Saturday, November 24, 2007

Does the Civil Liability System Undermine Business Ethics?

A question for ethics officers, consultants and academics:

Does the Civil Liability System Undermine Business Ethics?

By Robert Shattuck

I address this question to corporate ethics officers and consultants and academics who work at developing systems and programs for the promulgation, inculcation and institutionalized practice of business ethics.

Do you think the law is an impediment to achieving your business ethics objectives?

I believe it is.

You, however, are better situated and equipped to investigate and answer the question than I.

I base my answer on common knowledge about human nature and common sense analysis of what is needed for society to be able to regulate behavior to be ethical. You can do me better. You who are ethics officers have front line involvement with employees, the environment in which employees work, and their thinking, psychology, decision making process and resultant actions in that environment. You who are academics may have done psychological studies or be aware of studies that tend to support or not support my answer.

Is my answer that is based on common knowledge and common sense analysis borne out by what you are able to discern close up and/or is it supported by psychological studies?

I very much hope you will take the time to consider this article and tell me what you think. I believe that the civil liability system is in need of further reform, and if business ethicists have views that the system undermines business ethics, I would want to use those views as an additional basis for advocating further reform in the civil liability system.

Human nature; how society tries to regulate behavior

The starting place for my inquiry is the common knowledge that people have about human nature and why and how society tries to regulate behavior that grows out of human nature. Let me lay out what I think we commonly know.

Probably growing out of the self-preservation instinct, self-seeking motivations in the human species are powerful and predominant; altruism is weak.

A fundament of societal organization is subservience of an individual’s self-seeking motivation to a greater common good. This is based on an analysis that promotion of the well being of a group can contribute to the well being of the individuals in the group.

Society has various mechanisms to mitigate self-seeking behavior and to alter it to promote a greater common good. These include religion; the promulgation of codes of conduct; bestowal of honors and esteem on exemplary individuals; formal education programs that teach ethics; and systems of shame and legal punishments for individuals who violate society’s strictures.

The attempt to regulate behavior occurs at the individual level and within organizational structures, such as corporations.

An individual’s powerful self-seeking motivations are for money, power, material possessions, social standing, sex, honor, esteem, aesthetic refinements, recreational pleasures and ego gratification. The first listed motivator of money can contribute significantly to the procuring of the other desired objects. Much of the motivation at a larger organizational level, such as a corporation, is a collective expression of the constituent individuals’ motivations to obtain money and other objects of their desires.

Lying, cheating, stealing, defrauding, misrepresentation, concealment, breach of fiduciary obligations, bribery, blackmail, harassment, and lack of proper regard for the interests of third parties, have great potential for individuals and larger units such as corporations to obtain money. This is done, however, at the expense of other individuals and other units in the society.

The role of human intelligence is a very significant factor. Equipped with that intelligence, the human species is excellently endowed to conceive and implement dishonest activities and to exploit knowledge and information that others are lacking.

The extent and pervasiveness of dishonest, self-seeking activities by human beings is difficult to gauge.

Dishonest activities that are carried out successfully are concealed, and any researcher trying to estimate the quantum of dishonest behavior by human beings is ignorant of what has been concealed.

Dishonest activities on a large scale that are discovered get reported in the news. There is an unending procession of publicity about wrongdoing in the commercial world. It seems extensive and exhibits interesting combinations of novelty and repetition, and sometimes surprising audacity and scope. In the “boom and bust” cycle of the past decade, we have been inundated during the “aftermath” past four years with exposures of many instances of large scale wrongdoing that was perpetrated during the “boom” part of the cycle.

In the daily news about commercial wrongdoing, gauging the aggregate amount is complicated by the presence of large swaths of gray areas of right and wrong and varying degrees of culpability of involved individuals. Also, to repeat, one never knows about wrongdoing that has taken place and that is not found out.

Dishonesty that occurs on a smaller scale is not newsworthy. Sometimes many small-scale activities of a similar, wrongful nature get reported in the aggregate. Most of us are aware of significant amounts of fraud that occur related to car insurance and car repairs, Medicare and Medicaid claims, identity theft and credit cards, cheating on taxes, overbilling on government contracts, and bribing of government officials to obtain commercial contracts. From lots of everyday experience, people are distrustful in hundreds of commercial transactions they enter into over their lifetime. All in all, it is fair to say that the total quantum of small-scale dishonesty is unknowable but that there is a lot of it that goes on.

Business ethics and the role of the law

Business ethics is supposed to counter and lessen the perpetration of dishonest activity in the commercial world.

As referred to above, business ethics, along with other forms of moral instruction imparted through religion and other institutions, are taught in society, and society has practices for bestowing honors and awards on exemplary individuals.

It is submitted, however, that, without legal punishments for individuals who violate society’s strictures, society would be feckless in its efforts to lessen dishonest commercial activities, and that society needs to be rigorous and exacting in designing and implementing its regime of legal punishments for this purpose. In this regard, it would be a troublesome sign if society was fooled into thinking that its system was functioning effectively.

What is needed in the law for it to be rigorous and exacting?

One component is close attention to whether something is done deliberately and intentionally, or whether it is done negligently, or whether it is without fault. If a party who is without fault is punished and forced to pay a cost, that can undermine the regime of legal punishments. First, it can deflect attention from making sure that intentional wrongdoers are punished (i.e., the potential for societal self-deception to the effect, well, costs were paid so punishment must have been meted out so the law must have been doing its job). Further it offers opportunity for guilty parties actively to avoid punishment by accomplishing a shift to innocent parties. Would be wrongdoers will be encouraged by the idea that the responsibility can be shifted away from them if they decide to go forward with their wrongdoing and it is found out. When innocent parties are punished while guilty ones escape responsibility, a general disrespect for the law is engendered, and that disrespect is detrimental of the law performing a purpose of fostering ethical business conduct.

As to intentional wrongdoing versus negligent wrongdoing, a regime of legal punishments might rightfully be less strict with negligent wrongdoing. This is on the basis that people, as regards intentional wrongdoing, can and should be required in an absolute way to choose consciously not do the wrong, whereas everyone is negligent to some degree from time to time and “zero tolerance” is not a realistic objective. In the case of negligence, the law can and should look closely where, for example, the negligence is slight and other intentional or other more negligent actions (including of the plaintiff) caused a loss, and the law might also take into account that available resources for investigating and punishing wrongdoing are limited, and intentional wrongdoing should have priority.

Further, the law needs to be a definite as possible in advance about what is wrongful and what is not wrongful. Unless a person is able to know what is wrongful and what is not wrongful, there the person is disabled from being able to make a decision not to do something that is wrongful, and the law will fail as a tool for fostering ethical behavior.

Differentiating among intentional wrongdoers, negligent wrongdoers, and parties who are without fault should be in the foreground in dealing with entities that represent conglomerations of individuals, such as corporations. Any corporate act of wrongdoing is designed and implemented by particular individuals in the corporation, but lots of other individuals may be wholly without fault and costs and punishments imposed on the corporation will be ultimately borne by these latter individuals. The discussion above about the importance of punishing guilty individuals, and of not punishing innocent individuals while guilty ones escape, applies in the context of a corporation, and the legal system needs to strive to impose costs and punishments on individuals who design and implement a corporate wrongdoing and to try to be sparring in imposing them on innocent individuals.

The environment in which corporate wrongdoing happens

A corporation’s main objective is to operate as profitably as possible. The greater the profits, the more shareholders and employees can be rewarded monetarily. There are pressures on a daily basis for employees to advance the corporation’s business. Time frames are relatively short, typically for the corporation to achieve the current year’s revenue and profit goals. Bonuses for the contributions that employees make are paid on an annual basis. The employees’ jobs are their means of livelihood and of providing for their families. Plugging away every day to keep the business running profitably and to give security for this year’s source of income is a top priority for employees.

A corporate wrongdoing will be something intended to benefit the corporation financially by increasing revenues, reducing expenses or avoiding or lessening losses in the business. The corporate acts that comprise the wrongdoing are conceived of, authorized by, and carried out by officers and employees of the corporation, frequently a small fraction of all the corporation’s officers and employees. Of the perpetrating group, some have fuller knowledge of the wrongful activity and others will have very limited awareness. Many employees will be completely ignorant of the wrongful actions of the corporation, as well shareholders and customers being ignorant that wrongdoing is going on.

The officers and employees who know what is going on participate as part of their job to do things to benefit the corporation’s business. Their participation evidences their value to the corporation, and their assumption is that they will be rewarded for that in the compensation they receive from the corporation.

If an officer or an employee who is part of the group that perpetrates the corporate wrongdoing thinks the activity is questionable or that it is a clear wrongdoing that has risks of being discovered, and if the officer or employee has qualms about what is being done, there is significant internalized pressure nonetheless to go along with what the corporation is doing and to not try to block the activity. Raising objections can be viewed negatively by one’s peers in the corporation or by higher ups and result in adverse impact on the employee’s status and compensation in the corporation. The actions in question may be in a gray area and not clearly wrong. A tipping factor for the employee to go along can be a perception that, if something untoward happens as a result, only the corporation as a whole will bear the brunt and the employee will escape any personal punishment for his role in the corporate wrongdoing.

In short, all corporations are in the business of earning profits, by going along the employee is just doing his job and what others want him to do, the requested action is possibly in a gray area anyway, his employer will not punish him for what he did, and any other corporation that might learn of his willingness to go along with what others wanted to him to do will not hold that against him in getting another job.

How the civil liability system undermines business ethics

Let us focus on how the civil liability system goes awry in attacking corporate wrongdoing. Not all of it has gone awry but a very significant component of it does. This is a component that has, by and large, been wrought by lawyers, and in particular by plaintiff’s lawyers. Let us consider them, their motivations that drive what they do, and what they have wrought in the law.

Plaintiffs’ lawyers are part of the human species and their most powerful motivations are the same self-seeking motivations that are the most powerful for the rest of us. For plaintiffs’ lawyers, the big money is in suing the corporation. This big money comes in small bits out of lot of different pockets, many of which are entirely innocent of the wrongdoing, including shareholders who may receive slightly reduced dividends, innocent employees who may suffer slightly reduced wages, or customers of the corporation who wind up paying slightly higher prices.

To the extent that is all that happens, and no special punishment is ever imposed on the group of officers and employees who have personal culpability in the wrongdoing, there is going to be a substantial failure of deterrence effect, to wit, the officers and employees who were responsible are confirmed in their previous view that the wrongdoing they participated in had short term favorable financial results for the corporation, they the officers and employees got rewarded for the year in the compensation they received, the wrongdoing might never come to light and everything would be the rosier for it, and it is too bad the wrongdoing was discovered, but the officers and employees have come away basically unscathed, and either their current employer corporation may try a new trick next time, or else they have proved their mettle and the next corporation that employs them will be interested in seeing what they can come up for it.

The question presented is the extent to which plaintiffs’ lawyers have an effect of undermining society’s efforts to be rigorous in fining, jailing and otherwise punishing corporate officers and employees who are responsible for conceiving, authorizing, designing and implementing corporate wrongdoing.

Insight into answering the foregoing question can be obtained through a comparison of plaintiffs’ lawyers with governmental regulators, criminal prosecutors, state attorneys general and legislators, with a focus on their respective manners of compensation. The latter parties work on behalf of the public to design, implement and enforce laws and regulations and a regime of legal punishment to curtail dishonest commercial practices and conduct. The compensation they receive is reasonable for the work done, and in particular it is not geared to the dollar amount of economic activity that their public work affects (i.e., legislators and regulators don’t get paid millions of dollars because they put into effect large governmental budgets, levy commensurate amounts of taxes, and write and enforce laws and regulations that affect billions of dollars of economic activity and that impose and allocate large economic costs on and among businesses, consumers and other parties.)

Plaintiffs’ lawyers perform a similar public role in the design, implementation and enforcement of legal punishments to curtail dishonest commercial practices. Their compensation, which is huge, is geared to the amounts of economic activity that their work affects and to the economic costs that they get shifted around among various parties; the larger the scope of their lawsuits and the greater the dollar amount of the costs they can get shifted around, the greater their compensation. This manner of compensation of plaintiffs’ lawyers creates very powerful incentives for them to seek the objectives of (i) expansion of harms or detriments for which a payment should be made, (ii) higher rather than lower amounts that should be paid, (iii) expansion of liability where there is no fault, (iv) disregard of distinctions between intentionally culpable, negligently culpable and faultless parties, especially in the context of corporations comprised of a conglomeration of employees, shareholders and customers , (v) disregard of culpability of plaintiffs in their own injuries and harms, (vi) not having clear rules in advance about what is wrongful and what is not wrongful, so that a person does not know what is wrongful and cannot make a decision not to do a wrongful act, and exposing every decision and action to an ex post facto determination that it was wrongful and for which there is liability, (vii) disregard of rational cost/benefit principles, (viii) the invocation of junk science, and (ix) usurpation by them and the courts of the powers of the legislative branch and the executive branch regulatory apparatus.

These objectives of plaintiffs’ lawyers are inconsistent with the need, as discussed, for the law to be exacting in punishing and imposing costs on guilty individuals and in not punishing innocent individuals while guilty individuals are not held responsible, and of providing clear rules in advance about what is wrongful and what is not, in order that people may make a decision not to do a wrongful act. The plaintiffs’ lawyers have been very successful in achieving their objectives. This has bred contempt and disdain for the law, swallowed up large amounts of resources that could be available for other activities more effective for promoting business ethics, and has been otherwise distractive and undermining of society’s use of legal punishments to curtail commercial wrongdoing.

The Vioxx case as an example of how the law fails business ethics

Take for example the Vioxx litigation that is now working its way through the judiciary pipeline.

Let us start with all the shareholders who purchased Merck stock in the weeks leading up to the Vioxx announcement and who suffered an immediate 30% or so decline in value following the announcement. Profits that Merck made from Vioxx did not accrue to those shareholders, and they are entirely innocent of whatever wrongdoing Merck committed regarding Vioxx; nonetheless the legal liability system that is entrenched will give no consideration to those factors and results in that 30% being taken from them and contributed to the recovery that the plaintiffs eventually make.

Next consider, if Merck is guilty of wrongdoing, whether any officer or employee of Merck will be personally punished for his participation in the wrongdoing. There has been no indication that this is going to happen.

Next consider the hundreds of millions of dollars that plaintiffs’ attorneys will receive in the Merck litigation. Think how those sums might be alternatively expended in order to pay for programs and activities that would concretely advance protective and preventive objectives related to drugs such as Vioxx. These might include: greater FDA funding for post-drug approval monitoring and studies to detect adverse drug effects; design and implementation of better safeguards at the physician and patient level relative to decisions for a drug to be prescribed in a particular case; development of concrete protocols and guidelines for testing of drugs that drug companies could follow that would protect them against subsequent liability; development of concrete “conflict of interest” rules for researchers and physicians involved in testing or promoting a drug and punitive enforcement of the rules against researchers and physicians individually.

Ultimately, there is a question of what exactly the wrongdoing of Merck was, articulated with sufficient specificity, that Merck and other drug companies can have advance notice of such specifics so they can avoid “wrongdoing” in the future. For all the billions of dollars that might wind up getting paid in the Vioxx litigation, no such concrete guidance may be forthcoming at all from the litigation, and, if that is so, all that happens is effectively a huge transfer from one set of parties without fault to other parties who have suffered a harm not caused by any wrongdoing of the first parties.

The problem of the plaintiffs’ lawyers

The situation with Vioxx is emblematic of how plaintiffs’ lawyers cause a huge consumption of manpower, economic resources and mental attention and effort that has little or nothing to do with accomplishing reduction of corporate wrongdoing and is a corresponding enormous diversion of those resources from society’s efforts to reduce corporate wrongdoing.

In evaluating this argument that plaintiffs’ lawyers undermine the promotion of business ethics, we should not listen to the plaintiffs’ lawyers. Our country has seen enough in recent years of baneful effects of large amounts of compensation that create conflicts of interest and that that cause the recipient to advocate or follow a course of action that will increase that compensation and contrary to the better interests of other individuals and groups. Corporate executives standing to gain fortunes from stock options committed massive accounting frauds that contributed to maintaining and increasing lofty stock price levels that would enormously benefit them under their stock options and other compensation arrangements. Accountants have been charged with faulty accounting work arising from the conflict of having lucrative consulting work with the audit client. Stock analysts have been inappropriately influenced in their stock reports by reason of getting compensation based on investment banking business their employer gets from companies the analyst covers. Brokerage firms corrupted the IPO market by allocating stock in hidden exchanges for inflated commissions on unrelated transactions. Mutual funds and insurance brokers have acted in wrongful disregard of conflicts of interest in order to increase their revenues and profits.

Plaintiffs’ lawyers are no different. They are conflicted to the core by their compensation arrangements and are incapable of rendering to society any honest evaluation of how well the current civil liability system is in serving society’s objective of promoting ethical business behavior.


The above is a very descriptive, common sensical, common knowledge based explication of how the current state of the law undermines the promotion of ethical business conduct, and how the law results in a significant diversion of economic resources away from beneficial and desirable ethics programs and activities and misallocates those resources to wasteful and counterproductive uses.

Corporate ethics officers are in a special position to judge the validity of my arguments. They have front line involvement and first hand experience that specially enable them to discern circumstances and factors that abet or that impede the inculcation and institutionalized practice of business ethics in their corporation. They are in the best position to evaluate my descriptions of how the law affects the psychology and thinking of employees when it comes to deciding to engage in an unethical activity or not. To the extent ethics officers are uncertain about what I describe, they can conduct interviews and surveys of employees to find out about employee thinking and psychology. Academics working in the business ethics field also have a close in view of things and may may have done psychological studies or be aware of studies that tend to support or not support my answer.

I very much hope you will take the time to consider this article and tell me what you think. I believe that the civil liability system is in need of further reform, and if business ethicists have views that the system undermines business ethics, I would want to use those views as an additional basis for advocating further reform in the civil liability system..

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