‘OMMENTS WELCOME-1/13/2023 5:24 PM II. ETHICAL FRAMEWORK ANALYSIS An Overview of Corporate Governance Corporate governance is the implementation of policies and procedures to moderate or minimize the risk of unethical behavior by organization members.” Itis a system of management and control that is intended to infuse accountability and trust in an organization.*° Corporate governance rules, practices, and procedures are most effective when they balance the needs and interests of the many different company stakeholders. At the board and officer levels, good corporate governance activities include having a board and slate of officers that are diverse in background and experience, practices and policies that ensure director independence and objectivity, and regular review of director and officer compensation.*? Payment of directors with at least some ownership interests is likely to ensure that they are invested in the long-term reputation and well-being of the organization. Aspects of corporate governance might include a formal ethics program for the reporting of questionable behavior, an articulated code of conduct or code of ethies, and * Kuldeep Singh & Deepa Pillai, Corporate Governance in Small and Medium Enterprises: A Review, 22 Corporate Governance 23 (2022). See also Lawrence J. Trautman, Anthony “Tony” Lupino & Malika S, Simmons, Some Key Things U.S. Entrepreneurs Need to Know About The Law and Lawyers, 46 TEX. BUS. L. 155 (2016), bitp/ssn.com/alystract=2606808; Lawrence J Trautman & Janet Ford, Nonprofit Governance: The Basics, 52 AKRON L. REV. 971 (2018), hntps://ssm,com/abstract=3133818, °° OECD, G20/0ECD Principles of Corporate Governance, OBCD Publishing (2015), tips, doi org/10,1787/9789264236882-en. § Aimee B. Forsythe, Six Essential Elements of Effective Corporate Governance, CAMBRIDGI TRUST (Jul. 24, 2018), hitpsi/ivww.cambridgetrust com insights/investing-economyisix- essential-olements-of-effective-corporate-gove. ia © Melody Camper, 10 Board Compensation Best Practices, Climbtheladder.com, Nov. 13, 2022, utps:elimbtheladder.com/10-board-compensation-best-practices © 2022-23 Lawrence J. Trautman, Page 17 All rights reserved Lanry Foster, Lora Koretz, Clyde McNeil, Eric Yordy & Ashley SalinasDRAFT-COMMENTS WELCOME-1/13/2023 5:24 PM formal training for employees on ethics.** In addition, corporate governance includes implementation of policies and procedures to reduce the likelihood of unethical behavior. Examples of these policies and procedures include ensuring that there is a paper trail for all financial transactions, that the trail of cash includes multiple individuals, and that no single individual can collect cash, report cash, deposit cash, and reconcile the accounts.** Corporate governance also includes personnel policies and procedures to ensure that employees are not supervised by family members and that relationships betw nm supervisors and supervises are not allowed (or that there is a process for reporting those relationships and altering reporting structures when they are reported).°° In some countries, corporate governance is largely a governed by law or nationally articulated principles, while in others corporate governance is the result of individual companies or industries setting standards to comply with laws related to securities, consumer protection, and similar fields.*” In the United States, minimum standards for corporate governance are the result of state law or federal securities law, primarily through the Sarbanes-Oxley Act of 2002.%* Title III of Sarbanes-Oxley, known as SOX, is entitled “Corporate Responsibility” and includes several provisions directly related to corporate governance practices.” Section 301 requires that the board of directors of any corporation registered with the Securities and Exchange Commission have an audit committee made up of all members 8 See Puget, FRAEDRICH & FERRELL, BUSINESS ETHICS: ETHICAL DECISION MAKING AND Cases 40-44 (12" ed.) 2019, id 1d, * OBC (2021), “OECD Corporate Govemance Factbook 2021", ups:/iwww.oeed.org/corporate/corporate-governance-gacrbook htm at 33 § Id, at 36-7. See also, Theodore O'Brien, The Bleeding Edge: Theranos and the Growing Risk of ‘an Unregulated Private Securities Market, 28 U, MIAMI BUS. L. REV. 404, 414, (2020). § SOX, hups:!/www.govinfo.govicontent/pkg/PL.AW- 107pub1204/himl/PLAW-107publ204 him, © 2022-23 Lawrence J. Trautman, Page 18 All rights reserved Lanry Foster, Lora Koretz, Clyde McNeil, Eric Yordy & Ashley SalinasDRAFT-COMMENTS WELCOME-1/13/2023 5:24 PM who “external directors” or not affiliated with the company in any way other than serving on the board.” This independent audit committee is directly responsible for selection and. oversight of external auditors." Section 302 requires that the chief executive officer and chief financial officer sign any financial statements and SEC reports and certify that they have reviewed the report and attest to the accuracy and fairness of the report to their knowledge." In addition, Section 302 requires that internal controls be established and maintained to assist the officers in the detection of any irregularities or inaccuracies in the financial statements and reports. Section 302 also requires officers to disclose to the auditors and audit committee any “weaknesses in intemal controls” including “deficiencies in the design or operation of internal controls." They also must disclose any identified fraud that involved management and other employees with a role in the internal control processes. The details of the internal control policies and procedures generally are lef to the company, but they must be reviewed and assessed regularly to ensure that they are sufficient to detect fraud.“* In designing and reviewing the controls, itis helpful to understand the theory behind why and how fraud occurs in organizations. One common articulation in © SOX Sec 301 1d. ® SOX See 302. 1d, Od. © Id, See also Neal Newman & Lawrence J, Trautman, Securities Law: Overview and Contemporary Issues, 16 OHIO ST. BUS. L.J. 149 (2021), hitp://ssrn.convabstract~3790804 1d, © 2022-23 Lawrence J. Trautman, Page 19 All rights reserved Lanry Foster, Lora Koretz, Clyde McNeil, Eric Yordy & Ashley SalinasDRAFT-COMMENTS WELCOME-1/13/2023 5:24 PM accounting and finance literature of the reasons fraud can occur is the three-factor “fraud triangle.” ‘The Fraud Triangle and Failures of Corporate Governance ‘The fraud triangle theory was developed to explain why some employees in positions of trust would abuse their authority and embezzle or otherwise steal from the company while others would not. The three components of the fraud triangle are summarized as pressure (or motivation), opportunity, and rationalization.® Pressure to commit fraud, whether financial fraud and thefi, or other types of fraud like inflated production or sales numbers (or even a situation like Volkswagen where there was a coordinated effort to circumvent testing of emissions), can come from a variety of sources.” Organization-generated pressure comes from an overly competitive culture, a pay structure based on achievement or “numbers,” or a perception (or reality) that the organization is understaffed, and the workload is not manageable.” Pressure also might be unrelated to the organization but may be personal to the individual tempted to commit the fraud. This pressure could be unexpected bills, vices such as gambling, life changes such as a child entering college or a spouse losing a job. © Assn. Of Govt. Accountants, hitps:/www.agacgfin org/intergov/Fraud-Prevention/Fraud- Awareness-Mitigation/Fraud-Triangle.aspx ° Leandra Lederman, The Fraud Triangle and Tax Evasion, 106 1oWA L. REV. 1153, 1156-57 (2021), Pad. ® AICPA, Management Override of Internal Control: The Achilles’ Heel of Fraud Prevention, at 102016), htips://www. google. com/url?sat&ret= dea Seesto“séesource=web&ed=&ved=2ahUKEwifdvM 4Y38AMVMNEQIHTSIA VeQFnoCBsQAQ Sarl =https%3A%2F"42Fus.aicpa,org%2Feontent"42 Fdam?42F aicpa%2F forthepublic’2Fauditcommitteceffectiveness”%2F downloadabledocuments%2 achilles heel pdféeusg~AOvVaw2SiAn7Q-P10SHyPri RHKK2, "1d © 2022-23 Lawrence J. Trautman, Page 20 All rights reserved Lanry Foster, Lora Koretz, Clyde McNeil, Eric Yordy & Ashley SalinasDRAFT-COMMENTS WELCOME-1/13/2023 5:24 PM Rationalization is the concept that the person tempted to commit the fraud must believe (or convince oneself) that the fraud is not only “needed” which is the pressure component, but also is worth the risk.” Justification can be related to the organization such as a feeling that the employee is undervalued either financially or in terms of recognition and praise.”* Rationalization could come from organization decisions, such as an employee not getting a promotion or a bonus. Other times, the rationalization is more internal — a sense of entitlement or a belief that the activity is “victimless.” Taking a few dollars or taking supplies or equipment might be seen as a minimal incursion to the organization but a tremendous benefit to the actor.” The third component of the fraud triangle is opportunity.”* Opportunity arises when an actor has the ability to commit fraud or theft with very low risk of detection." Opportunity most often is the target of internal controls and corporate governance — implementation of policies that minimize or eliminate the opportunity to commit fraud or theft without collusion by multiple actors.” For example, separating a purchasing function from a receiving function would require one person or group to place and record orders and a different person or group to receive and record orders when arrived. A reconciliation of the records of the two different groups should show consistent numbers and dollar amounts from the order to the receipt. To commit fraud, two people (or two actors from the two groups) would have to work together.”* ® Lederman, supra note 68 at 1200-1206, Pid See, Lederman supra note 68 at 1200-1206 for a discussion of normative thinking 25 fd. a 1156. Id. at 1188-90. ” See Scott Langlinais, Reducing the Opportunity to Commit Fraud, IRM (March 8, 2008) % At least one theory posits a requirement for a fourth criteria, creating David T. Wolfe and Dana R, Hermanson, The Fraud Diamond: Considering the Four Elements of © 2022-23 Lawrence J. Trautman, Page 21 All rights reserved Lanry Foster, Lora Koretz, Clyde McNeil, Eric Yordy & Ashley Salinas