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BADM 2133 UNIT 4
- 1. Business Ethics: Cases and
Selected Readings, 7th Ed.
Marianne M. Jennings
Unit 4
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 2. 130
The New Car and Slippage
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 3. Levels of Moral Development
• Morally clueless – aware of no rules (George Costanza of
Seinfeld)
• Morally superior/moral egotist – rules are for others who are
less gifted (Dot-coms; Computer Associates)
• Inherently moral – natural law; will always follow credo
(Mother Teresa; Ed Begley, Jr.)
• Amoral technician – makes no determination; functions only
within the system and the rules; law is law and rules are rules
and they follow both, right down to the line/wire, but
personal ethics are irrelevant (Fastow)
• Moral schizophrenic – one set of ethics at work and another
in personal life or one set of ethics in personal life and
another at work (NBA referee Tim Donaghey)
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
131
- 4. Levels of Moral Development
• Moral procrastinator/postponer – aware of ethical issues but
will worry about the “ethics stuff” and morality at some time
in the future (Carnegie and Gates)
• Moral compartmentalizer or rationalizer – “I only do this in
certain situations.” “I only do this at work.” “I would never
allow my kids to do this.” (Willy Loman)
• Morally desensitized – was once aware of ethical issues, but
copes by no longer being affected by them (Charles Colson)
• Morally detached – still acutely aware of ethical issues but the
sandbox has worn them down so they go along in a depressed
manner (HP); sometimes called moral disengagement
(morally disillusioned)
132© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 5. Levels of Moral Development
• Moral chameleon – adapts to ethics of those
he/she is working with at the time; changes
with industry; changes with role being played
(Ford truck ad: “Made by the guys we used to
cheat off in high school”)
• Moral sycophant – adopts the ethics of those
in charge (John Dean)
133© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 6. Moral Development
Classifications
Person
• Wi-Fi piggybackers
• Speeders
• William Wilberforce
• Martha Stewart
• Pete Bacanovic
• Douglas Faneuil
• Dr. Sam Waksal
• Carly Fiorina
• Lloyd Blankfein (Goldman)
Category
134© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 7. Moral Development
Classifications
Person
• Goldman
• Fabrice Tourre
• John Paulson
• Heather Bresch
• Albert Carr
• Peter Drucker
• Milton Friedman
• Edward Freeman
• Marjorie Kelly
• Michael Noval
Classification
135© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 8. Moral Development
Classifications
Person
• Marianne Jennings
• John Rigas
• Franklin Raines
• Angelo Mazilo
• John Mackey
• Ice-T
• Dayton-Hudson
• Herman Miller
Classification
136© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 9. Gellerman’s Structural
Changes
• Boards of directors
• Organizational structure (“Chinese Walls”)
• Executive Pay
• Auditors
137© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 10. Changes in Compensation
Current Practice
• Resisting shareholder
activism
• One consultant for system
and certification
• Conflicts in consultants
• Staid, lock-step programs
Changes
• Working with and involving
shareholders in
compensation policies and
discussion
• Bifurcation of system and
certification functions
• System for preventing
conflicts
• Creativity/innovation
138© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 11. Common Traits in Ethical Collapse:
Watching for the Signals
1. Pressure to maintain numbers
2. Fear and silence
3. Young ‘uns and a Bigger-Than-Life-Execs
4. Weak boards
5. Conflicts
6. Innovation like no other
7. Goodness in some areas atones for evil in others
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
139
- 12. 140
Pressure to Maintain Numbers
• Deadlines
• Revenue
• Budgets
• Personal goals
• Sunk costs
• Rankings/ratings
• Loss of _________.
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 13. Iconic CEOs
• CEO a full generation older than direct
reports
• Lack of depth in direct reports
• “I hire them just like me: smart, poor and
wants to be rich.”
Dennis Kozlowski
Former CEO, Tyco
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
141
- 14. Weak Boards
• Lack of experience
• Lack of time commitment
• Conflicts: Everywhere
• Failure to understand industry issues
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
142
- 15. Robert Rubin, Former Chair,
Citigroup
“I tried to help people as they thought their
way through this. Myself, at that point, I
had no familiarity with CDO’s.”
Shawn Tully, “Wall Street’s Money Machine Breaks
Down,” Fortune, November 26, 2007, p. 65, at p. 68.
143© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 16. Innovation Like No Other
“. . . standard accounting rules [are] not the
best way to measure Computer Associate’s
results.”
Sanjay Kumar, former CEO, now in prison
Deciding which rules don’t apply to you, when
they don’t apply, and why
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
144
- 17. 145
HealthSouth and Pressure
“We have met earnings to the penny for 47
quarters in a row.”
HealthSouth Annual Report 2001
Last annual report before indictments
Next annual report would not be until 2005, when
numbers could finally be discerned
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 18. 146
Richard Scrushy on Jeffrey
Skilling
“The things he did to that company are horrible.
I don’t understand the mindset of a man who
would do what he did to that company.”
As he sat in on Lay/Skilling trial on March 8, 2006
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 19. 147
A Scrushy Meeting
Announcement
“I want each one of the [divisional] presidents to
e-mail all of their people who miss their budget.
I don’t care whether it’s by a dollar.”
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 20. 148
Scrushy on Performance by
Employees
In an interview in Fall 2002, Mr. Scrushy
explained his management technique, “Shine a
light on someone – it’s funny how numbers
improve.”
Reed Abelson and Milt Freudenheim, The Scrushy Mix: Strict
and So Lenient, N. Y. TIMES, April 20, 2003, at BU1, 12.
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 21. 149
HealthSouth and Conflicts
• One director had earned $250,000 per year on a consulting
contract with HealthSouth for a 7-year period
• Another director had a joint investment venture with Mr.
Scrushy on a $395,000 investment property
• Another director was awarded a $5.6 million contract for
his company to install glass at a hospital being built by
HealthSouth
• MedCenterDirect, a hospital supply company run online
and which did business with HealthSouth was owned by
Mr. Scrushy, six directors and one of those director’s wives
• The audit committee and the compensation committee had
consisted of the same three directors since 1986
• Two of the directors had served on the board for 18 years
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 22. 150
Scrushy Conversation with One
of His Many CFOs
• [If you] fixed [financial statements] immediately, you’ll get
killed. But if you fix it over time, if you go quarter to
quarter, you can fix it.
• Engineer your way out of what you engineered your way
into.
• I don’t know what to say. You need to do what you need to
do.
• We just need to get those numbers where we want them to
be. You’re my guy. You’ve got the technology and the
know-how.
Secret Recording Is Played at a HealthSouth Hearing, N. Y. TIMES, April
11, 2003, at C2.
Greg Farrell, Tape of ex-HealthSouth CEP revealed, USA TODAY, April
11, 2003, at 1B.
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 23. 151
"There's a big difference between
being aggressive and being
fraudulent."
Bill Schaff, Fund Manager
Berger Information Technology Fund
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 24. 152
Options And Their Effect
On Accounting
• Ken Lay – $123.4 million realized from exercising
stock options in 2000
• At that time not booked as an expense –
footnote only; Enron’s options, if booked, would
have reduced operating profits by 8%
• Increases compensation
• Increases income
• Only two S&P companies (Boeing and Winn-
Dixie) booked options as an expense prior to
FASB change
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 25. 153
Impact of Backdating
“I can say that, to my knowledge, every member of
management in this company believes that, at the
time, we collectively followed appropriate practices for
those option grants which affected all of our
employees, not simply selected executives, and that
such activities were within guidelines and consistent
with our stated program objectives.”
William McGuire, CEO UnitedHealth Group, June 2006
$1.6 billion in options expenses overlooked
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 26. 154
Options and Dates
Backdating: The granting of a stock option is dated
back to an earlier date, one that had a much lower
price and allows an immediate return to the
executive or employee. For example, suppose that
ABC Company stock is worth $90 today.
However, the stock was at $60 just a few months
earlier. If the award date is backdated to that lower
strike price, the option grantee has an immediate
gain of $30 per share
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 27. 155
Options and Dates
Backdating with limitations: Microsoft has
admitted some nuanced backdating in the
1990s, but it was only backdating for the past
30 days. The options were granted at a strike
price that was the lowest price of the stock
during the 30-day period prior to the award.
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 28. 156
Options and Dates
Spring-loading: Options are granted just prior
to a major announcement by a company that
sees its stock price jump. Once again, there is
an immediate gain once the news is public.
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 29. 157
Options and Dates
Downloading: Options are granted just
following bad news announcements that drive
the stock price down. Grantees thus have a
very low share price and can wait until the
stock climbs again and then realize a return on
those options.
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 30. 158
Option Exposure
• Oracle for Larry Ellison – $706 million (OI $933
million)
• Citigroup – not counting options meant
another $919 million in OI
• SOX requires reporting of grant of options
within 2 days
• Software is now more sophisticated in
detecting options grants and dates
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 31. 159
Warren Buffett on Options
Accounting: The Reg Cycle
“If options aren’t a form of compensation, what
are they? If compensation isn’t an
expense, what is it? And, if expenses shouldn’t
go into calculations of earnings, where in the
world should they go?”
Gregg Hitt and Jacob M. Schlesinger, “Stock Options Come Under Fire in
Wake of Enron’s Collapse,” Wall Street Journal, March 26, 2002. A1, A8.
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 32. 160
A Primer on SOX
• The Sarbanes-Oxley Act of 2002
• The Investor Confidence Act
• The Public Accounting and Corporate
Accountability Act
• The Public Company Accounting Reform and
Investor Protection Act of 2002
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 33. 161
SOX Amends Securities Laws
• 1933 Securities Act – IPOs
• 1934 Securities Exchange Act
– Secondary markets
– Reporting ($10M or more in assets and 500 or
more shareholder or NSE listing): 10K, 10Q, and
8K
– Insider trading
– Fraud
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 34. 162
General Provisions
• Quasi-governmental entity called the Public Company
Accounting Oversight Board (PCAOB, but called “Peek-a-Boo”)
• Auditor independence
• Corporate Governance
– Independent directors on audit committee
– Financial expert on audit committee
• CEO and CFO certification
• EBITDA
• Sales of stock disclosures
• Section 404 Internal controls certification
• Increased penalties and obstruction easier to prove
• New Sentencing Guidelines
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 35. 163
Sarbanes-Oxley on Structure
• The majority of the board must be made up of
outsiders.
• The audit committee of the board must be
comprised entirely of independent directors.
An independent director is defined as one
who is not employed by the company (or was
employed), is not related to an officer of the
company, does not do business with the
company, and has no personal compensation
contracts with the company.
• The audit committee must have at least one
director who is a financial expert.
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 36. 164
Sarbanes-Oxley on Structure
• The compensation committee must also be made up
of independent directors.
• The compensation committee must establish and
disclose clear policies for officer compensation and
must approve all compensation packages for
officers.
• Boards can no longer make loans to officers.
• The board must sign off on the financial statements.
• The audit committee must certify the internal
controls of the company as sufficient for ensuring
the accuracy of the financial report.
• Independent of management meetings.
• Ethics training.
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 37. 165
Conflicts and Sarbanes-Oxley:
Audit Committee of the Board
• No consulting contracts
• No advisory contracts
• No work with subsidiaries
• Must have at least one financial expert on the
audit committee
• Direct and independent contact with audit firm
• Procedures for notification of internal control
problems
• Process for verification of financial reports
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 38. 166
Auditors and SOX
• Conflicts on bookkeeping
• Conflicts on design of systems and IT systems
• Conflicts on appraisal, actuarial services
• Conflicts on auditing for internal control
adequacy
• Conflicts on providing management consulting
• Conflicts in serving as broker or dealer
• Conflicts on legal and expert services
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 39. 167
SOX and Financial Reporting
• GAAP must accompany non-GAAP
• Changes in accounting rules
• Section 404 Internal Controls certification
required
• CEO and CFO certification
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 40. 168
SOX and Criminal Penalties
• Increased penalties for obstruction
• Increased penalties for false financial
statements
• Requirement that bonuses earned on the
basis of false financial information be
returned
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 41. 169
SOX and Protection for
Employees
• Cannot retaliate against employees who
report financial issues and legal violations
related to financial reporting
• Cannot retaliate against employees who help
in investigations of financial fraud
• Enforced through the Department of Labor
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 42. 170
Corporate Sentencing
Guidelines
• Formula for sentences
• Reductions for good behaviors
• Ethics training
• Carrot and stick requirements
• Increases for bad behaviors
• CIA agreements
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 43. 171
Sarbanes-Oxley
• Sections 16 (a) and 16(b) of 1934 Act
–Officers, directors and 10% shareholders
–Must report transactions in stock
electronically by end of second business
day after they occur
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 44. 172
Kozlowski on Boards
“Most of us made it to the chief executive
position because of a particularly high degree
responsibility . . . We are offended most by the
perception that we would waste the resources of
a company that is a major part of our life and
livelihood, and that we would be happy with
directors who would permit waste. . . So as a
CEO I want a strong, competent board.”
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 45. 173173
Dennis Kozlowski Thoughts
“We have no perks, not even
parking spaces.”
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 46. 174174
Kozlowski To A Sentencing Judge On
A Tyco Employee Caught Embezzling
“Not only did he steal from the stockholders . . .
But he breached the fiduciary duty placed in
him. . . Wrongdoing of this nature against
society is considered a grave matter. He should
receive the maximum sentence.”
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 47. 175175
Kozlwoski And Henry Silverman (CEO
Of Cendant) Exchange When
Cendant Had Accounting Fraud
"It must really piss you off to hear
Cendant and Tyco mentioned in the
same sentence."
"Henry, it drives me nuts."
Dennis Kozlowski
former CEO of Tyco, circa 2000
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 48. 176
E-mails to Tyco Counsel from
Outside Counsel
Wilmer Cutler to Belnick:
“We have found issues that will likely interest the
SEC . . . creativeness is employed in hitting the
forecasts . . . There is also a bad letter from the
Sigma people just before the acquisition confirming
that they were asked to hold product shipment just
before the closing . . .”1
1Laurie P. Cohen and Mark Maremont, E-Mails Show Tyco’s Lawyers Had
Concerns, Dec. 27, 2002, C1. (on Tyco)
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 49. 177
E-Mails to Tyco Counsel from
Outside Counsel
Tyco’s financial reports suggest
“something funny which is likely
apparent if any decent accountant
looks at this.” 1
1Id.
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 50. 178
Bad Judgment is Bad Judgment
“There are payments to a woman whom
the folks in finance describe as Dennis’s
girlfriend. I do not know Dennis’s
situation, but this is an embarrassing fact.” 1
1Laurie P. Cohen and Mark Maremont, E-Mails Show Tyco's Lawyers Had
Concerns, Wall Street J., Dec. 27, 2002, C1. The payments were made to
Karen Mayo (then-girlfriend, then wife during trial, now ex-wife).
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 51. Bausch & Lomb & Krispy Kreme
Credo Moments
• “I would never sign a document that I know
contains false information.”
• “I would never release financial statements
that do not show the true financial situation
of the company.”
• “I would never ship product that I know was
not ordered.”
• “I would never backdate a document.”
179© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 52. 180
Enron’s Labyrinth Finances
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 53. 181
CALPERS
3%
FASB 125
New Power-
Enron Execs
(Fastow)
Not a subsidiary
LENDER-loans
Up to 97%
ENRON
Asset: Power Plant
Money
Help with capital
Enron guarantees loan
money
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 54. 182
Enron –
Total return swap
Guarantees pshp
Hawaii 125-0
(Raptor III)
Enron Execs
(Fastow)
881/700 Cayman
16-bank consortium
Canadian Imperial
Bank
New Power
Warrants
Cash
$500 million
loan
Warrants pledged as collateral
Share price drop risk
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 55. 183
LJM2 Co-LP
Fastow’s pshp
Porcupine LLC
(hedging vehicle)
After NP IPO, Fastow
Takes out $30 mil +
$9.5 mil profit
Fee for himself
Enron
$30 million$30 million
24 million New Power
Warrants ($10.75)
Hedges $245 million
If New Power drops
Because NP IPO is $21
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 56. 184
Enron – Mark-to-Market
Accounting
• Contract for sales of gas – one gallon at $2.10 for
2007
• Price to acquire gas at end of 2005 is $2.47
• Is there a loss?
• Converse – contract to sell one gallon at $2.75 for
2007
• Price to acquire gas at end of 2005 is $2.47 – is it a
gain?
• When can you book revenue?
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 57. 185
Enron –
Special Purpose Entities
• Accounting rules focus on control
• 50% rule intended to apply to entities with shareholders and
equity interests
• SEC implemented the 3% rule; some outsider had to own at
least 3%
• Enron would create off-the-book entities with a partner, like
Calpers
• Calpers would own 3%, but Enron would often front that 3%
• Enron did not disclose its loan guarantee on SPEs – one of
the missing management disclosures that caused Andersen
concern
• Officer ownership and conflicts
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 58. 186
Jeffrey Skilling, Former
CEO, Enron
“Andy, I have hit a brick wall. I just don’t
know what to do.”
Trial testimony March 7, 2006
Skilling resigned 2 months later
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 59. 187
Andrew Fastow, Former
CFO, Enron
“What I did was reprehensible. It is not easy to
look at yourself and to recognize that about
yourself. It took me a long time to do that. And
some days it is still hard to do that. I have
destroyed my life. All I can do is ask for
forgiveness and be the best person I can be.”
Trial testimony, March 8, 2006
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 60. 188
Andrew Fastow, Former
CFO, Enron
“Within the culture of corruption that
Enron had, that valued financial reporting
rather than economic value, I believed I
was being a hero.”
Trial testimony, March 8, 2006
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 61. 189
Andrew Fastow, Former
CFO, Enron
“We have to open up the kimono and show
them the skeletons in the closet, what our
assets are really worth.”
Testimony on what he told Ken Lay
(mixed metaphors aside)
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 62. 190
Andrew Fastow, Former
CFO, Enron
“I feel like I’ve taken a lot of blame for Enron
these past few days. It’s not relevant to me
whether Mr. Skilling’s or Mr. Lay’s names are
on that page. . . . I’m ashamed of the past.
What they write about the past I can’t affect.
I want to focus on the future. Even after
being caught, it took me awhile to come to
grips with that I’d done. . . I’ve destroyed my
life.”
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 63. 191
Andrew Fastow, Former
CFO, Enron
“I believe I was very greedy and that I lost
my moral compass.”
Trial testimony, March 8, 2006
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 64. 192
Andrew Fastow, Former
CFO, Enron
“My actions caused my wife to go to
prison.”
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 65. 193
Andrew Fastow, Former
CFO, Enron
“I thought I was being a hero for Enron. At
the time, I thought I was helping myself
and helping Enron to make its numbers.”
Trial testimony March 7, 2006
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 66. 194194
David W. Delainey, Former
Head of Enron Energy Services
“That was the worst conduct I had ever
been a part of and everybody knew exactly
what was going on at that meeting.”1
1Alexei Barrionuevo, “Ex-Enron Official Insists Chief Knew He
Was Lying,” New York Times, March 2, 2006, p. C3.
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 67. 195
David W. Delainey, Former
Head of Enron Energy Services
“I wish on my three kids’ lives I would
have stepped up and walked away from
the table that day.”
Response to cross-examination by Daniel Petrocelli
on why he did not walk away when other Enron
executives proposed transferring $200 million in
losses out of the company when he knew it was
wrong.
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 68. 196
Former Enron Investor Relations Officer
Paula Reiker After She Admitted Lying
On A Conference Call To Analysts
Daniel Petrocelli (lawyer for Jeffrey Skilling):
“Why didn’t you just quit?”
Ms. Reiker:
“I considered it on a number of occasions. I
was very well compensated. I didn’t have
the nerve to quit.”
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 69. How does this stuff happen?
Rogues
Bad Apples
Bad
Cultures
Industry
Patterns
and
Practices
Societal
Norms
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
197
- 70. What Gets in the Way of Ethics?
DRIVERS
1. Pressure (results) and
short-term focus
2. Lack of core values and
definitive lines
3. Failure to see issues
360 degrees
4. High comfort level
(complacency; labels;
rationalizations)
5. Failure to see limitations
(truth)
6. Lack of historical perspective
with resulting risk errors
+
ENABLERS
Communicating the Wrong
Message
1. Failure to make ethics
everyone’s responsibility
2. Organizational Behavior:
Retaliation, Incentives,
Rewards, Signals, and
Fear
3. Lack of enforcement and
mixed messages
=
Ethical
and
Legal
Debacles
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
198
- 71. Dodd-Frank Changes
• Management must include shareholder
proposals
• New requirements find more management
teams working with shareholders
• Shareholders have been more active and
more successful in gaining approvals even
prior to Dodd-Frank changes that make it
easier
• Confirmatory say on pay vote every 3 years
199© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 72. Shareholder Proposal Topics
• Advisory vote on compensation
• Right to call a special meeting
• Repeal board structure with classification
• Review of political spending
• Independent board chairman
• Require a majority to elect directors
200© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 73. Shareholder Proposal Topics
(cont’d)
• Take action on climate change
• End super majority vote requirement
• Retention period for stock awards
• Report on sustainability
• Adopt sexual orientation antibias policy
201© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 74. Levels of Ethical Lapses
202
Individual
Ethical
Lapses
1. Screening
2. Internal controls and audits
3. Training
4. Personal commitment
Company/
Organization
Ethical Lapses
1. Alignment of management goals with compensation
2. Enforcement
3. Leaders’ behaviors
Industry
Norms Ethical
Lapses
1. Strategic reviews and planning
2. Political and regulatory activism
Cultural/
Societal
Ethical Lapses
1. Philanthropy
2. Education standards
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 75. 203
Arthur Levitt in His “Numbers
Game” Speech at NYU
“Too many corporate managers, auditors, and
analysts are participants in the game of nods
and winks. In the zeal to satisfy consensus
earnings estimates and project a smooth
earnings path, wishful thinking may be winning
the day over faithful representation... Managing
may be giving way to manipulation; integrity
may be losing out to illusion.”
September 28, 1998
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 76. 204
"There's a big difference between
being aggressive and being
fraudulent."
Bill Schaff, Fund Manager
Berger Information Technology Fund
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 77. 205
Physical Techniques for
Managing Earnings
• Write down inventory
• Write up inventory product development for
profit target
• Record supplies or next year’s expenses ahead
of schedule
• Delay invoices
• Sell excess assets
• Defer expenditures
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 78. 206
Transactional Earnings
Management
• Large-charge restructuring
• Creative acquisition accounting
• Cookie jar reserves
• Materiality
• Revenue
• EBITDA
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 79. 207
Creative Acquisition
Accounting
• Overstatement of restructuring charges
(springloading)
– Soft charges
– Anticipated costs
• Toss extra charges over and above actual
charges into “cookie jar”
• Effect is to make post-acquisition year look
phenomenal
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 80. 208
Cookie Jar Reserve
• High estimates of acquisition costs
• High estimates of sale returns
• High estimates of loan losses
• High estimates of warranty costs
• Dipping in when needed to smooth earnings
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 81. 209
Materiality
• Judging whether to report a transaction by its
percentage relationship to
income, assets, earnings
• Fails to take into account qualitative nature of
the transaction or trends on immaterial
(singularly) items
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 82. 210
Questions for Materiality
• What historically has happened in cases in which these
types of items are not disclosed?
• What are the financial implications if this item is not
disclosed now?
• What are our motivations for not disclosing this item?
• What are our motivations for booking this item in this way?
• What are our motivations for not booking this item?
• How do we expect this issue to be resolved?
• Are our expectations consistent with the actions we are
taking vis-à-vis disclosure?
• If I were a shareholder on the outside, would this be the
kind of information I would want to know?
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 83. 211
Revenue Recognition
• Channel stuffing
• Delaying or accelerating research
• Delaying or accelerating maintenance costs
• Early retirement of debt
• Sales of securities and/or fixed assets
• Depreciation methods
• Inventory valuation (LIFO v. FIFO)
• Reserves
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 84. 212
EBITDA
• Earnings
• Before
• Interest
• Taxes
• Depreciation
• Amortization
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 85. 213
EBITDA
• Earnings
• Because
• I
• Tricked the
• Dumb
• Auditor
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 86. 214
EBITDA
• Non-GAAP reporting
• Aka Pro Forma earnings
• Consider purpose of showing real earnings
• Consider different types of companies such as
companies that have heavy equipment needs;
depreciation is a real expense for them
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 87. Total Bankruptcy Filings
215© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 88. The Ethical Issues in Mortgages
• Would you accept an approved mortgage loan that you
knew was stretching your budget?
• What are the moral hazards of mortgage bail-outs? Re-
default rates are 55% six months after restructuring
• What are the risks of bankruptcy court restructuring?
• Review the notion of consideration on all of these
restructures.
• What is the difference between a refinancing and a loan
modification?
• What are the risks in highly leveraged personal finance?
• Who are the stakeholders in mortgages?
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
216
- 89. The Systemic Effects: What About Bob?
Bob defaults
•Bob’s lender loses payments;
may have to change terms or
foreclose
•Purchaser of bundled mortgages
has a devalued asset on its
books, particularly if Bob is
joined by Betty, Bill, Brent, and
all through the alphabet
•Bob’s neighborhood is affected
by a n ill-maintained, an
empty, and/or a foreclosed
home; value of homes
drops, affecting taxes, affecting
government revenue, and keep
on going
Lender
•Tightens credit
•More homes on the market
•Harder to sell properties
•Market glutted with homes for
sale
•Construction slows down
•Those employed in the
construction industry are laid off
•Decorators, landscapers, title
companies ,and their employees
suffer loss of income and jobs
•These employees default on
more mortgages
•Lender can’t sell mortgages
•Credit freezes
Purchaser of bundled
mortgages
•Forced to revalue the worth of
the mortgage-based instruments
•Their assets are worth less
•They are downgraded
•They cannot sell mortgage
instruments
•Investors begin selling their
investments
•Market drops
•Money pool no longer there
•Frozen markets
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.
217
- 90. 218
Options for Whistle-Blowers
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 91. 219
Beech-Nut Chronology
1977 Beech-Nut and Interjuice contract for apple concentrate
1978 LiCari sends Beech-Nut employees to Interjuice plant; access to tanks
denied
1979 Nestlé buys Beech-Nut
Early 1981 LiCari goes to plant manager Lavery with suspicions and circumstantial
evidence; “Chicken Little” meeting
August 1981 LiCari takes chemical tests to Lavery; “Team Player” meeting
August 1981 LiCari takes evidence and tests to Hoyvald; “Naivete and Impractical
Ideals”
Nov. 1981 LiCari leaves Beech-Nut
1982 Processed Apples Institute lawsuit against Interjuice; Beech-Nut
cancels Interjuice contracts
March 1983 Bogus juice sales stopped
1986 Lavery and Hoyvald trials (conspiracy, fraud, food and drug law
violations)
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 92. Westland/Hallmark Meat Co.
“The video just astounded us. Our jaws
dropped… We thought this place was sparkling
perfect.”
Anthony Magidow, General Manager
David Kesmodel and Jane Zhang, “Meatpacker in Cow-Abuse Scandal May Shut as
Congress Turns Up Heat,” Wall Street Journal, Feb 25, 2008, pp. A1 and A10.
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
220
- 93. Lehman’s Former Chief Risk
Officer
“In the course of performing my duties for the
Firm, I have reason to believe that certain
conduct on the part of senior management of
the Firm may be in violation of the Code. The
following is a summary of the conduct I
believe may violate the Code and which I feel
compelled, by the terms of the Code, to bring
to your attention.”
Letter of Matthew Lee, dated May 18, 2008, as included and
discussed in the Report of the examiner for the bankruptcy
trustee in the Lehman bankruptcy
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
221
- 94. The Lehman Oversight
"We are also dealing with a whistleblower letter,
that is on its face pretty ugly.“
William Schlich, former lead partner on Ernst &
Young Lehman team. June 5, 2008. In July, 2008, the
E&Y team told Lehman's audit committee that the
allegations were unfounded and immaterial. Lehman
would file for bankruptcy on September 15, 2008.
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
222
- 95. 223
WorldCom
• What was behind its market climb?
• Who else had to “go along”?
• WorldCom culture?
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 96. 224
David Myers to Buddy Yates
“I might be narrow-minded, but I can’t see
a logical path for capitalizing excess
capacity.”
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 97. 225
Buddy Yates to Scott Sullivan
“David and I have reviewed and discussed your
logic of capitalizing excess capacity and can find
no support within the current accounting
guidelines that would allow for this accounting
treatment.”
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 98. 226
David Myers to SEC
“This approach had no basis in accounting
principles.”
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 99. 227
Betty and Buddy to Scott
Former WorldCom CFO Scott Sullivan met with two
accountants, Buford Yates and Betty Vinson, who objected to
the schemes, artifices, and frauds for which they were being
asked to serve as accomplices for. They wanted to tender their
resignations. They had been asked to make entries that took
from reserves (the cookie jar phenomenon) and applied them to
boost results so as to meet the earnings expectations of the
markets. Sullivan explained that the two of them should think
of the company as an aircraft carrier that has planes still in the
air. He told them that they could leave, but only after the
planes had landed.
From MARIANNE M. JENNINGS, THE SEVEN SIGNS OF ETHICAL COLLAPSE: HOW TO SPOT MORAL
MELTDOWNS IN COMPANIES BEFORE IT’S TOO LATE (2006).
Susan Pulliam, “A Staffer Ordered to Commit Fraud Balked, Then Caved,” Wall Street Journal, June
23, 2003, pp. A1, A6.
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
- 100. 228
Scott Sullivan at Sentencing
“Everyday I regret what happened at WorldCom.
I am sorry for the hurt caused by my cowardly
decisions.”
“I chose the wrong road, and in the face of
intense pressure I turned away from the truth. It
was a misguided attempt to save the company.”
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
- 101. 229
Common Factors in
Financial Fraud Cases
• Numbers Pressure
• Meeting numbers at all costs
• Fear among employees
• Unwillingness internally and externally to raise questions
about the company
• Perception that company was different and more innovative
than others
• Weak boards
• Conflicts of interest
• Tremendous community and philanthropic presences of
companies and officers
• Always meeting goals to the penny
• Unprecedented performance
© 2012 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.