What Behavioral Ethics Means For Ethics and Compliance Program

Jeff Kaplan/Kaplan & Walker LLPSCCE Compliance & Ethics InstituteOctober 2012, Las Vegas, NVWhat Behavioral Ethics Can Mean For Ethics and Compliance ProgramsBehavioral economicswww.kaplanwalker.com2Studies effects of social, cognitive and emotional factors on economic decision makingShows the limits of traditional notions of rationalityVery much part of mainstream business thinkingE.g., behavioral financeEmbraced as a matter of public policy in the UKNobel prize awarded to pioneer in this area 2002 Behaviorists view of human reasoningwww.kaplanwalker.com3Per Daniel Kahneman, it is often: mediocrefalliblebeset by inconsistent reasoning not trustworthy/vindictive Reasons are:attentional (in considering vast quantities of information, people have a tendency to focus on that which confirms expectations) motivational (a need/desire to appear confident to self and others) But the weaknesses in decision making arent sufficiently appreciated and we suffer from overconfidence

Behavioral ethicswww.kaplanwalker.com4Research showing how seemingly irrational factors can lead increase/decrease likelihood of unethical conductAntecedentsPhilosophy rediscovering the role of psychology (Appiah)The economist may attempt to ignore psychology but it is sheer impossibility to ignore human nature. If the economist does ignore psychology, he will force himself to make his own, and it will be bad psychology (JM Clark 1918)Princeton Theological Seminary experimentOverview of connection to C&E www.kaplanwalker.com5Two levels of relevance to work of C&E professionalsWhy C&E programs matterA policy argument on both public and private levelsHow to optimize C&E programsBoth in identifying and mitigating risks

Why the why matterswww.kaplanwalker.com6Two key constituencies dont fully appreciate the need for strong C&E programsBusiness leadersGovernment officialsBoth often think that good intentions alone are largely enoughBusiness leaders views can undercut key program supportGovernment officials views can undercut key incentive policiesWhy there arent more Morgan Stanley casesBehavioral ethics (BE) shows that achieving ethicality is hard work C&E is not a machine that can run by itselfRequires considerable knowledge, resources, effortAn important historical footnotewww.kaplanwalker.com7From the history of the creation of the Federal Sentencing Guidelines for Organizations more than 20 years ago:Early drafts had less on C&E and more on optimal penaltiesThis was based on a view of human nature as hyper-rational (homo economicus) Final draft rejected this approach in favor of providing C&E guidance and incentivesThe basic assumption of the FSGO (and subsequent related legal standards): businesses and people need help in staying honestThat is one of the lessons of BE, too

Why the how matterswww.kaplanwalker.com8Many E&C programs dont seem sufficiently impactfulA field largely out of energy and out of ideasWithout something new and helpful this malaise could get worseBE can help in two waysMake programs operationally stronger by better tying program measures to how humans actually operateGive programs credibility by tying them to scienceNote that many BE research findings confirm what is known anecdotally. (But some findings are very surprising) However, being able to prove such knowledge can be invaluable

Where the how matterswww.kaplanwalker.com9BE most likely to helpRisk assessment/cultureConflicts of interestTraining/communications/certificationsInvestigations/disciplineBut other possibilities as wellIt is up to C&E professionals to find the connections, as BE academics may not have enough information to do so

Risks: unknown victimswww.kaplanwalker.com10Research findings: in decision making, it is easier to disregard interests of unidentified individuals than known onesThe charitable giving experimentCould help explain the relative ease with which so many individuals engage in offenses where the victims are not identifiable, e.g.,Insider trading Government contracting or tax fraudBen Franklin (proto behaviorist?): There is no kind of dishonesty into which otherwise good people more easily and more frequently fall than that of defrauding the government

Unknown victims (cont.)www.kaplanwalker.com11The specialty pipe caseLarger point: moral restraints as a form of inner controls C&E program point:Identify areas where inner controls likely to be weakFortify those with extra measuresGeneral ones, and/orThose addressed to the source of weakness itselfBut this one area is tricky as long-term relationships dont inhibit wrongdoing just the oppositeThe dentist studyThe general counsel studyRisks: indirect actionswww.kaplanwalker.com12Research findings: acting indirectly can blind individuals to ethically problematic behavior more than direct action doesThe pharma company experimentSomewhat similar to unknown victims, but not the same Suggests that companies should:Recognize limits of inner controls in their dealings with third parties suppliers, agents, distributors, joint-venture partners and others Undertake supplemental targeted C&E measures to make up for the shortfall (e.g., communications, auditing)Risks: too much work/pressurewww.kaplanwalker.com13Research finding: individuals with depleted resources tend to have greater risks of engaging in unethical conduct than do othersMitigation perspective: Either reduce pressure (often difficult to do to any meaningful degree, since many sources may be external), orFocus extra C&E mitigation efforts on parts of an organization where employees are subject to greater-than-ordinary stressThe risk of good intentionswww.kaplanwalker.com14Research findingsBeing cognizant of ones ethical failings increases the likelihood of subsequently doing good The converse is true, tooExamplesGender equality acts licenses discriminatory onesBeing reminded of ones humanitarian traits causes reductions in charitable donationsPurchasing green products licenses ethically questionable behaviorUses in risk assessment

Check quotes14Just-in-time communicationswww.kaplanwalker.com15Research findings: being asked to read (and in one case, sign) an honor code shortly before being presented with the opportunity and motivation to cheat significantly decreased the incidence of such cheatingPossible use in various compliance areas:anti-corruption before interactions with government officials and third-party intermediariescompetition law before meetings with competitors (e.g., at trade association events)insider trading/Reg FD during key transactions, before preparing earnings reportsprotection of confidential information when receiving such information from third parties pursuant to an NDACheck quotes15Communications (cont.)www.kaplanwalker.com16conflicts of interest around procurement decisions, hiringgifts and entertainment many occasionsaccuracy of sales/marketing in connection with developing advertising, making pitchesemployment law while interviewing for jobs, conducting performance reviews, dealing with other terms and conditions of employmentNote: some of this already goes on, but not nearly enoughTraining/communications: leaderswww.kaplanwalker.com17Research findings:Those in power were not only more likely to condemn cheating in others but also more likely to engage in cheating themselves than were othersThe cookie experimentDo executives at your company view ethics as being for the little people?Use findings to train senior managers on their need for heightened ethical awarenessBut obviously need to be delicate

Training: slippery slopeswww.kaplanwalker.com18Research finding People are more likely to accept others unethical behavior when ethical degradation occurs slowly rather than in one abrupt shift. (Francesca Gino and Max Bazerman)Based on a what the hell effect (Dan Ariely)A good focus for training/communicationsAlso relevant to investigations and disciplineMotivated blindnesswww.kaplanwalker.com19Research findings: We often fail to notice others unethical behavior if its in our interest not to notice. This failure of oversight called motivated blindness is unconscious and common. (Bazerman)Underscores the importance of the Sentencing Guidelines expectation that organizations should impose discipline on employees not only for engaging in wrongful conduct but for failing to take reasonable steps to prevent or detect wrongdoing by others Relatively few companies do this well (and some dont do at all)

Motivated blindness: responses www.kaplanwalker.com20Build the notion of supervisory accountability into policies e.g., in the managers duties section of a code of conductSpeak forcefully to the issue in training and other communications for managersTrain investigators on the notion of managerial accountability and address it in the forms they use so that they are required to determine in all inquiries if a managers being asleep at the switch led to the violation in questionPublicize (in an appropriate way) that managers have in fact been disciplined for supervisory lapsesHave auditors take these requirements into account in their audits of investigative and disciplinary records

Conflicts of interestwww.kaplanwalker.com21Research findings: disclosure could be a cause of, rather than cure for, unethical behaviorInformation providers whose conflicts are not disclosed will feel morally bound to report accurately to information users, because they would consider it unfair to lie to someone who is unaware of the misalignment of incentives. Disclosing conflicts of interest would have the effect of removing the moral bound and providing a moral license to misreport. (Daylian Cain, George Loewenstein, Don Moore)Disclosure can place inappropriate pressure on the audience to heed the advice for example, in order to avoid insinuating that the [disclosing partys] advice has been corrupted (Cain)Additional research by Christopher Koch, Carsten Schmidt COI responseswww.kaplanwalker.com22Improve the way in which disclosed COIs are addressed, with the possibilities including:Educate those involved as to the generally under-appreciated dangers of COIsEnsure that decisions about COI waivers and COI management are made by those who are independent and possess relevant expertise (e.g., a C&E officer) not line managersHave a sufficiently rigorous COI management processAudit the process and report on the audits to senior management and maybe the board

Other: the power of social normswww.kaplanwalker.com23People are more likely to comply with a social norm if they know that most other people complyAssociated with Robert CialdiniThe tax compliance experiment Apply to areas of discretionary compliance initiatives Implications of BE for ethical reasoningwww.kaplanwalker.com24The two pre-eminent schools areUtilitarianismDeontologyBoth are reasoning basedThird school virtue ethics seems to strike more deeplyEthics (and other virtues) based on continuous and lifelong process of pursuing excellenceThus, may be more suited for BE, which deals with deeply engrained behaviorsHowever, virtue ethics is also character based and BE seems to show that character doesnt count for much

A related field: Moral intuitionismwww.kaplanwalker.com25Jonathan Haidts six core moral dimensionsCare/harmFairness/cheatingLoyalty/betrayalAuthority/subversionSanctity/degradationLiberty/oppressionWhile focus of work is on political morality, researchis useful to show how deep these reach into our moral selvessupports values-based C&E effortAlso suggests need to learn how the values can be risk causing

References www.kaplanwalker.com26BooksAppiah, Experiments in EthicsAriely, The (Honest) Truth About Dishonesty, Predictably IrrationalBazerman & Tenbrunsel, Blind SpotsHaidt, The Righteous MindKahneman, Thinking Fast and SlowThaler & Sunstein, Nudge

Links to all studies referenced can be found at www.conflictofinterestblog.com in posts found in the tab under moral hazard and bias