Ethics Sage

Is Zuckerberg Waiting Post-Facebook IPO to Open Up to 13-Year Olds?

Should Facebook Be Open to Children Under the Age of 13?

Speaking during the NewSchools Venture Fund's Summit in California earlier this month, Facebook CEO Mark Zuckerberg suggested that Facebook should be open to children under the age of 13 because it can be used as an excellent education tool. When asked if he had any plans in place for starting a new education service on the platform and how it would work, Zuckerberg said that because of the age restrictions, they had not yet started thinking about it. "Because of the restrictions we haven't even begun this learning process. If they're lifted then we'd start to learn what works. We'd take a lot of precautions to make sure that they are safe." 

One of the main reasons Facebook restricts use to people 13 and older is because of the Children's Online Privacy Protection Act (COPPA), a 1998 law that requires Web sites to get parental permission before it can make any use of data provided by children younger than 13. Facebook could create a service that is COPPA compliant, but it would be expensive and likely require not only changes to the terms of service but modifications to its privacy and advertising policies for pre-teen users. Facebook currently has somewhat different privacy policies in place for users between 13 and 18, but no programs for users younger than 13. Zuckerberg seems determined to change this. He is quoted in a Fortune CNN-Money online story by writer Michal Lev-Ramas as saying "That will be a fight we take on at some point." A cynic might say that Zuckerberg is waiting until after Facebook's IPO before fighting that fight.

Facebook's chief technology officer, Bret Taylor, was grilled by senators last Thursday on the adequacy of the social network's policy barring users under 13 years old after a recent report found that millions of children had Facebook accounts. "I want you to defend your company here because I don't know how you can," Senator Jay Rockefeller (D-WVA) told Taylor during a Senate commerce subcommittee hearing on mobile privacy. "That's actually news to me," Taylor said. "We don't allow people to have accounts under the age of 13." Rockefeller responded by questioning the veracity of Taylor's statement saying: "You can't just dismiss that seven-and-a-half million users are younger than 13 and say you have a policy that doesn't allow that to happen."

Though Facebook's terms of service prohibit children from using their site, the West Virginia Democrat questioned its efforts to verify users' ages, citing a recent Consumer Reports study that estimated 7.5 million children had profiles on the social network. The survey, included in the just-released June report, also found that those kids’ Facebook accounts were largely unsupervised by their parents, exposing the children to malware or serious threats such as predators or bullies. The report found that at least 7.5 million children—more than one-third of the 20 million minors who actively used Facebook in the past year—were under 13 and violated the site’s terms, which prohibit kids that young from joining.

Consumers Union said Facebook's default privacy setting for minors should be to share information with "friends only" instead of "friends of friends" -- a category that publicizes the average users information to 16,900 people. The group also called for Facebook to create an "eraser button" that would allow users to delete all potentially embarrassing information posted about them on the site when they were minors to help ensure that adult Facebook users will not be perpetually haunted by pictures and posts on the site added while they were too young to understand the consequences of their actions.

Of course, the same concerns exist about adults who post inappropriate pictures. So, perhaps the $64,000 question should be: When is a person old enough to understand the consequences of his or her actions before doing something foolish? Those of us who are older and wiser, and who have made our share of mistakes, know that actions can be regretted at a later time, after the deed is done. The consequences can be severe such as sending a naked picture of yourself to your boyfriend and discovering it went viral shortly after your break-up.

The problem with underage access to Facebook is a universal problem we face today as a society. Temptations to act in an immature, foolish manner are everywhere. Commercials appeal to the lowest form of human behavior starting with male stupidity (any beer commercial) and sexualizing females in demeaning advertisements often with submissive poses (e.g., Victoria's secret ads). The movies are "dumbed-down."  Witness the original Dumb and Dumber in 1994; the 2003 sequel, Dumb and Dumber: When Harry Met Lloyd; and, if you can believe it, those pesky Farrelly brothers are thinking about a third movie bringing back the original cast members. Entertainment reporter Kate Ward calls it: Dumb & Dumber: Man-Boys of a Certain Age?   

The inescapable conclusion is we no longer regulate our own behavior and no longer act in accordance with moral values. It's an anything goes mentality today. Values are relative to each person rather than emanate from some deep spiritual belief that there is a difference between right and wrong. Our so-called leaders act in their own self-interests and corporate tycoons make Gordon Gekko seem altruistic. It's no longer necessary to proclaim greed is good. No need. It's now embedded in our DNA.

  Blog by Steven Mintz, aka Ethics Sage, May 31, 2011

Mets, Madoff and Wilpon

Mets Owner Wilpon's Involvement with Madoff's Ponzi Scheme

A few months ago, it was disclosed that New York Mets’ team owners Fred Wilpon and Saul Katz were being sued for $1 billion in connection with Bernard L. Madoff’s Ponzi scheme. With impeccable timing, along comes hedge-fund manager David Einhorn who last week announced that he has entered into exclusive negotiations to spend $200 million for a noncontrolling stake in the Mets. How ironic it is that the Met's "white knight," Greenlight Capital Inc. President David Einhorn, is a hedge-fund manager given that Madoff's hedge fund, Ascot Partners, was a giant scam that had to intensify redemptions from scores of other hedge funds to meet its obligations. Wilpon pleaded innocent to charges he knew about the Madoff scam.

Wilpon needs all the friends he can get right now but recent comments about specific Mets players' on-field performance run counter to that goal. He may be justified in criticizing a team that is winning only 45 percent of its games following a season that was marginally better -- a 49 percent success rate. What's worse, the Mets have the 5th-highest payroll in Major League Baseball ($133 million or $$5.1 million per player).

In a May 30 story by Jeffrey Toobin in New Yorker magazine that was released on-line last week, it was reported that

                                  Fred Wilpon

Wilpon had previously made critical comments about a few key Mets players. Midway through the article, Tobin recounts an exchange he had with Wilpon during the Mets' 4-3 loss to the lowly Houston Astros. Here is a sampling of comments:

                 "He thinks he's going to get Carl Crawford money," referring to Jose Reyes                                     who had singled and stole second, leading off for the Mets. "He's had                                               everything wrong with him"

                On Carlos Beltran: "We had some schmuck (referring to himself) who paid                                     paid him based on that one series (the 2004 postseason)...He's sixty-five                                     to seventy percent of what he was."

                As for Ike Davis, "Good hitter,...Shitty team."

                When David Wright got up to bat, Wilpon said, "He's pressing. A really good                                 player. Not a superstar."

I'm not sure what Wilpon considers superstar statistics to be but Wright has to be given serious consideration with a career batting average of .305, and .383 on-base-percentage. He has averaged 23 steals the last five years. He has hit 26 home runs or more for 5 of the past 6 years. Wright also was the winner of the gold-glove award for his play at third base in 2007 and 2008. Wright is a five time All-Star and won the Silver Slugger Award in 2007 and 2008 that goes to the best offensive player at each position, as determined by the coaches and managers of Major League Baseball.  

Should we have sympathy for Fred Wilpon? After all, he was snookered into investing in Bernie Madoff's Ponzi scheme along with thousands of other investors. On December 11, 2008, the day that Madoff’s money-management business was revealed to be the largest Ponzi scheme in American history, Wilpon and his partners’ stake was listed at $550 million. On that one day, it all vanished. Adding insult to injury, last December, Irving Picard, who is the bankruptcy trustee charged with salvaging assets to compensate Madoff’s victims, filed a lawsuit against Wilpon and his partners.

Picard charged Mets co-owners Wilpon and Saul Katz were enablers, virtually Madoff’s accomplices in the vast crime, who “willfully turned a blind eye to every objective indicia of fraud before them.” For the Madoff investors, Picard had adopted a formula whereby the “net winners”—that is, those who cashed out more than they put into their Madoff accounts—would pay back their winnings to compensate those who were net losers. I previously blogged about this so-called "clawback" standard under which the Wilpon people would have had to repay approximately$160 million in profits that they had taken out of their Madoff accounts over the years. (The precise amount is in dispute.) However, Picard was treating Wilpon the way he treated those he believed to be complicit in Madoff’s fraud. From this group, Picard was seeking a refund of their Madoff principal, not just their profits. In other words, they would have to make good even on the money they had lost in the scam. Specifically, he was demanding that the Wilpon group pay damages of $1 billion.

The real question here is did (or should have) Fred Wilpon seen the red flags that trouble was brewing with Madoff and his funds? Wilpon's defense is that if the SEC wasn't aware of the fraud, how could he reasonably be expected to have known? Indeed, the SEC was informed about the scheme by independent financial fraud investigator, Harry Makopolis, who has received public acclaim for uncovering evidence over a period of nine years that Madoff's wealth management business was actually a massive Ponzi scheme.  Madoff was ultimately sentenced to 150 years in prison after admitting to operating the biggest Ponzi scheme in history. 

Picard's complaint alleges that Wilpon and Katz knew that Madoff was dishonest in his investment advisory business, and that his investment returns were "too good to be true." According to Picard, Wilpon and Katz had a "deep dependency" on the continuation of the Madoff fraud. In one example of the close relationship between Sterling Equities and Madoff, the complaint says Wilpon and Katz accepted an interest- and cost-free $54 million loan from Madoff to pay Cablevision for the broadcast rights for the New York Mets. According to Picard, the loan was documented by a fraudulent letter that described it as an "investment" by Madoff's wife, Ruth.

The complaint says Wilpon and Katz received fraudulent transfers from Madoff during a six-year period before the Trustee began liquidating Madoff's investment firm in December 2008. It also charges that Wilpon and Katz received "preferential transfers" in a three-month period after the liquidation proceedings started. If the latter is true, there can be no doubt that clawbacks are justified and the payments after the liquidation began would seem to indicate that Wilpon may have been one of many investors who chose to look the other way as Madoff's funds returned about 10-12 percent every year.

  Blog by Steven Mintz, aka Ethics Sage, May 30, 2011

 

 

 

SlutWalk is an Offensive Name Used for a Noble Cause

SlutWalk: An Ill-Conceived Name for a Worthy Cause

The use of an offensive term to attract attention to a cause is just as bad as if the term itself is used to degrade women.  Whould we be willing to sanction the use of the "N" word in front of walk or Kike-walk? Why not use a respectful name such as Respect for Women, walk? Or, Stand Up For Women?

According to its website, SlutWalk was a reaction to not one officer’s remark, but to a history that was doomed to keep repeating insults, degradation, shame, and the rape of women.  The site mentions offensive labels against women such as slut, whore, feminist, anti-feminist, and sexy feminist. The movement is admirably designed to promote "heated discussions about the use of language, shaming and sexual profiling."

According to a story on May 27 in the San Luis Obispo Tribune by Tonya Strickland, Cuesta College student Ashley Riddell learned about the Toronto-based sexual assault movement called SlutWalk and she was inspired to challenge society’s approach to victims on the Central Coast of California.  In April, she contacted SlutWalk's Toronto event organizers and began organizing a SlutWalk event on the same day, which is now planned for 3 p.m. on Saturday, May 28 at Osos and Buchon streets in downtown San Luis Obispo.

“ ‘Slut’ is a term that’s frequently used to justify violence against women. It’s so toxic and harmful, and gives criminals and bad people the idea that it’s OK to hurt women,” Riddell said. “We are reclaiming that word and saying that no word is an excuse to hurt anyone.” After reports of three rapes involving Cal Poly San Luis Obispo (SLO) students were announced earlier this month, Riddell said it was all the more reason for residents to hear SlutWalk’s message.

The first SlutWalk began in April, when a Toronto police officer said that “Women should avoid dressing like sluts in order not to be victimized,” according to the original event’s website. The walks have since sprung up in cities throughout the U.S and across the globe, including a walk in Santa Cruz on May 15 where about 400 people took part.

According to reporter Strickland's story, as of Wednesday afternoon, May 25, 130 people had signed up for the San Luis Obispo event. Organizers with the Sexual Assault Recovery and Prevention (SARP) Center of SLO County plan to be on hand to distribute information, although they are not affiliated with SlutWalk. “We believe that events that raise awareness about sexual assault and get our community talking about victim-blaming are a good thing,” SARP Development Director Megan Mastache said.

While the title of the event may raise questions, Riddell said reactions have “been positive for the most part.”  She believes critics will be more accepting of the title once they learn the facts that motivated the movement. Personally, I don't need to hear a demeaning name to identify with a cause, and it belittles the importance of the event especially in light of recent revelations of sexual escapades of the likes of disgraced Senator John Ensign and former California governor Arnold Schwarzenegger. I previously blogged about these kinds of creeps and the growing trend among politicians to allow testosterone levels to cloud their judgment.

The root cause of the problem is the sexualization of women in society  in all forms of media. Just as bad is the use of the Internet to project offensive and compromising images of women. The term SlutWalk is ill-conceived and reminds me of the pejorative term Feminazi used by a popular radio talk show host who has stated that the word refers to unspecified women whose goal is to allow as many abortions as possible. It wasn't morally correct then to use that term and it's not morally correct now to refer to a noble cause with a term simply for shock value.

 

Demonstration to mark International Women’s Day, Melbourne, 8 March 1975

  Blog by Steven Mintz, aka Ethics Sage, May 27, 2011

Whistle-Blower Rewards Under Dodd-Frank Under Attack

Corporate America and Whistle-Blowing

A new bill in the House of Representatives proposed by freshman congressman Michael Grimm (R-N.Y.), would make "any whistleblower who has legal, compliance, or similar responsibilities for . . . an entity and has a fiduciary or contractual obligation to investigate or respond to internal reports of misconduct" ineligible for the whistleblower awards incorporated into the Dodd-Frank Financial Reform Act. This  would include chief financial officers. The Dodd-Frank law passed last year aims to give witnesses to securities fraud a monetary incentive -- starting at $100,000 -- to report wrongdoing to the Securities and Exchange Commission. Under an SEC proposal made in December, informants would collect 10% to 30% of wrongdoers' payout to the commission for enforcement cases that involve penalties worth more than $1 million.

National Association of Corporate Directors (NACD) President and CEO Ken Daly testified before the House Financial Services' Capital Markets and Government Sponsored Enterprises Subcommittee on the impact of whistleblower reward provisions in the Dodd-Frank Act and supported the proposed Grimm bill. He enumerated the unintended consequences that may result from the proposed SEC whistleblower regulations to implement Dodd-Frank. Under previous rules, the SEC could choose to reward whistleblowers, but was not required to provide monetary compensation. The main focus of  Daly's testimony was to recommend deferral of the proposed regulations until further study can determine the effectiveness of the provisions that already exist in the Sarbanes-Oxley Act.    

The first person to win protection under the Sarbanes-Oxley Act's whistle-blower provision was a CFO, David Welch, a former finance chief of Cardinal Bancshares. Welch had claimed he was fired after raising questions about the bank's accounting policies and internal controls. A government review board later rejected the Department of Labor's initial decision that Welch should get his job reinstated and collect back pay. Dodd-Frank's whistle-blower rules were designed to make the process more favorable to informants.

 This is not an easy issue from an ethical perspective. On the one hand I believe whistle-blowing should be encouraged if it helps to uncover corporate fraud and save the investing public from untoled losses. On the other hand, a top company official like a CFO should go through the chain of command including reporting to the CEO and board of directors when he or she suspects corporate wrongdoing. I think it's reasonable to amend Dodd-Frank to require those steps be taken first before blowing the whistle externally. One would hope the proper corrective action would be taken internally before it comes to that point --  assuming the allegations are correct.

I have previously blogged about what it takes to have an ethical corporate culture -- one that promotes financial responsibility and fosters ethical behavior. However, I do take exception to Ken Daly's cynical characterization of Dodd-Frank that, he claims, " has created 'a perverse incentive' for whistle-blowers to let a problem fester in order to collect a higher reward." Daly is guilty of the same kind of rhetoric we hear all too often from corporate America today that they are over-regulated. Well, look in the mirror! Who do you think is to blame? Might it be these very same corporations that gave us Fannie Mae and Freddie Mac, Countrywide and all the risky derivatives trading, the Enrons and WorldComs of our world -- OR, should we blame Congress that, for all its other faults, is trying to protect the very public it was sworn to serve?

  Blog by Steven Mintz, aka Ethics Sage, May 27, 2011

Business Fraud on the Rise

 It's Déjà vu All Over Again!

On May 23 The Network, Inc., a leading provider of governance, risk and compliance  solutions, and BDO Consulting, a division of BDO USA, LLP, announced the first quarter 2011 findings of its Quarterly Corporate Fraud Index, a comprehensive examination of fraud incident report activity from almost 15 million employees worldwide.

For the first quarter of 2011, the Fraud Reporting Percentage (FRP), a statistic measuring fraud reporting in comparison to all compliance reporting activity from more than 1,000 organizations worldwide, was reported at 20.3 percent. The FRP statistic rose by more than 60 basis points since last quarter. FRP has increased in each of the last three quarters and stands at its highest mark since the second quarter of 2009.

Other first quarter 2011 findings include the following:

• FRP (Fraud-Related Reports versus all reporting activity) increased one-tenth of a percent – from 20.2 percent to 20.3 percent – compared to the same quarter in 2010
• Fraud-Related Incidents (FRI), the total number of reported fraud-related incidents, increased four-tenths of a percent compared to the same quarter in 2010
• In comparison to the fourth quarter 2010, FRI increased 3.3 percent during the first quarter of 2011
• First quarter fraud incident volume has steadily risen – by 1,000 basis points, or almost doubling – since the 2005 inception of the Quarterly Corporate Fraud Index

According to Luis Ramos, chief executive officer of The Network, the 2011 Q1 fraud index is at a near-record high. Ramos said: “This quarter’s FRP is only 10 basis points lower than it was in 2009, one of the worst years for business on record. The increase is in line with what we are hearing from financial analysts and reinforces the trend that even in a recovering economy, fraud reporting is still on the rise.”

Haven't we been down this road before with corporate America? In the 1980s it was frauds at companies such as ZZZZ Best, Miniscribe, ESM Government Securities, et al. In the 1990s it was Sunbeam, Lucent Technologies, and Waste Management to name a few. Then there were the glorious early 2000s that spawned the Sarbanes-Oxley Act. Who can forget Enron (Jeff Skilling), WorldCom (Bernie Ebbers), Tyco (Dennis Kozlowski), and the rest of the corporate crooks that caused a massive stock market sell-off? I guess Wall Street couldn't hold out for the historical ten years to pass before massive business fraud occurred again. I'm referring to the likes of Bernie Madoff and Countrywide's Angelo Mozilo, both of whom got their greedy hands on investor money and by their actions contributed to the financial meltdown of 2008, along with so many other banks and financial institutions.

I'd like to say that corporate America has learned its lesson and reformed its ways. I'd like to but I can't. As an accounting professor and expert in business ethics I am particularly dismayed by the results of the Quarterly Fraud Index that shows of the 30,000 ethics-and-compliance-related reports from people at those in the surveyed organizations in the first quarter, more than 6,100 concerned accounting or auditing irregularities, embezzlement, kickbacks, and other forms of fraud.

The bottom line as we say in accounting is that fraud in corporate America is just a reflection of the morally-bankrupt society that we have become. It has become endemic in our culture. If you don't agree or have had your head in the sand for the past few years, witness the growing number of politicians who have resigned or been forced out for improper behavior, the increasing number of men who are caught and/or admit to cheating on their wives, a matter I blogged about on May 21, or cyber-bullying and frequent reports of beatings by high-schoolers and younger kids including girl-on-girl attacks and gay-bashing in schools.

 Blog by Steven Mintz, aka Ethics Sage, May 26, 2011

 

SEC Playing Around With its Mandate to Protect the Investing Public

Should the SEC Take Action to Expand Private Share Offerings?

Republicans in Congress want the SEC to raise the 500-shareholder threshold that separates a private from public-offering of stock, or else change the rule so that more sophisticated investors who understand the markets will not count toward the total. The SEC is considering whether to ease the decades-old requirement that private companies with 500 or more shareholders make lengthy financial disclosures and a rule prohibiting closely held companies from advertising their shares, known as the "general solicitation" ban. The 499-owner limit, which applies to firms with more than $10 million in assets, was created to ensure that shareholders get sufficient information about their investments. House Republicans argue that restrictions on private-stock sales and the costs of complying with SEC rules for public stock offerings are negatively affecting companies' ability to raise capital.

In my previous blog on the LinkedIn IPO, I warned that inflated post-IPO stock prices following the LinkedIn IPO, and the prospect of the same happening with similar public offerings that are expected such as at Facebook, might create the same kind of pressure to manipulate reported earnings that we saw during the dark days of Enron and WorldCom. Past history tells us that too many top executive never seem satisfied with merely meeting financial analysts' earnings expectations. Revenue manipulations occur all too often to enhance reported earnings, drive up the stock price, and enable the top executives to cash in on lucrative stock options. I fear that any loosening of the 500-shareholder limit on private placements will add fuel to the fire that lays dormant right now but just needs a spark to set it off ablaze once again.

Am I an alarmist? Wouldn't it be a good thing for the SEC to loosen the rules and facilitate growing companies' access to America's investment capital? At a recent congressional hearing, SEC Chairman Mary Schapiro was pressed to make regulatory changes to help small and medium-sized companies more easily raise capital without going public. Rep. Darrell Issa (R-Calif.), chairman of the House Committee on Oversight and Government Reform, pressed the cause of businesses that want to tap investors for money but are far from eager to make the many financial disclosures demanded of companies traded on the stock market. Now, when companies amass 500 or more shareholders of record they are required to register with the SEC and make an array of disclosures, including how much money they are making or losing and how much they pay their top executives.

What's wrong with this picture? Why should honest companies that act with integrity be concerned about making financial disclosures including those about executive compensation? What ever happened to financial transparency as the goal of financial reporting? Moreover, why should the SEC even entertain this argument in deciding whether to relax the current rules? After all, its regulatory mission is to protect investor interests above all else. Schapiro hit the nail on the head at the hearing when she said: "Too often, investors are the target of fraudulent schemes disguised as investment opportunities...and that such frauds accounted for 22% of the commission's enforcement cases in fiscal year 2010."

You may recall that Goldman Sachs pulled the Facebook private offering on January 17 because of concern that '''immense media attention''' could violate SEC rules limiting marketing of private securities. Issa contends the decision showed that private capital formation in the U.S. is increasingly difficult. He believes that reversing this trend and efficiently attracting capital to the best investment opportunities in the  U.S.  is a critical step that would facilitate a widespread economic recovery and the long-term viability of our global market position. The SEC sharpened its focus on how unlisted companies raise money after Goldman halted a planned offering of as much as $1.5 billion in Facebook Inc. shares to U.S. investors. The foreign placement that followed was hugely successful and many investment bankers lament the lost opportunity for Facebook to tap into domestic capital markets.

The SEC's job is not to facilitate the process of raising investment capital in the U.S. The fact is some private companies are deliberately trying to avoid the disclosure and other laws enacted over time to protect the interests of the investing public, and Facebook is a prime example. Even if we concede that it may be a better economic policy for America to not  limit the opportunity for private companies to remain private and raise capital without full disclosure, I believe companies like Facebook and Twitter, and all other private companies that choose to raise more funds privately rather than go public, have forfeited the right to set the rules of the game. They are part of a pursuit of self-interests system that encouraged their brethren to make risky investments with the public's money and that directly led to the financial meltdown of 2008. These technology and predecessor telecommunications companies and their investment bankers gamed the system and took actions that caused so much economic pain and personal misery for so many in the investing public -- that very same public the SEC is sworn to protect.

  Blog by Steven Mintz, aka Ethics Sage, May 25, 2011

LinkedIn IPO: Are We Headed For Another Market Meltdown?

LinkedIn IPO, Facebook IPO and Concerns About a Future Market Meltdown

LinkedIn's public offering last week saw its shares more than double on opening day in the largest IPO by an Internet company since Google's debut in 2004. In an article by Barrons reporter Andrew Bary on  May 21, 2011, Bary suggests that the LinkedIn IPO evokes images of the dot-com bubble of the late 1990s, when dozens of dubious Internet companies surged following their IPOs, often attaining multibillion-dollar market values, only to crash when they ran out of money or couldn't meet Wall Street's expectations. Bary calls this Bubble 2.0.

This is the first of a two-part series on the wild reception for the LinkedIn IPO and whether that bodes well for future public offerings of social media companies such as Facebook. The issue to be explored in my next blog is the advisability of maintaining the 500-shareholder limit imposed by the SEC on private offerings and advertising constraints that are allegedly encouraging companies to raise private funds outside the U.S. as did Facebook recently. The underlying question is whether the success of LinkedIn and expectations for similar success for social media companies such as Facebook and Twitter when they go IPO raise the specter of an Internet stock-driven bubble similar to the telecommunications stock bubble of the late 1990s and early 2000s.

In case you were asleep on May 18, LinkedIn's IPO was priced at $45 per share up from the previous price range of $32 to $35 apiece. This gave the professional Web networking site a value of $4.25 billion. By May 20, the price had soared to a close of $93. That's more than a doubling of its value in two days. The offering of 7.84 million shares and rapid price increase may be a sign of a new Internet stock bubble. From an ethical perspective, the SEC must be vigilant and get out in front of the possibility that the manipulation of financial results will occur down the road as companies like LinkedIn struggle to reflect the kind of growth in advertising revenues and net income that stock market investors became used to during the telecommunications stock bubble of the late 1990s and early 2000s. We cannot afford another meltdown and the enormous destruction of wealth, job losses and economic pain that we went through in the post-Enron era.

Bary's article points out that LinkedIn "now has a market value of $8.7 billion, based on 94 million shares outstanding—and that doesn't include another 30 million that may be issued to satisfy options and executive stock grants. The market value is equal to 35 times 2010 revenue of $243 million and almost 550 times 2010 profit of 17 cents a share. By contrast, Google is valued at five times revenue and 20 times trailing earnings."

I'm not questioning LinkedIn's business model with its fast-growing membership base of more than 100 million subscribers and three diversified revenue streams: online advertisements sold to businesses; premium subscriptions for individuals; and hiring tools sold to recruiters. Those of us who have followed LinkedIn's rising start have witnessed the doubling of revenue in 2010 from 2009. The company says it adds a member every second. For me it's the greed factor that has infected Wall Street for so long that I fear will take over once again as companies like LinkedIn struggle, on a long-term basis, to meet financial analysts' growing earnings expectations. I'm also concerned about top executives' insatiable appetite for stock options, the motivation to keep share prices rising, and the need to hold on to key executives through lucrative pay packages. The IPO created another Internet billionaire in chairman Reid Hoffman. His 20% stake is worth $1.8 billion.

If we look closer at the numbers, more red flags go up. While LinkedIn's revenue is growing sharply with sales hitting $94 million in the first quarter of 2011, more than double the year-earlier total, the company made just two cents in the first quarter and doesn't expect to be profitable this year, as it "invests for future growth." From an accounting perspective it's not clear how making capital investments for future growth affects the bottom line right now.

In its regulatory filing with the SEC, the company said that a substantial majority of its users don't visit the site regularly. LinkedIn also faces stiff competition from other social networking companies as some users leverage the Facebook platform for recruiting and professional-networking purposes. The bottom line is LinkedIn may be a passing fade as competitors such as Facebook spread their wings and look for additional sources of customers following its expected IPO later this year. In other words, here is a warning to all current and future investors in LinkedIn: caveat emptor.

  Blog by Steven Mintz, aka Ethics Sage, May 23, 2011

 

Are All Men Dogs?

Who Let the Dogs Out?

First, let me apologize to the Baha Men for using the title of their song, Who Let the Dogs Out?, to talk about extramarital affairs by male politicians. Even though the song was ranked third of 20 of the most annoying songs in a poll conducted in 2007 by Rolling Stone, it deserves a better fate than to be linked to creeps such as Arnold Schwarzenegger, John Ensign, Mark Sanford, Bill Clinton, Elliot Spitzer, and the biggest creep of them all -- John Edwards.

Men behaving badly is not a unique U.S.-politician phenomenon. Who can forget the recent revelation that the 76-year-old Italian Prime Minister Silvio Berlusconi allegedly paid to have sex with a minor, aka ‘Ruby, the heart stealer’?  By the way, you can catch Moroccan model Karima El Mahroug commercials promoting a book by former European parliament member, Alfonso Luigi Marra, called The Female Labyrinth, according to a story in the Daily Telegraph. In the TV spot, a character that resembles the Phantom of the Opera walks in and strips off El Mahroug’s dress so that she is standing in front of the camera wearing only her underwear  -- yuck!. Perhaps we can add newly-resigned IMF chief Dominique Strauss-Kahn to the list who was indicted by a Grand Jury on May 19 over allegations of rape.

Just when I thought I had heard it all, the story broke this week that a unit of German insurer Munich Re hired about 20 prostitutes for a 2007 party held at Budapest’s historic Gellert spa as a reward for some of its top insurance salesmen. According to German Handelsblatt paper (it's in German, if you can speak it, the rest of you will have to trust me), the prostitutes hired for the event were designated with armbands (this is scary stuff). The prostitutes escorted party attendees to beds set up near the spa's thermal baths, and would earn a stamp on their forearm upon their return to keep a running tally of their services, the newspaper said (scarier stuff)!

Why are (some) men such dogs? Is it ego? power? Pure hedosim? Stupidity? All of the above? I suppose there is the feeling of invincibility and not being subject to the normal rules of moral behavior. I searched to try and find a recent example of a woman politician acting this way toward a male. I didn't find much but recalled that Catherine the Great was a woman with a legendary sexual appetite. During the 34 years of her reign, she had many consorts who were richly rewarded with choice positions on her court, or gifts of property or serfs. The rumor that spread after her death in 1796 was that she had been crushed under the weight of a stallion she was attempting to have sex with. I have no further comment on this issue.

I suppose narcissism is a good description of this type of male behavior so I consulted the DSM IV and found it descreibed the term as follows: Someone who suffers from Narcissistic Personality disorder (NPD) has at least 5 of the following characteristics:

1. has a grandiose sense of self-importance (e.g., exaggerates achievements and talents, expects to be recognized as superior without commensurate achievements)
2. is preoccupied with fantasies of unlimited success, power, brilliance, beauty, or ideal love
3. believes that he or she is "special" and unique and can only be understood by, or should associate with, other special or high-status people (or institutions)
4. requires excessive admiration
5. has a sense of entitlement, i.e., unreasonable expectations of especially favorable treatment or automatic compliance with his or her expectations
6. is interpersonally exploitative, i.e., takes advantage of others to achieve his or her own ends
7. lacks empathy: is unwilling to recognize or identify with the feelings and needs of others
8. is often envious of others or believes that others are envious of him or her
9. shows arrogant, haughty behaviors or attitudes

Need I say more? Oh well, I've resisted for 684 words but can no longer do so. Here is the original Baha Men video of the song written and originally recorded by Anslem Douglas (titled "Doggie") for Trinidad and Tobago's Carnival season of 1998. I apologize to all canines once again.

 

 Blog by Steven Mintz, aka Ethics Sage, May 21, 2011

The Ethics of Prop. 13 Repeal and Declining Work Ethic in Society

The New Normal is Not a Pretty Picture

I recently blogged that it was time to repeal Prop. 13 in California. I cherish the replies I receive from readers and one such reply encouraged me to expand on my position. Here is the original reply: “Instead of charging those of us who own commercial property more in taxes so schools can better educate our children, why don't you use the funds ALREADY voted on for schools and education... What a stupid idea... REMEMBER THE STATE LOTTERY WAS GOING TO DO THIS... Punish the business owners and property owners who are generating jobs and revenue in California by repealing Proposition 13? NON-SENSE...”

Reader, you have a good point. First, let me dispense with the notion that Prop. 13 funds were expected to replace property tax revenues as a source of funding for public education. That never was the goal. Instead, the funds have been used largely to supplement the high-cost technology needs of educational institutions to train future graduates in the technological skills needed to compete for jobs in an increasingly globalized economy. The amount we have have received over the years is a small drop in the bucket.

I, too, am a property owner and pay real estate taxes. I do believe California property owners have escaped for a long time the property tax increases that occur in virtually every other state as the appraised values of homes go up over a period of time. Out of fairness, we could end Prop. 13 as of a future date and even grandfather in property owners like you and me so that the rules don't change in the middle of the game. Such a policy might even spur a housing recovery in the depressed California real estate market as future home owners act now to fall under the current, restricted system of calculating property tax payments. We make these kinds of choices all the time and raising the retirement age to receive social security benefits is another example of how it can be phased in. So, my suggestion is that any Californian who buys property say as of January 1, 2012 would be subject to the post-Prop. 13-system. It would be a fair way of making the change in property tax philosophy and potentially raise a large amount of tax revenue for the state as property values (hopefully) recover. On the one hand, I don't like eliminating Prop. 13 because I know it's the incompetence of state legislators and their proliferate spending habits that have gotten us into the mess we are in. On the other hand, California, as in so many other areas, is a symbol of the new normal in US economics.

We have an aging, healthier population that will require economic support for a longer period of time thereby costing all of us more money. Remember that we, too, will be in that category one day. Unfortunately, we also have the double barrel effect of a new normal in the unemployment rate that will probably hover around 7-8% when all is said and done, about three percentage points higher than historical trends. The long-term unemployed will eventually run out of time to receive benefits thereby increasing the rolls of those dependent on welfare and other forms of state support. We also will experience increased displacement from the job market for high school and even college graduates who do not have the skills and/or desire to work hard to develop the abilities needed to be productive members of our new, increasingly globalized society. Our woeful education achievement scores when matched against other countries bears this out. We typically rank in the mid-20s in math and technical skill levels when compared to other industrialized countries.

The final issue is the outsourcing of jobs overseas. There is no doubt that millions of jobs that could have been filled by Americans here at home have gone to foreigners. This is a complicated problem and one that is, for the most part, driven by two factors. The first is the obvious -- cost savings. US companies save billions in lower labor costs and pay no health or retirement benefits to workers outside the US who perform the same services that our own citizens can perform. The second factor relates to the biggest challenge we now have as a society, which is the declining work ethic in this country. I have previously blogged about this issue. I've been teaching at the university level for almost 30 years and have witnessed a remarkable change in the culture of learning in today's college students. Most rather text, tweet, update their facebook page, or play around with other technology rather than put in the time to learn in a sustainable way. They are good at memorizing but retain little. They are good at arguing with teachers for a higher grade but do not realize they are developing habits that can hurt them in the workplace if they were to transfer those habits to job performance interviews. The desire to be visible to their peers -- to stand out from the crowd -- has driven the fifteen minutes of fame culture that infects all of society.

It's not a pretty picture but it is where we are after years of ignoring the real problem which is that a we live in a world where ethical behavior and doing good for its own sake has been replaced by egoism and self-gratification. I don't have the answers but I do know a recovery starts, like any other addiction, by first admitting we have a problem. Unfortunately, all too many in society don't see it that way in part because we no longer are tuned in to our ethical side. That inner voice called a conscience that once guided our behavior has long since been muted. Few, if any of us, make decisions on behavior only after considering the consequences of our actions on others including loved ones, those who are directly affected by our actions, society in general, and even our own best, long-term interests. Add to it today's popular cultural icon of celebrity and you have a recipe for disaster -- a sort of a tsunami effect that has engulfed what once was a nation of strong core ethical values that guided our behavior and sustained as the most admirable country in the world.

 Blog by Steven Mintz, aka Ethics Sage, May 20, 2011

 

 

Greed is Good -- huh?

An Ode to Gordon Gekko

I don't normally use other blogs or, in this case, an article from New York Magazine but this is an exception. The video is hysterical. It explains in just over three minutes the essence of the meltdown of our financial system and hubris of those responsible for the "crime of the century." Just click on the link below and enjoy!

 

Greed is good

 

Posted by Ethics Sage, aka Steve Mintz on May 18, 2011

Examining the Growth of Insider Trading Cases

Insider Trading Compromises the Level Playing Field for Average Investors

I previously blogged about the role of Raj Rajaratnam in the Goldman Sachs insider trading scandal. Last week Rajaratnam was convicted on all 14 counts of securities fraud and conspiracy in the biggest insider-trading case ever. The case centered on how the founder of the hedge fund Galleon Group trafficked in inside information obtained from corporate executives, bankers, consultants, traders, and directors of public companies including Goldman Sachs. Raj gained $64 million from his sale of insider tips and now faces 19 1/2 years in prison at a sentencing scheduled for July 29.

There has been an unprecedented growth in the number of insider trading scandals over the past several months, many due to activities of hedge fund traders. The government has had a hard time convicting the culprits because there is no clearly defined federal statute on just what constitutes insider trading. Most of us know it the use of private information for personal gain, but that doesn't cover passing it along to others for their personal gain or other forms of trading on the information.

Other insider trading cases that are pending include:

1.      Trades made in an account overseen by hedge-fund titan Steven Cohen that were suggested by two of his former fund managers who have pled guilty to securities-fraud charges for trading on inside information. The case involves trading in a $3 billion stock portfolio personally overseen by Cohen at SAC Capital Advisors and referred to by the government in the filings as "Cohen Account" and internally at SAC as "The Big Book." SAC portfolio managers allegedly funneled their best trading ideas to Cohen for this account and were paid a bonus if they generate big returns for Cohen.

2.      The feds have charged longtime New York stock trader Garrett D. Bauer, an unnamed co-conspirator and Matthew H. Kluger, with at least $32 million in illicit profits on investments of more than $109 million. Working on corporate merger and acquisition deals, Bauer was privy to insider information regarding big companies that were merging or being acquired and he started buying stocks in the companies before the deals happened.

3.      On the same day the feds claimed victory in the Rajaratnam case, they arrested Don Chu, an executive at Primary Global Research, a so-called expert-network firm that provides “market intelligence” to hedge funds and other money-management outfits. The government accused Chu of participating in an insider-trading conspiracy by arranging for his hedge fund clients to get illegal tips on technology companies including Broadcom, Sierra Wireless and Atheros Communications.

So, what's wrong with insider trading from an ethical perspective?  Just this: Investors must have confidence in the integrity of the markets, and that they are on an equal footing with those in the know and are protected against the improper use of inside information. If people fear that insiders will regularly profit at their expense, they will not be nearly as willing to invest. The argument is that efficient markets require a “level informational playing field” to avoid scaring away speculators, who contribute to securities market liquidity, and investors, who could invest their savings in markets with less risk of predation.

The question that must be asked is why so many insider trading cases now? I believe it is the response of federal regulators  to failing to heed the warning signs of the massive Ponzi scheme by Bernie Madoff. The SEC literally got caught with its pants down and thousands of investors paid the price of Madoff's hubris and self-dealing. A vigorous oversight mechanism with embedded warnings signals are necessary steps in fighting off insider trading crimes that are motivated by the greed is good culture on Wall Street that has persisted for almost thirty years following the release of the iconic film, Wall Street.

 

Blog by Steven Mintz, aka Ethics Sage, May 18, 2011

Cartoon reproduced with permission

 

Social Media Socially Irresponsible

Facebook, Google Engage in Unethical Actions

The social media sites Facebook and Google act as though the rules do not apply to them or it's too much for them to conform to expected standards of behavior. This past week we learned that Facebook engaged in a covert smear campaign against rival Google. Facebook paid a public relations firm to push well known journalists and bloggers to report that a new Google feature was putting users' personal data at risk and that Google was guilty of violating privacy rights. If this is true, Google should be labeled an unethical company because, according to Kantian Rights Theory, citizens have certain basic rights and privacy is one of them.

Google's "Social Circle" appears to do just that. It allows Google users who search for a topic like "restaurant in Boston" to see among the results items about that topic that were posted by their friends on services like Facebook, LinkedIn and Yelp. It works only for people who have chosen to link their Google accounts to their accounts on those services, and relies on information that those services make publicly available on the Internet. Furthermore, Google Social Search helps you discover relevant content from your social connections, a set of your online friends and contacts. Content from your friends and acquaintances is sometimes more relevant and meaningful to you than content from any random person. For example, an online movie review is useful, but a movie review from your best friend can be even better.

Google's actions seem to be motivated by an ends justifies the means approach to business decision making. However, the means to which a company achieves its goal is more important than the goal itself. It's wrong to jeopardize user privacy rights in the name of market share of enhanced revenue sources. Up until now, Google has enjoyed a relatively good reputation for honesty and integrity in its practices. Facebook has not. Facebook acknowledged hiring public relations firm Burson-Marsteller to "focus attention" on privacy concerns with Social Circles. The PR firm contacted key journalists and bloggers, including University of Indiana researcher Chris Sogholan, encouraging them to write critically about Social Circles. To his credit, Soghalan asked for the identity of the firm that had hired Burson. A representative of the firm declined to say, so Soghalan posted that exchange on line. After confirmation of the story by Dan Lyons, a Daily Beast reporter, Burson released a statement saying that the PR campaign was "not at all standard operating procedure" and "should have been declined."

Why is it that companies like Google and Facebook can't or won't think of the consequences of their actions before doing something of questionable legality and definitely unethical? I suppose it's a form of hubris, and it seems that these organizations may have gone to the Bernie Madoff school of ethics. Act Utilitarian theory tells us to weigh the harms and benefits to the stakeholders -- those potentially affected by an action -- prior to making decisions. Clearly, Google didn't do it or, perhaps, it did but weighed their own interests and benefits to the company above those of all the stakeholders combined. That's why Rule Utilitarianism is a more valid approach to ethical reasoning. It posits that regardless of utilitarian benefits, certain rules should never be violated, and that would include not to invade one's privacy.

Facebook has been involved in other questionable actions. In May 2010 it was reported that Facebook violated its own policy against transmitting personal information of its users by allowing advertisers to see detailed personal information about some Facebook users. Apparently, there was a security flaw concerning referer URLs whereby Facebook revealed information to advertisers that could be used to personally identify visitors. The problem was made far worse by the changes Facebook made in the past few months by designating radically more user data as "publicly available information" and creating new tools for mining that data. 

I suppose the bottom line is companies like Facebook and Google lack the integrity to make decisions in a principled manner, instead placing expediency and greed above all else. Here's an excerpt from Google's code of ethics: "Don't be evil." ...Our practices should be "built around the recognition that everything we do in connection with our work at Google will be, and should be, measured against the highest possible standards of ethical business conduct... Our commitment to the highest standards helps us hire great people, who then build great products, which in turn attract loyal users. Trust and mutual respect among employees and users are the foundation of our success, and they are something we need to earn every day."

All too many companies like Google and Facebook fail to "walk the talk" of ethics. Ethics is all about how you act when no one is looking. Unfortunately, Google and Facebook failed to look over their shoulders before deciding to engage in unethical actions.

Blog by Steven Mintz, aka Ethics Sage, May 16, 2011

Readers may be interested in my blog about Facebook Cozying Up to China by agreeing to  surrender information on request to the Chinese authorities so they can control dissenting comment.

Ethics Resources

Ethics Resources for Academics and Business Professionals

Business ethics researchers may want to check out the Ethics Resource Link on my blog site (http://www.ethicssage.com/) that identifies over thirty websites where you can obtain free information about ethics research, business ethics programs, codes of conduct, on-line ethics magazines, newsletters and other valuable resources for academic and business professionals. Also, some of my favorite blogs that deal with ethics, leadership, values-based decision making and accounting and auditing topics are referenced. Thanks to all my loyal supporters who read my blogs. I hope you find them stimulating, informative and enjoyable.

Individuals and organizations that want to learn more about what I do, expert areas for commentary, availability for speaking engagements, ethics consulting, or just to dialogue directly can e-mail me at steve@ethicssage.com.

Posted on May 15, 2011

The Ethics of Kicking the Can Down the Road

What Does it Really Mean to Kick the Can Down the Road?

I keep hearing politicians use the phrase "kicking the can down the road." Right after he got elected, President Obama said, "What I'm refusing to do and what I've instructed my staff that we will not do is to try to kick the can down the road..." Kicking the can down the road is a universally understood metaphor. But what does it really mean?

I grew up in Brooklyn, New York where we used to play the game -- kick the can down the road.  It's a street game where a round of the game is started by someone kicking the can as far as they can, then the person who is "it" has to reach the can before the next phase of the game can start giving the other players time to scatter, hide or whatever is required by the variation of the game. The idea was to catch up to the can before you got hit by a car (just kidding). In an amusing take on the expression, Riverside Press-Enterprise reporter Dan Bernstein talks about an experiment when he placed a can of chicken broth in the street and tried kicking it down the road. Bernstein explains how hard it was to control the can that went off in different directions. He concluded: "It is also a solitary, anti-social activity that, like obsessive video gaming, is potentially unhealthful." Here's Bernstein's amusing take on kicking the can down the road.

 Bernstein relates his experience to a politicians' way to play the game. He points out that "kicking the can down the road is a lot tougher than Washington windbags would have us believe. I bet they've never even tried it! Otherwise, they long ago would have staggered across the aisle to fix Medicare or Social Security. At least they could do that sitting down." That's the purpose of this blog -- to examine the ethics of the practice of kicking the can down the road. You see, I can find an ethical slant to just about anything.

Virtue theory, according to the ancient Greeks, identifies dispositions or tendencies to behave in a certain way as the foundation of virtue. It has become associated with character traits. This is an over-simplification of the theory but will do for today's analysis. A virtous person would never kick anything. It's potentially harmful, even to a can. It shows disrespect for the can's constituency, which would include other cans, people who walk the streets, and those who eat from the can for sustenance. In other words, politicians disrespect we the people when they put off solving problems such as becoming energy independent, fixing our education system, immigration reform, and the fiscal soundness of social security.

Out here in La La land Governor Jerry Brown is trying to live up to the promise he made in his January 31 State of the State speech:  “Kicking the can down the road, by not owning an honest budget, is simply out of the question.” Well it's more than three months and all Jerry is talking about is using short-term solutions to long-term, structural problems. This past week he placed a ban on most travel by state employees unless it is authorized by a senior official. Gee, Jerry, I don't know but it seems to me that sound internal controls dictate that the authorization of travel of a state employee who relies on state funds should only occur after proper authorization in the ordinary course of running a responsible government!

We've been hearing a lot about "American Exceptionalism." I don't think we can consider ourselves in that light anymore unless it's in terms of killing terrorists. I'm talking about exceptionalism in our education system, a fair immigration system, providing for the sick and elderly, eliminating poverty, and a whole host of other problems that we've been talking about solving for as long as I can remember. But, what's wrong with delaying action from time to time? Nothing, unless the delay is an inability or unwillingness to make the tough choices that help solve today's problems today and not leave them for our kids and grandkids.

Politicians have an ethical responsibility to put political ideology aside, drop all pretenses of being on the right side of the issue, and stop calling each other names so we can start to deal with the tough choices we need to make if we are to avoid the downward path of recent years to becoming a third-world nation. No, I don't mean in the literal sense. I'm referring to our failing education system, crumbling infrastructure, and growing dependence of large chunks of our society on public resources. We also risk falling further behind in the race to stay ahead of China as the world's number one economic power.

Blog by Steven Mintz, aka Ethics Sage, May 14 2011

Emerging Economic Development in Africa

Cultural Values and Untapped Resources Promote African Development

The U.S. has a moral imperative in Africa. That was the subject of a previous blog (http://bit.ly/fWcYTQ.) Today I look at emerging economic development in once was a forgotten-continent. The drivers of increased economic development include: (1) untapped resources and the desire of China to feeds its appetite while, at the same time, engaging in joint projects to build infrastructure and foster economic and political ties;  (2) a global demand for African resources from more advanced emerging economies including India and Brazil; (3) stronger U.S.-African economic and political ties since the election of President Obama; (4) advancing educational programs, some based on linkages with foreign universities and others prompted by the increased desire to improve the educational experience of all Africans; and (5) the desire to join the global community of advanced economies and improve living standards for the African people.

Economic development in South Africa since its turn toward democracy in 1994 has been an engine for change. South Africa is the leader of Africa’s emerging economic growth, leading the continent in industrial output and mineral production and generating a large proportion of Africa's electricity. The country has abundant natural resources and a modern infrastructure supporting efficient distribution of goods throughout the southern African region. The Johannesburg Stock Exchange now has more than 400 company listings and a market capitalization of more than $182 billion. The stock market’s size and capitalization make it the largest exchange on the continent and places it in the top ten largest exchanges in the world. This is a critical factor for foreign multinationals that seek investment capital to develop joint projects in Africa of mutual benefit.

Until the global economic crisis hit South Africa in late 2008, economic growth had been steady and unprecedented. According to Statistics South Africa, GDP rose by 2.7% in 2001, 3.7% in 2002, 3.1% in 2003, 4.9% in 2004, 5% in 2005, 5.4% in 2006, 5.1% in 2007 and 3.1% in 2008. South Africa has a diversified economy, better fiscal and trade balances, and improved governance, all of which should help to maintain a positive growth trend. The country’s availability of globally-demanded commodities bodes well for the economic future of the continent.

Other signs that the economic future of Africa is bright include the independence of the Republic of Southern Sudan that broke away from the north after a January 2011 landmark referendum poll where more than 98 percent of votes cast supported independence from the north. The new Republic is looking to the economic reconstruction in Rwanda after years of horrific conflict as a model for growth. Sub-Saharan African countries including Ghana, Côte d'Ivoire and Angola are experiencing economic growth and development.

Not all is well in Africa. The per capita income is among the lowest in the world with the exception of South Africa. The historically more advanced countries of northern Africa including Egypt, Libya and Tunisia are dealing with political strife that will take them into unchartered and potentially dangerous waters. Years of war and ethnic conflict hamper growth in countries such as The Republic of Congo and make for a risky place to do business. A fractionalized society, widening gap between rich and poor, endemic poverty, and inefficient, corrupt government all mitigate against developing the level of trust needed by economic partners to feel secure that Africa is the place to be in the next decade.

However, Africa offers much to the world and for those companies willing to take the risk. Its culture is marked by shared values including hospitality, friendliness, patience, and a consensus, group dynamic that views individual development within the larger context of community. This is quite different from the culture in the U.S. that emphasizes individual freedom above all else but can lead to disastrous results such as the pursuit of self-interest mentality that led to the economic crisis of 2008. Perhaps we have much to learn from communitarianism.

Kenyan theology professor John S. Mbiti believes that the individual has little latitude for self- determination outside the context of the traditional African family and community. He writes: "Whatever happens to the individual happens to the whole group, and whatever happens to the whole group happens to the individual. The individual can only say: 'I am, because we are; and since we are, therefore I am.' This is a cardinal point in the understanding of the African view of man."

 Blog by Steven Mintz, aka Ethics Sage, May 12, 2011

 

 

A Culture of Corruption Threatens India's Economic Growth

Corruption: How it corrodes Brand India

It's called ghoos (घूस) in Hindi, mordid in some Spanish speaking countries, and baksheesh in some Near Eastern countries. In the U.S., bribery constitutes a crime and is defined by Black's Law Dictionary as the offering, giving, receiving, or soliciting of any item of value to influence the actions of an official or other person in charge of a public or legal duty. The cultural expectation that bribes have to be paid to get things done is threatening economic growth in India. According to Transparency International, the global civil society organization leading the fight against corruption, India ranks 87th in the world (see:  http://www.transparency.org/policy_research/surveys_indices/cpi/2010/results). The group defines corruption as the abuse of entrusted power for private gain. It has become endemic in Indian society. There's even a website that encourages Indians to report personal instances of having to pay bribes to get things done. The site (http://www.ipaidabribe.com/)  reports about 8,600 such incidents as of May 11, and counting. It has been estimated that the cost of bribery to the Indian economy is about $2.5 billion (Rupees), or $55.8 million. A 2008 study put India's underground economy at 50 percent of the country's gross domestic product (GDP) or $640 billion!              

The problem has gotten so bad and threatens all systems in society (political, social and economic) that activist Anna Hazare proposed an anti-graft "Jan Lokpal" bill that calls for creating an independent ombudsman with court-like power that could prosecute ministers, bureaucrats and judges involved in scandals that have plagued the government of Prime Minister Manmohan Singh. The bill would send a clear message to those in high positions that they cannot escape (the consequences of) graft, but, according to Vijay Anand, president of 5th Pillar, a grassroots group that helps citizens seek transparency and accountability in governance, the country "must also look at protecting whistleblowers and also providing immunity for bribe payers." He believes "people are often afraid to come forward and report those who ask for bribes they have ended up paying, because they fear prosecution."

Some blame the rapid movement toward privitazation of business during the past 20 years for adding to the already existing culture of corruption in India. It seems as though payments must be made under the table to get virtually anything done whether it be of a personal nature or in business. Citizens pay simply to have their passport applications processed. Businesses pay to get their tax refunds. No, I'm not talking about accelerating the process. I'm talking about getting someone to do something that should be done anyway in the ordinary course of doing business. The government's benign neglect of the problem fosters a "pay to play" culture in India.

The Organization for Economic Cooperation and Development (OECD) characterized these so-called facilitation payments at its November 2009 "International Anti-Corruption Day" as “corrosive . . . particularly on sustainable economic development and the rule of law.” The only countries that permit facilitation payments are the U.S., Canada, Australia, New Zealand and South Korea. The 2010 UK Bribery Act that goes into effect in July 2011 bans facilitation payments – or “unofficial payments,” a departure from the U.S. Foreign Corrupt Practices Act that permits such payments but bans bribery. The OECD encouraged "companies to prohibit or discourage the use of small facilitation payments [by establishing] internal company controls, ethics and compliance programs or measures, recognizing that such payments are generally illegal in the countries where they are made, and must in all cases be accurately accounted for in such companies’ books and financial records."

Returning to India, an interesting proposal comes fromIndia’s chief economic adviser, Kaushik Basu, who, in a working paper, argues that for a certain class of bribes, which possibly for want of a better word he describes as ”harassment bribes,” bribe giving should be a legitimate activity. Such bribes should be directed only toward getting services to which a person is legally entitled at the moment, such as an income tax refund or customs clearance for an exporter’s goods. Basu argues that decriminalizing bribe paying would cause a sharp decline in the incidence of bribery. The reasoning he offers involves game theory, which tries to analyze how players will act in situations where the outcome also depends on the behavior of others. He suggests that once the law is altered in this manner, the interests of the bribe giver and the bribe taker will be at odds—and that will help reduce corruption.

The danger of Basu's recommendation is that it sanctions immoral behavior in the name of business practicality, a kind of moral relativism that opens the door to each country's definition of just what are harassment bribes and each person's and company's interpretation of the rules. More important, it fails to address India's underlying moral malaise that threatens its economic growth and development.  

Blog by Steven Mintz, aka Ethics Sage, May 11, 2011

(Note: Readers may be interested in one of my earlier blogs about the SEC's pending investigation of IBM for paying bribes to government officials in South Korea and China in exchange for millions of dollars in contracts. Link to: http://bit.ly/hnj4vj).

 

Ombudsman Needed to Investigate Abuse and Corruption in U.S. Government

It’s Time to Elevate Societal Interests through an Ombudsman Process

We need to do something in the U.S. before our system of government falls part under the weight of fraud, corruption, waste, mismanagement, and indifference to the public good. I recommend adopting an ombudsman process. The ombudsman has been around for a long time. In 1808, the Swedish Parliament first used the term “Ombudsman” for the office of Justitie-Ombudsman. The office functioned as a defender of the people in their dealings with government. It’s been used in many ways with many purposes since then but I use the term as a trusted person who would function independently of any political or government office with reporting responsibilities only to the President of the U.S., a newly formed internal Congressional Ethics Oversight Office, and the independent judiciary. The ombudsman would seek the blessing of a board of trustees within the newly formed, independent Office of the Ombudsman, to take action based on citizen complaints.

I will return to specific proposals later on but first some examples of how an ombudsman has been used and designated responsibilities are in order. In the United Kingdom, an ombudsman is charged with the handling of concerns about national government and is more formally referred to as the "Parliamentary Commissioner." In some countries an Inspector General may have duties similar to or overlapping with an ombudsman appointed by the legislature. In the U.S., an Inspector General is an investigative official in a civil or military organization such as the Office of Inspector General for the Department of Defense or Army Inspector General.

An Ombudsman should be a designated neutral person who provides confidential assistance for resolving citizen complaints. The ombudsman would be independent of any other organizational investigative process such as the existing Office of Congressional Ethics, an independent, non-partisan entity that is charged with reviewing allegations of misconduct against Members, officers, and staff of the United States House of Representatives and, when appropriate, referring matters to the House Committee on Ethics. This body rarely acts and it’s only after a questionable political process has unfolded. In my view the ombudsman should act as an“Über”-investigator. The German word is usually translated as over, above or meta.

In Singapore, the ombudsman offers whistleblowers an avenue to turn to and assures them of proper investigations. One problem in the U.S. is whistleblowing procedures in existing laws establish cumbersome and time-consuming processes that oftentimes do not led to ethically-justified outcomes and fail to create real reform. A good example is the whistleblowing provision of the 2002 Sarbanes-Oxley Act that provides for the reporting of whistleblowing complaints to OSHA in the U.S. Department of Labor. It considers alleged violations of mail, wire, bank, or securities fraud; violations of rules or regulations of the SEC; or federal laws relating to fraud against shareholders of public companies. OSHA’s role is to investigate whistleblower complaints of retaliation. A study of the success of OSHA in the first three years after the statute's enactment indicated that 491 cases were filed with OSHA; 361 were resolved and OSHA found for employees only 13 times, a win rate of 3.6%. On appeal from 93 OSHA decisions, administrative law judges in the Department of Labor found in favor of 6 employees, a win rate of 6.5%.

The objectives of the ombudsman process in the U.S. should be to investigate allegations made by citizens and citizen groups about:

• Corruption by members of Congress including influence-peddling and bribery
• Corruption in any agency of the U.S. government
• Mismanagement of public resources that borders on gross negligence or fraud such as the massive fraud that currently exists in the Medicare program
• Corruption in the judicial system including accepting bribes and other forms of payments to achieve a desired legal outcome
• Whistleblowing complaints filed under federal laws such as the Dodd-Frank Financial Reform Act and Sarbanes-Oxley

Two areas where the ombudsman process would not replace existing federal investigatory bodies are allegations of bribery under the Foreign Corrupt Practices Act (FCPA) and claims under the federal False Claims Act. In both cases the allegations are investigated by the U.S. Department of Justice (DOJ). The whistleblower lawsuits under the False Claims Act that allows the federal government to recover monies from contractors who have knowingly submitted a false or fraudulent request for government funds have yielded relatively good results given the arduous task of investigation. The latest annual recoveries under the act show continued progress: $3 billion for the fiscal year 2010, $2.4 billion for 2009 and $1.34 billion in 2008. All told, the government recently estimated that it had recovered nearly $29 billion since Congress revised the False Claims Act in 1986. The international governmental nature of the FCPA claims warrants continuation of U.S. Department of Justice adjudication process. The DOJ seems to be initiating actions against offending companies more aggressively. In the first 8 months of 2010, the U.S. Government levied over $1.5 billion in FCPA fines – the most ever in its 33 year history.

I don’t believe an ombudsman should be able to review court decisions or the conduct of organizations such as the Police. This is best left to existing processes. For whistleblowing complaints, an effort should be made to first determine whether the complainant made a good faith effort to resolve the matter internally. Most important, the chosen investigations must address issues of public interest and the integrity of our systems of governance under the Constitutionally-mandated rule of law.

According to the International Ombudsman Institute located in Vienna, Austria (see: http://www.law.ualberta.ca/centres/ioi/), more than 100 countries have ombudsman offices of one kind or another. In the U.S., virtually all federal government agencies have such processes as do an increasing number of municipalities including Portland, Oregon and Anchorage, Alaska. The United States Ombudsman Association is the national organization for public sector ombudsman professionals. Founded in 1977, USOA is North America's oldest national ombudsman association with members from ombudsman offices in local, state, and federal governments, and affiliated ombudsman offices.

The following four Principles should guide the Ombudsman in forming an independent opinion as to whether the act or decision warrants investigation:

• Does the act appear to be contrary to law both in legal form and/or in spirit;
• Was the act or decision unreasonable, unjust, oppressive or improperly discriminatory;
• Did the complainant make a good faith effort to resolve differences including the alleged harmful effects of the act using internal or other legal means (claims under the False Claims Act and FCPA are exclusively reserved for the DOJ)
• Does the act affect more than just one individual’s well-being, but all of society

Opinions should be formed in accordance with the International Ombudsman Association’s (IOA) ethical principles including: (1) Independence; (2) Neutrality and Impartiality; (3) Confidentiality; and (4) Responsible Action in accordance with established Standards of Practice, which are based on specific ethical principles. For more information on the IOA Code of Ethics or Standards of Practice please go to: www.ombudsassociation.org.

There is much to consider before adopting a federal ombudsman process in the U.S. My goal has been to put the idea out in the public forum for debate, inform interested parties about the process, and evaluate how the process can improve governance in our country. I believe we are at a crossroads as a nation. Our systems have failed us for way too long. Corruption is endemic in our political and corporate systems. The pursuit of self-interest has replaced any concern for how it affects society as a whole. We need to seriously consider a major shift in our philosophy as a nation of solely protecting individual rights to protecting individual rights within the broader context of societal good.

  Blog by Steven Mintz, aka Ethics Sage, May 11, 2011

Nothing Normal About AIG's "Normalized" Earnings

AIG's March 31 Quarterly Earnings Misleading Investors

AIG's reported "normalized earnings" for the quarter ending March 31, 2011 is anything but normal. Don't get me wrong. The company takes the same liberties as most others and defines normal however it wants. There are no specific accounting rules on how to determine that amount. In fact, the results can, and do in AIG's case, deviate significantly from what would have been reported under conventional generally accepted accounting principles (GAAP).  The differences are astounding. The reported net income attributable to AIG is $269 million (GAAP) whereas the after-tax operating income (normalized) is $2.030 billion. That is a 647 percent differential. How can that be?

		Three Months Ended March 31,
											% Inc.
			2011				2010				(Dec.)
Net Income Attributable to AIG		$	269			$	1,783				(84.9) %
Income from Discontinued Operations Attributable to AIG, net of tax			1,646				333				394.3
Net Loss on Sale of Divested Businesses, net of tax			(47	)			(76	)			(38.2)
Net Income from Divested Businesses, net of tax			6				484				(98.8)
Deferred Income Tax Valuation allowance (charge) / release			(563	)			821				-
Amortization of FRBNY prepaid commitment fee asset, net of tax			(2,358	)			(415	)			(468.2)
Net Realized Capital Gains (Losses)			(387	)			(229	)			(69.0)
SunAmerica DAC offset related to Net Realized Capital Gains(Losses)			11				3				266.7
Non-qualifying Derivative Hedging Losses , net of tax			(69	)			(107	)			35.5
Bargain Purchase Gain			-				332				-
After-Tax Operating Income Attributable to AIG		$	2,030			$	637				218.7

The numbers above were reported by AIG in its March 31, 2011 Financial Supplement that alerts the reader to read the report in conjunction with AIG's Quarterly Report on Form 10-Q filed with the SEC. The reason is the 10-Q reports the GAAP numbers only. AIG's Financial Supplement shows the reconciliation between GAAP net income and normalized earnings as required by Regulation G.  The numbers were included in a press release sent to analysts in advance of a conference call. The following explains AIG's reasons for normalizing its earnings: "Throughout this press release, AIG presents its operations in the way it believes will be most meaningful and useful… as well as most transparent… to the investing public and others who use AIG’s financial information in evaluating the performance of AIG. That presentation includes the use of certain non-GAAP measures."

Are investors supposed to have faith in the numbers provided by a company that needed a $182 billion bailout from the U.S. government? If that doesn't make you skeptical, read the following additional explanation:

"In light of the company’s significant divestiture and restructuring-related activities, AIG revised its definition of after-tax operating income (loss) (formerly adjusted net income) in the fourth quarter of 2010. AIG revised the definition in order to present and discuss its financial information in a manner most meaningful to financial statement users. AIG’s definition of aftertax operating income (loss) was revised to exclude income (loss) from divested businesses that did not qualify for discontinued operations accounting treatment, amortization of the FRBNYprepaid commitment fee asset, goodwill impairment charges arising from divestiture-related activities, the DAC offset associated with net realized capital gains (losses) for SunAmerica, and deferred income tax valuation allowance charges and releases. AIG believes that this revised measure of after-tax operating income (loss) permits a better assessment and enhanced understanding of the operating performance of its businesses by highlighting the results from ongoing operations and the underlying profitability of its businesses, without the distortive effects of the highly unusual events that have affected AIG since 2008."

So, AIG not only uses a non-GAAP measure to explain its results on a quarterly basis in reports to financial analysts that purportedly are most useful to investors, but the company even changed the way it defines the measurement of after-tax operating income in the fourth quarter of 2010. It even changed the name of the reported statistic from adjusted net income. Not surprisingly, most of the excluded items increased GAAP earnings to higher normalized amount. In fact, the increase from $269 million to $2.0 billion is 647 percent! To make matters worse, it's GAAP income went down 84.9% on a March 31 year-to-year basis.

The concept of transparent financial results implies a level of ethics not present in AIG's reporting. These are not statements of high quality that are clear, easily understood, candid and frank. They mislead investors into thinking AIG has made a remarkable recovery from its financial doldrums. I looked at its Statement of Cash Flows in the 10-Q and the all-important cash flows from continuing operations went from a positive $1.52 billion at 3/31/10 to a negative $6.54 billion at 3/31/11, or a 535 percent decline! 

On a broader scale, AIG's use of normalized earnings highlights a larger problem with accounting standards. We've been down this road too many times and the profession's still fails to clean up its act. Companies like Enron and WorldCom manipulated reported earnings to make it look like the company was doing better than it really was. Other companies routinely put their own spin on the numbers reported to analysts and investors on a quarterly basis. The profession has failed to address this issue; therefore, it is complicit with those companies that use normalized earnings to imply future results. As such, it has failed to live up to its responsibilities to protect the public interest.

  Blog by Steven Mintz, aka Ethics Sage, May 9, 2011

Business Schools Failing to Teach Ethical Leadership

Leaders Are Made Rather Than Born

Today our colleges and universities are failing to instill the skills needed to reverse the trend of the past twenty years whereby U.S. businesses routinely have placed their self-interests ahead of the interests of society. Corporate “leaders” think only in the short-term while ignoring the long-term effects of their actions. The result has been Enron, WorldCom, Fannie Mae and Freddie Mac, Bernie Madoff and a host of unethical actions by self-serving corporations, investment banks and other financial institutions that have caused real pain and destroyed massive amounts of personal wealth. The failure of leadership has become, quite frankly, endemic to our society.

Warren Bennis, who is widely regarded as a pioneer of the contemporary field of Leadership Studies, once said: “The most dangerous leadership myth is that leaders are born -- that there is a genetic factor to leadership. This myth asserts that people simply either have certain charismatic qualities or not. That's nonsense; in fact, the opposite is true. Leaders are made rather than born.”

So what makes for a good leader? It starts with an ability to articulate a vision that others buy into. Then, a series of guiding principles should be developed that encourages people to take action consistent with that vision. Most people want to work for an organization that makes a product that somehow improves one’s life or provides a useful service. A good example is renewable energy sources that promote sustainability. The world has a limited amount of natural resources that are being heavily taxed by rapid economic development in countries such as China and India, two countries that comprise more than one-third of the world population.

What does this have to do with college curricula? Simply this, they are remarkably outdated. Business schools focus too much attention on teaching technical skills and not enough on developing leaders who will act in a responsible, ethical manner. We need to teach the communication, interpersonal, leadership and ethical reasoning skills that are critical to a service-oriented economy such as we have in the U.S. College graduates have to learn to think critically, act decisively, and engage in intercultural communication. Typically, business schools rely on case studies to teach these skills. The problem is a case study does not engage a student on a personal level. Instead, the student is detached from the decision making and oblivious to the virtues that inform responsible decision making.

Students need to be taught to internalize the values that will enable them to act with integrity and take personal responsibility for their actions. Today’s college curriculum doesn’t cut it. What’s needed is a values-based curriculum that integrates ethical decision making with leadership. Ethical leadership is imperative if we are to avoid the kind of financial meltdown of 2008 that created systemic problems of high unemployment and an anemic housing industry, and that has widened the gap between the haves and have-nots – the rich and poor.

One of the best books I’ve read on values-driven leadership is Giving Voice to Values by noted scholar, Mary Gentile. I have previously extolled the virtues of Dr. Gentile’s work (see my blog at:  http://bit.ly/hsmHRe). Mary is the Director of an innovative global curriculum for values-driven leadership development at Babson College and Senior Advisor to The Aspen Institute Business & Society Program. Through their joint efforts and those of other committed academics and professionals, colleges now have the basic tools to teach what was once thought to be unteachable.                                    

I close with another quote from Warren Bennis: “Leaders are people who do the right thing; managers are people who do things right.”   

 Blog by Steven Mintz, aka Ethics Sage, May 7, 2011

Buffet's Failure of Leadership

Corporate Governance Failure of Buffet

Is Warren Buffet throwing former Berkshire Hathaway executive David Sokol under the bus as a human sacrifice? Buffet has been criticized for failing to ask the right questions and act to block the company's acquisition of Lubrizol just weeks after Sokol bought 96,060 Lubrizol shares and told Buffett last January that the company could be a takeover candidate? The Berkshire Hathaway audit committee report absolves Buffet of any blame stating that he didn't realize until March 14, when the $9 billion deal was announced, that Citigroup had brought Lubrizol to Sokol's attention. In my view Buffet exercised poor business judgment and failed to exercise due care in his corporate governance role as CEO.

Here is an excerpt from the Berkshire Hathaway audit committee report that, not surprisingly, places the blame on Sokol:

"The Audit Committee has considered the conduct of David Sokol in connection with his trading in the shares of Lubrizol, and has determined that it violated those standards. In particular his purchases of Lubrizol shares while serving as a representative of Berkshire Hathaway in connection with a possible business combination with Lubrizol violated company policies, including Berkshire Hathaway’s Code of Business Conduct and Ethics and its Insider Trading Policies and Procedures.... His misleadingly incomplete disclosures to Berkshire Hathaway senior management concerning those purchases violated the duty of candor he owed the Company." The audit committee report can be found at: http://www.berkshirehathaway.com/dlsokol/DLSokolReport.pdf.

On April 19, shareholder Mason Kirby sued the company's board, Buffet, and Sokol over alleged unethical behavior in the holding company's $9.7 billion purchase of chemical company Lubrizol Corporation. The complaint claims that "Sokol knew that Buffet would closely consider and likely take his recommendation regarding an acquisition of Lubrizol," noting Sokol's widely reported position at the time as Buffett's most likely successor. After meeting with Sokol in late January, Buffett did in fact take his advice, acquiring Ohio-based Lubrizol for $135 per share in a $9.7 billion cash deal, Kirby alleges. Sokol made $13 million in profit when the value of Lubrizol shares jumped March 14, the day Berkshire pulled the trigger on the deal, the suit says. The suit also claims that Sokol owes shareholders damages and restitution for breaching his fiduciary duty.

Buffet's failure is one of leadership at a time when CEO's should be skeptical and err on the side of caution when a questionable recommendation by a top official might appear to a reasonable observer to be motivated by personal gain. Has he learned nothing from the financial meltdown of 2008? Buffet's own words reflect his failure to act with due diligence and care.  In the past he has been quoted as saying: "In the business world, the rear view mirror is always clearer than the windshield." His rear view mirror should have passed by the financial wreckage about three years ago. Was he asleep at the wheel? Is he not aware of the pursuit of self-interest behavior that has infected the corporate world? Another quote is that, "It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently." Someone with Buffet's experience and presumed sophistication as an investor should have taken his own statement to heart -- walk the talk and order an inquiry of Sokol's disclosure before the company had purchased Lubrizol.  He owed nothing less to the shareholders of Berkshire.

Buffet first defended Sokol's action on March 30 stating that, "neither Dave nor I feel his Lubrizol purchases were in any way unlawful," when he announced Sokol's departure. "He has told me that they were not a factor in his decision to resign." His naiveté is shocking. Buffet failed to inquire further about the timing and extent of Sokol's purchases — a failure constituting a violation of Berkshire corporate policy, according to the lawsuit. Berkshire's insider trading policy restricts trading not only to material nonpublic information relevant to its stock but also to information relevant to other publicly traded companies." The latter includes "securities of other public companies in which Berkshire has invested or may in the future invest," the complaint said, quoting the company's policy.

It's not very encouraging to find out that one of the most respected people in the investment world and spokesperson for ethical corporate governance admits to a mistake only after his actions are questioned in the press and prior to the shareholders meeting last Saturday. He seems to have dodged a bullet at the meeting based on his explanations to shareholders and because of his personal gravitas. However, his unwillingness to act after Sokol's disclosure reflects a troubling pattern that has been repeated by many top company (and government) officials over the years. While Buffet may not have violated any law and may be able to hide behind Sokol's lack of full disclosure, it doesn't lessen his ethical culpability.

 Blog by Steven Mintz, aka Ethics Sage, May 5, 2011

City of Montebello Accused of Misusing HUD Funds

Responsibilities of City Government and Auditor Shortcomings

Is Montebello the second coming of the City of Bell? Last year we learned about former City of Bell administrator, Robert Rizzo, who was accused of stealing from the treasury while paying himself a salary well in excess of $800,000. Los Angeles County District Attorney Steve Cooley filed charges against eight current and former Bell officials last September alleging that they misappropriated $5.5 million in public funds. Rizzo is charged with 50 counts of fraud, including 44 counts of misappropriation of public funds, six counts of falsification of records by an official custodian, three counts of conflict of interest and one count of public officer crime.

Now we have the City of Montebello where the U.S. Department of Housing and Urban Development (HUD) is looking for possible criminal activity regarding the city's use of federal grant money in its HUD HOME program. In 2010, HUD demanded that Montebello repay $1.3 million because the city gave a developer HOME money to help build a housing project with affordable units and reported to the federal agency the project was complete, but construction had not started. The city is currently dealing with the suspension of funding by federal housing officials and the demand for repayment of a total of $5 million in grants.

According to a story written by two L.A. Times reporters on April 28, Abby Sewell and Jessica Garrison, departing city administrator Peter Cosentini said in a memo to City Council members that some of the city's past handling of HUD funds "may border on criminal." Whittier Daily News staff writer Bethania Palma Markus quoted James Todak, special agent in charge of HUD's Office of Inspector General, as saying,  "We're looking at it, and if there's criminal activity we'll work with the U.S. Attorney's Office and prosecute." HUD officials declined to describe Montebello's 31 violations but said they will outline them in a report that will be released later in the month.

The city is also facing several other probes by outside investigators. State Controller John Chiang last week announced his office will audit Montebello's books, citing concerns over delinquent financial reporting, use of restricted funds to cover operating costs and the discovery of two off-the-books bank accounts. It’s the first such audit since Chiang investigated the city of Bell last year and found massive misconduct.

The ethical issue in the Montebello situation is one of accountability. The City Finance Department prepares a Comprehensive Annual Financial Report (CAFR) that includes an independent auditor's report. The CAFR for the fiscal year ended June 30, 2010, includes a letter to the Mayor and City Council signed by Interim City Administrator Peter Cosentini that identifies the city's responsibility for the accuracy, completeness and fairness of the financial statement presentations. The letter clearly states the information is accurate and all disclosures are adequate "to the best of our knowledge." The audit report prepared by the independent firm of Eadie & Payne provides a clean opinion with respect to the City's financial statements.

It is interesting to note that the audit report is dated April 7, 2011, more than nine months after the fiscal year end of June 30, 2010. This time lapse between the date of the statements and issuance of the report is much longer than usual but probably can be explained by the ongoing HUD investigation. The financial statements include a footnote to the statements (# 17: Subsequent Events) that point to a December 22, 2010 notification by HUD that during its review of the City's books and records it discovered that:

"[T]the City could not provide sufficient documentation with respect to a $1,300,000 HOME expenditure. The City was ordered to repay HUD $1,300,000. The City has demanded payment from the developer who failed to provide the City the proper documentation to support the expenditure and has recorded a $1,300,000 receivable in its Capital Projects Fund. On February 18, 2011, the City was notified by HUD during its review of acquisition and related costs of property located at 124 South Sixth Street, Montebello, CA, that the City could not provide documentation and support regarding the City's acquisition of the property. The City was ordered to repay HUD $889,106. The City is currently negotiating a payment plan with respect to the above amounts due. The City has reflected these amounts due as notes payable - due within one year in the Statement of Net Assets - governmental activities."

Eadie & Payne's audit report does not mention the HUD investigation or payments already ordered with negotiated payments in the works. It also does not mention the city's failure to provide documentary support for the $1.3 million expenditure under the HOME program and its demand to be repaid that amount by the developer. Eadie & Payne may not have, in fact, violated generally accepted auditing standards because the financial statements include the appropriate footnote disclosure. However, I believe the firm failed in its ethical obligation to protect the public interest by not inserting a separate paragraph in its audit report about the HUD matter. The city already is reeling from a $1.6-million deficit this year, on top of $16.8 million that the general fund owes the city redevelopment agency as part of a highly unusual loan the council authorized last fall. How much longer can it be before the city of Montebello goes bankrupt as did the city Bell? The fact is Montebello's problems jeopardize its ability to continue to operate without outside intervention by the state and that should have been addressed by the auditors.

 Blog by Steven Mintz, aka Ethics Sage, May 4, 2011

Regulating the Derivatives Market

Financial Regulatory Morass: Delay in Dodd-Frank and Excluding Derivatives

The Treasury Department has proposed excluding certain foreign-exchange instruments from new rules on derivatives trading that were included in the Dodd-Frank Wall Street Reform and Consumer Protection Act that was signed into law by President Obama on July 21, 2010. Not surprisingly, business groups support the proposal. Tim Ryan, president and chief executive of the Securities Industry and Financial Markets Association, is quoted in the Wall Street Journal as saying, the Treasury's proposal to exempt these products "goes far in ensuring these markets will remain vital tools for business." The claim is foreign exchange derivatives are necessary for businesses and hedge fund managers to protect against currency fluctuations. Let's assume this is true, but why should they escape regulation? Traders can manipulate foreign exchange markets just as they have done with oil prices and other commodities.

It's hard to believe the Treasury is going to fall for the same line as when businesses fought tooth and nail to end the Glass-Steagall Act of 1933 that built a wall between commercial and investment banking services. The result of lobbying efforts was the passage of the Gramm-Leach Bliley Act, also known as the Financial Services Modernization Act of 1999 that repealed Glass-Steagall. It opened up the market for mergers between banking, securities and insurance companies giving us the mega-conglomerate Citigroup. The rationalization of economies of scale turned into a blank check from Congress to engage in unregulated action that caused the destruction of so much financial wealth and created economic misery for so many.

Perhaps a history lesson is in order. The Dodd-Frank Financial Reform Act calls for the adoption of the appropriate mechanisms to regulate derivatives. It's up to the SEC and CFTC to determine the scope and enforcement mechanisms to implement the law. The SEC has proposed some implementation measures but none have been adopted as yet.  We are in the public reaction phase of the process and Congress is concerned about the slow path of adoptive regulations. Moreover, it is necessary to harmonize potential   CFTC and SEC regulations implementing the derivatives provisions of Dodd-Frank with foreign regulatory counterparts to reduce systemic risk in our increasingly interconnected global marketplace.

CFTC Commissioner Jill Sommers has recently expressed her fears that differences with European Union draft legislation regulating derivatives are growing. The Commissioner is concerned that the CFTC is out of step with regard to timing and substance with both the SEC and non-US regulators. The CFTC is aware of the importance of establishing an appropriate regulatory framework for the cross-border swaps activities of foreign banks.

We need to adopt regulations for derivatives in the U.S. sooner rather than later and coordinate with global markets. Back in 2008, the Bank of International Settlements reported that the derivatives market is $683.7 trillion dollars. Let's put this into perspective. The gross national product (GNP) of the United States for 2008 as reported by the World Bank was 14.3 trillion dollars. The GNP of the world was reported by the World Bank at 69.3 trillion dollars meaning the global derivatives market is about 10 times the world GNP. What's wrong with this picture?

Are we to assume the derivatives traders have learned their lesson from the financial meltdown of 2008 and now, all of a sudden, will self-regulate and operate in an ethical manner? History proves otherwise. I fear we will be headed for another financial collapse within the next few years if the derivatives market remains unregulated and uncoordinated on a global basis. The fact is even with a regulatory regime in place there still will be unethical behavior by all too many because of the greed is good and pursuit of self-interests mentality that has infected business on a global scale.

Blog by Steven Mintz, aka Ethics Sage, May 3, 2011

Cartoon reproduced with permission

Are Businesses Over-Regulated or Is It Necessary to Protect the Public Good?

The Conundrum of Promoting Free Markets and Unethical Behavior

One of the core values in the mission statement of the Tea Party is to promote a free markest by reigning in government interference in the form of excessive regulation that limits individual and economic liberty. On February 9, 2001, the U.S. House of Representatives Committee on Oversight and Government Reform issued a preliminary report, Assessing Regulator Impediments to Job Creation. The report is based on almost 2,000 pages of letters from business groups that say government red tape is deeply harming the competitiveness of American industry and contributing to unemployment, especially in the manufacturing sector. The full report can be found at: http://www.scribd.com/doc/48523377/Assessing-Regulatory-Impediments-to-Job-Creation-Issa-Report-February-2011. The report comes as President Obama has vowed to eliminate unnecessary regulations, ordering a broad review of current government rules “to remove outdated regulations that stifle job creation and make our economy less competitive.”

Issa’s report cites an estimate from the National Association of Manufacturers that “structural costs imposed on U.S. manufacturers including regulation create a 17.6 percent cost disadvantage when compared with nine major industrialized countries.” The issue of cost disadvantage is important because Obama has made “winning the future” by making American business more competitive with foreign industries a top priority.

The issue of whether U.S. business are overly-regulated begs the question of why such regulation is needed in the first place. Our free market economic system depends on the exercise of ethical behavior by corporate officials to provide for the public good. Absent decision making based on ethical values such as honesty, integrity, and transparency, the system cannot be trusted to allocate resources in the best interests of society. The root cause of such problems is the pursuit of self-interests to the exclusion of all others. The financial crisis of 2008 was triggered by predatory lending practices and risk-shifting behavior that all but tossed aside the notion that banks and financial instituions have an ethical obligation to those who borrow money. Banks have an ethical obligation to be honest and candid about the inherent risks to borrowers of certain mortgage (subprime) loans and to fully disclose hedges against future nonpayment made by the holder of the mortgage through the purchase of credit default swaps.

It is important to remember that Adam Smith connected ethics to economics. Smith came to his philosophy of economic behavior described in The Wealth of Nations through his view of moral behavior espoused in his first book, The Theory of Moral Sentiments. Smith, who is generally regarded to be the founder of free market economics, posited that rational self-interest informed by moral judgments based on fairness and justice would lead to promoting the best interests of society guided by the invisible hand of the marketplace.

The self-serving and unethical conduct by commercial and investments banks led to passage of the Dodd-Frank Financial Reform Act by Congress that extends the regulatory arm of the government to areas including consumer protection, systemic risk oversight, executive compensation, and capital requirements. It is estimated that the act mandates nearly 250 regulations and 70 studies.

The Sarbanes-Oxley Act of 2002 was passed by Congress in response to a large number of business and accounting frauds at companies such as Enron and WorldCom that cost taxpayers billions and shredded 401-K and other retirement investment accounts. The Act added another layer of oversight of the accounting profession -- the Public Company Accounting Overight Board -- and imposed onerous internal control assessment costs that many credit with the flight of foreign companies from the U.S. stock market.

The Foreign Corrupt Practices Act of 1977 was passed after the disclosure of widescale bribery of foreign government officials by U.S. multinationals to gain business abroad. The antibribery act imposes disclsoure and internal recordkeeping requirements on U.S. businesses doing business outside the U.S.

Businesses claim these and other regulations impose excessive compliance costs that mitigate against job creation and economic growth. That may be true and it is unfortunate but corporate America has no one to blame other than themselves for decades-long self-serving behavior born out of greed with no accountability to shareholders who are ultimtaely harmed by such behaior and the public that has helplessly stood by and watched the enormous loss of wealth in our society. 

 Blog by Steven Mintz, aka Ethics Sage, May 2, 2011