December 2003

by Jon Entine

Jon Entine looks at the growing trend for large corporations to employ an ethics officer, focusing on the US defence industry.

Frank Daly has steered an unusual career path. A devout Catholic, the Boston native went to seminary before going to Rome to study at the Gregorian University. He became a priest and for eight years served as an assistant pastor. For a time, he was a university chaplain. He dedicated his life to living in God’s reflection.

So how did Frank Daly end up as a corporate director at Northrop Grumman, the southern California-based defence contractor, which employs more than 100,000 people? Daly is an "ethics officer," one of a new generation of corporate managers who believe that "business ethics" need not be an oxymoron. He’s also chairman of the board of the Ethics Officer Association, based in suburban Boston, the world’s largest multi-industry peer organisation for ethics and compliance practitioners (www.eoa.org).

An ethics officer? After all, isn’t business war? Or as professor Theodore Levitt wrote in the Harvard Business Review in 1958, "Business must fight as if it were at war. And, like a good war, it should be fought gallantly, daringly, and above all not morally."

Renewed focus

Times have certainly changed. The renewed focus on corporate ethics came in response to the avalanche of law suits that accompanied the business scandals of the anything-goes 1980s. The movement to hire ethical officers gained steam with the extension of the Federal Sentencing Guidelines to executives in 1991, which opened the possibility of huge civil fines against corporate officers, and even jail time, on account of wrongdoing by subordinates. That extended even to boards of directors. Considering the spate of ethical debacles in recent years involving Enron, Tyco, HealthSouth, WorldComm, Citibank, Arthur Andersen and much of the securities industry, the law has come in handy.

Ethical officers are a huge step forward from the so-called vision statements and ethical code of conducts that became so fashionable, particularly among entrepreneurial firms. Today, almost every company has one. They usually read something like this: "Every employee is educated about the company’s vision and values and is expected to conduct business with other employees, partners, contractors, supplies, vendors, and customers with respect, integrity, open communication and access." Judge its worth; that was Enron’s code.

Corporations are learning that ethical programmes can avoid expensive litigation and keep skeletons off the front page of The Wall Street Journal. Under the sentencing guidelines, companies that have established serious, sophisticated programmes can catch a break when they do step over the line. For instance, after being convicted of an ethics violation, Sears had its fine reduced from US$100 million to US$60 million after the prosecutor determined that the programme it had in place was not just paper, it was real. The relatively small investment to keep one’s corporate nose clean burnishes a company’s reputation and can pay off handsomely in employee loyalty. That goes right to the bottom line.

Defence industry

Surprising to some, the defence industry has been at the forefront of the ethics officer movement. During the 1980s, it faced enormous public relations and financial fallout from the "Ill Wind" defence industry scandals. The media was filled with embarrassing stories about huge cost overruns, symbolised by toilet seats and hammers costing hundreds of dollars. In what many people believed was a public relations move, President Reagan appointed the Packard Commission to study procurement fraud. That outcome was groundbreaking legislation. One of its key recommendations was that defence contractors as an industry should put together a self-governance programme that would enable them to set-up ethics programmes that educated their employees and meet their contractual obligations to their customers, which in most cases was the US government.

Today, by almost any ethical measure, the defence business in the United States faces far fewer scandals than almost any other part of American business landscape – certainly fewer than the communications, financial and health industries, which have a "get out of jail free" card from the misguided Socratic judges of the so-called ethical investment community.

"The goal of an ethics officer, my goal, is not only to insure that that we are operating in legal compliance but that we bring a strong, personal sense of values to our everyday experience in the workplace," says Daly. "Corporations are publicly-owned, after all. They no longer act – they no longer should act – as if they have no accountability. I think we’re making some real progress."

To many, this rings of public relations fluffery. But Daly is anything but a spin artist. After leaving the priesthood, he went to work in Massachusetts’ politics, first in the Michael Dukakis administration and then as an aid to former Senator Paul Tsongas. The ethics initiatives at Northrop caught Daly’s attention. He signed on as division manager of communications and public relations and was promoted to director of ethics and business conduct. Shortly thereafter, a crisis rocked the company, prompting an agonising appraisal of its corporate culture.

Fraud and conspiracy

In 1987, Northrop’s Pomona, California operation was making flight data transmitters for cruise missiles and sensors to stabilise the AV-8B Harrier Jump Jet. Northrop’s tests indicated that the parts functioned perfectly. But in the real world, both parts failed miserably. Operating on an anonymous tip, the FBI raided the plant, eventually charging 11 individuals and Northrop itself with 189 counts of fraud and conspiracy.

What had gone wrong? It turns out that Pomona engineers had long recognised that the equipment used to test the missile components occasionally malfunctioned. When this happened, they substituted a printout from a prior successful test. As for the Harrier Jump Jet, the chief engineer would later confess that they had falsified vibration level tests. Pomona managers say they felt pressure to find a way to pass the units even without adequate testing equipment. They had convinced themselves that their futures and millions of company dollars were on the line.

Ironically, and unfortunately for them, they were right. The Pomona plant was subsequently shuttered, most of the managers were fired and in 1989 Northrop paid a US$17 million fine.

Kent Kresa, then Northrop president and now chairman and CEO, was apoplectic. "This isn’t the case of a few rotten apples," he fumed. It was a corrupted corporate culture. "I think we have to blame our own process," he says. "It could be a problem in the future if we don’t stamp it out." Northrop employees at division headquarters in suburban Boston joined in the outrage at the betrayal in Pomona. "We found errors principally of management," Air Force investigators agreed. "Not so much of employees not being concerned abut ethical conduct but the failure of the management system to open these up, bring them to light."

Part crisis manager, part corporate theologian, Daly was called upon to do nothing less than address employee doubts about the internal ethics of the company and institute constructive, long-term solutions. He wasn’t looking for legal band-aids but to overhaul the corporate culture and introduce higher standards of accountability. The challenge tapped into Daly’s lifelong passion for personal responsibility. "We aren’t in the business of teaching people how to be ethical," says Daly. "We’re teaching ethical people how to make a good decision when it could be difficult."

No place to turn

It’s easy for any individual to say he or she would not cut corners when presented with the choice faced by the engineers in Pomona. But as with most real life dilemmas, the pressures can be overwhelming to those in the ethical crucible. They feared for their jobs and had convinced themselves that no-one would be the wiser for their short cuts. In fact, they had no place to turn – there were no clear company-wide ethical standards, no ethical hotline and no ombudsmen to whom to take their concerns.

Daly helped draw up a code of ethics that was both inspirational and practical – not just bromides about "doing the right thing". With the backing of Kresa, who navigated the crisis and was later named CEO of the merged Northrop Grumman, Daly oversaw the "Northrop Leadership Inventory", which attempts to evaluate the linkage of behaviour, values and leadership conflict resolution. To help employees make tough ethical calls, the company distributes guidelines that it calls "When to Challenge" and "When to Support". Employees can also call an ethics hotline, which is both confidential and responsive. Some 30 percent of the calls allege actual wrongdoing, about half of which check out. "Mostly, the hotline offers an outlet for employees to diffuse potential crises before they lead to unethical or unlawful behaviour," Daly says.

Daly believes that companies often go through a process roughly analogous to how people develop morally before setting up a serious ethics programme. They get in trouble. They get kicked in the butt, usually because of the sentencing guidelines. They get convicted of fraud or whatever and the company’s law department moves in, prepares a highly legal code and sets up a hotline and does initial and basic training for emloyees.

These are all necessary programmes, but they are far shot of what’s needed. What happens then, he says, is that many managers still say, "Well, you know, the rules don’t apply here," or "There isn’t a rule for this." Where does that person go for guidance then? And so they begin to see the need to develop something beyond the bare bones Enron-like verbal commitment to ethics. The key, Daly says, is corporate leadership. "What you need to develop is some sense of consensus within the organisation as to what the common values are. And that leads, for example, to looking again at the code that’s written in legal language because the code is not a legal document. It may be useful in a legal matter because it’ll provide you defence if you say you had a code, but it’s not a legal document. It’s a communication document."

Leadership

The next stage is strategic. "The whole organisation asks the question: ‘Is there an alignment between what the company does especially in the bid decisions and the values that they propose. Are they on the table, not just as another factor, not just as resources, human resources, money etc., but are they on the table as a ground rule that says this is how the company wants to be known.’ That effort is focused in leadership and it’s leaders who must create an open environment and model behaviour. It plays out a little differently in small and large companies."

At many corporations, crisis management, ethics and brand management are now closely intertwined. More than half of the companies in the Fortune 100 have serious programmes and are members of EOA. As recently as five years ago, says Daly, many businesses did not believe they had a duty beyond the minimum dictates of the law. "That just doesn’t work today. A small number of wayward employees can sink an organisation. For companies to survive, they have to learn to be pro-active in the grey areas of business. That’s where the tough decisions are made. That’s when ethics pays off."

Jon Entine is scholar-in-residence at Miami University (Ohio) and adjunct fellow with the American Enterprise Institute in Washington, DC.

Jon Entine is scholar-in-residence at Miami University (Ohio) and adjunct fellow with the American Enterprise Institute in Washington, DC. Jon is also an award-winning freelance journalist.