From: William L. Livingston, P.E. [vitalith@earthlink.net]
Sent: March 15, 2004
To: rule-comments@sec.gov
Subject: File No. S7-04-04


Mr. Chairman and Honorable Commissioners:

You are soliciting comments on codes of ethics designed to establish standards of business conduct reflecting the fiduciary obligations associated with particular positions in financial commerce. This submittal builds on the thesis of my earlier commentary - that every assessment of ethics succeeds the choice and consequences of action. Since ethics is an effect and not a cause, making ethics an input requisite in order to obtain a specific output (targeted individuals choosing to satisfy fiduciary obligations) is counterproductive. The ethical makeup of participants is independent of the consequences of selected activity. History contains no exceptions.

Rule-based activity, the theme of regulatory compliance, is ethically neutral to the regulated. When rules rule, change the code of ethics all you like. The public gives you credit for taking action to fix the fraud problem and the fiduciaries will not complain. There is no pressure to defer 204A-1 as you received for 404. As a professional engineer (PE) and member of the Institute of Internal Auditors (IIA), however, I am legally bound to herald a regulatory change that leaves business as usual as usual. Organizational ethics (reputation) is an attribute of the operational methodology (culture) employed by the institution. If you wish to improve the ethics grade constantly affixed by the stakeholders, corporate operating practices must align with stakeholder interests. There is no other way to influence ethics.

Having made the case that the ethics of fraud is an effect ultimately shaped by loyalty to business as usual, the thesis here is that when the conduct of a business is aligned with the strategic SEC mandate - participant ethics doesn't matter either. When and if you ever launch 404, you will have the opportunity to witness this connection first hand for yourself. For any of your clients that choose to get 404 "transparency" right, you will wonder at their ethical transformation. For the others, you'll just shake your head. This SEC affair with regulating ethics is an exact replica of the annual NIST Malcolm Baldrige Quality award examination process. If you missed the corporate ethics show at Commerce last year, you can see it again this year. Identical.

The transparency rule of 404 is a specification of an end attribute. Every other edict in your portfolio is a rule of action - means. What decades of rules for means got you was the operational opacity 404 now wishes to cure. The PE can specify operational transparency in tangible, measurable units. PEs can get their arms around the algorithms of transparency, crunch the transactional details in computers, and maintain transparency through the endless disturbances of the future. PEs will happily assault this complexity, not because of any moral superiority, but because you have specified a goal and left the professionals untied to develop the intelligence necessary to reach it. Stick with transparency. Forget about ethics.

By now you may appreciate that the PE benchmark (failure is not an option) is a reverse image of the regulator's mantra. The PE nerd is consumed with developing better and better methods for attaining significant goals and obeys authority only when necessary. In business as usual, obedience to authority is the goal. Regulatory compliance and corporate policy meld into the imperative amalgam you dial up to find out what to do next. The PE is as sensitive to the substitution of obedience for intelligence as the regulator is to knowledge development as a substitute for the rule book. Disparate conclusions from surveying the same wreckage are to be expected.

SEC Nobel

In the ethics rule of action, the SEC has an opportunity to run a grand experiment to settle the PE contention once and for all. Adjust the code of ethics a little for a random half of your clientele to require that senior management of every corporation in the group must be a convicted felon, like Martha Stewart. After you have so removed ethical uncertainty from half of the test participants, measure the results. External auditors will be unable to distinguish performance differences between the two groups. Business as usual is one cult.

With ethics finally set aside as a byproduct of regulation, you can then run another investigation far more significant. Impose 404 transparency on a random half of your clientele, half of which will be managed by felons. After a bit, send in the independent auditors. The differences will be dramatic. With the 404 compliant group, felons and all, the audit will be quick and completely confident. This is, after all, merely how transparency is attained and maintained in the first place. With the business as usual group, auditors will be bogged down in the financial birdsnest, as usual, and carefully word their lack of confidence in the audit, as usual. You will have validated that the stakeholders are far better off with their stake in the hands of certified felons bound to the appropriate methodology than they are with certified saints doing business as usual.

Both of these experiments can be run in the next few months and by the end of the year, the SEC will have the requisite knowledge to regulate in such a manner as to fulfill its mission. You will be awarded the 2004 Nobel Peace Prize because the same formula of success you validated works generically. This methodology of learning is, exactly, how the PE assaults complexity. Running dynamic simulations to get the future right is how engineers delivered the instrument packages to the surface of Mars in one piece.

The 404 story, PE perspective

The purpose herein is to inform the SEC about two significant professional matters. It is first the PE duty to warn you about pursuing the impossible. The second obligation is to elucidate the available practical capability to assault complexity in terms that encompass the SEC mission. No PE gets pleasure from warning about impossible pursuits. Establishing Scienter prior to damage is tiresome, thankless and monotonous work. However, more stakeholders are injured from the pursuit of the impossible than all other hazards combined. The PE will never understand why institutions filled with honest, intelligent individuals have to be told in blunt language to heed their own archives. The SEC, like the military, is already in possession of the result of every conceivable social experiment. Sociologically, nothing will happen in your future that has not already happened in your past.

The second duty, to acquaint you with the escalating tort standard of care (foreseeability, complexity - 404), is fun. Like the tort theater players, the PE operates in a warren kept far apart from the normal folks of business as usual. To his delight, the gigantic quantum leap in capability of the process of engineering that coalesced five years ago, reached critical mass, and spread by chain reaction - went unnoted. This capability leap, like it or not, is the prime mover driving the immediate social turmoil engulfing the SEC. The saga of this radical transformation of society, now playing at your local institutions, is Homeric.

The reason 404 even exists is because the 404 goal can be achieved. Ten years ago, operational transparency was generally impractical and so was the cell phone. Now, you can have both. The monster engine of progress in what the process of engineering can deliver was named "intelligence amplification" by the English polymath who assembled the first model in 1965 - W. Ross Ashby. The reason business as usual and the SEC should get acquainted with "intelligence amplification" is the same reason Achilles should have paid closer attention to the launch of that arrow.

The SEC has already noted that the aggressive obstruction of 404 by the regulated is not based on the feasibility of compliance at all. Whatever lobby effort it takes to deter 404 will be funded because 404 signals the end of business as usual. The pleading to the SEC highlights the fact that 404 implementation also means radical change to how the SEC regulates. True enough.

While the strategy to defer 404 is now viable, it will not prevail. To remain at the crossroads of the two great fundamental methodologies of natural law takes more strength than you possess. The derivative influence of intelligence amplification, exactly like power amplification, will only increase. The ethics of the choices now confronting the SEC regarding the inevitable collective transformation comprise an opportunity for the SEC to practice what it endeavors to preach to fiduciaries. Wait till the stakeholders find out the hard way there's no corporate liability insurance.

The operational reality of intelligence

Before intelligence amplification is even a fit discussion, it is necessary to be saddled with a complexity strong enough to require it. PEs use a handy benchmark for the demand dynamics of intelligence associated with a task. It is an order-of-magnitude scale with four categories. The PE knows the intelligence order demanded by the issue must be exceeded by the intelligence order applied in remedy. This axiom has direct application to regulatory challenges.

The elemental task unit (1) is called "experiencing." Only the limbic system is involved for characterizing the sensations of your experience interacting with some system. You can form an opinion about "car" riding as a passenger in a vehicle with your cognitive facilities on "off." There are many chores and habits of daily doings at the office done at intelligence one (1).

The next higher task level (10) is called "operating." In order to operate some engineered system it will consume at least ten times the brains it takes to experience it. The operating intelligence level characterizes the greatest portion of corporate activity - rule-based. The thinking involved is limited to picking out what to do next on the chores list. Connecting the dots. The operator functions oblivious to stakeholders.

The next task level up (100) is called "maintaining." The individual tasked to maintain a system must know at least ten times more about intra-system details than the union operator. The maintainer must know what is behind the control console and be familiar with component dynamics for troubleshooting. The maintainer must accommodate the requirements of select stakeholders. In maintenance, he owns some system behaviors.

The top task level (1000 and up) is called "designing." The system designer must know at least 10 times more about the system and its context than the maintainer. He must know all stakeholders, all stakeholder requirements, and establish feasible tradeoff-criteria. The designer owns all behaviors in all future circumstances of the system he designs. This is why tort law forbids the PE to pass the buck. Whatever intelligence the designer can muster from his cranium is applied to this responsibility. The designing level is where intelligence amplification (IA) became our genie.

When the PE uses this axiom to benchmark the SEC regulatory intelligence demand profiles, it is strikingly clear that, in 404, the SEC is demanding a designer-grade task from an operator-grade organization. Of course 404 is feasible. Duck soup. The problem faced by the regulated is that the operator-level of intelligence they oversee is two orders of magnitude mismatched to the task!

The dilemma facing the regulated, inherent to the process of engineering, is that 404 compliance with designer-level intelligence means jettisoning their chain of command. You don't supervise 10,000 level intelligence with operator-grade knowledge. NASA exhibits what happens when you do. The design professional must be free to do what it takes to best reach the goal. He develops the requisite knowledge for appropriate task selection as he goes and it is a messy, trial and error affair. There is no other path to stakeholder safety. It may be your professional duty, as it certainly is mine, to know that that is the case.

The ethical dilemmas wrapped up in 404 are owned by the SEC, not the PE. When faced with a 10K requirement, the PE applies 10K intelligence. If the organization overrules this axiom, the PE is legally bound to withdraw from the project. It is up to the SEC to arrange a match of intelligence appropriate to your rule. If rule compliance means the demise of hierarchical governance for internal control, so be it.

Providing 404 transparency is well inside the state of the art. When it is practical to develop the essential knowledge for zero-risk appropriate selection (intelligence), the role of judgment in choosing task action evaporates. The ability to rip through complexity without guesswork is heaven-sent to the PE, because he is legally bound to all laws, civil and natural, to do so. Senior management looks at the same competency and suffers cardiac arrest.

The framework of 404 transparency

As transparency is the ethical choice for stakeholder safety, there must be a coherent rack to hang the transaction data on. While there are many roads to vertical and horizontal coherency, the structure of rationale that holds it together must obey the laws of logic. Typical internal auditing experience finds no self-assessment of internal control structure logic.

Getting the design approach logic right with natural law is where the PE starts the assault. It is not something he does as an afterthought when his design runs amok. User-friendly tooling exists for the independent checking of the transparency structure against the rules of formal logic. Objectivity checking is a splendid example for showing how PE obedience to natural law takes care of ethics. While it may appear that the PE who takes the trouble to double check his design for sound logic before releasing to the stakeholders is doing his ethical duty, the truth of the matter is he does it to get his design to work to his purpose in the first place. For good or evil doesn't matter. Faulty logic and the system crashes on the proving grounds. Just like intelligence amplification, there is a rich history to formal logic benchmarkers.

Some of the earliest software programs (1965, Argonne National Laboratory) that had to be honed to absolute perfection were essential to the software developers themselves. Called "theorem provers," these engineered standards of formal logic were tools critical for finding logical errors in software under development - like those critical to the success of Apollo. Computers operate exclusively by natural laws, oblivious to the ethics, character, qualifications, charisma, and anguished asservations of its programmers. If the software designer wanted his program to "work," it had to be, at minimum, aligned with the rules of formal logic - even to compile. The ubiquitous mainframe operators were always there eager to grade your handiwork when you brought in the deck of punched cards. Failure to compile brought you instant computer-room ridicule and a machine-prepared averment. Adding injury to insult, there was nobody to blame but yourself.

Like all matter and energy in the universe, natural law governs computer behavior a priori. With no way to cheat the central processor, tools to help find the logical misaligments up front became basic engineering necessities. Such design aids have been available for decades to audit management decision-making for alignment with formal logic. Universal law, contrary to all reports otherwise, makes no distinctions by rank on the hierarchy. Logical formalisms to support decision-making is a mature technology being advanced today, particularly by the Department of Computing Science, University of Glasgow. Thousands of recent, real-world applications are available on the Internet's web.

Design engineers embrace internal control validated by theorem-provers. The safeguard shared by every engineering workstation is that any omission, any logical misalignments, any substantial input quality error - and the program doesn't run at all. It sits there, waiting with infinite patience, for you to get your informational act together. When the SEC does not include logic-proving, by toolbox, as a standard transparency benchmark, a huge ethics issue is deposited on the doorstep of the attestor. If the auditor is the first one to validate internal control logic against formalisms laws, the whole system will explode. If the logic is not validated, to just exactly what can he attest? Impeccable logic, by itself, is no guarantee of stakeholder safety. But, it sure is the place to start. It may be your professional duty, as it certainly is mine, to know that that is the case.

Binary latch-in

Cat and mouse ethics are often associated with the coupled regulator-regulated social system. One side makes rules and the other side searches for loopholes. To an insider observer, the change in relative influence over time can resemble the swing of a pendulum. At the regulatory level of corporate liability, there is an advantage to the regulated to promote the pendulum image. Once the SEC buys into pendulum dynamics as the standard, the regulated can complain that, as for ethics, "the pendulum has swung too far." When you hear this, it is absolute proof that a way around your rules has been figured - transforming the associated auditing and reporting formalities of your rules to pure overhead waste. Respond to the pendulum claim on any basis and you lose.

The task of running a corporation to benefit stakeholders with safety has absolutely no connection to the simple motion of a pendulum. Institutional dynamics is binary either or driven by two super-stable "attractors." There is no such thing as somewhat ethical, partially corrupt, or translucent operations. A context forms around a methodology and latches-in. Methods are either rule-based or goal-seeking. By virtue of natural law, there cannot be a third method and all combinations are transient and unstable.

The fact that the regulated are routinely using the pendulum analogy signifies a closed-system view where the rules become the object and the position of the pendulum is the imaginary scoreboard. Activity that could be directed towards productive corporate operations to benefit stakeholders is allocated instead to resist the encroaching impetus of the fantasy pendulum. Neither institutional goals nor the consequences have any role in this contest. The daily news is filled with tragic episodes of exactly the same closed coupled social system binaries in perpetual conflict. The goal is not national prosperity but revenge. Both parties playing pendulum lose.

There is only one way out of the pendulum trap. The coliseum in which the pendulum game is played must be dismantled. The SEC must abandon the attempt to coerce ends by specifying means. The SEC (and everyone else) knows you cannot force an unethical organization to be ethical by designing rules. You have issued reports of lessons-learned to the public that attest to your awareness of the limitations of rules of action. The SEC knows it is on the counterproductive side of the inflection point.

The SEC is commended for providing and maintaining this convenient and efficient method for submitting solicited commentary to your rule-making.

William L. Livingston, P.E.