Integrating Sarbanes-Oxley, Leadership, and Ethics

By Peter Koestenbaum, Patrick J. Keys, and Thomas R. Weirich

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To implement SOA, various bodies, including the SEC and the Public Company Accounting Oversight Board (PCAOB), are developing many new rules and guidelines. Nonetheless, SOA compliance will not by itself ensure that corporate scandals do not recur. Legislation rarely stops unethical acts or immoral behavior; rather, it provides a way to deal with such behavior within the legal system. Individual professionals and businesspeople have an enormous stake in preventing future corporate scandals.

Investor trust is premised on a strong and viable corporate control system. At its foundation is a code of ethical behavior that aligns the long-term interests of the corporation with the long-term interests of the shareholders. In a 2002 CNN/USA Today/Gallup Poll, 73% of respondents said that CEOs could not be trusted.

Setting the Tone at the Top

An important challenge to corporations and CEOs is the creation of a “tone at the top” that promotes ethical conduct and permeates the corporate culture. Such an environment would ideally deter misconduct before it takes place rather than punishing it after the damage has been done. A major determinant of such a proactive ethical environment is strong, high-quality leadership provided by senior executives. We need a new business model in which ethics and profitability are treated as complementary rather than as mutually exclusive. SOA underscores this need by requiring public registrants to have corporate codes of ethics.

Developing a comprehensive solution to mitigate an organization’s exposure to unethical activity will be difficult. A comprehensive solution should address more than one fundamental issue or cause. We must resist the temptation to implement quick fixes. Current and future business leaders are products of business schools, which often teach that money always comes before ethics. Because the foundations of the business establishment have been shaken by the examples of insider trading, manipulative accounting, and blatant fraud, any solution must address and rebuild those foundations. Sustainable solutions will involve profound paradigm shifts and self-improvement.

Compliance with SOA and punishment for noncompliance are critical parts of the solution. The remainder consists of components that address:

• Sustainability;
• The role of leadership;
• Behaviors and attitudes throughout the corporation; and
• Continuous improvement.

Boards of directors will still demand results that meet or exceed past performance. Stock analysts will continue to focus on bottom-line results. Shareholders will continue to demand return for their ownership of the company. In fact, one could argue that the post-SOA scrutiny has put more pressure on executives to drive outstanding corporate results. There is certainly more scrutiny from the press and the SEC. Customers, investors, the government, activist groups, and the media are all more aware and involved than before.

Crucial to determining the components of a sustainable solution is determining the fundamental causes of the scandals. The fact that the perpetrators did not follow established processes, or that the established process and procedures were weak, is not the fundamental issue. Regardless of how much pressure the perpetrators experienced from company leadership, the board of directors, and the marketplace, the fundamental issue is that the perpetrators chose to participate in unethical behavior.

Ethics as a Corporate Asset

Each company must develop a mechanism for successfully communicating and integrating appropriate ethical values into the corporate culture. Treating ethics as a corporate asset will permit investors and customers to distinguish between companies that have truly embraced an ethics-based approach to business and those that have not.

Corporations can no longer easily fake credibility through advertising and public relations “spin.” The public has learned that there is recourse against unscrupulous manipulation. The public will be increasingly skeptical of executives, like those at Enron, WorldCom, and Andersen, that staked out the ethical highroad through lip service to public codes of ethics they were apparently unable or unwilling to follow themselves. The sooner business executives understand this message, and realize that it embodies an enduring axiom about human behavior, the quicker confidence in the capital markets will return.

Refusing to deal with all aspects of human and corporate responsibilities is the recipe for meltdown. Barbara Toffler, author of Final Accounting and former partner of Arthur Andersen’s Ethics and Responsible Business Practices consulting division, traced the roots of Andersen’s ethical missteps and revealed the gradual decline of a major accounting firm and its once-proud culture. She reported that ambition, greed, and a lack of internal ethics were the firm’s downfall.

The Challenge and the Solution

Incomplete human beings become defective managers. Surviving in an ethics-less corporate culture requires executives to pursue their full potential. The first step is to embrace ethics through effective and appropriate leadership actions and behaviors.

Change of this magnitude is seldom easy. The hard truths that accompany this new paradigm are challenging. The solution consists of a multifaceted approach that incorporates the following:

• Process compliance and the price of nonconformance. SOA has set the rules for compliance as well as the price of noncompliance. The act itself impacts compliance in addressing the issues of a code of ethics, the audit process, whistle-blowing, and employee performance.
• Behaviors and attitudes throughout the organization. The second element focuses on the behaviors and attitudes of top management and the implications for lower-level employees.
• The role of leadership. Any organization can establish a code of ethics; however, without the proper “tone at the top” (leadership), a compliance program will fail.

An example of a tool to enable the sustainability of such a compliance program is presented in the Exhibit: “Leadership Diamond Realisms,” as developed by Peter Kostenbaum. A sustainable compliance program internalizes ethical behavior and the proper role of leadership within the organization. Without that internalization, Sarbanes-Oxley becomes a nuisance to those unethical minds that will instinctively look for ways around it. Sustainable compliance programs like Leadership Diamond Realisms focus on key issues that are fundamental to any leader: freedom, principle, realism, grand strategy, and accountability.

Freedom. The foundation of successful leadership is complete understanding and application of the fact that human beings have free will. Free will makes ethics possible. It is the source of our power and the origin of our anxiety. Much of leadership theory deals with influencing people’s thoughts, feelings, and behavior. Leadership coaching helps leaders convince personnel to think, feel, and behave in ways that help a business’ bottom line. Leadership involves learning and teaching the ascending ladder of freedom, free will, consequences, responsibility, ownership, and accountability.

Leaders choose principle. Leaders choose to live by principle. The 18th-century German ethicist Immanuel Kant wrote, “Two things fill the mind with ever-increasing wonder and awe, the more often and the more intensely the mind of thought is drawn to them: the starry heavens above me and the moral law within me.” Authentic leaders reject greed and selfishness, narcissism and naïve values, and embrace the things that matter most: what is enduring, genuinely worthy, and honest and generous, and what feels clean.

Realism is a way of life. Being fully in touch with the real world is one definition of mental health. Realism is more than the numbers. It means never lying to oneself or denying the truth about oneself, as threatening as that is.

Grand strategy. One mark of an authentic leader is the commitment to a grand strategy. An exercise that develops this insight is to consider a major news story and ask: What deep lessons does this have for you in how you conduct your business and your life? What messages can you derive from an enlarged perspective of this or other monumental and historic events?

Accountability. Being a true leader requires taking accountability for one’s decisions and actions. What follows from setting an example in both word and deed is holding other people accountable for their free will–based decisions and actions.

The Role of Leadership

The catalyst for the implementation of the solution lies with the leadership of the organization supporting those that behave ethically both financially and in other ways. Every conscientious businessperson should make it a priority to explore ethical behavior, and learn how to make ethical decisions.

Warren Bennis, business professor and founding chairman of the Leadership Institute at the University of Southern California’s Marshall School of Business, said that, “Exemplary leaders create a climate of candor throughout their organizations. They remove the organizational barriers—and the fear—that cause people to keep bad news from the boss. They understand that those closest to customers usually have the solutions but can do little unless a climate of candor allows problems to be discussed.” Exemplary leaders share information about what’s going on in the organization, the industry, and the world, and they treat candor as one measure of personal and organizational performance.

Character involves not just doing the right thing, but doing the right thing for the right reasons. When the leaders walk the talk and fight the good fight, then the organization observes and begins to follow. The first step, then, to becoming whole lies in courageous decisions—to be open-minded, to make self-transcending commitments, and to help create a common culture.

Deciding What ‘ Ethical’Means for a Company

Attitudes precede action. Leadership attitudes are ethical values. How-to guides without right attitudes are empty gestures. Doing right and doing well are not mutually exclusive; in fact, doing right is an integral part of doing well. But it is also possible to place too much emphasis on ethics to the detriment of other important facets of leadership. Balance is the key.

The executive team should meet and discuss where ethical lapses may exist within the company, incorporating input from stockholders, employees, and customers. This discussion needs to be brutally honest, even if it is also painful. The sought-for result is an ethics statement that represents the kind of company its leaders want it to be.

Because the word “ethics” means different things to different people, its definition should be spelled out and not left open for interpretation. The drafters must remember that these policies are not carved in stone; time and experience may reveal detrimental unintended consequences. Amending the ethics statement is acceptable as long as it remains true to the original spirit and intent. Implementing new ethics-based policies and procedures requires more than issuing a memo that says, “We’re all going to be ethical now.” Proper training makes a world of difference.