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Adding a carrot to regulatory stick

by Simon Longstaff

Hardly a year passes without significant increases in the risk and level of punishment that might be meted out to errant corporations. One need only look to the proposed consumer protection laws outlined in the Justice Statement announced by the Australian Prime Minister, Mr Keating, last year.

Fines are to be increased substantially and adverse publicity orders will be added to the list of possible sanctions.

I do not wish to suggest that these measures are unwarranted.

Consumers are certainly entitled to receive full protection from those who would engage in misleading or deceptive conduct, or any other of a host of potential misdeeds.

Both as a matter of ethics and 'economic hygiene' – a term borrowed from Professor Allan Fels – consumer protection is to be applauded.

However, what signals do strict legislative measures send – especially when they are the primary method for ensuring that commercial practice accords with community standards? Is it too far-fetched to suggest that much of the compliance related activity taking place is driven by nothing more than a fear of the consequences should due diligence not prevail?

If fear is the driver, then this general orientation will frequently be communicated throughout a company. In my experience, it is not uncommon to hear personnel labelling new initiatives in the field of ethics as a cynical exercise “to protect the backs of directors”. Such a view persists – even in circumstances where the initiative has been launched with the best and most positive of intentions.

Cynicism of this kind can be found in the private and the public sectors. For example, in the NSW public sector, compliance-related programs are frequently perceived to be all about avoiding trouble with the ICAC. The point is this: even enlightened management decisions are being tainted by suspicion they are motivated by nothing more than an attempt to escape punishment by the regulators or courts.

Turning around such perceptions is a major challenge, not just for companies but also for the whole community. We cannot afford to have developments, designed to foster best practice, being labelled in predominantly negative terms. While it is true that a healthy, ethical culture will reduce the incidence of fraud and also lower the costs of compliance, it is a grave error to think this necessitates the type of specific link that is in vogue in all too many organisations.

A proper concern about ethics is of importance for far more pressing reasons. Not least of these is the fact that a decision to include the ethical dimension, as an explicit element in the daily management environment, is a commitment to ensure that the organisation is equipped to handle new issues arising in a rapidly changing world.

Challenges arise with the advent of new technology, just as they do as a direct by-product of Australia's increasing engagement with people and organisations in the Asian region. Organisations wishing to embrace change in a positive manner need to be made capable of spotting and dealing with new issues and conflicts of value and perspective.

Having said this, it is important to realise many companies still view programs designed to reinforce the processes of corporate governance as an expensive imposition. Bearing this in mind, I would like to propose Government consider ways in which it can introduce incentives designed to foster and, in some cases, reward real and sensible efforts to implement best practice. That is, I wish to propose Government offer a carrot in addition to the stick.

How might this be done? One suggestion is to amend the Corporations Law so courts can take into account the extent to which corporations have instituted best practice in corporate governance (in its broad construction) when sentencing those that have been found guilty of an offence.

That is, I am proposing a modified version of the Federal Sentencing Guidelines that apply in the United States. Under that scheme, corporations are encouraged to implement compliance schemes, and have them independently audited, with the understanding courts are required to discount penalties by up to 90%. Under this regime, a company that does nothing about compliance is liable, say, to a minimum fine of $1,000. A company that has done all it can reasonably be required to do would be liable for a maximum fine of $100,000.

Companies are still held accountable for their actions. However, the US Government recognises that genuine mistakes occur – even when people are seriously concerned to foster compliance. As such, the community ensures responsibility is properly apportioned, while shareholders and other stakeholders with a financial interest in the company, are rewarded for efforts aimed at preventing wrong-doing.

If a similar scheme were introduced in Australia, then bodies like the ASC, ISC and TPC would continue to be responsible for monitoring and investigating breaches of the regulations and recommending prosecutions. Self-regulatory organisations would then be responsible for providing support services to companies inclined to engage in best practice in this area. The final leg of the tripod would be the auditing firms that would be required to conduct independent audits of each company's framework for compliance. Unlike normal financial or risk audit, the necessary audit would have to take into account measures designed to strengthen the ethical culture of the organisation.

It should be stressed that participation in these arrangements would be entirely voluntary. Companies feeling sufficiently confident about the efficacy of their own programs could choose not to be audited. This would generate a saving in expenditure but at the price of taking on extra risk if something should go wrong.

In the end, it is all a matter of balance. No responsible person would want to do away with proper safeguards designed to protect the interests of the wider community. After all, the community is fully entitled to set conditions under which privileges like limited liability are accorded to investors.

Yet, experience suggests dread of punishment is a blunt instrument for regulating complex human interactions. Rather, justice should be tempered with mercy – especially given common human frailty.

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