Revisiting Toyota, Ethics and Compliance

Toyota Logo

After many people slapped Toyota with the unethical label over its unintended acceleration problem, it appears that Toyota may be vindicated.

The Wall Street Journal is reporting some early results form the U.S. Department of Transportation’s analysis of data recorders. They found that throttles were wide open and brakes not engaged on Toyotas involved in accidents blamed on sudden acceleration.

Back in March, I pointed out that we saw the same situation with Audi back in the late 1980s. People claimed that the car suddenly accelerated when they applied the brakes. It turns out they were stepping on the gas pedal, not the brake pedal.

It’s hard to pin blame on your customers for failing to use the product correctly. Audi was never able to deal with the same issue. Steve Jobs failed to find much support in telling people they are holding the new iPhone 4 incorrectly.

Toyota has experienced quality issues since they began their quest to become the biggest car company, instead of staying with being the best car company. By looking at the sticky accelerators and stuck floor mats Toyota was cognizant that their cars had flaws. Those flaws seem to have distracted them from realizing that the fault may not have been not their own.

I continue to think that the Toyota saga is one of a failure of crisis management, and not one of ethics or compliance.  Toyota has also benefited from BP’s bigger crisis. BP’s failure seems to be one both of quality, ethics, compliance, ineffectual leadership, and crisis management.

I’m also still troubled by the conflict of interest the US government has with Toyota.  General Motors is one of Toyota’s  biggest competitors. The US government own almost 61% of General Motors after having invested about $50 billion to keep the company alive. It would be good for General Motors if Toyota was found at fault and lost market share as a result. Therefore, it would be good for the US government for Toyota to be found at fault.

I don’t mean to imply that the Department of Transportation is being biased in its investigation. There is just an inherent conflict in the marketplace when the government starts owning private enterprises.

Sources:

Power Corrupts – So Does Powerlessness

Rosabeth Moss Kanter points out another reason that the “tone at the top” is only one factor for corporate compliance in Powerlessness Corrupts.

“Power corrupts, as Lord Acton famously said, but so does powerlessness. Though powerlessness might not result in the egregious violations associated with arrogant officials who feel they are above the law, it is corrosive.”

  • Managers spread powerlessness by limiting information.
  • They compound the insult by sneaking unpopular decisions through when they think no one’s looking.
  • Powerlessness burgeons in blame cultures.
  • The powerless retaliate through subtle sabotage. They slow things down by failing to take action
  • Negativity and low aspirations show up in behaviors psychologists call defensive pessimism, learned helplessness, and passive aggression.

Those are a lot of points for targeting the tone at the middle and the tone at the bottom.

Dilbert, being the epitome of powerlessness, captures some of this in today’s strip.
Dilbert.com

Trust and Compliance

Yesterday’s Carnival of Trust post got me thinking about the relationship of compliance and trust.

“Compliance lays out policies and checks to make sure you are complying with those policies. Trust, but verify, and mostly verify.”

I equate trust more with the ethics side of business: Doing what you should (or should not) do, based on principle. Compliance is focused more on things you can’t (or have to) do. Compliance is mandatory.

Trust is focused on personal interactions. Compliance is focused on corporate interactions. Ultimately, a company is made up of a network of personal interactions.  You can’t mandate trust. You can’t require trust. You have to earn trust.

Being trustworthy means more than merely complying with the rules. Rules generally set some minimum standard of conduct. Breaking the rules – being non-compliant – will usually label you as being un-trustworthy. On the other-hand, there are enough bad rules and overly strict corporate policies that sometimes being non-compliant with your internal rules will make you more trustworthy externally.

In the end, the goal of compliance and the goal of trust-building should be the same: better personal and corporate behavior. They just get there by traveling different roads.

The American business culture is increasingly moving to a rules-based regulatory environment. Hence, the growth of compliance. Is that a good thing or a bad thing?

It’s good if it will stop bad behavior. Of course, it’s always hard to figure out if you’re stopping bad behavior. If you are catching more bad actors it could be because you are getting better at identifying the bad behavior. or it could be because there is more bad behavior. If there is a decrease in catching bad actors, maybe you are just doing a worse job of catching the bad actors and not stopping the bad behavior.

It’s bad if compliance is acting as a substitute for trust-worthy, or ethical, behavior. It’s hard to envision the vast majority of rules as being anything more than minimum standards of behavior.

As a compliance professional, I need to make to sure that I focus on how compliance can promote the business goals and promote trustworthiness within the organization. Compliance professionals need to work towards making themselves trustworthy individuals.


If you can find it, that is. by Jessica Hagy in Indexed, used by permission

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Twenty Dollar Image is from Wikimedia Commons. Enlargement of the 20-dollar bill. Enlargements conform with American copyright law if they show only small parts of the bill.

Carnival of Trust

The Carnival of Trust is the brainchild of Charles Green of Trust Matters. It’s intended to highlight the best posts about trust in the business and professional workspace over the previous month. He apparently ran out of worthy people to host his carnival and, in what must have been a moment of weakness, asked me to host the Carnival of Trust for July.

Compliance and trust are an odd fit. After all, compliance can be seen as the opposite of trust. Compliance lays out policies and checks to make sure you are complying with those policies. Trust, but verify, and mostly verify.

I love carnivals. So before Mr. Green could change his mind I agreed to host the carnival. Still unsure about how compliance and trust worked together, I’m even more unsure how carnivals and trust go together. So I decided I would write about some of my favorite things at a carnival:

The Happy Clown

Clowns are a highlight of the carnival, with their faces painted in a bright red smile. The classic clown uses “clown white” to cover his entire face, hiding his underlying features. Then the clown adds a perpetual grin. Is there a problem with having a perpetual grin?

Steven DeMaio writes When Being Positive Is Positively Meaningless. Being super-positive can create so much “white noise that when clear, authentic positive feedback is given, it gets muted and loses its punch.” Being positive all the time can lower trust.

The Sad Clown

On the other side of the midway is the sad clown. Everyone can’t be happy all the time. As the character clown, the sad clown is likely the one who will end up getting a pie thrown at his face.

Scott Greenfield of Simple Justice takes on the Happysphere? You can’t get there from here. If you’re going to write a blog or expect to hear the truth from your peers, you need to expect to get some pie thrown in your face. Scott is happy to throw a pie at those sad clowns who cross the line in the legal blogosphere.

(Expecting a pie myself, I’m sure Charlie is starting wonder why he let me host this.)

The Clown Car

It seems that all of our financial institutions piled into a clown car and engaged in the same foolish activities with home mortgages. It’s fun to see clowns pile out of the impossibly small car. It’s less fun when you realize it’s taxpayer money helping the clown banks get out of their predicament.

Peter Birks writes about Trust and Naivety when it comes to looking at the health of our financial institutions. He writes about how Europe has decided to follow the U.S. lead in running financial institutions through stress tests. Running the tests was fairly successful in the U.S. for improving the public’s confidence in the banks. Birks points out why it’s not as successful in Europe. Different societies have different levels of trust in their government and their institutions.

Ball Toss

It’s pretty easy to throw a ball. It should be easy to win at the ball toss. The game’s barker has little to judge. If the ball goes in, you win. Baseball umpires have a harder job.

Charles Green talks about Baseball, Billy Budd and Business, using the blown call by baseball umpire Jim Joyce as the backdrop for his article. He presents three lessons to be learned:

Lesson 1. From umpire Joyce: face facts. Deal with reality. And the minute you see the facts are against you, call it. Call it on yourself. Take full responsibility.

Lesson 2. From pitcher Galarraga: accept life gracefully. Do all that you can; when you win, be gracious; and when you lose, that’s when you really demonstrate class.

Lesson 3: From Commissioner Selig. Celebrate the humanity of sports, business, life. The humanity of the sport really does transcend winning and losing.

Lion Tamer

The lure of the lion tamer is man against beast; realizing that you are not at the top of the food chain. The hungry lions are looking to eat the lion tamer when he steps into their cage. Health care costs are threatening to devour the American economy. Congress stepped into this cage of hungry lions when it passed the huge new health care law this spring.

Gregory Warner brings us an interesting story on Marketplace about a link between the way private oncologists get paid and how much chemotherapy they prescribe. No surprise. Doctors, like the rest of us, are influenced by how they get paid.

Fortune Teller

What awaits us after we leave the carnival’s midway? The lure of fortune tellers is the hope that their mystical powers will help us see the future and better deal with it.

One of a leader’s job skills is planning for the future and leading their people to best deal with it. Mike Myatt points out the importance of truth & leadership. “Telling the truth is not always easy, and may subject you to substantial opposition and controversy over the short run, but it will do nothing but help build your reputation, success and sustainability over the long haul.”

Elephant Ride

Elephants impress us with their massive size. Mr. Bailey’s biggest triumph as a circus entrepreneur was gaining possession of the first baby elephant born in captivity. This allowed his circus to compete with Barnum’s traveling circus.

Outside the carnival people are often unwilling to talk about the elephant in the room. If you want to be successful, you need to address the obvious problems. Jan Schultink shares a great insight (and image) in VC Pitch: Talk about the elephant in the room.

Demolition Derby

One of the loudest parts of the carnival is the demolition derby. I love seeing old cars smash into each other again and again until there is one fiercely-damaged car left still moving in the arena.

Tom Cox points out that Nice Teams Finish Last. Being nice will lead to workarounds and uncrossed bridges. On the other hand, you don’t want to be fierce, where you attack preemptively and build walls. He proposes a middle path where you are bold. That may not lead to victory in the demolition derby, but it may be a better way to lead a team.

Bumper Cars

The bumper cars offer people of all driving skills the ability to rampage through a pack of cars, with the inevitable collisions resulting in nothing more than a sudden jolt.

Over at Trust is Everything, Karen Mishra shares some trust lessons she learned as part of her teenage daughter getting ready to drive in Drivers’ Ed: A Whole New Meaning of Trust. I hope her daughter’s learning process is more like the bumper cars than the demolition derby.

Bearded Lady

Carnivals are full of odd people. For most carnivals, that includes the attendees, not just the sideshow performers. The bearded lady has been a staple of the side show for over a century. Although there were many famous bearded ladies, there were also many fakes.

When do Exaggerations and Misstatements Cross the Line? asks Knowledge@Wharton. “Embellishment is part of human nature, experts say, and almost everyone is guilty of it at one time or another. Left unchecked, however, exaggerations that seemed innocuous at first could result in serious, potentially career-ending consequences.”

Big Prizes

The lure of many games at the carnival is that big prize hanging on the wall behind the barker. Everyone wants the big prize. You’re bound to feel some envy when you see a winner carrying that huge stuffed animal around the midway. That envy may drive you to play again, hoping for a shot at the prize.

Jon Ingham looks at the problem of Promotion (and salary envy) in Social Advantage. The workplace is a social environment and workers will “behave dysfunctionally if they believe they’ve been treated unfairly in just a relatively minor way.”

Cotter Pins

Pay close attention to the cotter pins. Carnival rides fold down into truck-sized boxes for transportation to the next venue. Those cotter pins keep the ride re-assembled and keep you from flying off  into the crowd. A cotter pin is the glue that keeps the ride together.

Jack Vinson points to a story with the theory that trust is the glue that holds people together. “Trust is the most important currency in business. By opening up to what is true and creating a vision for the highest good, leaders can build a culture of trust and enhance the bottom line.”

Ring Toss

The ring toss game at the carnival is notoriously difficult. Failure is the usual result. If it were easy, they wouldn’t be giving prizes for winning.

John Scalzi in Whatever discusses the failure mode of clever. He points out that to be really clever you need to know when not to be clever. Before you write that clever bit, realize that the perception of the recipient will affect it. “Just because you intended to be clever doesn’t mean you will be perceived as clever.”

(I should have read that advice before I put this post together.)

You can read more about the Carnival of Trust and find links to past Carnivals of Trust at Charles H. Green’s Trust Matters. You can also use that site to submit an article for consideration in the next carnival.
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Image credits:

Compliance Bits & Pieces for July 9

Here are some stories I found interesting:

Compliance Lessons in Country Music by Frank Sheeder in The Healthcare Compliance Blog

We all get our inspiration from different places. As you will see, country music can support some of the best themes that we can establish as compliance professionals. The titles of some of the more popular songs evoke all sorts of interesting parallels with what we confront in the compliance world every day. For example:

Top 3 FCPA Hits of the 2010 – The Gun Sting Case by Tom Fox

But what does all of this mean for the Chief Compliance Officer (CCO) sitting in his office in the US? It should mean quite a bit. There are several lessons from which you can learn and immediately implement in your FCPA compliance program if you have not previously done so.

Good Intentions But Wrong Message by Kathleen Edmond in Best Buy Ethics

This is a great reminder for all of us: ethical behavior does not mean that we never make mistakes – it is about quickly and transparently correcting a course of action when needed, and sharing the learning.

EU Financial Chief Says Hedge Fund Rules Near in Compliance Avenue

In an interview with Bloomberg News, Michel Barnier, the 27-nation bloc’s Financial Services Commissioner, said that EU member states and the European Parliament are “in the final stretch” before voting to approve the new rules in September.

How’s Your Business Doing?
Dilbert.com

Image of Garth Brooks is by Steve Jurvetson – edited by CPacker

Performance Fees for Private Investments Funds under the Investment Adviser Act

regulatory umbrella

As  more private investment funds will be pulled under the regulatory umbrella of the Investment Advisers Act,they will need to focus on the limitation on performance fees.

Section 205(a)(1) of the Advisers Act generally prohibits any investment adviser, unless exempt from registration pursuant to Section 203(b) of the Advisers Act, from entering into, extending, renewing, or performing under any investment advisory contract if the contract includes a performance fee. With the financial reform bill likely to pass any day, the 203(b) exemption will evaporate for many private investment funds.

Section 205(e) grants the SEC the power to create an exemption from the limitation “on the basis of such factors as financial sophistication, net worth, knowledge of and experience in financial matters, amount of assets under management, relationship with a registered investment adviser,” and other factors. The SEC created an exemption in Rule 205-3 for “qualified clients.”

A “qualified client”

1. has at least $750,000 under the management with the investment adviser

2. has a net worth of more than $1.5 million at the of the investment

3. is a “qualified purchaser” as defined in section 2(a)(51)(A) of the Investment Company Act of 1940 [15 U.S.C. 80a-2(a)(51)(A)]

4. is an executive officer, director, trustee, general partner, or person serving in a similar capacity, of the investment adviser

or

5. is an employee of the investment adviser who, in connection with his or her regular functions or duties, participates in the investment activities of such investment adviser.

The rule requires a look -through from the fund to the investors in the fund. If the fund is relying on the 3(c)(7) exemption from the Investment Company Act then the fund’s investors should all be qualified purchasers or knowledgeable employees and you won’t need to look much further.

If the fund is using the 3(c)(1) exemption, then it will need to take a closer look at its investors to make sure that each is a qualified client.

Sources:

The image is a black Tour de France umbrella available at the official store of Le Tour de France. (Yes, I’m a huge fan of the Tour de France.)

A Closer Look at the new SEC Rule 206(4)-5 on Pay to Play

Over the weekend, the Securities and Exchange Commission released the full text of Rule 206(4)-5 in Release No. IA-3043. I made few notes during the broadcast of the open meeting, but there were lots of unanswered questions.

Rule 206(4)-5 is only 12 pages long, but Release IA-3043 also includes another 190 pages of commentary and discussion.

Summary (from the SEC):

The Securities and Exchange Commission is adopting a new rule under the Investment Advisers Act of 1940 that prohibits an investment adviser from providing advisory services for compensation to a government client for two years after the adviser or certain of its executives or employees make a contribution to certain elected officials or candidates. The new rule also prohibits an adviser from providing or agreeing to provide, directly or indirectly, payment to any third party for a solicitation of advisory business from any government entity on behalf of such adviser, unless such third parties are registered broker-dealers or registered investment advisers, in each case themselves subject to pay to play restrictions. Additionally, the new rule prevents an adviser from soliciting from others, or coordinating, contributions to certain elected officials or candidates or payments to political parties where the adviser is providing or seeking government business. The Commission also is adopting rule amendments that require a registered adviser to maintain certain records of the political contributions made by the adviser or certain of its executives or employees. The new rule and rule amendments address “pay to play” practices by investment advisers.

Limitations on Political Contributions

It is unlawful for an investment adviser to provide “investment advisory services for compensation to a government entity within two years after a contribution to an official of the government entity is made by the investment adviser or any covered associate of the investment adviser.”

The rule defines an official as candidate for an elective office that can

  1. directly or indirectly influence the hiring of an investment adviser, or
  2. has the authority to appoint a person who can directly or indirectly influence the hiring of an investment adviser.

Unfortunately, investment advisers are left on their own to figure out if any political position is one that falls into the prohibited bucket.

De Minimis Exception

There are two de minimis exceptions. For an official they are entitled to vote for, a covered associate can contribute up to $350 per election. That exception is lowered to $150 if they are not entitled to vote for the official.

A primary election is separate election from the general election. [Release page 63]

Those are increases from the proposed rule.

Who is a Covered Associate?

  1. Any general partner, managing member or executive officer, or other individual with a similar status or function;
  2. Any employee who solicits a government entity for the investment adviser and any person who supervises, directly or indirectly, such employee; and
  3. Any political action committee controlled by the investment adviser or by any person described in 1 or 2.

Placement Agent Ban

The rule retreated from the complete ban on placement agents that was in the draft rule. The SEC seems willing to put a ban in place. For now, the rule allows you to use a placement agent provided that they are either an SEC registered investment adviser or a SEC registered broker dealer. The extra limit on the broker dealer is that they have be subject to a an equivalent restriction on political contributions. Something that  is not yet place. Apparently, FINRA is working on pay-to-play regulations for broker-dealers.

Does Rule 206(4)-5 Apply to Private Funds?

Rule 206 (4)-5 will apply to registered investment advisers and unregistered investment advisers who are relying on the small adviser exception to registration. (Of course, that exception is scheduled to be eliminated shortly as part of the financial reform legislation.)

Also, the rule deems the adviser to a “covered investment pool” to be providing investment advisory services directly to the investor in the pool.

Therefore, private equity fund managers and their employees will be subject to this rule. Even venture capital fund managers who managed to keep a registration exemption in the financial reform bill will need comply with this new rule.

The financial reform bill is bumping the SEC registration up to $100 million from $25 million. That means a bunch of advisers and small funds will fall out from having to comply with this rule since it does not apply to state-registered advisers.

Record-Keeping

The new rule also imposes new record-keeping requirements. A private fund will need to keep track of

  1. its covered associates
  2. all government entities that are investors
  3. all contributions made to an “official of a government entity”
  4. all contributions made to a political party
  5. all contributions made to a political action committee

You don’t need to keep records if you have no government clients.

What’s a Contribution?

“[A]ny gift, subscription, loan, advance, or deposit of money or anything of value made for:

(i) The purpose of influencing any election for federal, state or local office;
(ii) Payment of debt incurred in connection with any such election; or
(iii) Transition or inaugural expenses of the successful candidate for state or local office.”

Cash donations are clearly contributions. The release says that volunteer activity is not a contribution.[Release Page 23]

Effective Date

The rule has not made its way into the federal register, but will be effective 60 days after publication.

The limitations on political contributions and the record-keeping requirments have a compliance deadline of six months after the effective date. That means you need to get ready by the end of this calendar year, with the actual deadline likely to be in early March.

The limitation on the use of third parties to solicit government business has a compliance deadline one year after the effective date. That will likely be sometime during the summer of 2011.

The Changing Standard for an Accredited Investor

As financial reform has made its way through Congress there have been several proposed changes to the standard of what it takes to be an accredited investor.

In 1982, the SEC prescribed the standard in Rule 501 of Regulation D:

5. Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of his purchase exceeds $1,000,000;

6. Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year;

The Senate version of the bill would have increased both amounts. If you use the CPI index, the amounts would more than double.

Although the bill has not passed yet, but it looks like the accredited investor standard is going to change. Section 413 of the bill is Adjusting the Accredited Investor Standard.

The net worth standard will stay at $1 million for at least the next four years, but the value of the primary residence will be excluded from net worth. Otherwise the SEC will be tasked with a review of the definition of “accredited investor” and has a clean slate to develop its own definition. The SEC can revisit the definition every four years. The only standard is that the definition be “appropriate for the protection of investors, in the public interest, and in light of the economy.”

Looking into my crystal ball, I expect the SEC to adjust the income standards based on inflation. That would put them at around $459,000 if single and $688,000 if married. I would also expect the standard to include some sort investment expertise and knowledge standard. Having a big pile of cash or a big paycheck will likely no longer be the only standard.  At least that’s my guess.

Sources:

Updated pdf file with text of the Private Fund Investment Advisers Registration Act of 2010

Image: three horsemen of the apocalypse, greenspan, et al by daveeza

Fourth of July and Compliance

With the Fourth of July on Sunday, most businesses are closed on July 5th. (We hate to waste a good holiday.) What better way to celebrate the independence of the United States than by taking the day off from work and watching stuff blow up.

In colonial times, official proclamations were read from the Old State House balcony, looking down State Street towards Long Wharf.

Each July 4th, the Captain Commanding of the Ancient and Honorable Artillery Company reads the Declaration of Independence from the balcony of the Old State House. The reading of the Declaration of Independence dates back to July 18, 1776, when Colonel Thomas Crafts performed this duty for the first time.

Old State House

In this image, USS Constitution Sailor of the Year, Navy Counselor 1st Class Paul Grunder (at mic) leads a crowd of thousands in the Pledge of Allegiance at the Old State House in Boston on the morning of July 4th, 2009. Also on the balcony assigned to Old Ironsides are Storekeeper 1st Class Benjamin Hanson (left) and Electrician’s Mate 1st Class Michael Pendergraft.

Sources:

Compliance Bits and Pieces – July 2

Early this week, some people expected fireworks to come from the Free Enterprise v. PCAOB decision. Instead, we got cheap package of sparklers. Fun for a few minutes, but unlikely to leave much of a lasting impression.  Here are some interesting compliance-related stories from the past week.

SEC Statement on Supreme Court’s Decision in FEF v. PCAOB

I am pleased that the Court has determined that the Board’s operations may continue and the Sarbanes-Oxley Act, with the Board’s tenure restrictions excised, remains fully in effect. The PCAOB is a cornerstone of the Sarbanes-Oxley Act and serves a critical role in promoting investor protection and audit quality,” said SEC Chairman Mary L. Schapiro. “We look forward to continuing to work with the Board in connection with its mission to oversee auditors in order to protect the interests of investors and further the public interest in the preparation of informative, accurate and independent audit reports.”

The PCAOB Anti-climax by Professor Bainbridge

The real problem here is the Supreme Court’s decades long acquiescence in the creation of a fourth branch of government comprised of independent agencies over which the President has power of removal only for cause. It is not so much the double level of tenure protection that offends the President’s constitutional prerogatives, as the existence of any level of protection.

The New Sheriffs in Town by Halah Touryalai in RegisteredRep.com

There will be plenty at stake when the 4,000 firms currently registered with the SEC are transferred to state regulators. Between 2008 and 2009 the number of firms with $100 million assets or more dropped. Meanwhile, the number of firms with $25 to $100 million in assets increased by 15 percent. Firms in that range make up 38 percent of all SEC registered investment advisors — larger than any other asset range.

Enforcement Report for Q2 ’10 in the FCPA Blog

The first quarter of 2010 was the busiest ever for FCPA-related enforcement. This past quarter was one of the quietest for new enforcement actions, with just one from the DOJ and three from the SEC.

Image is sparkle3 by placid casual