Promoting Ethical Conduct: A Review of Corporate Practices

Promoting Ethical Conduct: A Review of Corporate Practices

FEI Research Foundation

Issues Alert

June 2002

Promoting Ethical Conduct A Review of Corporate Practices

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Purpose Publicity surrounding recent corporate financial failures has increased interest in promoting ethical business practices and improving corporate governance. With assistance from practitioners, the FEI Research Foundation reviews corporate ethics programs and codes of conduct, and provides some specific examples.

Current Events Heightened scrutiny of companies’ business and financial practices and of the corporate governance process has resulted in a renewed commitment on the part of business to strengthen corporate codes of conduct and ethics initiatives. In recent months, regulators have supported, if not spurred on, these efforts. Following a February 2002 board of directors meeting and discussions with SEC Chairman Harvey Pitt, the New York Stock Exchange (NYSE) established the Corporate Accountability and Listing Standards Committee. The Committee is charged with reviewing the listing requirements involving corporate governance. On March 19, 2002, Financial Executives International (FEI) followed suit with the announcement of a 12-point plan intended to strengthen financial reporting and corporate governance. An important focus of the plan is to escalate the commitment to ethical conduct in business; FEI offered specific recommendations on how to do so. In its guidance, FEI suggests that all financial executives should adhere to a specialized code of ethical conduct. This code should be extended to finance, accounting, tax and investor relations staff. FEI has held its own code of conduct as an example. The code of conduct calls for members to avoid actual or apparent conflicts, provide timely understandable information, comply with regulations of private and public regulations, and to act in good faith while proactively promoting ethical behavior at work and within their communities. Additionally, FEI advocates that companies actively promote ethical behavior and provide employees with the means to report perceived violations of ethical standards without fear of reprisal.

Initiatives by Nasdaq underscore FEI’s efforts. In an April 11, 2002, letter to the Chairman of the U.S. Securities and Exchange Commission, the Chairman and Chief Executive Officer of Nasdaq specifically recommended that companies adopt a code of conduct. The letter stated that the code “should be approved by the company’s Board and, at a minimum, address conflicts of The FEI Research Foundation interest and compliance with applicable laws. Companies should also adopt board-approved procedures for monitoring compliance with their codes.”

Nasdaq also established the Nasdaq Listing and Hearing Review Council (the Council) to evaluate “potential actions to strengthen corporate governance.” Based on a series of recommendations by the Council, Nasdaq announced on May 24 rule changes to several corporate governance standards. The changes addressed independent directors, related party transactions and disclosure of material information, among other corporate governance areas. On May 14, the Business Roundtable (BRT), representing CEOs of approximately 150 of the largest U.S. corporations, called on companies to adopt a number of best practices in corporate governance. The BRT strongly encouraged all U.S. public companies to adhere to these guidelines in order to “help restore public trust in American business.” Some of the best practices recommend companies to: • •

Create and publish corporate governance principles so that everyone from employees to potential investors understand the rules under which the company is operating; Provide employees with a way to alert management and the board to potential misconduct without fear of retribution.

The practices are discussed in detail in the organization’s Principles of Corporate Governance. 1

Current Practices A Few Statistics The recent rash of business crises is not the first time corporate ethics programs have garnered attention. In May 1991, after years of public hearings and analyses, the United States Sentencing Commission established the U.S. Federal Sentencing Guidelines for Organizations (Federal Sentencing Guidelines). Its purpose is to encourage “good corporate citizenship” and “rehabilitate” corporations found guilty of engaging in criminal conduct. Designed to deter criminal conduct at organizations and provide just punishment for offenders, the Federal Sentencing Guidelines outlined seven criteria that must be addressed in order for compliance programs to be effective. The Ethics Resource Center (ERC), a non-profit organization established in 1922 to foster individual and institutional ethical practices, noted that in some cases, the Federal Sentencing Guidelines “spurred ethics program development.” 2 In its 2001 study, the ERC provided, among other information, insight into the origins of business ethics programs. Research conducted by the Ethics Officer Association (EOA), a professional association founded in 1992 for managers of ethics, compliance and business conduct programs, supported this view. In a member survey conducted in 2000, 53% of respondents indicated that the Federal Sentencing Guidelines had significant influence on their company’s commitment to ethics. Formal regulation is not the only cause that appears to have an effect on ethics programs. In the EOA survey, 65% of the companies identified executive management changes, mergers or acquisitions and downsizing as changes that led to increased management support of programs. The ERC study also noted that half of the ethics officers who were interviewed were able to identify either an internal or external crisis that coincided with their company’s decision to develop an ethics program.

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Examples of Existing Codes of Conduct The establishment of a corporate code of conduct is the cornerstone of an effective ethics program and a thorough corporate governance process. While the institution of a code is not a new development, current events have given organizations an opportunity to reevaluate, reemphasize and re-educate employees and the public-at-large on the company code of conduct. For example, Parsons Brinckerhoff (PB) is updating its long-standing ethical conduct standards to address international office concerns and integrate affirmation of the code with Foreign Corrupt Practices Act (FCPA) compliance policies. Code of conduct issues could include political contributions and public service involvement, misrepresentation and false statements, employee discrimination and harassment, competition, safety and the environment, and employee relationships and conflicts of interest. CSX Corporation’s Code of Ethics, as an example, specifically addresses all of these issues. Many companies have an existing code of conduct that generally applies to all employees. Some codes actively address employee concern around reprisal, such as that of The Great Atlantic & Pacific Tea Company, Inc. (A&P) and Cardinal Health, Inc. (Cardinal), which includes a hotline for employees to call to report concerns and potential code violations. Cardinal’s hotline goes one step further and states that the outside company managing the hotline will share the information with Cardinal authorities within 24 hours. Its code also offers guidelines for identifying fraudulent activity and states procedures for reporting irregular activity to company management. Providing options such as the hotline for reporting violations is necessary, particularly when a company code calls for employees to refer to their immediate manager to report wrongdoing. Specifically, if the manager is suspected of violating the code, the employee will need alternative guidance on how to deal with a problem. In this regard, Weyerhaeuser defines a three-step issue resolution process, presenting employees with choices for reporting misconduct. In its Standards of Business Conduct, Harris Corporation (Harris) provides three alternatives, directing employees to seek additional assistance from either legal counsel, the employee’s pre-assigned divisional advisor (called a Business Standards Advisor or BSA) or the Corporate Director of Business Conduct. There are a variety of ways for companies to present code of conduct issues. Smaller nonpublic companies may have concise, straightforward codes of conduct. For example, Wiremold, a private manufacturing company, has a one-page summary while Washington Inventory Service, an international supplier of inventory and business solutions, has a threepage standard of conduct document that is integrated into the company’s HR Policy Manual. More elaborate codes of conduct and accompanying formal ethics programs are also in place. At Cardinal, in addition to the anonymous Ethics Hotline, the company has identified a team of corporate officers that make up the Corporate Responsibility Office. As part of its annual certificate of compliance process, Cardinal requests some employees “to certify that they are aware of and in compliance with the company’s policies on ethical behavior.”

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PB also requires a company-wide affirmation of its conduct code. This annual affirmation process requires all employees, non-employee directors and members from its international advisory board to sign a document signifying that they have read, understood and complied with the code. Harris also requires its employees to sign and submit a form (which is part of the Standards of Business Conduct booklet) that acknowledges receipt and understanding of their code. Many conduct codes cover issues that are industry-specific. Under sections titled customer gifts/medicare fraud and relations with government agencies, Cardinal’s ethics guide identifies situations where state/local institutions or Medicare Fraud and Abuse regulations may be more restrictive. In a section on use of patient medical records and prescription data, the company reviews policies on when patient records can and cannot be disclosed to others. Similarly, A&P’s industry-specific issues refer to policies on premiums and prizes related to supplier contests and acceptance of vendor samples. PB’s industry-specific issues deal with the work product, payments, claims and contract terms related to subcontractors. PB executives pointed out that when dealing with government agencies, employees may be subjected to further rules or regulations. For example, some clients’ gift rules prohibit PB employees from even accepting a cup of coffee. Consequently, awareness of both internal and external standards of conduct is necessary and continually promoted. PB executives also note that in the engineering/construction industry, there is a heightened potential for perceived conflict of interest due to the variety of related parties and vendor relationships. In response, PB’s code addresses conflicts of interest as they relate to both personal and professional ethics. These sections state that PB will avoid not only any actual association that conflicts with employment or compromises judgment, but also any association that gives the appearance of such. Cardinal’s ethics guide also addresses conflicts of interest, and provides guidance in preventing conflicts related to business with family members, ownership in other businesses, outside employment, gifts and gratuities and consultants and agents. Namely, the company provides the following question that employees should ask of themselves: “If all the facts were known, would someone question my objectivity or my ability to make the right decision for the company?”

Practical Application and Next Steps Establish Executive Support For companies with plans to establish a more formal code of conduct and ethics program or to improve existing ones, the tone must be set at the top. Company management must act in a manner indicative of a corporate culture that values ethical conduct. Effective standards for ethical conduct must be initiated, supported, encouraged and practiced by the Chairman and CEO of an organization. PB executives agree that top company management must deliver a continuous and consistent message to employees. They cite their own chairman/CEO who constantly addresses ethical conduct via company newsletters and speeches. The video program used for employee education on company ethics policies was even presented at a shareholders’ meeting.

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Follow-through is important. PricewaterhouseCoopers (PwC) and the Institute of Internal Auditors (IIA) point out that part of establishing an unvarying message is for executive management to illustrate adherence to the company code of conduct, “…the right behavior must be practiced consistently by management—through good times and bad.”3 PwC and the IAA cite an independent survey that notes the perception at the top varies significantly than that at the employee level. • •

More than 80% of CEOs believe they lead by positive personal example, less than 40% of employees agree. 95% of CEOs say they have an open door policy and will reward employees who communicate bad news, 50% of employees think the messenger runs the risk of being negatively impacted.

Many companies employ an ethics officer to “develop and manage an organization’s ethics and compliance programs.” 4 The ERC study findings cite that ethics offices are typically overseen by ethics advisory committees composed of senior-level executives. Ethics officers may report to the CEO or to another senior officer such as the corporate secretary, chief legal counsel or CFO. Finally, more than half of the ethics officers felt that direct access to the CEO is critical.5 For example, the Vice President of Ethics and Business Conduct administers Boeing’s ethics program that in turn is overseen by the board-appointed Ethics and Business Conduct Committee (made up of the Chairman and CEO, President and COO, operating-group presidents and senior vice presidents). Weyerhaeuser’s Business Conduct Office is another example of a stand-alone function with two full-time employees who report directly to the CEO. Harris has established two formal committees to oversee compliance with company standards. The Board of Director Business Conduct Committee (BCC) is comprised of external board members. Another committee, the Management Business Conduct Committee is headed by Harris’ President and CEO. It includes senior corporate management and sets the Business Conduct Policies and Practices for the company. The company has also established the position of Corporate Director of Business Conduct. The director is responsible for the day-to-day management of ethics and program compliance and vice-chairs the BCC. Middle management is also involved with Harris’ business conduct program and must be accessible to employees. Mentioned earlier, BSAs are designated for each Harris operating unit and are “charged with seeking guidance from the Director of Business Conduct on areas of uncertainty regarding company-policy requirements.” Employees are asked to print the names of their supervisor and BSA on the form before submitting the standards of business conduct form. Executives at PB have a different view regarding formal ethics officers. They believe that the presence of an ethics officer may lead employees to rely on the office to foster ethical conduct rather than take individual responsibility for doing so. Therefore, the final decision rests with the company and may depend on the corporate culture and the nature of a company’s business. With or without an ethics officer, employees need to understand that the entire organization, management included, is responsible for maintaining the integrity and

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complying with the spirit of the company code. Immediate action taken on all reported violations will assist management to send a clear message that “violation of the code leads to penalties, including dismissal, and that irrespective of whether the violation had positive or detrimental consequences for the corporation.” 6 Define the Code of Conduct and Ethics Program As evidenced in the previous examples, there is no one-size-fits-all code of conduct. The Novartis Foundation for Sustainable Development provides three “criteria for the formulation of corporate codes of conduct.” Specifically: • The principles of the code must be tailored to the specific corporate culture— merely taking over general codes is not enough. • The code of conduct addresses those activities of the corporation which are particularly sensitive or which concern the greatest vulnerability (legal, sociopolitical, and other). • Corporate codes of conduct have to be pragmatic, i.e., they must reflect the circumstances of the corporation and should only set standards which can reasonably be expected to be followed.” 7 At a minimum, an ethics program should be designed to meet the compliance effectiveness criteria provided by the Federal Sentencing Guidelines, namely: • Compliance standards and procedures must be established to deter crime. • High-level personnel must be involved in oversight. • Substantial discretionary authority must be carefully delegated. • Compliance standards and procedures must be communicated to employees. • Steps must be taken to achieve compliance in establishment of monitoring and auditing systems and of reporting systems with protective safeguards. • Standards must be consistently enforced. Any violations require appropriate responses, which may include modification of compliance standards and procedures and other preventive measures. 8 However, ethics programs should strive to do more than comply. Past research suggests “that good ethics programs and good compliance programs are interdependent; each is incomplete without the other. A good compliance program must emphasize values and moral responsibility, because this increases the program’s effectiveness among employees. A good ethics program must help employees to know and obey the law if it is to have any relevance to the company in its actual environment. 9 The establishment of a mission or vision and values statement can assist companies in defining the scope of their ethics programs. For example, Weyerhaeuser’s Guidelines for Business Conduct defines the company’s Business Ethics Core Policy and details expectations, responsibilities and consequences of noncompliance. A mission statement can also help a company define the broader areas to be addressed in the code. An analysis of competitors’ codes of conduct can provide additional guidance as to what areas may be more relevant for one company’s environment versus another. Suggestions provided by the Ethics Resource Center (ERC) include: • Use ethics codes to guide, not intimidate, employees. • Obtain employee input through interviews, focus groups or surveys. • Distribute draft codes for general employee review. • Perform pilot testing in select locations prior to rollout. • Address laws, rules and regulations that may be specific to an industry or location (i.e., FCPA, Federal Sentencing Guidelines). • Contemplate cultural issues specific to international offices. 6

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Building and Maintaining Organization-Wide Support A code of conduct cannot be effective if it is not adequately communicated and explained. There are various formats for communicating an ethics code: hard copy distribution; company websites; internal communications, such as employee newsletters; email; company presentations and meetings; new employee orientations and office bulletin boards. Additionally, the communication should include contact data for those who need more information. A simple example is found on the website of ApexMail, a company that provides messaging solutions. In its profile, ApexMail outlines corporate ethics as shared values and details four principles that shape its business practices. The use of real-life situations may be helpful for employees to define what does or does not comply with a code. The Cardinal ethics guide contains questions and answers that represent ethics-related situations common to employees. Presenting examples of how and where the company’s code of conduct can be applied may help employees understand and fully support management’s commitment to the code. Harris’ Standards of Business Conduct, includes real-life examples in a Question and Answer (Q&A) format. The Q&As are interspersed throughout the standards booklet and cover issues related to the environment, securities trading, antitrust laws, international business practices and conflicts of interest, to name a few. On its website, Boeing asks employees to “Take the Ethics Challenge.” Each question in the challenge presents ethical dilemmas with potential answers. Once the choices are selected, the interactive screen provides its opinion and a rationale on each response. Weyerhaeuser lists its “criteria for individual judgment,” to guide employees in identifying behavior counter to the company’s code of conduct. Bell Canada recently rolled out an Internet-based program for code of conduct training. The program has trained 30,000 managers, executives and front-line staff. 10 Once employees are either reminded about or made aware of a company’s ethical standards, communication efforts should continue in a steady stream through a variety of means, such as, “general awareness and functional/job-specific awareness” 11 training programs or human resource programs that address sexual harassment or management development. Johnson & Johnson conducts a five-day leadership program for senior management. The program’s content is comprised of five hours on ethics and values, led by one of the company’s most senior people. 12 General communications and employee evaluation during routine (e.g. the appraisal process) and the non-routine business practices (e.g. downsizing, restructuring, etc) is another way. “Such communications can reinforce the message that ethics touches all employees and is central to decision-making even at the highest levels.”13 Companies should periodically review a code after its initial establishment. Changes in company strategies, industry trends, laws, regulations and regional offices may initiate the need to revise a code of conduct.

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Expanding Codes of Conduct to Address Finance-Related Issues The research performed in preparation of this Issues Alert did not reveal an indication of whether companies were developing codes of conduct specifically for the finance function. However, some companies do refer to specific finance-related issues in codes of conduct. The Cardinal ethics guide briefly covers finance issues under “Accuracy and Retention of Business Records.” The section refers specifically to conformance with generally accepted accounting principles (GAAP) and to the company’s record retention policy. Cardinal policies prohibit undisclosed or unrecorded funds or assets and states that “No entry may be made on the company’s books and records which intentionally hides or disguises the true nature of any transaction.” Weyerhaeuser also refers to its policies on records retention, referring further to the company’s Asset Management Core Policy. Other companies distribute their records retention policy on annual basis, and require finance function employees to sign a form stating that they have read, understood and agreed to the policy outlined. A&P’s code of conduct section on Accounting Requirements outlines the accepted accounting rules and controls governing the company’s financials. The code states that “All account books, budgets, project evaluations, expense accounts and other papers utilized in maintaining business records of the company must accurately reflect the matters to which they relate.” Existing accounting literature and guidance also highlight the value of ethics in maintaining a company’s internal controls. For example, the AICPA Statement on Auditing Standards (SAS) No. 78 points out that ethical values and other elements of the control environment permeate the culture of an organization and affect the strength of all other controls. 14

Conclusion The past Chair for the Canadian Centre for Ethics & Corporate Policy states, "Ethical conduct creates goodwill and trust. This can be the edge a business or other organization needs to succeed in our increasingly competitive world..." To put it more simply, a PB executive advises companies, “Having a code [of conduct] is good for business. It costs more not to have it. Just do it. Have a code and mean it.”

Notes: 1. BRT press release, May 14, 2002, http://www.brt.org/press.cfm/702 The BRT’s Principles of Corporate Governance is available at http://www.brtable.org/pdf/704.pdf 2. Joseph, Joshua, Integrating Ethics and Compliance Programs: Next Steps for Successful Implementation and Change, Ethics Resource Center (2001), p. 19 3. Steinberg, Richard M. and Catherine L. Bromilow, Corporate Governance and the Board—What Works Best, p. 20 PricewaterhouseCoopers and The Institute of Internal Auditors Research Foundation (2000), p. 20 4. Ethics Officer Association, Mission, Vision & Values http://www.eoa.org.

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5. Joseph, op.cit., p. 28 6. Leisinger, Klaus M., “Corporate Ethics and International Business: Some Basic Issues” http://www.foundation. novartis.com/business_corporate_ethics_print.htm#business_corporate_ethics_corporate_code_conduct, Novartis Foundation for Sustainable Development (June 2, 1994), sect. 3.2, Corporate Code of Conduct for Sensitive Matters. 7. Ibid. 8. Murphy, Diana E., “The Federal Sentencing Guidelines for Organizations: A Decade of Promoting Compliance and Ethics,” Iowa Law Review (January 31, 2002), pp. 703-704 9. Driscoll, Dawn-Marie, et al., Business Ethics and Compliance: What Management Is Doing and Why, Business Society Review (1999), p. 35 and p. 39 10. Simpson, David, “Ethics and Corporate Social Responsibility—If You Think It’s Just About Better PR…Think Again,” http://www.ethicscentre.com/ethicscentrerob.pdf R.O.B. Magazine (February 2002). 11. Joseph, op. cit., p. 50 12. Axtman, Kris and Ron Scherer, “Enron lapses and corporate ethics, http://www.csmonitor.com/2002/0204/ p01s01-ussc.html, ” The Christian Science Monitor, (February 4, 2002). 13. Joseph, op. cit., p. 46 14. Verschoor, Curtis C., “Corporate performance is closely linked to a strong ethical commitment,” Business and Society Review v.104 no. 4 (Winter 1999).

Report authored by Cheryl de Mesa Graziano, CPA The FEI Research Foundation Copyright © 2002 by Financial Executives Research Foundation, Inc. All rights reserved. No part of this publication may be reproduced in any form or by any means without written permission from the publisher. Financial Executives Research Foundation, Inc. is an affiliate of Financial Executives International. The purpose of the Foundation is to sponsor research and publish informative material in the field of business management, with particular emphasis on the practice of financial management and its evolving role in the management of business.

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