Harm / Trust Issues

The potential for loss of trust and other types of harm can have a powerful bearing on the analysis and resolution of various COI issues, as will be examined here.

Conflicts of interest: why we fight

The current attention to President Trump’s using his official position to bring business to his properties – discussed here – has drawn national (and even global) focus on the area of conflicts of interest. It is thus an opportune time for the COI Blog to review some basic principles.

First, as Justice Louis Brandeis famously said: “Our government is the potent, the omnipresent teacher. For good or for ill, it teaches the whole people by its example.” While Brandeis was speaking about violations of law the point seems just as applicable to ethics.

Second, and as one would expect, the impact of COIs can go beyond the economic value of the transaction at issue. How much does it matter that organizations, individuals and governments pay close attention to identifying and mitigating conflicts of interest? One way to answer this question is to consider – as I used to ask students in my business school ethics class to do – what the world would look like without such focus and sensitivity. Below are some of the observations that I have heard from them over the years:

– Individuals might be reluctant to take the medicines that their doctors recommend for fear that those recommendations are motivated more by the doctors’ financial relationships with pharma companies than by the patients’ well-being.

– Individuals and organizations might not use financial advisors for fear that the advice they receive is driven by hidden, adverse interests – and would instead devote otherwise productive time to trying to become their own financial experts, resulting in a significant misallocation of capital as well as time.

– Organizations could hesitate to take a wide range of everyday actions for which they need to trust their employees and agents to do what’s right by the organizations – or would proceed only with highly intrusive and costly surveillance-like measures in place.

In short, Conflict of Interest World is a place of needlessly diminished lives, resources and opportunities.

Finally, and returning to the issue of Trump’s COIs, the negative impact of presidential impunity regarding COIs is particularly worrisome in a way that is unique in our history.  In the coming years we will be compelled to make sacrifices to address increasingly urgent needs regarding climate change and public debt. If government’s motives on these and other critical issues are subject to question due to COI’s then the (already small, in my view) likelihood of sufficient sacrifice being made is further diminished, with potentially catastrophic consequences for our country and planet. (For more on the link between morality-based sacrifice and the success of human societies see Jonathan Haidt’s The Righteous Mind.)

Expert product reviews

In Expert Product Reviews and Conflict of InterestTom Hamami  writes: “Many firms that produce expert product reviews have a vested interest in increased consumption of the products they review. The classic example is the Michelin Guide, which reviews restaurants, originally conceived to stimulate usage of automobiles and therefore also demand for automobile-related goods and services. The result is a conflict of interest; such firms have financial incentive to give better reviews than products merit… [Hamami] compare[d] video game reviews from two sources: one a video game magazine owned by a game retailer and the other a game website that does not sell games. The goal of the research is to evaluate to what extent, if any, the retailer-owned outlet inflates its reviews in order to boost sales. …, [Hamami indeed found] some evidence of increased inflation in periods shortly following the release of a game’s corresponding piece of hardware. Other literature on this industry finds that reviews have the largest effect on the sales of low-quality games, and [indeed he finds] evidence of review inflation for [such] games. These results are consistent with theoretical predictions for a firm that optimizes the trade-off between sales revenue and the reputational costs associated with biasing reviews.” On the other hand, “somewhat surprisingly, [he finds] no evidence of seasonal variation despite the increased demand for video games in the fourth quarter of the year.”

So, a mixed picture – and one that is indeed consistent with the author’s review of relevant literature on COIs of this sort. E.g., one study finds “evidence of a strong positive influence of advertising on media coverage in the fashion journalism industry…” But another finds “minimal differences between the reviews of two wine publications, one of which accepts advertising and one of which does not…”

How much does this matter?

Assuming that the COI is disclosed or is otherwise apparent – as I imagine is so  in the great majority of cases – there is evidently no “information deficiency,” a key factor in evaluating both the likelihood and impact of a COI.  Nor do the COIs reviewed by Hamami seem to be of the sort that the average buyer cannot evaluate on her own (as might be true, for example, of pharmaceutical or complex financial products). Indeed, the very focus on “reputational costs” suggests that consumers do appreciate and take into account the negative impact of a COI on the publisher of product reviews.

But even disclosed and understood COIs generally do have a pernicious effect on our society, as they can contribute to the cynicism that many feel about the press and business world. I don t know how to weigh that against the other factors mentioned above, but it is certainly part of the picture.

 

Conflicts of interest for “the little people”

The conclusion of the Mueller investigation does little to resolve the much broader set of concerns regarding President Trump’s conflicts of interest. These are too numerous to be chronicled on this site, but are being tracked on a weekly basis by the Sunlight Foundation, which even offers a searchable data base of Trump COIs. Additionally, a study recently conducted by USA Today showed that by failing to divest his various investments before taking office, Trump has created more than 1400 COIs.

The late Leona Helmsley is reported to have said that “only the little people pay taxes.” Trump’s view of COIs –  that the President can’t have one – while  similar in spirit to Helmsley’s timeless quip, is correct as a strictly legal matter.

As noted by USA Today: “There is no specific law that directly prohibits the president from owning any assets — whether real estate or anything else — that conflict with his official duties.” But the analysis is very different from an ethical perspective.

First, the foreseeable negative impact of a COI by a President is great. This is less a matter of the specific economic harm arising from an individual conflicted transaction as it is one of setting a bad example.

Justice Louis Brandeis famously said: “Our government is the potent, the omnipresent teacher. For good or for ill, it teaches the whole people by its example.” While Brandeis was speaking about violations of law the point seems just as applicable to ethics.

Indeed, I believe that the negative impact of presidential impunity regarding COIs is particularly worrisome in a way that is unique in our history.  In the coming years we will be compelled to make sacrifices to address increasingly urgent needs regarding climate change and public debt. If government’s motives on these and other subjects are subject to question due to COI’s then the (already small) likelihood of sufficient sacrifice being made is diminished. (For more on the link between morality-based sacrifice and the success of human societies see Jonathan Haidt’s The Righteous Mind.)

Second, the likelihood of a president having a COI  is – at least as a general matter —  very high. That is a function of the near-infinite breadth and depth of a president’s power to help or hinder various interests – which, in turn, can reward him for his action/inaction.

Several weeks ago the House of Representatives passed a wide-ranging bill that – among other things – would encourage presidents and vice presidents to divest assets or create of blind trusts, but the Republican leadership has pronounced the legislation “dead on arrival.” Given how many of the other provisions of this bill are controversial, maybe Congress should be focused more narrowly on what is truly an ethics no brainer.

 

Deadly – and small – gifts and entertainment

Virtually every conflict of interest policy contains monetary limits for individual acts of gift giving or entertainment, but not all seek to quantify how many of such acts are permitted to occur in a given time period. This issue was raised in a particularly grim way – as described in this article in MarketWatch – by a recent study which “found that both deaths from opioid overdose and opioid prescriptions rose in areas of the country where physicians received more opioid-related marketing from pharmaceutical companies, such as consulting fees and free meals,…”

Relevant to the specific issue in this post, Magdalena Cerdá, director of the Center on Opioid Epidemiology and Policy at NYU Langone Health and the senior author on the study, stated: “A lot of the discussion around the pharmaceutical industry has been around high value payments, but what seems to matter is really the number of times doctors interact with the pharmaceutical industry,… ‘A physician’s prescribing pattern could be influenced more by multiple inexpensive meals than a single high-value speaking fee,’ she noted.”

She also said: “’We think it’s because the more times physicians interact with someone from the pharmaceutical industry, the easier it is to build a relationship of trust,… ‘We in no way think the prescribing is some kind of nefarious intentional behavior by physicians. The fact that it is the frequent, low-level payments that have the most effect shows that it’s more unintentional ‘…” Of course, unintentional conflicts tend to be more difficult to address than are intentional ones.

More generally, this finding  seems to me to be significant in a broad-based way as it presumably applies to other commercial contexts as well. And, compliance officers in all industries should make sure that their COI policies address not just high-value gifts and entertainment but also high volumes of such.

Our fiduciary future?

There is, of course, no one body of law governing all conflict-of-interest issues. But the law regarding fiduciary duty comes closer to doing so than does any other body of law.

In “The Rise of Fiduciary Law,” recently posted on the Harvard Law School Forum on Corporate Governance and Financial Regulation, Professor Tamar Frankel of Boston University School of Law notes: Fiduciary rules appear in family law, surrogate decision-making, laws of agency, employment, pensions, remedies, banking, financial institutions, corporations, charities, not for profit organizations, medical services and international law. Fiduciary concepts guide areas of knowledge: economics, psychology; moral norms; and pluralism. Fiduciary law was recognized in Roman law and the British common law. It was embedded decades ago in religious Jewish, Christian, and Islamic laws. Internationally, fiduciary law appears in European, Chinese, Japanese and Indian laws.

Frankel traces the growth of fiduciary expectations to the increasing need in modern societies to share expertise while minimizing the risks that can arise from such sharing. Power can be used to benefit or harm. The recipients’ inability to check the experts’ power and services quality can result in suspicion and withdrawal from the expert. This result conflicts with society’s interests. After all, the financial, health, legal and education systems, to name a few, are built on offer and exchange of expertise. In response, fiduciary law establishes duty of care ensuring expert services and duty of loyalty prohibiting conflicting interests which undermine trust. Fiduciary law can entice and protect those who need expert services to rely and trust their experts. The lower the ability to check the experts’ expertise and honesty, the higher the fiduciary duty of experts and their punishment for abuse will be.

Looking forward, Frankel notes: The impact of fiduciary law is likely to rise. Fiduciary law issues are expanding. Inequality of knowledge and expertise exist and is likely to continue, depending on the degree to which those who rely on the experts can trust the experts, and the degree to which society benefits from this degree of trusting by expanding and exchanging knowledge and helpful services to its members….Regardless of whether they are enforced by law, by social rules, or by cultural pressures, fiduciary rules are a condition to the long-term well-being of a human society.

(For an earlier post on the many harms that can come from a COI-based lack of trust click here.)

For legislators, enforcement personnel and business leaders the lesson of this analysis is clear: fiduciary standards should be strongly defined and enforced. But what is the take-away for the fiduciaries themselves?

Frankel notes, in this regard: Fiduciary law should be based on one guiding test by a party that offers trusted fiduciary expert: “Would I, the trusted person, like to be treated the way I treat those who trust me?

I understand and partly agree with this proposal, but also worry – based on behavioral ethics research showing that people often underestimate the impact on them of others’ wrongdoing – that it might not produce the desired result enough of the time.  So, my friendly amendment is to put this suggested question into a third-party framework: Would the proposed action if taken by people generally tend to reduce trust generally in the context at issue?  (E.g., would non-disclosure of a payment by a pharmaceutical manufacturer to a doctor tend to reduce  the  trust of patients in their doctors generally.)

Just to be clear, I am not advocating a rewrite of the Golden Rule. I  am just suggesting that it can be easier to recognize vulnerabilities in others – i.e., people generally – than in ourselves, and this might be relevant to designing a guiding principle for fiduciaries.

 

The harm from conflicts you often can’t see

A few days ago Newsweek ran a piece on the Trump family’s “endless conflicts of interest,” describing in detail several dozen actual, apparent and potential conflicts, and related ethical infirmities. Another such list is maintained and periodically updated by The Atlantic. The sheer volume of these cases is so overwhelming that it may be worthwhile to step back and consider what the harm from COIs is as a general matter.

Over the years, one of the themes of this blog has been that the harm caused by COIs is often significantly underappreciated. Some of these posts are collected here.

Broadly speaking, COIs often give rise to two categories of harm: they encourage people to make undesirable decisions and discourage them from making desirable ones, as described in this post.  Neither type of harm is generally easy to spot but, of the two, the first – being incented to make bad decisions – is presumably more identifiable as a general matter than is the second – being discouraged from making good ones, as actions are typically more noticeable than inactions.

But an interesting and important case of the latter has been on display the past few days as Hui Chen – a highly regarded member of the compliance and ethics (“C&E”) community – has publicly explained her decision to leave her position as compliance counsel for the Justice Department’s Fraud Section. As described in The Washington Post : As a contractor for the Justice Department, Hui Chen would ask probing questions about companies’ inner workings to help determine whether they should be prosecuted for wrongdoing. But working in the Trump administration, Chen began to feel like a hypocrite. How could she ask companies about their conflicts of interest when the president was being sued over his? “How do I sit across the table from companies and ask about their policies on conflict of interest, when everybody had woken up and read the same news?” Chen said in an interview. “I didn’t want to be a part of the administration whose job it is to question others about these precise things.”

While this may seem like “inside baseball” to those outside of the C&E community, Hui Chen’s departure from Justice represents a loss for all who can be protected by strong C&E programs, meaning millions of shareholders, consumers, employees, taxpayers and others – in short, pretty much everyone.

Welcome to Conflict of Interest World!

How can conflicts of interest harm individuals, organizations and society?

My latest column in Compliance & Ethics Professional (page 2 of attached PDF) counts the ways.

I hope you find it interesting.

Do stock options discourage whistleblowing?

Paying hush money is big business, and hardly a day goes by without some press account of a company or powerful individual buying the silence of those with knowledge of wrongdoing. Sometimes this involves settling individual claims with confidentiality provisions – such as today’s story in the NY Times about the various settlements Fox News has paid to silence individuals who claimed they were sexually harassed by that organization’s Bill O’Reilly.  But of perhaps of greater interest to C&E personnel (or at least to me) are what could be considered structural inhibitions on whistleblowing.

Andrew Call, Simi Kedia and Shivaram Rajgopal recently published research they conducted on the relationship between companies issuing stock grants to their employees and employees at such organizations reporting fraud. As described on HBR.org, the possible connection between receiving stock options and deciding to blow the whistle is twofold. First, “the value of stock options is directly tied to the value of the firm’s stock, and … whistleblowing allegations result in an immediate decline in the firm’s stock price, [so] employees stand to lose financially when they blow the whistle. In addition, employee stock options typically have vesting terms that require employees to wait a few years before they can exercise their options, which may act as a disincentive to blowing the whistle before they’re able to exercise their options.”

Their research approach and findings were as follows:

“Using a Stanford Law School database, we identified a sample of 663 firms that were alleged to have engaged in financial misreporting and were subject to class action shareholder litigation in U.S. federal court from 1996–2011. We examined the number of stock options granted to rank-and-file employees during the period of alleged misreporting, and we found that these firms granted more stock options during the misreporting period than did a benchmark sample of 663 similar firms that were not being investigated for financial misreporting. Option grants by these misreporting firms varied over time. Specifically, misreporting firms granted 14% more stock options to rank-and-file employees when they were allegedly misreporting their financials, but the number of options they granted decreased by 32% after they appeared to stop misreporting. These findings suggest that these firms granted additional stock options strategically during periods of alleged misreporting. We also found that these efforts are effective. Misreporting firms that granted more stock options to rank-and-file employees were less likely to be exposed by a whistleblower. Approximately 10% of the firms in our sample were subject to a whistleblowing allegation. Firms that avoided a whistleblower granted 78% more stock options than these firms did not.”

 These are certainly interesting findings, although one wonders if the results would be similar with a study of exclusively post Dodd-Frank cases, given how that 2010 law has greatly enhanced the incentives for whistleblowing in public companies. I also have a hard time picturing a meeting of senior executives and human resources personnel agreeing to a strategy of using stock options to buy employee silence. I’m not saying this never happens but doubt it happens a lot – given the personal risks that participating in such a scheme would create for those involved. However, I can definitely see how this would happen in the poorly lit realm of what is understood but not spoken.

Regardless of how this incentive manifests itself, I think C&E professionals should be aware of it in assessing and responding to the challenge of encouraging employees to internally report wrongdoing in their organizations. For some companies the key will be in increasing disincentives for not reporting, such as imposing serious economic penalties for senior managers on whose watch the wrongdoing occurred regardless of fault by such individuals. For other companies, softer incentives might be what is needed – such as the appeal to a “larger loyalty” described in this previous post on behavioral ethics and whistleblowing. For still others, having a point of risk” communication strategy  around the granting of the option – also a behavioral ethics inspired approach – might be what is called for.

Finally, the study also raises a different issue: should C&E personnel receive stock options? I know of no research on this issue, but this post – which  explores the related area of incentive compensation for “governance monitors” (general counsel and internal auditors)  – may be of interest to readers facing this issue in their organizations.

When NOT lobbying suggests a conflict of interest

“It could probably be shown by facts and figures that there is no distinctly native American criminal class except Congress,” Mark Twain famously wrote. Providing some of those facts and figures, Aaron D. Hill, Jason W. Ridge and Amy Ingram – in an article published yesterday in the Harvard Business Review – describe a growing conflict-of-interest problem in the US Congress, an important topic that these days is largely overshadowed by the COIs involving the President.

The authors set the stage by showing that there is now widespread ownership of stock by members of Congress: “the average S&P 500 firm in [their]  sample has about seven members of Congress holding its stock. Some companies have closer to 100 members holding stock, and many firms have 50 or more in a given year.” They next show that “firms where a greater percentage of lawmakers invest have significantly higher performance in the subsequent year — with each percentage of congressional membership owning stock worth about a 1% improvement in” return on assets. “This suggests  that politicians may be privy to nonpublic information about future regulatory or legislative actions that may prove helpful to these companies. It’s also possible that members of Congress use their influence to benefit the firms in which they invest. This finding dovetails with prior research that shows members of the House and Senate generate abnormally higher returns on their investments.”

Hmmm. Perhaps just a coincidence. (As Twain once noted in a different context: “What a delightful thing a coincidence is.”) But wait, there is more.

The authors also show that “firms are taking note of congressional investments in a couple of ways … paying close attention to public disclosure laws that require members of Congress to report their stock holdings annually… [and] also hiring private companies that specialize in a unique business: identifying who owns firms’ stock (among other political intelligence activities). Firms can use information about which members of Congress own their stock to minimize the intensity of their lobbying activity,… [b]ecause owning stock aligns the interests of the firms with those of their stock-holding lawmakers …companies that have congressional stockholders no longer need to spend as much money on lobbying to influence opinion.” One example of this:  a “nearly three-quarter increase in members of Congress who held Apple stock from 2007 (22 people) to 2008 (38) was followed by a nearly 50% reduction in lobbying intensity the following year (2009).”

This is one of the most interesting use of facts and figures to show COIs that I’ve seen in a long time. Indeed, I think that, as a general matter,  more needs to be done to understand not only the incentives that COIs can create but also the disincentives, as discussed in this recent post.

And, there is more still to what Hill,  Ridge and Ingram have to say about Congressional COIs – both their consequences and also mitigation approaches. But for that you’ll need to read the original article, which I hope you’ll do.

 

Future conflicts of interest

First, a plug: at the upcoming annual conference of the Ethics and Compliance Officer Association , I’ll be speaking on a panel on “A view from the edge: exploring the future of ethics and compliance.”  It is a topic I addressed at the very first ECOA conference – held in 1992, when the organization had a grand total of 19 members and the entire C&E field was so new.  I hope to see you at this year’s event, which will be held next month in Dallas.

Second, the COI story of the week – is also about the future. It concerns the Clinton Global Initiative (CGI) accepting contributions from foreign governments, notwithstanding the prospect that Hillary Clinton will run for President.  When she was Secretary of State, the organization did not take such donations, but they lifted the ban when she resigned from that post.

Of course, since she isn’t president, technically this isn’t an actual conflict.  Rather, it is a potential COI.

What’s the difference? As discussed in this earlier post: Potential conflicts refer, as a general matter, to situations that do not necessarily constitute or appear to constitute a COI but where there is a reasonable possibility of an actual or apparent COI coming into play.

As with the risk analysis of any COI, with potential COIs one should consider the dimensions of likelihood and impact.

On likelihood, there are actually two questions relevant to this inquiry. First, how likely is the COI-triggering event to happen?  Here, that event – Hillary becoming President – seems reasonably likely to occur. (The analysis might be different if we were dealing with a “Bernie Sanders Global Initiative,” or organization associated with another long-shot seeker of the office.)

Second, if the triggering event does occur, can effective mitigation measures then be implemented? That might be difficult in this instance because, if she did win the Presidency, presumably returning the donations to the foreign governments, though not impossible, would be pretty unpalatable – particularly if the money was already spent on the many critically important causes the CGI supports.

Finally, the potential impact of a COI seems high here as well.  That is, the donations from foreign governments could undermine the trust that the American people have in the President, and perhaps cause suspicion in other countries too.

So I agree that CGI should ban foreign government contributions.  But I also applaud the organization for its effective work on climate change (and in other areas), as the actual conflicting interest we have with future generations on that issue may be the greatest COI of all time.

(Some additional reading:

Two conflicts of the apocalypse.

Is the road to risk paved with good intentions?

COI policies for non-profits.)