The Law Office (LO) and Compliance Officer (CO): Status, Function, Liabilities, and Relationship

Tamar Frankel is Professor of Law Emerita at the Boston University School of Law. This post is based on a recent paper by Professor Frankel.

The emerging position of Compliance Officers (COs) poses issues concerning their status and relations to Law Officers (LOs). Both professionals deal with law, However, LO’s position is recognized and established. Compliance is a recently recognized profession. Moreover, their services differ.

LOs advise and represent their institutions in legal matters. COs monitor their institutions’ activities for violations of the law and help prevent violations. LO is telling managements what they can do. CO is telling managements what their institutions should not do. Compliance programs might reduce corporate legal risks, but, may conflict with short-term business considerations. COs cannot shelter their corporation’ information, as LOs can. Arguably, LO’s focus on clients’ legal interests; COs act to prevent client’s legal violations.

LO’s client is the corporation (officers, directors, employees, shareholders); CO’s client may include investors, the securities markets and even society. The SEC noted the importance of COs, the need for their empowerment and autonomy, and the desirability of the CO’s reporting to the CEO to demonstrate that compliance is important to the corporation’s management.

The Corporate Integrity Agreement entered into between Pfizer, Inc., and the Office of Inspector General of the Department of Health and Human Services required that the CO report directly to the CEO and the board of directors’ Audit Committee. The CO should not be subordinated to the LO but be equally powerful. Yet when the facts are unclear or controversial, or the rules are vague, who should decide, especially if the CO’s advice conflicted with that of the LO?

Is compliance a separate profession? The opinion of Mr. John Walsh, as the SEC’s Chief Counsel, Office of Compliance Inspections and Examinations, is that compliance is a different and separate profession. Mr. Walsh defined a profession by three features. A profession is (i) “an occupation, for which the necessary training is intellectual, involving knowledge and learning as distinguished from skill” (ii) “pursued largely” in the service of others (iii) and the amount of financial rewards for the service is “not the accepted measure of success.” Compliance satisfies all three features.

Compliance Requires a Significant Degree of Learning and Creativity. It poses demanding intellectual challenges. Regulating business is complex and changing, applicable to unpredictable situations. Compliance rules are usually stated as general duties, rather than bright-line directives. Therefore, they require interpretation and application to particular, often unpredictable circumstances.

Professionals should understand changes in their area. Since the 1940s financial regulations were based on separate regulation of various intermediaries, including banks, credit unions, brokers, securities markets, mutual funds and advisers. Their regulations addressed the problems they posed. Throughout the years the boundaries between these intermediaries have been loosened. Functionalities and services were combined; in new structures. Most of these changes took place during the 1980’s and 1990’s. But they had effects for years thereafter. Consequently, the task of a competent navigator of today’s regulatory systems is a far more complex than it was and requires a high level of expertise.

Mr. Walsh noted that President Roosevelt took office during an economic crisis. Instead of controlling the securities industry, President Roosevelt “wanted the securities industry to be governed by ‘a simple code of ethics’ and “wanted to elevate its character, honesty, and honor,” “Only when business was conducted in this fashion, only when the public’s trust was morally justified, would confidence and prosperity return.” According to Mr. Walsh, “if there is any group in the modern securities industry that is ready to meet this ethical challenge, it is compliance.”

Like medicine compliance aims at prevention. Most compliance situations do not deal with violations that have occurred but with possible situations that may result in violations, like modern quality management: be “right the first time,” rather than catch and correct errors. “Waiting for problems” is not an adequate approach. An integral part of the institution’s routine and operations is “training line employees” to “understand the difference” between “conforming and nonconforming output.” “Education, training, and awareness are key elements.” These elements as well are the fundamental features of a profession.

A Profession Consists of Providing Service to Others. Its focus is service, said Mr. Walsh; Success for compliance, is “quality” and “ethics”—the service of fiduciaries.

Compliance must focus on flaws in the institutional structure and patterns of behavior. Like most management problems, most compliance failures have systemic causes. The more common causes include “misguided compensation,” “unrealistic performance goals,” and “uneven supervision.” Business managers may treat “quality management” and compliance as “unproductive cost centers.” There are examples of businesses that slashed quality management to increase short-term profits, ultimately destroying the firm’s long-term franchise. Managements are not always convinced, however, until it might be too late. Expert professional service is a service whose objective is to leads to long-term success. This success is defined as client’s satisfaction and avoiding as well as eliminating defects to secure customer satisfaction.

Mr. Walsh believes that “compliance satisfies Justice Brandeis’s definition of a profession.” “Moreover, in these characteristics, we can see some of the professional standards that it should meet. The practice of compliance is an intellectual challenge that should be met through the exercise of expert judgment. Compliance should make sure the customer’s interests, and the customer’s perspective, are not forgotten.”

Mr. Walsh “disagree[d] with Justice Brandeis in one respect: The Justice’s “definition is incomplete,” “In addition to [the Justice’s three elements,] a profession should be aware of its status.” “To be truly professional, compliance’s special status must be recognized by its practitioners, by those who employ them, and by the members of the public who deal with them. All should respect the public interest that fills this work. Earning compliance that recognition and respect is part of our mission.”

The “dual-hatted” CLO/CCO Confidentiality Privilege. A senior research analyst, holding several securities licenses, traded ahead of the firm’s clients on ten separate occasions over a two-month period. The analyst made a profit of $50,000 on the trades. The “dual-hatted” LO/CO investigated the front-running allegations and concluded that the analyst did in fact engage in this conduct. The LO/CO recommended to the firm’s management committee that the employee be asked to resign or be terminated. The management committee agreed with the recommendation, but the employee refused to resign and his service was subsequently terminated. In the U-5 filing required by the SEC to deregister the employee, the LO/CO described “front-running” as the reason for termination.

The employee sued the firm for wrongful dismissal. During discovery, the LO/CO claimed that his discussions with others in the firm were subject to the attorney-client privilege. The analyst objected and the court found that the LO/CO had been acting as a compliance officer in that particular instance rather than as a lawyer. Therefore none of the LO/CO’s conversations were privileged.

Mr. Walsh described the characteristics of Compliance Officers as entrepreneurs. They have the “what next” mentality, excited about change and interested in the unknown. They are eager to know and learn rather than afraid of what they do not know. Continuous learning helps recognize problems and ideas for solutions. Like entrepreneurs, COs seek to create new ways of doing things, and are often more interested in the future than in the present or the past. However, their objectives differ. COs’ aim is prevention but the ways to achieve their purpose can be creative, and their awareness of changing reality leads to addressing the same problem in different ways.

Conclusion

The status of LOs and COs is a moving target. Therefore, this conclusion is a conclusive prediction. COs are here to stay. Their position and status are likely to strengthen. Institutions are likely to prefer internal COs to regulators’ visits. However, the problem of large corporations’ self-control of violations may not be resolved by COs, without the support of management, at the board and the divisional level. Most importantly, corporate culture may be a key to legality of corporate activities. Hopefully, both COs and LOs will contribute to a culture that achieves successful competitive operations under legal constraints, sensing moves towards forbidden actions, and taking prompt strong actions of stopping the movement in time.

The complete paper is available here.

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