

I should emphasize that there is a whole host of compliance risks in JVs beyond COI ones.  And this recent post in Corporate Compliance Insights  –  “Joint Ventures and Compliance Risks: The Under-Discovered Country”  identifies  three categories of measures that companies should take to promote C&E in JV’s in which they invest: screening the contemplated JV partners; structuring the JV agreement to promote compliance; and once the JV is operational, having a C&E officer work on an ongoing basis with key company personnel who serve as JV board members or seconded employees in senior positions to manage compliance.

Also, this week Compliance Week is running a story “JV Compliance Takes Varsity Skills”; it is for subscribers only so I can’t link to it, but mention it as further indication that C&E issues surrounding JVs are a hot topic these days.

Finally, related to the issue of COIs and JVs is this post concerning COIs arising from serving on another company’s board of directors.

Conflict of Interest Policies for Non-Profit Organizations

An earlier posting discussed the important – and certainly non-intuitive – finding of behavioral ethics research that doing good can actually increase the risk of doing bad.  In addition to an unexpectedly high likelihood of wrongdoing, those in the business of doing good – e.g., charities, foundations and other non-profits – may face outsized impacts from ethical missteps, particularly related to COIs, given their need to maintain the trust of donors and others to fulfill their respective missions.  In this post we begin to explore measures that non-profits can take to address COI risks.

According to the National Council of Non-Profits, a “policy governing conflicts of interests is perhaps the most important policy a nonprofit board can adopt. To have the most impact, the policy should be in writing and the board (and staff) should review the policy regularly. Often people are unaware that their activities are in conflict with the best interests of the nonprofit so a goal for many organizations is to simply raise awareness and cultivate a ‘culture of candor.’ It is helpful to take time at a board meeting annually to discuss the types of situations that could result in a conflict between the best interests of the nonprofit – and the self-interest of a staff member or board member.” Indeed, the Internal Revenue Service – which has an oversight role over charities in U.S. – expressly recommends that they develop a COI policy .

Non-profits seeking to draft or revise their COI policies can find plenty of publicly available examples from which to draw ideas and language (including some at the National Council of Non-Profits web site).  For instance, the COI policy of the Gates Foundation  contains a clear and comprehensive articulation of what generally would be  considered a COI at the Foundation; a discussion of the types of situations that could give rise to COIs there; requirements concerning disclosure and management of COIs, including mandating the involvement of the legal team in these matters (see this post on the need for independence in COI  management measures); detailed guidance on COI issues regarding the receipt of directors’ fees, authors’ royalties and like matters (for further information on COI issues in serving on outside boards see this post); a provision on outside employment, with – understandably – greater restrictions placed on high ranking employees; and discussions of a range of other COI issues relevant to the foundation, including those concerning matching grants and employee political activities.  The Gates Foundation policy also has an extensive series COI-related FAQs that could be an invaluable source of ideas for those drafting/revising a COI policy for another non-profit.

But, by bringing attention to this resource I don’t mean to suggest that non-profits should simply adopt what the Gates Foundation, or any other organization, has done regarding COIs.  Different non-profits could have COI issues that are, relatively speaking, unique.  For instance, this article about COI policies for cooperative groceries – a very different sort of organization than a foundation –  identifies a series of “emotional conflicts of interest” that may pose risks for organizations of that kind. (E.g., “The board president’s daughter is a co-op employee. After she is denied a raise of the size she had expected, her father begins bringing up concerns at board meetings about the fairness of the pay raise system and staff turnover due to low pay.”)  As with any other sort of COI mitigation effort, the key for non-profits is to engage in some form of risk assessment before designing policies or other compliance measures. And, of course, the effort should include determining what any relevant legal requirements or expectations are for the entity regarding COIs.

Finally, understanding the COI risks of non-profits is important not only to board and staff members of such organizations but also employees of for-profit organizations who deal with non-profits, under the general imperative (often espoused in this blog) of not causing conflict in others.

A future post will discuss COI training for non-profits.