From: William Livingston [vitalith@earthlink.net]
Sent: Monday, February 16, 2004 8:39 AM
To: rule-comments@sec.gov
Subject: S7-04-04: Codes of Ethics
Mr. Chairman and Honorable Commissioners:
In proposed rule 204A-1 (IA-2209), you are soliciting comments on codes of
ethics designed to establish standards of business conduct reflecting the
fiduciary obligations associated with particular positions in financial
commerce. As a registered professional engineer (PE) and member of the
Institute of Internal Auditors (IIA), your attempts to use ethics, which is
intrinsically an effect, as a tool to obtain a separate corporeal effect
(deter fraud), have again triggered my professional duty to comment.
It is not just that, aligned squarely with millennia of history, the attempt to
stage ethics to achieve some mission objective is inherently futile. Devine
coronations around the world have produced far more tyrants than benefactors.
It's that this significant pursuit of the impossible diverts attention away
from viable means competent to attain your stated goals. Can corporate fraud
be deliberately averted? Of course.
Can fraud of any sort be averted by implanting, with regulatory fanfare and
flourish, a code of ethics? No regulator in history has ever been successful
in commanding ethics to achieve what its rules cannot. "These codes (of ethics)
should increase investor protection by forestalling supervised persons from
engaging in misconduct that defrauds clients." Not a chance.
The regulatory record of ethics as a cause of outcomes desired was summed in
1990 by U.S. District Court Judge Stanley Sporkin as he viewed the
scandal-caused rubble of the nation's savings and loans, "Where were these
professionals when these clearly improper transactions were being consummated?
Why didn't any of them speak up or disassociate themselves from the
transactions?" Does anything have to be changed for Enron?
The reason the record of ethics repeats is that natural law includes no
operative role for ethics in the linkage between cause and effect. This
intrinsic attribute has been recognized and accepted for centuries by many
guilds in many European countries and is clearly stated in their codes of
professional conduct. When any institution attempts to defy natural law, the
result it gets merely serves to exhibit the supremacy of the very laws it
strives to avert. The difference in litigation rates between the two different
treatments of professional ethics is striking.
The SEC, as with the collection of accounting guilds it regulates, is powerless
to alter the ethical grade it has received, affixed incessantly by its clients
and stakeholders, on the basis of past performance - and nothing else. The grade
is immune to Ipse Dixit argument. A functional twin of trust, ethics is
a variable - an attribute of conduct determined independently from the residuum
of previous conduct.
If ethics were a priori means, rather than an attribute contingent on
the result of means, the proposed rule 204A-1 would be commendable. Given its
premise, it is a well reasoned and constructed proposition. However, as a PE,
investing resources to defy natural law is Scienter - a violation of civil law
and the conditions of license. As an internal auditor, I am not held as an
uninterested bystander to this clear and present danger to the public. PEs are
forbidden to provide services in a context where ethics is held forth as a
cause. When ethics is misused, the error inserts a popular but fundamentally
wrong assumption that an ethical person will be more likely to win the
management of complexity lottery, a stab in the dark, than an unethical person.
If lady luck gave an intuition advantage to saints over sinners, Las Vegas
churches would be full 24/7. Casino operators need not be concerned.
Framework for comment
As you well know, in Daubert and progeny, the US Supreme Court
delegated the professional standard of care gatekeeper role exclusively to the
Federal District Courts. In the Ikarian Reefer decision, professional
engineers were bound as agents of the court as our first allegiance. The PE
asseveration is congruent with the responsibility of the court. Both must hold
the public interest (health, safety, and welfare) paramount. The engineering
profession is obliged (1) to determine when advances in the capabilities of the
process of engineering to resolve complexity (foreseeability) have become
material and (2) proactively notify and appropriately inform the court - as
its agent.
The rationale for this obligation and duty, unique among the various
professions, stems from the fact that the discipline of engineering is society's
functional custodian of the science and technology of method (complex problem
solving). It is the process of engineering, the methodology central to its
profession, which delivers the growing stream of artifacts that shape the world
we live in. Engineers are invisibly empowered in design. They silently transform
traditions but they do not know what the course of the transformation will be.
While the process of engineering is used to calculate the dynamics of a
particular and possible future, a design basis event, the science of
professional engineering can predict the actual future of Establishment affairs
no better than your retirement portfolio manager.
Ethics-as-proximate-cause doctrine
There are diverse independent ways to falsify the ethics as a priori
doctrine. One way is to apply it to the SEC. What can one conclude from the
long, punctuated record of achievements made by the SEC, given its noble mission
to prevent stakeholder damage by fraud? Was the SEC not the lead regulator
during the life cycle of the S&L scandals? Does not accepting ethics as
proximate cause drive the conclusion that huge persistent ethics deficits at the
SEC triggered the huge Enron wave of damage? Temporarily granting the SEC
as incorrigibly unethical, then, what on earth could Congress have been thinking
to instruct the SEC to set the legal code of ethics for the accountants? If the
SEC is not legally responsible for the Enron class scandals, it is clear, then,
that neither the law nor Congress hold regulator ethics as a cause of scandals
perpetrated by the regulated. I don't.
You can hold ethics as a cause of outcomes, as you wish. You can hold yourself
legally blameless for the repeated carnage of scandal cycles during your watch
to prevent them. What you cannot do is aver both at the same time. If ethics
does not cause outcomes, why the regulatory fuss over ethics as a means to its
mission? An ethical regulator would be attentive to the record set by the USSC
guidelines, offering huge financial rewards for compliance to ethical standards
as an input to operations. The recent example of ethical failure in Boeing,
perched for years at the top of the USSC good corporate citizen ethics
compliance class, is conclusive. So much for extravagant incentives to be
ethical. So much for the ethics police department.
Ethics for dummies
While the profession of engineering in the USA has maintained a code of ethics
for more than a century, the laws of man, to the PE, are a far distant second in
authority to the laws of nature. Engineering is not a subset of science. The
process of engineering is governed first and foremost by natural law. If the
design engineer fails to orchestrate in harmony with nature's laws for matter
and energy, no law of man will save him from catastrophe. When the system
designer aligns with and leverages natural law in fidelity to his compelling
purpose, no law of society can increase nature's reward. T.H. Huxley explained
the intrinsic relationship of the PE to natural law in simple terms.
"The player on the other side is hidden from us. We know that his play is always
fair, just and patient. But we also know, to our cost, that he never overlooks a
mistake or makes the smallest allowance for ignorance. To a man who plays well,
the highest stakes are paid, with that sort of overflowing generosity with which
the strong shows delight in strength. And one who plays ill is checkmated -
without haste, but without remorse."
When your supreme commander is omnipresent natural law and stinging complexity
is in your face, ethical purity is the least headache on your plate. Saint or
sinner, natural law is deaf to persuasion. Although all men are governed equally
by the laws of nature, only the PE is legally bound to forego attempts to defy
them. While the court is well aware that, as a group, PEs can make no claim to a
superior brand of moral nature, no character references are necessary to
establish trust and reliability. Ethical purity of the profession derives from
the simple fact that engineering design governance is provided automatically by
natural law - all else being crash and burn. When the process of engineering is
fully connected and coherent with natural law, it inherits the ethics-oblivious
attribute of natural law.
Attempts by the PE to defy natural law are deterred at the source by
self-assessment and the instant ridicule of guild members. Natural law is the
world's most viscous tar baby. The more you try to impose your will over its
precepts, the more you will be held fast to failure. If your peers don't get
you, the lawyers will. Why bother.
The users of engineered artifacts, preoccupied with performance expectations,
are aggressively uninterested in the ethical ranking of the design engineers. As
a profession innately in conflict with tradition, engineering is universally
despised by society - except during a war the country fears losing. To
conventional institutional affairs, the process of engineering is heresy. The
ethics of a practitioner counts as much as the church would consider during
condemnation of its blasphemers. The PE encounters indifference to his character
and odium towards his methodology throughout his career. He gets over it.
System dynamics are governed by the laws of nature, making no distinction
between systems of metal and systems of flesh. Character and reputation,
individual or organization, are independent, unrelated variables. No better
example of this reality is the development of powered flight by the Wright
brothers. Only after alignment with natural law, demonstrated by controlled
flight itself, could their protracted mess with societal law even begin.
Ethics in methodology
There are but two methodological systems. All other arrangements of procedure
are transient and explosively unstable. Regulation by rules of action represents
one method class - business as usual. The process of engineering represents the
other method category - goal-seeking (problem-solving). The two systems, each
stable and self-sustaining, are organizationally incompatible. Individuals
exchanged from one methodology context to the other instantly adopt the new
culture for selecting activity - one expressly forbidden in the environment they
just came from. It is easy to show that in both systems, rules or goals, ethics
has no role.
Anytime the ethics of others is the pre-excuse for mission failure, it is
conclusive proof that the mission is rules-driven. Outcome will be ministerial,
determined by the rules of business as usual. This means that the results from
one period of activity will not be used to influence the menu of activities for
the next period. When only rules matter, as presumed intent, both goals and
consequences are immaterial. This is the platform of regulation and compliance.
The inspections performed by the SEC on the regulated do not include an
evaluation of ethics in fieri. The audit is performed on compliance to
the rules of action. If the client is compliant, motive for compliance doesn't
matter. If the client is not in compliance to your regulations, motive for
non-compliance doesn't matter. If the next wave of Enron class scandals is
in fieri, regulatory process, by virtue of its inherent limitations, is
helpless to detect it. Early warning signs by the National Association of Fraud
Examiners are already flying.
Ethical savings accounts brought in by the newer employees are steadily consumed
by mindless compliance to institutional norms. In time, only the rules remain.
Recognition of the relentless organizational propensity to deplete ethics is the
reason for the "safe harbors," business judgment rules, caveats, disclaimers and
burdens of proof strewn about your regulatory dominion. These escape hatches for
unethical conduct are essential to preserve business as usual. If you made the
existence of unethical conduct illegal, there would be no one left to regulate.
In any goal-seeking enterprise, ethical bank accounts are increased by due
diligence for progress. Advances towards the objective give rise to improvements
to move towards the goal. Success in attainment reinforces the methodology
responsible. Efficiency, productivity and effectiveness speak for themselves to
the ethics paymaster. If you wish to enlarge your ethics account, increase your
goal-seeking competency. All else fails.
Stepping up to the plate
The SEC can readily prove that regulation can meet its promise to the public and
avoid the ethics quicksand. Guarantee to the regulated, in praescenti,
that check-list compliance to your rules will obliterate the risk of corporate
liability (statutory, contractual, civil) and defend against complaints of
ordinary negligence, whether comparative, contributory or imputed. Your
clientele will not need to obtain liability insurance. Regulatory offense is
defined by regulations, rather than by statute. As long as obedience to your
rules assures attainment of your goal, the intractable issue of ethics and moral
values is bypassed entirely. It is the ministerial scheme so successfully used
by Henry Ford to mass-produce automobiles - unaffected by employee turnover
rates that often exceeded 250% per year.
Fatal problems in coherency emerge if you promise anything less. For whatever is
remaining in corporate liability from what you warrant preempted by regulatory
compliance, you absolutely must waive strict obedience to your rules. The
organization needs release to take whatever actions are necessary and sufficient
to avoid leftover liability, tort in particular. Remember that your rules of
regulation comprise a methodological system incompatible with the method system
benchmark (foreseeability) applied retroactively by tort court. If you demand
strict rule compliance, you are forcing the regulated right into the malfeasance
defined by tort court. The colossal success of tort litigation for plaintiff,
called the litigation explosion by the media, is being sustained by this
Hobson's choice. The purpose of your system is what it does.
Ethics as a reflection of judgment
The PE gets his indicia on project ethics, as a basis for assessing the
prospects for project success, by taking measurements of the context during the
occasions of exercised judgment. There are logically sound occasions for
judgment and there are situations where inserting judgment where
knowledge-development should trod is gross professional malpractice. When
judgment must fail, ethics doesn't matter. No issue in management has
changed more dramatically in the last five years than the legitimate window for
exercising "judgment." The reason the PE is ultra sensitive about the use of
judgment is simply that his upwardly mobile standard of care now forbids it. In
principle, there is no difference between management and engineering in the
prudent application of judgment for the assault on complexity.
The legitimate use of judgment in its various forms, including whimsy, caprice,
intuition, and guess, is strictly governed by the size of the field of
ignorance, the practical capability to reduce it, and the consequences of error.
The field of ignorance for a coin toss, for instance, gives judgment an even
chance. If there are ten candidates for the one-man suicide mission, judgment
will select a longer straw 90% of the time. The reach and stab of judgment,
however, remains constant.
As the field of ignorance grows in acreage, the odds that the same reach and
stab of judgment will land on what turns out to be the appropriate selection,
progressively reduces. The grip of this reality hits home by virtue of the
mathematics of complexity. The size of the field of ignorance is a function of
the quantity of complexity in the sphere of interest. The selection of the
winning numbers in a big-prize lottery is a common example of the exceeding
limits of judgment and its ethics companion. Wizard or moron, saint or sinner,
the chances of winning the lottery by judgment peg at naught.
In modern practice, the use of judgment is never a close call. The reason is
that complexity grows exponentially while the span of appropriate judgment
remains frozen. Take, as a common example, the situation where your chief
executive responds with "I won't describe what I want, but I'll know it when I
see it." If the chief says he wants a particular graphical pattern on a display
20 pixels by 20 pixels, your task is to expose the client to possible displays,
one by one, until the one he wants is presented. The fly in that approach is
that the number of possible unique displays in a 20 by 20 array, is already
larger than all the atoms in the universe (10 to the fiftieth power).
Inappropriate judgment is a hardcore issue. When the only resource available to
deal with complexity was the information processing power of the human brain
(1940), the only practical way to make up the difference in corporate affairs
was judgment. The point has long been past, however (1965), where the gap
between the feeble capacity of judgment and the robust complexity of issues
confronting society presents a reasonable risk to the public. As the complexity
of commerce increases geometrically and compounds, the preservation of society
requires more proficient means to deal with complexity. It can be shown that the
greatest portion of growth in societal complexity experienced, is a direct
result of advances in the process of engineering to manage complexity.
In a reinforcing cycle with the democratization of technology, the practical
ability to conquer larger complexities is manifest in a growing stream of
sophisticated engineered artifacts ingested by society. As society thereby
complexifies, the necessity for more capability to assault complexity increases.
From the benchmark of success with complexity, the limits and deficiencies of
conventional practice with complexity become painfully obvious.
Because the capability to successfully assault complexity in the extreme
quantities attending contemporary affairs now exists and is propagating, the PE
benchmark is permanently locked on success, no excuses. At this time, the growth
in complexity confronting society and the advancing capability of the process of
engineering to deal with complexity, are on the same page - far beyond the
limits of hierarchical, rule-based processes. While business as usual serves as
the gold standard for regulation, the standard of care set by the tort system
keeps pace with the capability of the process of engineering (foreseeability).
With business operations being conducted on a regulated basis that is illicit,
by definition, with the legal standard of care used retroactively to assess it,
the arrangement is inherently unstable. Traditions are in transition.
Conventional practice cannot remain so.
Wrapup
The significance of ethics to SEC regulation is established by its own habits of
action. When the matter of compliance to rules of action is primary, ethics is
irrelevant. As compliance can be delivered by any character disorder, including
average, so can non-compliance. The thesis of this commentary is that a focus on
ethics is a diversion of substantial regulatory resources to a known black hole.
It has always been a mystery to the PE why other professionals, in Scienter or
not, would opt to invest their efforts in a counterproductive approach. Why
would it not seem prudent to an ethical regulator to collude with the other
segments of law comprising total corporate liability? What parts of the law are
responsible for providing bright lines to the regulated so they know where the
benefits of regulatory compliance end and certain liability for tortuous damage
begins?
The case showing that ethics is also irrelevant to methods successful with
complexity, mentioned above, will be submitted.
The SEC is to be commended for providing a convenient arrangement for
contributing commentary to your world-class rule making efforts.