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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.