Remarks of Larry D. Thompson*
PepsiCo SVP of Government Affairs, General Counsel and Secretary
Former U.S. Deputy Attorney General
State Bar of Texas Annual Meeting
Corporate Counsel Forum
Austin, Texas
June 16, 2006

ACHIEVING TONE AT THE TOP IN THE CORPORATE CULTURE

I’ve been asked to talk generally about how a business or a corporation can have — as a part of its culture — the right ethical tone at the top. This topic is obviously very important in today’s post-Enron corporate enforcement environment.

Before I try and tackle the subject of tone at the top, let me make an observation about corporate cultures based on my experience as a defense lawyer and prosecutor. Distinctive corporate cultures do exist. I think we all know and have experienced corporate cultures that are good — the majority of them in my experience. But, unfortunately there are also bad corporate cultures. Almost all organizations — including corporations — develop their own set of attitudes and practices that guide employees’ thoughts and behavior. This establishes the culture of an organization. In most corporations, the culture instills respect for the law and ethical conduct. In a minority of organizations, a culture develops that breeds contempt for the law and prizes business results regardless of means. And, of course, there are other corporations where the culture is uncertain because there has been no clear tone at the top set to guide employees’ behavior.

So, with this backdrop, I’ll review with you this morning some observations about setting the tone at the top of a business organization. What is the right tone? Exactly why is tone at the top important? How do you achieve the right tone at the top?

Next, I’ll review the role of lawyers in establishing the right tone at the top. I’ll discuss common mistakes I’ve observed lawyers make in representing business organizations that have aided in establishing bad cultures in those organizations. Finally, I’ll briefly explore with you whether the current, rather rigid fixation on privilege issues, by some in our profession, is an impediment to establishing the right tone at the top of business organizations, especially in today’s post-Enron and post-Sarbanes-Oxley environment.

Although I have drawn on my own practice experience in preparing these remarks and observations, I’ve also been aided by the work of two academics who have published some thoughtful and thought provoking works. They are Professor Lynn Sharp Paine of the Harvard Business School and Professor William Simon of Columbia University Law School.

Establishing the Right Tone at the Top

Now, let’s consider what is the right or correct tone at the top of a business organization. It is obvious that it is far easier to say you should have a certain tone at the top than to spell out in detail what that tone should actually be or say. One commentator in the field has noted that the answer to the question of what is the right tone at the top is similar to a famous line in the 1964 obscenity decision, Jacobellis v. Ohio, provided by Justice Potter Stewart when he noted that while we can’t define pornography, we know it when we see it.

For Professor Paine of Harvard, the right tone at the top goes beyond compliance systems which are prevalent in many corporations today and which focus on the avoidance of legal sanctions. The right tone at the top involves a system of organizational integrity where the business organization has a set of guiding values that are understood and support ethically sound behavior by all employees. These ethical values are the responsibility of all employees, not just lawyers or compliance officials.

Professor Paine’s work was published in 1994, well before the Sarbanes-Oxley legislation enacted in 2002 and the revisions of the organizational sentencing guidelines which went into effect in November 2004. So, while having the right tone at the top seems to be the smart and responsible thing to do, there are legal reasons for doing so as well.

Sarbanes-Oxley mandates that public companies adopt a code of ethics for their principal executive officers and senior financial officers. Among other things, the required code of ethics should have provisions that promote honest and ethical conduct, as well as provisions that promote full, fair, accurate, timely and understandable disclosure in public reports and documents. In other words, Sarbanes-Oxley calls for complete transparency in a corporation’s business dealings.

But, establishing the right tone at the top means much, much more than compliance with post-Enron legislation and regulations. Establishing the right tone at the top is the best way to preserve a business organization’s good reputation which can be easily destroyed when employees act unethically. Also, business organizations with the right tone at the top are, in the long run, winners in the marketplace. As one expert in the field has noted, these companies attract and retain the best talent. They are also the corporations other corporations want to do business with — attracting the best suppliers, customers and business partners.

Professor Paine has outlined five factors that are critical to establishing an effective integrity or ethics strategy in a corporation. First, the guiding values of the organization must make sense and be clearly communicated. Employees at all levels must take responsibility for them. At PepsiCo, a cross-divisional, cross-functional global team of more than 40 employees worked for over a year to develop a set of core values and guiding principles that could apply across all of our diverse businesses and in more than 200 countries. Those values have been rolled out across the world in thousands of in-person training sessions. Management constantly reinforces our values through town hall meetings, newsletters, posters and other types of communications. Our values are personal – they articulate who we are and what we stand for as individuals and as a company – and we expect each employee to take personal ownership for living our values.

Second, an organization’s leaders must be personally committed, credible and willing to take action on the values they promote. This is the essence of setting the right tone at the top. Corporate executives must visibly embrace the corporation’s values; they cannot be mere mouthpieces.

Third, a corporation’s other systems and structures must support its guiding values. For example, a performance appraisal system should be sensitive to means and not just reward ends. At PepsiCo, executives and managers are rated every year through a 360-degree process, not just on the results that they achieve, but on how they achieve those results.

Fourth, the corporation’s values should be integrated into the normal channels of management decision making and are reflected in the company’s critical decisions. For example, marketing plans, strategic decisions, dealings with customers and suppliers and people decisions should all reflect a company’s values. Two of PepsiCo’s core values are to care for customers, consumers and the world we live in, and to sell only products that we can be proud of. We continually review our products, our marketing and advertising programs and our operations to measure progress against these core values.

Fifth, managers throughout the corporation should understand the values and be empowered to make ethically sound decisions on a day-to-day basis. A system of ethics training is usually needed to achieve this factor. At PepsiCo, we just completed training over 20,000 employees worldwide through a multilingual web-based course on our Code of Conduct. The course was interactive and scenario-based and provided employees with practical advice on how to handle real-life ethical dilemmas.

To me, when you cut through it all, setting the right tone at the top of a business organization is simply communicating to employees that everyone, from the CEO on down, is expected to conduct the company’s business in accordance with high ethical conduct and absolute integrity. This is so because it is what it takes to be a great, successful company, and not just because the law mandates it. And, this is everyone’s job, not just the lawyers or the compliance officers.

Once you’ve set the right tone at the top — established the values that guide business decisions day-in and day-out — how do you know that your message is taking hold in the organization? At PepsiCo, we conduct electronic surveys whereby our employees can respond anonymously about the effectiveness of the values message they are receiving from the top. Early last month our CEO, Steve Reinemund, sent a message to all PepsiCo’s employees asking them to complete our bi-annual Organizational Health Survey. Steve told our employees that the survey is one way “we assess how we’re holding ourselves accountable for living our values ….”

The Role of Lawyers

While establishing the right tone at the top involves more than setting up a compliance program, everyone in this business recognizes that we lawyers play a key role in developing and promoting an ethics regimen which will always have legal compliance as one of its critical components. Certainly, in the face of some very high profile abuses by just a few corporations, we’ve come to understand that some lawyers have made mistakes when advising corporate clients — especially on issues relating to ethics and compliance. Based on my experience, lawyers tend to get into trouble in this area when they make one or both of the following mistakes.

First, some lawyers fail to give corporate clients their independent professional judgment. That phrase “independent professional judgment” is, and ought to be, redundant. A professional lawyer, by definition, is a person who renders independent judgment pursuant to his or her professional responsibilities.

Giving independent judgment should be more important than job security. Independent judgment is the only thing we lawyers, as professionals, have to offer. Think about this: without it, we are merely hired guns who trade off the reputation of our great profession.

Second, some lawyers in the corporate context forget who their client is. We all know from our first corporate law class — and now from Section 301 of the Sarbanes-Oxley Act — that the client is the corporate entity. It is not just the CEO or, if you’re in a law firm, the general counsel who hired you. A 2002 survey conducted by an organization of general counsel found that more than twenty percent of the general counsel surveyed felt that their corporate cultures were such that they emphasized “senior management” as the client, as opposed to the corporation itself. Yes, this is a minority view, but it is sufficiently large to put at risk billions of investor dollars at plenty of companies.

To me, these mistakes illustrate how we lawyers may sometimes inadvertently impede setting the right tone at the top of corporations. I submit we need to get past this type of thinking and behavior and understand that, as corporate lawyers, we represent the corporation as an entity and have a professional obligation to zealously protect the interests of shareholders. In corporations with the right tone at the top, lawyers’ professional obligations are co-extensive with the executive team’s, which is to ultimately be responsible for the interests of the shareholders. For example, as all of you know, we presently have this debate about the privilege going on, primarily amongst ourselves. It is interesting to some, emotional for many and somewhat puzzling to others — including myself. It involves the attorney-client privilege and its waiver in the context of government investigations. Professor Simon of Columbia University Law School provocatively challenges this almost unthinking devotion to the privilege in connection with government investigations. He calls this the confidentiality fetish. For Professor Simon, claiming the privilege to keep factual information from regulators or enforcement officials is inconsistent with the notion of openness and complete transparency in today’s post-Enron world. It also flies in the face of Section 406 of Sarbanes-Oxley.

Most corporations, when faced with a government inquiry, retain lawyers to conduct internal investigations to determine what happened and to give the corporation legal advice on a going forward basis. Oftentimes, factual information the government believes it needs to complete its investigation is withheld from the government because to do so, in the opinion of these lawyers, could constitute a waiver of the privilege and work to disadvantage the corporation in any subsequent litigation with third parties.

The debate about what to do in this situation is very complex, and I simply do not have the time this morning to get into all the issues about whether government policies actually coerce corporations into waiving the privilege. But, I do want to emphasize that I understand that the privilege is absolutely essential to a lawyer’s ability to effectively represent a client and protect the attorney’s advice to a client in our adversary system. And, I do believe the Department of Justice policies enacted in 2003 did not envision or contemplate privilege waivers for purposes of a corporation establishing cooperation except in limited circumstances when the factual information needed by the government could not be obtained in any other way.

I refer you to an excellent article on the subject of corporate internal investigations by George Terwilliger, the former U.S. Deputy Attorney General, and Darryl Lew. The article discusses the sophisticated investigative techniques that should be used in today’s enforcement environment — an environment which favors a corporation’s cooperation with government investigations. The authors also recommend legislation supporting a limited waiver which would protect a corporation from adverse litigation consequences associated with waiver of the privilege when cooperating with the government.

For me, when representing a corporation, much of the debate about waiver of the privilege in the face of a government investigation is misplaced. The privilege belongs to the client, the corporation, not to me, the lawyer. My client’s policy – one important part of the ethical tone at the top – is to cooperate fully with government investigations. In my view, that means making the necessary facts available to regulatory or enforcement officials, and to the company’s internal and outside auditors – not using the privilege to prevent disclosure of relevant facts. I want to stress here that I’m referring to facts and not an attorney’s advice to a client, which is, I think, almost sacrosanct and should only be requested by, or disclosed to, the government in limited, very special circumstances which are clearly articulated in the law. But when it comes to facts, not legal advice, the attorney-client privilege shouldn’t trump the full and complete disclosure of the necessary facts, even if there are potential consequences in future civil litigation.

As a prosecutor, I witnessed lawyers representing corporations refuse to provide factual information to the government for fear of a disclosure that might constitute a waiver of the privilege. I never really understood this because I could not even fathom a situation in which it would not be in the interest of a corporation, which had an on-going, viable business, to do anything but fully cooperate with reasonable requests by the government for factual information.

I have heard the argument in favor of doing things a different way. It goes like this. Without the confidentiality of the privilege, corporate officials would avoid lawyers or withhold information from us. As a result, we lawyers would not be able to properly advise the corporate officials on how to obey the law. However, one problem with this view is that it assumes an employee is bent on disobeying the law. This is usually not the case in my experience. But, if it is, a lawyer has another set of problems relating to his or her duty of loyalty to the corporation and not the employee or official who is bent on disobeying the law.

But, as Professor Simon points out, the rationale for preserving the privilege at all costs completely collapses when you understand that it is absolutely clear under Upjohn that the privilege belongs to the corporation. In fact, employees interviewed during the course of an internal investigation should be informed of who owns the privilege during the standard Upjohn advice to interviewees. No corporate executive can assume that everything he or she tells the corporation’s lawyer, especially during an investigation, will remain confidential forever. A corporation may direct its counsel to waive the privilege in the face of a government investigation, despite potential adverse civil consequences, in order to get the matter under investigation quickly behind it. In fact, this is exactly what happens oftentimes and corporations certainly do not need lawyers standing in the way of their ability to fully cooperate in a government investigation and receive the appropriate credit for doing so.

So, closing on the tone at the top theme, the right tone at the top, in my view, does not, in today’s environment, involve having lawyers keep factual information from investigators, its internal and outside lawyers and from government officials during investigations. This approach runs counter to the interests of the corporation and its shareholders.

And, this is not to say that we lawyers are always on the wrong side of the equation in these circumstances. I’ve seen lawyers play literally heroic roles in representing corporations where the culture and tone at the top were bad and caused the corporation to get into a lot of trouble. These lawyers literally saved their corporate clients and brilliantly represented the interests of the corporation’s shareholders.

So, we all know that having the right tone at the top is critical. Notwithstanding my concerns regarding the privilege, I’m absolutely confident that lawyers will play a pivotal role at most corporations in setting the right tone at the top. This is as it should be and is consistent with high standards of integrity in our profession.

* Note: Mr. Thompson frequently speaks from notes and may depart from the speech as prepared. However, he stands behind the speech as presented in written format.