by Robert I. Cusick

Robert I. Cusick is director of the Office of Government Ethics in Washington, the Executive Branch agency charged with preventing and resolving conflicts of interest and fostering ethical standards for government employees. Appointed by President Bush in 2006, he serves a five-year statutory term. This column is drawn from a speech he delivered in Melbourne, Florida, on April 14, 2009.

Over the past few months we have been overwhelmed with news of foreclosures, financial recession, huge public debt, and widespread social problems resulting from job losses. For many months we have lived under a foreboding cloud of numbers, amid a prevailing sense that no one really knows what to do.

But before banks failed — before they admitted that billions of dollars of their putative wealth were toxic assets, before AIG’s reputation crumbled, before our national debt expanded so drastically — there was another failure, one that was not to be measured in numbers. It was an ethical failure of enormous proportions.

Much of that failure was connected to conflicts of interest. Corporate directors and officers and investment bankers, who stood to gain so much from ethical compromise, found it easy to mischaracterize the real risk of investment vehicles. By misrepresenting lending practices, they exposed the companies and the shareholders they putatively served to risks contrary to their fiduciary duties. Short-term gains — or at least the appearance of gains — were more important than long-term integrity. Numbers, points on the board, were everything. Hubris and arrogance found a fertile field in the absence of firm ethical standards. Such leaders as existed in the financial industry allowed themselves to be distracted by “innovative” new products, higher short-term profits, and pleasing numbers. They did not lead with integrity — the integrity to acknowledge the illusion of wealth they had built. As a result, trust in these institutions now has failed, and “distrust,” as Ralph Waldo Emerson said more than a century ago, “is a very expensive thing.”

Let me be clear: I am not an economist. I do not speak for the administration. I regulate no one in the private sector. But the work I do with the Office of Government Ethics (OGE) produces a certain way of thinking, and it is from that perspective that I speak. That thinking has led me to my own definition of government ethics as that system of laws and procedures that tends to ensure that official government decisions are informed by the public interest and not corrupted by private interests. The core of that system is the identification and disclosure of conflicts of interest, along with measures to remove or remedy them. Accountability and transparency are the cornerstones of our effort.

Why do we at OGE care about conflicts of interest? Because while some people can make principled decisions uncorrupted by a desire to feather their own nests, others cannot. But which ones are they? Our experience and instinct tells us that we cannot know. It would be much easier to appoint government officials without considering possible conflicts of interest. But because public trust is the lifeblood of democracy, it would not be easier to govern.

In the private sector, however, many businesses regularly hire people with little thought to possible personal conflicts of interests. Yet there, too, such conflicts tend to produce detrimental effects. They can neutralize or impair free-market forces. They can result in contracts to engage less competent individuals or to produce products of less than the best quality. They can distort budget planning and make economic analysis less predictive. They can bestow economic power based on relationships rather than objective analysis. They can require rationalizations of inappropriate risk taking. And they may be cloaked in levels of complexity — as in credit default swaps or securitized debt investment packages — that create disincentives for transparency.

Under our national financial recovery efforts, these effects are less clear than they once were. Suppose a prospective Treasury appointee has a perfectly legal bank deposit of $400,000. If that official might participate in discussions about whether to “bail out” a bank, then does such a large account — in excess of the $250,000 limit that the Federal Deposit Insurance Corporation (FDIC) guarantees — present a possible conflict of interest? Are federal officials who supervise lending to such a bank able to act with ethical clarity when the federal government, as a majority shareholder, is almost indistinguishable from a private investor? Should these supervisors think only as government officials, or should they incorporate private-investor thinking as well? Exactly where is the distinction between private-citizen thinking and government thinking?

We at OGE, along with 6,000 ethics officials across the Executive Branch, are working our way through these shifting analytical sands. From our point of view, there are three essential elements in an ethical organization: A code or set of principles that is enforceable, ethical leadership of the organization, and an ethical culture that arises from the first two. I believe that for the financial recovery effort to be firmly grounded, these three elements should be required of every organization that comes under government supervision.

But promoting these elements cannot be a solely federal effort, particularly since virtually every corporation in the country is incorporated under state rather than federal law. Board members need to be addressed more directly by state government about their duties to shareholders. At present, their level of communication with shareholders (other than large institutional shareholders) is almost nonexistent. That is especially true as concerns the compensation committees of boards of directors. In the financial sector, the lack of transparency and failure of accountability have been particularly evident. Many funds have sold themselves to clients in a way that emphasizes a lack of transparency. While the name of Bernard Madoff is most prominent, dozens of other investment funds pride themselves on obscuring what they do except for the result. Can this be tolerated any longer?

Even prominent financial executives are admitting the need for greater regulation and for a serious effort to establish higher standards of behavior. If this effort does not arise from the common sense of influential, experienced members of the industry, it surely will be imposed from outside. National anger and government response cannot be ignored. Ethical leaders must emerge. Enlightened cooperation among government and private sector agents, as well as nonprofit bodies that long have tried to improve corporate governance, must be undertaken to produce organizations more immune from the lobbying pressures that bedevil legislative efforts in this sector.

Recovery cannot depend on regulation alone. But neither can it depend on corporate structures shot through with conflicts, secrecy, and disregard for the public interest. Such destructive power must be tempered by a new sense of ethics. The financial industry has created its own conflicts for itself. Ethics rarely thrives in secrecy. Ethical analysis is rarely served while participants are seated around a table stacked with shareholder cash. Ethical culture rarely grows in a group that feels itself immune from oversight.

The rules and regulations established at OGE are not easily transferable to the private sector. But the ethos that underlies them, especially in regard to conflicts of interest, should be studied in restoring integrity to the financial system.

©2009 Institute for Global Ethics

Rushworth Kidder is on vacation. His column will return next week.