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.

Compliance program standards of proof

The Chauvin trial in Minneapolis has caught the attention of much of the US, and rightly so, given the importance of the issues it raises and the highly compelling nature of the proof in the court. The case – like many highly public prosecutions – also provides the occasion for instructive civics lessons in various aspects of litigation.

One of these concerns standards of proof, with  commentators describing and discussing “proof beyond a reasonable doubt.” Another concerns the defendant’s state of mind, with possibilities including “depraved mind murder.”

Compliance officers sometimes deal with standards of proof and state of mind in connection with disciplinary procedures.  Less obviously, these issues can be relevant to conflicts of interest.

While some organizations bar conflicts of interest in all cases, many opt for allowing COIs  to exist where appropriate. But how should appropriate be defined for these purposes?

One formulation that I have recommended is: A COI may be approved only where doing so would clearly be in the best interest of the company.

Two comments about this.

First, the word “clearly” is intended to require a showing greater than a mere preponderance of the relevant facts. Of course, it is not as high as “beyond a reasonable doubt,” which, in my view, would be widely seen as too much in this setting.  But, it is still a high standard  and presumably would require rejection of any proposed COI where there was a lack of genuine clarity on this issue.

Second, the “best interest of the company” should be read broadly. It requires more than an absence of corruption or other  outright misconduct. Rather, it also mandates consideration of how  the COI at issue could impact the ethical culture of the organization and related matters.

A behavioral ethics and compliance primer

Published by Ethical Systems.

In praise of Goldilocks compliance

My latest column in C&E Professional.

I hope you find it useful.

Defamation as a compliance risk area

Dominion Voting Systems recently sued Fox News and two of President Trump’s former lawyers – Sydney Powell and Rudolph Giuliani – for their statements that Dominion had engaged in election fraud in connection with the 2020 presidential election. This could have profound adverse affects on the defendants. (Among other things, Dominion is suing Fox for $1.6 billion in damages and Powell for $1.3 billion.)

While of special relevance to the defendants, C&E professionals from all companies should use the occasion to consider if they have defamation risks of their own.

Defamation is generally not in the first tier of compliance risks for corporations, the way that corruption, antitrust and fraud tend to be. But second-tier risks can still be significant, as discussed in this recent post in the FCPA Blog.

Here are some brief thoughts and questions on defamation and compliance:

– Risk assessment. What kind of communications do your salespeople have about competitors? What about their salespeople communicating about your company?  Given the nature of the products and services you sell does defamation seem reasonably likely?

– Policies. Defamation should be mentioned in the code but generally need not be a standalone section. (It can often be part of a general sales compliance discussion.)

– Procedures. For high-risk areas, companies should consider preapprovals by the legal department or other control functions.

– Auditing or monitoring. Internal auditors should, for high-risk areas, be trained on defamation risks. And, for such areas, consider requiring monitoring.

– Training. For his risk companies consider including defamation in the code course. And for higher risk individuals consider targeted in-person training.

– Third parties. As with  other  risk areas third-parties can pose special C&E challenges and so should be focused on in the risk assessment.

There’s much more to be said about this topic but hopefully this post will help some companies get started.

Conflicts of interest: the role of norms

There has lately been much discussion of norms in the realm of politics and governance.  But norms are also important in the business world, particularly  those established within a profession.

In Regulating Conflicts of Interest Through Public Disclosure: Evidence From a Physician Payments Sunshine Law, Matthew Chan of William College and  Ian Larkin of  UCLA  Anderson  review the literature and report on the results of their recent study in the area of pharma companies providing things of value to prescribing physicians and legal mandates to make disclosure in Massachusetts, which has such a requirement, and several  other states which don’t. They also conclude with an interesting thought about the role of norms in COI mitigation.

In particular, they show a significant post-disclosure reduction in brand name drug prescriptions by Massachusetts physicians, relative to control doctors in other states. These effects are driven by heavy prescribers of brand name drugs in the pre-policy period, particularly for drugs with large pre-policy sales forces. Effects are also detected before the first data were released, implying that the effects are not because patients or administrators responded to the disclosed payments. Instead, some physicians may have reduced payments after disclosure is mandated, leading to changes in their prescriptions. Taken in tandem with the many studies showing that industry payments influence prescribing, this study suggests a strong role for mandatory public disclosure in reducing conflicts of interest in medicine and costly prescribing of brand name drugs.

They further note:

These results carry important managerial implications in healthcare. For health care managers and officials concerned with the effects of pharmaceutical marketing on prescription drug costs, increasing the coverage of disclosure or making disclosed payments more salient (e.g. by implementing hospital-wide communications or campaigns) may be an effective method for changing physician behavior. Other physician conflicts of interest may also benefit from disclosure. For instance, the “Total Transparency Manifesto” and the “Who’s My Doctor?” campaign advocates for physicians to disclose all sources of potentially conflicting incentives, including incentives for ordering additional tests or procedures (Wen 2013; Sifferlin 2014). Approximately 70% of surveyed physicians believed that clinicians are more likely to perform unnecessary procedures when they profit from them (Lyu et al. 2017); disclosure of these payments may be worth exploring, especially as alternative pay structures continue to be introduced into the field, thus making fee-for-procedure structures more optional.”

.They conclude with the following:

These results may also carry important implications for how managers and officials manage conflicts of interest even in non-healthcare settings. The principal-agent problems inherent in drug prescribing, where an informed expert makes important decisions for an uninformed principal, are found in many other industry settings such as retirement planning, consumer insurance, mortgage origination, and legal advice, to name a few. However, within medicine, there are norms (such as the Hippocratic Oath) that place great importance on earning a patient’s trust (Sah 2019); since our results suggest agents must care about appearing unbiased in order for disclosure to work, it remains for future research to test whether disclosure is effective in settings where such norms are not as heavily emphasized. Nevertheless, the results in this paper suggest that disclosure is at least worth exploring further in these contexts, despite the literature on the pitfalls of disclosure,

As a COI generalist, I am particularly interested in the notion that unlike the other professions they mention, “within medicine, there are norms…”  Of course, in light of the striking statistic that “70% of surveyed physicians believed that clinicians are more likely to perform unnecessary procedures when they profit from them” one might wonders what the real norms are.

But still, the point is an important one, and I do hope that there will be future research conducted along the lines they propose.

Liability of corporate officers: new developments

The liability of corporate directors is well-trod territory.   But what about corporate officers?

In a recent issue of the Harvard Law School Forum on Corporate Governance          /    Edward Micheletti, Bonnie David and Andrew Kinsey of  Skadden, Arps, Slate, Meagher & Flom LLP, write: “More than a decade ago in the seminal case Gantler v. Stephens, the Delaware Supreme Court clarified that officers of Delaware corporations owe the same fiduciary duties of care and loyalty that directors owe to the corporation and its stockholders.” But “until recently, officer liability cases were still few and far between. Over the past year, however, stockholder plaintiffs have increasingly pursued claims against officers for breaches of the duty of care.”

Note that the cases described in the Skadden memo involve deal litigation – not compliance program oversight, which is the setting for Caremark   the case which paved the way for fiduciary liability against directors and officers. But there is, to my knowledge, nothing preventing such a case against officers, at least as a general matter.

What should be done with this news? It should be the subject of training not only of corporate officers but also of the directors who oversee the officers and the chief compliance & ethics officer who helps the others keep fiduciary duties top of mind.