What “Behavioral Ethics” Can Mean For Ethics and Compliance Programs

1. What “Behavioral Ethics” Can Mean For Ethics and Compliance Programs Jeff Kaplan/Kaplan & Walker LLP SCCE Compliance & Ethics Institute October 2012, Las Vegas, NV

2. Behavioral economics • Studies effects of social, cognitive and emotional factors on economic decision making • Shows the limits of traditional notions of rationality • Very much part of mainstream business thinking • E.g., behavioral finance • Embraced as a matter of public policy in the UK • Nobel prize awarded to pioneer in this area 2002 www.kaplanwalker.com

3. Behaviorists’ view of human reasoning • Per Daniel Kahneman, itis often: • mediocre • fallible • beset 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 aren’t sufficiently appreciated – and we suffer from overconfidence www.kaplanwalker.com

4. Behavioral ethics • Research showing how seemingly irrational factors can lead increase/decrease likelihood of unethical conduct • Antecedents • Philosophy 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 experiment www.kaplanwalker.com

5. Overview of connection to C&E • Two levels of relevance to work of C&E professionals • Why C&E programs matter • A policy argument – on both public and private levels • How to optimize C&E programs • Both in identifying and mitigating risks www.kaplanwalker.com

6. Why the “why” matters • Two key constituencies don’t fully appreciate the need for strong C&E programs • Business leaders • Government officials • Both often think that good intentions alone are largely enough • Business leaders’ views can undercut key program support • Government officials’ views can undercut key incentive policies • Why there aren’t more “Morgan Stanley” cases • Behavioral ethics (“BE”) shows that achieving ethicality is hard work • C&E is not a machine that can run by itself • Requires considerable knowledge, resources, effort www.kaplanwalker.com

7. An important historical footnote • From 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 penalties” • This 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 incentives • The basic assumption of the FSGO (and subsequent related legal standards): businesses and people need help in staying honest • That is one of the lessons of BE, too www.kaplanwalker.com

8. Why the “how” matters • Many E&C programs don’t seem sufficiently impactful • A field largely “out of energy and out of ideas” • Without something new and helpful this malaise could get worse • BE can help in two ways • Make programs operationally stronger – by better tying program measures to how humans actually operate • Give programs credibility – by tying them to science • Note 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 www.kaplanwalker.com

9. Where the how matters • BE most likely to help • Risk assessment/culture • Conflicts of interest • Training/communications/certifications • Investigations/discipline • But other possibilities as well • It is up to C&E professionals to find the connections, as BE academics may not have enough information to do so www.kaplanwalker.com

10. Risks: unknown victims • Research findings: in decision making, it is easier to disregard interests of unidentified individuals than known ones • The charitable giving experiment • Could 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 fraud • Ben 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” www.kaplanwalker.com

11. Unknown victims (cont.) • The specialty pipe case • Larger point: moral restraints as a form of “inner controls” • C&E program point: • Identify areas where inner controls likely to be weak • Fortify those with extra measures • General ones, and/or • Those addressed to the source of weakness itself • But this one area is tricky as long-term relationships don’t inhibit wrongdoing – just the opposite • The dentist study • The general counsel study www.kaplanwalker.com

12. Risks: indirect actions • Research findings: acting indirectly can blind individuals to ethically problematic behavior more than direct action does • The pharma company experiment • Somewhat 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) www.kaplanwalker.com

13. Risks: too much work/pressure • Research finding: individuals with depleted resources tend to have greater risks of engaging in unethical conduct than do others • Mitigation perspective: • Either reduce pressure (often difficult to do to any meaningful degree, since many sources may be external), or • Focus extra C&E mitigation efforts on parts of an organization where employees are subject to greater-than-ordinary stress www.kaplanwalker.com

14. The risk of good intentions • Research findings • Being cognizant of one’s ethical failings increases the likelihood of subsequently doing good • The converse is true, too • Examples • Gender equality acts “licenses” discriminatory ones • Being reminded of one’s humanitarian traits causes reductions in charitable donations • Purchasing “green” products licenses ethically questionable behavior • Uses in risk assessment www.kaplanwalker.com

15. Just-in-time communications • Research 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 cheating • Possible use in various compliance areas: • anti-corruption – before interactions with government officials and third-party intermediaries • competition law – before meetings with competitors (e.g., at trade association events) • insider trading/Reg FD – during key transactions, before preparing earnings reports • protection of confidential information – when receiving such information from third parties pursuant to an NDA www.kaplanwalker.com

16. Communications (cont.) • conflicts of interest – around procurement decisions, hiring • gifts and entertainment – many occasions • accuracy of sales/marketing – in connection with developing advertising, making pitches • employment law – while interviewing for jobs, conducting performance reviews, dealing with other terms and conditions of employment • Note: some of this already goes on, but not nearly enough www.kaplanwalker.com

17. Training/communications: leaders • Research 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 others • The cookie experiment • Do executives at your company view ethics as being “for the little people”? • Use findings to train senior managers on their need for “heightened ethical awareness” • But obviously need to be delicate www.kaplanwalker.com

18. Training: slippery slopes • Research 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/communications • Also relevant to investigations and discipline www.kaplanwalker.com

19. Motivated blindness • Research findings: “We often fail to notice others’ unethical behavior if it’s 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 don’t do at all) www.kaplanwalker.com

20. Motivated blindness: responses • Build the notion of supervisory accountability into policies – e.g., in the managers’ duties section of a code of conduct • Speak forcefully to the issue in training and other communications for managers • Train 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 manager’s being asleep at the switch led to the violation in question • Publicize (in an appropriate way) that managers have in fact been disciplined for supervisory lapses • Have auditors take these requirements into account in their audits of investigative and disciplinary records www.kaplanwalker.com

21. Conflicts of interest • Research findings: disclosure could be a cause of, rather than cure for, unethical behavior • “Information 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 party’s] advice has been corrupted” (Cain) • Additional research by Christopher Koch, Carsten Schmidt www.kaplanwalker.com

22. COI responses • Improve the way in which disclosed COIs are addressed, with the possibilities including: • Educate those involved as to the generally under-appreciated dangers of COIs • Ensure 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 managers • Have a sufficiently rigorous COI management process • Audit the process and report on the audits to senior management and maybe the board www.kaplanwalker.com

23. Other: the power of social norms • “People are more likely to comply with a social norm if they know that most other people comply” • Associated with Robert Cialdini • The tax compliance experiment • Apply to areas of discretionary compliance initiatives www.kaplanwalker.com

24. Implications of BE for ethical reasoning • The two pre-eminent schools are • Utilitarianism • Deontology • Both are reasoning based • Third school – virtue ethics – seems to strike more deeply • Ethics (and other virtues) based on continuous and lifelong process of pursuing excellence • Thus, may be more suited for BE, which deals with deeply engrained behaviors • However, virtue ethics is also character based – and BE seems to show that character doesn’t count for much www.kaplanwalker.com

25. A related field: “Moral intuitionism” • Jonathan Haidt’s six core moral dimensions • Care/harm • Fairness/cheating • Loyalty/betrayal • Authority/subversion • Sanctity/degradation • Liberty/oppression • While focus of work is on political morality, research • is useful to show how deep these reach into our moral selves • supports values-based C&E effort • Also suggests need to learn how the values can be risk causing www.kaplanwalker.com

26. References • Books • Appiah, Experiments in Ethics • Ariely, The (Honest) Truth About Dishonesty, Predictably Irrational • Bazerman & Tenbrunsel, Blind Spots • Haidt, The Righteous Mind • Kahneman, Thinking Fast and Slow • Thaler & 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” www.kaplanwalker.com