Fun facts about corporate accounting scandals

Regular readers will know that we have a soft spot for corporate responsibility infographics. The one below, which recently crossed our desk courtesy of Accounting-degree.org, provides a nice overview of some of the big corporate accounting scandals of the last 15 years or so. The title may be misleading - it hardly seeks to capture the biggest scandals of "all time" - but it does give a good summary of those that have happened in recent memory. And the sources of the details they provide are cited - most of which (but not all) are pretty reliable. So if you want a five minute summary of all that's wrong in the world of accounting fraud, and you don't mind a strong US bias, this is a good place to start.

One thing we particularly like are the "fun facts" accompanying each scandal. OK, so most of these are not really much fun at all - is anyone laughing about the introduction of Sarbanes-Oxley after the Worldcom and Enron scandals? - but they do point to some of the absurdities of the system in which the accounting scandals have taken place. Enron being voted most innovative company six times in a row by Fortune magazine, Lehman brothers being honored with "Most Admired Securities Firm" a year before its collapse, AIG execs getting $165m in bonuses just after posting the largest quarterly loss in American corporate history and getting a government bailout? It doesn't say much about how well we scrutinize or reward supposedly "successful" companies, does it?

It's also interesting that the infographic has been created by an organization promoting online accounting degrees (we might add that their other Featured Article is titled "10 Accounting Tricks the 1% Use to Dodge the Taxman", which is also worth a look). Are they saying that an accounting degree will help avoid some of these problems in the future? That what we need are better accounting degrees? That an on-line offering is in any way more or less likely to lead people to engage in shady accounting practices? Clearly there is an important role for accounting education in here somewhere, but we're not too sure about the offerings being recommended by Accounting-degree.org, or even who the organization is or what its methodology is. In the spirit of good accounting, a little more transparency would be a good thing. But don't let that stand in the way of enjoying a nice infographic.

Source: Accounting-Degree.org

Photo by AJC1. Reproduced under Creative Commons Licence

A major day in business ethics

June 29, 2009, might go into the annals as a big day in the history of business ethics. Right on top of many US news sites, we learn, first, that Bernie Madoff got his whopping 150 years sentence and, second, the US supreme court ruled in a landmark case in favor of 18 white firefighters who were suing their employer for what is often called ‘reverse discrimination’.

The Madoff case is in some ways your run-of-the-mill textbook case for unethical behavior in business – if it were not on such a biblical scale and in these dire times. And for a change not only hitting poor or middle class people but the wealthy. For us this example of fraud and theft points to the clear limits and boundaries of business ethics: the strong approach to deregulation and self-regulation of the financial industry in the US (and elsewhere) in the past has delegated a lot of ethical issues into the realm of the voluntary.
Funnily, they interviewed Harry Markopolos, a stockbroker, recently on 60 Minutes who as early as in the year 2000 had filed a complaint to the Securities and Exchange Commission (SEC), the self-regulatory body overseeing Wall Street. Four more he filed over the years, mostly because he was mad at Madoff as a competitor who offered these fairy tale returns. Remember, this was the time of Enron etc, where one would have expected the SEC to take complaints about unethical behavior seriously. Based on mathematical modeling Markopolos ("It took me five minutes to know that it was a fraud. It took me another almost four hours of mathematical modeling to prove that it was a fraud.") could prove back then what the SEC never took serious. Madoff was just too respected and too powerful on Wall Street for the SEC to even daring to question his practices. It shows that ethical behavior in business still is very dependent on strong institutions, independent regulators and, no less, skilled and professional oversight. The ‘Case Madoff’ in that sense is in fact a ‘Case SEC’.

The second incident is equally important and will have massive consequences. The case is about the fire department of New Haven (a small town north of New York City) which had made their firefighters pass a test as the basis of promotion. None of the black firefighters passed the test. Out of fear to appear racist, the City of New Haven then refrained from promoting all the (white) guys who did pass. These 18 white guys (one of them Hispanic) went to court and now finally won fighting their case through all the levels.
For a long time, the business ethics literature has actually addressed these issues of retributive justice in rather favorable terms. Because of past injustices against a particular group, that group should now receive preferred treatment. The black guys, so the argument goes, did not fail the test for reasons in their control, but because they belong to an ethnic group, which in the US still struggles in education, family stability and other factors which make people successful. The problem here is though that in doing so, you discriminate against other groups in a similar way. The fact that a court now rules against this in some ways is a sea change in the way we will deal with affirmative action in years to come. The ruling will have massive implication for business too, as it is based on laws that apply not only to the public sector. It will surely lead to many complex discussions and tricky decisions in business.

The new business of shoplifting

It's this time of the year again. Classes have started (at least for us here in Canada) and in the first lesson it’s the thorny job of the business ethics professor to win over the skeptics. Those students who think that they shouldn’t be in this class in the first place. Those who need convincing that the law is just not enough to keep businesses on the bright side of life.

This day and age though, one doesn’t have to go far to find ammunition to make the case. This week, it can be found in a fascinating article in The New Yorker. The topic is shoplifting and how US retailers are trying to deal with it. Mind you, this is not about stingy shopkeepers trying to slap wrists of cheeky kids attempting to sneak out with a free ice cream. It is a US$ 40bn business issue for the industry. And it straddles class - remember Winona Ryder being caught with $5,000 of designer goods in Beverly Hills? It is also one of the most professionalized ‘sectors’ of the wider organized crime industry.

From a business ethics perspective this story is fascinating for at least two reasons. First, it is just mindboggling how much the industry has developed strategies, departments and instruments to prevent shoplifting. ‘Asset protection units’ as these are called – btw, relish the ‘amoralized’ language companies use! From hundreds of in-store cameras, armies of detectives on the shop floor, detailed profiling of customers, and even the operation of entire forensic labs, retailers have created their own mini law enforcement empires. The retailer Target alone faces 75,000 'theft apprehensions' a year. As their head of asset protection argues,

Even if all the U.S. attorneys across the country stopped prosecuting bank robberies, fraud, drug trafficking, and even terrorism, there would still not be enough capacity to prosecute even the apprehensions made by Target.

The result is simple enough: the tackling of this ethical issue is a core task for business. The article is a fascinating read for the challenges, risks and limits of addressing the problem in the corporate world.

The second aspect is even more striking: roughly half of all losses in retail are the responsibility of employees! It raises the thorny question of why these people commit such crimes. Fair enough, many organized crime rings try to recruit employees or even place their members as shop assistants. But for many shop assistants, being on low wages while selling $ 1,000 Armani Suits, the temptation may just be too much. As one VP of asset protection of a New York retailer argues in the article:

You're on commission selling. When times are good, you make a fortune. September through the holiday season, you're raking it in. Then Christmas is over, no one is shopping, gas is four dollars a gallon, and your paycheck went from fifteen hundred to five hundred a week and you have to pay off those bills from that Caribbean vacation you took when the money was rolling in. So you think, I'll credit my card for a thousand dollars and make out a fake return. When it works the first time, you try it again. But next time you load a little more onto your card. And the way this economy's going? We're going to be busy.

It turns our attention to what we call in our business ethics book (Chapter 4) ‘situational factors’ in ethical decision making. For some employees, given the wages and the nature of their products, the temptation is just too high. Whether security cameras and store detectives are the right answer then remains up for debate. Maybe it’s the general working conditions, the level of wages and the general identification with the company. Our guess is that a more in-depth understanding of why employees do these things would help to devise more appropriate strategies. We don’t know what you think. But we would love to hear.

"Unjustly incarcerated": Conrad Black, ethics, and the media

So with Conrad Black spending his first day behind bars as federal prisoner 18330-424, the issue of the ethics of senior executives is once more back in the headlines. Well, OK, in this case, its more than just about ethics - clearly we have a case that is as much about breaking the law as it is getting entangled in ethical gray areas. For all the complexities of this case, fraud of $6 million is, well ... just plain illegal. But with Black himself continuing to claim to be the slighted one, making all kinds of accusations about the integrity of, among others, dissident shareholders, a special committee set up at Hollinger to investigate the case, the media, US prosecutors, and even the trial jury for "compromising" in reaching its verdict, ethics have never been far from the surface of this one.

Not that we are going to enter the fray arguing about who did what and who was to blame for the whole Hollinger fiasco. Clearly a whole lot of value got leached out of the company one way or another. Some of it through poor management, some bad luck, and, as the courts have made clear, some through fraud. Whichever way you look at it, the situation doesn't look good for anyone much.

For us though, especially being relatively new to Canada, one of the most interesting aspects of the case has been the media reaction to it here in the former press baron's country of birth. Black is certainly a larger than life character, and the media here in Canada, as in the UK and the US, eagerly covered every detail of the case, and especially reports of his supposedly lavish lifestyle. Now that Black's six and a half year sentence has started, his fall from grace is back in the news. Prominent among the broadsheets covering Blacks last moments of freedom was his former title, The National Post, where he made front page headlines again yesterday.

As it goes, actually, he got more than just front page news. In addition to the interview with him on the front page, the whole of page 6 was turned over to a Conrad Black penned comment section headlined 'Unjustly incarcerated' where he laid out in detail why he was innocent, who was to blame, and what "really" happened at Hollinger. And all without further commentary from the Post's fine reporters.

Now we are all for freedom of the press, freedom of speech to the invidual, and freedom to do a whole lot of other things. But why exactly is a national newspaper giving such unembumbered press space to a convicted felon, and not an inch to any of those that have proven in a court of law why he should be behind bars? Surely the media, even a paper once owned by Black, has some kind of duty to present a more fair and balanced account of such events. Or at least to provide some analysis of the "news", if yet more bombastic denials of his wrongdoing really count as news.

We should be thankful at least though that one item managed to break the Black monopoly. Nestled at the top of the page above Black's trenchant commentary was a sidebar reporting on news that Canadians will at last be able to rate their favourite public washrooms. We're not sure how we all coped before, but even so we're guessing that Black's new home in the Coleman Federal Correction Complex in Florida won't be featuring too high on any national bathroom ratings.

Crisis management - European style?

Our more longstanding friends, i.e. those who have worked with the first edition of our Business Ethics book, will remember that its success was very much predicated on the proposition that it was the first text book to talk about business ethics from a European perspective. OK, we toned it down for the second edition, but still the main focus of the book is to provide an account of business ethics beyond the Anglo-American version of capitalism – which still is the backdrop of most textbooks in the field.

There has been some debate about whether – and if so, how – a specific European perspective on business ethics is warranted. A good way to learn about these things is to look at how different economies deal with ethical scandals (e.g. Ethics in Action 6.1 in our Business Ethics book). A newspaper article in the Canadian Globe and Mail discusses the recent scandal in France at the bank Société Générale in the context of the Enron case and comes up with some really striking comparisons.

We talked about Jérôme Kerviel in one of our latest blogs and it is indeed fascinating to watch how the French public, rather then seeing him as a villain and a crook, views the bank and its managers as the ones who are responsible for what happened (you can give your own assessment here, see the box on the right). The general mistrust of capitalism and big corporations still seems pretty entrenched in Europe. On facebook, there are now numerous support networks for Kerviel. For instance the group “Jérôme Kerviel should be awarded the Nobel Prize in Economics" has no less then 2,517 members! Could you imagine this happening to Ken Lay or Jeff Skilling in the wake of the Enron disaster…

It is also conspicuous to see the reactions. While the US government took a fairly hands-off approach to the actual downfall of Enron, incl. the plight of many employees who lost jobs, savings and pensions, Nicolas Sarkozy’s government is anything but ‘laissez faire’. Worried about a foreign takeover of Société Générale it appears that the French government has now elected to micromanage the case and has even considered a fairly unrealistic bail out. While the magnitude of this case probably will not allow for this, European governments have a longstanding history of becoming directly involved in managing these issues. And this even at a time where we would expect newly wed Sarkozy to have other things on his mind…

This hands-on approach contrasts significantly with the US, where the main reaction of the government was to issue new legislation with the Sarbanes-Oxley Act, setting tighter rules for the game, rather than trying to become a player in the game itself. It is also interesting to see differences within Europe here. The Globe and Mail article refers to how Gordon Brown has dealt with the recent collapse of a major British bank (Northern Rock): While Brown was actively (as it were, European-style) involved in protecting the savings and mortgages of millions of British working men and women, the solution was in the end left over to the market: brokering the takeover of Northern Rock by Richard Branson’s Virgin empire appeared the best solution, showing strong reliance on markets and free enterprise in the running of the economy – something we can associate more strongly with the Anglo-American system of capitalism.

It will be fascinating to watch how the personal fate of Kerviel will develop over the next couple of weeks. He will hopefully not end up as Enron’s vice chairman John (Clifford) Baxter who committed suicide, unable to deal with the personal shame about his role in the scandal. But it will also be fascinating to watch the further fate of Société Générale. Our money is on a take over by another French bank, brokered in some backroom of the Elysée Palace!

Rogue trader, latest edition

One of the bets you can place these days at Ladbrokes (a British chain of betting shops) is who will play the role of Jérôme Kerviel in a movie some people are planning to make this year. It is a dubious honor for Kerviel, whose covert trading gambles at Société Générale in Paris has brought down the bank last week. The funny thing though is that if a movie script writer would dream up this story, including the whopping €4.9bn losses Kerviel amassed, the plot would sound way too unrealistic to be credible screen material.

It is amazing that since legendary Nick Leeson, whose hidden trading brought down Barings Bank in the 1990s, these cases have keeping happening with a certain regularity (see Ethics in Action 4.1 in Crane & Matten). What’s different in this case is not only the magnitude of losses but also the fact that Kerviel had no immediate personal gain of his dealing and was acquitted of attempted fraud by a French court this week. The focus of the public is much more on the bank rather than the employee who caused the scandal.

While it is yet unclear how much the management at Société Générale actually knew about the secret deals the case is yet another example how unavoidable business ethics has become for companies. By all accounts, Kerviel himself has no record of criminal behaviour, on the opposite; he was a highly successful, skilled and appreciated employee of the bank. His bonus in 2007 was a nice €300,000. What the case makes blatantly obvious is the role of the organizational context in either encouraging or subduing ethical behaviour.

With ever more complex financial products, electronic systems and multifaceted global markets it appears to be increasingly challenging for senior bank managers to keep up with the pace of innovation and to design policies which would allow for better control of traders such as Kerviel. It also appears that rules at Société Générale, in so far they existed, seemingly were open to interpretation and discretion, though much of these things are just about coming out as a result of the ongoing investigation.

This case then ultimately leads us back to the old question why unethical behaviour occurs in business. Is it because the individual managers are inherently evil? Or is it because the organizational and bureaucratic context incentivized individuals to cut corners and take advantage of infringing the rules? Just today, French investigators published the first transcripts of the interrogation of Kerviel. What seems to emerge then is that Société Générale for some time had somehow known about his dealings, not at least as he allegedly made a profit of €1.4bn for the bank in 2007. His own explanation for his gambling is that he just wanted to show his superiors that he is better than his colleagues. His strongest argument for why the bank should have been suspicious much earlier: he only took 4 days of holidays in 2007: “One of the hard and fast rules of auditing is that a trader who never takes time off is a trader who just wants to keep auditors away from checking his books!” Whether Jérôme Kerviel will get away with this stance however will be a question of future investigations. It will continue to be a fascinating piece of corporate crime to watch over the next couple of weeks…