OMM 640 Business Ethics and Social Responsibility

4 Drivers of Ethics and Compliance

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Learning Outcomes

After reading this chapter, you should be able to do the following:

• Describe how laws, regulations, and guidelines form the underpinning of ethics and compliance.

• Summarize requirements for mandated legal compliance relating to business, such as competition, corrup- tion, corporate governance, consumer protection, and health, safety, and environmental considerations for employees and the community.

• Analyze the role that guidelines, self-regulatory initiatives, and industry standards play in global ethics and compliance.

• Examine cooperation strategies to utilize with external authorities to mitigate the punishment of a com- pany’s misconduct.

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Introduction

Introduction

Regulations Drive Organizational Ethical Programs

New employees of a major international pharmaceutical company are uneasy. During orien- tation, they are learning of ethical issues relating to their new position within the company. They discover that discussing a breakthrough drug before a public announcement, even with family and friends, could invite fines or imprisonment. Any contact with physicians, hospi- tals, or insurance companies must follow strict guidelines on gifts, travel, and entertainment, especially when working in other countries. Any unauthorized disclosure of client or patient information creates legal risks for the company and employee. The new employees learn that joking at the workplace about religions or race could jeopardize their employment if cowork- ers perceive it as bullying.

As the orientation concludes, the new employees receive a list of mandated trainings. Some trainings are online and others require classroom attendance. General training that all new employees have to take within 30 days include conflicts of interest, workplace harassment, confidential information security, gifts and entertainment policies, Internet use, and travel expense policies.

Other trainings are specific to the employee’s function. For example, supervisors are required to complete classes to prevent discriminatory behaviors, develop ethical leadership styles, and learn of reporting standards. Financial and accounting professionals must complete trainings in internal control systems. Employees joining the research and development team need training specific to regulatory approvals for new medicines. Sales and marketing train- ing includes learning to avoid bribery and kickbacks, deceptive selling and promotions, and inaccurate sales reporting. Additionally, any employee that interacts with healthcare profes- sionals has to undergo training on the ethical guidelines of the Pharmaceutical Research and Manufacturers of America (PhRMA) and the Association of the British Pharmaceutical Indus- try (ABPI) Code of Practice (Devlin, Hastings, Smith, McDermott, & Noble, 2007). The new employees’ excitement about beginning their career with the company begins to waver as they consider how to balance new job responsibilities with the mandated training. They won- der why the company is focusing so much on ethics and compliance.

Companies in the pharmaceutical industry are subject to increasing regulations worldwide that result in large fines and reputational damage. In a highly competitive industry, the pressure to make sales through incentives and off-label uses of prescription drugs is tempting. One report estimated that the industry spends more than $27 billion on the promotion of products to phy- sicians, including meals, gifts, travel, and lucrative speaking fees (“The hypocritical oath,” 2014). However, incentives to secure business can result in bribery charges with large fines. In 2014, GlaxoSmithKline plc was fined nearly $500 million for bribing hospitals and doctors to use their products. In the United States, a transparency clause in the Affordable Care Act provides for a public reporting of all other valuables given to physicians by pharmaceutical companies (Patient Protection and Affordable Care Act, Pub. L. 111–148, 124 Stat. 119, 2010). In 2012, the U.S. Department of State fined GlaxoSmithKline $3 billion for marketing drugs for unap- proved uses. Promoting a drug in the United States for uses not approved by the Food and Drug Administration (FDA) is off-label marketing and is illegal. AstraZeneca plc paid $520 million to settle a U.S. investigation into its marketing of the schizophrenia drug Seroquel for unapproved uses (Whalen, 2009). In a 2009 interview, the chief executive officer (CEO) of AstraZeneca high- lighted the need for more training in ethical conduct in the industry.

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Section 4.1 Evolution of the Ethics and Compliance Field

If you go back ten years in this industry, this was not an issue. I mean, we trained our people not to promote off-label . . . so it’s always been sensitive. But now, it’s even more sensitive because we’re paying fines. The government investigated this stuff, and they’ve said, “We don’t like the way you guys did this.” So we’re more sensitive than we’ve ever been. (Whalen, 2009, B2)

This chapter addresses the factors driving organizational ethics and compliance on a global scale, including mandated laws, regulations, and guidelines. It will include a review of the legal compliance requirements for a business, including laws and regulations relating to anti- trust/anticompetitive behavior, bribery/anticorruption, corporate governance, consumer protection, environmental protection, and worker health and safety. The chapter also recog- nizes the important role that industry guidelines, self-regulatory initiatives, and other non- mandatory standards play in encouraging ethical conduct in business. The chapter concludes with a discussion of relationships with legal counsel and enforcement authorities, including consequences for noncompliance and strategies for cooperating with governmental agencies.

4.1 Evolution of the Ethics and Compliance Field The ethics and compliance field focuses primarily on how to keep organizations out of trou- ble. The profession includes company positions such as chief ethics officer, chief compliance officer, and various other positions such as integrity/ethics officer and ethics ombudsman. The expansion of mandatory laws and voluntary self-regulation initiatives in recent years has made these roles in business particularly challenging. However, companies and industries that promote the use of ethics and compliance professionals foster trust in their stakeholders, which in turn contributes to a successful economy. Roy Snell, the chief executive officer of the Society of Corporate Compliance and Ethics, stresses the role of compliance:

If you build a trusted regulatory environment, you will have a better chance to succeed economically. The standard of living and safety of people depend on it. Countries that not only want to be at the top of the list but improve even more will have compliance officers in most of their companies. (Snell, 2013, p. 34)

Mandatory Requirements and Voluntary Initiatives

Both mandatory compliance requirements and voluntary initiatives compel companies to focus on compliance and ethics. Mandatory requirements include laws and regulations. A law is a rule enacted by a governing body, while a regulation is the process of monitoring and enforcing the rules. Governing bodies can include national state legislative branches, such as the U.S. Congress, state or provincial legislative authorities such as the State of California in the United States or the Guangdong Province in China. In the United States, federal agencies (e.g., FDA, Federal Trade Commission (FTC)) are responsible for documenting implementa- tion details of a law or legislation.

Worldwide, regulatory agencies represent a wide range of institutional settings. The trend in developed countries is to move toward independent regulators that are separate from the pol- icy makers of the national government, such as in the United States, Germany, and the United

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Section 4.1 Evolution of the Ethics and Compliance Field

Kingdom (Malyshev, 2008). In some countries, such as China and India, regulatory agencies are part of the central government with limited autonomy of budget and administration.

The Organisation for Economic Co-operation and Development (OECD) has found that regu- latory agencies that are independent from the legislative body and political system improve regulatory efficiency (Malyshev, 2008). There are two key benefits of independent regulators to monitor and enforce law. First, independent regulatory agencies should reduce interfer- ence from political and private interests. Second, independent regulatory agencies provide for a separation of the government role as policymaker and the government ownership of strategic industries such as energy, transportation, and communications. In order for an inde- pendent regulatory agency to be effective, it requires adequate resources and autonomy in monitoring and enforcing the laws. China is transitioning to independent regulation of the energy and financial industries, yet government officials express concern about giving inde- pendent regulatory agencies too much control over the energy sector, and therefore limit the amount of autonomy the agencies have in enforcing laws (Tsai, 2014).

Achieving full compliance for every regulation is not an easy task for businesses. Therefore, regulatory agencies will issue guidelines that describe the agency’s current thinking on a regulatory issue. Guidelines are nonbinding and clarify the official regulations. For example, U.S. companies often struggle with the interpretation of the Foreign Corrupt Practices Act of 1977. In 2012, the U.S. Department of Justice issued A Resource Guide to the U.S. Foreign Cor- rupt Practices Act that provides details and examples that clarify specific applications of the law. The U.S. Sentencing Guidelines outline recommended fines and prison terms for criminal violations, including organizational misconduct through the Federal Sentencing Guidelines for Organizations, or FSGO (United States Sentencing Commission, 2013). While only advi- sory, the guidelines promote ethics and compliance in organizations.

Ethics and compliance professionals must consider the ethical responsibilities of their employer within the global marketplace and their industry. To stress compliance with man- datory laws, or avoid pending regulatory oversight, companies demonstrate a commitment to ethics through self-regulative initiatives, which include global ethics standards and indus- try standards for business conduct. Global ethical standards stress international norms for responsible conduct that companies should comply with even though they are not legally bound, while industry standards for ethical conduct are generally accepted requirements that members of an industry follow. An example from Chapter 1 is the Defense Industry Ini- tiative on Business Ethics and Conduct, or DII, which established guidelines for ethics and compliance for defense contractors in the United States.

History of Ethics and Compliance

In the United States, businesses began recognizing ethics and compliance as a formal com- pany function in response to the guidelines of the FSGO and DII. In 1991, the FSGO prompted many U.S. companies to establish an ethics and compliance program. An article in Bloomberg Businessweek states:

. . . companies with tough ethics policies will receive treatment that is much more lenient as long as they cooperate with prosecutors and their policies meet the guidelines’ standards. For instance, a fine of $1 million to $2 million

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Section 4.2 Laws and Regulations

could be knocked down to as low as $50,000 for a company with a compre- hensive program including a code of conduct, an ombudsman, a hotline, and mandatory training seminars for executives. (Hager, 1991, para. 4)

The FSGO stipulate that a) high-level personnel of the organization need to be assigned over- all responsibility for the compliance and ethics program, and b) specific individual(s) within the organization must have operational responsibility for the compliance and ethics program (United States Sentencing Commission, 2013). According to the Sentencing Guidelines:

“High-level personnel of the organization” means individuals who have sub- stantial control over the organization or who have a substantial role in the making of policy within the organization. The term includes a director; an executive officer; an individual in charge of a major business or functional unit of the organization, such as sales, administration, or finance; and an indi- vidual with a substantial ownership interest. (United States Sentencing Com- mission, 2013, p. 492)

In the early 1990s, many companies did not have personnel with the knowledge to oversee ethics and compliance, and therefore formed compliance offices within the legal or human resource functions.

Companies that understand the legal dimensions for their business have a competitive advan- tage over companies that ignore ethics and compliance (Peterson, 2013). Compliance with legal requirements is not new to business. While it seems like it should be a straightforward process, there is no single way to develop an organizational capability to consider laws, regu- lations, and self-regulation. The legal dimensions vary by industry, company, and even depart- mental function. Nevertheless, simply knowing the laws is not sufficient to ensure an ethical business. For example, companies that rely solely on advice from company lawyers may focus too much on risk reduction and thus stifle innovation. The profession of compliance officer emerged to coordinate a company’s legal, ethics, audit, training, and risk functions (Snell, 2011a). Compliance officers need to identify the mandatory legal requirements relating to the business. The next section provides an overview of laws and regulations that pertain to community, industry, customer, employee, and investor stakeholders of the company.

4.2 Laws and Regulations There are two types of laws concerning business. Civil law refers to the rules that govern dis- putes between individuals in such areas as contracts and property. Individuals or a group of individuals harmed by fraud, defective products, illegal conduct, or deceptive practices may seek restitution through a civil lawsuit. When an issue is common to a larger group of persons, the lawsuit can become a class action that allows one or several persons to sue on behalf of a larger group. For example, employees may seek back pay from employers that paid less than minimum wage or failed to pay overtime. Customers may seek damages from unsafe products.

Criminal law refers to the rules and statutes that define conduct prohibited by the govern- ment because it threatens and harms public safety and welfare. For business, specific actions that could incur fines or imprisonment include fraud, theft, bribery, insider trading, tax

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Section 4.2 Laws and Regulations

evasion, and antitrust violations. In the United States, a corporation can be criminally charged when any employee commits a crime while acting within the scope of his or her employment and on behalf of the company. Western European countries have been resistant to holding companies accountable, only trying a company for misconduct if it is proven that a high-level manager perpetrated the crime. India is moving toward holding corporations liable for crimi- nal conduct. Australia, Japan, and China recognize corporate criminal liability and impose imprisonment of company managers deemed responsible (Sahu, 2012). Companies can incur fines, sanctions, and imprisonment of officers, managers, or employees.

Laws and regulations for business represent mandatory requirements for compliance. Gov- erning bodies such as national and local governments enact laws or acts that regulate trans- actions between parties in commercial matters. Federal laws apply to the people living within the territory of the nation-state. While there is no international organization able to man- date laws, many encourage implementation of regulations for ethical conduct in international trade. The European Union (EU) can enforce acts and implement regulations, or issue direc- tives that compel member countries to enact a national law addressing a particular issue. A good example is the 2007 EU Regulation on Registration, Evaluation, Authorisation and Restriction of Chemicals (REACH), which replaced 40 pieces of legislation related to chemi- cals “to provide a single regulatory framework for chemicals and their safe use in Europe” (Morpurgo, 2013, p. 786).

In some countries, state or provincial governments have jurisdiction over commercial activi- ties within a geographic area. For example, in the United States, the ease of doing business varies by state. In California, opening a business can take more than 2 years, minimum wage rates are among the highest in the nation, and an aggressive California Environmental Qual- ity Act exposes companies to consumer lawsuits (Malanga, 2011; “The not so golden state,” 2014). In China, the provincial and local governments have almost complete autonomy to encourage business development and promote exports. Provinces establish economic devel- opment zones, extend tax holidays, offer cheaper land prices for foreign investors, exempt firms from local tax, and provide them with subsidies and tax rebates (Liu, 2008).

While laws and regulations relating to business vary by locale, most governing bodies enact legislation that affects business for economic or social reasons. To strengthen the local econ- omy, regulations seek to provide a level playing field by encouraging fair competition and discouraging corruption. To safeguard long-term viability of an economy, many countries are passing laws that enforce ethical practices in a company’s corporate governance, defined gen- erally as the procedures and processes to direct and control an organization (OECD, 2005). Social reasons relate to protecting the health and safety of consumers, employees, and the community. The laws and regulations cannot address all ethical issues of business. The role of laws is to provide the minimum expectation of responsible behaviors of an organization. The sections that follow will provide overviews of mandated legal requirements that businesses would need to consider when developing an ethics and compliance program.

Fair Competition

In business, companies compete for customers and profit. Competition encourages innovation and efficiency, creates a wider choice for consumers, helps reduce prices, and improves quality (OECD, 2011a). Even start-up companies are more successful when competition drives efforts

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Section 4.2 Laws and Regulations

to satisfy customer needs as well as lower and contain costs (Burke & Hussels, 2013). Ethical issues arise when the intensity to win fosters behaviors aimed at gaining an unfair advantage. For example, consider the variance in gasoline prices between stations along major highways and in rural areas. Why would prices change so often and at the same time? As a consumer, you may have little choice but to pay the price at the pump to commute to your workplace. In a study of the competitive practices in the European Union, consumer organizations requested a review of gasoline prices because of concerns that “competition was being limited by market concen- tration, abuse of dominant position, and/or explicit price fixing agreements or tacit collusion” (Scribbins & Dayagi-Epstein, 2007, p. 16). The research found that when gasoline was available in more outlets, such as hypermarkets and supermarkets, lower gasoline prices occurred in all stations near the outlets. However, the member states of the EU in the study used varying degrees of anticompetitive behaviors ranging from prohibiting gasoline sales at other outlets in Italy to price fixing in Spain (Scribbins & Dayagi-Epstein, 2007).

To compete, some larger firms seek to weaken or destroy competitors. Because of their size, larger firms are able to offer lower prices. However, charging a price below cost with the expectation that rivals will exit the market is a predatory pricing strategy to reduce competi- tion. Once the competition is no longer offering the products or services, the larger firm can inflate prices to maximize profits. Predatory pricing leads to a monopoly, where a company has exclusive control over a commodity or service (Leslie, 2013). A company with monopoly power can force consumers to purchase a second product in order to purchase the desired product, a procedure referred to as tying. It is an anticompetitive practice since the company is limiting consumer choice in sourcing the second product.

Microsoft has been dealing with government charges of violating competition laws through- out the world (Ponsoldt & David, 2007). Regulatory agencies claim that the bundling prac- tices of Microsoft make it difficult for smaller software producers to enter and compete in software markets. In the United States, Microsoft settled with the Department of Justice for antitrust charges related to bundling Internet Explorer with its Windows operating system. In the European Union, Microsoft incurred fines and had to offer alternate software other than the Windows Media Player tied with the Windows operating system. In 2005, the Korea Fair Trade Commission found Microsoft’s bundling practices to be in violation of Korea’s Monopoly Regulation and Fair Trade Act.

Some companies strive to control the market for a particular good by coordinating among competitors in their pricing and production strategies. Consider the implications of compa- nies colluding on bids for a lucrative contract. The company requesting bids is seeking the best value provider. However, companies may engage in bid rigging, in which two competi- tors agree that if either company gets the contract then they will give part of the business to the other company. This practice lessens competition since both companies gain regardless of which one receives the contract. Cartels are groups of businesses that collude to control prices or divide the market to protect themselves from competitive pressures. Competitors that agree to raise, fix, or maintain the price of their goods or services engage in price fixing. While the example of gasoline prices is visible to consumers, much of the price fixing occurs at the component levels of product manufacturing. See Reputation Ruin: Auto Parts Suppliers Price-Fixing Scheme for an example of how price collusion affects consumers.

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Section 4.2 Laws and Regulations

Reputation Ruin: Auto Parts Suppliers Price-Fixing Scheme

In 2013, the U.S. Department of Justice announced the successful prosecution of auto parts suppliers for conspiracies to fix prices of automobile parts sold to U.S. car manufacturers (United States Department of Justice, 2013). The investigation coordinated with the Japan Fair Trade Commission, European Commission, Competition Bureau (Canada), Korea Fair Trade Commission, Federal Competition Commission (Mexico), and Australian Competition and Consumer Commission.

Nine Japan-based companies formed a cartel to “reach collusive agreements to rig bids, set prices and allocate the supply of auto parts sold to the car manufacturers” (Federal Bureau of Investigation, 2013, para. 8). The companies made arrangements in person and by tele- phone, using code names and meeting in remote locations. Furthering the anticompetitive behavior, the companies monitored and enforced the collusive agreements. The pricing scheme included over 30 different automobile parts sold to Chrysler Group LLC, Ford Motor Company, and General Motors (GM), as well as to the U.S. subsidiaries of Honda Motor Co., Ltd., Mazda Motor Corporation, Mitsubishi Motors Corporation, Nissan Motor Company Ltd., Toyota Motor Corporation, and Subaru. The U.S. Department of Justice (2013) estimated that the “international price-fixing conspiracies affected more than $5 billion in automobile parts sold to U.S. car manufacturers, and more than 25 million cars purchased by American con- sumers were affected by the illegal conduct” (para. 2).

This ongoing investigation into price fixing and bid rigging in the auto parts industry now includes 20 companies and 21 executives. These anticompetitive practices further erode consumer trust in the automotive industry. Trust in the automotive companies in the United States declined to 33% in 2009 and declined to 49% in the United Kingdom, France, and Germany (Edelman, 2009). The price-fixing scheme also erodes trust between the car manu- facturers and their suppliers. Trust in the supply chain depends on honest and reliable infor- mation (Liao, Sharkey, Ragu-Nathan, & Vonderembse, 2012).

Price fixing is in violation of the Sherman Antitrust Act in the United States and carries maxi- mum penalties of a $100 million criminal fine for corporations and a $1 million criminal fine and 10 years in prison for individuals. The criminal fines for the nine companies reached more than $740 million. Some of the company executives received prison sentences. The companies’ and executives’ agreed-upon fines and sentences were:

• Hitachi Automotive Systems, Ltd.—$195 million criminal fine; • JTEKT Corporation—$103.27 million criminal fine; • MITSUBA Corporation—$135 million criminal fine; • Mitsubishi Electric Corporation (MELCO)—$190 million criminal fine; • Mitsubishi Heavy Industries, Ltd.—$14.5 million criminal fine; • NSK Ltd.—$68.2 million criminal fine; • T.RAD Co., Ltd.—$13.75 million criminal fine; • Valeo Japan Co., Ltd.—$13.6 million criminal fine; • Yamashita Rubber Co., Ltd.—$11 million criminal fine; • Tetsuya Kunida, a Japanese citizen and former executive of a U.S. subsidiary of a

Japan-based automotive anti-vibration rubber products supplier—12 months and one day in a U.S. prison, and a $20,000 criminal fine; and

• Gary Walker, a U.S. citizen and former executive of a U.S. subsidiary of a Japan-based automotive products supplier—14 months in a U.S. prison, and a $20,000 criminal fine.

(continued)

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Section 4.2 Laws and Regulations

Class action lawsuits present additional legal challenges for the automotive parts suppli- ers. In one of the first settlements, automotive parts manufacturer Nippon Seiki Co., Ltd. agreed to pay $4.56 million to U.S. consumers who purchased automobiles since 2002 and to cooperate in the case against the remaining defendants. New class action lawsuits seek to represent all automobile dealers who purchased vehicles that included parts that were manufactured or sold by the defendants or any of their subsidiaries or alleged conspirators. Dealers assert that they were overcharged for every vehicle purchased over a 10-year period. In Canada, three class action lawsuits on behalf of Canadian auto dealers have pursued over $700 million in damages from companies involved in the price-fixing schemes.

Questions to Consider

1. What would prompt the automotive suppliers to collude on prices? What role does pricing pressure from the original equipment manufacturers such as GM, Ford, and Toyota have in the misconduct?

2. Who absorbed the cost of the inflated prices for the auto parts? Why do the fines go to the government instead of people who bought the cars?

Reputation Ruin: Auto Parts Suppliers Price-Fixing Scheme (continued)

Pro-competitive legislation is the laws by which governments attempt to foster and cre- ate the right environment for competition by prohibiting certain types of business practices and transactions that unduly limit competition. The objectives of pro-competitive legislation are to ensure strong incentives for businesses to operate efficiently, keep prices down, and maintain quality. Another term used for pro-competitive legislation is antitrust laws. Anti- trust refers to laws that protect trade and commerce from unlawful restraints and monopo- lies or unfair business practices. To avoid abuses of a dominant market power, most countries require approval for mergers and acquisitions, including takeovers, concentrative joint ven- tures, and other acquisitions of control such as interlocking directorates.

In the United States, the FTC Bureau of Competition enforces antitrust laws for the benefit of consumers. There are three core federal antitrust laws in the United States: 1) the Sher- man Antitrust Act, 2) the Federal Trade Commission Act, which created the FTC, and 3) the Clayton Antitrust Act. Table 4.1 lists some of the laws regulating competition in the United States. Some of the statutes allow exceptions from antitrust laws, whereas other laws remove the exceptions. For instance, the Webb-Pomerene Act of 1918 allowed exporters to engage in collusion in order to promote American trade abroad; however, the act now regulates export trade associations that restrict competition in the United States.

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Section 4.2 Laws and Regulations

Table 4.1: U.S. laws regulating competition

Statute Summary

Sherman Antitrust Act, 1890 Prohibits price-fixing, customer allocation, bid rigging, or other cartel activities.

Clayton Antitrust Act, 1914 Prohibits any merger or acquisition that substantially less- ens competition by conditioning the lease or sale of goods or commodities upon the purchaser’s agreement not to use the products of a competitor.

Federal Trade Commission Act, 1914 Establishes the Federal Trade Commission to take administra- tive action against anticompetitive practices.

Webb-Pomerene Act, 1918 Regulates export trade associations that may adversely affect competition within the United States.

Robinson-Patman Act, 1936 Prohibits price discrimination between retailers and wholesalers.

Lanham (Trademark) Act, 1946 Protects and regulates brand names, brand marks, trade names, and trademarks.

Consumer Goods Pricing Act, 1975 Prohibits contracts or agreements by the producer or distribu- tors that prescribe minimum prices for the resale of a com- modity bearing a trademark or trade name.

Hart-Scott-Rodino Antitrust Improve- ments Act of 1976

Provides the Department of Justice and FTC with several pro- cedural devices to facilitate enforcement of the antitrust laws with respect to anticompetitive mergers and acquisitions.

International Antitrust Enforcement Assistance Act of 1994

Authorizes the FTC and Department of Justice to enter into mutual assistance agreements with foreign antitrust authorities.

Standards Development Organization Advancement Act of 2004

Extends antitrust protections to standards development organizations (SDOs) while those organizations are engaged in standards development activity.

Trademark Dilution Revision Act of 2006 Strengthens protection from trademark dilution, or the unau- thorized use of another’s trademark on products that do not compete with the trademark owner.

Source: Adapted from Ferrell, O.C., Fraedrich, J., & Ferrell, L. (2013). Business ethics: Ethical decision making and cases (9th ed.). Mason, OH: South-Western Cengage Learning.

In the European Union, competition rules apply in all member countries, but it is the respon- sibility of each country’s courts to uphold them. Competition rules apply to any organiza- tion engaged in economic activity, such as businesses, trade associations, or other industry groups. Laws that deal with the competitive behaviors of companies in the European Union reside in the Treaty on the Functioning of the European Union (TFEU). Article 101 prohibits agreements between companies that restrict competition and Article 102 outlaws abuses by dominant companies. Under EU rules, businesses:

• May not agree to fix prices or divide up markets amongst themselves (Article 101); • May not abuse a dominant position in a particular market to squeeze out smaller

competitors (Article 102);

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Section 4.2 Laws and Regulations

• Are not allowed to merge if that would put them in a position to control the market. Larger companies that do a lot of business in the EU cannot merge without prior approval from the European Commission, even if they are based outside the EU (the merger regulation) (European Commission, 2013).

Pro-competitive legislation strives to provide a fair playing field for business. Practices that restrict competition can reduce customer choices, raise prices, and inhibit innovations. One such practice was described in Chapter 3; companies are not able to compete when competi- tors pay bribes to obtain business advantages. The next section examines the laws prohibiting corruption across the world.

Bribery and Corruption

Corruption law touches on a wide variety of issues including bribery, gift giving, money laun- dering, government transparency, organized crime, and trade and investment regulations. The U.S. Foreign Corrupt Practices Act of 1977 (FCPA) makes it illegal for any company or person in the United States to bribe government officials of other countries in order to obtain or retain business. As the first international anti-bribery statute of its type and scope in the world, the FCPA provides an impetus for anticorruption law worldwide (Chu & Wong, 2014). The principal purpose for anticorruption laws is to provide for a fair and competitive environment. The U.S. Senate expresses this objective in a report accompanying the passing of the FCPA:

Corporate bribery is bad business. In our free market system, it is basic that the sale of products should take place based on price, quality, and service. Corporate bribery is fundamentally destructive of this basic tenet. Corpo- rate bribery of foreign officials takes place primarily to assist corporations in gaining business. Thus, foreign corporate bribery affects the very stability of overseas business. Foreign corporate bribes also affect our domestic com- petitive climate when domestic firms engage in such practices as a substitute for healthy competition for foreign business.—United States Senate, 1977 (United States Department of Justice, 2012, p. 1)

The Department of Justice (DOJ) and the Securities and Exchange Commission (SEC) share the enforcement of the FCPA, working closely with other agencies such as the Federal Bureau of Investigation (FBI), Department of Commerce, and Department of State. Upon amendments in 1988, the FCPA grants the SEC jurisdiction over bribery committed outside the United States by U.S. entities or persons, holding the U.S. companies at a higher standard than non- U.S. companies in countries allowing bribery to gain business. To encourage trading partners to adopt anticorruption laws, the United States works with the OECD and the United Nations (UN) to prohibit bribery in international business transactions. The United States is an active participant in the OECD Convention on Combating Bribery of Foreign Officials in Interna- tional Business Transactions (Anti-Bribery Convention) with OECD member countries and the United Nations Convention against Corruption (UNCAC).

There are three basic provisions of the FCPA:

1. It is illegal to bribe foreign officials to obtain/retain business. 2. Companies must keep records that accurately reflect their transactions. 3. Companies must maintain adequate internal controls.

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Section 4.2 Laws and Regulations

The FCPA includes both anti-bribery and accounting provisions. The anti-bribery provision has five elements, including liable parties, type of offense, recipient, business purpose, and corrupt intent (Hermanson & Gramling, 2013). Table 4.2 outlines the elements of an FCPA violation. The FCPA’s anti-bribery provisions apply broadly to three categories of entities and their officers, directors, employees, agents, and shareholders. First are issuers, which include any U.S. or for- eign company listed on a U.S. securities exchange. Second are domestic concerns, which include any individual who is a citizen, national, or resident of the United States; or a business entity that is organized under the laws of the United States or has its principal place of business in the United States. Lastly, the FCPA applies to foreign persons and foreign non-issuer entities that, either directly or through an agent, engage in any act of a corrupt payment (or an offer, promise, or authorization to pay) while in the territory of the United States.

Table 4.2: Elements for an FCPA violation

Element Description

1. Who Any U.S. or foreign company listed on a U.S. securities exchange; any U.S. citizen or resident, company registered in United States; foreign persons and foreign non-issuer entities that, either directly or through an agent, engage in any act of a corrupt payment (or an offer, promise, or authorization to pay) while in the territory of the United States.

2. Offense Paying bribes: offering to pay, paying, promising to pay, or authorizing the payment of money or anything of value, including cash, gifts, travel, entertainment, and chari- table donations. Excludes payments made under duress or from extortion.

3. Recipient Foreign officials include any officer or employee of a foreign government, a public international organization, or any person operating in an official capacity.

4. Business Purpose

Bribes must be to obtain and/or retain business, or to secure a business advantage: to secure favorable tax treatment, to reduce or eliminate customs duties, to obtain government action to prevent competitors from entering a market, or to circumvent a licensing or permit requirement.

5. Corrupt Intent Whether it succeeds or not, corrupt intent exists if the payment is to influence a foreign official to use his/her power to affect a business decision.

Source: Hermanson, H.M., & Gramling, A.A. (2013). Nature’s Sunshine Products: Anatomy of an FCPA failure. Issues in Accounting Education, 28(3), 599–615. Modified from Exhibit 1, p. 602.

The other elements refer to the general anti-bribery provision that the

FCPA prohibits offering to pay, paying, promising to pay, or authorizing the payment of money or anything of value to a foreign official in order to influ- ence any act or decision of the foreign official in his or her official capacity or to secure any other improper advantage in order to obtain or retain business. (United States Department of Justice, 2012, p. 10)

The FCPA applies only to payments made to foreign officials, or officers or employees of a department, agency, or instrumentality of a foreign government. A 1998 amendment of the FCPA expanded the definition of a foreign official to include employees and representatives of public international organizations, such as the World Bank, the International Monetary Fund, the World Intellectual Property Organization, the World Trade Organization, the OECD, the Organization of American States, and others.

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Despite this definition, the interpretation of a foreign official can be difficult for companies to decipher. In some countries, many industries are state-owned and state-controlled. The amount of ownership and control that a public official has on a company can influence whether pay- ments are in violation of the FCPA. For example, the DOJ convicted three subsidiaries of a French company (listed in a U.S. exchange) for paying bribes to employees of a Malaysian telecom- munications company that was 43% owned by Malaysia’s Ministry of Finance and held veto power over major operational decisions (United States Department of Justice, 2012). When it is difficult to determine connections with government agencies, companies issue strict guidelines about travel, entertainment, and gifts to clients and suppliers.

Companies also struggle with interpreting what types of business conduct result in securing “any other improper advantage in order to obtain or retain business” stipulated by the FCPA (United States Department of Justice, 2012, p. 10). One indication is if the company acquires an advantage that allows for increased profits. A Resource Guide to the U.S. Foreign Corrupt Practices Act identifies examples of outcomes from bribery that constitute a business pur- pose. They include winning a contract, influencing the procurement process, circumventing the rules for importing products, gaining access to nonpublic bid tender information, evading taxes or penalties, influencing the adjudication of lawsuits or enforcement actions, obtain- ing exceptions to regulations, and avoiding contract termination. Along with the business purpose test, the FCPA stipulates that an offer, promise, or payment be made with “corrupt intent” to induce the recipient to misuse an official position. A violation of the FCPA occurs even if the bribe is not completed or successful. For example, an SEC investigation prevented a specialty chemical company from following through on a promise of $850,000 to Iraqi gov- ernment officials to obtain an upcoming contract (United States Department of Justice, 2012).

The accounting provisions seek to mandate transparency in financial reporting regarding trans- actions among business partners. The FCPA requires public companies to maintain a system of internal accounting processes and controls to provide reasonable assurances of the accuracy of transactions. During an investigation, regulators may be more willing to cooperate with a com- pany if a robust accounting and compliance program is in place (Berger & Yannett, 2007). The accounting provisions derive from attempts to conceal bribes through misclassification in the company’s accounting system. According to A Resource Guide to the U.S. Foreign Corrupt Prac- tices Act, mischaracterization of bribes as the following expenses is common:

• Commissions or Royalties • Consulting Fees • Sales and Marketing Expenses • Scientific Incentives or Studies • Travel and Entertainment Expenses • Rebates or Discounts • After Sales Service Fees • Miscellaneous Expenses • Petty Cash Withdrawals • Free Goods • Intercompany Accounts • Supplier/Vendor Payments • Write-offs • “Customs Intervention” Payments (United States Department of Justice, 2012, p. 39)

The FCPA has some limitations in deterring corruption. The only offense that the law cov- ers is the bribery of foreign officials. Therefore, the FCPA does not prohibit bribes paid to

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Section 4.2 Laws and Regulations

people working in the private sector, which is referred to as foreign commercial bribery. The DOJ prosecutes foreign commercial bribery under the U.S. Travel Act by use of interstate and foreign phone, e-mail, and other communications. For example, the DOJ charged the Salt Lake Bid Committee of the U.S. Olympics with numerous bribery offenses through the Travel Act, citing unlawful use of communications in interstate and foreign commerce, mail fraud, and wire fraud (Hamilton, 2010). The United Kingdom passed the Bribery Act 2010, which pro- hibits foreign commercial bribery. More countries are including commercial bribery in their anticorruption regulations, such as the Ukraine and Russia (Martini, 2012). Table 4.3 pro- vides a summary of a few countries that have anti-bribery legislation with details of prohib- ited offenses and penalties.

Table 4.3: Anticorruption laws in selected countries

Country Sources of Law General Offenses Penalties

Brazil Law to Combat Corruption, 2014

Bribery of domestic, foreign, or private parties

Fines upward of 20% of a com- pany’s gross annual revenue

China The PRC Criminal Law, the PRC Anti Unfair Competition Law, Industry and Commerce on Pro- hibition of Commercial Bribery

Active bribery of state working personnel, non-state working personnel, state organizations, state-owned enterprises, public institutions, or organizations Receipt of bribe (passive brib- ery)—an entity or an individual working for the entity demands or receives illegal money or property by taking advantage of his/her position for obtain- ing benefits for other entities or individuals

Individuals: Fine Confiscation of property Fixed-term/life imprisonment Companies: A fine of up to RMB 200,000 (~$32,500) Confiscation of illegal income Fixed term imprisonment (the person in charge or directly responsible) of 5 years

Russia Criminal Code, Code of Admin- istrative Offences, Federal Anti- Corruption Law, Public Procure- ment Law, Federal Law “On the State Civil Service of the Russian Federation”

Receipt of bribe by an official of money, securities or other prop- erty or benefits for his/her per- formance (or non-performance) of actions in favor of a briber, if such actions are related to the official’s duties Giving a bribe to an official Commercial bribery of a com- pany executive

Individuals: Imprisonment for up to 12 years Fine of up to RUR 500m (€12.5m) or up to 70 times the sum of the bribe Companies: Administrative fine of up to RUR 100m (€2.5m) and seizure of the monetary gain

Spain Articles 419–422, 424, 427 and 445 of Organic Law; Penal Code

Paying a bribe to a public official Requesting a bribe by a public official Commercial bribery to a direc- tor, manager, or employee of a corporation

Individuals: Imprisonment up to 6 years or fines Disqualification of the public official from public employment for up to 12 years Companies: Suspension of corporate activi- ties for up to 5 years and fines Fines up to 5 times the benefit obtained

(continued)

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Section 4.2 Laws and Regulations

Country Sources of Law General Offenses Penalties

Ukraine Law on Principles of Prevention and Combating of Corruption; Criminal Code of Ukraine; Code on Administrative Offences of Ukraine

Extortion (provocation of a bribe) by a public official Commercial bribery of an officer of a legal entity Bribing a public official

Individuals:Recipient and briber fine Debarment from certain positions and activities for up to 3 years Confiscation of property Detention for up to 5 years Imprisonment for 10–12 years Companies: Legal entities are not liable for corrupt acts

United Kingdom Bribery Act 2010 (in force from July 1, 2011)

Bribing, offering, or giving a financial or other advantage to a person intending to induce them, or another, improperly to perform a public function or business activity, or as a reward for the same Being bribed: requesting or accepting a bribe Bribing a foreign public official: 1) to influence them in their capacity as a foreign public official, and 2) to obtain or retain business or a business advantage

Individuals: Imprisonment for up to 5 years Return the value of the bribe Companies: Fine of up to 200 times the amount of damage caused or benefit obtained Confiscation Prohibition on participating in public procurement for up to 10 years

Source: CMS Legal Service EEIG. (2011). Anti-bribery and corruption laws. www.cmslegal.com; Martini, M. (2012). Trends in anti-bribery laws HELPDESK. http://www.transparency.org: Transparency International.

The FCPA allows exceptions for local laws, extortion, and facilitating payments for routine governmental actions. Companies may avoid charges of violating the FCPA by establishing that the payment or gift was lawful under the foreign country’s written laws and regulations at the time of the offense. Payments made under extortion or threat of physical harm are not in violation of the FCPA as corruption intent is absent. However, economic coercion for gaining access to a market or contract is a violation of the FCPA. The broadest exception of the FCPA is allowing facilitating or grease payments for routine governmental actions. Deter- mination of exemption from the FCPA relies on the nondiscretionary of the actions, meaning that the acts do not include a decision to award or maintain business. Examples of routine governmental actions include processing visas, providing police protection, phone service, power, water service, or mail delivery. The ambiguity and situational factors of anticorrup- tion laws reinforce the need for a comprehensive compliance and ethics program along with transparent corporate governance.

Table 4.3: Anticorruption laws in selected countries (continued)

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Section 4.2 Laws and Regulations

Corporate Governance

In 2001, accounting fraud at the energy company Enron led to one of the largest bankruptcy reorganizations in the United States. The scandal effectively ruined Arthur Andersen, one of the five largest audit and accountancy firms, for failing to prevent the fraud. As shown in Chapter 3, financial fraud is a major ethical issue that most often resides within a company’s leadership. The corporate governance structures in place may have been a contributing fac- tor to banking crises in the United States and Europe (Fortin, Goldberg, & Roth, 2010; Ross & Crossan, 2012). In response to the accounting scandals and banking failures, the United States and other governments enacted legislation to enforce responsible management of business.

Corporate governance structures include four dimensions: “1) define purpose and values; 2) key board and management practices; 3) top management (especially CEO) selection, compensation, and incentives; and 4) company performance measurements” (Windsor, 2009, p. 309). There are differences in the corporate governance structure among countries to address these dimensions. In the United States and the United Kingdom, one board of directors is responsible for all dimensions, including the monitoring of board and manage- ment practices, compensation standards, and performance toward the goals of maximizing shareholder value. In France and Germany, boards include stakeholder representation for lenders, suppliers, and worker unions that may have diverse goals for the business (Ross & Crossan, 2012). South Africa combines the U.S. and U.K. structures of a unitary board with the inclusive approach of France and Germany by overlaying regulations that com- panies address the lingering negative social and economic legacies of apartheid such as employment equity, Black economic empowerment, and HIV/AIDS (Ntim, 2013). A study of emerging markets showed that steps to mandate board independence in Korea and India provided for less fraud and greater transparency, whereas minority shareholders are more likely to be harmed in countries such as Turkey where low levels of board independence are encouraged by an existing commercial code (Claessens & Yurtoglu, 2013).

Corporate governance laws and regulations seek to mandate responsible management of the organization, hinder illegal insider trading, and encourage informers to report misconduct. In July 2002, the United States passed the Sarbanes-Oxley Act of 2002 (SOX) to protect investors by improving the accuracy and reliability of corporate disclosures. Other countries modeled their corporate governance after the act. In Japan, the Financial Instruments and Exchange Law passed in June 2006, and is so similar to the U.S. law that it has been nicknamed J-SOX (Bying- ton & McGee, 2011). The EU member states are implementing regulations in response to the European Commission’s directives to address issues relating to disclosure, shareholder protec- tion, and board structures. For example, one of the EU directives is for transparency, increasing the liability of a company’s directors for the accuracy of financial reports. In the United States, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 includes many provisions that deal with corporate governance and compliance programs such as executive compensation, public company disclosures, whistle-blower protections, and sourcing of con- flict minerals that supplement or augment the Sarbanes-Oxley Act. Therefore, elements of the Sarbanes-Oxley Act have influenced corporate governance regulations worldwide.

Sarbanes-Oxley Act of 2002 All publicly traded companies in the United States have a requirement to comply with the Sarbanes-Oxley Act. Industry responses to the signing of the Sarbanes-Oxley Act varied from

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Section 4.2 Laws and Regulations

optimistic to cautious about the ability of legislating ethical behavior of auditing and account- ing. One industry expert stated, “This is the most fundamental, far-reaching legislation to affect the accounting profession since the 1930s” (Felo & Solieri, 2003, p. 31). Others criti- cized the impact of oversight boards and audit committees to prevent common audit failures (Tackett, Wolf, & Claypool, 2004). Investors should have more peace of mind and be able to trust the information provided by companies now that management is accountable for the integrity of the financial statements. Opponents argued that the costs in complying with new regulations would exceed the benefits, would be detrimental to the economy, and the burden would fall too heavily on smaller public firms (Jahmani & Dowling, 2008).

The Sarbanes-Oxley Act has 11 titles containing provisions that affect many of the key players contributing to the financial scandals of the early 2000s, including auditors, management, the board of directors, attorneys, and security analysts. Auditors have new private oversight, independence rules, and reporting processes. Management has protections against conflicts of interest, disclosure requirements, obligations to certify financial filings, and to establish internal controls. The audit committee of the board of directors has greater responsibility for overseeing the audit process as well as new requirements for independence and expertise. Attorneys and security analysts are subject to stricter codes of professional conduct to main- tain independence from client firms. As far as company compliance is concerned, the most important sections are 302, 401, 404, 409, 802, and 906. Table 4.4 lists the key provisions of the Sarbanes-Oxley Act including those relating to auditors and securities advisors.

Table 4.4: Key provisions of the Sarbanes-Oxley Act

Section Major Provisions

101 Established the Public Company Accounting Oversight Board to oversee the audit of public companies that are subject to the securities laws.

201 Prohibits non-audit services by auditors to their audit clients.

301 Requires an independent audit committee to oversee the audit process.

302 Requires company CEO and chief financial officer (CFO) to certify all financial reports.

306 Makes it unlawful for any director or executive officer to engage in insider trades during a pension blackout period.

307 Requires an attorney to report evidence of a material violation of securities laws or breach of fiduciary duty or similar violation up the company’s chain of responsibility to the full board of directors.

401 Requires disclosure of off-balance sheet transactions, arrangements, obligations, and other relationships of an issuer with unconsolidated entities or other persons, that have, or are reasonably likely to have, a current or future material effect on financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capi- tal expenditures, or capital resources.

402 Prohibits a company from making a personal loan to any director or executive officer.

404 Establishes that management is responsible for establishing and maintaining an adequate internal control structure.

409 Requires companies to disclose information concerning material changes in its financial condition or operations on an almost real-time basis.

(continued)

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Section 4.2 Laws and Regulations

Section Major Provisions

501 Requires security analysts to certify that the views expressed in the report accurately reflect his/her personal views and disclose any compensation.

806 Provides protection for employees who provide evidence of fraud.

902 Establishes that it is a crime for any person to corruptly alter, destroy, mutilate, or conceal any document with the intent to impair the object’s integrity or availability for use in an official proceeding.

906 Stipulates that criminal penalties for certifying a misleading or fraudulent financial report can be upward of $5 million in fines and 20 years in prison.

Source: H.R. 3763—107th Congress: Sarbanes-Oxley act of 2002, 2002.

With the threat of heavy fines and 20 years of imprisonment, top management needs to ensure the accuracy of financial statements. Section 404 stipulates that management is responsible for establishing and maintaining an adequate internal control structure. As introduced in Chapter 1, the Committee of Sponsoring Organizations (COSO) coined the term tone at the top to describe top management’s commitment to ethics and compliance in an organization. Companies need to establish additional ethical policies for the senior financial officers and the audit committee to meet the requirements in the Sarbanes-Oxley Act (Weber & Wasieleski, 2013). Under the Dodd-Frank Act, the SEC exempted companies of $75 million or less from obtaining an independent auditor’s report on the effectiveness of their internal control over financial reporting to reduce the financial burden of compliance with the Sarbanes-Oxley Act (Rashty, 2012). The Sarbanes-Oxley Act prompts companies to establish internal controls through an ethics and compliance program.

Insider Trading Insider trading is an ethical issue involving trading corporate securities through misuse of nonpublic company knowledge, typically obtained by a fiduciary duty or position of trust (Chapter 3). Laws prohibiting insider trading protect investors, thereby reducing risk and increasing confidence in the financial reporting. In the United States, the Securities Exchange Act of 1934 is the authoritative federal law that governs insider trading. The law followed the 1929 stock market crash and was one of the first federal laws to regulate securities trading. In this act, Congress established the SEC to enforce the newly passed securities laws, to promote stability in the markets, and to protect investors.

SEC rules and regulations have evolved over the years, along with amendments to the Securi- ties Exchange Act made by Congress. Two sections of the act relate to insider trading. Section 16(b) prohibits profits realized in any period less than six months by corporate insiders in their own corporation’s stock, except in very limited circumstance. Corporate insiders include members of the board of directors or officers of the corporation and those holding greater than 10% of the stock. Section 10(b) makes it unlawful to employ any manipulative or decep- tive device or contrivance to circumvent SEC rules and regulations. To clarify implementation of Section 10(b), the SEC adopted Rule 10b-5 in 1942. Rule 10b-5 makes it unlawful for any person, directly or indirectly:

Table 4.4: Key provisions of the Sarbanes-Oxley Act (continued)

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Section 4.2 Laws and Regulations

(a) to employ any device, scheme, or artifice to defraud;

(b) to make any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circum- stances under which they were made, not misleading; or

(c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of a security. (U.S. Securities and Exchange Commission, 1998, p. 4)

In the 20th century, the United States expanded efforts to restrict insider trading through regulations and new laws. In 1961, the SEC established that tipping violated the Securities Exchange Act. Tipping occurs when an insider with confidential information does not trade, but rather informs, or tips, someone else who does trade. The Insider Trading Sanctions Act of 1984 imposed civil and criminal penalties for insider trading violations. The Insider Trading and Securities Fraud Enforcement Act of 1988 improved the procedures and rem- edies for the prevention of insider trading. The International Securities Enforcement Coop- eration Act of 1990 expanded the SEC’s international role by allowing cooperation with foreign insider trading investigations. Finally, although not specifically addressing insider trading, the Sarbanes-Oxley Act expedited access to insider trading information that pro- vides monitoring of insider financial transactions by the SEC. The Dodd-Frank Act makes insider trading of commodities more likely to be scrutinized by the SEC.

Compared to the United States, other countries were slow to consider insider trading prohi- bitions. Table 4.5 shows the insider trading laws by country. Prior to the early 1970s, only a handful of countries adopted insider trading laws, with a few more in the 1980s. In the 1990s and early 2000s, the number of countries with insider trading laws enforcement agencies grew from just a few countries to 57 countries (Kerner & Kucik, 2010).

Table 4.5: Insider trading laws by country

Country Law Against Illegal Insider Trading Year

Maximum Prison Time

United States Securities Exchange Act of 1934 1934 20 years

South Korea Securities and Exchange Act 1962 20 years

Canada Ontario Securities Act of 1966 1966 10 years

France French Monetary and Financial Code of 2000; Banking and Financial Regulation Act of 2010

1970 2 years

Australia Australian Industry Development Corporation Act

1970 10 years

Brazil Brazilian Corporations Law 1976 5 years

United Kingdom Criminal Justice Act 1980 7 years

Japan Financial Markets Abuse Act 1988 3 years

(continued)

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Section 4.2 Laws and Regulations

Country Law Against Illegal Insider Trading Year

Maximum Prison Time

Switzerland Swiss Criminal Code 1988 3 years

Hong Kong Securities Ordinance 1991 1991 10 years

India Securities and Exchange Board of India (SEBI) Act 1992

1992 10 years

China Establishment of Securities Companies with Foreign Equity Participation Rules

1993 10 years

Germany Securities Trading Act 1994 Per case

Source: Thompson, J.H. (2013). A global comparison of insider trading regulations. International Journal of Accounting and Financial Reporting, 3(1), 23. Based on Table 2, pp. 13–15

Insider trading allegations involving senators, representatives, and staff in the federal gov- ernment led to the passing of the 2012 STOCK (Stop Trading on Congressional Knowledge) Act, strengthening the ban on insider trading by members of Congress and other government officials who might profit on private knowledge they gain from work (Rivoli, 2012). The new law strengthened the restrictions on the use of nonpublic information as part of their position of trust and confidence with the U.S. government. The act also creates repercussions for any business or individual that has to interact with members of Congress or their staff on mat- ters that could include nonpublic information that could be used for insider trading (Burke, Kelner, & Durbin, 2012).

Whistle-blower Protection Financial fraud is difficult for the SEC and DOJ to detect unless someone from the organization brings it to the regulators’ attention. Many employees are aware of misconduct by their employer, such as falsifying or manipulating financial reporting, yet continue to work in the organization. Some find themselves participating in fraudulent activities or in a position of oversight of such activities even when they know it is wrong. Whistle-blower Cynthia Cooper describes her experi- ence while working at WorldCom: “My feelings changed from curiosity to discomfort to suspicion based on some of the accounting entries my team and I had identified, and also on the odd reac- tions I was getting from some of the finance executives” (Homer & Katz, 2008, p. 40).

When an organization does not act to prevent or punish unethical behavior, some employees take great personal and professional risk to become a whistle-blower, a person who informs on a person or organization engaged in an illicit activity. Whistle-blowing involves making misconduct public.

In 2002, Time magazine named three whistle-blowers as “Persons of the Year” for going public with stories of organizational fraud: Enron’s Sherron Watkins, the FBI’s Coleen Rowley, and WorldCom’s Cynthia Cooper (Lacayo & Ripley, 2002). In the interview for the Time magazine article, they conveyed reluctance to be a whistle-blower because of the repercussions—being fired, isolated, or made irrelevant in the company. The Ethics Resource Center (2013b) has estimated that more than six million employees suffer from retaliation for reporting miscon- duct to the company or regulators.

Table 4.5: Insider trading laws by country (continued)

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Section 4.2 Laws and Regulations

Retaliation is a negative consequence experienced by an employee for reporting observed misconduct. Forms of retaliation can include isolation (e.g., receiving a cold-shoulder from other employees or being excluded from decisions or work activity), verbal abuse by a super- visor or other employees, physical harm to person or property, harassment online or at home, denial of promotion or raises, relocation or reassignment, demotion, or firing (Ethics Resource Center, 2012b). Whistle-blower protection is provided under the Sarbanes-Oxley Act and Dodd-Frank Act.

Specifically, Section 302 of the Sarbanes-Oxley Act mandates that corporations establish pro- cedures for confidential reporting of accounting or auditing irregularities. Section 806 makes it unlawful to:

“discharge, demote, suspend, threaten, harass, or in any other manner dis- criminate against” an employee who acts: “(l) to provide information, cause information to be provided, or otherwise assist in an investigation regarding any conduct which the employee reasonably believes constitutes a violation of section 1341 [mail fraud], 1343 [wire fraud], 1344 [bank fraud], or 1348 [securities fraud], any rule or regulation of the Securities and Exchange Com- mission, or any provision of Federal law relating to fraud against sharehold- ers.” (Sarbanes-Oxley Act of 2002, Pub. L. 107–204, 116 Stat. 746.)

The whistle-blower protection of the Sarbanes-Oxley Act has not been very effective. Many employees filed claims during the first years of the act, yet few determinations were in favor of the employee (Pope & Lee, 2013). Retaliation claims may be hard to prove in court. The employee must show that he or she suffered an adverse employment action and that report- ing the illicit activity was the cause (Zucker, 2011). As a result, potential whistle-blowers typi- cally decline to report misconduct to the SEC.

The Dodd-Frank Act seeks to encourage individuals to provide the SEC with information about violations of the federal securities laws and accounting fraud through offering finan- cial bounties. In 2010, Congress created an Office of the Whistleblower at the SEC to manage the monetary incentives for individuals to report possible violations of the federal securities laws to the SEC. Under the Dodd-Frank Act, eligible whistle-blowers are entitled to an award of between 10% and 30% of the monetary sanctions collected in actions brought by the SEC and related actions brought by other regulatory and law enforcement authorities because of their information. Other regulatory agencies have similar programs, such as the Commodity Futures Trading Commission’s whistle-blower program, the IRS whistle-blower program, and the Department of Justice False Claims Act whistle-blower provisions.

In 2013, the SEC Office of the Whistleblower paid whistle-blowers a total of over $14 million (U.S. Securities and Exchange Commission, 2013a). According to their annual report, “the most common complaint categories reported by whistle-blowers in the 2013 fiscal year were corpo- rate disclosures and financials (17.2%), offering fraud (17.1%), and manipulation (16.2%) By comparison, in fiscal year 2012, the most common complaint categories reported by whistle- blowers also were corporate disclosures and financials (18.2%), offering fraud (15.5%), and manipulation (15.2%)” (U.S. Securities and Exchange Commission, 2013a, p. 8). Tips of financial misconduct are not only from U.S. employees. Since the beginning of the whistle-blower pro- gram, the SEC received tips from individuals in 68 other countries. In fiscal year 2013 alone, the SEC received whistle-blower submissions from individuals in 55 foreign countries.

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The court system defines the eligibility of receiving an award or protection from retaliation. According to the Dodd-Frank Act rules, protection from retaliation is not contingent on receiv- ing an award, though courts interpret the rules differently. For example, in October 2013, a federal judge ruled that a former employee was eligible for protection from retaliation under the Dodd-Frank Act even if he did not report suspected securities law violations to the SEC until after being fired (Ensign, 2013a). Whereas a district court in New York decided that a General Electric employee’s claims of retaliation for an FCPA violation was not protected under the Dodd-Frank Act because he had not provided information relating to a securities law violation to the SEC (Ensign, 2013b). In 2014, the Supreme Court ruled that the whistle- blower protection provisions of the Sarbanes-Oxley Act cover employees of private contrac- tors that provide services for public companies. These court decisions increase company risk for civil cases claiming retaliation. Companies that operate in more than one country have added risks from employees seeking restitution for adverse employment action under the U.S. or local whistle-blower protection laws. See Going Global: Whistle-Blower Protections for Employees Outside the United States for considerations that global companies should know.

Going Global: Whistle-Blower Protections for Employees Outside the United States

On October 13, 2013, a Southern District of New York judge ruled that the anti-retaliation pro- visions of the Dodd-Frank Act do not apply outside of the United States (Ensign, 2013b). The case involved a China-based employee of Siemens that sued the company for his 2010 firing after he reported internally that employees violated internal accounting controls and other violations of the FCPA. He reported potential misconduct to the SEC in 2011. The judge drew on the 2010 Supreme Court decision Morrison v. National Australia Bank Ltd., which limits extraterritorial application of U.S. securities laws. “There’s simply no indication that Congress intended the anti-retaliation provision to apply extraterritoriality,” said Judge William Pauley III (Ensign, 2013b, para. 3). The case was appealed and the judgment affirmed in 2014.

These court cases may have the effect of reducing the number of employees in foreign sub- sidiaries who report wrongdoing to U.S. regulatory agencies. However, corporations involved in international business may wish to look closely at their compliance reporting and anti- retaliation policies to maintain adequate internal control processes. The U.S. court decisions may sway toward ruling favorably for employees from other countries. The SEC issued a 2014 brief specifying that protection from retaliation is available to individuals who report suspected wrongdoing internally at a company or directly to the SEC. In addition, employees of foreign subsidiaries may have protection from retaliation through local laws.

In other parts of the world, whistle-blower protection laws vary greatly. The OECD is work- ing with member countries to offer whistle-blower protection through legislation. Countries that have passed comprehensive and dedicated protection include Australia, Canada, Ghana, Japan, Korea, New Zealand, Romania, South Africa, the United Kingdom, and the United States (OECD, 2012). For example, Korea provides monetary rewards for whistle-blowers who report misconduct that has contributed directly to recovering or increasing revenues or reducing expenditures for public agencies. Transparency International has found that of the EU member countries, Bulgaria, Finland, Greece, Lithuania, Portugal, Slovakia, and Spain have very limited or no provisions and procedures for whistle-blowers in the public or pri- vate sectors (Worth, 2013). For example, in Portugal, “whistleblowers have almost no legal protections and, under Portuguese law, they can be criminally prosecuted or face civil law- suits for defaming others—particularly those in positions of power” (Worth, 2013, p. 12).

(continued)

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Section 4.2 Laws and Regulations

Questions to Consider

1. Should U.S. whistle-blower protections apply to employees of U.S.-listed companies if the employee is not a U.S. citizen or resident?

2. Will international companies become more sensitive to employees’ concerns about misconduct now that almost any employee can be subject to whistle-blower protection?

3. How should a company’s ethics and compliance program provide whistle-blower protection outside the United States?

Going Global: Whistle-Blower Protections for Employees Outside the United States (continued)

In recognition of whistle-blower protection laws, companies need to establish policies and procedures to allow employees to report misconduct without retaliation. A strong policy statement should clarify to employees that no report made in good faith—even if unsub- stantiated—is to be retaliated in any form. Top management should support the policy and managers should be trained on fair project assignments, setting salaries, and determining promotions to avoid unintentionally punishing an employee for reporting misconduct. Con- fidentiality of a report could remove potential retaliation opportunities, as the less people know of the situation, the less likely coworkers and supervisors will isolate or harass the informant. A process for reporting, investigating, and protecting informants is an important part of corporate governance to ensure the accuracy of financial information and responsible management practices. Corporate governance regulation protects investors from fraudulent financial and business performance information. Consumer protection regulations provide similar safeguards to the resellers and end consumers of a company’s product or service.

Consumer Protection

Consider a recent purchase of a cold medicine, whether over-the-counter or as a prescription. There are multiple brands, each with differing features and prices. Would a generic product or private label work as well as the branded drug? Is the product available to purchase off the shelf or only through the pharmacy? What personal information does the pharmacy need? If the product is a prescription, the price charged may depend on insurance agreements. Each customer could pay a different price for the same product. Once purchased, one expects that the product is what the package indicates and trusts that the medicine will alleviate all symp- toms of the cold.

Customers are more able to make informed product or service choices, obtain safe products, and maintain confidentiality of personal information because of consumer protection laws and regulations. Governments establish consumer protection laws, policies, and standards to ensure customers’ rights to safe products, fair and honest treatment, product variety, and ability to redress for complaints. In 1962, President John F. Kennedy outlined the Consumer Bill of Rights:

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Section 4.2 Laws and Regulations

1. The right to safety—to be protected against the marketing of goods which are haz- ardous to health or life.

2. The right to be informed—to be protected against fraudulent, deceitful, or grossly misleading information, advertising, labeling, or other practices, and to be given the facts he needs to make an informed choice.

3. The right to choose—to be assured, wherever possible, access to a variety of prod- ucts and services at competitive prices; and in those industries in which competition is not workable and Government regulation is substituted, an assurance of satisfac- tory quality and service at fair prices.

4. The right to be heard—to be assured that consumer interests will receive full and sym- pathetic consideration in the formulation of Government policy, and fair and expedi- tious treatment in its administrative tribunals. (Peters & Woolley, n.d., para. 8–11)

At least four U.S. regulatory agencies enforce the statutes relating to marketing fraud and product safety. The FTC’s mission is to prevent fraud, deception, and unfair business practices in the marketplace by enforcing advertising and marketing laws, financial services regula- tions, and consumer privacy laws. The Consumer Product Safety Commission (CPSC) is an independent federal regulatory agency that protects the public against unreasonable risks of injury or death from consumer products. The FDA is responsible for protecting the public health by assuring the safety, efficacy, and security of human and veterinary drugs, biological products, medical devices, our nation’s food supply, cosmetics, and products that emit radia- tion. The Dodd-Frank Act created a Consumer Financial Protection Bureau (CFPB) within the Federal Reserve Board in 2010 to write rules, supervise companies, and enforce federal con- sumer financial protection laws. Table 4.6 provides a list of laws to protect consumers that the agencies enforce through regulations, guidance, and standards.

Table 4.6: Laws protecting consumers

Law Description

Pure Food and Drug Act of 1906 Prohibits adulteration and mislabeling of foods and drugs used in interstate commerce.

Federal Food, Drug, and Cosmetic Act of 1938 Authorizes the FDA to demand evidence of safety for new drugs, issue standards for food, and conduct fac- tory inspections.

Federal Hazardous Substances Act, 1960 Requires warning labels on hazardous household products, gives CPSC authority to regulate or ban products.

Fair Packaging and Labeling Act, 1966 Requires that all consumer commodities other than food, drugs, therapeutic devices, and cosmetics be labeled to disclose net contents, identity of commod- ity, and name and place of business of the product’s manufacturer, packer, or distributor.

Truth in Lending Act, 1968 Requires full disclosures of credit terms to purchasers.

Consumer Product Safety Act, 1972 Established CPSC to enact safety standards, issue recalls, and ban products.

(continued)

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Section 4.2 Laws and Regulations

Law Description

Magnuson Moss Warranty-Federal Trade Com- mission Improvements Act, 1975

Establishes rules for consumer product warranties that include minimum content and standards for disclosure.

Telemarketing and Consumer Fraud and Abuse Prevention Act, 1994

Prohibits telemarketers from engaging in a pattern of unsolicited telephone calls.

The Children’s Online Privacy Protection Act, 1998

Establishes rules for website operators that protect personal information and marketing of children under 13 years.

Gramm-Leach-Bliley Act, 1999 Stipulates that financial institutions must develop and give notice of their privacy policies to their own customers at least annually; before disclosing any consumer’s personal financial information to an unaf- filiated third party, the institution must give notice and an opportunity for that consumer to opt out from such disclosure.

Consumer Product Safety Improvement Act, 2008 Establishes safety standards for childrens’ toys and product safety.

The Do-Not Call Registry Act of 2003 Directs FTC and Federal Communications Commission (FCC) to provide consistent rules of telemarketing call practices.

Dodd-Frank Wall Street Reform and Consumer Protection Act, 2002 Titles X and XIV

Creates a Consumer Financial Protection Bureau within the Federal Reserve Board; limits transaction fees; prevents mortgage-related abuses; and ensures availability of responsible, affordable mortgage credit.

Adapted from Ferrell, O.C., Fraedrich, J., & Ferrell, L. (2013). Business ethics: Ethical decision making and cases (9th ed.). Mason, OH: South-Western Cengage Learning.

The FTC seeks to prevent business practices that are anticompetitive, deceptive, or unfair to consumers; to enhance informed consumer choice and public understanding of the competi- tive process; and to accomplish this without unduly burdening legitimate business activity. Within the FTC, the Bureau of Consumer Protection collects complaints and conducts inves- tigations, enforces the consumer protection laws, provides rules to maintain a fair market- place, and educates consumers and businesses about their rights and responsibilities.

Congress enacted the Consumer Product Safety Act (CPSA) in 1972, which established the CPSC as an independent regulatory agency. The CPSC’s mission is to protect the public against unreasonable risks of injury from consumer products through education, safety standards activities, regulation, and enforcement. CPSC is committed to protecting consumers from products that pose a fire, electrical, chemical, or mechanical hazard. In 2008, the Consumer Product Safety Improvement Act established safety standards and other safety requirements for children’s products.

The FDA protects and promotes the health of the American public by assuring the safety and efficacy of medicines and food. The first public health and consumer protection in the United States was the Pure Food and Drug Act of 1906, which was established after Upton Sinclair’s exposé of unhygienic conditions in the Chicago stockyards. The Federal Food, Drug, and Cos- metic Act of 1938 passed after a legally marketed toxic elixir killed 107 people, including

Table 4.6: Laws protecting consumers (continued)

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Section 4.2 Laws and Regulations

many children. The law authorized the FDA to demand evidence of safety for new drugs, issue standards for food, and conduct factory inspections. Today, the FDA has four roles:

1. Regulate the safety of all food except for meat, poultry, and some egg products; 2. Ensure the safety and effectiveness of all drugs, biological products (including blood,

vaccines, and tissues for transplantation), medical devices, and animal drugs and feed;

3. Regulate tobacco products and cosmetics; and 4. Make sure that medical and consumer products that emit radiation do no harm.

Firms that manufacture, sell, warehouse, transport, or import any of the thousands of FDA- regulated products need to be familiar with FDA requirements and processes. Just as the FDA protects the health and safety of consumers in the United States, other regulatory agencies protect the health and safety of employees and the community.

Environment, Health, and Safety

Regulations of environmental protection and worker safety have been increasing at an unprecedented rate over the past decade. In the United States, regulatory agencies enacted over 300 additional environmental protection regulations and over 30 occupational health and safety regulations in 2012 (Cahill, 2013). Globally, environment, health, and safety (EHS) regulations increased three times between 2006 and 2010 (Jusko, 2011). A new pro- fession to develop systems to comply with EHS regulation emerged in companies around the world—the EHS manager. The EHS function protects the environment and assures the health, safety, and privacy of employees.

Companies also have to consider the work environment and laws relating to fair treatment of employees. Environmental protection laws protect workers and the community from expo- sure to toxic chemicals, contaminated water, and poisonous emissions. Health and safety laws assure safe and healthful working conditions for employees. Privacy and security laws pro- tect sensitive personal information about employees. Equity laws protect employees and job applicants against employment discrimination and guarantee workers’ rights to fair compen- sation. Table 4.7 provides an overview of major laws in each category.

Table 4.7: U.S. environmental, health, safety, privacy, and equity laws

Environmental Protection

Clean Air Act of 1970 Regulates air emissions from stationary and mobile sources.

Clean Water Act, 1972 Regulates discharges of pollutants into the waters of the United States and regulates quality standards for surface waters.

Safe Drinking Water Act, 1974 Establishes minimum standards to protect the quality of drinking water.

Toxic Substances Control Act, 1976 Requires reporting, recordkeeping, and testing require- ments, and restrictions relating to chemical substances.

(continued)

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Section 4.2 Laws and Regulations

Federal Insecticide, Fungicide, and Rodenti- cide Act, 1996

Regulates pesticide distribution, sale, and use. All pesticides distributed or sold in the United States must be registered (licensed) by the Environmental Protection Agency (EPA).

Health and Safety

Occupational Safety and Health Act, 1970 Assures safe and healthful working conditions for working men and women by authorizing enforcement of the stan- dards developed under the Act.

Privacy and Security

Electronics Communications Privacy Act of 1986

Protects wire, oral, and electronic communications while those communications are being made, are in transit, and when they are stored on computers. The act applies to e-mail, telephone conversations, and data stored electronically.

Equity

Fair Labor Standard Act of 1938 Amendments 1949, 1955, 1961, 1966, 1974, 1977, 1985, 1989, 2011

Establishes minimum wage, overtime pay, recordkeeping, and youth employment standards affecting employees in the private sector and in federal, state, and local governments.

Equal Pay Act of 1963 Prohibits different wages to men and women if they perform equal work in the same workplace.

Title VII of the Civil Rights Act of 1964 (Title VII)

Makes it illegal to discriminate against someone because of race, color, religion, national origin, or sex.

Americans with Disabilities Act of 1990 Prohibits employment discrimination against qualified indi- viduals with disabilities.

Family and Medical Leave Act of 1993 Entitles eligible employees of covered employers to take unpaid, job-protected leave for specified family and medical reasons

Source: Adapted from Ferrell, O.C., Fraedrich, J., & Ferrell, L. (2013). Business ethics: Ethical decision making and cases (9th ed.). Mason, OH: South-Western Cengage Learning.

Different regulatory agencies enforce the EHS, privacy, and equity laws in the United States. The Environmental Protection Agency (EPA) is responsible for research, monitoring, setting stan- dards, and enforcing regulation to ensure environmental protection. The EPA’s purpose is to pro- tect Americans from significant risks to human health and the environment where they live, learn, and work. The Occupational Health and Safety Administration (OSHA) administers laws protect- ing the health and safety of workers. The FTC enforces data security laws. The Equal Employment Opportunity Commission (EEOC) is responsible for enforcing federal laws that make it illegal to discriminate against a job applicant or an employee because of race, color, religion, sex (including pregnancy), national origin, age (40 or older), disability, or genetic information. The Wage and Hour Division of the Department of Labor (DOL) enforces federal minimum wage, overtime pay, recordkeeping, and child labor requirements of the Fair Labor Standards Act.

States and local communities may have more stringent EHS and equity regulations than the federal laws. For example, a 2012 law in the San Francisco Bay Area requires businesses with over 50 employees to offer commuter benefits, including telecommuting options.

Table 4.7: U.S. environmental, health, safety, privacy, and equity laws (continued)

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Section 4.3 Voluntary Initiatives for Ethical Conduct

Environmental reasons for the law include reduced emissions of greenhouse gases and other air pollutants through lower automobile travel and traffic congestion. Employers must desig- nate a commuting benefit coordinator and pay expenses to administer the program.

Companies need to consider current mandated legal requirements and emerging regulations that affect their business. To avoid pending regulatory oversight, companies must demon- strate a commitment to ethics by embracing voluntary initiatives of industry associations, government agencies, and nongovernmental organizations.

4.3 Voluntary Initiatives for Ethical Conduct Recognizing the benefits of an ethical business, companies not only strive to comply with laws and regulations, they embrace voluntary initiatives to encourage an ethical culture. The key is that compliance is voluntary; the company can choose the level of commitment to indus- try codes of conduct, federal guidelines, and global ethics standards. For example, while the Federal Sentencing Guidelines for Organizations has prompted companies to establish ethics and compliance programs, it is only advisory. On the other hand, if a company chooses not to demonstrate an effective program, then penalties for misconduct could be severe. Industry associations provide codes of conduct to help member companies improve business practices and meet regulatory practices. The companies voluntarily agree to comply with the standards within the code, often requiring acceptance of the code to maintain membership in the associ- ation. Most voluntary industry codes can respond to changing industry and consumer needs.

The Financial Accounting Standards Board (FASB) establishes standards of financial account- ing that govern the preparation of financial reports of businesses in the United States. For instance, generally accepted accounting principles (GAAP) are a collection of rules, pro- cedures, and conventions that define accepted accounting practice. However, FASB has no authority to enforce the principles. The SEC recognizes GAAP as an authoritative accounting standard, but their use is not mandated. To protect investors, the SEC established a process for disclosing non-GAAP financial metrics as of 2003. The International Accounting Standards Board (IASB) establishes International Financial Reporting Standards that are becoming the global standard for the preparation of public company financial statements. The SEC is encouraging FASB to work with IASB to converge the accepted accounting practices.

The Sarbanes-Oxley Act stipulates that public companies have an effective internal control process. However, the regulations do not specify the manner of establishing and maintain- ing internal controls. Again, industry relies on voluntary initiatives to provide guidelines to comply with regulation. COSO assists public companies in complying with Section 404 of the Sarbanes-Oxley Act by utilizing COSO’s 2013 Internal Control–Integrated Framework. COSO is a joint initiative of the five private sector organizations in the United States: the Ameri- can Accounting Association (AAA), the American Institute of Certified Public Accountants (AICPA), Financial Executives International (FEI), The Institute of Internal Auditors (IIA), and the Institute of Management Accountants (IMA). The purpose of the initiative is to provide ethical leadership through the development of frameworks and guidance on enterprise risk management, internal control, and fraud deterrence.

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Section 4.3 Voluntary Initiatives for Ethical Conduct

A challenge of voluntary industry codes or standards is the inability to enforce them, creat- ing reputational risks for all members of an industry when a company engages in miscon- duct. For example, the Beer Institute, which represents the $246.5 billion beer industry with 2,800 breweries (Beer Institute, n.d.), provides voluntary advertising and marketing code guidelines for member breweries. The industry code identifies 14 guidelines that apply to all advertising and marketing materials, including all beer-branded digital advertising and mar- keting materials that the member breweries produce. However, research has shown that the industry code is not an effective deterrent of unethical advertising. In a study of almost 300 beer ads broadcast between 1999 and 2008 during the National Collegiate Athletic Associa- tion basketball tournament games, up to 74% of the ads had industry code violations (Babor, Ziming, Damon, & Noel, 2013). Over half of the violations included irresponsible beer drink- ing and the association of beer drinking with social success. Many of the advertisements used content appealing to viewers younger than 21 years.

Sentencing Guidelines

As mentioned earlier in the chapter, the FSGO prompted companies to focus on ethics and compliance to reduce risk of penalties for misconduct. The FSGO establish parameters for determining monetary fines; the base fine is normally the greatest of 1) an amount based on the offense level, 2) the monetary gain to the firm, and 3) the monetary loss from the offense caused by the organization. A culpability score becomes a multiplier of the base fine. The culpability score takes aggravating and mitigating factors into consideration by calculating a degree of blame or guilt. Aggravating factors include involvement of high-level management, prior history of offenses, violation of an order or condition of probation, and obstruction of justice. Mitigating factors include an effective compliance program, self-reporting, coopera- tion with authorities, and acceptance of responsibility. Therefore, fines may be up to 95% lower if an organization can demonstrate that it had implemented an effective compliance program. Table 4.8 outlines the seven key criteria of an effective ethics and compliance pro- gram in organizations found in Chapter 8 of the Sentencing Guidelines with some guidance on implementation (United States Sentencing Commission, 2013). An eighth element refers to the additional requirement for a periodic risk assessment of the effectiveness of the program to detect and prevent unethical or criminal conduct.

Table 4.8: Elements of an effective ethics and compliance program

Criteria Description

Standards and Procedures Code of conduct that reflects the unique culture, experiences, and identity of the organization. Code of conduct that places particular emphasis on specific high- risk issues for the organization.

Program Oversight and Management

Senior management leadership and oversight. Board of directors oversight and responsibilities. Compliance infrastructure: How do all roads lead to the audit committee?

(continued)

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Section 4.3 Voluntary Initiatives for Ethical Conduct

Criteria Description

Delegation of Substantial Authority Background checks and screening: • Pre-hiring. • Periodically for positions of substantial authority (e.g., 5-year

intervals).

Training and Communication Training should be consistent with the organization’s risk assess- ment and code of conduct. Train employees on the specific risks that arise in their area, including standard operating procedures (SOPs), where needed. Communicate to employees about available resources to assist in providing guidance and resolving dilemmas. Communicate tone at the top and other specific culture messages.

Monitoring, Auditing, and Reporting Design specific monitoring programs that address the organi- zation’s unique risks (e.g., sample accountability, educational programs, routine audits, etc.). Establish compliance metrics that are meaningful and measurable. Establish, publicize, and document multiple channels for employ- ees to raise concerns. Evaluate the effectiveness of the organization’s ethics and com- pliance program (by external parties).

Consistent Disciplinary Procedures and Incentives

Establish disciplinary standards that can be applied consistently (e.g., periodic consistency review of remedial actions). Incorporate ethics and compliance considerations into perfor- mance evaluation process. Recognize individuals who have shown exemplary performance in upholding company standards.

Response to Critical Issues Establish and communicate clear guidelines for the investigation of ethics and compliance issues. Written guidelines ensure predictability, consistency, and confi- dence in the process.

Periodic Risk Assessment Conduct periodic risk assessments at 3-year intervals, with annual updates.

Source: Modified from Brevard, J.E. (2013). Introduction to ethics and compliance. Essentials of Ethics + Compliance. Powerpoint. ECOA.

The FSGO have evolved since their inception in November 1991. Ethics is first included in the guidelines following a 2004 amendment that adds the section titled “§8B2.1 Effective Com- pliance and Ethics Program.” The amendment stressed that compliance is not sufficient with- out an ethical organizational culture. Along with clarity on the seven criteria for an effective ethics and compliance program, the amendment added the requirement for a periodic risk assessment. A 2010 amendment encouraged companies to allow the chief ethics and compli- ance officer access to the board of directors. The key criteria of the FSGO are replicated in the OECD’s 2010 Good Practice Guidance on Internal Controls, Ethics, and Compliance (OECD, 2010). The U.S. guidelines influence global ethics standards.

Table 4.8: Elements of an effective ethics and compliance program (continued)

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Section 4.3 Voluntary Initiatives for Ethical Conduct

Global Ethics Standards

The multinational corporation (MNC), with assets and operations in many locations, has the additional challenges of managing diverse ethical and legal expectations of business con- ducted across the world. Global guidelines provide ethical principles for responsible business, addressing human and labor rights, consumer rights, environmental stewardship, transpar- ency, corruption, and sustainable development (Laczniak & Kennedy, 2011). Voluntary global ethical guidelines include the Caux Round Table Principles for Business, the Ceres Principles, Global Sullivan Principles, OECD Guidelines, the United Nations Global Compact’s Ten Prin- ciples, Social Accountability International’s SA8000 Standard, and Global Reporting Initiative Guidelines (see Table 4.9 for summaries of these guidelines). These organizational principles serve as a basis for ethical decision making in business, regardless of company location.

Table 4.9: Global ethical guidelines

Initiative Year Summary

Global Sullivan Principles 1977 Eight basic principles to protect and enhance human rights: human rights, equal opportunity, worker treat- ment, child labor, forced labor, female abuse, freedom of association, compensation for basic needs, health and safety, fair competition, community develop- ment, and promotion of principles with suppliers and contractors.

Ceres Principles 1989 Ten principles for corporate environmental conduct relating to biosphere, natural resources, waste, energy, EHS risks, product safety, environmental restora- tion, transparency, management commitment, and self-evaluation.

Caux Round Table Principles for Business

1994 Seven principles: respect stakeholders, contribute to sustainable development, comply with law, respect rules and conventions, support responsible globaliza- tion, respect environment, and avoid illicit activities.

OECD Guidelines for Multinational Enterprises

1999 Eleven foundational principles including sustainable development, respect for human rights, employee training and nondiscrimination, and advocacy for the principles contained in the guidelines.

The Fair Labor Association Work- place Code of Conduct

1999 Nine key principles: employment relations, nondis- crimination, harassment and abuse, forced labor, child labor, freedom of association and collective bargain- ing, health, safety and environment, hours of work, and compensation

The Global Reporting Initiative’s Sus- tainability Reporting Guidelines

2000 A variety of indicators organized in six central catego- ries: economic, environmental, labor practices, human rights, society, and product responsibility. Requires stakeholder dialogue to identify relevant indicators from the overall list.

(continued)

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Section 4.4 Relationships with Enforcement Authorities

Initiative Year Summary

UN Global Compact’s Ten Principles 2000 Ten overarching principles on human rights, labor, the environment, and corruption. Development of local level networks between participating firms and other stakeholders.

Social Accountability International’s SA8000 Standard

2008 Auditable social certification standards for decent workplace conditions include nine elements: child labor, forced labor, health and safety, freedom of asso- ciation, discrimination, disciplinary practices, working hours, remuneration, and management systems.

Recall that in the 1970s, companies entering international markets exploited lax regulations to bribe government officials, contaminated the natural environment, and were involved in military coups to secure favorable political policy for business (Post, 2013). In response to MNC support of apartheid in South Africa, the Sullivan Principles established responsible behavior for international business. Environmental issues prompted the creation of the Ceres (Coalition for Environmentally Responsible Economies) Principles in 1998. Chapter 1 out- lines how the Caux Round Table Principles for Business set forth ethical norms for acceptable business behavior worldwide. The seven core principles encourage businesses to promote responsible stewardship, living and working for mutual advantage, and the respect and pro- tection of human dignity. Human rights issues prompted the OECD Guidelines for Multina- tional Enterprises and Fair Labor codes in the 1990s. In the 2000s, greater cooperation and transparency for responsible international business evolved as the UN Global Compact called for consistent reporting and auditing of corporate activities in all locations. Unlike mandated legal requirements, these global ethical initiatives are purely voluntary, and have no method of enforcement.

4.4 Relationships with Enforcement Authorities Enforcement officials monitor compliance of mandated regulations and launch investigations upon discovery of possible violations. Triggers for regulatory investigations include tips from employees or complaints from customers or competitors. Notification of an investigation may come in the form of a letter or company raids in execution of a search warrant. In 2008, agents from U.S. Immigration and Customs Enforcement and the FDA executed search warrants at the headquarters and manufacturing facility of medical laser maker The Spectranetics Cor- poration in Colorado Springs, Colorado, for customs violations (“ICE agents, police in raid of Spectranetics’ offices,” 2008). The agents separated key employees from others for interroga- tions without conveying the reasons for the warrants or the raid.

Some investigations begin as an audit of a company. The DOL may audit organizations for fol- lowing OSHA, Fair Labor laws, or other employment laws. The Employee Benefits Security Administration (EBSA) of the DOL investigates retirement plans focusing on excessive fees, expenses, and fees paid from the plan assets of qualified plans. EBSA conducts around 75,000 audits of retirement plan providers each year and assesses fines or accepts settlements from $20,000 to $1 million (Elswick, 2001). Typically, companies have 10 days to provide extensive

Table 4.9: Global ethical guidelines (continued)

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Section 4.4 Relationships with Enforcement Authorities

documentation that may not be available quickly (“Could you provide these documents to the DOL in ten business days?,” 2013). Companies may feel overwhelmed by the first indications of an investigation. Regardless of the industry, managers should be prepared to handle unexpected notifications from a regulatory agency of a potential violation of law. See Checklist: Responding to an Investigation for actions to take if a company is under governmental investigation.

Company relationships with regulatory authorities are crucial when ethical misconduct or com- pliance violations occur. Recall that the FSGO identify two main factors mitigating the punish- ment of a company. First is the existence of an effective ethics and compliance program. Second is the degree of self-reporting, cooperation, or acceptance of responsibility. Management must understand the repercussions of not cooperating with authorities. For example, the extent to which a company cooperates with authorities could affect its ability to maintain legal privilege.

Privilege and Cooperating with the Government

Self-reporting, cooperation, and acceptance of responsibility can lower monetary fines depend- ing on the timing and thoroughness of the mitigating factor. Self-reporting only applies if the company informs the appropriate governmental authority prior to the start of regulatory

Checklist: Responding to an Investigation

1. Don’t panic. Regulatory investigations can be prompted by many issues that vary depending on which agency is auditing your company. The fact that your company is being investigated does not necessarily mean that the agency knows you have done something wrong.

2. Secure outside counsel. In most instances, the company should immediately obtain outside counsel to conduct the investigation and negotiate with the government unless in-house counsel has experience and authority to cooperate with a regulatory agency.

3. Determine the nature and scope of the investigation. A conversation with the investigating agent may yield information about the focus and reach of the investigation and should be initiated by outside counsel only, as anything a company employee or an individual says may later be deemed an admission against that party.

4. Conduct an internal investigation. The information found may allow the company to obtain the potential benefits from self-disclosure.

5. Take care not to destroy evidence, even inadvertently. Immediately issue a memo to all relevant employees—including your information technology department—requiring them to preserve documentary and electronic records.

6. Remediate any misconduct. Governmental agencies appreciate corrective actions, but punish companies that deliberately ignore misconduct.

7. Document effort. Be sure to document the source of all information, and actions to obtain it.

8. Educate employees regarding government interviews. Inform employees that they have the right to have counsel present during any interview with regulatory authorities and it is their right to choose to participate in an interview.

Source: Long, A.G., & Schembari, J.E. (2011). Living through IRS and DOL audits and investigations. Benefits Magazine, 48(6), 14–19.

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Section 4.4 Relationships with Enforcement Authorities

investigations. To qualify for reductions of fines for cooperating with the governmental agency, the company must agree to disclose all pertinent information upon receiving official notice of an investigation. Cooperating with the government involves the following steps:

1. Collect and analyze documents relating to the suspected activity; 2. Interview employees; 3. Conduct costly and time-consuming internal investigations; 4. Conduct forensic audits; then 5. Submit all of the results to the government.

Cooperation with government authorities entails full disclosure of relevant information that constitutes a waiver of attorney-client privilege and self-evaluative privilege. Attorney-client privilege promotes freedom of consultation of legal advisors by clients by maintaining confi- dentiality. The history of attorney-client privilege goes back to English law in the 1700s (Haz- ard, 1978). The rule of confidentiality is necessary to allow candid and open communication between the client and legal counsel. In the United States, attorney-client privilege extended to in-house counsel in the early 1900s (Pratt, 1999). The client can waive the attorney-client privilege explicitly or implicitly by revealing information about privileged communications to a third party. Self-evaluative privilege keeps organizational internal assessments confiden- tial. Typically, internal audit assessment, including the information, documents, or evidence collected during the audit, could require disclosure in private litigation or criminal investiga- tions. However, companies maintain the right to determine whether information is to remain confidential. To ensure privilege, however, companies must request legal review of investiga- tions and audits (Glascock, 2005).

Should a company choose not to collaborate with regulatory authorities, they do so at the risk of damage to reputation and corporate brand, prosecution, debarment from future govern- ment business, and possible collapse of the organization. By choosing to cooperate, compa- nies can avoid criminal prosecution through two types of cooperation agreements.

Cooperation Strategies

Companies under investigation for criminal offenses can enter into deferred prosecution or nonprosecution agreements. In these agreements, they agree to cooperate with the government and take remedial actions, including hiring a monitor, or independent third party, to oversee compliance programs. A deferred prosecution agreement is an arrangement between a prosecutor and a corporation to delay prosecution while the company takes reme- dial actions to address the violations. A nonprosecution agreement is a resolution in which U.S. attorneys decline prosecution of a corporation that has taken appropriate steps to report a crime, cooperate, and compensate victims.

The Department of Justice can mandate a monitor to assess and verify a corporation’s com- pliance with the terms of a cooperation agreement, thereby reducing the risk of recurring misconduct. The corporation must engage the monitor to oversee fulfillment of conditions in a deferred prosecution or nonprosecution agreement. Denver-based United Launch Alliance (ULA) had to accept three compliance monitors at the start of business in 2006 (Jaeger, 2010). Two of the monitors were to comply with pre-existing agreements for compliance monitors of ULA’s parent companies, Boeing and Lockheed Martin. Therefore, to gain approval for the

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Summary & Resources

defense contractor joint venture, ULA entered into an agreement with regulatory agencies for a third compliance monitor.

A combination of mandated regulations and voluntary initiatives contributes to the perva- siveness of organizational ethics and compliance globally. The United States has set the pace, and the EU and Asian countries are ramping up their expectations for corporate ethical con- duct. The challenge for businesses is keeping abreast of evolving regulations worldwide.

Summary & Resources

Chapter Summary This chapter addresses the global factors driving organizational ethics and compliance. The ethics and compliance field deals with how to keep organizations out of trouble. Compliance officers coordinate a company’s legal, ethics, audit, training, and risk functions. Mandated compliance requirements for a business include laws and regulations relating to antitrust/ anticompetitive behavior, bribery/anticorruption, corporate governance, consumer protec- tion, environmental protection, and worker health and safety.

Voluntary initiatives play an important role in encouraging ethical conduct in business. The U.S. Federal Sentencing Guidelines of Organizations provide the greatest push for effective ethics and compliance programs. Global guidelines provide ethical principles for responsible business activity, addressing human and labor rights, consumer rights, environmental stew- ardship, transparency, corruption, and sustainable development.

Violations of mandated legal requirements or noncompliance of voluntary guidelines increase risks of regulatory investigation and prosecution that could result in monetary fines or imprisonment. Companies need to prepare for responding to investigations. Two main factors mitigate the punishment of a company: 1) the existence of an effective ethics and com- pliance program; and 2) the degree of self-reporting, cooperation, or acceptance of responsi- bility. Management must understand the repercussions of cooperating with authorities as it waives company privilege to maintain confidentiality. Ethics and compliance have an increas- ing importance in business today because of the prevalence of regulations, ethical guidelines, and possible penalties.

Key Terms

antitrust Laws that protect trade and com- merce from unlawful restraints and monop- olies or unfair business practices.

attorney-client privilege A client’s right to refuse to disclose, and to prevent any other person from disclosing, confidential commu- nications between the client and his or her attorney.

cartels Groups of businesses that collude to control prices or divide the market to pro- tect themselves from competitive pressures.

civil law The rules that govern disputes between individuals in such areas as con- tracts and property.

class action Lawsuits by one or several per- sons to sue on behalf of a larger group.

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Summary & Resources

criminal law The rules and statutes that define conduct prohibited by the govern- ment because it threatens and harms public safety and welfare.

deferred prosecution agreement An agreement between a prosecutor and a corporation to delay prosecution while the company takes remedial actions.

Dodd-Frank Wall Street Reform and Con- sumer Protection Act of 2010 Legislation that promotes the financial stability of the United States by improving accountability and transparency in the financial system and protecting consumers from abusive financial services practices.

global ethical standards International norms for responsible conduct that compa- nies should comply with even though they are not legally bound.

guideline Nonbinding clarifications of the official regulations.

industry standard The generally accepted requirements followed by the members of an industry.

law Rules enacted by a governing body.

monitor A person hired by a corporation to oversee fulfillment of conditions in an agree- ment to avoid criminal indictment.

monopoly A situation in which a company has exclusive control over a commodity or service.

off-label marketing Promoting a drug in the United States for uses not approved by the Food and Drug Administration

nonprosecution agreement An agreement in which U.S. attorneys decline prosecution of a corporation that has taken appropriate steps to report a crime, cooperate, and com- pensate victims.

pro-competitive legislation The laws by which governments attempt to foster com- petition and create the right environment for competition by prohibiting certain types of business practices and transactions that unduly limit competition.

regulation The process of monitoring and enforcing the rules.

regulatory agency Governmental or inde- pendent organization enforcing laws.

retaliation A negative consequence experienced by an employee for reporting observed misconduct.

Sarbanes-Oxley Act of 2002 U.S. legis- lation to protect investors by improving the accuracy and reliability of corporate disclosures.

tying An anticompetitive practice where a company forces purchasing a second prod- uct to purchase a desired product.

whistle-blower A person who informs on a person or organization engaged in an illicit activity.

Critical Thinking and Discussion Questions

1. Consider the ethics and compliance professionals of a large organization. How could they be effective in keeping the company out of trouble? What are the challenges that prevent an ethics and compliance professional from encouraging ethical and compliant behaviors?

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Summary & Resources

2. Why is bribery considered such an important competitive issue for multinational corporations? If bribery exists in some cultures as a normal way of doing business, how effective will countries be in preventing the bribery of foreign officials?

3. Why do so many insiders continue to engage in insider trading knowing the conse- quences will result in harsh penalties? How does insider trading damage investor confidence and the performance of securities markets?

4. How could the UN or OECD enforce global ethical guidelines? What prevents a company from becoming a signatory of the initiatives in order to be perceived as a responsible business as a cover for unethical behaviors?

5. Goldman Sachs entered into a nonprosecution agreement for the creation and selling of a synthetic collateralized debt obligation coined Abacus 2007-AC1. The bank paid a fine, neither admitted nor denied wrongdoing, and endured a slight loss of reputa- tion. In August 2013, former Goldman Sachs trader Fabrice Tourre was convicted of securities fraud for his part in selling the Abacus product. Why should a company receive a nonprosecution agreement and not its employees? Are companies abusing the cooperation strategies to avoid criminal or civil prosecution?

Suggested Resources

Caux Round Table

http://www.cauxroundtable.org

Ceres Principles

http://www.ceres.org/about-us/our-history/ceres-principles

European Commission, Competition

http://ec.europa.eu/competition/index_en.html

Fair Labor Association Workplace Code of Conduct

http://www.fairlabor.org/our-work/labor-standards

OECD Guidelines for Multinational Enterprises

http://www.oecd.org/corporate/mne/

Social Accountability International

http://www.sa-intl.org/

U.S. Department of Justice, Antitrust Division

http://www.justice.gov/atr/

U.S. Federal Trade Commission, Guide to Antitrust Laws

http://www.ftc.gov/tips-advice/competition-guidance/guide-antitrust-laws

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