Complying with Regulations and Ethics

If you are running a compliance program you spend a lot of time reading regulations and trying to figure out how they apply to your company. Some are very clear and make it easy to understand what you need to do. Unfortunately, many are not.

Are there corruption and ethical issues tied to your interpretation?

In my experience, the laws and regulations are often not so clear that you can draw a bright line around what is legal and what is illegal. In those instances where the rules are very clear, you end up having to implement some internal routines that seem obtuse. More often, you decide whether your approach to complying with the law is conservative or aggressive. Usually, that posture on your company’s approach is a matter of corporate culture.

A recent Harvard Business School Working paper by Malcolm Salter caught my eye: Lawful but Corrupt: Gaming and the Problem of Institutional Corruption in the Private Sector.

In the business world, gaming society’s “rules of the game” refers to subverting the intent
of socially mandated or legislated rules for private gain without resorting to blatantly illegal

He breaks “gaming” into two forms:

The Rule-Making Game involves influencing the writing of society’s rules by legislative or regulatory bodies, so that loopholes, exclusions, and ambiguous language provide future opportunities to “work around” or circumvent the rules’ intent for private gain. The Rule-Making Game is an influence game.

The Rule-Following Game involves the actual exploitation of these gaming opportunities. This game involves following the letter of the law but not necessarily its intent or spirit, as well as violating grey areas of the law in ways that are not easily understood or recognized as violations. The Rule-Following Game is thus a compliance game.

I end up disagreeing with Salter on many of his points.

On the Rule-Making side, I think there are really two distinct paths: the statutory and the regulatory. Certainly the statutory side is full of gamesmanship in setting the legislative framework. Political influence can be corrosive. There are few who think that political lobbying is a good thing. Most of the American population thinks poorly of Congress, often rating Congressman below car salesman in their perception of ethical standards.

I’ve written about the problems of pay-to-play many times. On the other hand, a company should not have to sit on its hands when faced with adverse laws being proposed in the legislature.

Look at one example in the recent Dodd-Frank Act. Section 403 of Dodd-Frank eliminated the Private Adviser Exemption used by many private fund companies to be exempt from registration as an investment adviser. But section Section 407 of Dodd-Frank created a new exemption for venture capital fund advisers. On one hand you could follow Salter’s argument and use this an example of “gaming.” On the other hand, you could argue that venture capital funds are inherently different from other types of private funds, don’t pose the same risks, and don’t need as much oversight. Clearly, the venture capital industry lobbied for this exemption. I expect your view on whether this was “gaming” depends on your view of venture capital.

The other half of rule-making is the regulatory bodies. You will get a spread of quality and respectability, but they are generally not subject to the same level of gamesmanship as elected officials. Sure, some agencies are subject to excessive influence by the industry they regulate. More often than not, the regulatory bodies are dedicated professionals who are looking to do the right thing for the long term success of the industry while protecting the interests of the consumer, the investor and the economy.

When it comes to following the rules, a company’s approach can be indicative of underlying issues.

Like violations of fairness norms and conflicts of interests, the Rule-Following (or
compliance) Game is often fueled by self-serving interpretations of appropriate conduct.
Many business people and their lawyers and accountants view testing the outer limits of the
law as a natural and acceptable feature of U.S. capitalism—as “American as apple pie.”
Herein lies the particular insidiousness of gaming—and the major difference between it and
clearly illegal conduct.

As I said earlier, rules are often not so clear. I agree with Salter when he points out that “inconsistent management style by institutional leaders—coupled with perverse incentives, breakdowns in internal controls, ineffective board oversight, and an absence of transparency—can quickly neutralize published codes, grease the wheels of ethical drift, and encourage gaming of society’s rules of the game.”

Of course the core goal of compliance programs is to prevent that kind of drift. You want to prevent your company from spending too much time close to the line of legal conduct. Spending that much time may make it too easy to stick a toe over into the land of illegality and be seduced by the ways of easy profit (fake profit) and magical gains (fake gains).

UPDATE: For another take at rule-making, NPR’s Planet Money published a story a yesterday on this topic: Writing the Rules.