Making a decision in conflict with the law can have a devastating impact on a company. Not only is the decision maker at risk for fines, penalties, and even imprisonment, but the very survival of the organization can often be at stake. The giant accounting firm Arthur Andersen was forced out of business due to its mishandling of the audits of Enron, even though the criminal conviction was overturned by the United States Supreme Court.[1] Enron itself was devastated by the fraud committed by its management. No decision maker should ever want to put their organization into such a position. It is important to remember the famous legal saying, “Ignorance of the law is no defense!”. One of the first data gathering exercises a decision maker should go through when making a critical decision is to catalogue the legal issues surrounding a decision. It may be advisable to utilize various outside experts including lawyers to clarify the legal limitations and rule out potentially illegal choices.
In an ideal world, illegal choices would not even be considered. Sometimes an illegal choice is inadvertently made. If a decision-maker finds this is the case, or a previous decision was found to be illegal, consulting an attorney is absolutely necessary to find the proper course of action.
The Legal and Regulatory Environment of the United States
We continue our discussion by reviewing the legal environment a decision-maker might encounter, using the United States legal structure as an example. The legal structure of the United States is a complicated one based mainly on several historical factors. Decision-makers need to take into account federal, state and local legislation and regulations issued by the various levels of government on a particular topic. The United States federal government is one of enumerated powers set forth in its Constitution. The federal government has preeminent powers in such defined areas as interstate commerce, bankruptcy, the Post Office, etc. All other powers remain with the states and their political subdivisions. In more recent years, states and even cities are becoming more and more active in major areas of business regulation as exemplified by environmental and privacy laws enacted by various states. For instance, the State of California has adopted digital privacy laws that are fast becoming the norm in the United States. Other States are following California’s example. The European Union has already acted in this arena as well. New York City has banned the sale of “jumbo” soda containers as not being healthy. Such legislation presumably falls under protecting the health and welfare of its citizens, a power primarily falling to the States under the U.S. Constitution. Many states and cities have banned the use of plastic straws as being environmentally hazardous.[2] New Jersey has just banned the use of plastic bags by retailers of certain size. This trend will continue, and the decision-maker needs to be on the look-out for such legislation.
Regulations issued by governmental agencies continue to grow. The term regulation is used here in its broadest sense to encompass not only formal regulations but also other authoritative guidance as well. Legislatures will often not “get into the weeds” and will delegate some of its legislative power to independent agencies or executive departments. Legislative bodies will often express their intent in legislation and require a regulatory body or agency to provide detailed rules implementing the legislation. An example of independent agency regulation is the Securities and Exchange Commission (SEC) rules dealing with financial reporting. Regulations S-X and S-K, the integrated accounting and disclosures rules for public companies were not legislated by Congress but do have the force of law in the United States. A company selling its securities across state lines would run quickly run afoul of the SEC if it did not adhere to these regulations. An example of an executive agency issuing regulations is the Secretary of the Treasury issuing federal income tax regulations to implement the Internal Revenue Code of 1986, as amended. The IRS makes other authoritative pronouncements including Revenue Procedures, Revenue Rulings, Technical Advice Memorandums, etc. Regulations implementing state laws are promulgated by state agencies as well.
Finally, court decisions will often impact organizations by setting new precedents. The United States follows a common law tradition, where court decisions establish precedent and interpretation of the law. An example of this is several court decisions have in effect created tax law in the United States. Regulatory decisions interpreting legislation are often given great deference by courts since they are often populated by experts in the particular field. However, there is a minority view amongst jurists less deference should be paid to regulatory body decisions as it is the purview of the court systems to interpret the law and not regulatory bodies. Only time will tell if this will become the majority view in the United States.
Corporate Social Responsibility
Organizations and decision makers also need to consider social responsibility and social justice issues. A relatively recent example of a social justice issue is the amount of executive pay and the disclosures required in proxy statements about it as a result of the Dodd-Frank Act in 2002. These include the non-binding “say on pay” vote and the controversial pay ratio disclosure in a company’s proxy statement.
At one time it was thought a business organization had one responsibility: to make the highest return for its shareholders. Milton Friedman, the Nobel Prize winning economist and a leader of the “Chicago School of Economics” was a major proponent of this doctrine. Modern management theory holds the organization and its management owes some responsibility to its stakeholders. Stakeholders is a broad term encompassing those who have a distinct interest in the operation of an organization. It includes such groups as customers, vendors, employees and the general public. Sustainability and the green environment movement are examples of the recent drive for businesses to become good citizens. These considerations impact very basic decisions in an organization such as the type of flooring being used. Bamboo flooring has become a popular alternative as being both “green” and “sustainable”. Ignoring these issues today in decision-making is simply impossible, and potentially wrong from the moral perspective. The Financial Accounting Standard Board has announced it will be looking to see if it should set authoritative sustainability accounting standards for the United States.
[1] Arthur Anderson v. the United States. https://www.law.cornell.edu/supct/pdf/04-368P.ZO
[2] This is a controversial decision among the disabled community.
Mark Koscinski CPA D.Litt. 