Thursday, April 22, 2010

What’s Missing From Financial Reform: Compliance, Ethics, Due Diligence

Earlier today, President Obama made a much-anticipated speech about reforming financial regulation. Financial reform is not a new item on the President’s agenda. He has advocated for this reform for about two years. And, as we all know, the recent calls for reform were ignited by the 2008/2009 economic meltdown that put our nation into a deep recession. The reform the President called for today responds to some of what is wrong with corporate governance in general, and Wall Street in particular.

But we’ve been through this before – recently. Remember the Sarbanes-Oxley Act? After a string of corporate bankruptcies and governance failures at companies like Enron, WorldCom, Adelphia, Tyco in 2001 and 2002, Congress enacted Sarbanes-Oxley in an attempt to address the managerial misconduct and accounting fraud that plagued these companies. Legislators, regulators, politicians, academics, lawyers and members of the business community argued about whether the Act was necessary, and whether it would prevent future wrongdoing.

The Sarbanes-Oxley Act attempted to close several troubling gaps in corporate governance and compliance, but legislation and regulatory reform cannot address the root causes of what went wrong at Enron at the beginning of the last decade. Legislation and regulatory reform cannot deal with what went wrong at the financial institutions and car manufacturers that were bailed out by the American taxpayers. Legislative and regulatory reform cannot prevent excessive risk taking and poor corporate governance.

Policymakers and reformers must initiate a discussion among business leaders about corporate culture itself. The discussion should include broad concepts relating to compliance, ethics, due diligence and fiduciary duty. For example, public companies should establish corporate cultures that take compliance and ethics programs seriously. Compliance and ethics officers should report directly to corporate boards in order to avoid the marginalization that frequently occurs with respect to this work. Another example - when mortgages are pooled, securitized and sold to investors, the financial institutions involved in the process must perform due diligence in order to understand what they have purchased.

Some say that the details of the reform that President Obama seeks fail to address the problems that led to the economic downturn. We, however, must not get mired in the details. Business leaders must go back to the basics of good corporate governance. And, as a nation, we must expect more from business leaders.

13 comments:

  1. I can picture the board meetings now. A gentleman walks into a board room of 10-20 corporate directors, officers, counsel And explains that the "New Act" requires these mandatory ethics compliances. An Alum from Wharton, Harvard, Hopkins, or NYU stands up and asks to use the restroom. If O'Bama wants to make a difference he needs to break the elite ranks of these institutions. Hiring outside the boys club may produce an actual checks and balanes amongst the corporations. A possible policy that a board or counsel must have mandatory 20 percent with diverse backrounds. I know id like to see more 4th tier catholic law schools sitting on general counsel as well as those whose parents made under $100,000 a year. Just a thought.

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  2. I agree with Mr. Passy.
    The status quo and good ol' boy/white shoe law firm and corporate mentality will not change until there are more people not from the establishment in Washington.

    Due Diligence is important and new laws help, however, the people making these laws are influenced by the major corporations and their PAC's who fund their campaigns.

    Hopefully we can get better leadership from the top in corporations which could start a positive trend from the inside.

    JDS

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  3. I have not been following up on this financial reform plan but I agree with my Business Associations classmates, I would like to see a mix of people from different backgrounds and law schools in power, people who are much more humble and willing to do the right thing than these rich stuck up corrupted elitists. Like the saying goes it takes one bad appple to spoil the bunch. We need new faces in leadership positions and better training in ethics and morals. These people need to be closely watched and held accountable for their actions. I sure hope things change for the better, this economy is awful and I need a job.

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  4. I think, in general, companies have compliance and ethics cultures. You can’t have a compliance officer or ethics officer standing behind every employee every minute. I recently wrote a law review comment that questioned, in part, the sentencing guidelines under for corporate supervisory violations. In Enron, Skilling and Lay and Fastow not only knew what was going on but were chiefly responsible for the fraud. But for a corporation doing everything possible to ensure compliance and an employee is set on committing fraud, the company is still responsible. There’s no way for a company to catch everything, but there’s no consideration in the sentencing guidelines for any efforts on the part of the company. There should be room for some reasonableness in taking into account what a company has tried to do.

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  5. I think it is normal for the government to only act once a problem has presented itself. In a recent classroom discussion, we noted that that government has always enacted reform only after society has suffered. But, unfortunately it is not is not always possible to predict the problems that may arise as a result of brilliant minds that are within the financial sector. Nevertheless, the government should continue to pursue reform in order to protect the unknowledgeable from the corporate giants. So, while the Obama financial reform does not detail all the issues that may be presented, something is better than nothing and nothing is perfect.

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  6. These are common sense solutions to a common problem. I support Ms. Wade's sentiment 100%. Unfortunately, their implementation is unrealistic. I agree - business leaders surely must go back to the basics of good corporate governance. However, bogus mortgage pooling, Enron, and lame corporate compliance programs are American corporate culture. We allow people sitting in board rooms to take advantage people sitting on La-z-boys. Yes, corporate ethical compliance demands more respect, but I feel it will continue to be minimal. I applaud President Obama for following through on another difficult campaign promise. The reform measures include proposals for tighter restrictions on credit lending and regulations on derivative trading. Both worthy endeavors. I'm eager to see what the final product will be and how it will affect business.

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  7. Its a great idea to regulate compliance, ethics, and due diligence only because our government protects certain companies that are considered to be "too big to fail." What ever happened to the invisible hand theory in economics? Rules and regulations are never going to force these over paid officers and directors into running their companies correctly. At common law these officers and directors ALREADY owe their companies and shareholders a duty of care. Yet they don't get sued by their shareholders. Why, maybe its because most investors diversify so much in mutual funds that they don't pay attention to invdividual companies they invest in. Shareholders are the only one who can effectivley regulate companies because all these duties are already owed to them in common law and state statutory law. The problem existed because most individual investors are apathetic and do not take the time to figure out what is going on in their companies, if they did most of these joker and clown CEO and board members would wake up and do what they were suppose to do instead of collecting a nice fat check while sleeping in their offices most of the time.

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  8. Good corporate governance and laws surrounding it comes down to the fundamental question: are people inherently good or bad? In the corporate sense it can be defined a little further by asking, is it bad to bend the rules just a little and is being greedy a good or bad quality. I've said this before and I'm saying this again: if you want to get corporate officers to behave like decent people you have to treat them like children. In order to teach a child what is good and what is bad parents have to punish their children. The child will then decide whether the joy or benefit of doing something bad is worth risk of punishment. This decision almost always necessitates the child to determine how much he/she disliked or was hurt by the punishment. If the child does the bad act again the parent should understand that that the punishment isn't severe enought to deter the child's behavior.
    Congress must take the same approach a parent uses with a child. Our corporations and their officers have continuously shown us that they decide that the punishments are not harsh enough to deter them from being bad (for prior time-outs received by corporate officers please see the 1980s, the 1990s and the New Millennium). Remember all those Enron COs that got life sentences. The World Com guys too. Oh, forgot their not even in jail anymore.

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  9. -Anthony Gonzalez

    Corporate governance is definitely a pressing matter. Enron gave us Sarbanes Oxley and Sarbanes Oxley gave us Lehman, huh? Something's wrong with that equation. It's clear that these federal acts are not sufficient and that the government needs to take a good, deep look into corporate governance. I do applaud the President who is slowly but surely getting around to those campaigning promises, and I have reason to believe that we will see deep rooted change in this area.

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  10. In these corporations you are dealing with some of the smartest people in the world and also the most connected. Whatever regulations you put in, whatever restrictions you try and place on them, they will always find a way around it, that is why they are paid the way they are paid. They know every loophole, and at the very least, are made aware of every loophole that is available by someone in the know. Restrictions placed on them by government will mostly do one thing, create a more specialized class of individuals who know their way around the rules and who will demand more money to do so.

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  11. This is a great post. I agree that the solution is much simpler than we make it out to be. It is all about the basic concepts of compliance, ethics, due diligence and fiduciary duty. If the corporations could genuinely take these four basic concepts to heart there would be no need for complex reform. Yes, I agree with Mr. Passy and Mr. Silver that in order to do this there may need to be more “outsiders” to break the current trend.

    - Jonathan Haskell

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  12. Awesome post!!...This is a really good read for all us, I think you must admit one of the best blogger I ever saw.Thanks for posting this informative blog post.Keep it up....




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  13. Great Article! If you want to learn more about due diligence you should read Due Diligence for the Financial Professional by L. Burke Files. It is a well written guide to the thought process and not just another book of mindless check lists.

    http://www.amazon.com/Diligence-Financial-Professional-Burke-Files/dp/1886295085/ref=sr_1_1?s=books&ie=UTF8&qid=1293118781&sr=1-1

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