The Enforcement of Ethics:An Update on the Federal Sentencing Guidelines

and Ethics Office Requirements

Charles R. McGuire, J.D.Illinois State University

Legal Requirements for Ethics Programs:

Federal Sentencing Guidelines (1991) First to require formal company-wide Ethics

Programs Results in reduction of fines and penalties Resulted in creation of Ethics Offices in

companies Resulted in explosion of Ethics Training Resulted in explosion of Ethics Consultants Applies to FEDERAL law only

Legal Requirements for Ethics Programs Sarbanes-Oxley Act of 2002

Requires certification of financial reports by top executives

Increases penalties and prison terms for fraud

Establishes new regulations Requires new reports to the SEC Requires disclosure of Ethics Codes

Federal Sentencing Guidelines United States Sentencing Commission

An ongoing independent agency created in 1984

Establishes sentencing policies and practices for the federal courts

7 members, appointed by the President Purpose in part was to “structure the

previously unfettered discretion of federal trial judges” and to “target white collar and violent, repeat offenders” for more serious penalties.

U.S. v. Missouri Valley Constr. Co., (8th Cir., 1984) (Healey, J.)

“The present practice of punishing corporate crime with fines paid to the U.S. Treasury has done little to deter

corporate crime. Once the payment is made, the public promptly forgets the

transgression, and the corporation continues on its way, with its

reputation only slightly tarnished by what it usually describes as a “highly

technical violation”

Organizational Sentencing Guidelines Most commonly apply to fraud, environmental

waste discharge, tax offenses, and food and drug violations

Criminal liability can attach whenever an employee commits an act within the apparent scope of employment, even if directly contrary to company policy and instructions.

Sentencing Guidelines incorporate preventative and deterrent aspects of “systematic compliance programs”

Sentencing Guidelines mitigate the potential fine range – up to 95% in some cases – if there is “an effective compliance program.”

“Aggravators and Mitigators” Mitigators

Effective program to prevent and deter violations of Law

Self-reporting Cooperation with authorities Acceptance of responsibility

Aggravators Involvement or tolerance of activity Prior history Violation of an order Obstruction of Justice

Seven Criteria for An “Effective Compliance Program” Compliance Standards and Procedures Oversight by high-level personnel Due Care in delegating substantial discretionary

authority Effective communication to all levels Reasonable steps to achieve compliance,

including systems for monitoring, auditing, and reporting suspected wrongdoing without fear of reprisal

Consistent enforcement of compliance standards including disciplinary mechanisms

Reasonable steps to respond to and prevent further similar offenses

Usual Components of an “Effective Compliance Program” An Ethics Code An Ethics Office, including high-

level oversight An Ethics Training Program A “hot line” or “tip line” Audit and compliance reporting

Ethics Codes: Best Practices Best when broad based; No “one size fits all” Should be continually reevaluated and

rewritten (the “dusty and musty” problem)

Should evidence high-level commitment; Should not be done entirely by either the

lawyers (compliance) the accountants (audit) or the security group (internal security) but by all

Ethics Offices: Best Practices Need to be high-level (V.P.) with access

to top management Must be beyond reproach Must be totally confidential Must have internal investigatory powers

at all levels Should have an advocacy function

within the company Should be responsible for reporting

Ethics Training Programs Best Practices Involve all levels and employees of

corporation Based on Ethics Code Involve a variety of internal programs and

multiple delivery mechanisms Should be strategic, rather than

“canned” Should aim at awareness, knowledge and

skill-building, and reinforcement

Hot Line/Tip Line Best Practices “Customers or Employees or both?” Confidentiality, confidentiality,

confidentiality…. And security. The problem of the anonymous

informant No retribution against

whistleblowers

Audit and Compliance Reporting Best Practices Done by (or under the authority of)

the Ethics Office Include positives:

Employee/customer surveys, customer satisfaction indices, trend lines, etc.

Make public

Impact of the Sentencing Guidelines: 500 Law Review Articles and 300

newspaper articles; 300 websites dealing with guidelines 18,381 articles on compliance programs; Created new job description: The Ethics

Officer EOA: 750 Members. www.eoa.org 53% of those surveyed by EOA reported

that the Guidelines had “a lot of influence” on their decision to adopt a compliance program.

The CareMark Decision Delaware Decision, 1996, a civil action for breach of

fiduciary duties resulting from kickbacks and false claims

The Caremark decision expanded liability for board members and said that a corporate director has “a good faith duty” to see that ethics information and reporting systems are established in the organization.

Failure to assure that a corporate reporting and information system exists may render a director liable for losses causes by non-compliance

Court examined the compliance program and found that the directors would not be held liable SINCE AN EFFECTIVE COMPLIANCE PROGRAM WAS IN PLACE.

The decision has been cited numerous times in other cases.

Sarbanes-Oxley Act of 2002 Amendment to 1934 Securities

Exchange Act Passed to help bolster investor

confidence following several corporate collapses

Provided for additional SEC rules to interpret and enforce the Act

Key Provisions of Sarbanes-Oxley Established Public Company Accounting

Oversight Board Prohibited registered firms doing an audit from

non-audit services, including consulting Required sign-off by CEO and CFO to certify

appropriateness of financial statements Required each annual report to contain an

“internal control report”, which requires an “internal control structure.”

Requires disclosure of whether the firm has adopted a Code of Ethics, and rules require that the Code be filed with the annual report

SEC Definition of a “Code of Ethics” Written standards that are reasonably

designed to deter wrongdoing and promote: Honest and ethical conduct, including the

ethical handling of actual or apparent conflicts of interest…

Full, fair, accurate, timely and understandable disclosure in reports….

Compliance with applicable governmental laws…

The prompt internal reporting …of violations of the code…

Accountability for adherence to the code.

EOA Survey -- 2000 Average number of contacts/year = 371 Full-Time Ethics Officer: 525 Average number of investigations/year = 59 Most Frequent contact categories (in rank

order): Conflict of interest Misuse of resources Discrimination Outside business activities Gifts and gratuities Sexual harassment

Summary and Questions The Sentencing Guidelines and

Sarbanes-Oxley should be read together

Ethics development must be an ongoing commitment

Ethics needs to be infused throughout the organization

The climate for ethics is strong… but cyclical.