Académique Documents
Professionnel Documents
Culture Documents
financial statement fraud. Chairman Kenneth Lay, former President Jeffrey Skilling, and former Chief Financial
Officer Andrew Fastow, among others, were accused of shielding debt from public view, and overstating revenues
and earnings, thus giving the impression of rapid profit growth. The same year, Enron declared bankruptcy, then the
largest corporate failure in U. S. history. Its stock price plummeted from $90 in 2000 to $ 0.26 per share, just a few
days before filing the bankruptcy petition in June 2001.
Enron had such a strong following on Wall Street that its CEO Jeffrey Skilling could bluff his way around tough
questions about the companys operations. Yet what happened to force this giant icon to come down in 2001 when
its stock plummeted to $0.26 and the company faced almost extinction? On August 2001, Daniel Sotto, an energy
market expert, changed his recommendations on Enron Stocks from Buy to Neutral, encouraging investors to
sell.
One of the reasons why Enron's implosion was so destructive was that it had managed to hide its problems
through complex round trip transactions, a scale that even WorldCom could not match. By co-opting Arthur
Anderson, formerly one of the world's top five accounting firms, Enron was able to spin out shell companies and
special purpose vehicles (SPVs) or financial entities to hide its fatally wounded core. Later in October-November
2001, Enrons Board of Directors scrutinized these transactions. Among the securities scams investigated were
associated with Enrons former Division Head, former CEO, and two former Division Heads, each cashed in stock
to mint $270 million, $108 million, $80 million and $74 million respectively; two other directors each cashed in $68
million worth of Enron stock. The retirement funds (401K) of more than 45,000 of its American employees forced
invested in Enron stock virtually evaporated since (Fortune 2002; Forbes 2002).
The Company boosted profits and hid debts totaling over $1 billion by improperly using off-the-books
partnerships, it bribed foreign governments to win contracts abroad, and it manipulated the California energy
market. Ex-Enron executive, Michael Kopper, pleaded guilty to two felony charges; acting CEO Stephen Cooper
said Enron might face $100 billion in claims and liabilities. Enrons former energy trader, Timothy Belden, pleaded
guilty on Thursday, October 17, 2002, to criminal fraud charges admitting he was part of a conspiracy to artificially
boost power prices during Californias devastating power crisis (Anderson, 2002). Belden is the first member of the
companys trading team to face such charges. Enron, ranked 7 on the Fortune 500 list two years ago, filed Chapter
11 protection on December 2, 2002 after revealing a $618 million loss and eliminating $1.2 billion of shareholder
equity (Hays 2002). Its auditor, Arthur Andersen, was convicted of obstruction of justice for destroying Enrons
documents.
The meltdown of Enron Corporation was one of the largest corporate bankruptcies in history, and certainly
represented the biggest accounting scandal ever, and possibly, the largest cash crisis in corporate business. Once a
stodgy focused gas pipeline company, Enron redefined itself into the nations leading marketer of natural gas,
electric power, and bandwidth capacity. It struck hundreds of joint venture deals with domestic and foreign partners
alike in projects that diffused its original focus. Revenues soared from $20 billion in 1997 to $31 billion in 1998 to
$40 billion in 1999 until it jumped to $100 billion in 2000. Its NYSE annual-high stock price rose from $22.5625 in
1997 to $29.375 in 1998 to $44.875 in 1999, until it peaked at $90.5626 in 2000. Profits increased almost tenfold
from $105 million in 1997 to $979 million in 2000. Its total assets expanded from $22.5 billion in 1997 to $65.50
billion in 2000.
Investors have sued Enron ever since, with the accumulated damage to them estimated at over $25 billion. New
York-based Amalgamated Bank, which lost millions in the Enron fraud, sued 29 top Enron executives. Enron
restated its financial statements, citing accounting errors, and cut profitability for the past three years by about 20
percent, or by around $586 million. Lawsuits against Enron claimed that its top executives reaped enormous
personal gains from off-the-book partnerships. Meanwhile, Enrons auditor, Arthur Andersen, allegedly instructed
employees to shred critical documents involving fraud. Enron fired Fastow; he was later prosecuted, and later
(September 26, 2006) served a six-year prison sentence. Kenneth Lay is dead, and Jeffrey Skilling is currently
serving a two-year prison sentence. This tragedy of enormous human, social, economic and monetary losses could
have been prevented had Enron applied strict internal cash and accounting controls (Harrison and Horngren 2004).
Enrons shoddy business practices, aided by bankers and advisors, brought down the company in December
2001. Enrons corporate ethics failure represents the biggest business bankruptcy ever. It is a stark reminder of the
implications of being seduced by charismatic leaders, or more specifically, those who sought excess at the expense
2
of their communities and their employees. In the end, those misplaced morals killed the company while it injured all
of those who had gone along for the ride. A lot of people suffered, not the least were the shareholders and pensioners
who lost it all.
Meanwhile, June 2013, Enron Chief Executive Jeff Skilling got 10 years shaved off his imprisonment of 24
years! That is, Jeff would go free in 2017. Enron took wrong measures for a high gain in short period, consequence
of which was detrimental not only to the top officials of the company, but to all the internal and external
stakeholders who showed confidence over them. The USD Government should have stricter scrutiny policies for
periodically scrutinizing the financials of a company which exhibits rapid growth, to ensure that the people who are
attaching their sentiment and money with the company should not face loss. The Sarbanes-Oxley Act of 2002 that
USA promulgated to prevent Enron-type scams could be used for undertaking such scrutiny.
In a recent public appearance (June 2014) former ENRON CFO Andy Fastow gave a public lecture for the
University of North Mexico (UNM) business students. Below are some points of his lecture.
Holding up his CFO of the Year award in one hand, and his federal prison ID card in the other,
Andy proclaimed: I got both of these for doing the exact same thing, before a crowd of eager
UNM business students.
I didnt set out to commit fraud. I cannot remember any time that I ever considered I was
committing fraud.
I thought I was so smart; I thought I was a hero for bending the rules. It comes down to individual
people making a decision we always asked is it allowed? But not Is it the right thing to do?
His message to the students was simple: rules and regulations are not enough. Only employees can
make a difference by standing up and saying no when they encounter unethical practices in their
business careers.
You can always find an attorney to get you the answer you want. You can always find an
accountant to get you the answer you want. Theres only one gatekeeper you.
Ethical Questions:
1.
2.
3.
4.
5.
6.
Andy Fastow masterminded the Enron fraud. How would you identify and assess the economics and
ethics of this fraud?
Among accounting scandals, Fastow was known to pioneer round-trip sales that apparently did not
violate the GAAP codes of those days. Today, it violates the Sarbanes-Oxley Act of 2002 that USA
promulgated to prevent such scams. Explain the unethicality and immorality of round-trip sales, and
their dangerous economic harm.
The retirement funds (401K) of more than 45,000 Enrons American employees that were forced to be
invested in Enrons stock have been wiped away. Explore the ethics of injustice in this deal.
Among other things, Andy Fastow wore two executive hats that implied serious conflict of interest.
Explain the ethical implications of such conflict situations.
Insider trading irregularities date from the origin of stock markets. But they took a dangerous scale at
Enron. Explain the unethicality and immorality of such irregularities, and their dangerous economic
harm.
By co-opting Arthur Anderson, an accounting firm that also provided consulting services, an obvious
conflict of interests, Enron was able to spin out shell companies and special purpose vehicles (SPVs) to
hide its fatally positioned and flawed business. Assess the economic, financial and ethical violations of
Arthur Anderson, and the shell companies and SPVs that it spun for Enron.
began to unwind these structures and forced a write down (non-recurring expenditures) of a billion dollars in the
third quarter of 2001, completely wiping previous years net income of $979 million.
Much of this loss could be attributed to Enrons foray into unrelated businesses, especially water business, and
broadband business. Moreover, the trading customers got very skittish. Enron had about $18 billion of energy
contracts as receivables and $16 billion as trade payables. Within 6 weeks, Enron lost $4 billion in receivables as
some of its trading customers went in for closures. On the other hand, most of its $16 billion dollar creditors
demanded to be paid during the same time. Enron had no option but to file for bankruptcy by September 2001.
Sherron was criticized for not disclosing the facts to the US government directly and delaying justice by
informing the CEO. But one must not forget that she had a family to run and her approaching the government
agencies would have resulted in her losing the job. The decision to bring forward her findings in front of Kenneth
Lay did backfire on Watkins. She should have half-guessed that many inside the organization were involved.
Looking at the magnitude of fraud it became later evident that all were into it. By bringing the facts the way she did,
it alerted the Enron management that they had loopholes in their system that were becoming evident. This also gave
time to the Enron team to cover up some facts before it became public. But on a personal front she could continue
with her job.
By hindsight, it would seem that reporting directly to the Federal authorities and law enforcement agencies
would have been a better option for Ms. Watkins, considering a larger interest. A clear disclosure to the law
enforcement along with going public in the media would have given her enough security against any probable
financial/personal attacks. In short, as Forbes said, she had the whistle, but blew it.
Ethical Questions:
1.
2.
3.
4.
5.
6.
old company would spread risk by diversifying into the infrastructure and real estate business by acquiring two
family-run firms: a) a listed Maytas Infra Ltd where the Raju brothers had a stake of 35%, and b) an unlisted Maytas
Properties Ltd where the family ownership was about 36% (Maytas is Satyam spelt backwards!). Surprisingly, such
a proposal to acquire two totally unrelated companies was readily approved by its eminent board.
The board of directors of Satyam as of December 16, 2008 was as in Exhibit 2.3.1:
Designation
B. Ramalinga Raju
B. Rama Raju
Ram Mynampadi
Mangalam Srinivasan
Krishna Palepu
Vinod Dham
M. Ram Mohan Rao
T. R. Prasad
V. S. Raju
Chairman
Managing Director
Whole-time director
Non-executive independent director
Non-executive director
Non-executive independent director
Non-executive independent director
Non-executive independent director
Non-executive independent director
However, the proposed $1.6 billion deal was aborted within seven-hours from its proposal due to a revolt by
investors, who opposed the takeover. The spontaneous and immediate uproar of Satyam investors against the
merger proposal led the board to call it off by December 17, 2009. Very shortly, Satyam shares plunged 55% in
trading on the NYSE.
Subsequently, B. Ramalinga Raju, Satyam Chairman, revealed that, especially in the wake of the dot.com
bubble bust and subsequent loss of IT business from several Fortune 500 companies, the company had been
reporting inflated profits, understating debts, and doctoring other financial parameters to fight its market share
erosion vis a vis domestic competitors such as Tata IT Services TCS, Infosys, and Wipro. Rajus self-motivated
whistle blowing stunned investors, perplexed government regulators such as SEBI and the CII (Confederation of
Indian Industry), intrigued accounting companies, leading to the dismissal of the Satyam board and installing a
board of government nominees.
But the company collapsed soon. Already on September 30, 2008, Satyam's balance sheet was found to contain
several irregularities. Without shareholder approval, the directors went ahead with the management's decision of
acquiring fiftyone percent stake in Maytas Infrastructure. Raju believed that Satyam could have been saved only if
the deal had been allowed to go through, as Satyam would have been able to use Maytas assets to shore up its own
books, since Maytas Infrastructure was owned by family members of Mr. B. Ramalinga Raju. But it was too little,
too late. Investors sold Satyams stock and threatened action against the management. As a result of this,
acquisition decision reversed. This was also followed by many lawsuits filed in the USA contesting Maytas deal.
On December 23, 2008, the World Bank, allegedly driven by inappropriate payments to staff and inability to
provide information sought on invoices, bars Satyam from doing business with the World Banks direct contracts for
a period of 8 years - one of the severest penalties by a client against an Indian outsourcing company. In a statement,
the World Bank said: Satyam was declared ineligible for contracts for providing improper benefits to World Bank
staff and for failing to maintain documentation to support fees charged for its subcontractors. On that day the
Satyam stock dropped a further 13.6% to reach the lowest bottom in more than four-and-a-half years.
On December 25, 2008, Satyam demands an apology and a full explanation from the World Bank for the
statements, which damaged investor confidence, according to the outsourcer. Interestingly, Satyam does not question
the company being barred from contracts, or ask for the revocation of the bar, but instead objects to statements made
by bank representatives. It also does not address the charges under which the World Bank said it was making Satyam
ineligible for future contracts.
On December 26, 2008, Mangalam Srinivasan, an independent board director at Satyam, resigns following the
World Banks critical statements. Two days later, on December 28, 2008, three more directors quit the Satyam BOD.
Hence, Satyam postpones a board meeting where it is expected to announce a management shakeup, from December
29, 2008 to January 10, 2009. The move aimed to give the group more time to mull options beyond just a possible
share buyback. Satyam also appoints Merrill Lynch to review strategic options to enhance shareholder value. But
by January 2, 2009, promoters stake falls from 8.64% to 5.13% as institutions with whom the stake was pledged,
dump the shares. January 6, 2009, promoters stake falls by another 3.6%. Meanwhile, investment bank Merrill
Lynch, which was appointed by Satyam to look for a partner or buyer for the company, ultimately blew the whistle
and terminated its engagement with the company soon after it found financial irregularities.
Satyam's shares plummeted to 11.50 rupees on January 10, 2009, their lowest level since March 1998 as
compared to a high of 544 rupees in 2008. In the New York Stock Exchange, Satyam shares peaked in 2008 at US$
29.10; by March 2009 they were trading around US $1.80. Investors lost $2.82 billion in Satyam.
January 7, 2009, ex-CEO and Chairman of Satyam, Ramalinga Raju resigns, admitting that his company
inflated its financial results. He notifies the board members and the Securities and Exchange Board of India (SEBI)
that Satyam's accounts had been falsified. Raju confessed that Satyam's balance sheet of September 30, 2008,
contained the said irregularities. He says the companys cash and bank shown in balance sheet have been inflated
and fudged to the tune of Rupees 50,400 million or Rs 5,040 crore. Financial irregularities included: Inflated figures
for cash and bank balances of US$ 1.04 billion vs. US$ 1.1 billion reflected in the books; an accrued interest of US$
77.46 million that was nonexistent; an understated liability of US$ 253.38 million on account of funds was
arranged by Raju himself; lastly, an overstated debtors' position of US$ 100.94 million vs. US$ 546.11 million in the
books.
Other Indian outsourcers rushed to assure credibility to their clients and investors. The Indian IT industry body,
National Association of Software and Service Companies (NASSCOM), jumps to defend the reputation of the
Indian IT industry as a whole.
January 8, 2009, Satyam attempts to placate customers and investors that it can keep the company afloat, after
its former CEO admitted to Indias biggest-ever financial scam. But law firms Izard Nobel and Vianale & Vianale
file class action suits on behalf of US shareholders, in the first legal action taken against the management of
Satyam in the wake of the fraud. Three days later, on January 11, 2009, the Indian government steps into the
Satyam outsourcing scandal and installs three new people to the Satyam board in a bid to salvage the firm. The
board is comprised of a noted banker Deepak S Parekh, the Executive Chairman of home loan lender, Housing
Development Finance Corporation (HDFC), C. Achuthan, Director at the countrys National Stock Exchange, and
former member of the Securities and Exchange Board of India, and Kiran Karnik, former President of NASSCOM.
The new Board members elected Ram Mynampati, the whole-time director of Satyam on the BOD, as interim CEO.
The Crime Investigation Department (CID) team picked up Vadlamani Srinivas, Satyam's then-CFO, for
questioning. The Indian Government stated that it may provide temporary direct or indirect liquidity support to the
company.
But the damage was already done as evidenced by:
Merrill Lynch (now with Bank of America) terminated its engagement with the company. Also, Credit Suisse
suspended its coverage of Satyam.
SEBI, the stock market regulator, said that, if found guilty, Satyams license to work in India may be revoked.
Satyam was the 2008 winner of the coveted Golden Peacock Award for Corporate Governance under Risk
Management and Compliance Issues; now it was stripped of the Award in the aftermath of the scandal.
India's National Stock Exchange announced that it will remove Satyam from its S&P CNX Nifty 50-share index
on January 12, 2009.
The founder of Satyam Ramalinga Raju was arrested two days after he admitted to falsifying the firm's
accounts.
Satyam's shares fell to 11.50 rupees on 10 January 2009, their lowest level since March 1998.
In New York Stock Exchange, Satyam stock was trading around US $1.80.
On 14 January 2009, Price Waterhouse announced that its reliance on potentially false information provided by
the management of Satyam may have rendered its audit reports "inaccurate and unreliable."
On 22 January 2009, CID told in court that the actual number of employees is only 40,000 and not 53,000 as
reported earlier and that Mr. Raju had been allegedly withdrawing INR 20 crore rupees every month for paying
these 13,000 non-existent employees.
The new board at Satyam held a press conference, where it discloses that it is looking at ways to raise funds for
the company and keep it afloat during the crisis. One such method to raise cash could be to ask many of its Triple
A-rated clients to make advance payments for services. NASSCOM welcomed the appointment of the new Satyam
board saying that it would help to ensure business continuity, build confidence and protect the interests of
employees, customers and investors.
On 5th February 2009, the six-member board appointed by the Government of India named A. S. Murthy as the
new CEO of the firm with immediate effect. The two-day-long board meeting also appointed Homi Khusrokhan
(formerly with Tata Chemicals) and Partho Datta, a Chartered Accountant as special advisors.
In March 2009, the company announced it would begin soliciting bids from potential buyers of Satyam. On
April 13, 2009, Kiran Karnik, the MD at Satyam, announced that IT services provider Tech Mahindra had offered
the highest bid at Rs 58 per share. The deal went through. That was the end of Satyam. It became Mahindra
Satyam, and now just Tech Mahindra.
The case of Satyam is an example of negligence of fiduciary duties, total collapse of ethical standards and lack
of social responsibilities. This led to the closure of the company and job-loss to thousands of employees and
money-loss to several groups of internal and external stakeholders. Employees of Satyam spent anxious moments
and sleepless nights as they faced non-payment of salaries, project cancellations, and labor-layoffs, coupled with
bleak prospects of outside placement. Clients of Satyam expressed loss of trust and reviewed their contracts,
preferring to go with other competitors. Cisco, Telstra and World Bank cancelled contracts with Satyam. Customers
were shocked and worried about the project continuity, confidentiality, and cost overruns. Shareholders lost their
valuable investments and there was doubt about revival of India as a preferred investment destination. Bankers were
concerned about recovery of financial and nonfinancial exposure and recalled facilities. Indian Government was
worried about the image of the Nation and its IT Sector affecting faith overseas to invest or to do business in the
county.
Satyam is a watershed event for the institution of independent directors, wrote Prithvi Haldea (2009), chairman
and managing director, Prime Database, in Economic Times. It has demonstrated that even highly credible,
qualified, and educated persons are no insurance for corporate governance, that they are no watchdogs of the
minority shareholders whose interests they are supposed to serve. In fact, boards can serve a negative purpose, that
of providing a false sense of security to the minority shareholders. In general, promoters want to enrich themselves
and their institutions; the independent directors, on the contrary, should be preventing this from happening. But this
is the core of the problem: what if promoters also seek positions of independent directors on boards? When this
happens, the promoters as directors may not even recognize or resolve the conflict they could exploit it, as it
happened with Satyam. Often, several independent directors may not be aware of some promoter-driven initiatives
as they attend only a few meetings a year.
8
References:
Satyam Case Study. University of the Fraser Valley. 14 November 2009, www.scribd.com
Financial Scams Storm the Market and Killed the Innocent, www.slideshare.net
Commentary about Satyam Scandal. San Diego Accountants Guide.
The Satyam Scandal: Now What? Rediff India Abroad. 9 January 2009.
Indian IT Scandal Boss Arrested. BBC News. 9 January 2009.
Ethical Questions:
a) To what extent did the Satyam episode bring to light the deficiencies in the BOD-based corporate
governance system in India?
b) In order to restore investor confidence in corporate governance systems in India, how would you design
an ethical mandate for Satyam that, among other things, would redefine the role of the board, the
executive directors, the non-executive independent directors, the internal auditors, the external auditors,
the audit committees, and government regulatory bodies?
c) To what extent can corporate governance failures be attributed to factors such as short-term quick fix
solutions that Satyam pursued to save itself?
d) To what extent can corporate governance ethical failures be attributed to factors such as corporate greed
of managers, chief executives, and even of boards and investors?
e) To what extent can corporate governance and ethical failures be attributed to more critical factors such
as the lack of a questioning culture and critical thinking in corporate boardrooms?
f) To what extent can corporate governance ethical failures be attributed to lack of effective separation
between governance and management, especially given the fact that several corporations have the CEO
(management) as also Chairman (governance) of the BOD?
special recipe or checklist for detecting and preventing corporate or personal fraud at all times. No such
thing exists and no such thing is truly capable of being developed to monitor and control all forms of
fraud (Silverstone and Davis 2005: 5-6). Managers should be aware of fraud, deal with the human factors
that generate fraud by hiring honest people and keep them honest by instituting strong deterrents of fraud,
and deal with the environmental factors that cause crime by enforcing adequate monitors, controls,
policies and procedures.
Losing investors confidence in the securities market can be disastrous. Thousands of shareholders
were shell-shocked and numbed when premium blue chip stock prices trading at the $100 and more levels
suddenly plummeted to a few cents a share within a year. What happened? Did the stock market crash?
Was it rigged? Neither. In reality, creative accountants fooled the markets they cleverly inflated
reported cash flow from operations by reclassifying items among the operating, investing and financing
sections of the statement of cash flows all this, presumably, well within the boundaries of the then
generally accepted accounting principles (GAAP). For instance, in acquisitions, cash paid for working
capital could be shifted to the investment section rather than shown as a reduction in cash flow from
operations (Mulford and Comiskey 2005: xi; see also Appendices 2.1 and 2.2).
Regardless of whether corporate scams have peaked or not, their intensity, frequency, and magnitude
over the last fifteen years since 2000, should be a moral and ethical wake-up call for all and must be
seriously scrutinized, objectively analyzed, effectively monitored, and expeditiously controlled. This
Chapter is a step in this direction.
The corporate world is failing in its fiduciary duty and loyalty to its stakeholders. During the last
decade and a half, the media has been reporting hundreds of corporate frauds either in the form of
accounting misdeeds or insider trading security scandals (see Appendices 2.1 and 2.2). Led by Enron in
2001, the list of giant corporate malfeasance grew steadily in 2002 and thereafter. In fact, there is a great
fear that we have just scraped the tip of corporate deviant behavioral iceberg.
clandestinely and never made public (Albrecht and Albrecht (2004: 3).
Each dollar lost in fraud is a dollar loss of net income, and hence, it takes significantly more sales
revenue to recover the effect of fraud loss on net income. For example, a fraud loss of $100 million to an
automobile manufacturer whose profit margin (i.e., net income divided by revenues) is ten percent would
necessitate the manufacturer to generate additionally ten times the fraud loss, that is, $1billion in revenue
to recover the effect on the net income. If the average ticket price of a car were $20,000, this would imply
that the auto manufacturer would have to make and sell an additional 50,000 cars ($1 billion/$20,000) to
counterbalance the fraud loss. Meanwhile, this loss could be easily passed on to the consumer via higher
ticket prices. Alternately, if that amount is deducted from R&D, the opportunity loss of $1 billion could
affect the quality of cars.
Whereas most employee crimes in the past were theft of physical goods (e.g., stationery, money,
commodities) that were either in small amounts or infrequent, owing to fear of being caught, modern
crime is much more sophisticated and electronic in nature. Telecommunications, particularly the
computers and the Internet, have facilitated and stimulated corporate fraud. Employees now need only to
make a telephone call or get on the WhatsApp, misdirect purchase invoices, bribe a supplier, manipulate a
computer program, misplace company assets, and other fraudulent transactions by a mere push of a key
on computer, PDA, Smart phones or Blackberry keyboards. Most of them take years to be detected. 1
The Association of Corporate Fraud Examiners (ACFE) in 1996 defined an occupational fraud as
The use of ones occupation for personal enrichment through the deliberate misuse or misapplication of
the employing organizations resources or assets (ACFE 1996: 4). This definition has remained more or
less the same in 2004: an occupational fraud is the use of ones occupation for personal enrichment
through the deliberate misuse or misapplication of the employing organizations services or assets
(ACFE Report 2004).
The ACFE defines occupational fraud against ones organization. ACFE also defines fraud as an
activity that is: a) clandestine, b) which violates the employees fiduciary duties to the organization, c) is
1Corporate fraud is a growing problem. The FBI (USA) has labeled fraud the fastest growing crime and hence, has committed
almost 24 percent of its resources to fighting fraud. At any given time, the FBI is investigating several hundreds of cases of fraud
and embezzlement, each averaging to over $100,000 in damages. These cases, however, relate just to FBI jurisdiction. Secondly,
insurance companies, that provide fidelity bonding or other types of coverage against employee and other fraud, undertake
regular investigations within their jurisdiction of employee bonding or similar insurance. Occasionally, researchers conduct
studies about particular types of fraud in specific industrial sectors. Fourthly, victims of fraud report crime. All four sources of
fraud, however, are incomplete, jurisdiction-specific, and periodical. They fail to provide a comprehensive and up-to-date
picture of organizational fraud at the national level.
11
committed for the purpose of direct or indirect financial benefit to the employee and d) which costs the
employing organization assets, revenues or reserves (ACFE 1996: 9). The term employee in this
definition includes employees of all categories: blue- and white-collar labor, managers, corporate
executives, including CEOs, CFOs, and presidents. Fraud can encompass any crime that uses deception
as its primary method or modus operandi.
Based on Websters Dictionary (4th edition, 2002) we may identify the following fraud synonyms or
equivalents:
Deception: The act or practice of deceiving. The fact or condition of being deceived. Something that
deceives, as an illusion, or is meant to deceive, as a fraud. In marketing, the word deception has been
defined as those instances in which consumers change their behavior for reasons not grounded on
fact or reality but on beliefs and impressions made on them by the influencer (such as
advertising, marketers, sales representatives) (Gardner 1975). Often, consumers are influenced by
non-substantial attributes and features of a product (such as style, appearance, color, sheen, display)
at the expense of disregarding the intrinsic aspects of the product (Gardner 1975: 43).
Fraud: Deliberate deception in dishonestly depriving a person of property, rights, etc.
Misleading: To lead in a wrong direction, error of judgment or into wrongdoing. This may or may
not be intentional.
Obfuscation: to confuse or obscure the mind or a topic so as to stupefy or bewilder people.
Subterfuge: An artifice or stratagem used to deceive others in order to evade something or gain some
end.
Trickery: Implies the use of tricks or ruses in deceiving others.
Chicanery: Implies the use of petty trickery and subterfuge, especially, in legal actions.
Beguile: To mislead people by ones charm or persuasion of cheating or tricking.
Seduction: In a marketing context, means interactions between marketer and consumer that
transform the consumers initial resistance to a course of action into willing, even avid, compliance
(Deighton and Grayson 1995: 660). It is the enticement of a consumer into an exchange where
ambiguity is resolved by a private (non-institutionalized) social consensus that the consumer plays a
part in constructing (Ibid 668). Seduction is a strategy whereby consumers are induced to tolerate
or overlook unsustainability, or even to connive in denying it. In this sense, seduction is more
voluntary than fraud and more collaborative than entertainment - a playful, game-like social form
(Ibid 661).
Thus, deception is a broader term that applies to anything that deceives, whether by design (fraud), by
delusion (trickery or illusion) or by device (subterfuge and chicanery). A fraud is a deliberate
misrepresentation or nondisclosure of a material fact made with the intent that the other party will rely
upon it. If the party did in fact rely upon such a misrepresented statement, and if this causes injury, then
the person may bring an action to rescind the contract. Statements of opinion, however, may not be
usually used as a basis for fraud or misrepresentation. If the seller says, "This car is the best buy in
town," such a claim is treated as a statement of opinion or puffery, but not a statement of fact. However,
if the person making such a claim has "superior knowledge" having specific expertise in the field, and the
buyer relies on this expertise in the actual purchase, then such a claim may be equivalent to a
misrepresentation. 2 The misrepresentation must be of a present or a past fact. False statements regarding
the future are not actionable. In addition, in general, silence or nondisclosure is not fraudulent, unless
2 The "Recovery Theory" in the U. S. Law is also based on the definitions of "fraud" and "misrepresentation." A misrepresentation occurs when a person, by words or acts, creates in the mind of another person an impression not in accordance with the
facts. Example: If the seller of a passenger car expressly states that the auto has been rebuilt to meet tougher road conditions,
when it has not been, and if the buyer relies heavily upon this statement (hence a "material fact") in deciding the purchase, then
the latters decision was not freely and voluntarily made, but triggered by misrepresentation. A fact is "material" if the person
trying to avoid the contract will not have entered into it had he/she known of the misrepresentation. The buyer may ask a court to
free him/her of the contractual obligations of the purchase contract.
12
13
All nine corporate scam-types involve selling or buying under fraudulent conditions, and hence, fall
well within the domain of fraudulent marketing.
The U. S. Federal Energy Regulatory Commission (FERC) defines wash trading, also known as
round trip trading or sell/buyback trading, as the sale of a product to another company with a
simultaneous purchase of the same product at the same price. Essentially, wash trading is a false trading
because it boosts the companies' trading volume, or even sets benchmark prices, but shows no gains or
losses on the balance sheets. While this kind of trading may not be strictly illegal, (possibly, they are too
recent frauds to receive federal scrutiny), it can manipulate the power market, which is illegal and it is
14
downright unethical. An inflated balance sheet from round-trip trading misleads investors about the true
value and volume of the company's business. Misled investors may tend to invest more, thus jacking up
the corresponding stock price. Large volumes of "wash trades raise the revenues but have no effect on
earnings. For example, in the energy industry, round-trip trades involved the simultaneous purchases and
sales of energy at the same quantity between the same parties; they inflated revenues in both companies
but added no profit.
For instance, in the energy trading market controlled by fraudulent energy
companies such as Enron, CMS Energy, Duke Energy, Dynergy, and Reliant Energy, each company
indulged in the same basic type of wash trading and thereby seriously affected market prices and
shortages (see Forbes.coms accounting tracker Internet service).
Wash trading also affects final consumers. For instance, wash energy trading created false
congestions and the perception of energy shortage in the Californian market in 2001, and the price of
electricity paid both by the industrial and home users skyrocketed (USA Today April 4, 12, 2002).Also, on
September 23, 2002, Allegheny Energy, a Maryland electric utility company, sued Merrill Lynch for $605
million and more unspecified punitive damages in a New York state court. The charge stated that Merrill
inflated revenues of Global Energy Markets (GEM) through a series of round-trip trades with former
industry giant Enron, before selling it to Allegheny for $490 million in 2001. The lawsuit also accused
Merrill for misrepresenting the qualifications (e.g., age, experience) of Daniel Gordon, GEMs head
(Yahoo! News, Thursday, September 26, 2002, 9:25 am, EST).
All of these behaviors are examples of occupational fraud. According to the Association of
Corporate Fraud Examiners (ACFE), an occupational fraud is the use of ones occupation for personal
enrichment through the deliberate misuse or misapplication of the employing organizations services or
assets (ACFE Report 2004). This definition is broad enough to include fraud schemes as simple as
pilferage to complex financial statement frauds. Each of these abuses implies: a) some clandestine
behavior, b) violation of perpetrators duties to the victim organization, c) some form of cheating the
employer, d) which costs the employer some money, revenues or assets, and e) some direct or indirect
financial benefit to the perpetrator.
The first five examples relate to cheating on time spent on work for which the employer must pay
extra. The sixth case of alcohol or drugs cheats on the quality of work that you owe to the company. The
next three abuses cheat on products and/or money. The tenth abuse cheats the company on everything:
time spent on work, quality of work and using companys products/services for ones private business.
All ten examples involve a corrupt practice, deception, and improper use of ones fiduciary trust.
15
Fiduciary duty implies that you are employed (entrusted with responsibilities) on the condition that you
are trustworthy and that you do not betray the trust your employer has in you.
In practice, how do you distinguish fraud from abuse? The difference is a matter of perspective.
Fraud implies more conspiracy and conspirators, more scheming, affects more people, involves greater
losses, and negatively affects large assets of the company. In contrast, abuses are often single-handed
actions that are ordinary and routine deceptions, which mostly benefit just the abuser, and involve smaller
corporate losses.4 [See Business Executive Exercises 2.3].
Based on Wells (2004: 46), Table 2.4 presents a detailed taxonomy of occupational fraud and abuse.
Table 2.4 traces occupational fraud to three major action-sources: a) corruption practices, b)
misappropriation of assets, and c) falsifying financial statements. Table 2.4 also includes several major
types and sub-types of occupational fraud under each of these three heads. Vigilant managers could use
this exhaustive list to check and identify occupational frauds in their companies.
16
nature and volume of the company's business. Large volumes of "wash" trades raise the revenues but have
no effect on earnings. Appendix 2.1 features recent mega accounting irregularities.
Earnings Management: The active manipulation of earnings toward a predetermined target, which
may be set by management, a forecast made by analysts, or an amount that is consistent with a
smoother and more sustainable earnings stream.
Income Smoothing: A form of earnings management designed to flatten peaks and valleys from an
actual earning series, including steps to reduce and store profits during good years for use during
slower years.
Creative Accounting Practices: This is a general euphemistic term for any of the above accounting
malpractices or irregularities. Typical creative accounting practices include recognizing premature
and fictitious revenues, aggressive capitalization and extended amortization policies, misreported
assets and liabilities, massaging income statements, and deceptive cash-flow reporting.
Many corporate frauds are crimes committed within the accounting system of various companies.
The accounting system comprises the methods by which companies record transactions and financial
activities. Accounting is a method of tracking business activities in a particular time period (e.g., week,
month, quarter, or a year). Some common frauds are: fraudulent disbursements when funds are disbursed
through false invoices or forging company checks, skimming, where cash is stolen before it gets ever
recorded, and cash larceny, where cash is stolen after it is recorded (Silverstone and Sheetz 2007: 25).
Ethical Implications
Deliberate accounting irregularities are failures of corporate accountability. In the wake of these
escalating corporate accounting scandals, several ethical and moral questions arise. As responsible
ambassadors and representatives of the corporation, and of its mission, products and services, corporate
executives in general, and accounting executives in particular, must represent integrity, honesty and
corporate responsibility to customers, shareholders and other stakeholders.
The Enron bankruptcy raised questions about the validity of the independent audits and of the
business practices of the accounting industry itself. It is clear that the auditors failed to pinpoint the
accounting irregularity problems with companies involved in corporate scams. Given the fact that the
accounting practices are relatively simple, it is hard to believe how easily the accounting firms disguised
17
the truth, presumably in collusion with the audit and accounting branches of the implicated firms. It is just
hard to accept that the accountants did not assess the magnitude of these frauds. Clearly, the accounting
principles and rules were not followed.
There were systems level failures at several points that allowed many corporate frauds and scams to
remain undetected until they were so large that they bankrupted large companies, with billions of dollars
of loss in shareholder equity. Some of the biggest and most prestigious U. S. accounting firms (e.g.,
Arthur Anderson, Deloitte &Touch, Ernst & Young, KPMG, and Price Waterhouse& Coopers) offered
consulting services to the same companies they also audited. This is gross conflict of interest. These firms
clearly compromised their credibility and independence when they had to audit their own work. The
Securities and Exchange Commission (SEC) failed to bar accountants from also being consultants for the
same company due to extensive pressure from the accounting lobbying groups. The same groups have
contributed millions of dollars to individuals, political activity campaigns (PACs), and soft money
contributions to fight any SEC rules change. Some of the largest scams recently uncovered were in the
utility business. Several wholesale power traders revealed that they participated in the so-called "round
trip" or "wash trading" practices.
Insider Trader: The term insider is specially defined in Section 16b of the U. S, Securities Exchange Act of
1934 that limits short-term transactions by insider parties (Vagts 1979: 827). Section 16b of the 1934 SEC Act
imposes express liability upon insiders - directors, officers, and any person owning more than ten percent of the
stock of a corporation listed on a national stock exchange or registered with the SEC - for all profits resulting
from their short-swing trading in such stock. The insiders are assumed to have special access to insider
information concerning a corporation either because of financial interests and/or a managerial position. If any
insider sells such stock within six months from the date of its purchase or purchases such stock within six
months from the date of its sale, the corporation is entitled to recover any and all profit the insider realizes from
these transactions. The profit recoverable is calculated by matching the highest sale price against the lowest
purchase price within the relevant six-month period, and losses cannot be offset against profits (Mann and
Roberts 2000: 961). Individuals classified as insiders are subject to special restrictions in using such data in
trading in securities. Insider trading during a tender offer is prohibited by Rule 14e-3 of the 1934 SEC Act
(Mann and Roberts 2000: 963). A tender offer is a general invitation to shareholders to purchase their shares at
a specified price for a specified time. Section 14e imposes civil liability for false and material statements or
omissions or fraudulent, deceptive, or manipulated practices in connection with any tender offer.
18
Security: A security includes any note, stock, bond, pre-organization subscription, and investment contract. An
investment contract is an investment of money or property made in expectation of receiving a financial return
solely from the efforts of others. Securities not subject to the registration requirements of the 1933 SEC Act
are exempt securities which include short-term commercial paper, municipal bonds, and certain insurance
policies and annuity contracts. Non-exempt securities come under 1933 Act such as notes, stocks, bonds and
some investment contracts. Similarly exempt transactions are issuance of securities that do not come under the
registration requirements of the 1933 Act (e.g., limited offers, intrastate issues). Disclosure of accurate material
information is required in all public offerings of non-exempt securities unless offering is an exempt transaction.
Disclosure requirements: these are statements disclosing specified information that must be filed with the SEC
and furnished to each client. Insiders are liable under Rule 10b-5 for failing to disclose material, nonpublic
information to the SEC and each client before trading on the information.
Antifraud Provision: Rule 10b-5 makes it unlawful to 1) employ any device, scheme, or artifice to defraud; 2)
make any untrue statement of a material fact; 3) omit to state a material fact without which the information is
misleading; 4) engage in act, practice, or course of business that operates or would operate as a fraud or deceit
upon any person. Recovery of damages under Rule 10b-5 requires proof of: 1) a misstatement of omission; 2)
materiality; 3) scienter (intentional and knowing conduct), and 4) relied upon 5) in connection with the
purchase or sale of a security. In an action for damages under Rule 10b-5, it must be shown that the violation
was committed with scienter or intentional misconduct. Negligence is not sufficient.
Material: A misstatement or omission is material if there is a substantial likelihood that a reasonable investor
would consider it important in deciding whether to purchase or sell a security. Examples of material facts
include substantial changes in dividends or earnings, significant misstatements of asset value, and the fact that
the issuer is about to become a target of a tender offer.
Tippers These pass on insider information that they had a legal obligation to keep secret even though they do
not trade on it themselves. Correspondingly, a Tippee is someone who accepts insider information from a
person who should not have revealed it, and trades on it.
Insiders, for the purpose of SEC Rule 10b-5, include directors, officers, employees, and agents of the security
issuer, as well as those with whom the issuer has entrusted information solely for corporate purposes, such as
underwriters, accountants, lawyers, and consultants. In some instance, the rule also precludes persons (tippees)
who receive material, nonpublic information from insiders (tippers) from trading on that information. A tippee
who knows or should know that an insider has breached his fiduciary duty to the shareholders by disclosing
inside information to the tippee is under a duty not to trade on such information (Mann and Roberts 2000: 962).
Insider Trading: SEC Rule 10b-5 applies to sales or purchases of securities made by an insider who
possesses material information that is not available to the public (Mann and Roberts 2000, p. 961). More
specifically, it is the attempt to benefit from stock market fluctuations by using unpublicized information gained
on the job (Mescon, Bove and Thill 2002, p. 58). An insider who fails to disclose the material, nonpublic
information before trading on the information will be liable under Rule 10b-5, unless he or she waits for the
information to become public. The U. S. Supreme Court has upheld the misappropriation theory as an
additional and complementary basis for imposing liability for insider trading. Under this theory, persons may
be held liable for insider trading under Rule 10b-5 if they trade in securities for personal profit using
confidential information misappropriated in breach of a fiduciary duty to the source of the information; this
liability applies even though the source of information is not the issuer of the securities that were traded (Mann
and Roberts 2000: 262).
Insider Information: Insider information is data or news that has not been publicly released and that could
affect a shareholders decision to buy or sell stock in a publicly traded company utilizing material, nonpublic
information (Markon and Schmitt 2002). The law bars trading in a material nonpublic information. In terms of
defining just what kind of information fits this category, prosecutors have some leeway. The most clear-cut
examples include market-moving news such as an impending merger or bad earnings report before it is made
19
public. But, gray areas abound. Numerous other issues abound. For example, many companies attend
professional conferences each year and they may provide information about new products to attendees, while at
the same time bar members of the general public from any of the above information (Business Week, April 26,
2002). The American Society of Oncology (ASCO) is a case in point. At each of their annual conferences a
great deal of information is released to those attending these gatherings. This is akin to insider trading if the
attendees begin trading on the information provided to them.
Legal Insider Trading: Insiders need to follow certain procedures when they wish to sell some or all of their
holdings. First, the potential inside trader needs to consult with legal consul so as to determine the
appropriateness of an insider purchase and/or sale at a given point in time such as a pending merger. Then a
Form 144 must be filed with the Securities Exchange Commission (SEC) indicating the number of as well as
the precise timing of the desired sale. Finally, an opinion letter must be sent from the appropriate legal counsel
and filed along with the above, to the Securities Exchange Commission (SEC). All these procedures are meant
to ensure that the corporate insiders do not trade on or tip others with insider information thus negatively
affecting the company and/or its shareholders.
Thus, although both Section 16b and Rule 10b-5 address the problem of insider trading and both
apply to the same transaction (i.e., trading securities), yet these two legal sources differ in many aspects:
1) Section 16b applies only to transactions involving registered equity securities, whereas Rule 10b-5
applies to all securities. 2) The insiders by Section 16b are only directors, officers, and those who own
more than 10% of the a companys stock, while the insiders by Rule 15b-5 extends to other categories
such as agents of the security issuer, underwriters, accountant, lawyers and consultants. 3) Section 16b
does not require that the insider possess material, nonpublic information; the liability is strict; whereas
Rule 10b-5 applies to insider trading only where such information is not disclosed. 4) Section 16b applies
only to transactions occurring within six months of each other, while Rule 10b-5 has no such limitation.
5) Under Section 16b, although shareholders may bring suit, any recovery of damages is on behalf of the
corporation; but under Rule 10b-5, injured investors may recover damages on their own behalf (Mann and
Roberts 2000: 962).
In 1988, the US Congress amended the 1934 Act by adding Section 20A that imposes express civil
liability upon any person who violates the Act by purchasing or selling a security while in possession of
material, nonpublic information. Any person who contemporaneously sold or purchased securities of the
same class as those improperly traded may bring a private action against the improper traders to recover
damages for the violation. The action must be filed within five years after the date of the last transaction
that is the subject of the violation. Tippers are jointly and severally liable with tippees who commit a
violation by trading on the insider information (Mann and Roberts 2000: 963).
Further, any person who distributes a materially false or misleading proxy statement may be liable to
a shareholder who relies upon the statement in purchasing or selling a security and thereby suffers a loss.
A misstatement or omission is material if there is a substantial likelihood that a reasonable shareholder
would consider it important in deciding how to vote or buy/sell shares, even if this misstatement or
omission occurred merely through negligence. Similarly, by Section 14e of the SEC Act of 1934, it is
unlawful for any person to make any untrue statement of material fact, to omit to state any material fact,
or to engage in any fraudulent, deceptive or manipulative practices in connection with any tender offer.
This provision applies even if the target company is not subject to the 1934 Acts reporting requirements.
Some courts maintain civil liability for violations of Section 14e; however, the requirements for such an
action are not entirely clear because relatively few cases have involved such violations. At present, the
target company may seek an injunction, and a shareholder of the target company may be able to recover
damages or obtain rescission (Mann and Roberts 2000: 963).
By legislations enacted in 1984 and 1988, the SEC is authorized to bring an action in a U. S. district
court to have a civil penalty imposed upon: 1) any person who purchases or sells securities while in
20
possession of material, nonpublic information; 2) any person who by communicating material, nonpublic
information aids and abets another in committing such a violation; 3) any person who directly or
indirectly controlled a person who ultimately committed a violation, even though the controlling person
knew or recklessly disregarded the fact that the controlled person was likely to commit a violation and
consequently failed to take appropriate steps to prevent the transgression. Violation in all three cases
must be on or through the facilities of a national security exchange or from a broker or dealer. Purchases
that are part of a public offering by an issuer of securities are not subject to this provision (Mann and
Roberts 2000: 963).
Corporate insiders for some time have been forbidden to trade while knowing about material,
nonpublic information such as earnings announcements or a possible merger. Currently, insiders need
only be aware of confidential market-moving information, as based on SEC Rule 10b-5. A second rule
(105b-2) extends liability for illegal insider trading to family members and other non-business
relationships that have agreed to keep secret the information they receive.
Further, as of August 2002, SEC has come up with newer rules requiring firms to report trades of
company stock by officers, directors and majority shareholders within two (2) days (Kristof 2002). This is
a vast improvement over past sales that allowed companies at least 10 days - and sometimes more than a
year - to reveal whether the top officers within the firm were buying or selling their equity or portions
thereof. Recently, the SEC is involved with more activities relative to insider trading cases: as a result, 57
insider trading related cases were filed in 1996, up from 38 in 1990 (Bryan-Low 2000). Appendix 2.2
features recent mega insider trading irregularities.
Opportunism is rampant in every area of business, and corporate finance is no exception as the long
list of corporate securities irregularities (e.g., Fortune September 2, 2002) demonstrates. The risk of
opportunism can be very high, and considerable resources might have to be spent in controlling and
monitoring it, resources that could have deployed more productively elsewhere in the company.
Opportunism is hard to detect owing to information asymmetry between the party engaging in
opportunistic behavior and the other exchange partner, even harder to control, and strategies for
suppressing opportunistic behavior may undermine existing exchange relationships (Murry and Heide
1998) as well as forfeit valuable deals in the process. While several strategies of external control of
opportunism have been devised, tried, and often failed (e.g. reduction of information asymmetry, closer
monitoring, higher monetary incentives to discourage opportunism, higher contracted penalties for
opportunistic behavior), very few internal control mechanisms have been tried. A major internal
control such as selecting, contracting, and rewarding marketing or securities managers whose virtues of
honesty, prudence, commitment, and fiduciary responsibility have been tested and proven may help
control opportunism far more effectively than external monitors.
Corporate irregularities are bred by corporate greed that in turn is stimulated by the corporate
virtue of selfishness (Rand 1964). What we need at this juncture is a real return to virtue, specifically
the virtue of caring for others, specifically advocated by recent feminist ethical scholars (see Gilligan
1982; Noddings 1984). Unless corporate executives aim higher (see Bollier 1997), and incorporate
virtue in their corporate strategies (see Morris 1997), they will never appreciate the social contracts
they have implicitly signed with society by their corporate position (Donaldson and Dunfee 1995, 1999).
India.
However, how and under what circumstances can ethics reduce corruption?
approaches:
We suggest two
1.
Much of corruption thrives on uncertainty or ambiguity of the law, licenses, and other excessive regulation
and its enforcement mechanism. There is much information asymmetry between the buyer and the seller
of excessive regulation services. Ethics should focus on reducing uncertainty, ambiguity and asymmetry in
the entire corruption phenomenon wherever it occurs.
2.
In order to do this, we breakdown the phenomenon of corruption into inputs, process, and outputs, and
distinguish the supply side and demand side under each. For a proper focus, we concentrate only on the
government as the supply side and business house as the demand side G2B domain.
Other things being equal, uncertainty/asymmetry in relation to inputs may be regarded as complexity,
uncertainty in the process may be construed as ambiguity, and uncertainty in the outputs as risk all this
both on the supply side and demand side. Table 2.5 is a representation of uncertainty involved in the
sources and sub-sources of corruption. When specifically applied to each cell, ethics can piecemeal
combat corruption. Additionally, Appendix 2.3 presents the essentials of the famed USAs SarbanesOxley Act of 2002 to Combat Corporate Frauds. [See Business Executive Exercises 2.4 to 2.8].
All businesses have a responsibility to the common good. Because corporate executives and
organizations are both economic and social institutional forces, their responsibilities to the public are
large and go beyond the sanctions of law and demands of competition. In serving each other, they must
strike at some unity that goes beyond a mere melding of self-interests to sharing of socially responsible
values and ideals. Howsoever defined, the social good of investors is very high, and the investing public
recognizes this good. Corporate irregularities of whatever form reduce this potential for social good by
depriving investors of necessary, objective and timely securities information to which they are entitled.
This goal is achieved in USA through existing organizations such as GAO, SEC, DOJ, and CFTC.
It is possible that corporate executives would justify their improper action under the guise of
situationism. The latter affirms that when confronted with conflicting rights or duties, it is usual to let the
situation with all its circumstances define whose rights should prevail. But this does not mean that the
rights of shareholders, investors, employees with 401K moneys invested in the company, and other
stakeholders should be totally disregarded, as seems to be the case with the corporate accounting and
insider trading irregularities. In fact, moralists (e.g., Rawls 1971) prescribe that under situationism one is
obliged to give additional protection to the rights of the disadvantaged.
Hence, it seems certain industries, by the very nature of their market offerings, are more prone to
corporate scams than others are. For instance, service companies do not deal with tangible products, thus
allowing more subjective accounting practices and overstatement of earnings.
All these companies belong to the so-called fuzzy sectors that produce mostly intangible products
or services where it is easy for top executives to hide and manipulate segments in the short term without
being caught. Moreover, companies within the energy and IT industries have grown so significantly over
the recent years that the average shareholders are allured to invest heavily in them, a fact that top
executives can comfortably exploit to feed their corporate money-greed egoism.
Further, most of the reported corporate securities scams relate to 1) insider trading, 2) fake
transactions to boost revenues, and 3) inflation (and restatement) of earnings. All these transactions relate
to internal operations of a firm that take place close-doors within small departments in a company, and
normally do not get disclosed or reported, but which can be detected only years after some auditors have
analyzed the annual reports. Other than these generalized statements as to how and where corporate
scams originate, there is no systematic research reported to date that has probed into the real reasons
behind such illegal and unethical transactions.
Corporate scams are often the results of short-term profit maximizing strategies. There is an almost
obsessive desire among many managers to show improvements in the bottom line, year after year, by
finagling, creative accounting, aggressive financing, takeovers and mergers, acquisitions and
speculations. Outrageously high executive salaries, bonuses and perks are often pegged to executive
profit performance. In the anxious process of demonstrating short-term profitability, corporate
executives, additionally motivated by money greed, tend to cut corners and often overstate earnings or
understate debt, thus padding financial statements (Boyle 2002; David 2002). Further, there is always the
pressure to please the Wall Street analysts in order to meet their expectations and thus, score better stock
and bond ratings (Pelofsky 2002).
CEOs these days are compensated largely in stock options. Thus, given that their compensation is
valued by stock performance, CEOs would be severely tempted to make their companies appear as
fiscally attractive as possible for high returns. This would explain several fake transactions such as
round trip deals to inflate revenues. For example, in 2002, CMS Energy, Dynergy and El Paso, all three
energy-based companies, executed round-trip trades to boost artificially energy-trading volume. Duke
Energy engaged in 23 round-trip trades in 2002 to boost trading volumes and revenue; Duke claimed
that its round trip trades had no material impact on current or prior financial periods (See Fortune
September 2, 2002; Forbes, July 25, 2002). Despite these fake transactions, however, when those at the
top realized their ships were about to sink, sold their stock options while the companies were still
performing well. These were massive securities trading executed on insider information, and the
company stocks soon began to nose-dive to almost nothing, of course, impoverishing shareholders,
employees, creditors and other stakeholders.
Corporate psychologists, however, also connect corporate creative accounting irregularities to
boredom and not money, to loneliness and not wealth, to insecurity and not power, to unrealistic fantasy
and not greed, to negative self-images (low self-esteem) and not corporate egos (see Horowitz, 2002).
In any case, this area needs serious research; the earlier the causes of corporate fraud are identified,
the better they may be treated, and further disasters to the organization, economy and stakeholders might
be averted.
In general, one can distinguish two broad levels of responsibility: Responsibility for the action itself,
and responsibility for the consequences of the action (Hart and Honor 1975):
Responsibility for the action is primarily moral, and involves the concepts of duty, obligation,
blame, and answerability.
Responsibility for the consequences of the action is primarily legal and is associated with the
concepts of liability, imputability, accountability, and punishment/compensation for the harm
accruing from the action.
This double use of the expression responsibility arises from the important fact that doing an action and
compensating harm from the action are two distinct sources of holding persons responsible. Both sources
of responsibility are independent of, but may be influenced by, a third consideration: did the said action
cause the harm for which compensation is sought? Or, equivalently, did the doer of the action cause the
harm? Aristotle raised a fundamental question in responsibility: Under what conditions of the agent and
the action could one say that the agent deserves to be praised or blamed, rewarded or punished, for the
action the agent performs? The answer would depend upon how we understand an action, how an action
is distinguishable from its consequences, and what it means for a person to be the cause of an action, and
in particular, a moral cause of a moral action (Mascarenhas 1995). These questions are too complex
to resolve, and for practical purposes, legal responsibility, especially under the rubric of strict liability,
may not always deal with this third consideration. The principle of strict liability asserts that all harm
should be compensated for via compensatory justice, regardless of the fact, state and direction of
causality of the action between the said parties.
Responsibility for the consequences can impute in two ways (Mascarenhas 1995):
If the executives themselves act or omit an act that causes harm to some stakeholder, then the
executives are directly responsible for it - this is called consequent causal responsibility.
If the executives command or delegate an action (commission or omission) that causes harm, then
they are indirectly responsible for the harm - this is called consequent agent responsibility.
The corporation authorizes the advertising agency to act on its behalf. The corporation assumes that
the ad agency will work on behalf of the interest of the entire company and its stakeholders and not be
opportunistic by serving its own interests. The principal or the corporation assumes vicarious liability
or vicarious responsibility for the advertising agent. 5
5 Obviously, because of its multi-polar and multivalent use (as a noun, adjective, adverb, object, subject, predicate, verb, etc.,),
the word responsibility can be ambiguous in connotation and denotation when used. The fact that responsibility is a relatively
modern word (i.e., it appeared in the English language just about four centuries ago) and has picked up such a diversity of
meaning and usage indicates that the word is extremely potent and flexible in concept. Further, since we link responsibility to a
human action, and given that human action can be a very complex phenomenon (see Chapter 03), the concept of responsibility
will be even more complicated (Rehrauer 1996: 139-144).
24
In the Western philosophical tradition, moral causation is associated with an action resulting from
the unique property of human beings, freedom. Freedom is the necessary presupposition for responsible
action - that is, for an action that deserves praise or blame, reward or punishment. 6
Three major philosophers, David Hume, Karl Marx and John Stuart Mill, question the existence of
free will that responsibility presupposes. All three deny free will on the grounds that too many external
circumstances determine our decisions and actions. David Hume asserts that external factors render our
actions temporary and perishing, and hence, that they do not originate from the durable and constant
character of the moral agent. Actions may be blamable in themselves but we may not be held responsible
for them. Karl Marx overemphasizes the external determinant factors and circumstances, and
accordingly, proposes the thesis of historical determinism social consciousness and social choices
determine the economy of products, production and profits, and these, in turn, determine individual
decisions and actions. Hence, our freedom is a historical necessity. Stuart Mill concludes: responsibility
is retributive punishment [For details see Mascarenhas 2008: 23-44].
David Hume (1711-1776) denies the necessary logical connection between freedom and
responsibility. Responsibility does not need a free cause, but only the absence of impediments to the
realization of ones wishes and desires, which themselves are caused by many determining factors. In
fact, moral responsibility, argued Hume, far from presupposing freedom, presupposes determinism. In
order to associate objectively an agent with his or her act, the rational desires of the agent must be the
determining cause of consequences; instead, praise and blame, reward and punishment are themselves
causes that modify the character of the agent. Hence, wrote Hume:
Actions are, by their very nature, temporary and perishing, and whereas they proceed not from
some cause in the character and disposition of the person performing them, they can neither
redound to his honor if good, nor to infamy if evil. The actions themselves may be blamable; they
may be contrary to all the rules of morality and religion. But the person is not answerable for
them, and as they proceed from nothing in him that is durable and constant, and leave nothing of
that nature behind them, it is impossible he can, upon their account, become the object of
punishment and vengeance." (See Concerning Human Understanding, VIII, 2).
Thus, according to Hume, it is only in terms of something "durable and constant" (which defines a
character) that one can judge or assess responsibility for an act. 7 In doing so, one need to know whether
the agent intended to perform the act (intention), what the underlying motivation was, and whether there
was a clear possibility and opportunity for deliberation. However, this information is inferential for the
most part. The judge must deduce this from the agent, and the agent's character is the most important
premise for this sort of inference and reflection. Does the act reflect what we know of the person in the
light of his habitual conduct? Would the agent intend this sort of act? Would the agent act on such a
6 Thomas Aquinas argued for the existence of free choice thus: Man has free choice, otherwise counsels, exhortations,
commands, prohibitions, rewards and punishments would be in vain (Summa Theologiae I, 83.1). Kant argued for freedom as a
postulate of the practical reason - the unconditioned ought of the law requires a can on the part of the rational will (Critique of
Practical Reason, 1.2.2). Responsible action, then, presupposes the existence of a free cause - a human being that is selfdetermining and capable of choosing.
7 Incidentally, even Aristotle maintained that an act could be called virtuous only if it "springs from a firm and stable character"
(Nichomachean Ethics 2.14, 1105a30, p. 40). Vice, the opposite of virtue, should, therefore, be logically condemned or punished
only if it stems from one's character (Hauerwas 1981). "A Person's faulty action is registrable to him only if it reveals the kind of
person he is" (Feinberg 1965: 140-141).
25
motive? Would the agent normally investigate other courses of action before choosing one? In short, is
the agent a criminal type just because he or she committed this crime?
Humes deterministic position on personal responsibility is obviously an extreme caricature of
human conduct. Some determinism, however, in a few of the routine corporate behaviors and strategic
decisions and tactics cannot be ruled out. Typical examples of turnaround executive decisions that have
moral implications and that for the most part are "temporary and perishing" are: plant closings and
massive layoffs to cut down costs; pressurizing suppliers to reduce prices of supplies below break-even
points; forcing retailers to overstock their shelves with slow-moving products or force them to channel
stuffing; to over-promote products to vulnerable customers with persuasive and attractive price and
product bundling; overstating revenues and understating debts to obtain better SEC ratings, and the like.
Most of these decisions may not be much planned or deliberate, nor purposively deceitful. Hence, they
may be temporary and perishing.
On the other hand, some executive decisions and actions that have a moral content may stem from
the "durable and constant" aspects of the executive's character. Hence, several moral philosophers (e.g.,
Aristotle, Thomas Aquinas, Kant, Francis Bradley, Max Weber, John Dewey, and Dietrich Bonhoeffer)
affirm freedom as the foundation of moral responsibility (for details see Mascarenhas 2007: 23-70).
Typical fraudulent behaviors are deliberate persistent exorbitant pricing of life-saving products, planned
subliminal advertising directed to children, exploitative under-supplying or over pricing of products and
services in inner city ghetto markets, creating artificial shortages to jack-up prices, and deliberate underevaluation of sales-performance of minority salespersons. The more these decisions reflect serious
planning and deliberation, the more do they seem to originate in ones durable and constant character.
However, according to Hume, deviant or fraudulent behavior is deterministic; it stems from the
durable and constant aspects of ones life; it may indicate real responsible agency. In this Humean
sense, fraudulent behaviors may be partly exonerated because of ones "deterministic" character or by
overpowering circumstances.
Discussion Point 02: As a best practice of corporate freewill and responsibility that will actively
avoid or remediate corruption, how will you incorporate durable and
constant aspects of corporate life that include free-will and moral
deliberation?
maintained that crime is learnt, primarily from ones environment in the process of interactive
communication (Siegel 1989: 193). Criminality, Sutherland argued, cannot occur without the assistance
and influence of other people. Potential criminals learn crime within intimate personal groups (e.g.,
dysfunctional family, buddies, street gangsters, high school peers, neighborhood clans, and close
workmates).
The learning process involves two elements: a) the techniques to commit the crime, and b) the
attitudes, motives, drives and rationalizations of crime. The incidence, frequency, and intensity of crime
are dependent upon both elements, but more so on drives and rationalizations.
Discussion Point 03: To what extent does Sutherlands theory of differential association explain the
deviant behavior of Andy Fastow, the CFO at Enron, or of Ram Lingaraju,
the CEO of Satyam?
27
Opportunity
Pressure
The Fraud
Rationalization
Triangle
Violation of Ascribed Obligation: Financial obligations incurred in violation of ones role and position
as a trusted person in the corporation or society and the specter of being unable to pay ones debts
make people secretive about their debts. Resolving such debts becomes a non-sharable financial
problem.
Personal Failure Problems: Several personal and family expenses could exceed budgets and drive
one into accumulated debts. Such debtors do not like to share the debt problem owing to fear of
status loss, fear of disclosing ones stupidity or lack of judgment that drove them to debts.
Business Reversals: Accumulated debts, short and long term, because of overspending and bad
financial planning, can make business executives desperate, secretive, and refusing to share with
others their problems, lest they be thrown into false light.
Physical Isolation: The person in financial trouble is physically isolated, by design or choice, from the
people who could help him.
Status Gaining: People quickly live beyond their means and incur debts, but now must trim their
lifestyles, and hence, feel disabled to meet with their one-time peers.
Employer-Employee Relations: The employee resents the status within the organization in which he is
trusted. This resentment is presumably triggered by perceived economic inequities (e.g., in job stress,
work hours, pay, promotions, bonuses, and recognitions). Such persons nurture their resentment
quietly and seek to get even with their employers by embezzlement.
Embezzlement can occur because of any one or more of the above six factors. For instance,
accumulating personal and work-related financial problems can become serious as to become nonsharable, fearing that any disclosure would lose ones approval rating with others or lose ones face with
ones family. This in turn drives to physical isolation from trusted persons who could help. The
wrongdoer wants to solve his/her problems secretly. Crime of secret embezzlement follows. The crime
28
supposes that the trust violator does have the technical skills required: a) to pull the fraud off in secret,
and b) also use the funds in secret to resolve the un-sharable financial problem. Some criminals felt it
was more difficult to return the stolen funds than to steal them in the first place, and claimed they did not
pay back their ill-gotten goods lest they should be detected and punished.
Similarly, most teenager crime is for getting even with bosses (e.g., parents, teachers, and part-timework supervisors) that have humiliated, wronged or angered them. This becomes an un-sharable problem
that is resolved by cheating the person you want to get even with.
In any case, how does the trust violator justify the crime? Cressey (1972) argued that criminals
rationalize or justify their crime by viewing it as: a) non-criminal (it is ok, good, cool and nonharming), b) justified (it is reasonable, compensatory, and collateral) and c) something they cannot control
(it is necessary, inevitable, and organizationally determined). Such rationalizations can take place before,
during and after the crime (Cressey 1972: 94). The first fraud may be difficult to rationalize, execute and
conceal. Subsequent crimes become easier to rationalize, execute and conceal. Callousness sets in, and
the trust violator may feel even religiously impelled to bring about justice by embezzlement or terrorism.
Most trust violators embezzled to keep their families from shame, want or disgrace. Others felt that there
was no other way to bring their dishonest employers to justice. The employees strongly believed that
their employers were already cheating and exploiting them and the corporation financially and
handsomely. Embezzlement was the only means for making the playing field even. Some felt that they
were just borrowing funds temporarily in the hope of restituting them eventually. Some offenders felt
that they already had gone too deep into crime, and there was no looking back now. The best they could
do was to support crime by crime.
Some embezzlers absconded with entrusted funds as they could not share with others what their
financial problems were, why they stole, and what they intend to do with stolen assets. These are
absconders who take the money and run; they are mostly unmarried, divorced or separated, with few
connections with their primary group associations (Cressey 1972: 128).
A major factor in lessening occupational crime is to build employee loyalty to the company. Loyal
workers or partners do not commit crime, cheat or embezzle. However, with the recent wave of plant
closings, massive labor attrition, outsourcing of labor, and the resultant increase in non-contractual labor,
loyalty may be eroded, and crime could step up. This could diminish worker productivity, since it is
difficult to justify how employees stealing from organizations can be beneficial to anyone (Wells 2004:
10).
Discussion Point 04: To what extent does Donald Cresseys theory of the Fraud Triangle explain
the deviant behavior of Andy Fastow, the CFO at Enron, or of Ram
Lingaraju, the CEO of Satyam?
Sales and Accounts Receivable: The fundamental concept of any business is to design new products and
services, distribute them, market and sell them, and collect revenues. Revenues from sales appear on the
income statement, and corresponding accounts receivable from credit appear on the balance sheet. Cash
sales directly affect the cash balance, which also appears on the balance sheet. In order to minimize fraud
and financial risk in this cash cycle, various checkpoints are:
a
b
Marketing department: Identifying and soliciting customers, processing customer orders and fulfilling
them exactly (e.g., timely sorting, packaging and shipping of products) - this is the marketing and
sales function.
Accounting department: costing products, pricing products, sending invoices, guidelines for credit,
approving credit, collecting receivables, record keeping and assessing bad debts - this is the credit
function.
Finance department: collecting cash, cashing checks, banking cash and financing production and
marketing - this is the financial function.
In minimizing fraud, keep these three functions separate. Accordingly, custody of data and
customers, authorization of credit, and recordkeeping should be separate functions. That is, separate the
credit function from the sales function, thereby avoiding granting credit to an unsuitable potential
customer in order to force a sale. Similarly, sales recording and receipt of cash should be separated so
that skimming of cash may be minimized.
Payments and Accounts Payable: Any production business involves procurement of goods and
services and subsequent payment. In this accounting cycle, the expenses appear on a companys income
statement, and the respective accounts payable appear on the balance sheet. Cash purchases would
directly affect the cash balance, a balance sheet item. Check points in this payment cycle are: identifying,
selecting and approving vendors, due diligence and ensuring they actually exist and are legitimate
businesses; proper processing of purchase orders; proper assessing, processing and posting of receipt of
goods and services; recording defective products, theft, and pother liabilities; and processing of cash for
payment.
Other safeguards are constant checking of cash, prepaid expenses, inventory, accounts payable,
equipment, land and buildings, office equipment, depreciation, and other long-term assets and liabilities.
One should be sure that the person who makes the bills, generates checks, signs the checks, mails the
checks, and the person who reconciles the checks with bank accounts cannot be the same this is a
fundamental principle of accounting.
Human Resources and Payroll: Any business systems need employee skills. This HR cycle includes
identifying skills, recruiting, developing, promotion, and retention of employee talent, performance
appraisal, and other related matters. Cash, payroll and taxes payables appear on the balance sheet, while
salaries/payroll, tax, travels, training and entertainment appear in the income statement. Fraudulent
practices prevalent in the HR cycle are ghost employees, falsified hours and overtime; false expense
reports (e.g., padding); false medical claims; false sick leave; improper recruiting, hiring, firing, wages,
salaries, promoting, appraising, and personnel development.
Inventory and warehousing management: This purchase cycle includes ordering, transportation,
logistics, receiving goods and reports, processing requisitions, control over requisitions, storage,
warehousing, continuous inventory records, shipping documents, JIT inventory management, inventory
costing, FIFO, LIFO, theft, spoilage, and other related functions. From an accounting perspective,
inventory appears on the balance sheet, and cost of goods sold (CGS) in the income statement.
Fraudulent practices prevalent in the inventory management function include overstocking, creating
30
artificial shortages, creating production bottlenecks, overstating inventory as bank collateral, improper
use of FIFO or LIFO, theft, spoilage, and the like.
Capital Expenditures: This fifth part of the accounting cycle is also known as the capital acquisition
and repayment cycle or the financing cycle. It includes borrowing of funds, payment of interest, debt
structure of the company, debt amortization, leveraged buyouts, issuance of stock, stock repurchases, and
the like. Several of these items feature in the financial statements, such as cash, liabilities (e.g., debt,
mortgages), capital and retained earnings on the balance sheet, and interest paid and received, among
others on the income statement.
Several sources of fraud can occur, especially in the recording of debt and interest, and payment of
interest and dividends. Periodic monitoring and control should check bank deposits, loan authorizations,
proper documentation of loans, journal entries, and stock certificates. Certain financial duties should be
separated such as stock issuance and handling of cash and, in general, separating accounting from cash
handling.
In general, control of frauds in the entire accounting cycle is critical. Transaction of a business (that
underlie a corporations financial statements) are formally called accounting cycles. Such cycle can be
periodic (e.g., weekend, month-end, quarter-end, or year-end) closing of books for reconciling various
accounts and ensuring everything is in balance. In this connection, a journal is a chronological listing of
transactions or business activities where each original transaction and the corresponding debit or credit
entry is originally made. A general journal records all such entries, and identifies them to which specific
journal it should next be posted.
Matching (i.e., debits should equal credits) of all specific journals by each weekend or month-end
accounting cycle should be common practice. It detects and prevents frauds at their source. Each ledger
or specific journal entry should correspond to an entry in the general journal. Each specific journal
should also match. For instance, all accounts receivable from the sales journal should match all cash
receipts with the cash receipts journal, and vice versa. Currently, several computer programs can do this
very effectively (e.g., Quicken, QuickBooks of Intuit).
Discussion Point 05: According to the fundamental principle of accounting, one should be sure that the
person who makes the bills, generates checks, signs the checks, mails the checks, and
the person who reconciles the checks with bank accounts cannot be the same. To what
extent does this best practice minimize embezzlement?
exist because of their superior abilities to attenuate opportunism through the exercise of hierarchical (both
rational and social) controls that, in general, are not accessible to "markets." 8 In this regard, TCE makes
two behavioral assumptions: a) one cannot predict others' behavior, and b) one cannot identify one's own
best behavior. Not all are inclined to opportunistic behavior; those who do, the "determined minority"
(Williamson 1993: 98), may do because of the above two assumptions. Some may be inclined to
"instrumental behavior" in which there is no necessary self-awareness that the interests of a particular
party are being furthered by opportunism (Williamson 1975). These people, without being aware, are
instrumental in opportunistic outcomes of others.
Other things being equal, opportunism can thrive:
When the transaction partner has invested much capital and technology in the transaction-exchange
that cannot be used for other products, (this phenomenon is called asset specificity in TCE theory);
the predator can "hold-up" such assets by being opportunistic. Such hostage type of terrorist
opportunism is the ultimate cause of the failure of the free markets and for the existence of
organization. When asset specificity is high, it acts as a "locomotive" for opportunism (Williamson
1985: 56).
When behaviors of individuals and of the outcomes of those behaviors become uncertain, and this
uncertainty, in turn, makes measurability of individual or group performance uncertain, and when
rational control of such behaviors cannot be cost-effectively enforced, then opportunism abounds.
When opportunistic behaviors are facilitated by a high-discretion (that is, non-fiat, nonmonitored) environment within an organization (Goshal and Moran 1996).
When the predator nurses negative feelings for or an unfavorable assessment of the specific
transaction partner (Goshal and Moran 1996).
When the predator perceives biases, inequities or unfairness in the organization he or she
works for (Goshal and Moran 1996).
Opportunism under any form is not a typical constraint as Aristotle (1985) understands it, nor is it
ignorance as Aristotle defined it. Hence, actions resulting from opportunism cannot be involuntary as
defined by Aristotle (1985). Moreover, Aristotle (1985) maintained that certain conditions do not make an
action involuntary, such as compelling pleasure, emotions or appetites howsoever strong, and willed
ignorance, or ignorance without regret. To our understanding, opportunism is best described in Aristotelian
terminology as a compelling pleasure or a strong appetite. Such conditions cannot make opportunistic
actions involuntary but voluntary. Hence, despite opportunistic challenges in a corporation, executives can
and should always exercise moral restraint and responsibility.
8 However, recently some critics of TCE (e.g., Bromiley and Cummings 1992, 1993; Chiles and McMackin 1996; Goshal and
Moran 1996; Moran and Goshal 1996) have shown that hierarchical controls need not necessarily curtail opportunistic behavior.
Indeed, they are more likely to cause the opposite effect (Goshal and Moran 1996). Non-control mechanisms have been suggested
instead such as joint ventures or strategic alliances (Balakrishnan and Koza 1993), trust (Bromiley and Cummings 1992, 1993;
Chiles and McMackin 1996), leveraging work-force ability to take initiative, to cooperate and to learn (Goshal and Moran 1996).
Organizations created to attenuate opportunistic behavior fail when they are unable to create the social context necessary to build
the trust and commitment that are needed for maintaining cooperation in transaction-exchanges.
32
Discussion Point 06: To what extent can reduction in opportunistic opportunities in corporations
reduce corporate fraud, and why?
Remediation Point 7:
The Sarbanes-Oxley Act to Control Corporate Frauds
The collapse of Enron was preceded by the ill-advised decision of the company's board of directors to
specifically waive provisions of the company's code of ethics. That decision allowed Enron's chief
financial officer to benefit from transactions involving the company. The precise facts of the directors'
decision led to proposed reforms incorporated in Section 406 of Sarbanes-Oxley (SOX). Section 406
requires public companies to disclose whether they have codes of ethics and also to disclose any waivers
of those codes for certain members of senior management.
A major objective of SOX Act was to control and combat corporate fraud by: a) developing better
reliable information about companys operations to avoid making bad decisions, and thus, b) improving
the reliability of financial reporting, and c) restoring investor confidence. The ACT went into effect in
2002, and public CEOs and CFOs had to implement it by fiscal year 2004. The SOX, also known as
Public Company Accounting Reform and Investor Protection Act of 2002, was intended to provide a
proper accounting framework and rules for public companies by improving the accuracy and reliability of
corporate financial statements and disclosures made pursuant to the securities laws. The goal of SOX is
for internal controls to be so effective that degradation of the system through fraud is virtually impossible
(Silverstone and Davis 2005: 23).
The SOX code pertains only to employees of public companies who have financial disclosure-related
responsibilities. Item 406 defines a code of ethics as "written standards that are reasonably designed to
deter wrongdoing and to promote:
1.
2.
3.
4.
5.
Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of
interest between personal and professional relationships;
Full, fair, accurate, timely, and understandable disclosure in reports and documents that a company
files with, or submits to, the Commission and in other public communications made by the
[company];
Compliance with applicable governmental laws, rules and regulations;
The prompt internal reporting of violations of the code to an appropriate person or persons
identified in the code; and,
Accountability for adherence to the code."
The SOX code of ethics stops short of prohibiting conflicts of interest, in favor of assuring that those
which arise are "handled" appropriately. Potential conflicts of interest are present at all levels of an
organization. For this reason, it is important to emphasize in a code the values underlying the prohibition
of conflicted interests, including fairness, integrity, and loyalty. For example, in a discussion of loyalty, a
code of ethics may discuss the need to separate personal interests from those of the organization.
Additional reference points may offer direction to the employees, the Board, or senior management.
Often, the remedy for a conflict of interest is to avoid the conflict. However, when conflicts are
unavoidably present, disclosure and recusal may be required.
Many codes of ethics require executives and Board members to disclose any relationships that could
create the appearance of conflicted interests--family or financial, past, present, or anticipated. Once
disclosed, the conflict can be examined to determine if the conflicted party should participate in related
decisions, or if it would be better for the conflicted party to recuse him or herself.
33
Honesty, for example, includes being candid, open, truthful, and free from deception and deceit-telling the truth, even when doing so may be difficult, and being forthcoming with all relevant facts and
information. The core principle of telling the truth and coming forward with information in internal
discussions is important (Navran and Pittman 2003).
Compliances with SOX are enshrined in three brief Sections: 302, 404 and 906.
Section 302 (Title III): Corporate Responsibility for Financial Reports: Section 302 requires that
CEOs and CFOs personally certify:
1
2
3
4
The accuracy of financial statements and disclosures in the periodic reports issued by the
corporation,
That these statements fairly represent in all material aspects the results of operations and
financial condition of the company,
That the financial controls and procedures of sox have been implemented and evaluated, and
Any changes to the system of internal control since the previous quarter will have been
noted.
An annual statement of the issuer to contain an internal control report which shall state that
the management is responsible for establishing and maintaining an adequate internal control
structure and procedures for financial reporting;
CEOs and CFOs to periodically assess and vouch for their effectiveness, and
That no loans be extended to senior executives.
Section 906 (Title IX White-Collar Crime and Penalty Enhancements): Corporate Responsibility for
Financial reports: Section 906 requires CEOs and CFOs to sign and certify the report containing
financial statements; they must confirm that the document complies with SEC reporting
requirements and fairly represents the companys financial condition and results. Willful failure to
comply with this requirement can result in fines up to $5 million and imprisonment from five to 20
years.
By Section 404, companies are also obliged to include an internal-control report as part of the annual
report that should minimally include the following:
a A statement acknowledging responsibility for establishing and maintaining adequate
internal control over financial reporting.
b A statement identifying and specifying the internal-control framework to evaluate the
effectiveness of internal control over financial reporting.
c An assessment of the companys internal control over financial reporting as of the end of the
most recent fiscal year.
d Disclosure of any material weakness in the companys internal control over financial
reporting (the latter is deemed ineffective if any material weakness exists).
e A statement that the independent external auditor has issued a report on the companys
assessment of internal control over financial reporting, and
f A statement that the companys external auditor has examined and reported his/her
assessment of requirements under (c) and (d) above.
34
The first step toward SOX compliance is the establishment of an audit committee composed of
financially experienced members of the board of directors, who are independent (in the sense, they
perform no other corporate duty, receive no compensation other than their directors fees). At least one
member of the audit committee must be a financial expert (the SEC will judge the level of expertise based
on previous responsibilities, education, and experience with internal controls and the preparation of
financial statements). The audit committee will not have members with close family ties among directors
such that concentration of power in too few hands is avoided. The audit committee is responsible for
hiring and compensating both internal and external auditors and any other consultant, and is thus, a
logical body to oversee the entire SOX compliance process. Without meddling with everyday company
affairs, the audit committee must be able periodically to access all major financial and accounting
transactions to identify, monitor and question any unusual transactions and novel practices within the
company.
Besides the actual code of ethics, one would need numerous support mechanisms that will determine
the effectiveness of the company's overall ethics program. Central among these is a formal program to
communicate the company's core values to company personnel. These programs, as well as the conduct
and involvement of senior management, are far more important than the words of the code. The creation
and enforcement of an effective ethics program may offer substantial benefits to companies in terms of
both legal and performance measurements. Clearly expressed values are important because they provide a
touchstone that reduces the likelihood that any individual's personal values will exist in conflict with
those of the company. The absence of an ethical tone also may negatively affect the company's reputation
and present legal difficulties. Generally, it is assumed that whatever the nature of the organization's
culture, it is the product of attention or neglect--both of which are attributed to senior management.
(Navran and Pittman 2003).
Rarely do character flaws of a lone actor fully explain corporate misconduct. More typically,
unethical business practice involves the tacit, if not explicit, cooperation of others and reflects the values,
attitudes, beliefs, language, and behavioral patterns that define an organizational operating culture....
Managers who fail to provide leadership and to institute systems that facilitate ethical conduct share
responsibility with those who conceive, execute, and knowingly benefit from corporate misdeeds.
Discussion Point 07: To what extent can the SOX Act or an equivalent Law for India be effective in
the reduction of corporate fraud, and why?
addition, Section 1107 of Sarbanes-Oxley makes it a crime for any person, with intent to retaliate, to
knowingly take any actions harmful to any person (including interference with lawful employment or
his/her livelihood) just because that person provided truthful information to a law enforcement officer
relating to the commission or possible commission of a federal offense.
Factors the Sox considers in assessing whistle blowing include (Navran and Pittman 2003):
1.
Was the misconduct the result of pressure placed on employees to achieve specific results, or a
tone of lawlessness set by those in control of the company?
2. How high up in the chain of command was knowledge of, or participation in, the misconduct?
How systemic was the behavior?
3. Is it symptomatic of the way the entity does business, or was it isolated? How was the misconduct
detected and who uncovered it?
4. How long after discovery of the misconduct did it take to implement an effective response?
5. Are persons responsible for any misconduct still with the company? If so, are they still in the
same positions?
6. Did the company promptly, completely and effectively disclose the existence of the misconduct to
the public, to regulators and to self-regulators?
7. Did the company cooperate completely with appropriate regulatory and law enforcement
bodies?
8. Did the company take steps to identify the extent of damage to investors and other corporate
constituencies?
9. Did the company appropriately recompense those adversely affected by the conduct?
10. Were the Audit Committee and the Board of Directors fully informed? If so, when? What
assurances are there that the conduct is unlikely to recur?
11. Did the company adopt and ensure enforcement of new and more effective internal controls and
procedures designed to prevent a recurrence of the misconduct?
Discussion Point 08: To what extent can legalized whistler blowing abroad and in India be effective
deterrent to corporate fraud, and why?
36
Task Ambiguity
Low
High
Non-Physical:
Persuasion,
Forced
consensus
Discrimination
Corruption
Bribery
Fraud
Theft by Fraud
Physical: Much
Force and
Undue Powerpressure
Larceny
Stealing
Robbery
Theft by Force
Trickery, Beguile
Chicanery, Conning,
Seduction, Deception
Money-laundering;
Racketeering;
Theft by Stealth
Terrorism
Ethnic Cleansing
Genocide
Preemptive Wars
Aggressive wars
Corporate
Financial
Statements and
Annual Reports
Deceptive accounting;
Income smoothing;
Ghost or shell companies;
Ghost employees or accounts;
Restating annual financial statements
Kickbacks;
Wash Trading or Round Trip sales;
Accounting abuses (e.g., over-invoicing, underinvoicing, dumping)
Hostile Takeovers;
Corruption as Deceptive
Advertising:
Corruption as Deceptive
Reporting:
Insider Trading;
Active or passive bribery;
Excessive executive compensation;
Seduction;
Market dominance;
Undue market entry barriers;
Exorbitant pricing or price wars;
Dishonoring warranties and guarantees
Understating Debt;
Overstating revenues;
Overvaluing tangibles/intangibles;
Massive write-downs
Hence Remediation Point 9 suggests that we reduce task ambiguity to the minimum. Most of the
complicated tax legislations of India provoke tax evasions, tax fraud, and other ways of avoiding taxes.
Most of the ambiguities in more recent legislations regarding The Land Bill are indirectly encouraging
rather loose interpretations that, in turn, trigger crime.
37
Discussion Point 09: To what extent can reduction in corporate legal ambiguity in India bring about
drastic reduction of fraudulent behaviors in the corporate world?
Throughout history, if there are profits to be made, some type of scheme attempts to skirt the law or
even cross boundaries. It is a choice between short-term gain and long-term stability. It is often some
form of self-indulgence. Obviously, ethical dilemmas are not always black and white. There are shades
of grey between black and white, between good and evil, between right and wrong, between truth and
falsehood, and between just and unjust. The sweatshops of China represent grey areas even to this day for
a lack of a proper and universally accepted definition. Similarly, when can supplier gift-giving in India be
considered bribery? When is competition good or bad? When are market-entry barriers good or bad? Is
evil counter-intuitive? If so, why do some leaders involved in highly publicized business or government
scandals seem still unrepentant, refuse to admit wrong-doing, even publicly rationalize their decisions
after they have been caught, castigated, and were forced to pay billions of dollars in punitive damages? A
few of them are even repeat offenders.
The situations that can lead corporate executives to hard choices can be as complex as the options
themselves. Some companies therefore struggle with how to manage and measure ethics and particularly
in cases where they have worldwide offices that operate in diverse cultures. Those decisions have a direct
bearing on their public identities and will affect their share prices. But with each passing scandal, new
rules and codes emerge that surpass those of the past. And while Enron will not be the last case of
corporate malfeasance, its tumultuous tale did initiate a new age in business ethics. Ethics and integrity
are at the core of sustainable long term success; without them, no strategy can work and, as Enron has
demonstrated.
Concluding Remarks
Whether corporate scams are described as accounting frauds, deceptive accounting practices, inflating
revenues, round-trip trades, understating debts, overstating financial worth to boost stock prices and
consequent corporate insider trading, or just, cooking the books, they are all corporate failures of public
trust. They are failures of corporate accountability and social responsibility. In the wake of these
escalating corporate scandals, several ethical and moral questions arise. Are these corporate accounting
frauds legal or quasi-legal? Even if they are legal and, therefore, non-criminalizable, are these practices
ethically and morally justifiable? How could these frauds occur in such exemplary corporations
traditionally known for their corporate executive virtues of honesty and integrity? As frontline
ambassadors and representatives of the corporation, its products and services, how could corporate
executives in general, and accounting, financial and marketing executives in particular, represent the best
of themselves and their companies through such frauds?
In an era of questionable and fraudulent accounting, cash flow is the only trustworthy measure of
financial performance available. It is almost impossible for accountants to manipulate cash flow. The
balance in cash and the total change in cash from one period to the next are generally not prone to
misstatement. The balance in cash is readily verifiable from banks and other institutions holding reported
balances. Hence, cash is a fact, while profit (which accountants can easily manipulate) is an opinion.
Cash flow is real and is not easily subject to the vagaries of GAAP. Most investors rely more on cash
flow statements than on reported annual statements such as the balance sheet and the profit and loss
statements.
There are three dimensions to any corporate fraud: the human, the technology, and the legal
dimension. The most important one is the human. People will always try to find ways to get around any
regulatory system if it is to their advantage to do so. Any legal or technology system is only as good as
38
people that designed it. Consequently, there will always be someone smarter and more knowledgeable
that is willing to take the risk of exploiting the system for ones own benefit.
There are several issues that make it difficult to predict, uncover or control corporate corruption and
fraud. When the top-level business executives are corrupt, it is difficult for the mid-level managers to
detect or uncover the deceptive acts and the problems underlying them. Moreover, the mid-managers
would be worried about their jobs, especially if whistle blowing is punished in corporations.
Additionally, corporate executives involved in fraudulent activities that could launder billions of unearned
personal profit to them would not hesitate to pressurize and bribe subordinates into silence even if the
latter detected something irregular. Some subordinated could be could be easily seduced to keep quiet
"for the good of the company" or "only until the mess is straightened out." A sense of personal loyalty
may deter some from resigning their jobs under such strenuous situations.
As managers move from one place to another, it is possible they inherit an already messy business
from a previous executive, and would be reluctant to expose the situation for any number of personal or
professional reasons. Thus, many instances internal audits do not work and are just another form of
unnecessary nuisance in the bureaucracy. The Enron bankruptcy raised questions about the validity of the
independent audits and of the business practices of the accounting industry itself. It is clear that the
auditors failed to pinpoint the problems with companies involved in corporate scams. The accounting
practices are relatively simple. It is just hard to believe how easy it was for the accounting firms to
disguise the truth, without resorting to collusion between the audits and accounting branches of the
implicated firms as an explanation. It is just hard to believe that the accountants would miss the
magnitude of these frauds. Clearly, the Enron executives did not abide by the usual accounting principles
and rules.
There were systems level failures at several points that allowed many corporate frauds and scams
to remain undetected until they were so large and unredeemable. Some of the biggest accounting firms
such as Arthur Anderson, Deloitte &Touch, Ernst & Young, KPMG, and PriceWaterhouse Coopers
increased their earnings by offering consulting services to the same companies they audited. These firms
clearly compromised their credibility and independence when they had to audit their own work. The
Securities and Exchange Commission failed to bar accountants from also being consultants for the same
company due to extensive pressure from the accounting lobbying groups. The same groups have
contributed millions of dollars to individuals, PAC's, and soft money contributions to fight any SEC rules
change.
Whatever may be the underlying motivation for corporate scams, what we advocate is a corporate
ethical culture that is guided by some teleological rules and deontological imperatives. Some of these
have clear managerial implications, such as:
1
2
3
4
5
6
7
Corporate or personal good should not take primacy over social good of the stakeholders.
A corporate strategy should gratify the maximum number of people affected by that strategy ( Rule
Hedonism).
The total sum of utilities generated by any strategy should exceed that of any comparable
alternative strategy (Rule Utilitarianism).
A corporate strategy should seek the happiness of the maximum number of people affected by that
strategy (Rule Eudemonism).
A corporate strategy should result in an action that can be the norm for all persons in such
situations (Rule Formalism: Universalizability).
A corporate strategy should result in an action that must be based on reasons that one would be
willing to have all others use to judge that corporations strategy (Rule Formalism: Reversibility).
A corporate strategy should fulfill the implied contractual duty to protect the rights and duties of all
stakeholders affected by that strategy (Rawls Contractualism).
39
8
9
A corporate strategy should fulfill the implied macro social contractual duty to protect the rights
and duties of all stakeholders affected by that strategy (Integrated Social Contracts Theory).
A corporate strategy must observe all legitimate laws that bind (Rule Legalism).
Subsequent handouts will clarify and discuss these rules in greater detail. Any corporate
strategy that fulfills one or more of these nine rules has lesser likelihood of corrupting into a
corporate scam or indulging in the corporate virtue of selfishness (Rand, 1964). What we need at
this juncture is a real pursuit of virtue, specifically the virtue of caring for others (see Gilligan 1982;
Noddings 1984), and a keen sense of corporate social responsibility (Mascarenhas 1995). Unless
corporate executives aim higher (Bollier 1997), and incorporate virtue in their corporate strategies
(see Morris, 1997), they will never appreciate the social contracts they have implicitly signed with
society by their corporate position and mission (Donaldson &Dunfee 1995, 1999).
40
Level of
Ambiguity
Inputs
Process
Outputs
Perfect
information; full
awareness and
motivation to act;
no physical
inducements other
than puffery and
persuasions
The victims
response to the
evidence is not
simply to misread
it but go along with
it.
Every day theft of
small items from
the organization
Compelling but
fair trade with
mutual gain.
There is much
scope for
marketing
here.
A Win-Win
bilateral
exchange in the
standard
microeconomic
sense
Personal fraud
and scam one
gets involved in
consciously or
unconsciously.
Compelling
physical nonviolent
persuasions
Ambiguously
Fair
All transparent
products and
services
Con Game
Inherently
Ambiguous with
social consent
Skimming,
Pilfering
Ambiguously
unfair
High
information
asymmetry; the
thief commands
but the victim
plays along.
Belief you are
not noticed
Theft by Stealth
Unambiguously
Unfair and Onesided
One-sided
intervention to
theft. The
victim is
unaware or
absent.
The victim is
physically absent
or psychologically
unaware of the
action of the thief.
Theft by Fraud
Inherently
Ambiguous with
no consent
High
information
asymmetry; the
thief
commands.
The action is
noticed but
misinterpreted.
Pure
embezzlement.
Theft by Force
Unambiguously
Unfair
Force, physical
or mental or
psychological;
threatening and
intimidating
elements; high
information
asymmetry;
Coercion is the
only reason why
transaction occurs;
parties no longer
Pareto informed;
the victim is
physically deterred
from responding.
Pure robbery.
Larceny
Unambiguously
Unfair
Larceny is
felonious
stealing using
tricks, frauds,
chicanery,
obfuscation,
and the like.
It is taking and
carrying, leading,
riding, or driving
way another
persons personal
property.
41
Theft by
Fraud: The
victim suffers
loss by
misreading
evidence.
Theft by force.
Transaction
for the thief;
loss for the
others. No
marketing
needed here,
other than
bullying and
coercing to
give in.
Larceny is a
cunning way of
taking goods
against the will
or consent of
the owner but
with a
felonious
intent.
Remarks
Often, occult
compensation for
ones low wages
The thief is
cunning,
contriving,
stalking,
scheming, and
vigilant for the
right occasion to
steal.
Corporate fraud,
corruption and
bribery are here
under various
forms.
The thief knows
more than others
in the forced
transaction. The
felons
overwhelming
superiority of
power accounts
for the victims
cooperation.
It is a transaction
with minimal
consent from the
victim, who may
be silent and nonresistant out of
fear of attack.
Fraud is a subset
of larceny.
42
Level of
Ambiguit
y
Inputs
Process
Outputs
Remarks
Promotion
al
Persuasion
Ambiguity is
moderate
Persuasion results
given enough
prior consensus
between buyer
and seller.
Trickery
Ambiguity is
moderately
high
Pre-existing
consensus. The
value of the
transaction can
be established
within it.
No pre-existing
social buyerseller
consensus.
Chicanery
Ambiguity is
high
No pre-existing
social buyerseller
consensus.
You
unconsciously
capitulate to the
wiles of
advertising
You are charmed
by glossy
brochures;
Most advertising is
persuasive in this
sense. PR is also
persuasive when you
fit news material into
a prior consensus.
Is a con game in
disguise where the
victim is drawn into a
social consensus
Beguile
Ambiguity is
very high
No pre-existing
social buyerseller
consensus.
To mislead people by
ones charm or
persuasion of
cheating or tricking.
Seduction
Ambiguity is
highest
Involves
construction of
a new
consensus, a
deliberate and
stepwise
process.
Deception
Ambiguity is
moderately
high
Involves
construction of
a new
consensus, a
deliberate and
stepwise
process.
It is a strategy
whereby consumers
are induced to
tolerate or overlook
unsustainability, or
deny it. In this sense,
seduction is more
voluntary than fraud
and more
collaborative than
entertainment - a
playful game form
Consumers are
influenced by nonsubstantial attributes
and features of a
product or service.
Cheating
Ambiguity is
high for
trickery +
deception
No pre-existing
social buyerseller
consensus.
Cheating is often
fraudulent and
dishonest
exchanges
43
Is a con game in
disguise where the
victim is drawn into a
social consensus
You
unconsciously
capitulate to the
freebies and
charms that come
inside cartons.
Enticement of a
consumer into an
exchange where
ambiguity is
resolved by a
private social
consensus that
the consumer
plays a part in
constructing.
Is a con game in
disguise where the
victim is drawn into a
social consensus
Deception is when
consumers
change their
behavior for
reasons not
objective but on
beliefs and
impressions made
on them by
promotions.
Often,
consumers are
influenced by nonsubstantials of a
product at the expense
of disregarding its
intrinsic aspects
(Gardner 1975).
Cheating is
trickery +
deception
towards ones
clients
Consumers,
customers, clients
and buyers get often
tricked via
ambiguous
marketing
promotions.
44
Fraud
Method of
Perpetrators Deception
Victims of
Deception
Costs of Deception
Management
Fraud
Top executives
such as CEO,
CFO and chief
accounting
officer (CAO)
Creative and
aggressive
accounting such as
earnings
management;
Income smoothing
Gain on sale and
Wash trading
Organization,
Investors,
Employees,
Suppliers,
Customers
Shareholders,
Creditors or lenders
Securities
Fraud
Top executives
with insider
information
Illegal insider
trading
Investment
Scams
Any individual
involved in such
scams
Tricking or conning
into worthless
investments
Telemarketing fraud
Public investors
who do not have
access to inside
information
Unsuspecting
investors, especially
the elderly,
teenagers, the
marginalized
Tax Fraud
Corporate and
non-corporate tax
evaders
Failure to report
income from fraud
or bribes; filing false
returns
Racketeering
Racketeers
Corrupt
organizations
Commercial
exchange partners
affected by
racketeering
Vendor Fraud
Vendors
Suppliers
Brokers
Distributors
Retailers
Employee
fraud or
embezzlement
Employees
At all nonexecutive levels
Computer
Fraud
Computer
hackers, codebreakers, and
classified data
destroyers
Criminal violations
of commercial
exchange laws and
ordinances;
Money laundering
Significant overcharging either
singly or by
collusion
Non-shipment of
goods paid for
Skimming, theft;
Cheating on time,
money, quality of
work
Illegal access to a
protected computer
vaulting or classified
data; hacking
Bribery and
Kickbacks
Bribery &
kickbacks;
strategies
Customer
Fraud
Some customers
Some borrowers
Angered
False prizes/sweepstakes
Unnecessary magazine sales
Worthless buyer club fees
Unrealized advance fee-loans
Work-at-home schemes
Deceptive travel/vacation packages
Violation of Title 26, US Code #
7201
Bribes may not lawfully be deducted
as business expenses
Loss of tax money to governments
Racketeer influenced and Corrupt
Organizations (RICO) statue
violated; Title 18, US Code # 1961
Government with
defense contracts;
Innocent
corporations and
customers
Employers,
Shareholders,
Customers,
Other employees
The public, defense,
national security
and all
governments
affected by
classified data
Suppliers
Prime contractors
of government
projects
The vendors
Retailers
Banks tricked into
45
customers getting
even with
employers
granting loans or
funds transfers
46
Fraud
Action
Major
Types
Conflict
of
Interest
Bribery
Corruptio
n as
Abuse
Illegal
gratuitie
s
Economi
c
extortion
Cash
related
Sub-Action Types
Purchaserelated
SalesRelated
Transaction
s-related
Interaction
s-related
Other
Actions
Purchase
schemes
Sales schemes
Joint venture
schemes
Strategic
alliance
schemes
Other
Invoice
kickbacks
To self
Bid rigging
Concealed perks
Family favors
Other
To subjects
To other groups
Gratuities in
kind
Gratuities in
stocks
Purchase
undercharges
Sales
surcharges
Extorting
commissions
Distorting
Sales
performance
Other
Larceny
Of cash on
hand
From the
deposit
Other
Billing
schemes
Shell company
Payroll
schemes;
falsified
wages
Expense
reimburseme
nt
schemes
Ghost employees
From
marketable
securities
Nonaccomplice
vendor
Commission
schemes
Mischaracterizi
ng expenses
Overstate
expenses
Check
tampering
Register
disbursement
s
Sales
Forged maker
or endorsement
False voids
Altered payee
False refunds
Fictitious
expenses;
multiple
reimbursemen
ts
Concealed
checks
Other
Unrecorded
Understated
Other
Receivables
Misuse of
inventories
Misuse of
payables
Lapping
schemes
Tampered
returns
Misuse of
receivables
Unconcealed
Refunds
Write-off
schemes
Used returns
Larceny
Asset
requisitions
and transfers
Purchasing &
receiving
Asset/revenue
Overstatements
Timing
differences
Fictitious
revenues
Concealed
liabilities &
expenses
Asset/revenue
Understatemen
ts
To make lean
years look
good
To provide for
future leaner
years
To jeopardize
budgets
Fraudulent
Disbursements
Fraud as
Asset
Misappropriation
Skimming
Inventor
y & All
Other
Assets
Fraudulen
t
Financi
al
Misuse
47
Personal
purchases
Workers
compensation
Stolen returns
Misuse of
other liquid
assets
Unconcealed
larceny
Improper
disclosures;
improper asset
valuations
Other harms
Statement
s
Nonfinancial
Employment
credentials
Fudging
Internal
documents
48
Doctoring
External
documents
Overstating
credentials
Understating
credentials
Table 2.5: The Supply and Demand Side of Fraud and Corruption:
An Input, Process and Output Analysis
Source of
Corruptio
n
SubSource of
Corruptio
n
Corrupt
People
G2B
Supply
Side
(Laws &
Governments)
Corrupt
Instruments
or Means
Corrupt
People
B2G
Demand
Structure of Corruption
Structured Inputs
to Corruption:
Complex People
and Instruments
Structured
Processes of
Corruption:
Ambiguous
Exchange Situations
G2B information
asymmetry;
G2B opaque transactions;
G2B obfuscation and
chicanery;
G2B subtle bribery
demand;
Information asymmetry
products;
G2B Seduction and
Deception;
GEB Blackmail and beguile
set-up;
G2B Structured deception;
G2B Excessive bribery or
robbery;
Excessive
industry/market
regulation;
Complicated industry
excise/tax haven laws;
Complex mining licensing
systems;
Complex Public bidding
tenders;
Overbearing G2B
bureaucracy;
Ambiguous law
interpretation;
Many G2B authorization
requirements;
Ambiguous G2B bid
process/selection;
Government market
opacity;
Structured market
injustices;
Loss to the government exchecker;
Lost business opportunities;
Tax Losses govt. deficit
budgets;
Consequent loss in GDP
growth;
Unethical/immoral
executives;
Overbearing middle
managers;
Unscrupulous
accountants;
Corrupt internal
auditors;
Corrupt external
auditors;
49
Structured Outputs
of Corruption:
Risk Consequences
Side
(Business
Houses)
Corrupt
Instruments
or Means
50
Bribing government
distributors and retailers;
Bribing or pressurizing G2B
suppliers;
Bribing and buying G2B
bank credit;
Deceiving financial analyst
by fraud;
Silencing institutional
shareholders by promises;
Buying business licenses
and project approvals via
B2G bribes;
Company
Accounting Irregularity
Enron
(October 2001)
WorldCom
(March 2002)
Enron and
Qwest
Communicatio
ns
(April 2002)
CMS Energy
(May 2002)
Global
Crossing
(February
2002)
Duke Energy
(July 2002)
Dynergy
(May 2002)
Homestore.com
(January 2002)
Halliburton
(May 2002)
AOL Time
Warner
(April 2002)
Adelphia
Communications
(April 2002)
Some Details
51
Company
Qwest
Communications
Total
Haul
($Billions)
2,260
Biggest Takers
Phil Anschutz, Director,
Jo PeNacchio, former CEO
Individual
Haul
($Millions)
1,570
230
2,080
AOL Time
Warner
1,790
Gateway
1,270
Ariba
1,240
222
191
127
114
JDS Uniphase
1,150
246
206
175
I2 Technologies
1,030
SanjivSiddhu, Chairman,
CEO,
Ramesh Wadhwani, ViceChairman,
SandeepTungare, former
Director
Bill Joy, CTO,
Ed Zander, former President
447
103
100
270
102
80
74
Enron
1,030
994
810
799
Broadcom
Sun
Microsystems
Remarks
475
225
213
1,100
160
144
52
Global Crossing
951
Charles Schwab
951
Yahoo
901
Cisco Systems
851
508
353
188
160
148
116
239
72
Total
Haul
($Billions)
818
726
Biggest Takers
John Moores, Chairman
Individual
Haul
($Millions)
646
Gururaj Deshpande,
Chairman,
Dan Smith, President, CEO,
Director,
Chi Kong Shue, EVP
137
129
122
Remarks
Peregrine is restating revenues from
April 1999 to December 2001, during
which Moores dumped $530 million
of stock.
BY the time main customer, Williams
Communications, went bankrupt last
April, these insiders had done most of
their selling.
Nextel
Communications
615
343
117
Foundry
Networks
582
308
Juniper Networks
557
148
108
87
Infospace
541
406
Commerce One
531
115
75
AT&T
475
John Malone
348
Network
470
111
53
Appliance
Thomas Mendoza,
President,
Daniel Warmenhoven, CEO,
Director
Paul Gauthier, former CTO,
David Peter Schmidt,
Chairman, CEO
58
48
107
84
Inktomi
431
Priceline
417
276
45
Vignette
413
98
92
Totals:
No. of
Companies:
25
Totals:
No. of Executives involved:
55
Sum
Mean
Std. Dev.
23, 074
923
502
Sum:
Mean per executive:
Std. Dev.
14,147
257
262
54