SARBOX AND THE DILEMMA OF THE EMPLOYEE-PROFESSIONAL

Gwendolyn Yvonne Alexis, Ph.D., J.D.Associate Professor of Management

Leon Hess Business SchoolWest Long Branch, New Jersey 07764 U.S.A.

galexis@monmouth.edu

Track 18. Innovative Work Behavior – the role of corporate culture as a link between personal characteristics, interpersonal relations and job characteristics

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Aspirational Role Models?

• “There should be less emphasis on analytical rigor in business and more focus on training business students to become true professionals who adhere to a code of conduct and who are committed to an ideology which assigns business a role in the betterment of society.”……. Harvard B School Prof Rakesh Kurana, quoted in March 15 2009 article in New York Times (“Is It Time to Retrain B-Schools?”)

• Back in the 1950s, the Ford and Carnegie Foundations examined ways to improve business schools and recommended that “business become a true profession, with a code of conduct and an ideology about its role in society”

• These recommendations make sense given the traditional characteristics of a profession:

Certain Level of Specialized Expertise (acquired after advanced study and training)

Allegiance to a Specific Code of Ethics (with moral and professional standards) Autonomy in Carrying out Work (independence of action, self-determination)

The Professionals

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HOWEVER, TRADITIONAL ENTREPRENEURIAL PROFESSIONS HAVE LEFT SOLO PRACTICES AND SMALL PARTNERSHIPS TO BECOME SALARIED CORPORATE EMPLOYEES

Goodbye, Perry Mason! Hello, Corporate Legal Department!

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Consequences of New Habitus • No Longer Entrepreneurial Professionals Servicing Their

Own Clients– In corporate setting, independence of action associated

with professional careers is completely absent– Employer Establishes Guidelines and Implements Procedures

Governing Work of its Employed Professionals• Profit-Maximization Goals of Corporate Employer Can

Conflict with Professional Responsibilities of Employed Professional

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Role Strain

Role strain occurs when a single status, such as in-house accountant, results in a person having conflicting roles.

Accounting Employee Accounting Professional

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Role Strain: The Fannie Mae ExampleRichard Stawarz, Director for [Fannie

Mae's] Accounting and Audit, told OFHEO that in 2003, before controls were enhanced in compliance with the Sarbanes-Oxley Act, he was unaware of any requirement for either the reviewer or approver to understand the purpose of a journal entry or to verify that such an entry was valid**

What Professional Standards?

**Office of Federal Housing Enterprise Oversight (OFHEO), Report of the Special Examination of Fannie Mae (May 2006).

FANNIE MAE CORPORATE CHARTER

THE CONDUCT OF INTERNAL AUDITORS ARE TIEDTO PROFESSIONAL STANDARDS SUCH AS THOSE PROVIDED BY:•Standards for the Professional Practice of Internal Auditing•Generally Accepted Auditing Standards•Code of Conduct of the Institute of Internal Auditors

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Role Strain at Fannie Mae, Continued

The Bottom Line

Professional Oath

During period 1998 - 2004, Fannie Mae overstated its earnings by $6 billion. The bonuses based on these bogus profits went to high level management, not to the internal auditors who fabricated the numbers necessary for the higher echelon executives to receive bonuses.

Fannie Mae paid $400 million to settle lawsuit brought by S.E.C. solely on basis of failure of Fannie Mae auditors to adhere to GAAP during period 1998-2004!

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‘Where were the professionals?’…..U.S. Congress during ENRON Hearings

They were In-House and thus no longer Gatekeepers!

Niklas Luhmann’s Systems Theory helps explain why this is a problem:• Luhmann posits society as the main social system from which

various subsystems differentiate themselves– A subsystem is delineated by the boundaries that close it off from the

overall system and that make it a distinct and separate from the other subsystems

• Both the social system (society) and the subsystems are systems of communication– communication within a subsystem takes place with only limited input

from its external environment (communication is used by a subsystem to constantly reinforce its own identity)

• Professionals who become corporate employees are ensconced in a subsystem in which communication is focused on economic success and financial statements are the means of communicating this success. In short, success is measured by the corporation’s ability to meet its monetary objectives. (And, in-house professionals are rated in terms of their contribution to meeting the monetary objectives.)

“How close are we to our quarterly goals?”

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Luhmann’s Systems Theory or System Differentiation

Max Weber theorized that bureaucratic efficiency could only be matched by establishing another bureaucracy that could command the same adherence to internal rules and structure; hence a “Securities Professionals Subsystem” might counteract an MNC Subsystem. SARBOX creates just such a subsystem!

System Differentiation within a

Secular Capitalist Society

MNC Subsystem

Legal Subsystem

Political Subsystem

Educational Subsystem

Religion Subsystem

Entertainment Subsystem

Family Subsystem

Government Subsystem

Professional Entrepreneurs Subsystem

Securities Professionals Subsystem

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“Securities Professionals” under the Sarbanes-Oxley Act of 2002 (SARBOX)**

• Public Accountants• Public Accounting Firms• Investment Bankers• Investment Advisers• Brokers and Dealers• Attorneys• Other Securities Professionals practicing

before the Commission**Section 703(a)(1) of SARBOX

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SARBOX: Specific Provisions Aimed at “Securities Professionals”

CHALLENGES SUFFICIENCY OF SELF-REGULATION OF PROFESSIONS IN THAT IT DIRECTS THE S.E.C. TO GIVE AN ACCOUNTING OF JUST HOW MANY OF THE SECURITIES PROFESSIONALS WHO WERE “AIDERS AND ABETTORS” DURING CRUCIAL 1998-2001 PERIOD MANAGED TO ESCAPE ANY TYPE OF DISCIPLINARY ACTION (§703)

• Takes skilled professionals to concoct the schemes and prepare the paperwork that enables financially troubled corporations to maintain a façade of prosperity. Accountants and attorneys play central role in what disclosures are made in financial reports filed with the S.E.C. and released to public through EDGAR system.

CALLS UPON THE S.E.C. TO ISSUE RULES SETTING FORTH MINIMUM STANDARDS OF PROFESSIONAL CONDUCT FOR ATTORNEYS PRACTICING BEFORE THE S.E.C. (§307)

REQUIRES ATTORNEYS TO REPORT EVIDENCE OF VIOLATION OF THE SECURITIES LAWS TO THE CHIEF LEGAL COUNSEL OR CEO OF A COMPANY AND, IF NECESSARY, TO THE AUDIT COMMITTEE OF THE BOARD. (§307)

• Mandatory Whistleblowing for attorneys as well as accountants.

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SARBOX: Its Benefits Supplies Guidelines for protecting the public interest from the

Costs/Benefits Analysis of the MNC

Links Privilege of Practicing a Profession with Obligation of Adhering to Specific Professional Standards

Makes it Clear that Duty to Adhere to Professional Codes of Ethics Stays with the Individual even when Ensconced in the Corporate Setting

Co-opts in-house Accountants and Attorneys as Internal Watchdogs

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SARBOX: Its Limitations• Aimed at Protecting the “Investing Public” Only.

– Fannie Mae case showed that luring investors is only one of the motives for inflated earnings statements; enabling executives to qualify for bonuses was major impetus in Fannie Mae

• Primary Focus is Corporate Disclosure and only Incidentally Professional Ethics– Financial Statements filed with S.E.C. jurisdictional basis

• Reaches only Companies with Publicly Traded Stock– Hence, does not affect all in-house professionals

• N.B. Any multinational company that is listed on the American stock exchanges is required to comply with SARBOX.

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Need for an External Authority

• With so many accountants and attorneys employed by corporations or affiliated with mega-sized partnerships that operate as “professional corporations,” it has become increasingly important for them to have an external authority (external to the corporate employer) that will:– Empower them to adhere to the professional codes and ethics

standards that they swore to uphold upon entering the profession; and

– Ensconce them within a communications subsystem (e.g., the “securities professionals subsystem”) that is not dominated by utilitarian principles and goal-rationality to such an extent that there is no place for value-rationality and deontological principles that have traditionally been the hallmark of professionalism.

• The pre-emptive federal standard for professional conduct established by SARBOX effectively accomplishes these two goals.

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GovernmentalityThis suggests that another beneficial theoretical lens is Foucault’s theory of “Governmentality” which states that Government is about the conduct of conduct.In a piece in which he draws on this theoretical

perspective, Nikolas Rose describes Governmentality as “the deliberations, strategies, tactics and devices employed by authorities for …. acting upon a population and its constituents to ensure good and avert ill.”

Nikolas Rose, 1996. ‘The death of the social? Re-figuring the territory of Government’. Economy and Society 19/1: 327-356; 328..

The End!