Accounting Ethics Midterm 1

Arthur Andersen

- 1984 consulting service revenue was greater than audit service revenue - 1989 consulting arm was spun off to form Accenture - Revenue generation became the key to promotion - Revenue chasing led to conflicts of interest and ultimate collapse

Decision-Making Model

- Determine the Facts - Define the Ethical Issue - Identify Major Principles - Specify Alternatives - Compare Values and Alternatives - Assess Consequences - Make Your Decision

Pastin Approach

- Ground Rule Ethics - End Point Ethics - Rule Ethics - Social Contract Ethics - Virtue Ethics

Bernie Madoff

- Harry Markopolos, a finance expert, performed an analysis that concluded it was mathematically impossible for Madoff to have paid the returns he claimed that he paid.

SOX

- Responsibilities of Management o CEO must verify/attest to financial reports o Internal control systems must be put into place - Conflicts of Interest o Management must disclose stock trades or dealings with major investors - Responsibilities of Auditors and the Audit Committee o Directors who sit on the audit committee must be independent of management o Audit committee must have at least one member who is a financial expert

Modified Moral Standards Approach

- Utilitarian - Individual Rights - Justice - Virtues

WorldCom

- Who: CEO Bernie Ebbers, Treasurer Scott Sullivan - What: In the early 1980s a group of investors formed a small telecommunications reseller called Long Distance Discount Services. Continue acquiring nearby competitors and expanding its operations. Expands into internet services. When tech boom bursts there is a recognition of overcapacity in telecom markets. WorldCom stock price drops. Board approves significant loans to Ebbers to keep him from selling his stock. 2002 WorldCom says its books are off by 3.8 Billion. They had been capitalizing line costs inappropriately. Ebbers sentenced to prison. WorldCom files bankruptcy and changes to MCI, new tone at the top with a commitment to doing the right thing. Cynthia Cooper was whistleblower.

Tyco

- Who: CEO L. Dennis Kozlowski, CFO Mark Swarts, General Counsel Mark Belchick - What: Essentially, they treated Tyco as their own private bank, taking out hundreds of millions of dollars of loans and compensation. There was an extreme weakness in the governance process. Took "relocation loans" that were interest free. Paid out unapproved bonuses. Had a lavish birthday party for his wife. Really expensive shower curtain.

Adelphia

- Who: John Rigas and the Rigas family - What: Rigas family member had 4 seats on a 7 member board, they used their own company as a piggy bank, withdrawals coupled with bad management and raped expansion led to deteriorating financial position. This led to the Rigas family commiting fraud.

Enron

- Who: Ken Lay, Jeffrey Skilling, Andrew Fastow - What: Enron used SPEs to conceal certain transactions and inflate earnings. Jeffrey Skilling, then CEO was also allowed to operate private equity funds that were dealing with Enron. Whistleblowing was done and nothing happened.

HealthSouth

- Who: Richard Scrushy - What: This case highlights how difficult it can be to make CEOs and Directors accountable for fraud. When numbers were off he basically told employees to "fix it" yet he got acquitted

Ethical Decision-Making Framework Considers

1. Consequences 2. Rights and Duties Affected 3. Fairness Involved 4. Motivation or Virtues Expected

5 Question Approach

1. Profitable? 2. Legal? 3. Fair? 4. Right? 5. Demonstrating expected motivation, virtues, & character.

How can a corporation integrate ethical behavior into its reward and remuneration schemes?

A corporation can integrate ethical behavior into their reward or remuneration processes by offering financial rewards to employees or others who identify potential fraud or other violations of corporate code and follow the appropriate procedures for reporting the problem. Sanctions or penalties should apply equally in situations where employees knowingly fail to report potential fraud or conflicts of interest.

. Explain why corporations are legally responsible to shareholders but strategically responsible to other stakeholders as well?

According to stakeholder theory, corporations need the support of their stakeholders to reach their strategic objectives on a continuing and sustainable basis. Consequently, corporations are legally responsible to shareholders and strategically responsible to a broader set of stakeholders.

Is a professional accountant a businessperson pursuing a profit or a fiduciary that is to act in the public interest?

An accountant's primary role is to act in the public interest. While they do act in pursuit of a profit this should not conflict with their primary role.

Utilitarianism

An action is ethical based on whether it produces the greatest good for the greatest number of people upon which it has an effect. A cost benefit analysis must be performed. AKA Consequentialism.

How could you monitor compliance with a code of conduct in a corporation?

An internal auditor is best positioned to advise on how to monitor compliance with a code of conduct, as well as overseeing the monitoring process. Much in the same way that internal auditors monitor other activities in a corporation, their methods would likely include surveys, annual sign-offs, interviews, whistle-blower comments, review of HR complaints and lawsuits, and reporting of disciplinary actions.

Virtue Ethics

Aristotle says life without virtue is an unhappy life.

How did the manipulation of HealthSouth's financial statements take place?

Each quarter, the senior officers would present the CEO with a variance analysis of the Company's actual earnings compared with street expectations. Adjustments and entries would be made to mask the shortfall.

How can corporations ensure that their employees behave ethically?

Ethical behavior starts at the top with executive management and the Board of Directors.

What breaches of fiduciary duty does the Adelphia case raise?

Fiduciary duty involves the responsibility of a second party to act in the best interest of a first party in a relationship of trust. There are four elements to consider in determining breach of fiduciary duty; the duty itself, breach of duty, direct causation, and damages. The breaches of fiduciary duty in this case include; failure of managers and directors to act in the best interest of all shareholders, the auditors failed to adequately account for risks arising from Adelphia's family ownership structure and the high potential for conflicts of interest.

How can a board ensure that whistleblowers will come forward to tell them about questionable activities.

Foster a culture where dissension can be discussed and not ignored.

How much and in which ways did unbridled self-interest contribute to the subprime lending crisis?

Homeowners failed to understand that they could not afford to own a home, sales agents were only concerned with making commissions on sales, banks were interested in generating transaction fees, investors were ignoring fiscal responsibilities.

Why should an auditor make decisions in the public interest rather than in the interest of management or current shareholders?

I mean that's what they are required by law to do.

What should EY have done if they had perceived these flaws.

If the auditors had perceived these flaws they should have discussed the matter with senior management. However, if they suspected fraud, they should have brought it to the attention of the Audit Committee.

Ken Lay was the chair of the board and the CEO for much of the time. How did this probably contribute to the lack of proper governance?

Lack of oversight, nobody to call him out on his actions or lack thereof.

Would a post-SOX whistleblowing program to the Audit Committee of the board have eliminated the improper and illegal actions?

It depends, a whistle blowing program is only as effective as its implementation execution.

Bernie Ebbers was not an accountant, so he needed the cooperation of accountants to make his manipulations work. Why did WorldCom's accountants go along?

It is likely they had to go along with Ebbers in order to maintain their jobs. "Keep the party going."

Why did Arthur Andersen go along with each of these mechanisms? (WorldCom)

It is unclear if Andersen was aware of the manipulations as WorldCom went to great lengths to conceal the manipulations. That said, Andersen failed to identify or follow up on these manipulations which raises the question of how effective Andersen's audit practices were. WorldCom was also a lucrative consulting client for Andersen.

Deontology

Kantian Ethical Standards. Focuses on obligations or duties rather than consequences. Always act in such a way that your action should become a universal law.

Why would a board of directors approve giving its Chair and CEO loans of over $408 million?

Likely due to a misplaced but longstanding trust in Ebbers.

Why might ethical corporate behavior lead to higher profitability?

Lower cost for liability protections, higher customer retention, higher employee retention, better productivity, lower cost of capital due to lowered perceived risk.

How could Markopolos and the other whistle-blowers have gotten action on their concern earlier than they did.

Markopolos contacted the SEC and had strong suggestive evidence to back up his claims. Beyond going to the SEC, he and other whistleblowers could have "gone public" however he might have faced an uphill battle getting his case heard.

What were the three most important ethical failures that contributed to the subprime lending fiasco.

Mid to senior level bankers who changed loan compliance standards so they could market worse securities. Many people in the risk management chain who knew of risk but failed to report it to authorities. Selling extraordinarily risky securities onto naïve investors without proper, clear disclosure of those investment risks in the investment documents.

What were the major flaws in Health-South's governance?

Overall weak ethics environment/culture, inadequate understanding of professional duty by professional accountants to challenge CEO on matters of concern, inadequate whistle blower process, insufficient oversight of related party transactions, lack of independence of the board of directors, inadequate understanding of accounting issues by members of the board of directors, failure of probing Board Audit Committee, deficient audit risk assessment and audit procedures

What Could Professional Accountants have done to prevent the development of the credibility gap and the expectations gap?

Professional accountants are expected to implement best practice principles and set predefined objectives. On the other end focusing on the services being rendered in such a way that it brings loyalty to the public's best interests.

How could Stewart have handled this crisis better?

She could have not committed insider trading in the first place, or she could have responded fully and quickly to the charges instead of impulsively maintaining her innocence.

Why didn't Arthur Andersen partners responsible for quality control stop the flawed decisions of the audit partners?

Some of them tried to through meetings and memos, however Andersen's governance structure allowed the senior audit partner to supersede their concerns without consulting with anyone else.

Was Scrushy's defense ethical?

The CEO continued his less-than-exemplary behavior through the litigation process. He alleged that he lacked the accounting knowledge to understand the manipulated journal entries. In addition, he used questionable tactics to influence juror selection and jurisdiction including an active public relations campaign focused on bolstering his background as a local, working-class boy made good.

What is the role of a board of directors from an ethical governance standpoint?

The board is responsible for the actions of the corporation, both with regard to the achievement of the corporation's strategic objectives to enhance shareholder value and maintain the support of the company's stakeholders to achieve these objectives. The board must build into the company's governance framework such objectives as growth, profitability in the short and long run, compliance with laws, and respect for the rights of primary stakeholders. Directors must oversee the governance system. Leadership plus value plus reinforcement equals culture, you reap what you sow.

What was the basis of stewart's reputation?

The company of Martha Stewart living was as a trustworthy and experienced homemaker.

What conflict-of-interest situations can you identify in the SPE Activities and Executive Activities?

The entities or vehicles which have been designed or developed especially for certain specific objectives are known as Special Purpose Entities. It was assumed that the proposed SPE management and operating management would violate Enron's conflict of interest policy. However, the key SPEs did make a significant impact on conflict of interest policy. Study this more

What is the most important contribution of a corporate code of conduct?

The most important contribution of a corporate code of conduct is to ensure that employees understand and comply with the code of conduct. The employees have a clear, unintimidating path for reporting potential violations and/or seeking advice and potential conflicts of interest. The code of conduct gives a clear picture of do's and don'ts of the employees in an organization. The code of conduct is important as it plays a vital role in avoiding activities which would lead to chaotic situations.

What was the prime motivation behind the decisions of Arthur Andersen's audit partners on the Enron, WorldCom, Waste Management, and Sunbeam audits; the public interest or something else?

The prime motivation was an internal culture that emphasized on revenue generation and client retention and compromised the firm's traditional strong approach to integrity and independence on its audit activities.

Are one or more of the fundamental principles found in codes of conduct more important than the rest?

The principle of integrity supports all of the other principles thereby making it arguably the most important.

Under what circumstances would it be best to use each of the following frameworks: (1) the philosophical set of consequentialism, deontology, and virtue ethics; (2) the modified 5-question approach; (3) the modified moral standards approach; and (4) the modified Pastin approach?

The traditional philosophical approaches - consequentialism, deontology, and virtue ethics, taken as a set, can be applied to any problem, while the modified approaches (five questions, Pastin, and moral standards) are best suited to particular types of problems. Therefore, as a set, the modified solutions would be superior when there are strong needs to demonstrate duty and virtues in the solution. Modified five question approach is best suited to short-term, profit-oriented problems that confront the law and impact the environment or require a tailored specific question. Modified Pastin's approach suits problems internal to an organization. Each approach/or part thereof can be used on almost all problems. Modified moral standards approach is suited to people of future problems where there are issues that are not captured in the profit measure.

What concerns should have been raised in the following areas of risk assessment in Adelphia's control environment: integrity and ethics, commitment, Audit Committee participation, management philosophy, structure, and authority?

There were a number of red flags; high number of family members in key management positions, relative lack of independent board members, weak oversight by board of directors, strong personality in key executives, a focus on aggressive growth, and an overemphasis on meeting specific financial targets.

What should internal auditors have done that might have assisted the directors?

They could have advised the directors that Andrew Fastow, the CFO and his supporters were involved in significant conflict of interest situations. They could have not approved the structure of several erroneous SPEs. They could have notified directors about the importance of adherence to GAAP.

What should an employee consider when considering whether to give or receive a gift?

They need to consider if it creates an issue of conflict of interest.

Why should directors, executives, and accountants understand consequentialism, deontology, and virtue ethics?

They will frequently be in situations where the "best" action is not covered in law or a corporate code, so they need to make ethical judgements.

Why are philosophical approaches to ethical decision making relevant to corporations and professional accountants?

This question relates to the ideas of consequentialism, deontology, and virtue ethics. Consequentialism requires that ethical decisions have good consequences. Deontology holds that an ethical act depends upon the duty, rights, and justice involved. Virtue ethics states that an act is considered ethical if it demonstrates the virtues expected by stakeholders of the participants.

Why didn't more whistleblowers come forward, and why did some not make a significant difference? How could whistleblowers have been encouraged?

Top management never allowed auditors to have access to complete information regarding deals. Whistleblowing could have been encouraged by creating a notion of trust and confidence among the staff, so that they felt safe while disclosing fraudulent practices.

How can a company control and manage conflicts of interest?

Training, clarification and guidance, codes and counsellors.

Before recent financial scandals and governance reforms, few corporate leaders were selected for their virtues other than their ability to make profits. Has this changed, and if so why?

Yes, largely because corporate governance requirements have increased as a result of SOX.

The pattern of illegal and improper conduct described above took place for at least 5 years prior to June 3, 2002. What red flags or governance mechanisms should have alerted the following people to the pattern? Management accountants, internal auditors, external auditors, board of directors.

Tyco's management accountants should have raised concerns about several items including the CEO's lavish parties, frequent and sizable loans to executives and compensation that was out of line with that of its peers. Tyco's internal auditors should have raised concerns upon seeing the same information. Tyco's external auditors should have detected unusual executive expenditures. Tyco's board should have monitored management's compensation and facilitated better communication with both external and internal auditors.

Egoism

We ought to behave in our own self interests, we only have a duty to ourselves.

If a framework for Ethical Decision Making is to be employed, why is it essential to incorporate all four considerations of well-offness, fairness, individual rights and duties, and virtues expected?

When using a framework for ethical decision making, it is important to consider its entirety. Selecting particular aspects of a framework and not others compromises the framework.

How should WorldCom's board of directors have prevented the manipulations that management used.

WorldCom's board was to a large extent dominated by CEO Ebbers. He had a large personality characterized by tremendous arrogance. WorldCom should have established procedures that would have encouraged the personnel who were ordered to manipulate to whistle blow. Unfortunately, with so many acquisitions, it was likely that employees were too busy merging finances to really focus on reconciling misstatements.