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Ethics for Sale

In today’s regulatory climate, CEOs may have no choice but to buy.

Most chief executives say they are ethical people and that they run ethical organizations. But a vast new industry worth hundreds of millions of dollars is springing up to help companies be ethical€¦quot;whether they need it or not. The captains of this new ethics industry include lawyers, auditors, psychologists, academics, Web masters, video makers and management consultants. Its product is ethics advice. Its fees are steep. And its targeted customer is the CEO.

Creating An Ethical Culture

Long before the current craze for ethical management, retired Air Force Col. Ernst Volgenau started an IT consulting firm in his Fairfax, Va., basement with the motto “honesty and service.” In the sticky world of Pentagon contracting, he set himself apart by building ethics into his business plan. His firm, SRA International, which went public in 2002, now has $750 million in revenues and 3,500 employees. Volgenau recently spoke with Chief Executive:

On enforcing ethics: Our employees have not only the right but the obligation to report it if they think anything shady is going on. We maintain an anonymous hot line for that. And management has the obligation to conduct a prompt and fair investigation while protecting the employees as much as legally possible.

On compensation: Our top 200 executives have performance plans. The first part says that to get a bonus and options, you must comply with the letter and spirit of “honesty and service” and perform well from a business standpoint. If you violate the first part, your job is at stake. If you pass it, you still have to perform.

On CEOs: You have to continually emphasize ethics. Employees are very perceptive. They see through hollow statements. You can be the most eloquent speaker, but if you are evasive in your everyday dealings, if you don’t treat people well, if you don’t keep expenses carefully, they’ll follow your example.

The Sarbanes-Oxley Act of 2002, among other provisions, made CEOs and chief financial officers personally responsible for ensuring the accuracy of financial reporting. But balance sheets are only the beginning. The act also required the U.S. Sentencing Commission to review its 14-year-old guidelines on what constitutes an “effective compliance and ethics program.” The tougher guidelines, which went into effect Nov. 1, charge CEOs with promoting “an organizational culture that encourages ethical conduct.”

Circulating a boilerplate code of conduct won’t cut it anymore. Nor will having an in-house lawyer vet key transactions, or making sure your IT department keeps all company emails for five years. And forget about bringing in an expert for an annual employee briefing.

Under the new rules, if a company is indicted, the CEO and the board must prove they directly oversee and monitor a comprehensive ethics program€¦quot;or else incur stiffer fines and sentences. “The sentencing guidelines acknowledge that no program can prevent 100 percent of the problems,” says Thomas R. McCormick, director for global ethics at Dow Chemical. “So it basically becomes a due diligence standard. You have to show that the company is doing everything it can do.”

Already reeling from the financial and bureaucratic burdens of implementing new internal controls to comply with Sarbox, do CEOs need to invest even more time and money teaching their employees how to be good? If the mushrooming demand for ethics consultants is any guide, many feel they don’t have a choice. Sherrie McAvoy, director of Deloitte & Touche’s compliance and ethics services, says client calls to her practice have risen fourfold in the past two years. Business at PricewaterhouseCoopers’ corporate governance, risk and compliance practice has doubled during the same period, bringing in some $100 million worth of assignments annually. At LRN, a Los Angeles firm that sells Web-based ethics training programs, half of the $150 million in revenues it has earned from online education since its founding in 1993 were booked in the past 18 months.

Such providers will perform everything from a quick evaluation of compliance procedures to a radical overhaul. “It depends on how deep the company wants to go,” says Carlo di Florio, a director with the PricewaterhouseCoopers practice. “Some just review the code of conduct. Others want to be able to measure [ethics] performance.”

But the common denominator among consultants these days, in response to the sentencing guideline amendments, is a focus on corporate culture€¦quot;that is, ensuring that ethical guidance comes from top management and that the message is continually reinforced. “Enlightened CEOs aren’t just running a separate compliance department. The whole company has to do compliance,” says Dov Seidman, LRN’s founder and chief executive.

Dow, DuPont Seek Outside Help
Dow, for instance, set up a wide-ranging internal ethics and compliance program in 1998 and has contracted with several outside vendors to make sure its good intentions actually bear fruit. The chemical giant turned to suppliers like LRN and Integrity International, a Waltham, Mass.-based provider of online compliance courses, for tools such as Web-based ethics training modules and an electronic annual survey on questionable payments. “The impetus came from our chairman and CEO, who wanted to elevate the whole idea of ethics and integrity,” says Dow’s McCormick. “The challenge is, Are our leadership messages being cascaded down through the organization and are people getting it?”

Some large companies are undergoing huge structural reorganizations to upgrade compliance at the highest management layer. DuPont is creating a new department to oversee governance functions that were formerly carried out by legal, human resources, finance and auditing staff. A new compliance committee reporting to the board of directors will consist of 10 full-time officers, representing its business platforms, geographical regions and core staff groups. “These positions will be high-potential people at the operating level who will be rotated out every two or three years,” says Marjorie Doyle, a 24-year veteran of DuPont’s legal department who will run the new compliance department. “They’ll serve and then eventually be heads of our businesses. The point is to really get compliance into their DNA.” Doyle suggests that DuPont’s future CEOs are likely to be drawn from this committee’s ranks. It’s not clear whether the reorganization is related to DuPont’s alleged cover-up of the health dangers associated with a West Virginia plant’s manufacturing of Teflon.

But besides restructuring at the top, DuPont uses outside vendors to make sure it’s reaching all 55,000 of its employees. With the help of a Canadian production company, legal staff has filmed videos dramatizing hypothetical situations that require an ethical decision. DuPont is also a customer of LRN’s Web-training modules.

If a company does fall under the shadow of scandal, using independent consultants to improve compliance practices can carry more weight with a skeptical market than keeping things in the family. A year after Tyco International’s former CEO and chief financial officer were accused of raiding the company and hiding their actions, new CEO Ed Breen was eager to polish Tyco’s tarnished image. Besides shaking up management, Breen installed a senior vice president for corporate governance, Eric Pillmore, and signed on with LRN for five years of Web-based ethics courses. “Outside consultants can be objective in a situation where there might be limited internal objectivity,” says Pillmore. “That has more credibility when you’re telling [investors] about it.” Since only about 120,000 of Tyco’s 260,000 employees have computers, though, the company is still working out ways to reach the rest.

Not surprisingly, the Big Four audit firms€¦quot;themselves under new regulatory pressure to minimize conflicts of interest€¦quot;are high-profile players in the compliance field. In July, KPMG founded the Global Center for Leadership & Business Ethics, an independent body, modeled on the Nobel committees. It will give annual awards to business leaders deemed outstanding in areas including social responsibility and financial disclosure. Major law firms are also getting into the game. Skadden, Arps, Slate, Meagher & Flom has re-engineered internal governance programs for more than 200 of its clients, either helping to start them from scratch or reviewing existing procedures.

In many cases, companies have outdated compliance systems that need to be brought up to the new standards. For example, under Section 301 of Sarbanes-Oxley, publicly traded companies must maintain a telephone hot line that employees can call with questions or complaints about issues ranging from governance to sexual harassment.

To be sure, such whistleblower systems are nothing new. Defense contractors have been required to use hot lines since the 1980s to monitor waste and fraud. Under the Foreign Corrupt Practices Act, multinational companies have had programs for more than 30 years enabling employees to report cases of illegal payments.

But the U.S. sentencing guidelines’ emphasis on executive accountability means that CEOs now must show they are monitoring and interpreting their ethics hot lines. Logging not just the number but the nature of calls can paint a useful portrait of employee fluency in compliance issues. “The hot line can be a metrics tool,” says PricewaterhouseCoopers’ di Florio. “The more calls coming in, the better. It means people feel confident raising issues.”

The whole point of investing in an ethics program, of course, is to minimize costly surprises. “People don’t wake up in the morning and think, €˜Boy, this would be a great day to screw my company,'” says Christopher Bauer, a psychologist who runs Nashville-based Bauer Ethics Seminars. “But you can do preventive maintenance to make sure people don’t work out their nonbusiness issues€¦quot;financial issues, relationship issues, whatever€¦quot;at the office. You can take practical steps to reduce risk, to make sure people hear a little voice when they’re about to step onto a slippery slope.” Bauer’s practical steps consist of on-site presentations that range from 90 minutes to several days and cost anywhere from $5,000 to $50,000.

While CEOs must measure ethics awareness among the rank and file, top executives themselves are increasingly being assessed. In fact, some see a trend toward linking pay to ethical behavior. In recent remarks to the Financial Times, Securities and Exchange Commission Chairman William Donaldson pointed to executive compensation as evidence that companies still aren’t setting the right tone at the top.

Management consultants, with their expertise in organizational matrices, say they can help redraw lines of reporting within a company to maximize independence and build compliance into performance reviews. Di Florio describes one financial services firm that had a “good program on paper” but didn’t include ethics and governance in annual executive appraisals. Now, the CEO regularly evaluates the head of each business line, scoring 50 percent on financial results and 50 percent on risk management and ethics programs. “Even Ivan the Horrible will clean up his act if his bonus is at risk,” remarks di Florio.

Will the Ethics Craze Last?
The result of such practices, say some in the ethics business, is likely to be a new attitude toward the economics of compliance. “Governance and ethics are going the way that quality control did,” says LRN’s Seidman. “Rather than being a back-end process, they’re built in from the beginning. They’re no longer considered a cost of doing business.” Instead, Seidman points out to clients that bad behavior detracts from productivity, which suffers in a cynical environment. “Ethics isn’t just a P&L issue any more,” he says. “By the time an indictment rolls around, you’ve already lost billions in market capitalization.”

Not everyone believes the love affair with ethics will last. Ernst Volgenau, CEO of Virginia-based information technology provider SRA International, fears if corporate scandals stop making headlines, CEOs will revert to focusing mainly on their companies’ stock prices. “We’ve seen waves of reporting on corporate wrongdoing rise and fall in the past,” he says. “They don’t last.” What’s needed, he argues, is for companies to make ethics a central part of their business and operational plans (see sidebar, page 48).

But DuPont’s Doyle, for one, thinks it’s time to put to rest the notion that being good and making money are at odds. “People have ethical problems at work because they think they’re doing what the boss wants or are being team players,” she says. “So the boss has to say, Do whatever it takes to beat the competition, but within the context of our core values, including high ethical values. If you have to give up those values to win, don’t go there.”

As the bar for good corporate behavior rises and the penalties for knocking it down get higher, CEOs can’t afford to leave ethics out of their business plans. If shelling out for a training program will help prevent even one rogue employee from making an expensive mistake, getting help may be well worth the cost.

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