United States Sentencing Commission Public Hearing
Testimony of Dov L. Seidman

United States Sentencing Commission
Judge Ruben Castillo, Vice Chair
Judge Michael E. Horowitz
Judge Ricardo H. Hinojosa
Judge Michael E. O'Neill
Judge Deborah J. Rhodes
Judge William K. Sessions
Judge John R. Steer
Panel One

Patrick Gnazzo, Corporate Member, Ethics Resource Center Fellows Program; Vice President Business Practices, United Technologies Corporation
Kenneth Johnson, Director, Ethics and Policy Integration Centre
Dov L. Seidman, Chairman and CEO, LRN

Proceedings
JUDGE CASTILLO: Before we get to questions, we'll let Mr. Seidman proceed.

MR. SEIDMAN: Thank you. I'm Dov Seidman. I'm the founder and CEO of LRN. It's an honor for me to be before the commission today. For over 10 years, it's been my and LRN's privilege to work with hundreds of organizations, including some of the world's leading companies, on governance, ethics, and management programs and compliance programs. We've been fortunate to work with these companies to help them communicate with, educate, and certify four million employees around the world on the day-to-day legal and ethical issues they face on the job.

During this time, I believe I've gained some insight on the relationship between law and compliance and the role culture plays in shaping that relationship in the organization. During these same 10 years, I have observed that this commission, through its guidelines, has had the most profound influence on corporate behavior generally and specifically on how companies think about and pursue compliance with law. That being said, many of us agree with the advisory group that while there has been widespread movement to adopt compliance programs, there's not much evidence that the movement has resulted in effective compliance programs. And that's why we are here today to consider a new set of constructive recommendations from the advisory committee.

Again, I'm honored to be invited to focus on the issue of whether the commission should explicitly recognize in its guidelines the important role ethics plays in establishing effective compliance programs. I believe the advisory group was right to focus on culture and the dispositive role culture plays in getting the outcome we all want - more respect for the law. However, by requiring only that an organization promote a culture that encourages a commitment to compliance with law, I believe the advisory group stopped one step short. Principally, I will argue that to understand the very nature of what culture is and how it informs human decisions and actions is to understand that you can't have a culture of compliance unless you also have a culture of ethics.

In making this argument, I'm not asking judges to become moral philosophers, passing categorical or universal judgment on right versus wrong and good versus bad in a corporate context. I agree that we should avoid, as the advisory group suggests, having courts make "determinations of whether a particular organization has adopted a good set of values or appropriate ethical standards."

Instead, I'm simply going to argue that courts can and should evaluate the consistency and the efficacy of a company's efforts to instill values, the result of which will lead to respect for the law. I should remind us that one of the stated purposes of the commission's work, as established in the 1984 enabling statute, is to "reflect the advancement in knowledge of human behavior as it relates to the criminal justice system." While I believe my arguments stand on their own, I also believe their relevance is particularly apt, given our new knowledge of human behavior informed by the times we are in. So please indulge me as I provide a perspective on these times. Most people, I believe, believe that the scandals and failures of corporate responsibility were, at their core, not failures of legal compliance, but more profoundly and fundamentally failures to do the right thing. Companies and their leaders forgot the critical distinction pointed out by Justice Potter Stewart that there is a difference between doing that which you have a right to do and that which is right to do. In their pursuit of their dreams or schemes, people focused on what they legally can do and forgot what they should have done.

We owe the current environment to a loss of ethical rather than simply legal footing. We now find ourselves in a deep crisis of trust in our institutions and our markets, and fundamental questions are being raised about American capitalism and whether ethical capitalism is, in fact, possible.

Consequently, there has been a sea change in how business is conducted and how Wall Street and Main Street, i.e., the public, view business. Combined with the scrutiny from Wall Street, Main Street, government, media, and the public, technology has resulted in a transparent world where all actions-illegal, unethical, good-see the light of day and are instantly retrievable from databases and websites. In this world where nothing stays hidden, businesses must conduct themselves as though they have nothing to hide. Given this transparency, the market is now ironically regulating corporate behavior and shifting in some respects away from compliance towards corporate reputation and reputational value as they are becoming more central than ever.

Think of it this way. While earnings remain important as ever, companies are increasingly managing themselves to their balance sheet, not just to their profit and loss statements. Compliance tends to focus companies on avoiding millions in fines and penalties, i.e., hits to their P&Ls.

But in this world where accusations of impropriety, rumor, and innuendo have cost companies not millions, but billions in market capitalization - way before legal guilt, if ever, is established - companies are increasingly focused on protecting and strengthening their reputation, which in turn focuses them on ethics, not just compliance. Because we all know that a good and enduring reputation without ethics is not possible. During these times, I have also gained some distinct knowledge from my vantage point as a lawyer and a CEO of a business that has been working with companies way "B.E." - before Enron - on their compliance and ethics management programs. Increasingly, companies are combining law and ethics programs. They're following the lead of our most admired companies who have long understood and demonstrated that the more they invest in creating do-it-right cultures, the better it is for business. In their communication and education efforts, companies are teaching law and ethics and the meaningful connections between law and ethics on the same website at the same time. There is growing evidence that when employees come to understand the rationales, the ethical rationales, the ethical underpinnings, the spirit of the law, they become more inspired. Or in the words of the ad hoc committee, more committed to following. They will also better navigate gray areas and stay on the right side of the law even when they don't know that there is a law that applies. From my vantage point, companies today are not shying away from explicitly demanding ethics from their employees.

In my opinion, what all of this knowledge about the times we are in and the knowledge about what leading companies are doing suggests is that it's all about culture. After all, corporations are merely legal fictions or abstractions. At their essence, they are communities of human beings held together by a set of values, norms, and standards passed from one generation to the next that govern how decisions and actions are taken. In other words, a culture. I, therefore, want to commend the ad hoc committee in focusing on a culture that encourages a commitment to compliance with law. But what is the relationship between culture and compliance with law? I believe there is a spectrum that we can focus on here, a spectrum that I call the spectrum of culture. We start on one end of the spectrum with a culture of anarchy or lawlessness. We move to blind obedience with law, to informed acquiescence with law, all the way to self-governance, where employees define themselves by a set of values that inspire them to not just follow the law, but to respect it and to ensure that those around them equally respect it.

Compliance is about self-governance by its very nature. And therefore, if we believe that the most powerful form of self-governance is further down the spectrum of culture beyond mere acquiescence with law, then only ethics can get us there. I'm also rejecting as unfeasible in today's world is that a set of corporate mechanisms and bureaucracies can be created, indeed pure compliance programs that attempt to ensure that everyone acquiesces and complies with the law. Instead, I believe that compliance with law is, in fact, an outcome - an outcome of a true self-governing culture. We've seen in the last 14 years a lot of progress in moving along this spectrum. But I believe that programs that focus on compliance alone land on the point of the spectrum of informed acquiescence. Perhaps this is why the ad hoc committee suggested that there is little evidence that compliance programs have actually been effective. There is a paradox here that by focusing on informed acquiescence, you often get the opposite. You also get ever-increasing bureaucracies designed to enforce compliance with ever-increasing legal and regulatory requirements. And these bureaucracies are often met by cynicism and by clever employees who game the system. Their violations lead to more bureaucracy, and this vicious cycle continues.

Even a company doing well in this game would be challenged in this hyperkinetic, transparent, fast-moving world. How would a global company build a big enough bureaucracy to ensure that all hundred thousand of its employees in 150 operating companies in 50 countries around the world follow each and every law each and every day? They can't. Even if this company were 99.9 percent compliant, that's still 100 cases every day of noncompliance, 36,500 cases every year of noncompliance. So what will guide employees when they don't know the law or are confused about it? What will guide them in the gray areas? The answer-only a true self-governing culture, where people are committed to respect the law and to do the right thing. Self-governance is not about acquiescing to someone else's rules, but about willing choice based on one's free will and values. And since ethics is ultimately about choice, this culture must be an ethical one.

Therefore, I believe that insofar as the commission embraces the centrality of culture, it must take one more step to embrace cultures of both ethics and compliance. Again, I'm not asking the commission to require courts to delve into relative morality of organizations. Instead, they should evaluate whether companies promote, invest, and encourage a commitment to law and ethics, whatever their ethics might be. I'm asking courts to evaluate the consistency of a company's efforts to instill values, their own values, that will lead to respect for the law. What I am fundamentally saying is that while ethics is about values, in this context, promoting an ethics culture is a business process, similar to other business processes that courts routinely review, such as internal controls, safety programs, and compliance.

I, therefore, respectfully recommend that the commission take another step along the spectrum of culture to embrace true self-governance, indeed the very spirit of compliance, by explicitly encouraging commitments to both law and ethics. I'd like to add one final short point. As a CEO who uses bonuses, among other things, to incent my colleagues to reach higher, I believe that mitigating credit works like a bonus. And it's appropriate for the commission to incent companies to reach for higher ethical standards, either by going beyond legal minimums or at times refraining and restraining from taking advantage of legal rights.

I'm not suggesting that you ever punish companies that don't promote ethics by increasing their sentence. A bonus is not punishment. They just won't get the credit, i.e., a bonus. I urge you to make the underlying commitment to an ethical culture as important as the commitment to compliance, and I thank you, the commission, for the opportunity to appear before you.

JUDGE CASTILLO: Thank you. You went slightly beyond the time, but I didn't want to cut you off. We're going to open it up for questions. Let me just put this in perspective. The organizational sentencing guidelines hit their 10-year anniversary in 2001, and then using the term that you just threw out there, way B.Q. Way B.Q, this commission - or way B.E. I guess it goes - before Enron. Way before Enron, this commission, through the leadership of Judge Murphy, set up the advisory committee to improve the organizational sentencing guidelines. But I guess I'd like to know, just from your perspective as experts, do you all think that the organizational sentencing guidelines without any amendments, just on their own, have been successful or unsuccessful? Just I'd like to get your perspective on that.

MR. GNAZZO: Having been in this business for a long time, I think they are successful. But they're successful at the larger corporation level. I don't think they're quite understood at the smaller company level or the medium-sized company level. And you have been overtaken by events with respect to Sarbanes-Oxley and the New York Stock Exchange and the NASDAQ. Companies are becoming overly concerned with respect to governance, and that is added to the burden of dealing with effective compliance programs.

But I think that large corporations got it a long time ago. For companies like myself, we were members of the Defense Industry Initiatives back in 1986 and had compliance programs in place as a result of it. But I'm not seeing that level of activity for smaller companies, and it's only until they feel the burden of the sentencing guidelines will they then recognize that they need to put effective programs in place. I don't know whether it's - I don't know the reason, but it's been effective for large corporations.

JUDGE CASTILLO: Anyone else want to add to that?

MR. JOHNSON: I have a slightly different take on it. I think they've been very successful in terms of setting a framework. Certainly more programs exist than would otherwise. However, my sense is that the seven minimum steps, which were intended as a floor, in many cases come very close to a ceiling. That is that the minimum steps have become bundles of best practices. And I've seen organizations that will basically take a best practice here and a best practice there and accumulate it together to have a program - not a paper program. But in many cases, they didn't understand the basis by which one came up with a best practice and how that would apply to their organization. The best example I think is the varied definitions of ombudsman. I mean, in some cases, the definition of ombudsman in some programs effectively is an ethics officer. And so, I think that what happens is not to say someone didn't give adequate thought to it. But nonetheless, there is such a great difference that I've seen organizations that will basically pick and choose, put them together, and custom design a program without completely understanding the basis for the best practice or why it should or should not apply in their organization.

That's why I think that the idea of seeing it as a program, as opposed to a compliance program, in many cases, I think, would make more sense. I think this focus on culture is very, very important. And I think that the focus on good corporate citizenship is important as to an effective program.

MR. SEIDMAN: I believe they've been incredibly successful in galvanizing, calling attention, inspiring companies to focus on this issue, talk about these issues, and put programs in place. And as I've said, we've moved far along the spectrum. At the same time as you focus on something, you gain new knowledge, and this is a very dynamic space. And there are companies that are outstripping the very requirements you gave them because once they focus on this, they learn and they gain some new knowledge about what works and what doesn't.

And I think it's important for the commission to be in synchronicity, to use one of the ad hoc's words, with evolving new standards. I submit that leading companies are setting higher bars and that knowledge of these higher bars is getting around. But pausing today, I think there's a lot to celebrate in the last 14 years in terms of where we've arrived.

MR. GNAZZO: Just if I could make one point with respect to the last 10 years, though. From a large corporation's perspective, you're never going to - for the most part, you're not going to see large corporations be found guilty of crimes. They're going to plead at some point in time.

And for large corporations to understand what the plea has - whether their compliance program has benefited or not, for the overall program, we don't see any impact because we don't see what the Justice Department is able to accomplish and how the Justice Department deals with large corporations. So I have nothing to take back to my board of directors or to my management and saying, see, strong programs benefited them in this way, and weak programs were a deterrent in this way. Anything that the commission could do to encourage the Justice Department to at least give us some guidelines as to how they are resolving problems with large corporations based on their compliance programs would be very beneficial.

JUDGE CASTILLO: Any other questions?

JUDGE HOROWITZ: Just following up on that, when you mention guidance, I know in certain instances, the U.S. attorney's office sometimes announces when it makes a decision not to charge. Is that the kind of information that would be useful? MR. GNAZZO: And if they're making a decision not to charge because of strong compliance program, that would be extremely useful.

JUDGE CASTILLO: Commissioner Sessions?

JUDGE SESSIONS: Mr. Gnazzo, you talked about your concern about expansion essentially under the guidelines, the violations of the law. In a sense, when Mr. Seidman talks about ethical culture, that's an expansion. That's certainly-that's hopefully, at least from his perspective, an expansion of the impact of the guidelines on the culture. And I guess I'd like to hear your response to whether or not we should add ethical considerations?

MR. GNAZZO: Adding ethical considerations would obviously have a good impact on corporations. But my concern is it's very subjective. When you talk in terms of business ethics around the world, I can tell you today that United Technologies Corporation does not use prison labor for soccer balls, to make soccer balls. But we don't make soccer balls.

And therefore, the subjective nature of whether a company has good, strong ethical programs, if you talk in terms of Europe, they talk in terms of social responsibility. So I like the positive nature of it. I am concerned that we might box ourselves into whether a corporation is philanthropic by some degree that some judge believes is good, or whether they're not giving enough money to the community is an example that says to me it's very positive. It would look positive. It would benefit a judge in making a decision with respect to penalties. But to the same extent, I worry about the nature of the-the subjective nature of it.

JUDGE SESSIONS: So how would you respond to that, Mr. Seidman? Not to say that judges do this, play one against the other. [Laughter.]

JUDGE SESSIONS: But how would you respond to the question as to whether there is guidance for a judge in determining what is ethical?

MR. SEIDMAN: As I said, I don't think the judge should determine what is ethical. I think companies should determine for them, in their context, in their industry, what their aspirations are, what values they need to be consistent with accomplishing their goals. A judge should say, "Do you even have a code of conduct? Do you have stated values?"

They're your own. If you have them, what steps are you taking to promote, encourage, to ensure consistency, to invest, to make sure these are not paper values, but real values?

So I think we're in violent agreement. I, too, would be worried about passing judgments about how soccer balls are being made or philanthropy and who's writing what checks to whom. But rather, tell me what your values are, and I will evaluate what you're doing about weaving them into the culture in the same way I evaluate what you're doing into weaving your compliance program and respect for the law into the culture.

It's the same analytic, rational, legal judgment about what are you doing about the values you have.

JUDGE CASTILLO: Commissioner O'Neill?

JUDGE O'NEILL: Boy, I have so many questions. It's hard for me to figure out even where to start on this.

When you talked about success, in terms of the programs have been a success, I guess I'd like to have an idea-because it's always a little hard for me to get my mind around this whole area-as to how you sort of measure success. I know if you look at sort of publicly available data in terms of the prosecution of corporations over time, both that, you know, there was- Sarbanes-Oxley was obviously in response to some very well-publicized, you talked about B.E., before Enron, there was Enron, WorldCom, NASDAQ. There's been a number of sort of large corporate scandals. I notice, as sort of an empirical matter, that there aren't that many more corporate prosecutions at least that are publicly sort of available. I do notice that since the adoption of the organizational guidelines, there actually have been more companies that have run afoul of law. And that may be a matter of simply, you know, shifting priorities of the Department of Justice. I doubt there is any sort of causal connection between the adoption of the organizational sentencing guidelines and more companies running afoul of the law, for example. So what I'm wondering, especially given the limited nature of the impact that the Sentencing Commission has in terms of our statutory authority and what kind of a real world impact that we can have upon corporate corporations. Because I always have a little trouble about the Sentencing Commission or judges, for that matter, deciding what ought to be ethical behavior for any industry. And that's why I'm worried about the same concern that you had, sir, about the business - about violations of law versus criminal violations.

When you're dealing with, you know, civil regulatory problems of individual states, when there are violations where people don't know whether or not it's civil or criminal, may not know about the existence of the regulation, about holding people responsible for those sorts of circumstances, given our sort of limited authority. And so, I guess my twofold question would be how ought we to be measuring success in determining whether or not the organizational guidelines actually have an impact in terms of turning corporations away from actual criminal law violations? And is the Sentencing Commission well positioned to make broad ethical pronouncements about what corporate behavior ought to be?

Or ought we to be in the position of creating incentives and disincentives for reporting criminal violations to the government, having some sort of a whistle-blower effect? It just seems to me, and I don't know because I'm not a businessman, it just seems to me that if I were in that circumstance, however, what would incentivize me to report behavior is if I know that I can get some sort of a downward departure, or I can get some sort of a break. I can get a better plea agreement out of the Department of Justice.

What strikes me that you're very right in terms of wanting to know something from the department in terms of how have companies been able to avoid liability or have been able to obtain, you know, favorable plea agreements by having corporate compliance programs. So those would be sort of my two -

MR. GNAZZO: If I were - from a large corporation, if I were to answer the one part of your question as to the measurement of success, I think you have to measure the success based on the overall nature of the program over a longer period of time. For example, does the company have a consistent policy with respect to disciplinary action? You can actually measure success by saying are they disciplining on a regular basis for the same kind of activity, or is it disparate with respect to how they are disciplining or when they are disciplining, depending upon the level of individuals? So I think - but that's not a snapshot of a year.

That's the snapshot of 10 years of disciplinary action after disciplinary action for activities. I hate to bring up a comment that my chairman made at one point in time. But George David said, "When am I going to see no allegations of wrongdoing from you, Pat?" Or from the company. And my answer is, "Not in my lifetime." Or yours. Because human nature being what human nature is. So in measuring success, you want to see how does the company deal with the issues when they occur. I think the other measurement of success is how open are they to their employees bringing to them issues? United Technologies has had an open communication program since 1986, when we all agreed to put in hotlines. We put in an open communication program. To date, we've had 59,000 written dialogues from our employees around the world and 10,000 phone calls or visits to our ombudsman.

JUDGE O'NEILL: Do you keep track of that?

MR. GNAZZO: We certainly do.

JUDGE O'NEILL: And discipline, is that sort of available outside of the corporation? MR. GNAZZO: Available in what way? We keep it confidential and anonymous, another issue that I raised in a letter that I sent to the commission. But we publicize to our employees the number of communications that we get. We tell management about the issues that are being raised by the employees.

Those 59,000 and 10,000 are not wrongdoing. They're for anything that the employee wants to raise that's business-related, but it sets a tone. And it's a measurement of success that says we're willing to listen to you and respond to you and deal on those issues that you bring to our attention.

JUDGE O'NEILL: And was this created as a result of the organizational sentencing guidelines?

MR. GNAZZO: No. It was created as a result of the DII, Defense Industry Initiatives. One of the tenets of the Defense Industry Initiatives was that we were to put in hotlines for fraud activity. Our company decided to go one step further with respect to an open communication program for any issue that's business-related.

MR. SEIDMAN: Can I add something to - I agree with Pat that these are issues that you measure over time. I think companies can measure this defensively. What's happening to our fines, penalties? Who's going to jail? Who's not?

Companies are also going on offense figuring out if employees want to work at this company. When people look to their left and they see someone breaking the law, and they look to the right and someone is being unethical, they become cynical. Companies become less productive and distracted.

And if you look at the quality and safety movements, 50 years ago, we didn't know how to talk about quality and safety, how to precisely measure it. They were values. And people stood at the end of assembly lines and threw away bad products, and that was quality assurance. Or people investigated safety lapses and that was safety. Today, we talk about quality, once an amorphous value, with incredible precision-TQM and Six Sigma. We can reduce quality defects in infinitesimal levels because we've designed quality into business processes and have done the same with safety. And I think where corporations are going is they're going beyond defense. How many fines are we paying? And they're starting to figure out the way they did with quality, what's happening to our business as we invest in these programs? Are employees more engaged? Are we being more productive? Are we winning in the marketplace?

And I think that over time we should stay tuned. I think we're going to become very precise in these areas that have heretofore been very hard to measure.

JUDGE O'NEILL: And what type of specific guidance can the Sentencing Commission provide at least that can enable you both to measure success and allow that kind of change in corporate behavior? To the extent that we've got any role in that at all?

MR. SEIDMAN: Well, I think the place to do it is in the bonus category and not in the what should be penalized and what not. But more to encourage programs that are more holistic so that people don't split hairs and focus either on just criminal law versus all law or law versus ethics. Even the use of the word "culture," how do we define what a culture is? We're already half-baked, if you will, with some of these amorphous concepts.

So I would encourage us to put pressure on companies and others to figure this out by jumping in with holistic programs, and then we'll see how the next 14 years go.

JUDGE CASTILLO: Any other questions?

MR. JOHNSON: I have one comment. One aspect where I think we'll catch where you're heading, Commissioner O'Neill, is the requirement for regular program evaluation. What will happen is there's a logic to program evaluation. There is a starting point. There's things you're trying to accomplish with known risks. There's cultural aspects. There's things that you need to do. There are benchmarks. There is outcomes. There's all sorts of things.

And I think sort of following what Mr. Seidman had referred to, it's not enough to tell them what measures to follow. But they need to demonstrate that they did a good scan to know what the risks are. They set forth program evaluations. They followed the seven minimum steps. They used best practice. They did benchmark. They evaluated the program to see if they accomplished those. And I think internally those will provide the measurements, and it will become a notion of whether or not it was a best practice in terms of evaluation. And very much, as he was indicating, don't say they have to be ethical, per se, but show that they set forth their values and live them. It's an internal matter, and it will be judged on terms of whether or not evaluated properly. The second thing in terms of success is vocabulary. Vocabulary of good citizenship in these programs has become part of the fabric that it wasn't before, even internationally. I leave for the Slovak Republic on Saturday, and I will talk in terms of the federal sentencing guidelines. Not to say they need to follow - because they don't need to follow in Slovakia - but because it's a good framework, and it's an endorsed framework by the H&HS, by the Air Force's voluntary disclosure program, and these sorts of things.

It's hard to prove, many cases, the best things. In the evaluation community that I'm part of, it's hard to prove the really good aspects of things. It's the harder numbers, the harder facts you can get that are not the important ones sometimes.

JUDGE CASTILLO: If there are no other questions, I want to thank you all. We will proceed to our second panel.