by Rushworth M. Kidder

By all accounts, the world’s financial institutions are surging toward reregulation. But unless the new rules are set in a context of corporate integrity, they could make things worse. Here’s why.

The smartest guys in the room — the moniker for corporate hotshots like those who wrecked Enron and shattered their own careers — used to be the smartest kids on the playground. Back in third grade, ordinary kids followed the rules. These other kids found the loopholes. When the rules said, “Don’t run in the halls” and “Don’t chew gum,” these kids found ways to walk really fast and use tongues (rather than teeth) to avoid the definition of chew. Where ordinary kids saw rules as necessary annoyances, these kids took them as delicious challenges.

Back then, adults could have helped these kids understand the relationship between ethics and regulation. They could have explained ethics as “obedience to the unenforceable,” a term coined in 1924 by a British jurist, Lord Moulton, to distinguish the idea of morality from the principle of law. Adults also could have shared analogies about the usefulness of rules: As a former London banker put it to me recently, “Cars have brakes so they can go fast.” In addition, they could have developed in kids a sense of community beyond self, a moral commitment to doing right even when nobody’s looking. Finally, they could have explained that while any dolt can bend the rules, only the wise can maintain integrity and prosperity at the same time.

Would those lessons have crushed out the entrepreneurial wizardry of youth? On the contrary, it would have nested it safely within a moral conscience. In many cases, of course, adults did say these things. As a result, today’s financial community has a strong cadre of creative talent moderated by a sound moral compass.

But it also has its devil-may-care cohort. Dressed up as adults, but carting around a third-grade moral neutrality, that cohort is exceptionally bright. Their lust for challenges is almost Pavlovian: When a new rule comes along, they salivate at the idea of taking it apart, seeing what makes it tick, finding its flaws, and inventing a workaround. As in third grade, well-crafted rules serve only to inspire a more aggressive loopholism. Like computer hackers, for whom every new firewall is a chance to prove their mettle, they relish the gotcha game of one-upping the regulators. And like hackers, they find technology showering them with new products that regulation hasn’t caught up with yet.

What’s to be done? Start by recognizing that twentieth-century rule-making procedures won’t stand up to twenty-first-century pressures. As we learned from Sarbanes-Oxley, layering on rules without addressing ethics simply causes corporations to build extensive compliance operations. It does nothing to change thought. It doesn’t shift the balance away from those playing Masters of the Universe and toward those living by their values. Instead, it stimulates more rule bending.

So should we stop regulating? No. Deregulation has proved calamitous. Instead, we need to parallel every regulatory advance with concerted efforts to promote ethics in the marketplace. Research on this point, beginning with a string of surveys from the Ethics Resource Center in Washington, overwhelmingly points to the need to shift the emphasis from enforcing compliance to building cultures of integrity.

How can regulators foster such cultures? For starters, don’t make them mandatory. If Lord Moulton is right, that would reduce the unenforceable to the punishable — more rules and more loopholism. Instead, regulators should use their enormous moral suasion. From their bully pulpits, regulatory agencies can encourage financial institutions to recognize (among other things) four characteristics of such cultures. They are:

• Identifiable. They have attributes that any reasonable observer can spot. These include a commitment to the core values of honesty, responsibility, respect, fairness, and compassion, along with a decision-making methodology for applying them and the moral courage to put them into practice.
• Measurable. These attributes allow a culture to be compared to others in its field. These measures should not be imposed by external demand but arrived at through internal self-regulation.
• Replicable. These measures can be imported into other corporations and bring noticeable improvement. Business schools can play a role here in encouraging such replication as an effective management tool.
• Sustainable. Successful cultures of integrity make ethics a core part of the corporate mindset rather than a passing fancy.

What will the result be? No more Bernard Madoffs? Probably not. But Madoff and his ilk have given regulators a powerful ally: public moral outrage. If regulators work equally hard on each side of this two-pronged approach — creating rules while promoting ethics — they’ll tap into an enormous public yearning for integrity. Corporations that don’t get it will find themselves increasingly isolated, at the pointy end of piercing public opprobrium. Meanwhile, corporations who do get it will relearn an ancient truth: Rules alone won’t create an ethical culture, but an ethical culture makes it easy and natural to obey the rules.

©2009 Institute for Global Ethics

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