Edited by Jeff Kaplan
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Employment
In this section, we will examine COIs arising from employment-type relationships (not only traditional employment but consulting and board service, too).
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In today’s NY Times, Michael Greenstone, an economics professor at MIT, writes about a study on auditor COIs that he – together with Esther Duflo of M.I.T.; and Rohini Pande and Nicholas Ryan, both of Harvard – recently published. The study was conducted in Gujarat, India, where industrial plants with high pollution risks are required “to hire and pay auditors to check air and water pollution levels three times annually and then submit a yearly report to” a governmental body. In the study, for a randomly selected set of companies, but not for a control group, “auditors were paid a fixed fee from a central pool of money, a subset of the audits was chosen to have its findings re-examined, and auditors received payments for accurate reports, judged by comparisons with the re-examinations. The control group continued under the status quo system in which auditors were chosen and paid by the plants they were auditing.”
The results of this real-world experiment powerfully demonstrate the impact on the ethicality of conduct that financial incentives can have – even on the judgment of individuals who, by virtue of their professional norms, are supposed to be resistant to COIs. That is: “While many of the plants violated the pollution standards, few of the auditors in the control group reported these violations. In the case of particulate matter, an especially harmful air pollutant, auditors reported that only 7 percent of industrial plants violated the pollution standard. In reality, 59 percent of plants exceeded it.” However, “[t]he rules changes [in the experiment] caused the auditors to report more truthfully. In the restructured market, auditors were 80 percent less likely to falsely report a pollution reading as in compliance, and their reported pollution readings were 50 to 70 percent higher than when they were working in the status quo system. This difference was as large even when comparing reports of auditors working simultaneously under the two systems. Finally, and most important, the plants that were required to use the new auditing system significantly reduced their emissions of air and water pollution, relative to the plants operating in the status quo system. Presumably, this was because the plants’ operators understood that the regulators were receiving more accurate information and would follow up on it.”
Three comments on this important study.
First, while most directly relevant to auditors, these results can, I believe, be broadly applicable to COIs generally. That is, if professionals who are trained to rise above COIs fare this poorly, one can only imagine the impact of COIs on the rest of us.
Second, the more important compliance and ethics program efforts become to society, the greater the need for not just C&E auditing but other forms of checking – such as monitoring, as was discussed in a piece in Corporate Compliance Insights. But monitoring (as a general matter) is even less independent than is auditing, so this recent study underscores the considerable challenges for making forms of checking beyond auditing effective.
Third, research to determine “what works” is vitally important for the C&E field to mature and realize its full promise, and real-world studies such as this one can be particularly valuable in that regard. Interestingly, another article in today’s NY Times describes how in the UK there is now an government-run effort (headed by a “Behavioral Insights Team”) to use research to determine what works with respect to various public policies, including some compliance-related ones. I hope that the US and other countries will follow the UK’s lead here.
Finally, here is a prior post on auditor COIs.
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A prior post catalogued various COI issues arising from moving from one job to another. To this inventory should be added the recent case of David Ostermeyer (which was brought to my attention by a COI blog reader, for which I am grateful).
As described in this press release issued on October 25, 2013 by the Department of Justice, Ostermeyer had been the Chief Financial Officer of U.S. Agency for International Development (USAID) and “shortly before [he] retired from the USAID, he helped the agency draft a contract solicitation for a senior advisor – a position that Ostermeyer intended to apply for after he retired. In an effort to ensure he would be awarded the position, Ostermeyer allegedly tailored the solicitation to his specific skills and experiences.”
The press release further notes: “Federal conflict of interest laws prohibit executive branch employees from participating personally and substantially in matters in which they have a financial interest. Since Ostermeyer had a financial interest in the contract solicitation, the government alleged that he could not participate in drafting it and, therefore, violated 18 U.S.C. § 208(a),” which is one of the Federal COI statutes. Ostermeyer agreed to settle (without admitting wrongdoing) and pay a penalty of $30,000.
For those interested in learning more about the federal COI law – violations of which, in some instances, can be prosecuted criminally as well as civilly – the web site of the Office of Government Ethics (“OGE”) is the place to start. Of course, other governmental entities have their own COI rules – and sometimes have web sites like that of OGE. (An example that is rich in information – particularly concerning prior enforcement actions – is the web site of the NY Conflicts of Interest Board. Among other things, much of what’s on this and similar web sites can be useful for drafting COI policies and designing COI training.)
Even smaller municipal governments than that of NYC often have COI issues, too. Indeed, the very size of small communities may make COIs relatively more likely to occur in their governmental bodies than in those of larger municipalities (i.e., on average, I assume there would be a higher percentage of people with multiple roles, and thus opportunities for conflicts, in the former than the latter). Also, local governmental units may well lack robust ethics-related controls that larger official entities more typically have, as noted in this prior post. On the other hand, where ethics issues involve dealing with neighbors instead of strangers, there would seem to be a greater chance of virtue prevailing (although note that I may be stretching the logic of certain behavioral ethics research a bit in saying this and indeed some findings in this area suggest an opposite impact of closeness on ethicality).
Indeed, in the very town where I live – Princeton, New Jersey – the top local news story of the past week was the mayor’s decision whether to participate in negotiations with Princeton University (over the issue of voluntary payment-in-lieu-of-taxes contribution to the town) given that her husband is employed as a professor there. While “the town attorney, had given an opinion in August saying the mayor’s marriage did not constitute a conflict of interest under the state local government ethics law,” the mayor commendably determined that the issue had become too much of a distraction for the town government and so decided to recuse herself from taking part in the negotiations. One wishes that the former USAID official had shown the same degree of sensitivity to COIs that the mayor did, and I imagine that he now does too.
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Within the world of conflicts, those arising from prior employment relationships occupy a particularly significant territory. (Indeed, one of the most notable COI cases of this – still young – year concerns the former head of a pension system helping a fund manager get business from the system.) In today’s post, I briefly explore different aspects of this part of the COI map.
First, the most consequential forms of conflicts based on previous employment tend to involve public-to-private sector transitions (as in the above-mentioned pension case), and here the relevant standards are generally defined by law. At least in the U.S., the rules for such transitions can be fairly restrictive, as reflected in this 2009 memorandum from the Gibson Dunn law firm relating to employees of the federal executive branch and also in this discussion of relevant state law on the UCLA web site. Government employees and those who would hire them need to be very mindful of these rules and the latter should build into their hiring processes rigorous means for ensuring compliance.
Second, in terms of purely private sector employment transitions, restrictions of the above sort are less universal – and tend to be the domain of internal policy, rather than law. Here (on page 24) is a good example of one such approach from the Verizon Wireless code. Based on what I’ve seen over the years, this is an area where many companies have room to improve.
Finally, there are other less common COI-related employment transitions for which the inquiry goes beyond law or internal policy to something else – an ethical concern, with an element of public policy, perhaps. While difficult to define using current COI categories, these cases tend to be among the most interesting of the lot.
For instance, late last month, as reported in the Guardian, a report issued by the public accounts committee of the House of Commons in the UK charged that Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers “are using knowledge gained from staff seconded to the Treasury to help wealthy clients avoid paying UK taxes… [the firms provided] the government with expert accountants to draw up tax laws [but] went on to advise multinationals and individuals on how to exploit loopholes around legislation they had helped to write… Margaret Hodge, the [committee’s] chair, said the actions of the accountancy firms were tantamount to a scam and represented a ‘ridiculous conflict of interest’ which must be stopped.” Note that for various reasons (some of which are laid out in the Guardian piece) this doesn’t sound like a black-and-white issue to me, but it is indeed worrisome. And given the importance – not just in the UK, but pretty much everywhere – of enhancing the fairness and efficiency of tax systems, I imagine that it is the sort of issue that we’ll be hearing about more in the years ahead.
Finally, there is the story from earlier this year about Treasury Secretary Jack Lew having received a $685,000 severance payment when he left an administrative post at NYU for one at Citibank, which he subsequently left to return to government work – at which time he also got a bonus from Citibank. While the latter payment was contractually mandated, the former one was not and, as noted in this article, was “considered unusual by outside experts in benefits and raises questions about why a tax-exempt university would give a large exit bonus to an executive who was departing voluntarily.”
In light of the chronology, Lew was presumably not being paid by NYU to influence his exercise of specific duties as a government employee – and so this cannot be called a COI in the traditional sense. But it is also hard to see the severance as the school simply rewarding an employee for a job well done – especially since, in addition to a large salary, he also received a loan forgiveness valued at about $440,000. Moreover, given the path of his career (most of which was spent in public service, including holding some powerful posts) it doubtless seemed likely at the time he left NYU that he would at some point return to government in a high ranking position.
So in terms of where the Lew matter fits on our “map,” it may be most accurate to say that it has the spirit – if not the actual form – of a conflict of interest (although perhaps it could be called a COI “on spec”). But – along with other such cases – it may suggest a need to look at the adequacy of our current understanding of what a COI is, and consider redrawing the boundaries of what is out of bounds along the lines of common ethical sense.
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Just in the past few months:
– A police officer was caught allegedly “moonlighting” as a pimp – and was fired.
– An IRS employee with broad supervisory authority (to decide, among other things, which taxpayers were audited) was found to have set up a private tax advisory business – and was charged with a violation of a federal conflicts of interest law.
– A business organization (which was already tainted by a high-profile COI scandal) was discovered to be allowing some of its salaried managers to “moonlight” as hourly workers for the organization – and was publicly embarrassed.
(Also worth noting – but not, in my view, as clearly wrong as the others: a judge in New Jersey is under fire for moonlighting as a stand-up comic.)
Moonlighting has been around for a long time. (For COI history-minded readers, here’s an interesting example involving a 19th century Chilean general who had a second job — as an agent for an arms contractor that sold to the Chilean military.) But due to macroeconomic headwinds, relatively pervasive job insecurity and the expansion of telecommuting the practice seems likely to grow in the future (although this is only a guess).
While the cases we read about tend to involve intentional breaches or stunningly bad judgment, moonlighting viewed more generally can be beneficial, and not only for the moonlighter. Most obviously, the second employer gets the assistance of an employee that might not otherwise be available to it. Less obviously, the first employer can benefit from the employee’s experience at the second job – although this wouldn’t be a factor in all cases. Still, all involved need to be mindful of relevant C&E issues.
First, if you are employed by a governmental body, know the law, as some violations – such as in the IRS case – are punishable by criminal prosecution. (Here is an overview of relevant federal law and here is one regarding employment with NY City.) Similarly, if employed in the private sector, know and follow your company’s moonlighting policy – which is often found in the conflict of interest section of a company code of conduct.
Second, if you are an employer, make sure you in fact have implemented a moonlighting policy – and note that the failure to have one could, in certain circumstances result in a violation of state “lawful conduct” statutes. (I don’t know about laws outside the US on this issue.)
Such policies typically include conflicts-of-interest provisions – barring/restricting employment:
– with a competitor company or a firm that does (or seeks to do) business with the organization – like a supplier or customer;
– in jobs that might entail use of the organization’s confidential information or commercial relationships; or
– where the work could otherwise adversely affect the organization’s image or interests.
Beyond such conflicts, these policies generally provide that a second job shouldn’t interfere with performance of duties required by the first – e.g., by making an employee too tired for the latter or causing her to use time that should be spent on the latter for the benefit of the former.
Third, these policies should be promoted and enforced. They should be the subject of periodic communications – and not just buried in an employment manual that no one reads. There should also be a formal process to help ensure that approvals are documented and justified and, from time to time, the company should check to make sure the policies are actually being followed.
Fourth, whether as a matter of practice or policy, the “second company” (i.e., one that is hiring the moonlighting employee), should enquire of applicants if they have received any necessary permissions from their principal employer. I.e., an ethical organization will want to make sure not only that it is free of conflicts of interest internally but that it is not causing conflicts in others.
Finally, for a post on COI issues potentially arising from service on an outside board click here.
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I don’t think so – at least not in most cases. But given the general importance of incentives to compliance the question is a fair one, and has been raised occasionally over the years. (The conflict, of course, would be that to the extent that a C&E officer’s compensation was tied to the profitability of her company, she might be discouraged from challenging improper conduct that contributed to that profitability.) And, the issue has recently been raised again – at least indirectly – by two researchers at Stanford’s Graduate School of Business.
In “Fixed or Contingent? How Should ‘Governance Monitors’ Be Paid?”, David F. Larker and Bryan Tayan discuss compensation approaches for two types of such monitors – general counsel and internal auditors. Of course, C&E officers are no less monitors than are internal auditors (and indeed, as Joseph E. Murphy – a long time leader in the field – has pointed out, they tend to be in a more pure monitoring role than are general counsel, who typically have many duties beyond their monitoring related ones).
The authors suggest that to the extent the role of monitors is to prevent errors, “monitors should be paid on a fixed salary basis, with failure to prevent malfeasance punishable by a substantial reduction in salary or outright termination from the firm.” But they also note that such an approach “might not provide sufficient incentive for vigilant monitoring.” They further point out that to date there has been little research to guide firms in finding the best approach to compensating monitors (other than research regarding directors, whose monitoring related duties are very different than are those of management).
But a recent study by Larker, Chris S. Armstrong and Alan D. Jagolinzer described in the paper found “a lower frequency of adverse outcomes (class action filings, financial restatements, SEC actions, and material weaknesses) among firms that offer higher incentive payments” to their governance monitors. They conclude that such an approach either incents better monitoring efforts or helps attract a better class of monitors.
So, good news for C&E officers!
A separate question, that goes beyond what is discussed in the Larker/Tayan paper, is what should the basis an E&C officer’s incentive compensation be? We will explore that in a future posting.
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A recent study shows that – contrary to what might be called popular suspicion – lawyers with the Securities and Exchange Commission do not seem to try to curry favor by making lax enforcement decisions when dealing with law firms that might offer future employment prospects. Rather, the study found evidence to support a “human capital” hypothesis that SEC lawyers interested in future private sector employment would use such encounters to showcase their skills, and be “tough.”
Perhaps because they are somewhat surprising, the study’s results have not been universally accepted. The author of this piece, for instance, argues that it seeks to “measure the unmeasurable,” and she points to another recent study showing that “that SEC alums may exert a much more subtle influence at their old agency when they begin to represent clients in private practice.”
Having been a white collar defense lawyer in a prior life, I was not especially surprised by the results (although I also agree that some of what the study is looking at is immeasurable). If anything, what I saw of former enforcement personnel who became defense lawyers is that many of them still viewed the world through a prosecutorial lens, i.e., a reverse revolving door.
But I do believe that there two dysfunctions in the enforcement realm which, if not constituting true COIs, come from the same neck of the woods, meaning they reflect the operation of forces that lead to enforcement decisions that are not well aligned with the public’s interests.
The first is that prosecutors seem too easy to accept resolutions of investigations where the company (meaning its shareholders) pay a heavy price but the guilty executives go free. As described last week in a NY Times story : “The ballooning settlements are for civil charges of fraud against the government, criminal charges often related to the same conduct and, in the case of health care companies, recovery of money for states for Medicaid fraud. But while the collections are a boon to the government and taxpayers, they are resurrecting questions about the relative lack of charges against executives at the companies that are getting the stiffest penalties.” The misalignment of interests here is that while prosecutors can claim credit for record settlements in charges against companies, the outcomes do little to protect the public from future crimes, since it is executives – much more than shareholders – who are in a position to engage in or prevent wrongdoing. (Of course, to the extent that a company pays extra to allow an executive to go free, the shareholders, as well as the public, are being ill served.)
The second (and related) misalignment of interests is that prosecutors are often rewarded (in terms of enhanced future job prospects) for the large settlements that they win in cases but, to my knowledge, none has ever been recognized for the crimes that they prevented, meaning for their work in promoting compliance programs. One can readily see what would be wrong with a health care system that measures success only by the number of surgeries conducted – not the health of the patients it serves, and indeed this criticism has been directed against aspects of the current health care regime. But when it comes to embracing prevention, medicine is light years ahead of law enforcement. (For more on how the legal system does too little to promote compliance programs, see this piece.) Aligning the interests of individual prosecutors with society’s interest in preventing crimes as well as punishing them is key to a more overall effective approach to promoting law abidance by businesses than we have now.
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Some codes of conduct and C&E policies and certifications identify outside board service as a potential COI. What should an analysis of COIs of this sort entail? This is a topic about which relatively little has apparently been published. Below are links to some helpful resources on it combined with a few hopefully helpful thoughts of my own.
First, in this post on the Business Ethics Blog, Chris MacDonald notes that serving on a board typically involves significant compensation (and hence should be considered an interest for COI purposes); an individual’s board member duties could conflict with her employee duties if the entities in question did business with each other; and given the sheer time commitment expected of board service, there could be a significant time-management conflict in situations of this sort. This is a good foundation for analyzing COIs in these types of situations, to which one might add that even where the two entities don’t do business with each other a conflict could arise if they both do business with a given third party, i.e., employee of Company A joins the board of Company B, which is seeking to do business with Company C, a supplier to Company A. (This would not necessarily be a COI – but, depending on a variety of circumstances, might be one.)
Second, another valuable post on this topic comes from Meghan Daniels of SAI Global – who offers various questions companies might ask when considering whether to allow an employee to join the board of another entity based on: a) the employee’s role at the company; b) the time commitment involved in the contemplated board service; c) the status of the external company; and d) the relationship between the two entities.
Third, here is a useful code provision on board service from a publicly available code of conduct:
Entergy recognizes that there may be limited cases where it is in the Company’s best interest for you to hold a position on the board of directors of a for-profit entity not affiliated with Entergy. However, the position must not place you or the Company in a potential conflict of interests situation, must meet all regulatory and legal requirements, and must be appropriately disclosed to all relevant parties. There are certain laws and regulations that can impact this service and you must discuss the situation with your supervisor and receive appropriate approvals prior to taking action.
Two points about this language: a) the need to make disclosure to “all relevant parties” is important, as disclosing to the company alone might not be enough; b) the policy appropriately focuses on the company’s interest in deciding the issue at hand. Note, too, that the laws and regulations referenced here may be largely specific to the industry that this company is in, and being familiar with any relevant laws applicable to one’s own organization can be critically important for addressing issues of this sort.
Fourth, worth considering (although perhaps of less immediately obvious relevance to our topic) is a judicial decision in a case called Raley v. Superior Court. In Raley, the Court ordered the disqualification of a lawyer’s firm from participation in a litigation against a corporation that was owned by a trust, the trustee of which was a bank on whose board the lawyer sat, based, in part, upon the fact that the lawyer’s fiduciary duties to the bank and trust “require him to make every reasonable effort to maximize” the assets of the trust, which could lead to his acting contrary to the firm’s client in the litigation.
As relevant to the issue addressed in this posting, this language underscores just how strong the ethical and legal duty that arises from board service is – which, in turn could support a strict approach to determining COIs when an employee of one entity seeks to serve on the board of another. The case is indeed a reminder that serving on a board is serious business, and before agreeing to such service an individual – and, if relevant, her employer – should think through all that that entails from an ethical and legal perspective.
Fifth, in some situations a company might decide to permit an employee to join another company’s board subject to management of any COIs flowing therefrom. If going this route, all concerned need to consider the implicatons vis a vis the confidentiality of the latter’s information.
Finally, I should stress that there are a host of possible advantages to an organization in having one of its employees serving on the board of another entity (as reflected in the language from the Entergy code). Here is a good piece identifying some of those and my post should not be read as suggesting any presumption against permitting such service – it is offered only to help identify what some of the relevant COI issues might be.
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