Compliance systems: “ethicization” of the law and competitiveness risks for companies

by Giovanni Reho  – SUMMARY: 1. Compliance systems between law and ethics. The end of the self-sufficiency of law? The integrative function of the so-called “S.p.A. “soft law”. – 2. Lights and shadows of the process of “ethicization” of compliance systems. The “coercion of the ethical principle” and the risk of an instrumental ethics (“ethic washing”). – 3. Competitive disparities and “ethical dumping”.   The risk of market concentration and reduced competitiveness. – 4. Absence of global standards and the phenomenon of the so-called “forum shopping”. The risk of “compliance washing”. – 5. Possible mitigation measures for unfair practices. Regulatory proportionality and international harmonization. – 6. Compliance between formal ethical norm and substantive ethical norm. The need to unmask the risk of the “ethical dilemma”. – 7. Proportionality and social justice in compliance systems. – 8. Compliance systems and artificial intelligence. From the “ethical-reputational state” to the “computational state”.

1. Compliance systems between law and ethics. The end of the self-sufficiency of law? The integrative function of the so-called “soft law”.

In the current phase of important social transformations, there is a frequent integration between legal norms and ethical principles.

It is necessary to ask whether the law, in sectors where the need for ethical behavior on the part of companies is emphasized, has the primacy of self-sufficiency or whether there is an “invasion of the field” by ethics, in areas in which the protection of the legal norm was undisputed and, above all, fundamental for the certainty of the rule of law.

In fact, the adoption of compliance systems fits into an evolving dimension of social and legal dynamics that reflects the awareness by positive law of its own limits, first among them being its inability to always respond rigorously and timely to the numerous complex phenomena characterizing the globalized reality, interconnected and undergoing rapid and radical social and economic changes.

In a globalized world of normative pluralism, businesses operate in heterogeneous legal contexts, while national regulations are not always able to govern phenomena and activities crossing geographical and legal borders. The speed of technological changes imposes a pace that law struggles to keep up with, as it is slow to regulate technological innovations and new business models (from the digital economy to artificial intelligence), leaving inevitable grey areas. In many sectors, the inefficiency of the law regulating new and pressing social issues in a timely manner leads to a crisis of legitimacy for public institutions.

In this scenario, positive law is increasingly complemented by voluntary mechanisms and so-called “soft law” tools such as ethical codes, company policies, and international compliance frameworks.

One might think that compliance and ethical behavior are a necessary extension of the law, with no alternative options.

Compliance, in its legal, regulatory, and ethical dimension, acts as a bridge between positive law and practical reality, enabling businesses (i) to prevent reputational risks in an interconnected world with immediate and direct impacts on profits; (ii) to meet the expectations of diverse stakeholders, including consumers, investors, employees, and international organizations, all of whom demand higher standards of transparency and social responsibility; (iii) to adapt to complex supranational regulations that require sector-specific codes of conduct.

In this context, the increasing formalization of ethical principles through compliance codes represents an inevitable process of complementarity, which, on the one hand, confirms the autonomy of ethics from law, and, on the other, includes a necessary mutual influence. Many legal norms arise from ethical demands that solidify into legal principles. In this sense, ethics cannot replace the law, but it can favor the adoption of behaviors that anticipate or complement legal provisions. However, as we will see, this complementary system has some important challenges.

2. The pros and cons of the “ethicization” process of compliance systems. The “coercion of the ethical principle” and the risk of instrumental ethics (“ethic washing”).

The growing process of “ethicization” in compliance systems includes some negative factors:

–              The risk of so-called “instrumental ethics” or “ethics washing,” i.e., the adoption of ethical codes and compliance tools merely as a façade, without a real commitment to applying the adopted ethical values;

–              The potential loss of legal certainty, with confusion between mandatory norms and voluntary ones, leading to ambiguity over the boundary between legal obligations and voluntary choices;

–              the risk of the so-called “coercion of the ethical principle” against subjects who have their own different values and ethical principles that cannot be reconciled with those of others;

–              the risk of competitive disparities, i.e. the possibility that small firms may not be able, due to insufficient resources, to implement complex compliance systems.

These critical issues are the result of a transformation that reflects the transition from a purely legal model to a multidimensional one, where law, ethics and social responsibility must converge to face the challenges of the modern world.

The issue of competitive inequality is among those that should be most sensitive to the law (as well as to the ethical norm itself as such) to which this study proposes a specific in-depth study.

3. Competitive Disparities and “Ethical Dumping”. The Risk of Market Concentration and Reduced Competitiveness.

Competitive disparity can manifest in various ways, especially when regulatory systems and associated costs are not proportional to businesses’ ability to bear them. This phenomenon can be particularly noticeable in the gap between large companies and small or medium-sized enterprises (SMEs), but it can also emerge among businesses operating in countries with different regulations or with varying access to resources.

Large companies have significant financial and organizational resources to implement complex compliance systems, creating dedicated internal structures (such as legal compliance offices); providing periodic employee training programs; and using advanced technologies to monitor ethical and regulatory compliance.

SMEs, on the other hand, do not always have the financial or managerial capacity to sustain the costs of such structures, leading to a related competitive imbalance.

Each process, from risk assessment to the drafting of compliance documents, from employee training to subsequent monitoring activities, incurs costs that are often disproportionate to the revenue of SMEs, and can represent a much larger share of their budget compared to a large company.
Many SMEs have to make economic and financial choices that often exclude the possibility of sustaining costly compliance systems, thus facing what are known as barriers to entry: in sectors where compliance is essential to access specific markets (e.g., public procurement, regulated sectors like pharmaceuticals or energy), SMEs risk being excluded.

Another phenomenon that can erode competitiveness arises from the risk that companies unable to invest in compliance may be perceived as less reliable by clients or partners, unjustly suffering from a loss of reputation, opportunities, and profits.

Notoriously, EU member states have stringent regulations on compliance and ethical responsibility and face significantly higher costs and obligations than those operating in environments with less rigorous regulations.

The possibility of geographically uneven systems and regulations on compliance obligations can lead to a very insidious form of ethical dumping: companies operating in countries with lower compliance standards have a greater ability to compete on product and service costs and prices, benefiting from lower regulatory costs, such as those related to environmental protection, human rights, or corruption prevention.

In this way, companies that meet high standards may find themselves at a significant competitive disadvantage compared to less ethical competitors, having to reconsider their internal policies for voluntary adherence to virtuous behaviors to avoid unacceptable distortions of the global market. It should also be considered that the risk of exclusion from regulated markets for companies lacking models that comply with international standards is increasingly high.

Among the severe consequences of competitive disparities is the risk of fostering a gradual and unstoppable market concentration phenomenon, where very large and powerful companies can easily integrate any compliance operating model, which is welcomed and regulated in terms of absolute competitive-speculative advantage.

This phenomenon can have worrying implications in terms of the loss of competition, with a drastic reduction or elimination of the variety and diversity of economic players, increasing the entrenched power of large companies.
A pathological response to this phenomenon may have equally severe consequences: less structured companies or those located in less stringent regulatory contexts could offset competitive costs with unsustainable practices, such as reducing wages or worsening working conditions; externalizing environmental costs (e.g., poor adherence to ecological standards) or tax evasion or resorting to informal economies.

Moreover, the issue of increasing regulatory fragmentation should not be underestimated. Companies operating internationally must face a complex and unharmonized regulatory mosaic.

Just to give a few examples, compliance requirements in the European General Data Protection Regulation (GDPR) are very different from those in other countries, increasing the costs for companies that need to comply with systems applied in multiple countries and jurisdictions.

4. Lack of Global Standards and the Phenomenon of “Forum Shopping.” The Risk of “Compliance Washing.”

The absence of uniform global standards encourages, as mentioned, countries with less stringent regulations, contributing to the phenomenon of “forum shopping,” where companies choose to establish themselves in jurisdictions with lighter regulations, initiating a process of relocating their business activities and allocating resources to less regulated markets.

Large companies may exploit compliance merely as a marketing strategy, formalizing ethical codes and seemingly rigorous tools without actual implementation. The danger of compliance washing can thus erode consumer trust and create further disparity compared to those companies (often SMEs) that adopt virtuous practices without publicizing them.

The trap of compliance washing lies in the deliberate asymmetry between apparent representation and the actual business context, with significant consequences for fair competition among economic operators. Indeed, an organization can claim adherence to norms, standards, or ethical values without ever actually implementing the necessary measures to ensure their correct and practical application. While this behavior may fit within a strategic framework the company considers beneficial, it undermines the foundational principles of transparency, integrity, and accountability, which are essential for fair and transparent interaction between businesses, consumers, and society.

In this way, competitiveness between businesses risks a severe threat to its stability within a system that should base its legal values on fair market competition, with inevitable significant consequences for virtuous businesses. Organizations that implement effective compliance measures incur significant organizational and management costs to develop and maintain compliance policies and processes. These companies are committed to considering internal compliance policy as a strategic area, necessarily structured according to a comprehensive and detailed approach that includes training obligations, technology, resources, dedicated spaces, audits, and specialized professional consultancy. In contrast, companies that adopt a mere appearance strategy can save these resources, gaining an unfair economic and competitive advantage that allows them to dominate on an uneven playing field, which can depress investments and lead to a regressive collapse of industry standards.

The very regulatory system governing compliance measures risks appearing less effective, losing credibility and being perceived as unable to truly govern its objectives, leading to a loss of general support. Consider, for example, the sensitive areas of personal data protection, anti-corruption systems, and environmental sustainability. The perceived risk may be that of a complete breach of the regulations, undermining the expectations of transparency and justice that had been cultivated, with serious harm to all the collective efforts that businesses had invested in their compliance systems.

Beyond the mere issue of reputation, compliance washing can represent a genuine systemic problem, requiring the adoption of stringent regulations, systematic controls, and effective monitoring, given the risk that the failure of compliance systems could seriously compromise trust in a truly sustainable and responsible competitive model.

5. Possible Mitigation Measures for Unfair Practices in Compliance Systems. Regulatory Proportionality and International Harmonization.

From a perspective of mitigating risks to free competition in a legally fair market, some fundamental strategies for implementing current regulations would be necessary.

The regulations should include compliance requirements tailored to the size and resources of businesses, in order to avoid excessive burdens on SMEs, by adopting a binding principle of regulatory proportionality in compliance systems.

It would also be desirable to promote uniform global standards (e.g., ISO standards or OECD initiatives) to combat and reduce market distortions in international markets, according to a real and effective principle of international harmonization in compliance systems.

SMEs, to be encouraged to implement their own compliance systems, should receive economic and technical support through public funding or training programs, in accordance with a true plan for incentives and support.

Equally necessary is the structured and widespread adoption of effective sanctioning systems capable of addressing any potential phenomenon of “compliance washing,” where compliance adoption is merely superficial.

Without a real strategy for effectively addressing the distortions that compliance systems can create, the risk of establishing barriers for SMEs or fostering opportunistic behavior by large companies becomes not only real but also drastically harmful. An approach based on a balance of incentives and regulatory harmonization is therefore essential to ensure that compliance does not become an exclusionary factor, but, on the contrary, a true factor for sustainable growth for all businesses, regardless of their size.

6. Compliance between formal ethical norm and substantive ethical norm. The need to unmask the risk of the “ethical dilemma”.

History has witnessed dramatic experiences of formal ethics in organizations under state regimes that dismantled democracy and the rule of law. The ethics of the regime was a disturbing label that established principles of difference, exclusion, and segregation to assert violations, such as social, religious, or racial abuses.

The formal ethical norm, in its modern formulation, establishes ethical-reputational principles erga omnes and imposes itself as an undisputed (or unquestionable) model based on which clear distinctions are made between what is “right” and, conversely, “wrong.” In this system, it can be difficult for principles of civilization, such as legality and specificity of legal norms, or the presumption of innocence or conviction based on documented causality, to survive.

Indeed, the strength of the formal ethical norm is that of establishing criteria for the attribution of responsibilities according to reputational models that reduce the examination of the underlying legal norm to a mere summary and formalistic evaluative passage.

With obvious differences, an ethical-reputational compliance system, where the principles of the rule of law have no space, advocates reward or punitive criteria centered on the direct and unconditional correspondence between the mere reputational evaluation of conduct (based on a judgment of intrinsic morality) and the direct revocation of the reward system or the immediate imposition of a sanction (sometimes exemplary, as in the cases of current blacklists).

The substantial ethical principle, on the other hand, introduces elements and contents of thought, reflection and evaluation that – subordinate to the rule of law – become part of the legal norm that continues to preserve its primacy over the formal ethical norm.

The confusion between the two distinct levels of ethics, formal and substantive, plastically represents the normative phenomenon of the so-called “An ethical dilemma” that a state of law cannot accept.

The ethical dilemma is hidden within the normative models that propose the discipline of intrinsically universal human principles and values, which, however, at the application level, sometimes openly approve indistinct generalizing schemes for the entire range of regulated cases, without any distinction whatsoever.

In an articulated and stratified system of compliance — which seems to present itself as the new protagonist of future regulatory organizations (to the detriment and downsizing of classical law) — there is a necessary and inescapable need to include the preventive requirement of the principle of regulatory proportionality and to consider the practical implications and impacts on regulated entities, promoting a fair and sustainable application.

Ethics are based on values such as justice, fairness, and respect for human dignity. The principle of proportionality aligns with these values, as it demands that every obligation be necessary (rules must pursue concrete and justified objectives), adequate (the instruments adopted must be chosen for their effectiveness in achieving the purpose), and proportionate (the means used must not impose an excessive burden relative to the benefits obtained).

When an ethical norm disregards these dimensions, it risks becoming an unjust imposition and loses the moral legitimacy that forms its foundation. For instance, a rule requiring identical compliance investments from a small craftsman and a multinational corporation can hardly be deemed ethical, as it overlooks the structural disparities between the two.

The risks of an ethical rule without proportionality are experienced (i) in terms of regulatory inefficiency: less structured companies fail to meet their obligations, nullifying the overall effect of the rule; (ii) systemic inequalities: larger and better-positioned companies exploit the rules as a competitive tool, deepening existing disparities. This leads to a loss of moral legitimacy because the rule no longer maintains a substantial ethical character, transforming into an imposition perceived as arbitrary or instrumental.

A practical example is environmental compliance systems. If these rules do not account for the different capacities of companies, SMEs may find themselves unable to comply, potentially leading to business closure or attempts to bypass the rules.

7.   Proportionality and Social Justice in Compliance Systems

The inclusion of the principle of proportionality in an ethical norm also carries a dimension of social justice. SMEs represent the main economic fabric in many countries. Proportional rules allow them to actively participate in achieving ethical goals without being excluded or disadvantaged.

A proportionate regulatory system does not discourage less structured companies; rather, it encourages them to progressively adopt virtuous behaviors, while proportionate ethical norms ensure a more balanced distribution of the costs and benefits of policies, preventing only certain categories of entities from bearing the burden.

To ensure that an ethical norm respects the principle of proportionality, it is necessary to provide tools that take into account the specifics of the recipients according to differentiated criteria based on size and economic capacity (e.g., a compliance system that requires SMEs to meet minimum and progressive standards, while imposing stricter obligations on large enterprises).

Furthermore, it is essential to foresee incentives for the gradual adoption of compliance systems (such as tax breaks, financing, or technical support for businesses that choose to comply voluntarily).

It is also fundamental to allow for an “ex-ante impact assessment.” Every ethical norm should be accompanied by a study on its economic and social impact to avoid generating disproportionate burdens. A positive example is represented by the European regulation on sustainability reporting (CSRD Directive), which imposes stricter environmental and social reporting requirements on large enterprises, while providing greater flexibility for SMEs.

When the integration between legal norms and the ethical principle proceeds through a synchronous process, permeated by the primacy of the rule of law, significant positive effects are achieved, including (i) greater adherence to the compliance system, as businesses perceive the rules as just and sustainable; (ii) strengthening trust, allowing stakeholders and civil society to recognize the fairness of the regulatory system, accepting it as legitimate; (iii) inclusive economic growth, because ethical norms become a tool to promote sustainability without sacrificing the competitiveness of small businesses.

An ethical regulatory system that does not consider the principle of proportionality risks betraying its moral foundations. Ethics, in order to be genuine, must be fair, sustainable, and inclusive, and the principle of proportionality is the fundamental tool for achieving these objectives. Only by integrating this dimension into norms can we ensure that their impact is truly just and that they do not become tools of exclusion or economic discrimination.

8. Compliance Systems and Artificial Intelligence: From the “Ethical-Reputational State” to the “Computational State”

From a future perspective, as indicated by the numerous and growing compliance systems, it is not entirely far-fetched to consider a possible evolutionary association between compliance systems (which replace or significantly integrate classical law) and the emerging and unstoppable rise of artificial intelligence.

While classical law — the living law within the historical stratification of human and legal experience — represents a normative body that is difficult to subsume within the algorithmic functioning of artificial intelligence, the incorporation of simplified ethical-reputational normative systems might pose fewer challenges. These systems inherently have a straightforward organization (almost Manichean, “just” or “unjust”) that fits easily into a computational framework characteristic of artificial intelligence.

An ethical-reputational regulatory system could, therefore, be easier to manage with artificial intelligence compared to classical law for several reasons related to the flexible, dynamic, and data-driven nature of such a system.

The structure of an ethical-reputational system primarily consists of data and metrics, with its fundamental references being behavioral indicators, reputation evaluation indices, and objective, observable, and sensitive data such as feedback, ratings, and environmental or social performance. These elements collectively allow the formation of standardized and real-time accessible metrics.

This system is highly compatible with artificial intelligence, which adapts almost instantaneously to the task of managing large amounts of structured and unstructured data derived from specific sources such as company reports, social media, consumer feedback, digital audits, and so on.

Thus, compliance and AI can be harmoniously integrated through the analysis of behavior models using machine learning algorithms, or by evaluating conformity or deviation from ethical-reputational standards according to clear criteria based on scores.

In classical law, this integration is more problematic since an evaluation of compliance must inevitably go through the correct, articulated, and complex interpretation of a multitude of legal norms, each inspired by its own rationale according to the relevant legal system, and within a plurality of regulations through which the law integrates into an infinite combination of principles, values, and meanings. In other words, the classical legal system is very difficult to decipher and automate by AI, especially considering legal norms whose interpretation can be subject to fluctuating assessments based on personal discretion, changing contexts, and the possible need to balance conflicting interests.

Thus, integration with classical law requires a profound understanding of legal language and the sociocultural context, elements that, by their nature and essence, are difficult to manage in a fully automated way.

Conversely, as mentioned, an ethical-reputational system is easily standardized and thus processable through AI models because it is based on general principles (e.g., transparency, social responsibility, fairness) and measurable outcomes (e.g., worker rights performance, consumer satisfaction).

As is well known, AI can achieve excellent results in automating repetitive processes and in predictive analytics. In this sense, an ethical-reputational system, being driven by dynamics subject to continuous evaluation processes, offers a fertile ground for processing by AI.

Another element in favor of the integration between compliance systems and AI is the possibility of continuous monitoring by AI, which can provide constant surveillance over corporate or individual behaviors, quickly identifying potential deviations or negative factors that need to be evaluated.

An ethical-reputational system focuses on actual results, not just formal compliance. AI will, therefore, be able to verify these results by analyzing objective and observable data (e.g., environmental reports, verified certifications).

In classical law, however, the focus is on procedural formalities and regulatory compliance, which may not always be fully respected (for example, phenomena like compliance washing).

The inherent characteristics of classical law make AI’s work more complex, both in the interpretation phase and in data manipulation, resulting in greater difficulty in the automation process.

While the integration of compliance systems and AI is characterized by streamlined and flexible processing, in a possible future scenario — though seemingly futuristic today — it is conceivable that a shift toward ethical-reputational systems would be functionally preferable for the organization, planning, direction, and management of the global community according to standardized rules, encapsulated within ethical codes that align with the needs of a metric-computational system and, thus, essentially algorithmic.

This could be a possible development, albeit somewhat alarming in certain respects. If we push the vision further, we could consider the hypothesis of a future state and global organization based on computation (the so-called “Computational State”: this is a new definitional concept developed within the framework of this study).

A computational system processes information through algorithms, rules, and data, with the goal of achieving specific results. It is based on three fundamental components: (1) Input: the data or information that enters the system for processing; (2) Processing: the phase where the data is processed using mathematical models, algorithms, or programs; (3) Output: the final results, which could be decisions, actions, or new useful information.

Computational systems can range from simple mathematical calculations to complex artificial intelligence models, such as predictive systems or decision-making automation.

A “Computational State” can be defined as a state, administrative, and judicial system in which human intervention has become marginal or absent, as it is based on computational systems such as artificial intelligence, machine learning, and automated data management. This form of state, assuming decisions are based on objective data, is characterized by the integration of advanced technologies in every aspect of state management, with the promise of increasing administrative efficiency, ensuring transparency and uniformity of treatment, and minimizing judicial errors.

Technological systems thus take on a central role in the functioning of institutions, algorithmically managing legislative, executive, and judicial processes.

The Computational State could maintain and embrace the principle of separation of powers, with innovations that might have disturbing implications for the future of the human species.

The decision-making structure could be based on algorithms, thus becoming a true form of algorithmic legislation: the process of lawmaking would go through stages of proposal, analysis, and optimization using computational models that scan and analyze the impact of proposed legislation on different sectors. For instance, the potential impact of a new tax in a specific sector could be evaluated. Based on the results, the law would be enacted following a preliminary evaluation of its approval or acceptance.

The administrative management of the Computational State is entrusted to fully automated executive decisions. Public policies could be implemented by computational systems that allocate resources based on priorities established by real-time data (e.g., environmental crises or health emergencies).

Moreover, a true computational justice system would be established: legal disputes could be partially resolved by artificial intelligence systems that analyze cases based on legal precedents and regulations, issuing preliminary verdicts.

A crucial aspect for the existence of a Computational State is the massive, real-time collection and analysis of data to monitor the needs and trends of the population (demographic and social data); to anticipate economic, health, or environmental crises (predictive systems); and to personalize judicial policies, where each citizen could be individually considered in the decision-making system, receiving services or responses tailored to their specific needs.

Such a state would, of course, have a sprawling algorithmic capacity, enabling the automated management of bureaucratic systems, welfare systems, and social services according to a continuously updated assessment personalized to each citizen’s income, health, education, etc. The tax systems themselves could be automated to adjust taxes to the economic conditions of each taxpayer or the overall economic system.

While all of this is possible, it is equally desirable that it does not happen, to avoid plunging into the abyss of humanity. A computational state could ensure competitiveness among businesses and solve every market issue, but under what rules, and more importantly, whose rules? And at what human cost?

The potential — or even partial — risk of such a prospect must prompt a profound debate on the ethical, social, and legal implications that could arise for the future of humankind and prevent calculation from replacing justice and power from being concentrated in the hands of a few.

Giovanni Reho

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