Codes of Ethics with Impact

By Bruce R. Gaumnitz and John C. Lere

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Section 406 of the Sarbanes-Oxley Act requires publicly traded companies to disclose if they have a code of ethics for senior financial officers, and if not, why not. Few companies will wish to explain why they do not have such a code, so it is likely that those publicly traded companies that do not have a code of ethics are in the process of developing one. Those companies that already have a code of ethics are probably reviewing them for compliance with the law’s requirements.

According to the act, a code of ethics comprises standards “reasonably necessary to promote —

(1) honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;
(2) full, fair, accurate, timely, and understandable disclosure in the periodic reports required to be filed by the issuer; and
(3) compliance with applicable governmental rules and regulations.”

Therefore, in developing or revising a code, a company should make sure that it addresses honest conduct, conflicts of interest, disclosure in periodic reports, and compliance with applicable governmental rules and regulations.

Before developing or revising a code, however, a company may find it helpful to consider why it is developing a code and what it wishes to achieve in that code.

Why Develop a Code?

Some companies may develop a code of ethics simply to avoid the embarrassment of explaining why they do not have one. For this group, any code that adequately addresses the issues expressed in Sarbanes-Oxley may suffice. For example, Financial Executives International (FEI) (www.fei.org/download/CoEmodel.doc) and Parsons Consulting (www.parsongroup.com/sarbanes-market_position.asp) have both developed sample codes of ethics.

Other companies, however, may wish to achieve more with a code of ethics. As Deloitte & Touche point out in its Guidelines for Writing a Code of Ethics/Conduct, “there is no pre-packaged verbiage for a code of ethics/conduct.”

Code of Ethics Possibilities

A code of ethics can guide individuals who face novel ethical situations and serve as a general statement of company expectations for individuals who face situations with ethical dimensions. A specific code’s effectiveness depends on the likelihood that a position in it will influence a decision and whether it effectively communicates the intended ethical position.

Some ethical positions, even if expressed in a code of ethics, are unlikely to have an impact on decisions. To help identify code statements with potential to impact decision making, statements can be classified according to whether the senior financial officer already has a known ethical position. Code statements for which there are known positions can be divided further into—

  • those that express a position with which the senior financial officer agrees;
  • those that express a position with which the senior financial officer mildly disagrees; and
  • those that express a position with which the senior financial officer strongly disagrees.

The Exhibit summarizes these positions and the potential for a code of ethics to have an impact.

Code statements addressing ethical issues for which the senior financial officer does not have a position or that take a position with which the senior financial officer mildly disagrees are the ones most likely to have an impact. Here the individual is probably susceptible to influence and may even wish or seek guidance. A code statement that relates to an issue for which the senior financial officer already has a strong opinion is less likely to have an impact. A code statement expressing an ethical position with which the senior financial officer agrees will have no impact on the alternative selected in a decision.

Impact

When the code position agrees with that held by the senior financial officer, it merely reinforces practices that should already be followed. Although it is impractical to ensure that a code of ethics includes no statements that express positions held by the senior financial officer, many such statements express commonly held ethical positions, such as being honest and obeying the law. Statements in a code of ethics that restate commonly held positions are unlikely to influence decisions.

Such statements will have no impact on the action chosen, though they may serve other purposes, such as reinforcing common values.

For example, a statement that senior financial officers are expected to comply with applicable governmental rules and regulations establishes a position that the company’s senior financial officer hopefully would already hold. If so, expressing such a position within a code can have no impact on decisions made by the senior financial officer because, even in the absence of the statement, this is the existing position.

Such a statement also probably fails to serve as a guide to company expectations when an individual faces a new ethical situation. If it is news to the senior financial officer that the company expects compliance with applicable government rules and regulations, these are much more fundamental and serious issues than a code of ethics could address.

In some cases, a company may wish to express these positions while recognizing that doing so will have little impact on decision making. Reasons for doing so might be to achieve some sense of completeness or to demonstrate due care to employees, investors, or the public. Of course, such a statement would also meet the requirements of section 406.

At the same time, a company should be cautious about including too many such positions in a code of ethics. Comments by participants in research on codes of ethics suggest that employees generally tend to dismiss codes of ethics as simple restatements of common sense or common business practice or as platitudes with which no one could disagree. A code of ethics composed primarily of ethical positions with questionable impact on decision making may not be taken seriously. This will likely diminish the impact of those positions in the code that do have the ability to affect decision making.

When the position expressed in the code statement disagrees with a position strongly held by the senior financial officer, it is also unlikely that the statement will have an impact. This situation can become problematic because when the senior financial officer disagrees with the one expressed in the code, the alternative chosen will generally not be the one desired by the company. If an individual strongly holds a strong, contrary position, merely stating an ethical position is unlikely to change behavior, in the absence of an enforcement mechanism.

Unlike statements with which general agreement exists, the company will wish to include statements expressing this type of ethical position even though the statements, by themselves, may not have the desired impact on some individuals.

Statements in codes of ethics are most likely to have an impact when they address new situations or when they take positions with which one mildly disagrees. For example, although keeping up to date professionally is generally held to be important, some individuals may not have given it much thought. For them, a statement that keeping up to date is ethically desirable behavior will provide guidance and has the potential to affect their decision making.

While section 406 of Sarbanes-Oxley addresses codes of ethics for senior financial officers, a company may wish to satisfy the act’s requirements by developing a code of ethics that includes the senior financial officer as part of a larger group. The broader the group covered, the more likely that there will be ethical issues about which some members of the group do not have positions. For example, all senior financial officers are probably aware that it is appropriate to keep company information confidential. Newer members of the finance staff, however, may not be aware of this. Therefore, including a statement about maintaining the confidentiality of information may have an impact on decisions made by some members of the group.

Novel situations provide the potential for impact. Deciding which situations are novel requires an understanding of the experience and background of individuals covered by the code. The lack of an ethical position, however, does not necessarily indicate a lack of ethics; it could indicate a need for guidance.

Finally, a senior financial office might mildly disagree with the code’s position. While it is unlikely that a code can significantly alter a strongly held position, it probably can affect mildly held positions. Mildly held positions and no positions are the ones most susceptible to a decision-making impact.

Communication and Enforcement

To affect decisions, a code must clearly communicate the ethical position to the individuals making the decision. Words that have a meaning to one individual, however, often do not adequately convey that same meaning to others. Clear communication increases the likelihood of appropriate action.

Consider conflicts of interest. Contemporary American society does not have a consistent ethic for addressing conflicts of interest. Codes of ethics of professional organizations generally adopt one of two ways to handle conflicts of interest. Some codes require the strict avoidance of conflicts of interest. Others treat conflicts of interest as acceptable as long as they are disclosed to affected parties. The Code of Professional Conduct for CPAs contains elements of both. Some conflicts of interest compromise the appearance of independence and must be avoided; others do not impair independence, but require disclosure and possible recusal. A code statement that simply says a senior financial officer should ethically handle actual and apparent conflicts of interest may not provide guidance to the senior financial officer, because it does not communicate whether such conflicts should be disclosed or avoided.

There are also legitimate differences of opinion as to when an “actual and apparent conflict of interest” exists. If conflicts of interest are a serious issue for a company, it should clearly identify those that must be avoided and those that must be disclosed. Some companies may even prefer to empower an ethics officer to whom all conflicts of interest must be referred for action.

Although the Sarbanes-Oxley Act does not specifically refer to the enforcement of codes of ethics, some companies may wish to develop specific enforcement mechanisms for their codes. Their existence indicates the importance a company ascribes to its code.

Enforcement mechanisms are particularly important for positions that differ from those held by individuals covered by the code. Appropriate discipline can increase a code’s effect on decision making, because there are always some individuals that will choose the desired alternative only if they fear discipline


Bruce R. Gaumnitz, PhD, and John C. Lere, PhD, are both professors of accounting at St. Cloud State University, St. Cloud, Minn.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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