Edited by Jeff Kaplan
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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.
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The Coronavirus is,of course, creating considerable volatility in the stock market. With such volatility comes opportunity for investors to make profits, either honestly or otherwise. Are companies prepared for what might be an increase in insider trading risk?
In many companies the principal “owner” of insider trading compliance on best trading platforms like MetaTrader 4 for retail traders, is the corporate secretary or other member of the law department – not the compliance & ethics officer. That is generally fine, as the subject is of a fairly technical nature.
But in my view the CECO should still have a “line of sight” into insider trading compliance too. This is particularly so given that insider trading laws are – at least in part – conflict-of-interest based, and COIs are within the “heartland” of a CECO’s duties.
The basics
The core of an insider trading compliance program is the policy, which every public company (and some private companies) should have. A typical policy should cover the following
– Explanation of insider trading , including definitions of key terms such as “material” information, non-public information, purchase and sale. Personal experiences and ironfx scam can teach more about insider trading and how to handle it smoothly.
– Procedures to prevent insider trading, including preapprovals and black-out periods.
– Policy and procedures on “tipping.”
– Any additional transactions that are prohibited by the policy, such as trading in options in the company stock or buying on margin,
– Rule 10b5-1 trading plans.
– Penalties and enforcement.
The basics also include:
– Insider trading training and periodic communications.
– Certificates of compliance.
– Avenues for seeking guidance and reporting concerns.
The role of the CECO
Most of these items are, as noted above this is fairly technical. But an insider trading program can also have a broader cultural dimension.
For instance, as noted in an earlier post: insider trading should be seen as a form of private corruption, rather than as a more technical and indeed victimless form of wrongdoing, which it is sometimes seen as. This can give enforcement and compliance efforts a degree of moral force that they might otherwise lack.
Can the corporate secretary make the case about insider trading being a form of private sector corruption? Sure – but in all likelihood the CECO can do it better because she will be able to place insider trading within the larger conflict of interest framework. This could make both areas stronger.
Again, I’m not trying to take work from the corporate secretary. But having the insider trading program learning from the CECO could help companies strengthen their compliance in a time of heightened risk.
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You might be interested in this piece about abuses in the gifts and entertainment area being viewed as “soft-core corruption.”
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Compliance programs have long been viewed (at least by me) as a “delivery device” for bringing behavioral ethics ideas and information into the workplace. And now something similar can be said about corporate governance.
In Corporate Law for Good People Yuval Feldman, Adi Libson (both of Bar-Ilan University) and Gideon Parchomovsky (of the University of Pennsylvania Law School) offer “a novel analysis of the field of corporate governance by viewing it through the lens of behavioral ethics.” As they note: “In the legal domain, corporate law provides the most fertile ground for the application of behavioral ethics since it encapsulates many of the features that the behavioral ethics literature found to confound the ethical judgment of good people, such as agency, group decisions, victim remoteness, vague directives and subtle conflict of interests.”
Of these, the topic of COIs is (predictably) is of greatest interest to me. The authors’ area of particular focus here is independent boards of directors. They note that independent directors may suffer from the “curse of partial independence. Their status as independent directors intensifies their self-perception as ‘objective’ agents, making them more susceptible to subtle conflicts-of-interest. As many scholars have pointed out, independent directors have a weaker type of a conflict-of-interest. According to behavioral ethics, this might cause those directors to be more rather than less biased, making it easier to ignore or justify self-interested decision-making.”
“Even though they have no formal ties to the management or major shareholders and do not receive direct benefits from them, some degree of non-formal ties are likely, which may make them less rather than more objective relative to other directors. Furthermore, it is mostly the management that effectively chooses independent directors, so even without any pre-existing ties, the management is to some degree the benefactor of the independent director. This subtle conflict-of-interest may lead independent directors to lean to return the favor by showing leniency toward the management, similar to the studies that have found tendency to take sides even when the actor does not derive direct gains from the triumph of the party she supports.”
“This analysis does not necessarily lead to the conclusion that the institution of independent directors should be abolished. On the contrary, independent directors have the potential to improve corporate governance, if measures are taken to address the subtle conflict of interest that undermines their performance.”
I agree with this analysis, as I do nearly everything said in this paper.
But one area that I found questionable was the finding that “building an atmosphere of a ‘corporate family’ and forming organizational loyalty is mostly perceived as an important value for investors, but under certain circumstances it may work to their detriment. Similar studies have found that ethical codes that use more formal and less ‘familial’ language—usage of the term ‘employee’ and not ‘we’—are more effective in curbing unethical behavior” (emphasis added). The principal support for this is a reference to an unpublished manuscript on file with authors, which left me eager to learn more about this contention.
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In “Can Ethics be Taught? Evidence from Securities Exams and Investment Adviser Misconduct,” forthcoming in the Journal of Financial Economics, Zachary T Kowaleski of University of Notre Dame, Andrew Sutherland of the Massachusetts Institute of Technology, and Felix Vetter of the London School of Economics “study the consequences of a 2010 change in the investment adviser qualification exam that reallocated coverage from the rules and ethics section to the technical material section. Comparing advisers with the same employer in the same location and year, we find those passing the exam with more rules and ethics coverage are one-fourth less likely to commit misconduct. The exam change appears to affect advisers’ perception of acceptable conduct, and not just their awareness of specific rules or selection into the qualification. Those passing the rules and ethics-focused exam are more likely to depart employers experiencing scandals. Such departures also predict future scandals. Our paper offers the first archival evidence on how rules and ethics training affects conduct and labor market activity in the financial sector.”
This seems like a very important study and there are far too many aspects of it to provide a comprehensive summary here. But I was particularly struck by the following:
“[W]e find the misconduct differences across passers of the old and new exam persist for at least three years, which we would not expect if advisers merely memorize rules rather than draw more fundamental lessons about acceptable conduct from the ethics portion of the exam. In sum, this evidence suggests that our main results cannot be explained by compliance alone, and that the exam change altered advisers’ perceptions of acceptable conduct.”
“[T]he behavior of the least experienced advisers is most sensitive to the extent of rules and ethics testing. These results are consistent with the exam playing a ‘priming’ role, where early exposure to rules and ethics material prepares the individual to behave appropriately later.”
“[W]e find the exam’s coverage to be less pertinent to those advisers working at firms where misconduct is prevalent. Thus, the contagion of misconduct behavior appears to limit the effectiveness of training in preventing transgressions.”
“We study turnover among all Wells Fargo advisers, and find those passing the old exam are most likely to leave after the scandal broke.”
There is much more to the study than this and I encourage you to read the original.
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The settlement by President Trump of a lawsuit brought by the NY Attorney General claiming that the Trump Foundation misused funds to benefit his 2016 campaign was attention getting not only because of who was involved in the case but also because he was compelled to pay $2 million to have the matter resolved. But while unique in some ways, the matter is a good reminder of the need for effective COI compliance in the nonprofit world generally.
Writing in a recent issue of Nonprofit Quarterly Vernetta Walker notes: “Just in the past few months, Baltimore’s mayor Catherine Pugh resigned following a scandal that revealed she had profited in the hundreds of thousands of dollars from selling her self-published children’s book to the University of Maryland Medical System, where she served as a board member; the Washington Post exposed eighteen board members of the National Rifle Association who were paid commissions and fees ranging from thousands to over $3 million; and ProPublica’s searing investigation into Memorial Sloan Kettering Cancer Center revealed a nest of self-serving behavior, including top executives who received personal annual compensation in the hundreds of thousands of dollars and in one instance over a million dollars in equity stakes and stock options from the drug and healthcare companies. Meanwhile, dozens of stories have appeared that raise questions in the minds of the public about pharmaceuticals’ funding of patients’ rights groups. These are just the tip of the iceberg of recent examples eroding the public trust.” She also writes that a “closer look at real-life examples reveals three separate but related issues that surface repeatedly: (1) failure to navigate the gray areas of conflicts of interest, including group dynamics within the boardroom; (2) failure to navigate the gray areas of recusal and disclosure; and (3) failure to fully appreciate unintentional reputational damage because, technically, the transaction being considered is not illegal.”
Walker further asks: “So, how should nonprofits navigate the gray areas where relationships are involved, the actions are not illegal, and the organization has complied with the conflict policy (i.e., disclosure and recusal)? Some organizations decide, as a matter of policy, never to enter into paid contractual relationships with any board member, so as to avoid speculation about abuse of position and influence for personal gain. Such organizations, of course, steer well clear of inviting vendors or potential vendors onto their boards. They also tend to be very careful about contracting with other organizations where staff members have an interest in the vendor or hire family members or personal friends, because they are consciously holding an ethical standard that argues against it. Where using a board member as a vendor is concerned, there may be some cases in which such situations emerge and the connection is limited enough, or thought to benefit the organization enough, that it may decide to leave some room in its policy while recognizing the risks it incurs in doing so. In all such cases, the board should make comparisons of alternative options; and it should take a vote on whether the proposal is fair and reasonable and in the financial best interest of the organization, but only if no other acceptable option is available.”
There is much more to Walker’s piece and I encourage those involved in compliance work for non-profits to read all of it.
And, you might find of interest this earlier post on nonprofit COI policies.
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In “Companies Need to Pay More Attention to Everyday Unethical Behavior” – published last month in the Harvard Business Review – Yuval Feldman, Professor of Legal Research at Bar Ilan University, argues:
Many large scandals have sounded the alarm on the need to monitor corporate corruption. The typical response from policy makers is to propose a patchwork of reforms to address various corporate transgressions. But by and large, these reforms focus on preventing gross and blatant violations of the law – and they ignore the more banal, ordinary acts of unethicality that are far more common in organizations. Numerous studies have documented the prevalence of practices such as stealing office supplies, inflating business expenditures reports, and engaging in behaviors that raise conflicts of interest. While these may sound negligible, these violations reduce trust over time and alter prevailing business and legal norms. Their aggregated effect can be quite harmful. Behavioral ethics research suggests that this type of misconduct occurs not because people are unethical or deliberately choose to act unethically, but because they fail to understand that their behavior is indeed unethical and can have harmful consequences. Thus, sanctioning rule breaking and looking for “smoking guns” will not prevent most employees from acting unethically. If organizations want to do a better job at preventing misconduct, they need to adopt a two-stage approach. The first stage focuses on increasing people’s awareness of the illegality and unethicality of their behavior. The second stage is about ensuring that employees clearly recognize that misconduct will be penalized.
Achieving what is contemplated by both of these stages could sound daunting – particularly the first. However, for companies that already have compliance and ethics (“C&E”) training for managers and supervisors there may be an opportunity to use that training to increase employees’ awareness of the sort of risks described by Professor Feldman.
That is, such training can be expanded to include:
– A brief explanation of the findings of the above-referenced behavioral ethics research.
– An explanation that managers’ C&E duties include identifying seemingly negligible risks in their respective parts of the organization that could over time adversely affect trust there.
– An expectation that these risks will be addressed by managers when speaking to the workforce (e.g., in townhalls, staff meetings, etc.) and through written communications.
Note that I am proposing a more or less “local” approach to this issue, as opposed to a top-down one, as I believe that having managers of various ranks involved in the process is necessary to make the effort risk based. Also, hopefully being given this role will lead managers to reflect on their own ethical performance.
Note that there is much more that can be done in communications and training to use behavioral ethics information and ideas to prevent and detect wrongdoing. See prior posts collected in this index.
There is also more to be said about slippery slopes, some of which can be found in this prior post.
Finally, here is an article on drafting managers’ C&E duties.
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In today’s edition of the FCPA Blog.
I hope you find it useful.
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In 1994 I spoke at a meeting of a company’s executives that took place shortly before the end of the company’s financial quarter, and in the same session the CEO made the point that the executives needed to be vigilant against any mischief designed to dress up the quarter. This was my first exposure to “just-in-time” training/communication. And although more companies time their compliance measures in this sort of way now than did then (mostly because there are more measures to time), it is an area where many organizations can and should up their respective games.
The basic idea of just-in-time communications (also sometimes called “point of risk” communications) – as described in this post – is that compliance communications are most likely to have the desired impact if delivered shortly before exposure to the risk in question. As noted in that post, this mechanism could be used to address a wide range of risks: “anti-corruption – before interactions with government officials and third-party intermediaries; competition law – before meetings with competitors (e.g., at trade association events); insider trading/Reg FD – during key transactions, before preparing earnings reports; protection of confidential information – when receiving such information from third parties pursuant to an NDA; … accuracy of sales/marketing – in connection with developing advertising, making pitches; and employment law – while conducting performance reviews…”
To his discussion I would like to add the notion of a just-in-time risk assessment. Specifically, when conducting risk (or program) assessment interviews or surveys, compliance personnel should inquire a) for any given area or risk, whether there is a need for just-in-time training/communications; and b) if so, what the specifics of such training/communications should be.
Finally, the need to look for opportunities of this sort can be added to lists of managers’ C&E duties (e.g., those set forth in the code of conduct, training for new managers, and perhaps personnel evaluations). This will not only help companies develop more “just-in-time” communications but will raise the level of managers’ C&E knowledge and commitment generally.
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Marketers have long known that “point-of-sale” display of products can be a powerful advertising tool. But can its logic be put to work for promoting compliance and ethics?
I was recently asked by a client to fill out a vendor information form and noticed that in addition to seeking information from vendors the form required the employee proposing the hiring to certify that any conflict of interest involving the vendor had been disclosed and okayed by management and the C&E officer. While I know that many companies have some form of COI certifications (see prior posts collected here), I can’t recall having seen one on a vendor information form of this sort before – even though the common sense of such a “point-of-risk” compliance approach seems pretty obvious. Indeed, it is hard to think of any reason why a company wouldn’t do this.
Moreover, such an approach is supported by behavioral science, as described in this earlier post. And, as also noted in that post, beyond the COI risk area there is no shortage of other “point-of-risk” compliance opportunities for many companies: “anti-corruption – before interactions with government officials and third-party intermediaries; competition law – before meetings with competitors (e.g., at trade association events); insider trading/Reg FD – during key transactions, before preparing earnings reports; protection of confidential information – when receiving such information from third parties pursuant to an NDA; … accuracy of sales/marketing – in connection with developing advertising, making pitches; and employment law – while conducting performance reviews…” (Note: in the earlier post I refer to this approach as “just-in-time” compliance, but on reflection think that “point of risk” is closer to the mark.) Doubtless there are many others too.
I should stress that this suggestion does not imply an increase in the total amount of C&E education, which for some companies would be a non-starter. Rather, a robust “point-of-risk” strategy might allow a company to decrease its use of less impactful communications, meaning principally those that lack immediacy and context.
Thinking more broadly, a “point of risk” C&E communication strategies might work for teaching ethics in business schools and colleges. Writing last week in the Huffington Post, William Steiger of the University of Central Florida’s College of Business Administration argued that: “Business schools should use examples of ethical practices and decision-making throughout the curriculum, not just in the ethics class.” I agree (and indeed when I was teaching business ethics years ago made a similar proposal; I hope Steiger has more success with this than I did).
Whether it is in the workplace or classroom, there is a growing need to find ways to better communicate and otherwise support ethical expectations. For many businesses and schools, a point-of-risk approach may be a good place to start.
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Director COIs are in the news again.
First, the Wall Street Journal reported last week: “Generic-drug maker Mylan NV moved into new headquarters in December 2013 after buying vacant land in an office park near Pittsburgh and erecting a five-story building for about 700 employees. The company hasn’t publicly disclosed that the office park’s main developer is Rodney Piatt, Mylan’s vice chairman, lead independent director and compensation-committee chief. The new headquarters was a big boost for the mixed-use real-estate development, called Southpointe II, where all the land has been sold and some of the last buildings are now rising.” As the article further describes, Piatt sold his interest in two parcels to a business partner for nominal amounts, who in turn sold the parcels to Mylan for several million dollars each, but that does not mean that Piatt received no benefit from the dealings: “Mylan’s decision to build the new headquarters may have helped boost the value of Mr. Piatt’s other holdings in [the development]. After local officials in 2011 approved permits and rezoning for a plan that included the headquarters, a firm managed by Mr. Piatt sold a nearby hotel for $14.8 million, property records show. Mylan’s plans helped spur interest from retailers to sign leases, says… the business partner of Mr. Piatt. ‘The more people there are in offices, the more demand there is for lunches’ and other services,… .”
While there is presumably more to this story than what appears in the article, it is hard to argue with the take of corporate governance expert Charles Elson: “’The optics are terrible. Pittsburgh is a big town with no shortage of real estate. Either they could have gone somewhere else, or [Mr. Piatt] could have relinquished the directorship and eliminated the conflict.’”
The second article – which appeared this past weekend in the New York Times – is no less interesting: “Consider a document recently filed in a 2013 shareholder lawsuit against directors of Dish Network, the television provider based in Englewood, Colo., which contends that the company’s co-opted board cost its investors at least $800 million in one recent episode. The document also provides some seriously good, well, dish on personal and family ties between Charles W. Ergen, the company’s co-founder and chief executive, and two Dish directors the company identifies as independent in its regulatory filings. Lawyers for Dish shareholders found, for example, that the family of Tom A. Ortolf, a director who is head of CMC, a private investment firm, has taken numerous hiking trips with Mr. Ergen’s family. Another fun fact unearthed in the case: Four invitees to a 17-person bachelor party for Mr. Ortolf’s son were Ergen family members. Then there’s the note Mr. Ortolf sent after Mr. Ergen offered two Super Bowl tickets. “I love you man!” the director exulted. George Rogers Brokaw, a managing partner at Trafelet Brokaw & Company in New York, is another independent Dish director with personal ties to Mr. Ergen. Mr. Brokaw’s family hosted members of the Ergen clan at their homes in New York City and the Hamptons, the lawsuit says. Mr. Brokaw also provided advice on a job search to one of Mr. Ergen’s children. Cantey Ergen, Mr. Ergen’s wife and a Dish co-founder who is also a director at the company, is godmother to Mr. Brokaw’s son.” The Times piece further describes: “The close relationships between Mr. Ergen and his directors might not have mattered so much if not for a private investment he made in 2012 [which, the shareholders contend in their suit, represents a usurpation of a “corporate opportunity” belonging to the company] “that could generate personal profits for Mr. Ergen of perhaps $800 million. After shareholders sued, contending that the transaction was a breach of the chief executive’s duty to Dish, a special litigation committee of the company’s board was formed to investigate the deal. As it turned out, Mr. Ortolf and Mr. Brokaw were appointed to two of the committee’s three posts.”
There’s lots to be said about director conflicts (see prior posts collected here ) but perhaps the overarching point is that a big part of the reason that the position of corporate director exists is to ameliorate the conflict-of-interest-like “agency problem” that comes from executives managing other people’s (i.e., shareholders’) money. Since directors’ COIs can raise questions about the ability of a board to perform this vital function, they can be especially pernicious. For this reason, it is part of a director’s job, I believe, to avoid situations that give governance experts like Charles Elson just cause to berate them publicly for creating terrible optics, as he did the Mylan directors. Put otherwise, directors have to be attentive not only to actual COIs but apparent ones too.
Of course, every member of a public company board would swear that they are familiar with this principle. But what is less well appreciated is just how difficult mitigating an apparent conflict can be – and particularly so for powerful people with complex business dealings. For more on what is involved in mitigating apparent COIs see this earlier post. On the other hand, maybe the Mylan board did understand how challenging mitigating the apparent COI facing them would be, and so opted for non-disclosure. Of course, once uncovered, non-disclosure itself contributes to the appearance of wrongdoing.
Turning to the other case of the week, while the Dish directors might feel that the various purely social ties described in the Times piece are not the stuff of conflicts, the conception of COIs under Delaware law does indeed encompass non-financial relationships, as established by an important (but sometimes forgotten) case in 2003 involving the directors of Oracle. As described in this article about fiduciary duties, the court there held that “a director must base his or her decision on the merits of the subject matter rather than ‘extraneous considerations or influences’ and that a director may be ‘compromised if he is beholden to an interested person.’ Most importantly, the court stated that ‘[b]eholden in this sense does not mean just owing in the financial sense, it can also flow out of ‘personal or other relationships’ to the interested party.”
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In the vast realm of conflicts of interest those involving boards of directors tend to stand out. That is because part of the reason the role of corporate director even exists is to mitigate the conflict-of-interest-type tensions (which fall under the broad heading of “agency problems”) that managements may have vis a vis shareholders. Moreover, while the role of officers obviously differs somewhat from that of director, the duty of loyalty that both owe shareholders is the same.
Director and officer COIs can arise in many settings but often the most consequential of these involves mergers. And, as described in a post last week in the D&O Diary: ”Within the past few days, two merger objection settlements – one involving Activision Blizzard, Inc. and the other involving Freeport-McMoRan, Inc. — have been announced involving massive cash payments,… The Activision settlement may represent the largest cash settlement payment ever in a shareholder derivative lawsuit.” The post further describes about how we can do home renovations from a settlement and stated that “[t]he common feature of these two cases that may account for the magnitude of the cash payments seems to be the conflicts of interest that were alleged to be part of the challenged transactions.”
The specific facts of these two cases – both of which are complex, as COI cases involving mergers typically are – may be less important than is what they (and another one last year involving News Corp, which is discussed in the same post) may mean for insurance costs to companies: “The rise of jumbo shareholder derivative lawsuit settlements has a number of implications. Among other things, it is a topic that will have to be taken into account as D&O insurance buyers consider how much insurance they will need to ensure that their interests are adequately protected.”
While most directly relevant to risk managers and others in companies in charge of securing D&O coverage, I think C&E professionals also need to know about this development – because directors and officer of their companies likely will and will be concerned about it. And, hopefully this awareness will contribute to a greater overall sensitivity at high levels in companies to COIs generally – meaning that this may be a good time to train (or retrain – or schedule training of) your directors and officers on COIs.
For those looking to develop such training, here is a prior post on that topic. And here are some other posts, portions of which might provide helpful ideas or information for training boards on COIs:
– Friendship – and the ties that blind (directors to conflicts of interest).
– CEOs’ ethical standards and the limits of compliance.
– Are private companies more ethical than public ones?
– Catching up on the backdating cases
– Behavioral ethics training.
– Catching up on CEO COIs.
– Catching up on director COIs.
– The largest derivative lawsuit settlements (from the D&O Diary).
Here are some pertinent words of wisdom from two good friends of the blog: Steve Priest (on keeping ethics training real) and Scott Killingsworth (on mitigating C-Suite risks).
Finally, if you are training your board, and want to use the occasion to look beyond the COI area to general C&E oversight by directors this recent article by Rebecca Walker and me from Compliance and Ethics Professional magazine might be useful.
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