Institutionalization of Ethics – Chapter 4 Notes

Mandated vs Voluntary Boundaries of Ethical Conduct

  • Mandated boundaries – Externally imposed boundaries of conduct, such as laws, rules, regulations, and other requirements.
  • Core practice – Documented best practices, often encouraged by legal and regulatory forces as well as industry trade associations.
    • Helps ensure compliance with legal requirements, industry self-regulation, and societal expectations.
    • Example: Better Business Bureau (BBB) – A leading self-reg regulatory body that provides directions for managing customer disputes and reviews advertising cases.
  • Voluntary boundaries – Include the beliefs, values, and voluntary contractual obligations of a business.
    • Examples: philanthropy, giving back to communities and causes.

Figure 4-1 Elements of an Ethical Culture

  • Reference to a figure illustrating the components of an ethical culture (content not provided in transcript).

Mandated Requirements for Legal Compliance

  • 4-2 overview: Mandated Requirements for Legal Compliance.
  • Laws are categorized as civil or criminal.
    • Civil law – Defines the rights and duties of individuals and organizations (including businesses).
    • Criminal law – Prohibits specific actions (e.g., fraud, theft, securities violations) and imposes fines or imprisonment.

Mandated Requirements for Legal Compliance (Laws Regulating Competition)

  • Issues surrounding the impact of competition on social responsibility arise from rivalry among businesses.
    • Unfair competition raises legal and social responsibility concerns.
  • Size can confer advantages to larger companies.
  • Competitive strategies may aim to weaken or destroy competitors.
  • Intense competition can lead to corporate espionage.
  • Procompetitive legislation – Laws designed to prevent monopolies, inequitable pricing, and other practices that reduce or restrict competition.

Mandated Requirements for Legal Compliance (Laws Protecting Consumers)

  • Consumer protection law – Requires businesses to provide accurate information about goods/services and follow safety standards.
  • Bureau of Consumer Protection – Protects consumers against unfair, deceptive, or fraudulent practices.
  • FDA – Federal agency with stringent standards for approving drugs; regulates food safety, human drugs, tobacco, dietary supplements, vaccines, veterinary drugs, medical devices, cosmetics, products that emanate radiation, and biological products.

Debate Issue: Take a Stand

  • Sherwin-Williams case (lead-based paint): court argued that even though lead paint wasn’t illegal until 1978, companies knew of dangers and marketed anyway.
  • Settlement: $305 million over six years, without admitting wrongdoing.
  • Take a stand options discussed:
    • Should there be a statute of limitations protecting businesses from decades-old advertising?
    • Should there be no time limit to hold businesses responsible for past practices?

The Sarbanes–Oxley (SOX) Act

  • 4-3 Overview: SOX enacted in 2002 in response to widespread corporate accounting scandals.
  • Key provisions:
    • Fraudulent financial reporting became a criminal offense.
    • Strengthened penalties for corporate fraud.
    • Requires corporations to establish codes of ethics for financial reporting and to increase transparency in financial reporting to investors and stakeholders.

The Sarbanes–Oxley (SOX) Act (PCAOB, Auditor Independence, Whistle-Blower Protection, Cost of Compliance)

  • Public Company Accounting Oversight Board (PCAOB) – Oversees auditing firms for public companies; sets standards for auditors.
  • SEC oversight – Overhauls PCAOB quality-control rules; ensures inspections; addresses challenges with foreign auditing firms.
  • Auditor and Analyst Independence – Section 201 prohibits registered public accounting firms from providing both nonaudit and audit services to a public company; aims to prevent conflicts of interest; similar conflict-of-interest rules adopted by exchanges and associations.
  • Whistle-Blower Protection – Employees reporting unethical behavior are protected from retaliation; remedy includes special damages and attorneys’ fees; not all protections retroactive to prior crises; later strengthened by Dodd–Frank.
  • Cost of Compliance – Internal costs, external costs, and auditor fees; initial high costs declined over time as compliance infrastructure matured.

Dodd-Frank Wall Street Reform and Consumer Protection Act

  • 4-4 Overview: Dodd–Frank aimed to improve financial regulation, increase oversight, and prevent risky behavior and deceptive practices.
  • New agencies created:
    • Office of Financial Research – Improves quality of financial data for government use and better industry analysis.
    • Financial Stability Oversight Council (FSOC) – Monitors the market, identifies threats, and promotes market discipline; responds to major risks.
  • Consumer Financial Protection Bureau (CFPB) – Independent agency under the Federal Reserve System to regulate offering and provision of consumer financial products/services under federal laws; supervises credit markets and monitors lenders for compliance; oversees institutions accused of questionable practices (e.g., payday lenders, debt collectors).
  • Whistle-Blower Bounty Program – Whistle-blowers who report financial fraud to the SEC/CFTC are eligible to receive 10% to 30% of fines/settlements if their information leads to convictions over $1 million in penalties.
  • SEC continues to receive tips; monetary rewards attract tips, though some whistleblowers seek rewards rather than information.

Laws That Encourage Ethical Conduct

  • 4-5 Overview: Institutionalization of Ethics through the U.S. Sentencing Guidelines for Organizations (FSGO) is presented with a table of year-by-year amendments and emphasis on building an ethical culture within organizations.

Federal Sentencing Guidelines for Organizations (FSGO)

  • 4-6 Overview: FSGO provides incentives for organizations to develop and implement ethics/compliance programs.
  • Applicability – Applies to all felonies and class A misdemeanors committed by employees in association with work.
  • Due diligence benefits – Organizations that demonstrate due diligence to prevent, detect, and report misconduct may receive reduced penalties if an employee commits a crime.

Federal Sentencing Guidelines for Organizations (FSGO): Key Criteria

  • Firms must implement and disseminate effective compliance standards and procedures.
  • Oversight by high-ranking personnel in the organization.
  • No one with a known propensity for misconduct should be placed in a position of authority.
  • A communications system must disseminate standards/procedures to all levels of employees.
  • Mechanisms for employees to report misconduct without retaliation; monitoring and auditing systems are required.
  • If misconduct is detected, firms must take appropriate, fair disciplinary action.
  • After misconduct is discovered, the organization must respond to and prevent similar offenses in the future.

Amendments to FSGO

  • 2004 – Amendments: Governing authority must be well informed about the ethics program’s content, implementation, and effectiveness.
  • 2005 – Supreme Court decision: Federal sentencing guidelines are not mandatory but serve as recommendations for judges.
  • 2007–2008 – Amendments: Extend ethics training to board members, high-level personnel, employees, and agents; emphasize due diligence, risk assessment, and organizational culture.

Amendments to FSGO (continued)

  • 2010 – Amendments: Chief compliance officer reports directly to the board; promote internal controls (hotlines, self-audits); expands operational responsibility to all personnel in the ethics/compliance program; penalties may be reduced if program meets four conditions: internal misconduct discovery, prompt reporting, no one with operational responsibility involved, and compliance officer access to the board to report misconduct.
  • 2014 – Focus on best practices sharing among regulators and law enforcement; encourages development and sharing of best practices across industries; assesses effectiveness of institutional cultures in preventing misconduct.
  • 2015–2020 – Emphasis on organizational culture standards, procedures to prevent and detect misconduct, and potential use of community service as remedy when misconduct occurs.

Core or Best Practices 4-7

  • Core/Best Practices focus on integrity and structurally sound organizational practices; aim to measure financial and nonfinancial performance; gatekeepers play an important role in oversight.
  • Voluntary responsibilities include:
    • Improve communities
    • Reduce government involvement
    • Develop employee leadership skills
    • Foster an ethical culture

Core or Best Practices 1 of 2 and 2 of 2

  • Core/Best Practices 1 of 2 – Focus on integrity in developing structurally sound organizational practices and for financial and nonfinancial performance measures; no universal standard for nonfinancial performance measurement; gatekeepers are important.
  • Core/Best Practices 2 of 2 – Cause-Related Marketing: ties product to a social concern through a marketing program; strategic philanthropy; social entrepreneurship.
    • Cause-related marketing – Publicizes social concerns through product marketing.
    • Strategic philanthropy – Uses core competencies/resources to benefit stakeholders and society in alignment with mission.
    • Social entrepreneurship – Founding organizations to create social value.

Knowledge Check

  • Question: Fashion designers and brands helped create masks during COVID-19, e.g., Christian Siriano offering unused resources and sewing team to manufacture N95 masks.
  • True or False: This is an example of strategic philanthropy.
  • Answer: True.

The Importance of Institutionalization of Business Ethics

  • Institutionalization helps implant values, norms, and artifacts in organizations, industries, and society.
  • Failure to understand core practices creates opportunities for unethical conduct.
  • Institutionalization of business ethics has advanced rapidly as stakeholders recognize the need to improve ethics.

Discussion Activity

  • How do you institutionalize business ethics programs?

Discussion Activity Debrief

  • Focus on sound organizational practices and integrity for performance measures; most ethical issues are non-financial.
  • Adhere to SOX and Dodd-Frank standards for financial performance and accounting.
  • Embed values, norms, and artifacts in organizations, industries, and society.
  • Understand that not understanding highly appropriate core practices creates opportunities for unethical conduct.