Association member codes of ethics provide valuable benefits, not only to associations and their members, but also to professions and industries, government, and the general public. However, to successfully establish, operate, and enforce such programs, associations must have a basic understanding of, and take measures to protect the association from, the potentially significant legal risks.
Although clearly in the public interest and of benefit to members and others, association codes of ethics may incur liability risk for the association. Courts generally are reluctant to second-guess the reasonableness of an association’s enforceable code of ethics and the self-regulation of members, certificants, and accreditants by an association. Yet the costs, burdens, and distractions of mounting a defense to a lawsuit can be significant. And even aspirational codes of ethics can create professional or industry performance expectations that can be used against members of the profession or industry in litigation. Fortunately, there are steps associations can take in structuring and administering such codes to minimize the risk of being sued in the first instance, and, if a lawsuit does materialize, to increase the odds for success. In addition, appropriate insurance coverage can help protect the association against the financial burdens of such litigation.
Note that references herein to “member” codes of ethics should be read broadly to include codes of ethics that regulate conduct by individuals or entities that are certified or accredited by an association. Also note that codes of ethics that are merely “aspirational” in nature generally do not give rise to much legal risk, while codes that are “enforceable” (through any myriad of sanctions) are the ones that should be the primary focus of legal risk mitigation.
Outlined below are the principal areas of legal risk that associations typically encounter in connection with the operation of member codes of ethics: antitrust, due process, defamation, negligence, and tax. Other theories of liability exist as well – such as theories of warranty and enterprise liability – but the areas of legal risk outlined here make up the typical claims brought against associations in connection with member codes of ethics.
From an antitrust perspective, under the federal Sherman Act, an association will be at risk of antitrust liability if its enforcement of its code of ethics against a member or prospective member is held to be an unreasonable restraint of trade in the relevant market and that restraint causes antitrust injury. The courts and antitrust enforcement agencies have agreed that the mere existence of membership qualifications, restrictrions and standards – codes of ethics generally are a form of membership qualification, restriction and standards – will not necessarily be considered unreasonable. For example, geographic location, the functional level served, or the type of service performed by the member are routinely considered to be reasonable, pro-competitive restrictions – essential definitions of the profession or industry that is represented by the association.
However, unreasonable, anti-competitive restrictions may be viewed as prohibited "group boycotts" or "concerted refusals to deal." Obvious examples would be refusal to admit members who offer discounted prices to their customers or who do business with "disfavored" suppliers or customers.
Under the two traditional modes of antitrust analysis (rule of reason and per se illegal), the key determination made by the courts in determining whether a challenged activity violates antitrust law is whether the restriction, on balance, promotes or suppresses competition. (It is far more preferable for an association to have a challenged activity viewed under the rule of reason, as it is much more difficult for a plaintiff to demonstrate the requisite anti-competitive injury using the rule of reason.)
Among the more problematic types of membership restrictions are those which seek to guard against immoral or unethical behavior. When such "ethical" restrictions are imposed, it is important not only that the restrictions themselves are reasonably tied to a pro-competitive purpose (e.g., discouraging fraud or deception in a profession), but also that there is ample procedural fairness offered to the affected member or applicant. Thus, it is strongly recommended that to ensure fairness and uniformity, restrictions and the process for enforcing the restrictions be set forth plainly and objectively in association policies. By doing so, associations are able to put members and prospective members on notice as to the types of restrictions that apply, and associations are better able to defeat any future assertion that they acted arbitrarily. Even when an association membership restriction may have strong pro-competitive justifications, if the restriction is applied arbitrarily or subjectively, the association may still be at antitrust risk.
B. Due Process
In addition to antitrust issues, associations also may incur legal risk for violating common law "due process" claims based on a lack of either substantive or procedural fairness. Substantive fairness requires the use of objective standards reasonably related to a legitimate organizational purpose, while procedural fairness requires the uniform application of such standards.
Procedural due process is a doctrine that essentially requires associations to provide notice of a potential adverse decision to a member or prospective member, to provide an opportunity for the affected individual to respond and defend the potential adverse decision appropriately, and to provide the individual with an opportunity to appeal any adverse decision. Of course, it is incumbent on an association to both have the relevant procedures in place and actually follow all due process obligations it places on itself through such procedures.
Defamation is the oral utterance or written publication of false or misleading facts, or false or misleading implied facts, that are derogatory or damaging to an individual's, entity's or product's reputation. Accusing someone of dishonesty or other moral deficiency, or of professional or business deficiency, raises particularly significant risks of defamation liability. In the self-regulation context (such as with member codes of ethics), this risk is most likely to arise: (i) when an individual or entity is denied or expelled from membership, and then damaging statements are made (to one or more third parties) by a representative of the association about the individual or entity; or (ii) when sensitive, potentially damaging, information about a member or prospective member becomes known to the association during the code of ethics enforcement process, and that information is subsequently disclosed to one or more third parties (intentionally or unintentionally).
In general, courts will give great deference to internal association decisions, particularly those involving self-regulation. Still, reliance on the fact of membership, certification or accreditation of a professional, entity, product, or service can, in some cases, cause the association that granted the membership, certification or accreditation to be held liable when a patient, client or customer suffers harm (physical, financial or otherwise) at the hands of the member. The most common claim is that the association was negligent in granting membership, certification or accreditation and should therefore be liable for resulting injuries.
This liability risk to third parties generally means negligence liability (a form of tort liability). Court decisions holding associations liable for negligence in the self-regulatory context are relatively rare. This type of liability is subject to a number of conditions and remains infrequent, although there have been several high-profile cases holding associations liable for negligence arising from their self-regulatory programs. In short, an association generally will be found liable under the tort of negligence only if the injured party can prove all of the elements of negligence liability – duty, breach of duty (negligence), reliance, and causation, along with proof of damages (injury).
It is conceivable – although very unlikely – that an association that is exempt from federal income tax under Internal Revenue Code (“Code”) Section 501(c)(6) could run afoul of Code restrictions that prohibit such organizations from providing substantial "particular services" to members. Such a restriction might apply in the event that the Internal Revenue Service ("IRS") reviewed a particular association's code of ethics enforcement program and determined that, in fact, the program's primary purpose is the mediation of intra-membership business disputes. An association would only be in danger of losing its tax-exempt status if the IRS were to determine that the activity constituted greater than 50 percent of the association's total activities. If the questioned activity accounted for less than 50 percent of the association's total activities, the IRS still might seek to tax fees received by the association in exchange for the provision of such services as unrelated business income.
Suggestions to Mitigate Legal Risk
There are a number of important steps that an association may take that will help to mitigate its legal risk when it offers and enforces a membership code of ethics:
A. Codes of ethics should be clear and unambiguous, reasonable, fair, and objectively grounded – care should be taken to ensure that valid, objective bases support each code provision. Code provisions should never be arbitrary or capricious, or vague or ambiguous, and procedures should be developed that document the development and reasonableness of, and the objective basis for, proposed code provisions.
B. Code provisions should be no more stringent or rigid than necessary to ensure that minimum acceptable levels of conduct are met.
C. Specific commercial or economic considerations should play no role in the setting or application of the code provisions. In addition, codes of ethics should never be created or used for the purpose of raising, lowering or stabilizing prices or fees, excluding competitors from the market, or limiting the supply or products or services.
D. Prior to finalizing code of ethics provisions, associations should provide interested parties with notice of the proposed provisions and an opportunity to comment, and then fairly and objectively consider such comments in finalizing the code of ethics.
E. The code of ethics should be reviewed and updated periodically to ensure that it is current. In addition, associations should document any and all complaints or concerns about the code of ethics and act on such complaints or concerns as appropriate.
F. There must be no bias, partiality or inconsistency in establishing or operating the program. The process must be objectively and uniformly administered, without subjectivity, favoritism or discrimination. The rules of the process must be consistently and objectively followed by those administering the program.
G. Due process should be built into the program. Before discipline is enforced, individuals who would receive such discipline should ideally be provided with: (i) notice of an adverse decision and a meaningful opportunity to respond to the notice, (ii) a hearing before a panel of peers, none of whom has a direct economic or personal interest in the outcome of the proceeding, (iii) the right to be represented by another person, including an attorney, and to submit evidence and arguments in defense, (iv) the right to examine the evidence and to cross-examine witnesses (if applicable), (v) the right to a written decision explaining the reasons underlying it, and (vi) the right to appeal an adverse decision to a higher-level decision-making body within the association. Proceedings of this nature should remain strictly confidential.
H. Associations should require full disclosure by those involved in the ethics enforcement process of any factor that might be considered bias or a conflict of interest, and should require recusal or removal if a bias or conflict is particularly severe or pervasive. Generally, reduced volunteer involvement and increased association staff involvement may assist in objectivity and the absence of bias.
I. All decisions should be based completely and exclusively on the record of the review and not on extraneous, anecdotal, subjective, or other outside sources of information.
J. Associations should maintain strict confidentiality with respect to all adverse allegations, complaints, actions, and proceedings that arise in connection with the process.
K. Associations should avoid any implicit or explicit guarantee or warranty of members. To this end, avoid "puffery," do not overstate how a professional or company who is a member of the association performs, and do not use superlatives such as "never fails" or "safest" in describing those that are members, and do not allow members to express or imply that they are endorsed by the association by virtue of being accepted as a member.
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For more information, contact the author at jtenenbaum@TenenbaumLegal.com.