Editor’s note: Compliance Week is thrilled to honor Tamar Frankel for Lifetime Achievement in Compliance at the 2022 Excellence in Compliance Awards. Frankel, who worked 50 years as a law professor at Boston University, has authorized Compliance Week to share excerpts from her book “Institutional Self-Regulation.” Below is a passage from the book’s chapter on compliance, governance, and self-regulation.
Why are corporations required to impose internal compliance? Why are laws and regulations not enough?
These questions are not unreasonable. We hear complaints about the rising costs of the enormous number of rules that corporations must know and follow. Here are six possible answers to this complaint.
First, to be sure, violations expose the corporations to risks of sanctions that could undermine reputation and result in serious monetary fines and losses. This is especially true when the corporations are large and deal with complex processes that pose danger to the public. However, many business and financial relationships involve a high level of trust. Loss of trust may mean total financial disaster for a business enterprise. Short-term benefits and “slippery slopes” of minor actions can lead to serious crimes, resulting in frauds on a grand scale.
The individuals involved are harmed as well. For example, a university administrator purported to have completed an undergraduate degree and a graduate degree. She had done neither. However, she was an able and ambitious person and advanced to become dean in 1997. She did not have the courage to correct her résumé and paid the price of the discovery.
A 2005 business ethics survey showed that although formal ethics programs (written standards of conduct, ethics training, etc.) had increased over the last five years, the expected positive outcomes had not increased.
The punishment for some violations can be horrendous and hard to imagine. For example, MBA students were taken to a minimum-security facility to meet with inmates convicted of business crimes. The students realized prison officials controlled the inmates’ lives, determining, for example, when they would eat and sleep. The inmates consistently said their wrongful activities were not a single act but a “slippery slope” that began when they wanted to accomplish a goal or help the company.
Thus, corporations and their stakeholders should protect themselves from violations of the law by their own “populations,” including employees, management, close independent contractors, and affiliates. The required compliance is not necessarily a punishing; it may provide protection from liability and its dire results. Yet, short term, when rules create barriers to immediate or shorter-term prospects of higher profits, complying with restrictive rules can be resented and viewed as constraining market freedom. If activities are not clearly illegal—and many are not—these constraints may initially seem patently unreasonable.
Second, corporate legal violations can cause serious harm to their own investors and employees, as well as to the country’s citizens and its economic and financial well-being. Unemployment may rise; the gap between the wealthy and the poor may widen; and a corporate or even national culture of costly dishonest behavior may develop. In many cases, the harm can spread to other countries as well as to the international economic and financial system.
Third, as corporations grow larger and more complex and operate internationally, monitoring by regulators becomes increasingly difficult and sometimes impossible. Internal corporate compliance programs, if operated effectively, may be better at limiting malfeasance than government regulation.
Fourth, rules and detailed regulations are very costly to enforce, both by corporations and by the regulators. A culture of voluntary compliance is likely to reduce these horrendous costs.
Fifth, the demand for specific rules leads to a search around specific prohibitions and to the claim: “Where is it written?!!” But circumventing a specific rule may lead to another specific written rule and so on. When more general principles lead to a culture—a social habit of behavior that interprets the prohibition in light of the general problems that the rule was designed to resolve—then fewer rules would be needed. Thus, one of the main enforcement mechanisms of compliance is culture: The accepted general rules that are followed by the group, rather than the specific rules that lead to the search for exceptions.
Sixth, compliance involves international relationships. A growing number of multilateral agreements are negotiated by members of the international community. Mistrust can undermine such beneficial interactions.
Teall Crossen has proposed a number of solutions to ensure corporate compliance with obligations and to strengthen parties’ trust in each other: First, the notion that a treaty relates not only to its obligations but also to the underlying problem; second, the notion that compliance is driven not only by sanctions but also by reputational injury; third, the notion that international law is based on legitimacy—the recognition that different ways of doing things are the right thing to do; fourth, on a higher level, many, but not all, corporations should share the basic principles of the same culture; and fifth, as the number of the corporate shareholders grows, so do oversight problems.
The larger the number of shareholders, the more difficult it becomes for them to organize and monitor the corporation. With the monitoring weakness of investors and outsiders, the managers’ discretion and freedom of action expands, and their accountability shrinks. Managers may then seek, and sometimes receive, justifications for claiming ownership rights—after all, it is they who produce corporate profits, rather than the shareholders. Shareholders are then viewed as parasites.
Yet, unless culture and ethics constrain the managers’ claims and justification for entitlement—in effect, agency costs and/or conflicts of interest—prosecutors’ activities will increase. Prosecutors seek indictments and convictions, resort to civil and administrative actions against such corporations, and drive for criminal indictments and other means of punishments against their leadership. With this trend, which may be in sight, corporations and their leaders increasingly view corporate compliance and ethics as risk management, similar to insurance. The risk that is being managed is the risk of prosecutorial punishment and loss of reputation.
*If compliance is so good for corporations, why do so many corporations experience fraudulent activities, detailed compliance programs notwithstanding?
*What should corporate leaders do if their competitors do not follow the law and consequently are more profitable in the short term? How can a corporation follow the law and yet avoid losses? What if the investors and customers prefer short-term profits or more competitive pricing to law-abiding corporate behavior? Is there anyone who might suffer then?
*What if competitors are not clearly breaking the law but are merely interpreting it differently, due to the law’s inherent ambiguity? How, if at all, does this situation change your answers?