Disclosure and Management

In many instances, COIs are not categorically prohibited but rather required to be disclosed, so that the organization can consider whether to permit the COI, and, if so, under what terms and conditions. This section of the blog (and the sub-categories below) will explore a variety of issues related to these aspects of COI compliance.

Can ethics be “unbundled” from business?

Imagine the following: You need to hire a lawyer to advise you on a complex and highly confidential corporate acquisition, but the one you’d most like to have is pretty pricey. You explain this to her and she proposes what she calls a “win-win” solution:  if you sign an engagement letter that broadly states that she need not act in your best interests while performing services for you she’ll discount her hourly rate by 25%.

Or, imagine that your doctor has two schedules of fees: a “full price” one for patients who want the doctor to prescribe medicine based purely on what’s in their best interests and a lower-cost “value plan” for those who agree that the doctor can receive money from pharma companies for prescribing their medicines. Like the lawyer, your doctor is offering to “unbundle” his professional ethical obligations from the other aspects of his service – as a way of saving you money.

You seek clarification from both of them – what will this mean for me?  They both have the same response: while we won’t promise to act in your best interest we will act in ways that are “suitable” for you.

Would you be tempted by either offer?

Note that it is doubtful that either arrangement would be considered lawful – certainly the medical one  wouldn’t be, and I doubt the lawyer one would be either (although professional ethics issues arising from providing unbundled legal services are somewhat complicated – as reflected in this piece in the ABA Journal).    But even if they were permissible it is hard to imagine clients and patients saying yes to such options, where the risk of betrayal is so clear-cut and the adverse impact of such could be so great.

Yet a less obvious but not at all hypothetical version of ethics unbundled from business is already standard operating procedure in large parts of the investment world, where some of those who give advice to investors about retirement accounts have been allowed to operate outside of a best-interests-of-the-client framework. The main argument for this state of affairs is that “Consumers Deserve Choices”,  as described in this recent article in Investment News – including the choice of low-cost/non-fiduciary advice.

Of course, not all business relationships warrant the imposition of fiduciary duties. With some, “the morals of the marketplace” – in the immortal words of Judge Benjamin Cardozo – may well be morality enough.  But the business of providing advice about retirement accounts would not seem to be in this category, given how much is at stake for retirees (and, in a sense, for society as a whole), and the massive conflicts of interest problems that have beset the financial services industry for decades.

However, change is in the air. As described by the director of policy research at Morningstar,  last week “the Department of Labor proposed an amendment to the fiduciary definition under ERISA, the Employee Retirement Income Security Act. In short, the proposal would require any individual receiving compensation for providing investment advice to a plan sponsor, plan participant, or IRA owner making a retirement investment decision to adhere to a series of fiduciary duties–that is, to act in the best interests of their clients. The rule is based, in part, on a Council of Economic Advisors analysis showing that when individuals receive what the White House calls ‘conflicted advice,’ they tend to enjoy lower investment returns.”

Note that the even the proposed rule does have some exceptions built into it. For instance, “you can call a broker to execute a trade without triggering fiduciary duties, you just can’t ask for advice,…” as noted in this article in Forbes.   There are other exceptions too.  But overall it is a big step forward.

At this risk of being repetitive, I definitely recognize that there are times when it may indeed make sense to “unbundle” what would otherwise be an ethical duty from a business relationship.  An example from an earlier post is that joint ventures partners may and sometimes do waive fiduciary duties expected of board members on the JV.

However, one would be hard-pressed to look at instances such as this – where the investors in question tend to be powerful and sophisticated – as being relevant to the reality faced by most individuals struggling to grow/maintain their retirement accounts. Like the lawyer and doctor examples at the beginning of the post, if you take ethics out of the equation for investment advice involving retirement, what’s left might well be worthless …or outright damaging.


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.)


Conflicts of interest disclosures, waivers, recusals … and fig leaves

Much of the most interesting  case law and social science research around conflicts of interest concerns the related topics of disclosure and waivers, some of which is discussed in the prior posts collected here.   Recusals are relevant to this general area, too, in that they represent an alternative to waiver as a response to a disclosed conflict.   Today, we look a bit deeper at two stories covered in earlier posts to see what they tell us about disclosures, waivers and recusals.

The first story concerns disclosure and waiver in the recent Royal Bank of Canada case.  The case is noteworthy because the court declined to find that generalized language in an engagement letter between the bank and its client concerning a possible conflict was sufficient to waive the actual conflict at issue there. (See discussion starting on page 71 of the court’s decision, which is available through the link immediately above.)

Of course, at least in some circumstances, COI waivers by sophisticated parties are acceptable.  But in all cases involving any ambiguity, whether from a legal or ethical perspective, the efficacy of disclosures should be closely scrutinized and common sense applied to the claim of waiver.   By common sense I mean asking: Would a rational party have waived the COI  knowing all the relevant facts? And where the COI at issue seems to have been genuinely harmful to the complaining party – which was evidently the situation in the Royal Bank of Canada case – the proponent of the waiver will often have a tough sell indeed.

The second story concerns an aspect of the investigation (that is part of the broader inquiry concerning Governor Chris Christie)  of the chair of the Port Authority of New York and New Jersey, who was also a partner in a law firm – as  previously discussed briefly here  and more fully in this New York Times story.   Specifically, a Port Authority matter came before the chair in which a client of his firm had a clear interest and, while the chair apparently recused himself from voting on the matter, according to sources in the Times story, he evidently still “made his support for the plan [at issue] known to his fellow commissioners and was involved in planning” relating to the matter.

As described by a historian of the Port Authority, Jameson Doig (an emeritus professor at Princeton), who was interviewed for the Times piece, “the recusal afforded [the chair] an ethical fig leaf. ‘And the fig leaf is not adequate’…”  Note that the historian’s analysis may not be the final word on this – given the official investigations.  But the logic of analyzing recusals (this one and others) through a substance-over-form lens (like that which was applied by the court in the Royal Bank of Canada case) seems compelling to me.


The science of disclosure gets more interesting – and useful for C&E programs

In “Nothing to Declare: Mandatory and Voluntary Disclosure Leads Advisors to Avoid Conflicts of Interest,” published last month in Psychological Science,    Sunita Sah   and George Loewenstein   note that “[p]rior research documents situations in which advisors— subject to unavoidable COIs—feel morally licensed to give more-biased advice when their conflict is disclosed,” as well other  factors suggesting that disclosure is often less of an effective mitigant than might be imagined.  (For more information on some of this research see this post on moral licensing and this one  on the pressure that individuals to whom disclosure is made might feel to accept the conflict.)  However, the authors argue – and support with the results of several experiments  that they conducted –   “[w]hen COIs are avoidable … the situation can change dramatically because the ability to avoid conflicts brings other motives into play.”

One of these motives is that “disclosure becomes a potential vehicle for demonstrating one’s own ethics …to signal to themselves and to others that they are honest and moral …and that they prioritize others’ interests over their own.”  A second motive is that “in many situations advisors benefit financially when advisees follow their advice… [and] disclosing the absence of conflicts increases the likelihood that the advice will be followed,…”

Sah and Loewenstein also note: “Evidence from the field complements [their] findings. The American Medical Student Association’s PharmFree Scorecards program (which grades COI policies at U.S. academic medical centers…) has been successful in encouraging many centers to implement stronger COI policies.  Similarly, mandatory disclosure of marketing costs for prescription drugs in the District of Columbia produced a downward trend in marketing expenditures by pharmaceutical companies, including gifts to physicians, from 2007 to 2010…”

The authors’ findings make sense to me.  Indeed, in one of the above-noted earlier posts I suggested that the research indicating that disclosure could be harmful in the professional advisor context because it creates pressure to accept the COI  may not apply to the same extent “in the setting of a business organization – with defined and enforced ethical standards regarding COIs, where one might be more concerned about looking bad to one’s colleagues (or bosses) than to the conflicted party.”

That is, the first of the two motivations that Sah and Lowenstein identify as relevant to disclosure – the desire to show one’s trustworthiness – is likely to be a powerful force in many business organizations given the often strong enforcement of COI rules that began with the Sarbanes-Oxley Act and which is also supported  by the general importance of “organizational justice” to C&E program efficacy and the specific relevance of COI enforcement to organizational justice.  (The other motivation, however, is much less applicable outside of the professional advisor context, and indeed the notion of mandatory versus avoidable COIs may also be more relevant to the advisor context than for business organizations.)

So, the results of this study seem like good news.  But is it news that C&E professionals – who operate more in the business organization rather than in the professional advisor context – can use to make their companies’ C&E programs stronger?   Or, is it – as one C&E professional I know recently said of much behavioral ethics – the stuff of “parlor games”? (Note: I don’t agree with this critique, but it is worth noting that C&E practitioners, as a group, don’t seem to be doing much with behavioral ethics findings.)

I think that this knowledge can in fact be put to use for C&E purposes.   That is, it suggests that in policies, training and other C&E communications, companies should emphasize how timely and complete COI disclosure may be important to an employee’s being seen as trustworthy within an organization – as well as by other important parties (e.g., customers or suppliers).

More broadly, C&E professionals should find ways to address this motivation in helping employees understand the business case (in terms of their careers)  not just for full COI disclosure  but for ethical excellence  generally. Of course, this approach already exists to varying  modest degrees in some C&E programs, but there is plenty of room for many organizations to do more in this regard.

Thanksgiving edition: conflicts of interest and cholesterol

For millions of individuals (including me) Thanksgiving is not only a time for giving thanks but also for thinking about cholesterol.  And  if guidelines recently issued by the American Heart Association and American College of Cardiology are followed, the number of us who use  statins – cholesterol reducing drugs – will increase substantially, as described in this piece from Forbes.   But as described in this piece in Time (and also in the Forbes article) “the chair of the panel responsible for the new advice, which many see as favorable to … statins, had previous ties to a number of drug makers that manufacture those very same medications,” as did six of the other fourteen members of the panel.

I should add that the financial ties were duly disclosed and applicable guidelines (issued by the Institute of Medicine) were complied with, in that the guidelines do not prohibit any such COIs – only COIs by a majority of members of a panel.  Still, one cannot help feel uneasy about this situation for several reasons.

First, with respect to the panel’s report, one should not assume that disclosure cures the COI.  Indeed, as described in earlier posts in this blog, behavioral ethics experiments have shown just the opposite – that disclosure may “license” conflicts-inspired decision making.

Second, it is not clear to what extent the disclosures here are sufficiently processed.  As described in this article in MedPage Today by a faculty member at Harvard Medical School: “[A]midst all the late-breaking clinical trial presentations and ask-the-expert sessions, what I didn’t hear were the speakers’ financial conflicts of interest. Don’t get me wrong — the AHA mandates that all speakers present a disclosure slide at the beginning of every talk, and this rule was reliably followed by all presenters … in the following manner: ‘Here are my disclosures’ — PowerPoint slide flashes on screen with a list of pharmaceutical/device companies. Yet, by the time the speaker finishes speaking those four words, the slide deck has already advanced to the next slide. I, and my fellow audience members, didn’t even have enough time to read the disclosures, let alone process them.”

Finally, and on a broader level, COIs of this sort could have a more pernicious effect beyond directly impacting the patients involved, because of the great extent to which health-care costs are borne by the country as a whole.  As discussed in this recent post:

–          there are certain challenges (such as climate change and public debt) that both pose great risks to society as a whole and will require broad-based sacrifice to successfully address; and

–          COIs can imperil the likelihood that all relevant parties will be willing to make such sacrifices.

Health care costs fit into this category, too, and, like the others, key players in these areas have, in my view, a higher (i.e., “Caesar’s wife”) duty when it comes to addressing COIs ethically.

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.

How Well Does Disclosure Really Mitigate Conflicts of Interest? (continued)

Earlier posts have questioned the efficacy of disclosure as a mitigant for COIs for several reasons:

Disclosure can “morally license” the conflicted party to act in a COI-based way.

– Individuals impacted by the COI may not fully understand /be aware of what is being disclosed.

– A “reverse conflicts of interest” could occur, meaning that an individual dealing with the conflicted party could over-compensate for it.

To this list a fourth area of concern should be added: “disclosure can place inappropriate pressure on the audience to heed the advice — for example, in order to avoid insinuating that the [disclosing party’s] advice has been corrupted,” as noted in this interview with Daylian Cain of Yale.

It is important to add that Cain (and the colleagues who collaborated in his research on conflicts) “still think that transparency is a good thing and agree that disclosure will surely be part of the solution. So now [they] are more focused on how to improve disclosure because the word is out that it is no panacea.”

But what does it mean to improve COI disclosure?

In the context of COIs in business organizations (the focus of this Blog), the issue is, I think, less a matter of how to improve disclosures themselves than how to improve the way in which disclosed COIs are addressed, with the possibilities including:

– Educating (through C&E training and other communications) those involved as to the generally under-appreciated dangers of COIs.

– Ensuring that decisions about COI waivers and COI management are made by those who are independent and possess relevant expertise (e.g., a C&E officer) – not line managers.

– Having a sufficiently rigorous COI management process.

Finally, the danger identified by Cain of, in effect, of feeling pressured to heed COI-based advice may seem inconsistent with the “reverse COI” concern of overcompensating for COIs.  But I think they are not inconsistent when viewed in their respective relevant contexts. That is, overcompensation is more likely to occur in the setting of a business organization  – with defined and enforced ethical standards regarding COIs, where one might be more concerned about looking bad to one’s colleagues (or bosses) than to the conflicted party.

More to come in future posts.

Conflicts of Interest in the News: A transaction “tainted by disloyalty”?

An earlier post described a lawsuit brought by shareholders of El Paso Corp. seeking to block an acquisition of that company by Kinder Morgan due to claimed COIs on the part of Goldman Sachs, which advised  El Paso on the transaction, and that company’s CEO.  Last week, the judge – Leo Strine of the Delaware Chancery Court  – refused to issue the requested injunction (a ruling that was expected – given the absence of a competing offer for El Paso), but also had harsh words for Goldman and the CEO, and left open the possibility of a claim for damages against them.

As described in these articles in the NY Times, Bloomberg, and the Wall Street Journal,  (which I draw from since the opinion itself hasn’t, as of this writing, been posted on the Court’s web site):

– The Court found that Goldman was clearly conflicted because at the time it advised El Paso in the negotiations with Kinder Morgan its private equity arm also owned  more than 19 percent of the latter company (and had two appointees on its board).  As noted in the Times piece, the court found that Goldman was not “capable of ignoring its $4 billion investment” in connection with providing this advice: “Goldman was fighting for every dollar, securing a $20 million fee for advising El Paso on the sale…if Goldman was so greedy for $20 million, it surely would be for $4 billion.”

– “While Morgan Stanley was hired as a second adviser to El Paso because of this conflict, [the judge noted that] Goldman also arranged the ‘remarkable feat’ of limiting the scope of Morgan Stanley’s engagement so that it got paid only if El Paso was sold but not if El Paso decided to engage in an alternative”  transaction.  In other words, the attempt to mitigate the COI was structurally defective (and, in my view, could be seen more as a proof of the COI than meaningful mitigation).  Moreover, as noted in the Bloomberg story, “Goldman Sachs was able to ‘exert influence’ on the sale to Kinder Morgan because the investment bank continued to advise on the [alternative transaction]. Goldman Sachs’s conflict was ‘real and potent, not merely potential,’ the judge wrote.”

– El Paso’s CEO – who had told Kinder Morgan, but not his own board, that he hoped to buy El Paso’s pipeline business from Kinder Morgan once the transaction was consummated – “inexplicably caved in to Kinder Morgan” in agreeing to the price of the transaction.  As described in the Times, the CEO “was supposed to be getting the maximum price for El Paso out of Kinder Morgan. Instead, [the judge] observed that [he] appeared more interested in currying Kinder Morgan’s favor in order to make this subsequent purchase.”

Although, as noted above, the judge denied the request for an injunction, the shareholders can still seek monetary damages if they can prove the transaction was “tainted by disloyalty,” which parts of the judge’s opinion certainly seem to suggest occurred.  And, the Times piece concludes that in light of two other recent cases involving claimed COIs by Goldman: “[I]t is hard to see why Goldman Sachs was willing to risk its reputation again for a $20 million fee.  While it will continue to dispute these facts and its liability exposure is limited [due to an indemnity], Goldman is most likely the biggest loser because of its continuing self-inflicted … reputational wounds. This is another black eye.”  Finally, the bank’s COI-related troubles are still not completely behind it: in addition to the continuation of the El Paso case, Goldman Sachs faces a lawsuit filed two weeks ago based on claimed COIs in another (completely unrelated) transaction.

Does disclosure really mitigate conflicts of interest?

The first posting in this series  on behavioral ethics provided an overview of that emerging and important area of knowledge and what it might mean for the C&E field.    In this post we examine what behavioral ethics teaches about COI-related compliance.

Conflict-of-interest compliance regimes are, for the most part, based on disclosure requirements.  That is, while some types of conflicting interests are prohibited in  all circumstances, a more common approach is to require appropriate disclosure of the interests in question (and, in some instances, approval from specified parties before the COI condition is permitted to continue).

But how effective is this way of addressing conflicts?  In “Disclosing Conflicts of Interest – Does Experience and Reputation Matter?, Christopher W. Koch and Carsten Schmidt (replicating the results of an earlier study – “The Dirt on Coming Clean: Perverse Effects of Disclosing Conflicts of Interest,”  by Daylian  M. Cain, George Loewenstein and Don A. Moore)  found that in some circumstances  disclosure could be a cause of, rather than cure for, unethical behavior: “information providers whose conflicts are not disclosed will feel morally bound to report accurately to information users, because they would consider it unfair to lie to someone who is unaware of the misalignment of incentives.  Disclosing conflicts of interest would have the effect of removing the moral bound and providing a moral license to misreport.”

The particulars of the experiments undertaken for these studies (Koch and Schmidt used an audit-related setting) are, in my view, less important for C&E professionals than is the larger message, which is that disclosure should not be considered a panacea for COIs.  We have already seen in the Blog how disclosure can be ineffective (when patients don’t use information from publicly accessible data bases of  pharma company payments to health care providers) or even lead to “reverse conflicts of interest.” The findings reported in these two papers suggest that even when disclosed and approved COIs may need to be actively managed (to the extent that can be done in a given set of circumstances).

Part of that process should be educating both the individuals with the COIs and those managing the COIs on the nature of the challenge facing them.  As described by Cain,  ,  people often fail to “understand how big a problem conflicts of interest” are and he further notes that COIs can affect the judgment of even well-meaning individuals, i.e., someone “need not be intentionally corrupt to have difficulty in objectively navigating a conflict of interest.” 

Finally, one unsurprising but still important aspect of this research is showing that disclosure is likely to be more effective as the level of relevant experience/expertise of the party to whom the disclosure grows.  This, in turn, suggests that COI approvals generally should not be made by line management alone, but should involve a C&E officer, who is likely to be a more sophisticated estimator of the impact of a COI in an organization.

Coming up: what  behavioral ethics teaches us about C&E risk assessment and training.


Conflicts of Interest in the News: 011412 Edition


The two big COI news stories of the week were:

–  Economists Adopt New Disclosure Rules for Authors of Published Research.  The reforms follow “heavy scrutiny of economists’ conflicts of interest before the financial crash of 2008.”  This is a good (and certainly overdue) step (and sadly underscores how it often takes a scandal for COI-related reforms to be implemented).  Of course, disclosure by itself does not necessarily mitigate COIs.

Ties of FDA experts to pharma companies revealed. The “FDA asked outside experts in December to discuss the safety of birth control that contains the compound drospirenone, including Bayer’s Yaz and Yasmin. The panel decided by a four-vote margin that the benefit of pregnancy prevention from these pills outweighed their risk of dangerous blood clots. But according to court and public documents, three of the FDA’s 26 advisers had research or financial ties to Bayer. A fourth adviser had a connection to a manufacturer of generic copies of Yaz, Barr Laboratories, now part of Teva Pharmaceuticals. All four of these advisers voted that the drugs’ benefits outweighed risks, meaning the pills could stay on the market…” Beyond the impact on the decision at issue, one can imagine the harm that COIs of this sort have on public trust of the FDA.

Other news of the week concerns COIs and…

Government contractors.  This is an analysis from the Corporate Compliance Insights website of an important decision from the General Accounting Office concerning government contractors hiring former government officials, underscoring, among to other things, the need to do meaningful conflicts checks in hiring.

Journalists: “Next week, thousands of tech journalists will descend on Las Vegas to get a sneak peek at coming tech gadgets at the International Consumer Electronics Show.  Many will also probably come away with grab bags of goodies…The question, of course, is whether journalists can properly serve their readers when the industry is handing them bottles of top-shelf booze and pricey toys.”

Supreme Court Justices.  A tricky issue,  indeed: who decides COI issues for the court of last resort?

Regulators: “A former Securities and Exchange Commission official has agreed to pay a $50,000 fine for going through the revolving door and working for alleged Ponzi scheme mastermind Robert Allen Stanford after purportedly taking part in SEC decisions to not investigate Stanford, the Justice Department said Friday.” (Bad facts – but also an unusual case.)

And, thanks to Broc Romanek of the invaluable – particularly for securities and corporate lawyers – theCorporateCounsel.net for featuring our post on COIs in serving on other companies’ boards.  Apparently this was the occasion for much discussion there – and so we will return to the topic before not too long.

Coming up next week: more on COI risk assessment, moral hazard and a video coming attraction for a series on cognitive bias and “behavioral compliance and ethics.”