Conflict of Interest Blog

New data on whistleblower incentives

Does offering financial incentives for reporting misconduct to the government in fact work?  Apparently, there is not much data on this point, as noted in a post on the Harvard corporate governance blog by Aiyesha Dey, Jonas Heese, and Gerardo Pérez Cavazos, all of the Harvard Business School .  However, they set out to fill this gap.

“To examine the effects of financial incentives on whistleblowing, we exploit staggered decisions taken by U.S. Courts of Appeals that increase the financial incentives for whistleblowing under the [False Claims Act]  specific judicial districts. We find the following three effects. First, we find that whistleblowers file a greater number of lawsuits in district courts following decisions that increase financial incentives for whistleblowing. However, we do not find a reduction in the fraction of allegations reported internally before the filing of a lawsuit. Second, we find that the DOJ increases the investigation length for allegations filed in treated courts. Third, we find an increase in the percentage of DOJ-intervened lawsuits and the percentage of settled lawsuits. In sum, these findings support the view that cash-for-information programs help to expose misconduct. Our findings show that whistleblowers respond to financial incentives by filing additional lawsuits, which the DOJ investigates for a longer period and that are more likely to result in a settlement. These findings are inconsistent with the critics’ view that greater financial incentives for whistleblowers primarily trigger meritless lawsuits.” (Emphasis added.) (Note: they also report on  some interesting data on the financial impact of whistleblowing on the whistleblowers themselves.).

So, good news for supporters of incentives for whistleblowing.

But if offering financial incentives works for the government shouldn’t companies implement reward programs for internal reporting by employees?

To my knowledge the first business to try this was Bear Stearns, many years ago.  The firm has long since gone out of business and I don’t recall  whether this practice was seen as successful in its time.  In any event, not many have followed since.

I have indeed cautioned clients against going this route. My primary concern is that paying for information can be seen as inconsistent with the important – indeed solemn – obligation that employees already have to protect their company.  This obligation goes well beyond reporting suspected wrongdoing, touching the many ways employees can support and promote the efficacy of a C&E program.

 

 

 

Caremark and caring about carelessness

Samuel Johnson once said: “It is more from carelessness about truth than from intentionally lying that there is so much falsehood in the world.” And carelessness is obviously at the root of many other types of wrongdoing too.  But what does this have to do with the liability of boards of directors in connection with ESG failures?

In a recent posting in the Harvard Law School Forum on Corporate Governance the Wachtell Lipton law firm argues: “the Caremark doctrine—which requires directors to monitor enterprise-level risk and is newly invigorated by recent Delaware court rulings—is the likely tool of choice for plaintiffs complaining about board inaction in the face of climate-related exposure.”

How should companies and boards mitigate the risk of Caremark liability? Per the Wachtell memo: “Firms throughout the economy—anyone who manufactures, sells, or finances products that are implicated in environmental harm—should be preparing today for governance, regulatory, and litigation challenges. Thus, among other steps: Companies should focus on robust disclosure of climate-related economic and business risks. Management and boards should consider new playbooks and strategiesfor engaging with institutional shareholders, asset owners, and even activist investors focused on climate and other ESG-related issues. Boards should ensure regular consideration of climate-related risk, oversight structures, and robust documentation of risk-management and monitoring efforts. Companies that take these steps, and then tailor bespoke responses to any remaining climate-related risks, will earn goodwill with regulators and investors and be better prepared to weather the climate-litigation and climate-activism storm.”

This is sound advice from the perspective of companies, officers and directors. But is the underlying legal regime – particularly the Caremark doctrine – up to the gravely important task of protecting society as a whole from the ravages of climate change?

In A Simple Model of Corporate Fiduciary Duties: With an Application to Corporate Compliance WC Bunting of Temple’s business school  notes that compliance failures  by boards are currently  cognizable under Delaware law based on  the duty of loyalty, not the duty of care — – even though the latter would make more sense.  He writes: “the optimal judicial approach would define the duty to monitor as a subset of due care–and not loyalty.”

The reason he suggests this is that “that compliance is fundamentally about inducing effort” by managers more than it is about honesty. Lack of effort seems more a matter of failure of care than it is failure to be loyal.

Does this matter? To draw again from the Samuel Johnson treasure trove of memorable sayings, the change of law proposed by Bunting, could help focus the minds of directors on a subject that is truly life or death.

 

Drafting and reviewing conflict of interest policies

Here is my latest column in Compliance Ethics Professional – on drafting/enhancing conflict of interest policies.

I hope you find it useful.

Behavioral ethics in an age of ESG

We are entering an era of  unprecedented Environmental, Social and Governance (“ESG”) imperatives  This could be hugely beneficial  to millions of people in many ways. But those involved in ESG efforts (and others) need to be aware of the dangers of “moral licensing.”

As described in Rational Wiki: “Moral licensing or self licensing is a cognitive bias that occurs when a person uses their prior ‘good’  behavior to justify later bad behavior, often without explicitly using that logic. The effect has been demonstrated in numerous psychological studies.[1]

For instance, as noted in  an article in the Irish Times: “One experimental study found people ‘are more likely to cheat and steal’ after purchasing green products than after purchasing conventional products.”

I should stress that this is not a reason to do less when it comes to ESG efforts. But it is worth knowing about from a risk assessment perspective and may be worth mentioning in training.

Also, moral licensing is relevant not only to ESG-related work but also to the work of governmental bodies, charities and other non-profits.

Finally, here is an earlier post on this issue.

The spirit of liberty – and the spirit of ethics

Learned Hand – considered by many to be the greatest of all US judges – once famously said:  “The spirit of liberty is the spirit which is not too sure that it is right.”   This is a spirit which sadly seems as distant from us today as it ever has been before.

Of course, Hand’s primary concern was the realm of politics/governance, not business ethics. But, as discussed in prior posts the various spheres in which ethics operates – not just political and business, but also personal –  can overlap with and support each other, at least to some degree. They can also undercut each other, when not done right.

I believe that – at least for some companies – humility should be a core value.  (I do see it at some companies, but not many.) As noted in an earlier post:

First, humility is a logical and arguably inevitable response to the vast body of behavioral ethics research showing “we are not as ethical as we think.”  Thinking and acting with humility is indeed a way of operationalizing behavioral ethics. (For a list of behavioral ethics and compliance posts click here l

Second, humility is well suited for addressing ethical challenges that are based not on the purposeful failure to be honest but on the less well-appreciated dangers of being careless.  Recognizing the limits of one’s abilities – which is part of being humble –  should help underscore the need for carefulness.

Finally, humility has the potential to resonate deeply in our political, as well as business, culture. By this I mean humility can help form part of a broader mutually supporting relationship between business ethics and ethics in other realms..

Something new regarding gifts and entertainment

I once asked students in an executive MBA ethics class if they thought that their employer organizations should have restrictive policies on gift receiving.  Nearly all said that such policies were unnecessary – as the students were certain that they would not be corrupted by receipt of gifts from suppliers or customers.  I then asked if the school should allow teachers to receive gifts and entertainment from students. As you can imagine, the response was very different.

Issues concerning gifts and entertainment are commonplace in the business world. There are many aspects to crafting and enforcing an effective compliance policy in this area, but one aspect of it that is often underappreciated is how even small gifts and entertainment can  still influence behavior in an undesirable manner.

This issue was raised several years ago in a particularly grim way (as described in this article in MarketWatch) by a 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,…”

Another study “showed that the receipt of a single industry-sponsored meal, with a mean value of less than $20, was associated with prescription of the promoted brand-name drug at significantly higher rates to Medicare beneficiaries.”

Note that while these studies took place in the life sciences area they are potentially relevant to promoting compliance and ethics in conflicts/gifts in industries of all kind.

Finally, in a recently published study Julian Zlatev and Todd Rogers  contributed in a potentially important way to our knowledge of what makes giving gifts and providing entertainment effective    (Returnable Reciprocity: When Optional Gifts Increase Compliance, Harvard Faculty Research Working Paper Series  They found – somewhat surprisingly – that providing the recipient with an opportunity to return a gift increased the likelihood that she would respond positively to whatever the giver was seeking to have her do.

This is a phenomenon they call “returnable reciprocity” and it may work by triggering feelings of guilt in recipients who  have the opportunity to but do not return the gift.

Besides the question of efficacy there is the matter of ethics. Is it more ethical to provide returnable reciprocity – or less? An interesting subject for another post.

 

 

 

 

 

Conflict of interest’s cousin moral hazard

A post from the FCPA Blog.

I hope you find it interesting.

“Third prize is you’re fired”

In David Mamet’s Glengarry Glen Ross the boss explains a new sales contest to the assembled members of the office:

“The first prize is a Cadillac El Dorado. Anyone wanna see second prize? Second prize is a set of steak knives. Third prize is you’re fired.”

The corrupting influence of high-pressure is an oft-told tale. In recent years the most prominent  case of this sort involved Wells Fargo, where a toxic corporate culture pressured many employees to engage in serious legal and ethical transgressions.

The impact of pressure on ethicality has been shown to work not only as a matter of practice but also theory. That is, many years earlier, in what was perhaps the mother of all ethics/compliance experiments, individuals put under time pressure were about six times more likely to engage in unethical conduct than were those not under such pressure – an incredible result.

Most recently, in its invaluable Global Business Ethics Survey: the State of Ethics and Compliance in the Workplace the Ethics Compliance Initiative reported that: “Pressure to compromise ethical standards is the highest it has ever been” in the US. The phenomenon is not just limited to the US.  E.g., “Employees in China are experiencing a five-fold increase in pressure.”

Dealing effectively with pressure is one of the greatest challenges a C&E program can face.   Some of the things that a company might consider in this area:

– Having the CEO speak about the need to avoid undue pressure at key times (such as near the end of a financial reporting period).

– Cascading the message down through the ranks of management.

– Having the manager’s duties section of the code of conduct address the issue of avoiding undue pressure.

– Including the issue in performance evaluations.

– Having pressure within the scope of the risk assessment.

– Including pressure in the interview sections of audits. and assessments.

Of course, not every company needs to do all of these, and some will address the issue of undue pressure in other ways.

 

Executive Misconduct and Employment Contracts

To twist a famous saying of F. Scott Fitzgerald, CEO’s who engage in wrongdoing are different from you and me – they have the protections of employment contracts. But that is beginning to change, due to the MeToo Movement.

In  Anticipating Harassment: MeToo and the Changing Norms of Executive Contracts     professors Rachel Arnow-Richman, James Hicks and Steven Davidoff Solomon state:

“A critical question post-MeToo is whether the power behind that social movement as translated into real change in organizational treatment of and tolerance for sex-based misconduct. This paper provides affirmative proof for this question. Our study of over 400 CEO contracts reveals that, post-MeToo, publicly traded companies are reserving greater discretion to terminate executives for sex-based misconduct in statistically significant numbers. By insisting on expanded contractual definitions of “cause” to terminate, these companies are signaling to CEOs that such behavior will not be tolerated, while ensuring that corporate boards are reducing the costs of penalizing wayward CEOs…. To be sure, CEO employment contracts—with their narrow and exclusive grounds for cause—remain highly favorable to CEOs, at least when compared to the rights of employees generally. However, the space to engage in sex-based (and potentially other forms of) misconduct that was previously afforded by these contracts is narrowing.”

While not a surprise, these findings are important – and should be shared with a company’s board of directors, senior leadership and compliance & ethics team.   Among other things, taking a strong position on CEO cause terminations should send a powerful message  to decision makers about the importance of C&E generally to an organization.

Can the government make us more ethical?

An always important and interesting question!

In Preferences Change & Behavioral Ethics: In Can States Create Ethical People?  Yuval Feldman and Yotam Kaplan (no relation) of Bar-Ilan University write:

“Law and economics scholarship suggests that, in appropriate cases, the law can improve people’s behavior by changing their preferences. For instance, the law can curb discriminatory hiring practices by providing employers with information that might change their preferences towards discriminatory hiring. Supposedly, if employers no longer prefer one class of employees to another, they will simply stop discriminating, with no need for further legal intervention. The current paper adds some depth to this familiar analysis by introducing the insights of behavioral ethics into the law and economics literature on preference change. Behavioral ethics research shows that wrongdoing often originates with semi-deliberative or non-deliberative cognitive processes. These findings suggest that the process of preference change, through the use of the law, is markedly more complicated and nuanced than previously appreciated. Thus, for instance, even if an employer’s explicit discriminatory stance is changed, and the employer no longer consciously prefers one class of employees over another, discriminatory behavior might still surface if it originates with semi-conscious, habitual necessitate a close engagement with people’s level of moral awareness. “

They further write:

“Organizations, such as schools and workplaces, can be more effective than the law and the state in inducing ethical awareness and in changing people’s implicit attitudes. Such organizations offer intense social frameworks, in which people spend a significant amount of time in close proximity to guiding rules and supervisory authorities. Such organizations are also allowed to engage in practices of habit-formation that we might not tolerate when it comes to states. This means the law can change ethical preferences more effectively not by trying to engage with people’s awareness directly, but by creating requirements that will change relevant organizations, and incentivize those organizations, in turn, to engage directly with people’s preferences and awareness. Thus, the law might sanction organizations when they discriminate, in the hope that those organizations will then act to improve ethical awareness among decision-makers.”

I agree with this (and the other major aspects of the paper).  Indeed, with the promulgation of detailed compliance program evaluation standards over the past few years by the Department of Justice, we see what is probably  a more compelling use than ever before of sanctions to promote businesses to take the type of  intense engagements described above.

I also agree that it is important to consider – as the authors have done – how ethical forces in one sphere of activity can impact the ethicality of others. For instance, here is a post  which considers whether  working from home reduces ethical risk.

Finally,  in considering government’s role in promoting ethical thought and deed, it is worth recalling that  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.