A business ethics perspective on Sarbanes-Oxley and the organizational sentencing guidelines.

• Author: Hess, David

This Article assesses the ability of Sarbanes-Oxley and other recent changes in the law and stock exchange listing requirements to reduce the incidence of fraud and to increase the reporting of financial misconduct. It begins by examining the individual decision-makers within a corporation and analyzing their intentions and behaviors under the Theory of Planned Behavior. It then examines the ability of the organization to influence the employees' intentions and behaviors through codes of ethics and compliance programs, and finds growing support for the usefulness of integrity-based compliance programs. Finally, the Article considers how the Sarbanes-Oxley legislation and Organizational Sentencing Guidelines modifications influence corporations to adopt compliance programs and to proactively manage their organizational cultures in a way that improves the ethical behavior of their employees. It also provides additional reform proposals related to the structure and processes of the firm, and discusses the role of the law in incorporating intermediary groups into the process of assisting and encouraging firms to develop ethical corporate cultures.

TABLE OF CONTENTS INTRODUCTION I. UNDERSTANDING INDIVIDUAL ETHICAL DECISION MAKING IN ORGANIZATIONS: THE THEORY OF PLANNED BEHAVIOR A. Fraud and Whistleblowing in TPB Studies B. Summary II. MANAGING ETHICS IN ORGANIZATIONS A. Corporate Compliance Programs and Ethical Behavior 1. Criticism of Mandatory Compliance Programs 2. The Implementation of Compliance Programs: Compliance-Based versus Integrity-Based Programs B. Organizational Ethics and the Theory of Planned Behavior 1. Improving Attitudes 2. Changing Social Pressures 3. Control Systems and Control Beliefs 4. Managing Moral Obligations 5. Integrity-Based Programs and the TPB III. LEGISLATING ETHICS IN ORGANIZATIONS: SMALL STEPS TOWARD REDUCING FRAUDULENT BEHAVIOR A. Why Don't Firms Adopt Integrity-Based Compliance Programs? B. Encouraging Integrity-Based Programs 1. Hardware Fixes 2. Software Fixes CONCLUSION INTRODUCTION

Fraudulent activity within the workplace is widespread. One recent survey (1) found that five percent of respondents had witnessed "falsification or misrepresentation of financial records" within the past year. (2) Another provides evidence that this number is three times as great for those specifically involved in accounting and finance. (3) The costs of such abuses are tremendous. In its 2006 Report to the Nation on Occupational Fraud and Abuse, the Association of Certified Fraud Examiners ("ACFE") estimates that companies are losing approximately five percent of their revenue to occupational fraud, (4) which equals $652 billion each year. (5)

Congress enacted the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley") to restore public trust in the markets. Among its ways of achieving this, Sarbanes-Oxley attempts to improve organizational ethics by defining a code of ethics as including the promotion of "honest and ethical conduct," requiring disclosure on the codes that apply to senior financial officers, (6) and including provisions to encourage whistleblowing. (7) The Securities Exchange Commission's implementing rules expand the disclosure requirement on the code of ethics to include codes that apply to the chief executive officer and further develop the definition of a code of ethics. (8) In addition, Sarbanes-Oxley mandated that the United States Sentencing Commission review the Organizational Sentencing Guidelines ("OSG"). (9) As a result of this review, (10) the Sentencing Commission modified the OSG to redefine an "effective" compliance program as one that includes efforts to "promote an organizational culture that encourages ethical conduct and a commitment to compliance with the law." (11) Following the lead of Sarbanes-Oxley, the New York Stock Exchange ("NYSE") and the NASDAQ both adopted listing requirements that compel firms to adopt and disclose codes of ethics for all directors, officers, and employees of the company. (12)

Many managers challenge such attempts to "legislate" ethical behavior, even if they recognize the importance of proactively managing the ethical environment of their firms. (13) Some commentators argue that the methods used to attempt to improve a firm's ethical behavior--codes of conduct and compliance programs--are ineffective and costly. (14) Others claim that these mechanisms may actually lead to more illegal or unethical behavior, because firms can adopt a compliance program that provides the benefits of a mitigated sentence under the sentencing guidelines without actually changing the firm's operations. (15)

This Article assesses the ability of the above changes to reduce the incidence of fraud and to increase the reporting of financial misconduct. Approaching these issues in Part I, I look specifically at the individual decision-makers within the organization and the ethical problems they face. For the purposes of this paper, that decision is whether or not to participate in fraudulent activity or to blow the whistle on those that do. (16) To understand the individual's decision, I use the Theory of Planned Behavior ("TPB"). The TPB is a widely tested theory from the field of social psychology. It is a parsimonious model but has significant power in explaining variations in intentions. The simplicity of the model also makes it useful for understanding and explaining the various studies that have been conducted on ethical behavior in organizations.

In Part II, I move upward to the level of the organization and examine its influence on the employee's intentions and behaviors. Section II.A reviews the research on managing ethics and compliance programs, while Section II.B analyzes compliance programs through the TPB. With that understanding, Part III takes another step back to consider how legislation such as Sarbanes-Oxley, or the OSG, does and can influence corporations to take actions that will improve the ethical behavior of their employees.

1. UNDERSTANDING INDIVIDUAL ETHICAL DECISION-MAKING IN ORGANIZATIONS: THE THEORY OF PLANNED BEHAVIOR

   Icek Ajzen developed the TPB (17) based on the earlier Theory of Reasoned Action ("TRA") that he developed with Martin Fishbein. (18) The TPB claims that there are three determinants of a person's intentions, which then deter mine a person's actual behavior. (19) First, there is a person's attitude toward the behavior, which is a measure of the person's evaluation of the behavior as "good" or "bad." (20) The antecedents of attitudes include both behavioral beliefs about the action and outcome evaluations Behavioral beliefs are the expected consequences of a behavior (e.g., a belief that an act will increase my job security) and outcome evaluations are the actor's assessment of those consequences (e.g., a belief that it is good to have job security). (21) Second, a subjective norm refers to the social pressure a person feels from important others to perform or refrain from performing the behavior and to the person's motivation to comply with those pressures. (22) Third, there is the actor's perceived behavioral control, which is a measure of the person's ability to perform the behavior, based on their past experience, competence, and any expected obstacles they may face. (23) Although each determinant will have an impact on a person's intentions toward a behavior, the relative importance of each determinant will vary based on the circumstances and the behavior studied. For example, two employees, each with a positive attitude toward whistleblowing, may engage in different behaviors if they face different social pressures in their environments.

   To improve the above model, Ajzen has suggested the inclusion of moral obligation as an additional determinant of intentions in situations where ethical behavior is involved. (24) Moral obligations refer to a duty or obligation that "is sanctioned by one's conscience as right." (25) In addition to one's own moral belief system, these moral obligations can come from laws, professional codes of ethics, and other similar sources. (26) Researchers have included this determinant in empirical studies: most find it a useful addition to the model, but some find that moral obligation functions primarily as an additional determinant of a person's attitude. (27)

   Overall, hundreds of studies on a wide variety of issues have confirmed the value of the TPB (and the TRA). (28) However, only a handful of studies have used these theories in studying organizational members' decisions in business ethics situations. (29) The studies, reviewed briefly in the next section, generally find strong support for the usefulness of these theories in understanding unethical behavior and whistleblowing. In addition, various other studies on organizational ethics that did not specifically use the TPB are directly relevant for helping us understand how organizations influence these determinants both positively and negatively.

   1. Fraud and Whistleblowing in TPB Studies

      Studies using the TPB (30) have looked at the intentions of public accountants (31) and chief financial officers to engage in fraud, (32) and managers to violate generally accepted accounting principles ("GAAP"). (33) These studies all find support for the TPB model in predicting intentions, and also find that among the determinants, attitudes have the greatest impact on intentions. (34) In one study, the researchers were able to manipulate the three determinants with a positive or negative influence, which then affected the actor's intention. (35) For example, the researchers manipulated attitude by telling the research subjects that the corporation specifically encouraged (or discouraged) the GAAP violation used in the study. (36) Although the above studies generally did not include the moral obligation determinant, Kurland's studies (37) on the intention of insurance sales agents to disclose information to prospective buyers (38) found...