Why it is time to legislate business ethics and how Australia can capitalize on the latest research to restore confidence in business leaders.

The Australian Federal Government creates a facilitating legislative environment to encourage organisational leaders to actively manage the ethical dimension of business. Organisational leaders have the power to nurture a culture where the ethical dimension of their activities are routinely canvassed rather than viewed simply as business decisions.

It is suggested that where the ethical dimension is managed, it is done so in an informal and reactive manner.  In contrast to the situation in America and Europe, there is a prevailing assumption in Australia that “business ethics” is an oxymoron. This unexamined cultural perspective sets the bar of acceptable business standards lower than in other advanced economies.

Australia needs to enact legislation similar to the US Federal Sentencing Guidelines to encourage higher ethical standards from both business and the public sector leaders.  As has been found overseas such legislation will encourage organisational leaders to firstly clarify and then secondly define what the management of the ethical dimension of organisational life looks like.  This might in turn be the catalyst needed to move from the current perspective of managing ethics in the breach to one of proactive management or managing ethics in the practice.

Four developments have increased the urgency with which government needs to review its current laissez faire approach to the management of business ethics including:

-        The blurring of the boundaries between economic and political power

-        The commercialisation of education and the rise of the amoral manager

-        Evolving research showing the business case for ethics management

-       The need to do design things differently post the GFC

Blurring of the boundaries between economic and political power

Ethics field research suggests that the separation of business and ethics is the systemic sources of much corporate misbehavior especially by those at the top.  We appear to be locked into a prevailing mindset that stifles debate on the ethical accountability of the people within business.

In contrast to other Western economies, Australian business leaders shy away from sponsorship of ethics research and the scant research that has taken place ([1]) suggests that neither Australian Boards nor the CEOs they appoint, accept that managing ethical risks is a key accountability.

Against this ethical  vacuum backdrop, systemic unethical practices such as those highlighted most recently by Visy, Amcor, Opes Prime, Australian Wheat Board in the private sector and NSW RailCorp and Wollongong Council in the public sphere is more readily understood.  Failure to set the tone from the top stifles ethical conversations throughout the enterprise and it takes a crisis before ethics hits the Boardroom agenda.

The failure to successfully prosecute white collar business crimes in Australia has eroded popular conceptions that the system is a fair system and  instead it seems that those who have been found guilty of cheating such as Dick Pratt or Steve Vizard, are treated differently than others who break the law. People will be about as virtuous as the society in which they live, if this is so then it will be increasingly essential to work toward the building of a just society if we are to have any hope at all of being fair and honest individuals.

The commercialisation of education

Ethics is concerned with providing a set of specific skills to analyse a situation and identify right from wrong. In the case of many in business, what is regarded as right seems to be both distorted and typically aligned with an inappropriate set of financial incentives.

There is an increasing body of research to suggest that  modern day management syllabus are breeding a new type of business leader – the amoral manager – who is incapable of addressing the need to balance competiting stakeholder interests including balancing what is good for themselves and their bottom lines and what is good for the rest of socity.

Amoral leadership rather than unethical leadership was found to be more common among senior executives in an American study of executives. (Source: Academy of Management Executive, 2004 Vol 18 No. 2 Linda Klebe Trevino & Michael Brown)

It is interesting to note that contemporary American researchers, Conry and Nelson, have correlated business graduates with the least developed ethical skills. Furthermore, the study highlighted the worrying trend that upon graduation, ethics scores had reduced from their undergraduate level. Similar findings were supported by research undertaken by the Aspen Institute. In a 2002 report published by the Washington Post, 82% of graduates were of the opinion that shareholder primacy was the prime responsibility of business, a 14% increase from their undergraduate year. Based on such figures one may ask the question, just how are business schools shaping the ethical maturity of their students and future business leaders?

The Business Case for Ethics:

Ethisphere charted the stock performance of the publicly traded award winners from 2007, and notes that the most ethical companies consistently and significantly outperform S&P500, by more than double over the period of last five years. Explained Leffel, “This a proof positive that being ethical (in a full sense of it) is actually profitable and adds significantly to the shareholder value.”

The U.S. 2007 National Business Ethics Survey conducted by the Ethics Resource Center found that companies that adopted an enterprise-wide approach to building a strong culture of ethics reduced observed misconduct by three-fourths and retaliation against employees who reported misconduct was virtually eliminated.

The blurring of the border between legal and ethical/moral liability is signalling a change from a compliance base to an accountability driven business environment. It is no longer enough for business to bear witness to the melding of legal and ethical liability. Increasing expectations to include social and environmental considerations have placed pressure on firms to move beyond the comfort of compliance and enter into the uncharted waters of accountability.

Properly addressed, the schism between business thinking and ethical thinking need not exist. What is needed is a facilitating environment for business leaders to step up to their ethical accountabilities and create the appropriate learning opportunities within their enterprises. If half of the effort and investment spent today on building internal controls instead went into creating organisational cultures of integrity and honesty we would not longer by subject to the recurring corporate scandals. The best protection any corporation can put in place is not a regime of compliance but a culture of integrity

In our experience most people don’t step over the line they slide over it because the organisational context created a situation where they were unable to manage the tension between doing what was in the organisaton’s best interest and the negative impacts this entails for other stakeholders.

THE US Ethics Framework

What are the Sentencing Guidelines?

• In 1991 the United States Sentencing Commission introduced guidelines for Federal Judges for sentencing organisations.  The guidelines were revised in 2004.
• They enable Judges to provide harsh sentences on organisations whose employee or agents commit federal crimes while acting in their organisational role.
• Penalties include restitution, remedial orders, community service and substantial fines
• Judges were originally directed to consider 3 aggravating factors:
  • Managerial involvement
  • Prior criminal history
  • Obstruction of justice
• And four mitigating factors:
  • Maintenance of an effective program to prevent and detect violations of law
  • Self-reporting of the offence
  • Full cooperation of the investigation
  • Clearly demonstrating recognition of, and affirmative acceptance for, its criminal conduct
• Applies to most organisations, including corporations, partnerships, unions, not-for-profits and trusts
• Had a carrot aimed at deterrence: ‘rewarded’ at the time of sentencing, organisations that at the time of an offence had implemented an effective compliance and ethics program. Rewards were lenient sentences.
• Had a stick: punishment for those who did not have effective compliance programs
• Board and executive have the responsibility for ensuring the program was designed and operating effectively and tailored to the organisation’s most significant risks
• Specifically, the revised Sentencing Guidelines define the following minimum requirements for an effective compliance and ethics program (CEP) – taken from Section 8 of the Sentencing Guidelines

1. Establish Standards and Procedures: Organization shall establish standards and procedures to prevent and detect criminal conduct.

2. Requirements for an organization’s governing authority, high-level personnel, and specific individuals:

(A) Governing Authority shall be knowledgeable about the content and operation of the CEP, and shall exercise reasonable oversight with respect to the implementation and effectiveness of the program.

(B) High-level personnel shall ensure that the organization has an effective CEP, and specific individuals within high-level personnel shall be assigned overall responsibility for the CEP.

(C) Specific individual(s) within the organization shall be delegated day-to-day operational responsibility for the program, and shall periodically report to high-level personnel (and as appropriate, the governing authority or appropriate subgroup) on the program’s effectiveness. Such individuals shall be given adequate resources, appropriate authority, and direct access to the governing authority/subgroup.

3. Substantial Authority Personnel: Organization shall use reasonable efforts not to include within substantial authority personnel any individual whom the organization knew, or should have known through the exercise of due diligence, has engaged in illegal activities or other conduct inconsistent with a CEP.

4. Communications; Training: Organization shall take reasonable steps to communicate periodically and in a practical manner to certain individuals its standards and procedures and other aspects of the program by conducting effective training programs and otherwise disseminating information appropriate to the respective roles/responsibilities of individuals.

5. Monitoring; Evaluation; Reporting/Guidance Mechanism: Organization shall take reasonable steps to:

(A) ensure the program is followed (including monitoring and auditing to detect criminal conduct);

(B) evaluate periodically the effectiveness of the program; and

(C) have and publicize a system which may include mechanisms that allow for anonymity or confidentiality where employees and agents may report or seek guidance regarding potential or actual criminal activity without fear of retaliation.

6. Enforcement: The CEP shall be promoted and enforced consistently throughout the organization through appropriate incentives, and appropriate disciplinary measures for engaging in criminal conduct and for failing to take reasonable steps to prevent or detect criminal conduct.

7. Response following detection of criminal conduct: After criminal conduct has been detected, the organization shall take reasonable steps to respond appropriately to the criminal conduct and to prevent further similar criminal conduct, including making any necessary modifications to the CEP.

• The revised guidelines:
  • Require the organisation to gather data to measure the impact of the program on employee’s perceptions of company standards
  • Place more emphasis on an effective program to promote an ethical culture within an organisation
  • Recognises the challenges of compliance for the small organisation
  • Places more of an emphasis on managing identified risks than on best practice CEP design, implementation and enforcement
• The guidelines focus on providing restitution and fines for organisations through far-reaching probation provisions – requires organisations to institute and maintain an effective compliance program
• Organisations have to remedy any harm that resulted from the conduct of its employees – if a fine would limit its ability to make good any harm, a fine is not imposed – restitution is most important
• Ultimate purpose of the guidelines is to promote good corporate citizenship through encouraging effective compliance programs – which will hopefully reduce crime
• In January 2005 , the U.S. Supreme Court issued its controversial decision in the Booker and Fanfan cases, which were to shed light on the constitutionality of the application of the Guidelines in the aftermath of the Blakely decision, in which a Washington state sentencing guideline system, patterned on the Federal Sentencing Guidelines, was held unconstitutional. The Supreme Court’s decision in Booker/Fanfan left the Guidelines in place, but made their use by judges advisory – the Guidelines are no longer mandatory in application.
• An organisation will not be granted a reduced sentence even if they have a CEP if the organisation delays reporting an offence or if individuals within certain levels of the organisation “participated in, condoned or were wilfully ignorant of the offence.”
• The deterrent effect of sentencing under the organizational guidelines stems from both the large fines that may be imposed and the possibility that a sentencing court may impose restrictive probation conditions such as appointment of a special master or creation of auditing and monitoring groups.
• The Sentencing Guidelines only reward companies with a CEP where the training program is geared to the specific risks the organisation has identified and where the organisation can demonstrate that the training program has actually contributed to an explicit program outcome: reducing misconduct or encouraging reporting of misconduct

How and where have they had an impact?

• The guidelines have had the most impact in the areas of sentencing, corporate culture, government enforcement and regulation and corporate law.
• In the first 10 years of the guidelines (1991 – 2001), 1500 cases were sentenced under the guidelines with $2.3 billion in fines, $279 million in restitution and over 3000 years of probation
• Research conducted by Warin and Debold shows that the biggest impacts of the guidelines have been in defining effective compliance standards and in both guiding and offering leverage to prosecutors deciding what charges to bring.
• Companies most likely to receive sentences under the guidelines are smaller and privately owned companies – possibly because they are less likely to have compliance programs or less likely to receive legal advice to settle and receive lenient sentencing in exchange for cooperation.
• Only a very small number of cases that are subject to the application of the Sentencing Guidelines after trial have received a reduced sentence because of their compliance efforts (less than 5 cases between 1991 and 2001) – the Guidelines in practical application at sentencing will almost always work against the company, increasing, rather than offering an opportunity to decrease, the sentence handed down.
• The threat of the Guidelines is an extremely effective tool used by the Department of Justice to drive corporate “cooperation”, and often acts to discourage companies from independently investigating allegations or fighting the charges.

Impact on ethical framework

• Early studies indicated the Sentencing Guidelines were extremely influential in persuading organisations to adopt compliance or ethics programs:
  • According to “A National Study of Compliance Practices” which involved 333 corporations representing various sizes and industries, 44 percent of the respondents stated that the Guidelines caused them to add vigor to their compliance programs, while 20 percent added compliance programs because of their awareness of the Guidelines (U.S. Sentencing Commission, 1995:134).

• Another study by the Council of Ethical Organizations of approximately 750,000 employees from 203 large U.S. companies found that 38 percent of the companies significantly improved their ethics compliance environments following the enactment of the Guidelines (U.S. Sentencing Commission, 1995:178).
• The Ethics Officer Association (EOA) of the US recently completed a survey indicating that the organizational guidelines influenced many corporations to adopt compliance programs. Nearly half of those surveyed responded that the organizational guidelines had “a lot of influence” on an organization’s commitment to ethics as manifested through the adoption of a compliance program.
  • The Guidelines have had the greatest impact on ethics training, ethics officers, ethics offices and ethics hotlines (over 90% of large companies in the US already had a code of ethics in place by 1990)
  • A study released by the Ethics Resource Center (1994) entitled “Ethics in American Business: Policies, Programs and Perceptions” provides an indication that ethics programs are beneficial in improving organisational ethics.  The study examined the attitudes of over 4000 employees in relation to the existence of codes of conduct, the introduction of ethics into employee and management training and the establishment of an ethics and compliance officer.  The survey found that employees in organisations with ethics programs have a more positive opinion about the ethics of their colleagues, management, their companies and even themselves.  Ethics initiatives appeared to increase employee awareness of misconduct, employee willingness to report misconduct, and the level of satisfaction with the outcome of their reporting
  • Another study by the Council of Ethical Organizations of 750,000 employees from large U.S. corporations found that, “Employees of companies that had implemented or fortified comprehensive ethics compliance programs in response to the guidelines…reported that they were less likely to violate laws and policies” (Sentencing Commission, 1995:178).
  • One of the areas in which compliance programs and organizations have grown immensely is in the health care industry. The Health Care Compliance Association (HCCA), like the Ethics Officer Association, is an organization designed to “promote quality compliance programs” consistent with the seven minimum criteria of the organizational guidelines.  According to Roy Snell, its founder, HCCA membership has grown from two members in 1996 to over 2000 members currently. He credits the organizational guidelines as being a significant impetus to that growth. As Dr. Robert Olson, Executive Director of the Alliance for Health Care Integrity, has stated, “More than any other public or private initiative, the Guidelines have motivated stakeholders in the health care industry to take seriously the importance of compliance with federal statutes and regulations, especially those related to the prevention of fraud, waste, and abuse.”

• One of the biggest impacts of the Guidelines has been the creation of the position of Ethics and Compliance Officer, to develop and manage an organisation’s ethics and compliance programs

Impact on preventing illegal behaviour

• There is no empirical data that comprehensively charts changes in organisational crime rates over time. Consequently, it is not possible to assess directly the success, or lack thereof, of the organisational guidelines in altering the rates at which organisations commit crimes.
• For example, as stated above organisational ethics officer/compliance officer, or assignment of those duties to in-house counsel, have become routine at larger corporations. Organisations that represent these positions regularly sponsor programs designed to broaden and deepen the understanding of effective compliance program criteria and the manner in which organisations can operate effectively in an increasingly regulated and rapidly changing environment.
• Effective in 1996, the US Environmental Protection Agency implemented a new enforcement policy designed to encourage self regulation, prevention, voluntary reporting, and correction of environmental violations. This policy statement was modelled after the Guidelines. As of late last year, EPA reported that over 1,000 voluntary disclosures had occurred, 75 percent of which resulted in penalty waivers or substantial mitigation of penalties. EPA subsequently adopted a criminal enforcement policy that would recommend against prosecution when organisations self-discovered and reported violations during the course of compliance audits and other due diligence efforts.

Impact on legal scene

• In 1995 prosecutors from various divisions of the Department of Justice stated that their offices take into account whether a company had a compliance program at the time of the offence in determining whether to prosecute the company. In other words, the Justice Department is now providing stronger incentives for compliance efforts than do the Guidelines themselves
• Today, prosecutors and regulators are not just interested in investigating and prosecuting corporate criminal conduct, they are striving to shape corporate behaviour by increasingly making use of non- or deferred-prosecution agreements and monitorships under the Guidelines.

What other equivalents are available internationally?

Europe

• Although the European Union has no formal regulations, it has created incentives for organisations to establish CEPs by mitigating penalties for companies that have found to have had compliance programs with respect competition law

Australia

The Criminal Code provision that looks at the culture of an organisation places Australia as a world leader (at least on paper) of ethics regulation according to many commentators in this area however it has never been tested in court.

The Code states that a corporation can be held criminally responsible if it is established that “a corporate culture existed within the body corporate that directed, encouraged, tolerated or led to non-compliance with the relevant provision” or by showing that “the body corporate failed to create and maintain a corporate culture that required compliance with the relevant provision.” [Criminal Code Bill 1994, Part 2.5, Division 12, Section 12.3(2) (c and d)]. What is substantially different about this legislation is that it relates directly to liability, and not merely the sentencing of corporations as does the U.S. Sentencing Guidelines.

• The Australian Trade Practices Act, enacted in 1986, which regulates such activities as anti-trust or misleading advertising is also considered world-leading. According to the Act, “an effective compliance program can constitute a corporate defense” and is also a key factor in the assessment of the penalty. The organisation must have sound policies and procedures and actively supervise and enforce these policies
• In the past, the Australian judicial system has not responded well to regulators attempts to influence sentencing and sentencing guidelines may be perceived as interference with judicial independence.  For example, the ACCC attempted to grant a defendant who had provided substantial cooperation a much larger discount than another, less cooperative defendant.  The ACCC took the view that the discount was necessary to maintain incentives for parties who agree to cooperate.  The court, however, disagreed with the proposed reduction in sanctions and instead found that for fairness reasons no single party should receive a substantially greater benefit than any other party, notwithstanding the significant differences in cooperation.  At the time, one commentator concluded that a coherent, consistent and well-publicised approach to the setting of penalties would be helpful to strengthen the system of negotiated penalties.  Some workable solution could be reached through dialogue between regulators and the judiciary
• One way to increase certainty would be the development of sentencing guidelines similar to those used in the United States. They address judges, but indirectly assist the government and the targets of an investigation to negotiate a plea agreement as they can anticipate what sentence range a judge would likely approve. Sentencing guidelines do not completely eliminate the possibility for both sides to bargain and perhaps in some cases get around the outcomes envisaged in the guidelines

Canada

• Similar legislation to the Australian Criminal Code was considered by Canada in the mid 1990s.  A consultation paper was issued that discussed whether corporate criminal liability should be based on corporate culture.  The proposed legislation read: “A corporations commits an offense when there exists within the corporation an attitude, policy, or practice that directed, encouraged, tolerated or led to the offense, or that failed to require its representatives to comply with the law.” (Department of Justice Canada, 1994:27).
• Similar to the Australian Criminal Code, if the Canadian Criminal Code was amended to include such a provision, compliance programs would relate directly to liability and not merely sentencing or potential defences to liability.
• An effective compliance program was defined as: (1) the involvement and support of senior management; (2) development of relevant policies and procedures; (3) on-going education of management and employees; (4) monitoring and audit mechanisms; and (5) disciplinary mechanisms
• The legislation however was not passed, and towards the end of the 1990s, a government downsizing movement weakened regulatory regimes.

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[1] KPMG White paper 2006