Ethics Sage

ACLU Sues the State of California for Failing to Teach 20,000 Students English

Who is at Fault for Students’ Failure to Learn English in California Schools?

I was surprised to learn on April 25, that the American Civil Liberties Union (ACLU) filed a lawsuit against the State of California for failing to correctly teach the English language. The lawsuit was filed by the ACLU on behalf of 20,000 students. The lawsuit is seeking a court order to ensure that students receive the courses they need to learn English, as many have been given low grades and are frequently being held back due to a language barrier.

Earlier this year, state officials said 98% of the state's 1.4 million English learners were receiving services. The number of students in the "2012 Cohort Graduation and Dropout Rates" is staggering.

 

 

State Department of Education statistics show 23.7 percent of English learners in the class of 2012 dropped out between 9th and 12th grade. State Department of Education statistics show 23.7 percent of English learners in the class of 2012 dropped out between 9th and 12th grade.

ACLU attorney Mark Rosenbaum said: “These kids are not getting the differentiated learning they’re supposed to be getting. English learners are falling behind without proper language lessons, even as school districts collect federal funds specifically for that purpose. Under state and federal law, schools are required to teach non-English speakers the language, but by its own records, the state isn’t offering English instruction to nearly 20,000 students.”

The suit, filed in Los Angeles County Superior Court, accuses state education leaders of violating section 300 of the California Education Code, which states, in part, “The government and the public schools of California have a moral obligation and a constitutional duty to provide all of California’s children, regardless of their ethnicity or national origins, with the skills necessary to become productive members of our society, and of these skills, literacy in the English language is among the most important.”

Advocates of the lawsuits base their conclusions on information that school districts report to the state Department of Education. About 250 districts acknowledge they are providing no services or inappropriate language help to these students. One example is that of F.S., a student in the Compton Unified School District who was allegedly denied language help in third grade, failed most of his classes, and ultimately was retained. The next year, the same student, in the same school system, received help and showed sufficient progress in his classes to move on with his education.

Although federal and state funds are set aside to help English learners, the best approach has long been a topic of contention. It's more common for English-speaking teachers to receive training in how to make their lessons more accessible. And students can also receive support in classes taught in English.

For their part, state officials insist they are meeting their legal obligations and not shirking their responsibilities. The education department is "determined to ensure that all English-learner students receive appropriate instruction and services," said Chief Deputy Supt. of Public Instruction Richard Zeiger.

"When questions arose," he added, the department "asked local educational agencies to provide additional information regarding the services they are required to provide." Zeiger also urged parents with specific issues to contact the department though its established complaint process.

It seems to me the education department is being reactive rather than proactive. The department waits for a problem or complaint to occur and then responds to the matter. This is different from making sure the English language instruction and use of technology for English language students is provided on a timely basis. If those with inadequate English language skills don't learn them before going to college, there is no doubt they will suffer throughout their college education. I have seen it first hand as a college professor.

The sad part for California is that its education budget has been cut for about five straight years. California’s K-12 public schools have been cut by over $18 Billion, or roughly $3,051 per student during the 2009-2012 periods. Over 30,000 educators and 10,000 other school employees have lost their jobs during that same time. Class sizes are increasing; music, art and sports programs being eliminated; and computer labs, libraries and schools are being shut down.

According to a study Winners and Losers: Corrections and Higher Education in California, since 1980, higher education spending has decreased by 13 percent in inflation adjusted dollars, whereas spending on California's prisons and associated correctional programs has skyrocketed by 436 percent. The state now shells out more money from its general fund for the prison system than the higher education system.

These statistics are alarming. Unfortunately, they are likely to get worse before they get better. The causes of the problem are many, and that is a subject for another blog. If I can identify one factor that leads to the lagging English language skills and burgeoning prison population it is the breakdown in the family unit. All too many kids grow up in one-parent families with the result that responsibility and accountability are not adequately taught. All too many parents do not spend the time to teach their kids -- not only learning and technical skills but a work ethic.

Nothing will change in California until parents, guardians, and the kids themselves start to focus on learning, working hard, bettering themselves, and contributing to society. As for parents, what ever happened to the mantra of generations that we want our kids to have a better life than we had growing up?

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

Threats to Independence Raise Ethical Questions for the Big-Four CPA Firms

KPMG Faces Conflict of Interest Charges in Audit of JobsOhio

KPMG is at it again. In the most recent allegation of violating independence standards of the accounting profession, KPMG’s Columbus, Ohio office was auditing JobsOhio’s books while, at the same time, an out-of-state office of the firm was seeking $1 million in taxpayer money from JobsOhio for an unnamed client. As the state’s lead economic-development agency, JobsOhio is charged with recommending financial incentives for companies seeking to relocate in the state. On November 5, 2012, about the time that the audit was being conducted, KPMG was also listed on a sheet of eight pending grant commitments from the state for fiscal year 2013, one of which was for the unnamed client.

I will return to this case later on, but first a review of the recent insider trading charges against the firm. I have previously written about about insider trading at KPMG. In that case, KPMG resigned two audit accounts and withdrew its blessing on the financial statements of Herbalife for the past three years and of Skechers for the past two. KPMG withdrew its audit opinions, a serious step for any auditor, after concluding it was not independent because of alleged insider trading.

The KPMG insider trading case is a particularly egregious one because it involves an auditor tipping off a friend about stock of audit clients. Scott London, the KPMG auditor, did not trade in the stock himself but he did gain personal wealth (“unjust enrichment”) when his friend, Brian Shaw, used the inside information to trade in stock of Herbalife Ltd. and Skechers USA Inc. Shaw benefitted by $1.27 million on the trades. Shaw paid London $50,000 cash and gave him a Rolex watch.

Looking at the JobsOhio case, as KPMG was auditing JobsOhio's books in the fall of 2012 the firm also was seeking $1 million in taxpayer money from JobsOhio for an unnamed client. JobsOhio, the state's privatized development agency, said that the grant request was handled separately from and without the knowledge of the firm's auditing division.

The ethical problem for KPMG in the JobsOhio case is independence in appearance. This is an important requirement of an independent audit because factual independence is sometimes difficult to determine. Factual independence goes to the mindset of the auditor in approaching an audit with objectivity and professional skepticism. It is difficult to assess so appearances serve as a proxy in that regard.

JobsOhio denies any conflict of interest. Laura Jones, a spokeswoman for JobsOhio, said KPMG LLP's Columbus office conducted the audit, but the grant was sought by an out-of-state office. "The fact that KPMG serves JobsOhio and countless other businesses ... from the same office here in Columbus is not a conflict in our minds," she said, adding that “the state also monitors and ultimately approves taxpayer-funded incentives to companies.”

Most observers would probably conclude that the two offices of KPMG would never collude on their own to achieve some benefit for the firm. However, the more troubling issue is whether JobsOhio might perceive some pressure on them to provide financial incentives to the KPMG audit client perhaps to make it less likely that KPMG would point out problems with the JobsOhio audit, assuming any occur.

The accounting profession has strict independence standards to protect the public interest. Shareholders, creditors, and the beneficiaries of public funds rely on the honesty, trustworthiness, and responsibility of auditors to go the extra mile to ensure that the financial statements of entities that operate in the public interest are based on an independent audit – both in fact and in appearance.

KPMG is not alone in violating the most basic and cherished independence standards. As I have previously blogged, in 2010 Deloitte and Touche was investigated by the SEC for repeated insider trading by Thomas P. Flanagan, a former management advisory partner and a Vice Chairman at Deloitte. Flanagan traded in the securities of multiple Deloitte clients on the basis of inside information that he learned through his duties at the firm. The inside information concerned market moving events such as earnings results, revisions to earnings guidance, sales figures and cost cutting, and an acquisition. Flanagan’s illegal trading resulted in profits of more than $430,000. In the SEC action, Flanagan was sentenced to 21 months in prison after he pleaded guilty to securities fraud.

On January 7, 2013, the SEC announced it is investigating whether Ernst & Young violated independence rules by letting its lobbying unit perform work for several major audit clients. The SEC inquiry began shortly after Reuters reported in March 2012 that Washington Council Ernst & Young, the E&Y unit, was registered as a lobbyist for several corporate audit clients including Amgen, CVS Caremark, and Verizon Communications.

The problem for EY is that U.S. independence rules bar auditors from serving in an "advocacy role" for audit clients. The goal is to allow auditors to maintain some degree of objectivity regarding the companies they audit, based on the idea that auditors are watchdogs for investors and should not be promoting management's interests.

Finally, in December 2012, Thomson Reuters announced it signed a three-year contract with PwC, the company’s auditor, to provide use of the Thomson Reuters ONESOURCE Corporate Tax solution for China. PwC U.K. also uses this Thomson Reuters software for its tax clients. Business alliances between a company and its auditor are prohibited under U.S. and U.K. auditor regulations. Once again an independence violation exists because such arrangements create a “mutuality of interests” as a result of the business relationship between the auditor and audit client.

I am very concerned about the actions of KPMG in the JobsOhio case, Deloitte & Touche and KPMG insider trading scandals, EY serving as an advocate for an audit client, and PwC in becoming involved in a joint business relationship with an audit client. These relationships create threats to independence and taint the audit because of conflicts of interest.

The SEC needs to look into these matters, not just individually but collectively, and determine whether the Big-4 CPA firms have built adequate safeguards to protect audit independence and whether more stringent independence and ethics standards are needed to protect the public trust in the independent audit.

Blog posted by Steven Mintz, aka Ethics Sage, on May 7, 2013

KPMG Insider Trading Scandal Damaging to the Reputation of the Accounting Profession

What Possesses an Audit Partner to Trade on Insider Information?

KPMG is embroiled in an insider trading scandal that concerns me because a pattern of such improprieties may be developing. In 2010, Deloitte and Touche was investigated by the SEC for repeated insider trading by Thomas P. Flanagan, a former management advisory partner and a Vice Chairman at Deloitte. Flanagan traded in the securities of multiple Deloitte clients on the basis of inside information that he learned through his duties at the firm. The inside information concerned market moving events such as earnings results, revisions to earnings guidance, sales figures and cost cutting, and an acquisition. Flanagan’s illegal trading resulted in profits of more than $430,000. In the SEC action, Flanagan was sentenced to 21 months in prison after he pleaded guilty to securities fraud. Flanagan also tipped his son, Patrick, to certain of this material non-public information. Patrick then traded based on that information. His illegal trading resulted in profits of more than $57,000.

The KPMG case is a particularly egregious one because it involves insider trading by an auditor of client stock. Scott London, the partner in charge of audits of Herbalife Ltd. and Skechers USA Inc., traded on inside information for personal gain.  KPMG resigned as the auditor of both companies after learning that London provided non-public information about the companies to a third party, who then used the information in stock trades. The firm fired London.  

In resigning the two audit accounts, KPMG said it was withdrawing its blessing on the financial statements of Herbalife for the past three years and of Skechers for the past two. KPMG stressed, however, that it had no reason to believe there were any errors in the companies' books. Both companies said they are moving to find new auditors.

In a statement that should raise red flags for all CPA firms that audit public companies, KPMG stated it had concluded it was not independent because of alleged insider trading. Independence is the foundation of the accounting profession and the cornerstone of an audit conducted in accordance with generally accepted auditing standards. The public (i.e., shareholders and creditors) relies on auditors’ independence, objectivity, and integrity to ensure that the audit has been conducted in accordance with such standards and that the financial statements are free of material misstatements.

I’m having a hard time understanding the stupidity and moral blindness of London in this case. Surely he knew of his ethical obligations. All audit firms supposedly have been carefully assessing independence in the aftermath of financial frauds in the late 1990s and early 2000s (i.e., Enron and WorldCom). Firms generally have quality controls in place to prevent compromises to audit independence.

Trading on insider information for cash and gifts is bad enough, and when done by an audit partner it is unforgiveable. Even more baffling to me is that the quid pro quo for passing along stock tips about clients to a friend for London was to receive cash and gifts in return. According to London, he received a discount on a watch, and the friend bought him dinners from time to time and on a couple of occasions gave him $1,000 to $2,000 in cash. A cynic might say he sold himself cheap.

So, what happens next? Both Herbalife and Skechers will need to have their financial statements re-audited, not an inexpensive proposition. Even though the companies were not at fault, the public may misunderstand and think the companies were complicit in the matter.

For KPMG, the insider trading investigation is a setback. The accounting firm has worked hard to rehabilitate its reputation after coming under scrutiny last decade in a wave of corporate accounting scandals and the firm’s role in the marketing of fraudulent tax shelters. KPMG paid large nine-figure settlements to resolve lawsuits related to accounting scandals at the drugstore chain Rite-Aid and Oxford Health Plans. In 2005, the firm paid a $456 million penalty to the government related to tax fraud.

I have to wonder whether insider trading by partners at Deloitte and KPMG portends a larger scandal on the horizon. It seems every ten years or so the accounting profession finds itself in a “pickle” and hauled before Congress to explain its actions. It is about that time following financial frauds at Enron, WorldCom and a host of other companies. I don’t know how to get the message across to those in the profession that every time such incidents occur, and now insider trading, the public loses patience with the profession and doubts begin to surface about whether the profession truly acts to protect the public interest.

Blog Posted by Steven Mintz, aka Ethics Sage, on April 12, 2013

The Ethics of Profit Repatriation by U.S. Multinationals

U.S. Companies Using Short-Term Loans to Avoid Taxes on Repatriated Cash

I have previously blogged about the use of transfer pricing techniques by U.S. companies to shift profits away from the U.S., which has the highest corporate tax rate (about 40%), to countries with lower tax rates such as Ireland (12.5%). As long as profits made overseas are not repatriated back to the U.S., those overseas profits remain untaxed by the IRS. Critics claim that a much lower tax rate (say, 15-20%) would encourage U.S. companies to bring the profits home in the form of investments and spur economic development and job growth.

Other countries have come to realize their corporate tax rates are too high. For example, Germany has reduced its rate from a high of 45% in 2008 to 15% today. The UK has gradually lowered its rate from 52% in 1981 to a projected 20% in 2015.

Repatriation is more than an economic issue; it has ethical overtones. It also highlights a practice used by some U.S. companies to skirt the repatriation law by taking the “trapped” overseas cash and providing loans to their U.S. parent companies. Under U.S. tax rules, a foreign subsidiary can lend funds to its parent without jeopardizing its untaxed status. Here is how it works:

• The loans have to be short term and can remain outstanding throughout a fiscal quarter as long as they don't cross beyond its end. If they do cross a quarter, they can remain outstanding for a total of 30 days. And that can be done for 60 days a year by any one foreign unit.
• If the borrowing is carefully set up to comply with IRS rules and U.S. auditing standards, the funds can be used over and over without incurring taxes.
• Companies are not required to disclose these moves, which makes it difficult to assess how many use them.

According to the Wall Street Journal, Hewlett-Packard (H-P) entities lent the parent about $6 billion in the year that ended in October 2010. For the 2011 fiscal year and through July 2012, the average outstanding balance of the alternating loans was $1.6 billion.

The sums rivaled H-P's borrowings in the commercial-paper market—the traditional source of big firms' day-to-day funds. Those averaged $1.9 billion over the 2011-2012 period.

More details of H-P's transactions have emerged since a 2012 hearing conducted by the U.S. Senate. The company said it told the Senate panel it used the alternating loans for all but 85 days of the 2011 and 2012 fiscal years. In a 2008 internal presentation, H-P called the loans "the most important source of U.S. liquidity for repurchases and acquisitions."

H-P spokesman Michael Thacker says H-P has "complied fully with all applicable provisions of the U.S. Internal Revenue Code, and auditor Ernst & Young has consistently reviewed and approved the accuracy of H-P's financials." The IRS has never raised concerns about the loan programs, he adds.

American concerns have long argued they should be allowed to bring back some of the estimated $1.7 trillion in profits they hold at their foreign subsidiaries, saying the money could be put to use in the U.S. The firms claim to be deterred by the huge tax liabilities they would incur under current IRS tax rates.

The U.S. is the only major economy that taxes its companies' overseas earnings. Those taxes aren't actually incurred until the money is considered to have been transferred to the U.S. parent, giving companies an incentive to maximize their earnings at foreign subsidiaries and keep them there indefinitely.

People on both sides of the debate argue the system doesn't work, creating perverse incentives that distort companies' balance sheets and deprive the U.S. Treasury of tax revenue. The short-term loans to avoid repatriation and taxes is the main example of the practice.

During the last Presidential election, business interests called for a “tax holiday,” in which American corporations would be allowed to transfer their foreign profits to their American bank accounts at a tax rate under 6 percent for one year. Such a holiday would raise revenues and create jobs in the U.S., according to the WinAmerica Campaign, a coalition of companies including Apple, Google and Pfizer.  

But the last time such a holiday was tried, in 2004, it raised less than $19 billion and did not substantially increase jobs. Most of the repatriated profits went to corporate shareholders, through dividends or stock repurchases.

Instead of a one-off holiday, some corporations — Caterpillar and Kimberly Clark, for example — have called for a permanent fix: a territorial system for taxing foreign corporate profits, as most industrialized countries use. In a pure territorial system, the profits of multinational companies based in the U.S. would be taxed only by the country in which the profit is earned.

But none of our major trading partners takes a pure territorial approach, for two good reasons. First, almost all countries impose domestic taxes on “mobile” corporate income — for example, investment interest or royalties that can easily be shifted from one country to another. Second, many countries still collect taxes on foreign profits of domestic corporations if those profits are earned in tax havens that collect little or no taxes, like Bermuda and the Cayman Islands. These havens violate the premise of the territorial system, which is that corporate profits are taxed somewhere in the world at a reasonable rate.

The ethical issue I raise is: Does a U.S. corporation have an ethical obligation to repatriate profits to the U.S. to pay their “fair share” of taxes and help to stimulate the economy in an increasingly competitive global economic marketplace?  The answer is not a simple one because we could argue about the ethics of having the highest tax rate in the world. We could also argue and debate whether the government uses its tax revenue in an ethical or socially-desirable manner to employee the unemployed, give opportunity to those wanting to improve their economic lot, and help stimulate our economy.

For me, it is time to lower the corporate tax rate to be more competitive with other countries and challenge U.S. companies on their claim to repatriate profits with a lower rate. Without debating how low is low enough to achieve the desired goal, we need to try harder to improve the economic status and wealth of the middle and lower-classes and repatriation with taxation is one way the goal might be accomplished. At least it is worth a try. If corporations do not repatriate with lower taxes but still find ways around their obligation, then they will be exposed for all to see the hypocrisy of their position.

Blog Posted by Steven Mintz, aka Ethics Sage, on April 1, 2013

IRS "Dirty Dozen" Tax Scams

Tax Scams and Scammers Cheat All of Us

The IRS issued it “Dirty Dozen list of tax scams" Tuesday, highlighting fraudulent schemes commonly committed by and upon taxpayers. The annual warning, released to coincide with tax filing season, emphasizes the most egregious schemes involving filing false returns or return items, but it also advises the unsuspecting about practices that prey upon the unwary and uninformed.

As you read thought the 2013 list, think about all the scams and scammers and how they cheat all of us who pay the correct amount of our taxes due and, while we may not agree with the way the government uses our tax dollars, we do see paying taxes as a civic responsibility.

1. Identity theft: The IRS spotlighted its measures, including its new Identity Protection we portal, to prevent and combat the growing problem of tax fraud involving stolen identities, which it called one of its top priorities. During 2012, the IRS prevented issuance of $20 billion in fraudulent refunds including those related to identity theft, up from $14 billion in 2011, it said. The IRS also noted that its identity theft enforcement sweep in January led to nearly 300 indictments, complaints, and arrests, on top of thousands of enforcement actions against identity theft tax fraud in 2012.

2. Phishing: The IRS again this year warned against fake electronic communications designed to obtain recipients’ information, reminding that the IRS does not initiate contact with taxpayers by email, text messages, or social media to request personal or financial information.

3. Return preparer fraud: In addition to suggesting taxpayers make sure paid preparers sign returns and enter their preparer tax identification number (PTIN), the IRS this year included information about using Form 14157, Complaint: Tax Return Preparer, to report abusive tax preparers.

4. Hiding income offshore: This warning also updated the number of participants in the IRS’s Offshore Voluntary Disclosure Program to 38,000 and its collections to $3.4 billion from the 2009 program alone (March 23, 2009, through Oct. 15, 2009) and $1 billion so far in “up-front” payments from the 2011 program (Oct. 16, 2009, through Sept. 9, 2011). In 2012, the program was extended indefinitely.

5. “Free money” from the IRS and tax scams involving Social Security: With fliers and advertisements “appearing in community churches around the country,” promoters of schemes promising refunds for returns with little or no documentation have enticed “unsuspecting and well-intentioned” victims, some of whom have spread the word to friends and relatives, the IRS said. One scheme falsely advises taxpayers to claim the American opportunity tax credit even if they have no current qualifying educational expenses.

6. Impersonation of charitable organizations: Some fraudsters have doubly victimized people hit by a natural disaster by claiming to be working on behalf of the IRS to help them claim a tax casualty loss but instead steal their financial and personal information. This replaced “abuse of charitable organizations and deductions” from the 2012 list.

7. False/inflated income and expenses: Exaggerating wage or self-employment income is a common ploy by some unscrupulous preparers to inflate refundable credits, including the earned income tax credit, by more than any additional tax.

8. False Form 1099 refund claims: One scheme involves issuing a bogus information return, often Form 1099-OID, Original Issue Discount, to the IRS. A refund is then claimed on a corresponding tax return. The IRS says this is based on the theory that “the federal government maintains secret accounts for U.S. citizens and that taxpayers can gain access to the accounts by issuing 1099-OID forms to the IRS.”

9. Frivolous arguments: The IRS maintains a webpage describing some of the more common and legally fanciful of these theories.

10. Falsely claiming zero wages: A Form 4852, Substitute Form W-2, or “corrected” Form 1099-MISC, Miscellaneous Income, is fraudulently filed to reduce or eliminate income on a legitimate information return. Sometimes it is accompanied by a frivolous argument regarding the income.

11. Disguised corporate ownership: The IRS said it works with state authorities to identify entities by which taxpayers underreport income, claim bogus deductions, and engage in other misconduct.

12. Misuse of trusts: The IRS said it has seen an increase in improper use of private annuity trusts and foreign trusts to shift income and deduct personal expenses.

As frequent readers of my blog know, I like to use famous quotes to make a point.

James Madison, the "Father of the Constitution," "Father of the Bill of Rights," 4th President of the U.S. stated the purpose of income taxation:

"The power of taxing people and their property is essential to the very existence of government.''   

A poignant statement that expresses a philosophy held by some today (whether you agree with it or not) dates back to 400 B.C. and was expressed by Plato, the Greek philosopher:

“Where there is an income tax, the just man will pay more and the unjust less on the same amount of income.” 

I leave you with a quote from Ben Franklin: “…but in the world nothing can be said to be certain except death and taxes."

Blog posted by Steven Mintz, aka Ethics Sage, on March 29, 2013

Entitlement Ethics

Making Sense of our Entitlement Society

The one issue that divides us as a nation more than any other is “entitlement ethics.” Entitlement theory comes from the Theory of Justice. Here, I discuss the theory as espoused by two philosophers – John Rawls and Robert Nozick – and evaluate it against the Moral Theory of Rights put forth by Immanuel Kant. The issue of whom in society is entitled to the resources produced by others and how much of it lies at the foundation of the divide. An important point is there is no one right or wrong point of view. More important, there are practical limitations on those resources that must be considered in making the arguments.

Theory of Justice: Just Distribution of Resources

Rawls argues that the state should have whatever powers are necessary to ensure that those citizens who are least well-off are as well-off as they can be (though these powers must be consistent with a variety of basic rights and freedoms). This viewpoint is derived from Rawls’s theory of justice, one principle of which is that an unequal distribution of wealth and income is acceptable only if those at the bottom are better off than they would be under any other distribution. Hence we have the viewpoint to tax the rich and transfer resources to the least well off amongst us. This view of Justice Theory would justify the reallocation of resources in society.

Entitlement Theory of Justice

Nozick, on the other hand, responds to such arguments by claiming that they rest on a false conception of distributive justice: they wrongly define a just distribution in terms of the pattern it exhibits at a given time (e.g., an equal distribution or a distribution that is unequal to a certain extent) or in terms of the historical circumstances surrounding its development (e.g., those
who worked the hardest have more) rather than in terms of the nature of the transactions through which the distribution came about. For Nozick, any distribution of “holdings,” as he calls them, no matter how unequal, is just if (and only if) it arises from a just distribution through legitimate means.

One legitimate means is the appropriation of something that is unowned in circumstances where the acquisition would not disadvantage others (i.e., taxing the rich at, say, 50% would not disadvantage them – a popular notion espoused by the liberal point of view). A second means is the voluntary transfer of ownership of holdings to someone else (i.e., the Warren Buffett’s of the world
choose voluntarily to share their wealth with others less fortunate). A third means is the rectification of past injustices in the acquisition or transfer of holdings (i.e., those harmed by wrongful acts in the past deserve an increased distribution of resources). According to Nozick, anyone who acquired what he has through these means is morally entitled to it. Thus the “entitlement” theory of justice states that the distribution of holdings in a society is just if (and only if) everyone in that society is entitled to what he has. Ah, but there is the rub: Who is entitled to what?

Theory of Moral Rights

So, the key becomes how to define “entitlement.” In this regard we can turn to the theory of “moral rights.” Rights theory provides that human beings have certain fundamental rights that should be respected in all decisions: the right to free consent, privacy, freedom of conscience, free speech, and due process. A right is a capacity, a possession, or condition of existence that entitles either an individual or a group to enjoy some object or state of being. For example, the right to free speech is a condition of existence that entitles one to express one's thoughts as one chooses.

The moral force of a right depends on its strength in relation to other moral considerations applicable to the context in question. According to rights theory, as long as the distribution of wealth in society is achieved through fair acquisition and exchange, the distribution is a just one
regardless of any degree of inequalities that may ensue. The morally correct action is the one that a person has the moral right to do, that does not infringe on the moral rights of others, and that furthers the moral rights of others.

People who rely on rights theory to reason their actions emphasize the entitlement of individuals. Restrictions on behavior should prevent harm to others, but unless your actions harm others, you should be free to do as you please.

My discussion is, of course, a simplification of the theories made necessary by the limitations of blogging. Bringing it home in today’s terms, an entitlement is a guarantee of access to benefits 
based on established rights or by legislation. A "right" is itself an entitlement associated with a moral or social principle, such that an "entitlement" is a provision made in accordance with legal framework of a society. Typically, entitlements are laws based on concepts of principle 
("rights") which are themselves based in concepts of social equality or enfranchisement.

Individual Entitlements

In a casual sense, the term "entitlement" refers to a notion or belief that one is deserving of some particular reward or benefit—if given without deeper legal or principled cause, the term is often given with pejorative connotation (e.g. a "sense of entitlement").

In the past election Mitt Romney claimed that 47% of Americans "are dependent upon government.” That sounds about right. According to the Center on Budget & Policy Priorities, the percentage of the federal budget devoted to aid to others is about 54 percent: 20% social security; 21 percent Medicare/Medicaid/Children’s Health Programs; and 13% for “safety net” programs including programs that provide cash payments to eligible individuals or households, including Supplemental Security Income for the elderly or disabled poor and unemployment insurance; various forms of in-kind assistance for low-income families and individuals, including food stamps, school meals, low-income housing assistance, child-care assistance and various other programs.

On a practical level, we cannot sustain these levels of payments going forward given that: the numbers will increase with an aging population; poorly trained or poorly motivated young people are not competitive in today’s technology-driven economy; and the growing attitude that “I am entitled to be sustained by the government if I choose not to work because it is my basic right and the government’s duty to meet it.”

We need to distinguish between entitlement payments, including those in the supplemental security income programs, and rights-oriented payments including social security and Medicare, both of which most of us have paid into through payroll deductions throughout our working lives. Entitlement payments should be restricted to a percentage of the resources coming into the government so that if we become more prosperous as a nation i.e., GNP goes up, we can then share more with the less fortunate. The shortfall should be made up by religious institutions and private charities. As for social security and Medicare payments, these emanate from rights we have as tax-paying citizens. Oh, by the way, 47 percent of Americans pay no tax.

Blog posted by Steven Mintz, aka Ethics Sage, on March 25, 2013

Accounting for Nuts

Diamond Foods Fraud Illustrates the Danger of overly-optimistic Earnings Projections

Management does it all the time – set overly optimistic earnings and earnings per share projections to motivate financial analysts to give positive recommendations to current and potential investors with respect to stock holdings. It was the fuel that engineered the accounting frauds at Enron, WorldCom, et al. A recent example is Diamond Foods.

On November 14, 2012, Diamond Foods Inc. disclosed restated financial statements tied to an accounting scandal that reduced its earnings during the first three quarters of 2012 as it took significant charges related to improper accounting for payments to walnut growers. The restatements cut Diamond’s earnings by 57 percent for fiscal 2011 to $29.7 million and by 46 percent for fiscal 2010 to $23.2 million. By December 7, 2012, Diamond’s share price had declined 54 percent during 2012.

Diamond Foods, long-time maker of Emerald nuts, and subsequent purchaser of Pop Secret popcorn (2008) and Kettle potato chips (2010), became the focus of a SEC investigation after The Wall Street Journal raised questions about the timing and accounting of Diamond’s payments to walnut growers. The case focuses on the matching of costs and revenues. At the heart of the investigation was the question of whether Diamond senior management adjusted the accounting for the grower payments on purpose to increase profits for a given period.

The case arose in September 2011, when Douglas Barnhill, an accountant who is also a farmer of 75 acres of California walnut groves, got a mysterious check for nearly $46,000 from Diamond. Barnhill contacted Eric Heidman, the company’s director of field operations, on whether the check was a final payment for his 2010 crop or pre-payment for the 2011 harvest. Diamond growers are paid in installments, with the final payment for the prior fall’s crops coming late the following year. Though it was September 2011, Barnhill was still waiting for full payment for the walnuts he had sent Diamond in 2010. Heidman told Barnhill that the payment was for the 2010 crop, part of fiscal 2011, but that it would be “budgeted into the next year.” The problem is under accounting rules you cannot legitimately record in a future fiscal year an amount for a prior year’s crop. That amount should have been estimated during 2010 and recorded as an expense against revenue from sale of walnuts.

An investigation by the audit committee in February 2012, found payments of $20 million to walnut growers in August 2010 and $60 million in September 2011 that were not recorded in the correct periods. The $20 million payments to growers in 2010 caught the eye of Diamond’s auditors, Deloitte & Touche. However, it does not seem that the auditors lived up to their professional responsibilities in detecting and/or reporting the fraud.

The disclosure of financial restatements in November 2012 and audit committee investigation led to the resignation of former CEO Michael Mendes who agreed to pay a $2.74 million cash clawback and return 6,665 shares to the company. Mendes’ cash clawback was deducted from his retirement payout of $5.4 million. Former chief financial officer Steven Neil was fired on November 19, 2012 and did not receive any severance.

An interesting aspect of the case is the red flags including unusual timing of payments to growers, a leap in profit margins, and volatile inventories and cash flows. Moreover, the company seemed to push hard on every lever to meet increasingly ambitious earnings targets and allowed top executives to pull in big bonuses, according to interviews with former Diamond employees and board members, rivals, suppliers and consultants, in addition to reviews of public and nonpublic Diamond records.

Nick Feakins, a forensic accountant, noted the relentless climb in Diamond’s profit margins including an increase in net income as a percent of sales from 1.5 percent in fiscal 2006 to more than 5 percent in fiscal 2011. According to Feakins, “no competitors were improving like that; even with rising Asian demand…it just doesn’t make sense.” Reuters did a review of 11 companies listed as comparable organizations in Diamond’s regulatory filings and found that only one, B&G Foods, which made multiple acquisitions, added earnings during the period.

Another red flag was that while net income growth is generally reflected in operating cash flow increases, at Diamond the cash generation was sluggish in fiscal 2010 when earnings were strong. This raises questions about the quality of earnings. Also, in September 2010 Mendes had promised earnings per share growth of 15 percent to 20 percent per year for the next five years. In fiscal 2009, 2010, and 2011, $2.6 million of Mendes’ $4.1 million in annual bonus was paid because Diamond beat its EPS goal, according to regulatory filings.

The ethical issues in this case are fairly obvious: misleading financial results; improper accounting; and a corporate governance system that did not work. The earnings projections raise questions whether auditors should include these projections in their audit work. In accounting, they are referred to as “forward-looking” statements and cautionary language is assigned to the amounts. However, this is insufficient to protect the public in an environment of capitalism run amok.

Blog posted by Steven Mintz, aka Ethics Sage, on February 18, 2013

Sandwich Generation

What are our Ethical Obligations to Care for our Aged-Parents and Children?

The other day I found out for the first time in a conversation with my brother that I was part of the “sandwich generation.” You can find the term in both the Oxford English and Merriam Webster Dictionaries.

In the early 1990's very few had even heard of the term "sandwich generation." Most thought it was connected to a sandwich eaten by children who were "latch key" kids. Instead, sandwich generation refers to those people who are sandwiched between aging parents who need care and/or help and their own children. It could be the parents have “boomerang” adult kids who come back home after school and/or unsuccessful attempts to get a job. At the same time, one’s parents need in-home care, 24/7 adult supervision or independent/assisted living.

The task is not easy to become elderly or a parent to your parent(s). After all, our society "says" adults should be able to take care of themselves. But, as more live well into their 80s and 90s and families are dispersed across the country, everyone is going to be involved somehow, some way, in elder care. If not today, then tomorrow.

Being a Sandwich Generationer - an elder/parent caregiver - is a new role on the stage of life for which no one can ever rehearse. Becoming a parent to an aging parent presents extraordinary challenges. The challenges to elders are just as daunting. To lose control of one's life - even the little things - can be shocking and frustrating.

Members of the sandwich generation face difficulties in allocating time and money and often describe themselves as being pulled in two directions. Emotional difficulties, especially depression, and marriage conflicts are common problems for those in this situation.

The challenges currently present in the field of aging lend themselves strongly to issues that require ethical consideration. Ethics, defined as a set of principles of right conduct, or a theory or a system of moral values, are critical to reevaluating our treatment and beliefs toward aging individuals. 

Should families be required to care for their aging family members? One ethical principle is “Universality” that asks: Would I want others in my situation to do the same thing I am about to do for the same reason? For me the answer is simple. I would want my daughter and her family to care for me if I were in the position of my aged mom.

We must create a world that provides to older adults independence (including access to safe environments, health resources and opportunities for personal growth), participation (including the ability to remain integrated in society and have a voice), care (care and protection, ability to maximize well-being, and enjoy basic human rights and freedoms), self-fulfillment (access to educational, cultural, spiritual and recreational resources) and dignity (freedom from exploitation and being valued independently of their economic contribution).

While the need for care by older adults is increasing, availability is decreasing; people over 65 are expected to increase at a 2.3% rate, but the number of family members available to care for them will only increase at a 0.8% rate. Unfortunately, availability of care is a major factor in predicting whether or not an older person can remain at home (aging in place) versus being moved to institutionalized care. Furthermore, the services provided by family caregivers represent 80% of all home care services and are conservatively valued at $306 billion a year, more than twice the amount spent on paid home care and nursing home services combined.  

Family caregiving has become the norm. According to the National Family Caregivers Association, more than 50 million people provide care for a chronically ill, disabled or aged family member or friend during any given year. Currently, there are over four million family caregivers in California alone. Caregivers care for spouses (5%), and parents (40%) as well as grandparents, parents-in-law, other relatives, and friends (55%).

Here are five simple rules for caring for the aged: (1) listen; (2) always be there; (3) make them smile; (4) don’t lie; and (5) protect them.

Blog posted by Steven Mintz, aka Ethics Sage, on January 25, 2013

Transocean Settlement of Deepwater Horizon Spill and Ethical Responsibility

Transocean Settles with US Government

On January 3, Transocean whose floating Deepwater Horizon oil rig blew out in 2010, causing a massive oil spil in Gulf of Mexico agreed to settle civil and criminal claims with the federal government for $1.4 billion.  

The Deepwater Horizon exploded, burned and sank in April 2010. Eleven men were killed and millions of gallons of oil flowed into the Gulf of Mexico and fouled the shores of coastal states. The well, known as Macondo, was owned by British oil giant BP, which settled its own criminal charges and some of its civil charges in November for $4.5 billion.

While this settlement resolves the government’s claims against Transocean, that company and the others involved in the spill still face a civil case, which is scheduled to begin in February in New Orleans. Stephen J. Herman and James P. Roy, lawyers who represent the steering committee of plaintiffs in the cases, said that Thursday’s settlement did not change the case, and that the plaintiffs thought that BP, Transocean and Halliburton “will be found grossly negligent” at trial.

In a deal filed in federal court in New Orleans, a subsidiary, Transocean Deepwater, agreed to one criminal misdemeanor violation of the Clean Water Act and will pay a fine of $100 million. Over the next five years, the company will pay civil penalties of $1 billion, the largest ever under the act.  Under a law passed last year, 80 percent of the penalty will be applied to projects for restoring the environment and economies of Gulf States.

As part of the criminal settlement, Transocean also agreed to pay the National Academy of Sciences and the National Fish and Wildlife Foundation $150 million each. Those funds will be applied to oil spill prevention and response in the Gulf of Mexico and natural resource restoration projects. The agreement will be subject to public comment and court approval. The company agreed to five years of monitoring of its drilling practices and improved safety measures.

The company announced in September that it had set an “estimated loss contingency” of $1.5 billion against the Justice Department’s claims.

The multistate trial over claims in the Deepwater Horizon cases that have not been settled are scheduled to begin in February.

BP continued its longstanding argument that the accident, in the words of the spokesman Geoff Morrell, “resulted from multiple causes, involving multiple parties,” and that other companies had to shoulder their share of the blame. This attitude continues BP’s approach of trying to lay off blame to other parties. Whatever happened to the buck stops here?

Looking back at was has happened since the spill, federal inspectors do share much of the blame for not catching safety problems before they got out of hand. on December 2, 2010 the staff of the presidential commission looking into the Horizon Deepwater oil spill issued a report critical of the way federal inspectors handled their role in dealing with what has become the largest oil spill in U.S. history.  While some safety experts investigating the causes of the spill lay blame on human error, it goes much deeper than that and reflects the general malaise in the way federal agencies oversee such activities. As I see it, the causes of the spill can be attributed to the following factors: (1) poorly trained inspectors; (2) lack of resources to adequately oversee and inspect oil rig operations; (3) failure of inspection procedures to keep up with the advanced technology of oil rigging operations; (4) starting salaries for college graduates that pale in comparison to what Engineering school graduates make ($47,448 versus $94,000); (5) a failure of management to devote the resources necessary to prevent oil spills and a cutting corners mentality as was the case with BP; (6) and, perhaps, the most significant cause, the conflict of interests that exists between inspectors and their managers and oil industry executives who develop social ties with the inspectors and pressure them to not look as closely as they should at potential problems.

Looking at the ethics of the matter, I believe the root cause of the BP oil spill was an attitude that has become pervasive in our society that we don’t have to look to closely at oversight because the worst won’t happen. Let’s just go through the motions, document what we have found, and move on to the next assignment. The failure of savings and loan institutions in the late 1980s and early 1990s and the meltdown of financial services companies starting in 2008 can be blamed partly on regulator incompetence or at least, indifference to the possible crises that could arise in the institutions being regulated. In other words it is a failure of work ethic.

Also, it is a lack of ethics in the sense of failing to exercise a reasonable level of care in doing one’s job that contributes to disasters happening such as the Horizon Deep Water Oil Spill. We must get back to pursuing excellence in whatever we do, accepting responsibility for our actions, and being accountable. BP has not learned that lesson as yet. I guess they feel the dozens of commercials they have funded about how clean the coast now is and “come on down” statements from representatives of Alabama, Florida, Louisiana and Mississippi have satisfied its corporate social responsibility and mitigates its horrific response to the Horizon disaster.

Blog posted by Steven Mintz, aka Ethics Sage, on January 7, 2013

Groupon Reports Troubling Financial Results

Problems for the Company and Stock Price Declines Continue

Groupon just released its 3^rd quarter 2012 earnings report, marking its first full-year cycle of earnings reports since its initial public offering (IPO) in November 2011. While the net operating results show improvement year-to-year, the company still shows a net loss for the quarter. Moreover, while its revenue has been increasing in fiscal 2012, its operating profit has declined over sixty percent. This means its operating expenses are growing faster than its revenues, a sign of impending disaster. The company’s stock price on Nasdaq has gone from $26.11 per share on November 5, 2011, the end of the IPO day, to $4.14 a share on November 30, 2012, a decline of more than 80 percent in one year. The company did not meet financial analysts’ expectations for the 3^rd quarter of 2012.

Groupon blamed the disappointing results on its European operations. Some analysts took solace in the fact that Groupon reported it has 39.5 million active customers, an increase of 37 percent from the previous year. But, what good does it do to have a larger customer base if it also leads to larger-than-expected operating costs? This is the question Groupon needs to answer.

I want to go back awhile to the day of the IPO to show how Groupon’s problems first started. On November 5, 2011, Groupon took its company public with a buy-in price set at $20 per share.  Groupon shares rose from their IPO price of $20 by 40% in early trading on Nasdaq, and ended at the 4 p.m. market close at $26.11, up 31%. The closing price valued Groupon at $16.6 billion, making it more valuable than companies such as Adobe Systems and nearly the size of Yahoo.

At a size of up to $805 million, Groupon ranked as the third-largest Internet IPO sold in the U.S.in 2011, after a $1.4 billion issue by Russian search-engine operator Yandex NV in May and a $855 million issue by China social networking platform Renren, according to Dealogic. It was the ninth-largest ever on a list topped by the $1.9 billion sale by Google in 2004.

Less than five months later on March 30, 2012, Groupon announced that it had revised its financial results, an unexpected restatement that deepened losses and raised questions about its accounting practices. As part of the revision, Groupon disclosed a “material weakness” in its internal controls (accounting speak for we blew it, were caught, and now admit it), saying that it had failed to set aside enough money to cover customer refunds. The accounting issue increased the company’s losses in the fourth quarter to $64.9 million from $42.3 million. The news that day sent shares of Groupon tumbling 6% to $17.29. Shares of Groupon had fallen by 30 percent since it went public and the downward trend continues.

In its announcement of the restatement, Groupon explained that it had encountered problems related to certain assumptions and forecasts the company used to calculate its results. In particular, the company said it underestimated customer refunds for higher-priced offers such as laser eye surgery.

Groupon collects more revenue on such deals, but also carry a higher rate of refunds. The company honors customer refunds for the life of its coupons, so these payments can affect its financials at various times. Groupon deducts refunds within 60 days from revenue; after that, the company has to take an additional accounting charge related to the payments.

As Groupon prepared its financial statements for 2011, its independent auditor, Ernst & Young, determined that the company did not accurately account for the possibility of higher refunds. By the firm’s assessment, that constituted a “material weakness.” We did not maintain effective controls to provide reasonable assurance that accounts were complete and accurate,” Groupon said in its annual report.

In an interesting twist, in response to the conclusion that the company’s internal controls contained a material weakness, Groupon said it’s been working for several months with an accounting firm, not Ernst & Young, and will report on the effectiveness of those controls by the end of 2012. This could be because the company blames Ernst & Young for not finding the problem earlier. In fact, it was management’s own report on internal controls over financial reporting that first disclosed at the problem.  

In a related issue, on April 3, 2012, a shareholder lawsuit was brought against Groupon accusing the company of misleading investors about its financial prospects in its IPO and concealing weak internal controls. According to the complaint, the company overstated revenue, issued materially false and misleading financial results, and concealed how its business was not growing as fast and was not nearly as resistant to competition as it had suggested.

These claims bring up a gap in the sections of the Sarbanes-Oxley Act that deal with companies’ internal controls. There is no requirement to disclose a control weakness in a company’s IPO prospectus. Groupon would have no obligation to disclose the problem until it filed its first quarterly or annual report as a public company – which is what it did.

What should we make of the financial results at Groupon? I see a company that hasn’t reigned in its operating costs while it expands into new markets. This may be a disaster ready to happen if Groupon doesn’t get a handle on these costs and soon. One area to look at is executive compensation. Groupon wouldn’t be the first company to overpay its top executives while it struggles to develop a sustainable market. I can just see LivingSocial and Amazon chomping at the bit as it reads about the continuing problems at Groupon.

Blog posted by Steven Mintz, aka Ethics Sage, on December 3, 2012

Oregon Duck Uniforms and the Poverty Level in the U.S.

Cost of Multiple Duck Uniforms Raises Ethical Issues

Saturday night I watched the football game between Oregon and Stanford. I’ve watched the Oregon Ducks before and noticed they seem to have a new uniform for each game. I was intrigued by the fact the University must spend thousands of dollars just on uniforms, although my guess is Nike absorbs most or all of the costs because of the advertising value of millions of kids watching the Ducks in their glossy uniforms. Still, someone is paying for the uniforms.

It seems a bit excessive, even reckless, given there are 46.2 million Americans on poverty or 15.2% of the nation. The government's definition of poverty is based on total income received. For example, the poverty level for 2012 was set at $23,050 (total yearly income) for a family of four. Most Americans (58.5%) will spend at least one year below the poverty line at some point between ages 25 and 75.

Nike sells replica jerseys for between $85 to 90. The authentic jerseys with sewn on patches will come out soon, costing $120. For the players, Nike says the new full uniforms are made of sixteen different fabrics, making them lighter, cooler and more durable. Here is part of their description of the product that debuted at last year’s Rose Bowl:

The new uniform incorporates pinnacle performance innovation and design while providing enhanced thermoregulation and more durability with the inclusion of Nike Chain Maille Mesh – a lightweight ultra-breathable material – used in both the jersey and pant.

I figure each uniform costs Nike about $20 to manufacture. The Ducks list 100 players connected to the football team in some way or another. That means $2,000 just for one uniform. The Ducks play about 15 games each year so we’re talking $30,000 in total.

Another Ducks product is the Oregon Duck Lunar TR-1+ shoes with Win the Day and Duck logos on them. Each pair costs $235. The Nike Store sold out of the shoes online in just six minutes. I figure the shoes cost Nike $60 to make so let’s add another $6,000 for all the players and triple it ($18,000) assuming they need three pairs to get through the season. There may even be separate shoes for each game but I think my point is made.

The poverty line threshold in the U.S. ($23, 050 for a family of four) is, on a daily basis, about $16 per person per day. If my estimates are close, the cost to outfit the Duck football players for a year is about $48,000, double the poverty level for a family of four and enough to sustain 3,000 people for one day or about 8 people for one year. When you think about the extravagant spending on uniforms by the Ducks, you begin to understand that it reflects a society where glitz and glamour are valued over feeding the hungry -- not a pretty picture.

The Ducks are not alone. Last year the University of Maryland rolled out a uniform that appeared to be two in one (depending on which side you're looking at) with their state flag tribute digs. This year Notre Dame introduced an alternate “Shamrock Series” uniform that broke something that didn't need fixing. Then Michigan used the Cowboy Classic this month to trot out neon maize road uniforms; a Yahoo Sports writer called them “ ‘firefly goo’ that were about as subtle as a four-year-old's highlighter.”

In addition to the ethics of spending so much money while others go hungry every night is that college sports /players are role models for younger kids. Now we see some high school football programs mimicking Oregon’s multiple-uniform approach.

Central High School in Knoxville Tennessee is one example. They settled for only two jerseys and one pair of pants from the manufacturer, Under Armour. The Bobcats also went with the trendy flat-black, no-shine helmets from Riddell. The coach is quoted as saying: "I came up with a couple of ideas that I liked, and we asked the kids. They're always going to give you their opinions on what looks good and what doesn't."

A mid-grade helmet costs $200-250 but can go as high as $325-350. A stock Under Armour jersey retails for $50. Team dealers can offer jersey discounts. But factor in printing costs and any deviations from the basic stock style, a jersey can surpass $100 per player.

Here are some more disturbing facts about poverty that make the lavish uniform situation all –the-more troubling. About half of all American children will receive Supplemental Nutrition Assistance Program (SNAP) benefits at some point before age 20. Among African-American children, 90 percent will enroll in SNAP before age 20.

This has gotten out of hand. What message are we sending to our youth when we squander badly needed resources in the name of “looking good” while playing a game that makes you look dirty?

Blog posted by Steven Mintz, aka Ethics Sage, on November 19, 2012

Are Banks Finally Being Held Accountable for their Lax Mortgage Lending Practices?

Wells Fargo and Bank of America Sued for Faulty Mortgages

Have you lost thousands of dollars in retirement money due to stock market declines since the financial meltdown started in 2007? Is your mortgage underwater because lenders made ill-advised loans only to find risky homeowners defaulting on their mortgages? Well, you are not alone in your misery. The recent recession wiped out nearly two decades of Americans’ wealth, according to government data released in June, with ­middle-class families bearing the brunt of the decline.

The  Federal Reserve Bank said the median net worth of families plunged by 39 percent in just three years, from $126,400 in 2007 to $77,300 in 2010. That puts Americans roughly on par with where they were in 1992.

I have previously blogged about the failure of the U.S. government to hold mortgage companies accountable for their lax and even fraudulent mortgage-lending activities in the early part of the 2000s that ushered in a period of financial distress from which we still haven’t recovered. If you are looking for institutions to blame for our financial meltdown, look no further than the mega-financial institutions such as Banks of America and Wells Fargo.

On October 9 the government sued San Francisco-based Wells Fargo accusing the biggest U.S. mortgage lender of "reckless" lending and leaving a federal insurance program to pick up the pieces. The action, filed in federal court in Manhattan, is the latest use of the Federal False Claims Act against a lender accused of fraud against the government-backed mortgage insurer, Federal Housing Administration, which has historically backed loans to first-time buyers and those with low incomes.

The Federal False Claims Act has often been used as an effective legal tool because the government can collect treble damages if violations are proven. Back in February, Bank of America agreed to a $1 billion settlement of False Claims Act fraud allegations involving FHA-backed loans without admitting wrongdoing, and three other large banks have agreed to pay more than $490 million total in similar cases, each accepting responsibility for "certain conduct."

Wells Fargo's internal reviews identified more than 6,500 deficient loans it was required to report from 2002 to 2010, including more than 3,000 that were 60 days into default within the first six months, yet only reported about 300 of them to the department, allowing it to avoid repayment on about $190 million in benefits, according to the complaint.

Prosecutors are seeking "hundreds of millions of dollars" in damages on behalf of the FHA. The complaint alleges nearly a decade of misconduct dating back to May 2001. The lawsuit contends that Wells Fargo engaged in "regular practice of reckless origination and underwriting" of government-backed loans. The company said that more than 100,000 FHA loans met federal guidelines when more than half of them didn't, according to complaint.

The U.S. is also seeking compensatory damages for claims including breach of fiduciary duty, gross negligence and unjust enrichment for the insurance claims that the department has paid and expects to pay for mortgages wrongfully certified by Wells Fargo.

The lawsuit is the third federal mortgage-related case this year for Wells Fargo. The current complaint alleges that the bank knew that in at least half the cases those loans didn't meet federal requirements that would allow them to be insured by the government.

Wells Fargo denied the allegations in the complaint. In a statement in response to the charges, a company spokesperson said it acted in "good faith and in compliance" with federal rules. Many of the issues in the lawsuit had been previously addressed with federal agencies, the company also said. "The bank will present facts to vigorously defend itself against this action."

Wells Fargo is not alone in being sued by the government.  In February, the Bank of America  settled a $1 billion action brought by the U.S. attorney in Brooklyn that sought penalties over loans sold to the FHA. More recently, on October 24, federal prosecutors in New York filed a lawsuit against Bank of America, seeking at least $1 billion in damages for mortgage fraud.

According to the suit, after acquiring Countrywide Financial in 2008, Bank of America continued that firm's practice of rapidly issuing mortgages without safeguards that could have weeded out unqualified applicants, then sold the bad mortgages to the federal agencies Fannie Mae and Freddie Mac, sticking them -- and in turn U.S. taxpayers -- with heavy losses and foreclosed properties.

The collapse of the housing market goes far beyond just the people who lost houses and the federal agencies that ended up stuck with the tab for the bad loans.The results include steep decreases in home prices, underwater mortgages, a slim market for home sales, and fewer people now qualifying for loans. Nevertheless, I have to wonder whether banks truly have learned their lessons or will another catastrophe occur sometime in the future after the mortgage-meltdown-dust has settled.

I raise these questions because of the following story. Annette Alejandro  emerged from bankruptcy in April; she doesn’t have a job; and her car was repossessed in 2011. Still, after spending her days job hunting, she returned to her apartment in Brooklyn where, in disbelief, she sorted through the piles of credit card and auto loan offers that have come in the mail. “Even I wouldn’t make a loan to me at this point,” Ms. Alejandro said.

In the depths of the financial crisis, borrowers with tarnished credit like Ms. Alejandro were almost entirely shut out by traditional lenders. It was hard enough for people with stellar credit to get loans.

But as financial institutions recover from the losses on loans made to troubled borrowers, some of the largest lenders to the less than creditworthy, including Capital One and GM Financial, are trying to woo them back, while HSBC and JPMorgan Chase are among those tiptoeing again into subprime lending.

Albert Einstein’s immortal words sum up the recent trend of banks getting back into the risky mortgage-lending business. Einstein defined insanity as doing the same thing over and over again and expecting different results.

Blog posted by Steven Mintz, aka Ethics Sage, on October 29, 2012

Do we need more Regulation of Corporate America?: Romney vs. Obama

Is our Free-Market Economic System Morally Bankrupt?

Mitt Romney argues that business must be free to follow free-market principles unfettered by regulations such as the 2010 Dodd-Frank Financial Reform Act while President Obama believes regulation is needed to prevent another meltdown of our financial system such as the one that occurred five years ago. Who is right? The answer is both are right and that is why it is so difficult to know where the true answer lies to recent questioning of the capitalistic system such as we witnessed by the ‘Occupy’ movement.

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, objectivity and 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 way it is supposed to work is corporate America would regulate itself and the government would stay out of its way – Romney’s position. Clearly, that has not worked for some time.

The financial crisis that started in 2007 resulted in large part from unethical conduct including making home mortgage loans when financial institutions knew (or should have known) that borrowers were not qualified – a fact that was ignored (or overlooked) so that these institutions could earn large fees from closing and other transaction costs. This scandal came on the heels of accounting frauds in the early 2000s at companies such as Enron, WorldCom, Tyco and Health South that shredded billions of dollars of shareholder wealth while top management pay packages at these companies were in the multi-millions and led to passage of the Sarbanes-Oxley Act of 2002. 

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. What is missing from the calculation of recent economic decision making is ethical decision making.

Corporate actions should be guided by the question: What are the rights of shareholders and other stakeholders and what are the obligations of CEOs and boards of directors to those parties? A case in point is multi-million-dollar severance packages. How is it in the best interest of shareholders for CEOs to walk away with multi-million severance packages? Perhaps the most glaring example of unfairness is the $130 million package given to Michael Ovitz in 2005, after he was fired as CEO of Walt Disney & Co. by Michael Eisner, the chair of Disney’s board of directors, just fifteen months after being hired. Notwithstanding the fact that the Delaware Chancery Court upheld the legality of the payment, boards need to be held ethically accountable for such actions.

The nature of the present economic crisis illustrates the need for departures from uncontrolled self-dealing for the good of society.  Smith had a diagnosis for this: he called such promoters of excessive risk in search of profits "prodigals and projectors,” an appropriate description of many of the promoters of credit swap insurances and sub-prime mortgages in the recent past. Yet, more government regulation is not the answer – Obama’s position. Recent efforts at financial regulatory reform may stem the tide in the short-run. However, in the long-run we should expect new and “creative” attempts at financial engineering to benefit the few to the detriment of the many. Unmitigated greed is not what Smith had in mind in writing “Sentiments.”

Do we need more corporate regulation? Yes, and the more important point is to investigate abuses and hold the perpetrators accountable for their action. I am heartened by the fact that on October 9 the U.S. government filed a civil mortgage fraud lawsuit against Wells Fargo & Co. According to the lawsuit, the Federal Housing Administration was compelled to pay Wells Fargo hundreds of millions of dollars in insurance claims on defaulted mortgages upon false certifications of more than 100,000 loans for FHA insurance, with the full knowledge that underwriters had failed to verify information directly related to the borrower’s ability to repay.

Manhattan U.S. Attorney Preet Bharara said, “As the complaint alleges, yet another major bank has engaged in a longstanding and reckless trifecta of deficient training, deficient underwriting and deficient disclosure, all while relying on the convenient backstop of government insurance.” The suit against Wells Fargo has charges under the False Claims Act and under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989.

The bottom line, however, is that ethical behavior cannot be legislated. It comes from within and a desire to do what is right for society and not to act solely in one’s own self-interests. Dodd-Frank, Sarbanes-Oxley, and other financial regulations are needed not so much because they will prevent, or even slow-down financial fraud. That won’t happen any time soon because our society has morphed into one where there no longer is a moral compass to guide our actions.

We need regulations to provide the ground rules with which business should be conducted in the public interest. We need regulations to punish the abusers of free-market capitalism – to hold them accountable for their actions. Finally, as a college professor who teaches ethics I know we need regulations to discuss in class the pitfalls of capitalism and exhort our students to act more responsibly after they graduate and join corporate America. The real meaning of corporate social responsibility is to contribute to the betterment of society by starting with the notion “do no harm” and then progressing to taking concrete steps to leave an ‘ethical footprint’ every step of the way and in all decision-making.

Blog posted by Steven Mintz, aka Ethics Sage, on October 26, 2012  

The Ethics of Awarding Military Uniform Contracts to Prison Inmates

Is Federal Prison Industries Stealing Jobs?

It's hard to compete with workers willing to take pay as low as 23 cents an hour. Do I mean workers in Guatemala or Vietnam? No. I mean Americans in federal prisons.

Two American companies which make military uniforms are laying off hundreds of workers as the federal government decides to use prison inmates to make soldier fatigues. American Apparel currently charges $29.44 per uniform. The cost will increase by 15 percent when Federal Prison Industries (FPI) convicts begin sewing the clothing at a cost of $34.18 each. FPI also functions under the name UNICOR. The convicts are reported to receive between 23 cents and $1.15 per hour. That’s quite a markup for FPI. The ethical question is whether it is right to take work away from private industry to support a prison-based program with the government’s blessing?

Under the law, FPI receives preference for contracts up to a certain percentage, about 7%, before they have to compete against private industry. My concern is an item such as the army combat uniform is earmarked directly for FPI without competitive bidding. American taxpayers pay more for it, but the bottom line is each soldier is paying more for their uniform.

FPI currently operates approximately 80 factories with more than 13,000 convict workers. The correctional institute factories are not permitted to sell goods to the private sector. The law mandates that federal agencies buy the products, even when they are not the least expensive available option.

Critics accuse UNICOR which last year pulled in $900 million in revenue, of shifting its focus from the betterment of inmates to profits. Those profits, they allege, have largely come at the expense of small business which are already struggling to secure government work. A bipartisan group of lawmakers has proposed new rules that would change the way prison manufacturing companies do business, subjecting them to stricter standards that would lead to higher prices.

In my mind it is difficult to ethically justify the program when so many US businesses are suffering from the great recession. I recently read that Alabama-based American Apparel was forced to close one plant and downsize at others due to the loss of contracts to prison inmates, according to company spokesman and retired Air Force Colonel Kurt Wilson. A total of 190 employees had their hours cut, and 255 others were laid off this year.

Also, I can’t think of any other situation where the government awards a contract to a private company without competitive bidding. I don’t like the government picking winners and losers with respect to government contract work when the playing field is not level.

One way to justify the FPI program is that it teaches inmates a skill and aids in their adjustment back to society. Some claim it also can decrease crime because that skill will enable them to become productive members of society. I’ll withhold judgment on that claim until the program has had several years or so to follow inmates in the program who have subsequently been released back to society. However, I can’t help but wonder whether the adjustment “reason” is a rationalization for an unfair action that knowingly harms private companies making military uniforms.

It seems to me if we want to teach inmates a marketable skill it should start with computer skills. These are in great demand and are transferable to any numbers of jobs and occupations.

I can’t imagine what would be the uproar from the public if we were importing goods manufactured by prison labor in someplace like China? That leads me to my final point. How can we argue against outsourcing manufacturing overseas to countries like India and the Philippines when we insource manufacturing in the US to companies chosen by the US government and not by free-market principles? It seems to run counter to our capitalistic system that relies on non-interference by the government. You know the “laissez-faire” concept!

Blog posted by Steven Mintz, aka Ethics Sage, on October 9, 2012

Are U.S. Corporate Tax Rates Stifling 'Ethical' Behavior?

Are Lower Corporate Income Rates the Answer to Increased Economic Activity?

Given the focus on ‘paying your fair share’ of taxes this election cycle, I want to bring attention to the controversial issue of whether the U.S. corporation tax rate is too high, leading to the outsourcing of jobs overseas; motivating companies to set up shop abroad and; skirting U.S. taxes. If this is the case, are U.S. corporations following ethical practices or, more specifically, acting like socially responsible businesses. It seems an appropriate topic for my blog since the Presidential debates start tonight and it is a contentious issue between the candidates.

As you may know, the U.S. has the highest corporate tax rate in the world. The U.S. rate stands at 39.2% when both federal and state rates are included. The second highest is Japan with a 36.8% rate after lowering it from 39.8 this past April. We all know how Japan’s economy has been in a malaise in the last two decades. Perhaps high corporate tax rates are part of the reason.

In comparison, France has a 33.3% rate [and a top rate of 75% on individual income of more than €1 million ($1.25 million)]; the United Kingdom, a 26% rate, China, 25%, and, at the low end, both Canada and Germany with a 15% rate. Finally, Switzerland’s rate is 8.5%. Perhaps not coincidentally, Canada, Germany, and Switzerland have fared better during the Great Recession of the past five years than other countries.

Loopholes and other special treatment for different kinds of businesses mean that businesses in the United States pay an effective rate of only 29.2% of their income, which puts the U.S. below the average of 31.9% among other major economies, according to analysis by the Treasury Department. However, the effective rate is not known until tax deductions are determined and it doesn’t affect the decision whether to shift profits overseas or keep it in the U.S.

Should corporations act in a ‘socially responsible’ manner and pay the highest corporate tax? Our capitalist economic system relies on the belief that corporate managers should act in the best interests of shareholders. And, as noted economist Milton Friedman stated in a 1970 essay in the NY Times Magazine, the only social responsibility of business is to maximize profits to enhance shareholder wealth. Friedman believed the basic doctrine of "social responsibility" involves the acceptance of the socialist view that political mechanisms, not market mechanisms, are the appropriate way to determine the allocation of scarce re­sources to alternative uses.

I believe the issue of social responsibility should be couched in the avoidance of taxes by U.S. businesses that keep their profits overseas. Under the U.S. tax system, corporate profits are not taxed until they are repatriated back to the states. Further, companies use a technique known as transfer pricing to shift more profits overseas to countries with low tax rates. Ireland is a popular destination for U.S. businesses with its low 12.5% rate. Essentially, parent corporations charge artificially low prices to overseas subsidiaries for goods shipped overseas thereby minimizing taxable income in the U.S. while those subsidiaries charge market prices for their sales to customers in overseas markets.

It has been estimated that the deferral of tax payments may be costing the U.S. Treasury $100 billion or more each year. Republicans contend that a lowering of the corporate tax rate would encourage U.S. businesses to repatriate profits and it could stem the tide of outsourcing jobs. There is no hard evidence to believe this to be so. However, I contend we are in desperate economic times in the U.S. and need to think outside the box to improve the economy.

My suggestion is to institute a lower rate of 15% to be competitive with other industrialized countries, and keep it in place for two years. If this leads to repatriated profits, higher taxes paid to the U.S. government, and the in-sourcing of jobs, then the 15% rate should be made permanent. If, however, U.S. businesses do not send their profits overseas and continue to outsource jobs, it means one or more of three things: (1) they are motivated by lower wage rates outside the U.S.; (2) they may feel stifled by the excessive regulatory system in the U.S.; and (3) they may truly want to be closer to their expanding overseas markets.

Corporate America reacts to incentives to maximize profits that can lead to higher personal income through bonus and other incentive compensation, and rising stock prices. There is nothing wrong with it. It is a part of our system. However, we must begin to initiate policies to reduce the growing number of people in poverty, bring more into the middle class, and do what is necessary to reverse years of stagnant growth that has lowered the overall income of far too many currently in the middle class. In my view this is an ethical issue, not one based on paying a “fair share” of the taxes. Corporations have an ethical obligation and social responsibility to do what it takes to improve the economic circumstances of all members of its community -- a community that depends on jobs and economic activity. Our society cannot prosper without an ever-expanding middle class and lowering of the poverty rate in this country.  

Blog posted by Steven Mintz, aka Ethics Sage, on October 3, 2012    

Holding CEOs Responsible for Fraud at their Companies

Tyco & Kozlowski

You remember Dennis Kozlowski, the former CEO of Tyco International, who was convicted in 2005 of crimes related to his receipt of $81 million in purportedly unauthorized bonuses, the purchase of art for $14.725 million for his $30 million New York City apartment which included $6,000 shower curtains and $15,000 "dog umbrella stands," and numerous other diversions of company funds. Kozlowski's North Hampton, NH. estate was auctioned off for $4.135 million after he was sent to jail. It looks like something out of Hearst Castle.

Who can forget the $2 million spent for the 40th birthday party for his wife by flying friends and corporate hotshots to the Italian island of Sardinia for fun and games including a Roman toga party complete with entertainment by Jimmy Buffet. There was a board meeting on the last day of the week of fun and frolic, and Kozlowski billed Tyco for ‘only’ $1 million.

Kozlowski is a non-repentant individual who not only used company funds for personal reasons but told Morley Safer in a 60Minutes interview that he did nothing different than prior CEOs of Tyco. He was playing by the ‘book.’ Kozlowski’s approach to ethics is called “ethical relativism.” This is when a person believes ethical decision-making is relative to the situation. In other words, everyone is free to define his or her ethics in situations encountered based on the prevailing facts – and pressures – at the time. Most ethicists would scoff at the suggestion that I define my own ethics.

Ethics is based on certain immutable ideas that include a set of core ethical values to be followed in all situations. For example, honesty and truthfulness are core values. Once a person starts to lie, deceive, or cover-up past actions, that person begins the slide down the ethical slippery slope and oftentimes there is no turning back. I always encourage my students to tell the truth when they have made an error in judgment – admit it; be remorseful and promise never to do it again; and change your behavior to avoid repeating the mistake.

I was pleased to learn that on Friday, August 10, Tyco and Kozlowski reached a tentative settlement in litigation over compensation before he was convicted and jailed in 2005 for a massive fraud. The civil litigation was filed in 2002 in U.S. District Court in Manhattan. Tyco accused Kozlowski of fraud and breach of fiduciary duty. Two years ago, a judge found Kozlowski liable on most claims and a trial scheduled to start this week would have decided any damages owed to the company.

Kozlowski, who is in his mid-60s, was convicted in June 2005 of securities fraud, grand larceny and falsifying business records in New York State Supreme Court. A jury found that Kozlowski and former chief financial officer Marc Swartz stole $137 million from the conglomerate.

Kozlowski was sentenced to 8-1/3 years to 25 years in prison. The New York State parole board denied him parole in April.

Goldman Sachs & all the President’s Men

It’s high time we started to hold CEOs responsible for fraud at their companies. The buck should stop with those at the helm of these companies who knew, should have known,  and/or looked the other way while the fraud was committed. That is why I was dismayed to learn last week that the Justice Department won’t prosecute Wall Street firm Goldman Sachs or its employees in a financial fraud probe.

In a written statement, the department said it conducted an exhaustive investigation of allegations brought to light by a Senate panel investigating the 2008-2009 financial crisis. "The department and investigative agencies ultimately concluded that the burden of proof to bring a criminal case could not be met based on the law and facts as they exist at this time." But the department added that if additional or new evidence were to emerge, it could reach a different conclusion about prosecuting Goldman.

A Senate subcommittee chaired by Sen. Carl Levin in April 2011 found that Goldman marketed four sets of complex mortgage securities to banks and other investors but that the firm failed to tell clients that the securities were very risky. The Senate panel said Goldman secretly bet against the investors' positions and deceived the investors about its own positions to shift risk from its balance sheet to theirs.

The Obama administration is infested with people with ties to Goldman Sachs. Goldman was Obama’s biggest campaign contributor ($994,795) in 2008 and before that as a candidate to the Senate. Moreover, I can’t help but wonder whether ties to Robert Rubin, former co-Chairman of Goldman, head of Citicorp, and U.S. Treasury Secretary in the Clinton Administration, biased the decision. After all, protégés of Rubin include Larry Summers, Obama’s chief economic adviser and head of the National Economic Council, and Timothy Geithner, current Treasury Secretary and past president of the Federal Reserve Bank of NY.   

It’s ironic that the Democrats accuse Mitt Romney of being an unfeeling capitalist while crony capitalism is practiced by the current administration. We, the People, deserve better from our elected officials. To allow Goldman executives to escape unscathed by a scandal they were part and parcel of, is, quite frankly, an outrage.

Blog posted by Steven Mintz, aka Ethics Sage, on August 13, 2012

Ethics of using Eminent Domain to Seize, Restructure Underwater Mortgages

What is 'Public Use' in the Context of Seizing Private Property?

Last Friday an opinion editorial I wrote was published in the Pacific Coast Business Times. Given the interest in the topic, at least out here in California, I decided to post it on my blog.

Eminent domain refers to the power possessed by the state over all property within the state, specifically its power to appropriate property for a public use.

Generally, when a unit of government wants to acquire privately held land the government attempts to negotiate the purchase of the property for fair value. If the owner does not want to sell, the government files a court action to exercise eminent domain, and serves or publishes notice of the hearing as required by law. In the state of California, the eminent domain process can only be stopped if the proposed taking does not meet the requirements for public purpose or public necessity.  

On July 5 it was reported that officials in San Bernardino County, and in the cities of Fontana and Ontario, are considering using eminent domain to seize and restructure underwater mortgages and help struggling homeowners. The idea is to acquire the mortgages of distressed homeowners and restructure them in a way that allows the borrowers to stay in their homes.

As might be expected, banking and housing groups are not on board. They are concerned that forced restructuring through eminent domain could lead to big losses for the investors in these home loans and a loss of confidence in the ability of the cities to repay debt in the future. Seizing mortgages in this way would result in losses for public pension plans, 401(k) plans and individual investors who bought the individual loans as part of a packaged group of securities known as collateralized debt obligations. You remember these securitized assets that were at the forefront of the 2008 financial meltdown.

Two important ethical issues exist in using the eminent domain process to help one group of homeowners and not others. The first is the problem of moral hazard whereby the costs of risk-taking are passed along to other parties. The second is basic fairness. Is it fair to help out a group of people who got in over their heads or who no longer have the ability (or desire) to meet their obligations? What about homeowners who did the right thing? There are many homeowners who are living up to their obligations and making mortgage payments even though their mortgages far exceed the fair market value of their property.

The use of eminent domain rewards irresponsible behavior, even if caused by events out of the control of the benefited party. It sets a bad precedent that the government will be there to help you if economic conditions create challenges that otherwise would be met. It is unfair to others who play by the rules.

The use of eminent domain to refinance underwater mortgages is an ethical slippery slope. Where does it stop? Why not use it to pay off automobile loans and prevent repossession? Why not restructure student debt to relieve the burden of years of loan repayment?

There is a reason we live in a free market economy. We believe in letting the marketplace resolve issues of supply and demand for housing. We should also learn from the past and acknowledge that various affordable housing programs have not worked to stem the tide of foreclosures and underwater mortgages. The real problem is stagnant economic growth.

The U.S. Constitution states that “No person shall be… deprived of… property, without due process of law; nor shall private property be taken for public use, without just compensation.” The key is to define ‘for public use’. Public use is generally thought of as having a public benefit such as seizure to develop infrastructure. The eminent domain action being contemplated by San Bernardino county officials benefits one group of people and might lead to the loss in value of homes for those who have played by the rules.

The free-market solution to the housing dilemma is for banks to work with their customers to restructure debt. We should not expect the banks and investors to sit idly by and watch the government intervene in the process. The eminent domain solution is more akin to socialism than capitalism.

Blog posted by Steven Mintz, aka Ethics Sage, on July 26, 2012

Bank Financial Fraud Goes Global

The LIBOR scandal infects Global Financial Markets

Last week it was disclosed that Barclays, a 300-year-old British bank, rigged the LIBOR rate. The LIBOR is a borrowing rate set daily by a panel of banks for ten currencies and for 15 maturities. The most important of these, three-month dollar LIBOR, is supposed to indicate what a bank would pay to borrow dollars for three months from other banks at 11am on the day it is set. The dollar rate is fixed each day by taking estimates from a panel, currently comprising 18 banks, of what they think they would have to pay to borrow if they needed money. The top four and bottom four estimates are then discarded, and LIBOR is the average of those left. The submissions of all the participants are published, along with each day’s LIBOR fix.

Many financial institutions, mortgage lenders and credit card agencies set their own rates relative to (and typically higher than) LIBOR. The LIBOR is among the most common of benchmark interest rate indexes used to make adjustments to adjustable rate mortgages. So, it affects virtually all people around the world and the scandal described below threatens to infect the global financial system if left unchecked.

Over the past week strong evidence has emerged in documents detailing a settlement between Barclays and regulators in the U.S. and Britain that employees at the bank and at several other unnamed banks tried to rig the number time and again over a period of at least five years. Investigations by regulators in several countries, including Canada, America, Japan, the EU, Switzerland and Britain, are looking into allegations that LIBOR and similar rates were rigged by large numbers of banks. Corporations and lawyers, too, are examining whether they can sue Barclays or other banks for harm they have suffered. That could cost the banking industry tens of billions of dollars.

As many as 20 big banks have been named in various investigations or lawsuits alleging that LIBOR was rigged. The scandal also corrodes further what little remains of public trust in banks and those who run them. Still, the fraud is bigger than just LIBOR manipulation.

A second sort of LIBOR-rigging has also emerged in the Barclays settlement. Barclays and, apparently, many other banks submitted dishonestly low estimates of bank borrowing costs over at least two years, including during the depths of the financial crisis. In terms of the scale of manipulation, this appears to have been far more egregious—at least in terms of the numbers. Almost all the banks in the LIBOR panels were submitting rates that may have been 30-40 basis points too low on average. That could create the biggest liabilities for the banks involved.

As the financial crisis began in the middle of 2007, credit markets for banks started to freeze up. Banks began to suffer losses on their holdings of toxic securities relating to American subprime mortgages. With unexploded bombs littering the banking system, banks were reluctant to lend to one another, leading to shortages of funding system-wide. This only intensified in late 2007 when Northern Rock, a British mortgage lender, experienced a bank run that started in the money markets. It soon had to be taken over by the state. In these febrile market conditions, with almost no interbank lending taking place, there were little real data to use as a basis when submitting LIBOR. Barclays maintains that it tried to post honest assessments in its LIBOR submissions, but found that it was constantly above the submissions of rival banks, including some that were unmistakably weaker.

At the time, questions were asked about the financial health of Barclays because its LIBOR submissions were higher. Back then, Barclays insiders said they were posting numbers that were honest while others were fiddling theirs, citing examples of banks that were trying to get funding in money markets at rates that were 30 basis points higher than those they were submitting for LIBOR.

Regulators around the world are concerned that global financial markets may have been rigged by a large number of banks. The list of institutions that have said they are either co-operating with investigations or being questioned includes many of the world’s biggest banks. Among those that have disclosed their involvement are Citigroup, Deutsche Bank, HSBC, JPMorgan Chase, RBS and UBS.

The U.K. Serious Fraud Office (SFO) opened a criminal probe into the attempted rigging of interest rates that led to a record fine against Barclays, adding to pressure on banks already under investigation by regulators around the globe. (As a side point, I never could understand why, in certain countries, large scale frauds ware distinguished from tamer ones by having the “Serious Frauds Office” do the investigation. It seems to me all frauds are serious on their face.)

Politicians including Chancellor of the Exchequer George Osborne and Opposition Labour leader Ed Miliband called for a criminal probe after Britain’s second-biggest bank was fined $451 million two weeks ago in the UK and U.S. for submitting false LIBOR rates. Chief Executive Officer Robert Diamond and Chief Operating Officer Jerry Del Missier resigned over the scandal.

The SFO joins the U.S. Department of Justice in criminally investigating how derivatives traders and rate submitters colluded to rig interbank offered rates. The U.K. Financial Services Authority is seeking civil penalties against banks and has said its criminal powers don’t include Libor rigging.

As part of the U.S. and U.K. settlements, Barclays admitted rigging the LIBOR as well as Euribor, its equivalent in euros, as early as 2005. In testimony to the British Parliament last week, Diamond apologized and said 14 Barclays traders were involved.

Citigroup Inc., Royal Bank of Scotland Group Plc, UBS AG, ICAP Plc, Lloyds Banking Group Plc and Deutsche Bank AG are among the firms regulators are investigating. About 18 banks are surveyed as part of the process of determining LIBOR rates.

The bottom line is now global interest rates and the global financial system is coming under attack. If we can’t trust that system, then the global transfer of money may be in doubt. In the US, we have our own problems with the financial system. Now, we have to consider the LIBOR-rigged rate problem to determine how, and to what extent, it has affected the actions and performance of US banks. US regulatory authorities should investigate as quickly as possible to assure investors the scandal has been controlled.

Blog posted by Steven Mintz, aka Ethics Sage, on July 14, 2012

Social Responsibilities of a U.S. Company Doing Business Abroad

Ethics and Social Responsibility go Hand in Hand

Should use companies adhere to U.S. standards of health and safety in the workplace of a foreign supplier? Or, is the old adage true: "When in Rome, do as the Romans do."

Corporate social responsibilities come from ethical obligations including acting responsibly and being accountable to the stakeholders of an organization, including employees, and practicing full disclosure. Transparency is important as is adhering to relevant laws and regulations. A code of ethics provides support for these ethical obligations.

It is in this light that I was intrigued to learn that a major Apple Inc. supplier agreed to change its labor practices following an outside audit of its Chinese factories by the global nonprofit organization -- the Fair Labor Association. It found widespread breaches of work rules including 60-hour work weeks in violation of the FLA code and Apple’s own standard, and other health and safety violations. The investigation of manufacturer Hon Hai Precision Industry Co., known as Foxconn, is the latest to document workers-rights violations in Apple's supply chain.

It is worth noting that the audit was at the request of Apple. However, Apple launched the initiative not out of a sense of social responsibility but in response to recent concerns over labor practices and reported abuses in the Chinese factories of its suppliers. In other words, Apple was not concerned about the disgraceful working conditions until it created negative publicity for the company.

Foxconn, with 1.2 million Chinese employees, is one of China’s largest employers and a major supplier of Apple. It assembles an estimated 40 percent of the smartphones, computers and other electronic gadgets sold around the world. Foxconn’s decisions set standards other manufacturers must compete with.

Evidence gathered from news reports and other sources indicates that 17 Foxconn workers have killed themselves. What had seemed to be a series of isolated incidents has become a worrisome trend. When one jumper left a note explaining that he committed suicide to provide for his family, the program of remuneration for the families of jumpers was canceled.

Reports from inside the factories warned of “sweatshop” conditions and allegations of forced overtime came to life. Foxconn and its partners—notably Apple—found themselves defending factory conditions while struggling to explain the deaths. Some saw the Foxconn suicides as a damning consequence of our global hunger for low-cost electronics.

In a plant in Wuhan, central China's Hubei province, up to 200 workers from the Microsoft Xbox production line of Foxconn, staged a strike. They were not demanding sleek new gadgets, but simply decent pay in return for making them. To drive their point home, they had threatened to kill themselves by jumping off a building.

The Foxconn suicides that started in 2010 are due to oppressive work conditions that include standing for eight hours or more without a break. One worker said that he constantly wanted to drop something on the floor so he could bend down to pick it up while working. Due to the long hours standing, if he had the chance to lie or squat down on the floor, it would be the most enjoyable moment during the work day so he could get the chance to rest.

Foxconn has been criticized for running "blood and sweat" plants in China. Plants depend on workers’ being at assembly lines six or seven days a week, often for as long as 14 hours a day. In one instance where Foxconn makes computer cases for Acer, a Taiwanese computer company, workers all had blisters and the skin on their hands was black. The factory was also really choked with dust and no one could bear it. Such facilities have made it possible for devices to be turned out almost as quickly as they are dreamed up.

In February, following a prolonged period of criticism about the working conditions, Foxconn raised wages for its Chinese workers by 16 to 25 percent according to a report by Taiwan's Central News Agency. In the Shenzhen plant, which has been the initial production location for Foxconn since 1988, the basic wage will be raised to no less than 2,200 Chinese Yuan (about $348) a month from 1,800 ($285) Chinese Yuan. Before the series of wage hikes, the basic salary in the Shenzhen complex stood at 900 ($138) Chinese Yuan three years ago.

By bowing to such demands, Foxconn has conceded that employees and consumers have gained a sway once possessed only by Chinese bureaucrats and executives at the global electronics firms that hire Foxconn to build their products. For the system to genuinely change, Foxconn, its competitors and their clients — which include Apple, Hewlett-Packard, Dell and the world’s other large electronics firms — must convince consumers in America and elsewhere that improving factories to benefit workers is worth the higher prices of goods.

This is the way capitalism is supposed to work. As nations develop, wages rise and life theoretically gets better for everyone. China has been slow to realize the changing landscape even though it is promoting a more western style of capitalism albeit state controlled. The question is whether the Chinese government and business leaders are ready for the change. My guess is if it occurs at all, it will happen grudgingly at best.

The question raised earlier was should U.S. companies like Apple apply the same standards of workplace health and safety as expected in the U.S., or do they rationalize a lower set of standards in the name of cultural differences? Some argue that Apple is providing a service by hiring many Chinese workers that might otherwise be unemployed and/or be forced to live the life of a peasant. After all, the Chinese worker is not used to more advance working conditions and the government is in no hurry to adopt them.

The bottom line is if China wants to move toward a western model of capitalism it should adopt western-style working conditions as the norm that protects worker rights and not react in a knee-jerk fashion only after well-publicized incidents of attempted suicide. With greater profits come greater social responsibilities to contribute to the betterment of society.

Blog posted by Steven Mintz, aka Ethics Sage, on May 17, 2012

Abramoff, PACs, and Campaign Financing

Abramoff is Out of Prison Just in Time to Witness the Buying of the Presidency

Last week it was reported that Jack Abramoff, the former lobbyist, businessman and movie producer who was indicted on charges of fraud, conspiracy and tax evasion after an extensive corruption investigation, will give a talk on ethics at The University of Texas at Austin on May 2. "You Don't Know Jack! A Conversation with Jack Abramoff” will be held at the AT&T Executive Education & Conference Center on the UT campus.

Abramoff, who served four years in federal prison after pleading guilty, will discuss the importance of ethics in government, as well as personal ethics as they relate to his own experiences. He will describe the pitfalls he didn’t see, what he didn’t do, how he came to the point of making only bad choices and how he came to realize his mistakes and work through them.

I don’t know about you but I have a problem with a convicted fraudster going on the speaker’s circuit and making money by telling listeners why and how s/he did what they were convicted of doing. It’s worse when that person gives advice on how to spot fellow-fraudsters. Perhaps it’s just me but the only way in my mind of justifying a speaking engagement for a fraudster is to donate the speaker’s fee to a worthy cause. On that comes to mind is The Association of Certified Fraud Examiners.  This is a group of well-trained accountants, auditors, lawyers and investigators who examine incidents of fraud and provide expert information on the causes and results of such actions, and how to prevent and detect fraud in an organization.

Abramoff has the dubious “distinction” of having been involved in the most widespread influence-peddling scandal to date. On September 4, 2008, he was sentenced to a four-year term in federal prison for mail fraud, conspiracy, and tax-evasion charges stemming from an influence-peddling scandal in Washington, D.C. Lawmakers, lobbyists, Bush administration officials, congressional staffers, and businessmen got caught up in the Abramoff public corruption probe including former Ohio Representative Bob Ney (R-GA) who was sentenced to a 2 1/2 year prison term for taking bribes from Abramoff.

Abramoff was released from prison in June 2010 having been confined since November 2006. I guess he received four months off his sentence for good behavior. Perhaps he gave seminars in prison and counseled prisoners on the errors of their ways.

Abramoff has been trying to regain the notoriety he once had by establishing a promotional website and he began to charge for giving talks about corruption in Washington with titles like "How Lobbyists Shape Your Industry" and "Can Congress be Fixed?" Abramoff also made the rounds on talk shows like "Hannity," "60 Minutes," "The Early Show" and "Piers Morgan Tonight" in an attempt to rebrand himself as a whistleblower against corruption. He has a Facebook page and game app called "Congressional Jack," and a feature film called “Casino Jack.” The movie tells the story about how a band of amoral lobbyists and ideologues bought and sold favors from a slew of influential Republicans.

How timely it is that Jack’s lobbying entanglements seem to have ushered in an era of sanctioned influence peddling in Washington, D.C. During the past several months we watched as Political Action Committees (PAC) were used to influence the outcome of primary elections. Critics of Mitt Romney claim he paid for and bought the Republican nomination for President through the operations of his PAC.

We can thank a 2010 Supreme Court decision, Citizens United v. Federal Election Commission. In the case, a bitterly divided court ruled 5 to 4 that the government may not ban independent political spending by corporations, as well as labor unions and other organizations, in candidate elections. The decision and subsequent court rulings led to tens of millions of dollars in donations -- often by wealthy individuals, of as much as $5 million at a time -- to super PACs supporting candidates in the Republican primaries.

We now live in a political campaign environment where there are no limits on how much cash can be raised and spent by anonymous donors seeking to influence elections and legislation. It is a world that would suit the old Jack Abramoff quite well. The 2012 presidential election is almost certain to be the most expensive in history, as the two main candidates set lofty fundraising goals and money floods in to “super PACs,’' independent political committees that have been supercharged by a series of court decisions.

The sad fact is that millions of Americans go hungry every night while politicians and their PACs and Super PAC’s spend outrageous amounts of money to influence a contest that is supposed to pick the next President of the US, a person who should represent all the people.

Blog posted by Steven Mintz, aka Ethics Sage, on April 16, 2012

Groupon Restatement of Earnings a Cause for Concern

The Signs are there: Market Stability at Risk

You may have heard that Groupon restated its “earnings” to reflect a larger fourth-quarter loss after failing to set aside enough money to account for customer refunds. Groupon’s stock has been falling since it revealed last Friday that it was revising its first quarter earnings to reflect a larger than expected loss. With its past accounting problems, some of which I have previously blogged about, Groupon is now a prime target for shareholder lawyers who believe the company may be liable for the losses investors have suffered since Friday. The stock is currently down about 12% and falling.

Groupon’s restatement increased the company’s fourth-quarter losses from $42.7 million to $64.9 million, more than a 50% increase in the reported loss. Moreover, the company had $500 million revenue last year so the amount of restatement is significant, or material as accountants would say.

According to Groupon’s accountant, Ernst & Young, the accounting error came from a “material weakness in its internal controls”. This means other transactions may be at risk since poor controls in one area tend to cause problems elsewhere. More important, the internal control problems raise questions about the management of the company and its corporate governance.

The red flags have been waving even before the company went public last year. In preparing its IPO, the company used a financial metric it called “Adjusted Consolidated Segment Operating Income”. The problem was that figure excluded marketing costs, which make up the bulk of the company’s expenses. The net result was to make Groupon’s financial results appear better than they actually were. After the SEC raised questions about the metric — which The Wall Street Journal called “financial voodoo” — Groupon downplayed the formulation in its IPO documents.

Groupon’s latest restatement is partially a consequence of the “Groupon Promise” feature of its business model. The company pledges to refund deals if customers aren’t satisfied. Because it has been selling those deals at higher prices lately — which leads to a higher rate of returns — it needs to set aside larger amounts to account for refunds — something it hasn’t been doing. It’s another example of Groupon failing to accurately account for a part of its business that reduces its financial performance. That shouldn’t inspire investor confidence.

In an updated filing with the SEC, Groupon said it is working to “remediate the material weakness,” in its internal financial reporting controls, and will hire “additional finance personnel.” But it warned: “If our remedial measures are insufficient to address the material weakness, or if additional material weaknesses or significant deficiencies in our internal control over financial reporting are discovered or occur in the future, our consolidated financial statements may contain material misstatements and we could be required to restate our financial results.”

In a statement, Groupon tried to put a positive spin on the whole matter. “We remain confident in the fundamentals of our business, as our performance continues to highlight the value that we provide to customers and merchants,” said Groupon Chief Financial Officer Jason Child.

This is right out of the Enron playbook when former CEO and chair of the board of directors, Ken Lay, stood in front of a meeting of employees, many of whom bought Enron stock for their 401-Ks, and touted the viability of the company’s unusual business model that had served Enron so well for so long albeit because of falsified financial statements.

Groupon's latest missteps, combined with its previous accounting issues, call into question whether the start-up was ready to be a public company that has to produce reliable financial reports, said Sandra Peters, head of financial reporting policy for the CFA Institute, which represents chartered financial analysts who work with individual investors.

"It really demonstrates, for an IPO, were they really ready to go?" she said. "Did they have the financial systems, did they have the processes and procedures in place?"

Similar concerns were echoed by people who track the company on Wall Street. "It's going to definitely unsettle a lot of investors," said Ken Sena, an analyst covering Groupon for Evercore Partners.

What is the lesson to be learned from Groupon’s experience? It is that we are vulnerable once again to a market meltdown because there are many companies like Groupon that want to cash in on Google’s phenomenal stock growth since its IPO. A better economic outlook and rising stock market are heating up the market just weeks before Facebook's highly anticipated IPO.

Congress, meanwhile, is lessening restrictions on IPOs in an attempt to make it easier for younger companies to raise money. Where have we heard this before? Was it when the Congress repealed the Glass-Steagall Act that had served the market so well by preventing commercial and investment banks from combining? Let’s not forget that the repeal in the law ushered in a period of over-selling in the market and, ultimately, the financial meltdown of 2008.

Let’s also not forget that famous line from Albert Einstein about insanity. Einstein defined insanity as “doing the same thing over and over again and expecting different results.”

Blog posted by Steven Mintz, aka Ethics Sage, on April 5, 2012

Self-Employed Eligible for Unemployment Benefits: Ethics and Moral Hazard Considerations

Should the Self-Employed be Eligible for Unemployment Benefits?

From time to time I write an opinion editorial for the Pacific Coast Business Times. The following Blog was posted on March 9.

On Feb. 22, President Obama signed into law H.R. 3630, the Middle Class Tax Relief and Job Creation Act of 2012, a bill that is estimated to cost $150 billion.

Most people are familiar with the payroll tax cut extension provision through December 31, 2012 that lowers the workers’ payroll tax obligation from 6.2 percent to 4.2 percent. Many know about the change in requirements in the unemployment benefits program, including weaning some of the 3.5 million current recipients off federal jobless benefits. It would eventually cap the maximum duration of benefits at 73 weeks, instead of 99, depending on a state's jobless rate. Americans out of work the longest and in the hardest-hit states would be shielded from most of the cuts. What few Americans know, however, is the bill provides unemployment benefits for self-employed workers.

The Startup Technical Assistance for Reemployment Training and Unemployment Prevention (STARTUP) Act alters the rules governing the unemployment insurance program to allow recipients starting their own small businesses to collect their unemployment without the added burden of searching for other full time work.

Current unemployment insurance rules require recipients to be actively searching for and willing to accept suitable work. Self-employment assistance (SEA) allows a small number of those same recipients who want to start their own businesses to maintain their benefits while they build their companies. Allowing entrepreneurs the ability to focus on building their businesses instead of looking for other work just to keep their unemployment benefits increases their likelihood of success. Would-be entrepreneurs must have a valid business plan to receive SEA but will also be eligible for job training opportunities to further increase that likelihood of success.

H.R. 3630 allows for a one-year program totaling $35 million which is both authorized and appropriated, guaranteeing that the funding will be used to foster small business growth. Several states like Oregon and Delaware already offer similar programs to qualified unemployed. The provision in the payroll tax and unemployment insurance or UI extension agreement would expand that opportunity to promising entrepreneurs nationwide.

The bill would allow the long-term unemployed to take advantage of the program. Currently, SEA participants are not eligible to use the program during extended or emergency unemployment periods, which have been extended to 99 weeks in many states. Instead, SEA is only available for the first 26 weeks of unemployment. The STARTUP Act allows an unemployment beneficiary to use 26 weeks of funds for self-employment assistance at any point during their eligibility. The bill would also incentivize every state to offer the program, providing technical assistance from the Labor Department and authorizing $35 million in state grants over the next three years to establish, implement, improve, and administer the programs.

One of the bill’s sponsors, Representative Ronald Wyden (D-OR) is quoted as saying: “Starting a small business is a full time job.” It takes time and sweat equity to make a business successful which the current unemployment rules don’t provide. With the unemployment rate remaining high, there is a great deal of talent sitting on the sidelines vying for too few jobs. Self-employment assistance allows the most industrious of those people to maintain their unemployment insurance benefits while building businesses that could take even more people off of the UI rolls.” Please answer this question, Representative Wyden: How will we identify “the most industrious of those people”?

The economic rationale for the self-employed assistance program includes: (1) it will get some unemployed off the public doll; (2) it helps to foster a spirit of entrepreneurship; and (2) it will assist small businesses to hire Americans thereby reducing the number of unemployed. This rationale relies on the long believed notion that small businesses are the creators of new jobs and engines of future economic growth.

I agree with the rationale but question what happens in the real world and whether the cost of yet another level of bureaucracy creates more costs than benefits to society. How will it be determined that an unemployed, would-be self-employed individual, is eligible for the expanded benefits program? The notion that “Would-be entrepreneurs must have a valid business plan to receive SEA… and be eligible for job training opportunities to further increase that likelihood of success” is problematic. What is a valid business plan? It seems that states would need to hire additional, better-trained workers to assess the skills of SEA beneficiaries.

These are just a few questions that should have been fully addressed before the SEA provision was adopted. But, like many flawed pieces of legislation such as Obamacare, the Congress tends to act first, answering questions later, and let the chips fall where they may. Do we really want an additional state bureaucracy on top of the federal layer at a time when state and federal deficits are spiraling out of control?

There are many ethical issues to consider. First and foremost is: Do the added costs of administering and monitoring the new program exceed the benefits to society of providing unemployment assistance to the unemployed --- self-employed wannabes? This is similar to many issues we face with respect to trying to be a compassionate society while recognizing our moral obligation to future generations not to provide them with a bankrupt country.

To carve out a new group of UI recipients, no matter how well intended, opens the door for other exceptions that can create an ethical slippery slope. Moreover, moral hazard risks exist because the tendency may be to look to become unemployed in order to use the 26 weeks to create one’s own business. In this way the provision may unknowingly lead to questionable behavior that raises doubts about a person’s work commitment and increases the emphasis on the pursuit of one’s self-interest without regard to the possible costs to society. In other words, the behavior of the would-be unemployed person may change as a result of the availability of the SEA provision in that the risk of being unemployed during the 26 week period shifts to the government. – and taxpayers like you and may will be picking up the tab.

Blog posted by Steven Mintz, aka Ethics Sage, on March 15, 2012

Allen Stanford: A Ponzi Schemer from the Madoff School of Fraud

What makes Ethically-Challenged People do Bad Things?

So how does a once prominent financier find himself convicted of an $8 billion dollar Ponzi scheme? Just ask Bernie Madoff, the former chairman of NASDAQ, who set the standard for avarice. In March 2009, Madoff pled guilty to 11 federal felonies and admitted to turning his wealth management business into a massive Ponzi scheme that defrauded thousands of investors of about $65 billion.

In early 2009, Stanford became the subject of several fraud investigations, and on February 17, 2009, was charged by the SEC with fraud and multiple violations of U.S. securities laws for alleged massive ongoing fraud involving $8 billion in certificates of deposit. Last week the jury that convicted former Texas tycoon R. Allen Stanford of operating a massive Ponzi scheme found that there was sufficient evidence that $330 million in frozen foreign bank accounts he controlled was money he stole from investors, clearing the way for U.S. authorities to go after the funds.

I sometimes wonder how successful businessmen (I’ll leave out women because none seem to have mastered the art of a Ponzi scheme) become so greedy as to use and abuse friends, colleagues, and even family members for their own financial gratification. I’m convinced they must be narcissists who have become self-delusional and blind to the harm they have caused to others. They are lacking in empathy; care only about themselves; feel no guilt or shame for their actions; and have illusions of grandeur.

Stanford was involved in one of the largest incidents of fraud against investors since the fraud that involved Bernie Madoff. Stanford's personal fortune was once valued at $2.2 billion. Still no match for Madoff who is supposed to make restitution of $170 billion partly by having Irving Picard, the trustee charged with unwinding the Bernie Madoff fraud, file about 1,000 lawsuits worth some $100 billion against individuals and companies accused of profiting from Madoff's scheme including multibillion-dollar lawsuits against  mega financial firms JP Morgan, UBS and HSBC. These “clawback” lawsuits include NY Mets owners Fred Wilpon and Saul Katz and associated individuals and firms, who allegedly received $300 million from the scheme.

During a six-week trial, prosecutors told how Stanford, 61, repeatedly raided the bank he owned in Antigua, Stanford International Bank, using it as his "personal ATM." He bought a castle in Florida for one of his girlfriends and his oldest daughter lived in a million-dollar condominium in Houston. He wore custom-made suits, lived in luxury homes and on a yacht in the Caribbean and bankrolled a $20 million prize for an international cricket tournament. In short, he was from the Dennis Kozlowski school of creep-ism. You may recall that Kozlowski, the former CEO of Tyco International, was convicted in 2005 of crimes related to his receipt of $81 million in purportedly unauthorized bonuses, the purchase of art for $14.725 million for his $30 million New York City apartment which included $6,000 shower curtains and $15,000 "dog umbrella stands," and numerous other diversions of company funds.

The government's star witness in the Stanford case, former aide James Davis, testified that he and Stanford faked documents and made up financial reports to calm investors and fool regulators. They funneled millions of dollars from Stanford International Bank to a secret Swiss bank account that Stanford tapped for his personal use, Davis testified.

Prosecutors said Stanford lied to investors from more than 100 countries, telling them their funds were being safely invested when instead he used the money to fund a string of failed businesses, bribe regulators and pay for luxuries such as yachts and private jets. His attorneys portrayed Stanford as a visionary entrepreneur who made money for investors and conducted legitimate business deals. Seriously?

Blog posted by Steven Mintz, aka Ethics Sage, on March 12, 2012

Regulators are Considering Forcing Companies to Change their Auditors

Is Mandatory Auditor Rotation a Good Thing?

Auditor rotation has been recommended by many years as a way to cut down on the cozy relationship that develops between an auditor and the client. Given that independence, objectivity, and integrity are cornerstone ethical values in accounting, it does make sense to change auditors every so often. In the past a five-year rotation has been suggested.

This is too short a period of time because it takes a few years to become familiar with the client’s systems. Audit firms invest much time and effort in the learning process. They should be able to benefit from their time and expertise with respect to servicing a client and earning audit fees. It seems to me ten years might work better. After all, it can be a good thing if new auditors take a fresh look at a client’s financial results every ten years.   

Let’s look at the recent past. Companies that ran into trouble in the financial crisis—Lehman Brothers, AIG and GM, for example—were with their auditors for decades without obvious benefit to investors. And regulators are increasingly worried that being overly-friendly with clients erodes auditors’ independence. In August James Doty, the head of the Public Company Accounting Oversight Board, (PCAOB) suggested forcing companies to rotate audit firms after a set (and as yet undefined) period.

According to Audit Analytics, a research firm in Sutton, Mass., 30% of the 1,000 leading U.S. companies have used the same firm to audit their books for at least a quarter-century. Fully 11% have used the same audit firm continuously for 50 years or more. Eight companies haven't changed auditors in at least a century; the last time any of them hired a new accounting firm, William Howard Taft was in the White House.

The PCAOB has asked whether long tenure might lead to complacency. Late last year, the board sought opinions on whether it should require listed companies to rotate their accounting firms every few years. The last of those 611 public comments came in to the PCAOB last month. An overwhelming 94% were opposed to term limits.

Auditors say it helps to know their clients’ business intimately. The Big Four accounting firms—PwC, Deloitte, Ernst & Young and KPMG— agree that forced rotation will impair audit quality. PricewaterhouseCoopers and Deloitte pointed to studies casting doubt on whether changing auditors improve financial reporting. Ernst & Young said that some clients have threatened to hire a different firm if E&Y didn't bless a dubious decision—which E&Y refused to do. KPMG said it evaluates the judgment and ethics of each partner at least once every three years.

As for the PCAOB, James Doty, chair of the Board, recently said: "We know from our own inspection reports that there is a problem." Without independence, it's unlikely you're going to get skepticism or a healthy look for disconfirming evidence."

This certainly was the case before Sarbanes-Oxley because not one of the accounting frauds in the late 1990s and early 2000s that led up to the Act were reported by the external auditors. In fact, peer review reports indicated the firms were doing just fine.

The problem, says Howard Schilit, an accounting expert at Financial Shenanigans Detection Group in Key Biscayne, Fla., is simple: "When you're an auditor who's trying to protect a long-term relationship, you have to suck up to the client, and the client knows it."

Since floating the idea last August about mandatory rotation, the PCAOB has received 620 letters, about 20 times the normal amount, with most warning of unintended consequences if rotation is passed.

Chief among the critics are auditors, who warned rotation would raise audit costs and hurt the quality of audits as new audit firms got up to speed. Board audit committees also complained about rotation, saying it would usurp their choice over auditors, a responsibility given them by the Sarbanes-Oxley Act. And financial officers at some large companies said they might have trouble finding a new auditor at all because of the shortage of firms with necessary industry expertise.

John Biggs, former chair and CEO of the mega-retirement fund TIAA-CREF, testified in favor of rotation during hearings on audit reforms that became part of the 2002 Sarbanes Oxley Act. Rotation was left out of Sarbanes-Oxley Act in lieu of other measures to shore up auditors’ independence, such as making board audit committees rather than company managers responsible for hiring audit firms.

In Biggs’ view, the recent financial crisis shows those reforms may not be doing the job. He wrote:

“The financial collapse of 2008-2009 certainly suggests that public confidence still needs to be restored in the financial management of our banking institutions. In particular, investors have to wonder about the independence and professional skepticism of the auditing profession.”

While many have criticized sloppy underwriting by banks and securities firms and rating agencies’ lack of skepticism, they were not alone, Biggs wrote.

“Shouldn’t there have been some skeptical auditors, of say, triple-A valuations of CDO’s (collateralized debt obligations) based on sub-prime mortgages?”

Many audit committees have become more diligent about assuring the independence of their auditors since Sarbanes-Oxley was passed, Biggs said.

If rotation is not found acceptable, regulators should at least require that companies disclose how long they have had the same auditor in annual proxy statements sent to investors, he said.

This makes a great deal of sense to me. Transparency is always a good thing. I would think the accounting profession would embrace this proposal if for no other reason than to rebuild trust in the public arena.

Blog posted by Steven Mintz, aka Ethics Sage, on March 8, 2012

Michael Douglas says Gordon Gekko was wrong -- greed is not good

Do the Rich Act More Greedy than those Less well-off?

You may have heard that Michael Douglas came out earlier this week and confessed that greed is not so good after all. Some believe that two memorable lines from the 1987 movie “Wall Street” helped usher in an era of self-serving behavior by investment fund managers that led to the economic collapse in 2008 -- Greed is good and greed is right.

So, what are we to make of the fact that Douglas who played Gordon Gekko, a corporate raider who cheated innocent investors out of their savings in the original movie and 2010 sequel, has discovered the error of his character’s ways? No doubt it is a reaction to the difficult economic times and massive decline in wealth due in large part to the greedy actions of corporate managers and Wall Street investment bankers. But, in the real world do the rich act greedy in their own personal dealings or is it just play-acting portrayed in the movies?

A new study shows that while the poor might seem to have the most reason to cheat and steal, the rich are more likely to be dishonest. In a series of experiments, University of California at Berkeley researchers showed again and again that upper-class individuals were more prone to unethical behavior than people from more deprived backgrounds, according to the study published in the Proceedings of the National Academy of Sciences.

Paul Piff, a doctoral candidate and the study's lead author, says he was surprised at how little incentive it took to get high-income people to cheat.

In one study, for example, people were asked to play a game of chance online. The 195 volunteers were told that a die would be rolled for them five times and that the participants with the highest scores from the five rolls would get more credits toward a drawing for a $50 Amazon.com certificate. The researchers also told the volunteers to keep track of their own scores.

But Piff and his colleagues had designed the game so all players would end up with a score of 12. As it turns out, “the upper socio-economic status people were way more likely to report a score above 12,” says Piff. “It was fairly remarkable. You wouldn’t think that people reporting incomes of $150,000 per year and up would be so motivated to win this prize.”

In another study, the researchers asked 108 volunteers to fill out a survey online. Along with questions about their backgrounds, the volunteers were asked to imagine that they were employers who needed to hire someone at the lowest salary possible. In the hypothetical, they would get a bonus if they negotiated a low enough salary. The job was one that would last just six months.

Then they were asked what they would do if a candidate came in who was willing to work for less if he could be guaranteed the job would last two years. “Thus, if participants (acting as employers) were honest about the six-month limit of the job, chances are they wouldn’t be able to negotiate a very low salary,” Piff says. In this scenario, the wealthier participants were more likely to act unethically to get a reward.

Piff suspects that a combination of factors, including greed and a heightened sense of entitlement, are what spur the wealthy to cheat. While there are examples of rich people who are especially generous such as Warren Buffet and Bill Gates, money seems to have a deleterious effect on ethics in most cases, Piff says.

Now that I’ve explained some of the test procedures and findings, let me tackle the problem of greed in our society. I do believe we have morphed into a greedy, self-serving society. I have blogged about this issue many times before. It has become routine for people to think of themselves first and then, oftentimes only after already acting, to think about how their actions affect others.

I believe the cause of greed that is endemic in our society can be traced back to the 1960s, well before Gordon Gekko came on the scene. It was the era of the hippie movement fueled by the mantra to “do your own thing.” Hippies were not concerned with the way they were viewed by conventional society. This may sound good in principle but doesn’t work very well in practice because we are accountable to others. We do have a civic duty to act in ways that improve society by enabling others who may be less fortunate to get ahead.

Does this mean that the 1%ers are uncaring, greedy, and indifferent to the plight of others as many in the “Occupy” movement would have us believe? Some criticize Presidential hopeful Mitt Romney for just such behavior. For example, about a month ago he responded to a question about helping the poor by saying: "I'm in this race because I care about Americans. I'm not concerned about the very poor. We have a safety net there. If it needs repair, I'll fix it."

In theory there is nothing wrong with Romney’s message. He is, after all, a businessman first and his answer reflects a business approach. Unfortunately, it is lacking in compassion. This is a valid reason to criticize Romney and, I believe, what is behind the results of the Cal Berkeley study.

Perhaps the most interesting aspect of the study results is an online preference poll conducted by MSNBC after reporting the story. By no means are these results indicative of the entire population of the U.S. However, it is quite curious to have solicited the following responses.

Do you think rich people are more likely to cheat, steal or cut you off in traffic?

• Yes (71%). How do you think they got rich in the first place?
• No (4%). In my experience, rich people aren't less ethical than the poor.
• Not sure (25%). I think it depends on the person, not on the tax bracket.

I, myself, would have answered “not sure.” I do not stereotype people. There are good people and not so good people of all shapes and sizes. Goodness is an end result sought by those who act out of virtue and includes having empathy for others.

There is an old proverb that dates back to the Cherokee tribe of Native Americans, who said “Don’t judge a man until you have walked a mile in his shoes”. Nelle Harper Lee, an American authoress, was seemingly inspired by the saying of the Amerindians in her book “To Kill a Mockingbird,” where she wrote

“You never really know a man until you understand things from his point of view, until you climb into his skin and walk around in it.”

This is the most challenging part of being an American today. We have lost touch with those who are less fortunate than us; those who are struggling to make ends meet during the most trying times; and those who need a gentle push to help pull themselves up by their bootstraps.

Blog posted by Steven Mintz, aka Ethics Sage, on March 1, 2012

Fraud at Chinese Companies Raise Questions of Transparency and Oversight

SEC Brings Charges against Ming Zhao, chairman of Puda Coal Inc., and its former CEO, Liping Zhu

I have previously blogged about ethical problems in Chinese Businesses and financial reporting practices that bring into question the trustworthiness of accounting and financial reporting practices by Chinese companies. In particular, a massive fraud at Longtop Financial, a popular Chinese software company raises doubts about whether and when China will be accepted as playing by the free market rules that depend on financial accuracy and transparency.

Additional problems have been identified by federal regulators after filing civil fraud charges on February 22 against the chairman and the former CEO of a Chinese company, accusing them of duping people to invest in a coal company that was an empty shell.

According to the Associated Press, The Securities and Exchange Commission announced the charges against Ming Zhao, chairman of Puda Coal Inc., and its former CEO, Liping Zhu. The SEC said they conspired to “loot” and sell the company’s main asset, a coal mining firm.

Puda Coal’s stock traded on the New York Stock Exchange from September 2009 to August 2011. The SEC said Zhao and Zhu raised money from U.S. investors in two public stock offerings during which time they stole and sold the company’s assets before they raised more than $100 million from public investors in the United States.

Because Zhao and Zhu failed to disclose their moves in regulatory filings, the investors were unaware that Puda Coal no longer owned the coal mining firm and was a shell company with no business operations, the SEC said in a lawsuit filed in federal court in Manhattan.

Their “massive fraud ... wiped out hundreds of millions of dollars in shareholder value,” George Canellos, director of the SEC’s New York regional office, said in a statement.

The agency also alleged that Zhao and Zhu obstructed its investigation of Puda Coal, forging a letter from a large Chinese state-owned financial firm attesting that the coal company’s investors weren’t harmed by the sale of the mining firm.

The SEC is seeking unspecified fines and restitution from Zhao and Zhu, and a ban against them serving as officers or directors of any public company.

There have been troubles at several other Chinese companies, most of which went public in the U.S. through a back-door procedure known as a reverse merger that doesn’t require an initial public offering. A private company can access the public markets by buying a shell company that is already listed.

The most interesting aspect of the Puda Coal case is how easy it turned out to be to discover the fraud. It was basically spelled out in documents that were publicly available in China months before American and Canadian investment banks, advised by major law firms, raised the money from investors. But it appears no one bothered to look — not the underwriters and not the auditors.

“They charge a lot for due diligence,” says the man who uncovered the fraud, Dan David, a 43-year-old money manager from Skippack, Pa. “But they don’t do it.”

What the documents showed was laid out last week by the S.E.C. Puda’s principal asset was a coal mining company, Shanxi Puda Coal. But in 2009, chairman Zhao transferred that interest from Puda to himself. The next year, he sold a controlling interest in it to Citic.

Puda, which had gone public in the US through a merger with a shell company in 2005, did not disclose those crucial facts when, in February 2010, it raised $12.8 million selling stock to American investors, in an offering underwritten by Brean Murray, Carret & Company of New York and Newbridge Securities of Fort Lauderdale, Fla. In December 2010, a $100 million share sale was underwritten by Macquarie Capital, a Canadian firm, and Brean Murray. Investors in that offering paid $12 a share for stock that now trades for about 25 cents.

The fraud blew up last spring. On Friday, April 8, Mr. David posted his analysis on his Web site, GeoInvesting, and a similar analysis was posted on the Web site of Alfred Little, a firm that had a reputation for spotting Chinese frauds. That analysis was unsigned, but it was written by Andrew Wong, the head of the IFRA Group, a Hong Kong research firm.

“In contrast to most of the other Chinese frauds, where the business was not real, this was a profitable company that the chairman just stole,” Wong said in an interview last week. He said he had looked into the company after David asked him to review his own research.

“Incredibly,” Wong wrote in his report, “Puda’s auditor, Moore Stephens, failed to catch this theft of an entire company that is clearly documented in government ownership filings that any lawyer can obtain directly from the source.” In July, Stephens quit as the company’s auditor and said its previous audits could not be relied on.

The company’s audit committee investigated the allegations, and eventually concluded they were accurate. But there was contradictory statement by Zhao who in April produced a letter, ostensibly from Citic, saying that it had not purchased the company, and sought to reassure investors by saying he was considering taking the company private at $12 a share. Eventually, Citic said the letter was false, and the company said Mr. Zhao had admitted forging it.

The readily available documents were filed with China’s State Administration for Industry and Commerce, known as S.A.I.C., showing transactions affecting the filing companies. Chinese companies must publish lists of all their subsidiaries, and it is necessary to check filings by all the subsidiaries.

The Chinese authorities appear thus far to have shown no interest in bringing charges against the men named by the S.E.C. and, according to David, the Chinese government was restricting access to some S.A.I.C. filings and asking why people they were interested in a certain company, a fact that has scared some investigators who fear reprisals.

A basic requirement of investment markets is for investors to have a reasonable confidence that they are not being defrauded, and — if it turns out they are — that the government will seek to punish those responsible. It is quite clear to me that businesses in China have failed to establish a corporate governance system that prevents fraud from occurring and fully discloses it when it does occur. For those of you who are considering investing in Chinese companies to take advantage of their economic boom I can only offer two words of advice – caveat emptor.

Blog posted by Steven Mintz, aka Ethics Sage, on February 27, 2012

Gap Between Rich and Poor Widens

Will the Younger Generation Survive the Economic Downturn?

I have previously blogged about the wealth gap in the U.S. in the conext of the "occupy" movement. A recent study by the Pew Institute provides evidence of this disturbing trend.

The wealth gap between younger and older Americans has stretched to the widest on record, worsened by a prolonged economic downturn that has wiped out job opportunities for young adults and saddled them with housing and college debt.

The typical U.S. household headed by a person age 65 or older has a net worth 47 times greater than a household headed by someone under 35, according to an analysis of census data recently released. The 47-to-1 gap in net worth between old and young is believed by demographers to be the highest ever, even predating government records.

While people typically accumulate assets as they age, this gap is now more than double what it was in 2005 and nearly five times the 10-to-1 disparity a quarter-century ago, after adjusting for inflation.

The analysis by the Pew Research Center reflects the impact of the economic downturn, which has hit young adults particularly hard. More are pursuing college or advanced degrees, taking on debt as they wait for the job market to recover. Others are struggling to pay mortgage costs on homes now worth less than when they were bought in the housing boom.

The report casts a spotlight on a government safety net that has buoyed older Americans on Social Security and Medicare. "It makes us wonder whether the extraordinary amount of resources we spend on retirees and their health care should be at least partially reallocated to those who are hurting worse than them," said Harry Holzer, a labor economist and public policy professor at Georgetown University who called the magnitude of the gap "striking."

The median net worth of households headed by someone 65 or older was $170,494. That is 42 percent more than in 1984, when the Census Bureau first began measuring such data broken down by age. The median net worth for the younger-age households was $3,662, down by 68 percent from a quarter-century ago, according to the Pew analysis.

Because the Pew report examines households at the midpoint of the economic scale, it does not delve deeply into changes occurring at the top and bottom of the distribution. A new census measure shows the poverty rate to be higher than previously known — about 15.9 percent for Americans 65 or older, compared to the official 9 percent rate reported last September. Working-age adults ages 18-64 also saw increases in poverty — from 13.7 percent to 15.2 percent.

Nancy LeaMond, an executive vice president of AARP, noted that older Americans spend a disproportionate share of their income on out-of-pocket medical care, compared to other groups. "Millions of older Americans today continue to struggle to make ends meet," she said. "Many older Americans do own their homes, but plummeting housing values — along with dwindling savings, stagnant pensions and prolonged periods of unemployment — have taken their toll."

In all, 37 percent of younger-age households have a net worth of zero or less, nearly double the share in 1984. But among households headed by a person 65 or older, the percentage in that category has been largely unchanged at 8 percent.

While the gap in net worth has been widening gradually due to delayed marriage and increases in single parenting among young adults, the housing bust and recession have made it significantly worse.

For young adults, the main asset is their home. Their housing net worth dropped 31 percent from 1984, the result of increased debt and falling home values. In contrast, Americans 65 or older were more likely to have bought homes long before the housing boom and thus saw a 57 percent gain in housing net worth even after the bust.

Older Americans are staying in jobs longer, while young adults now face the highest unemployment since World War II. As a result, the median income of older-age households since 1967 has grown at four times the rate of those headed by the under-35 age group.

Social security benefits account for 55 percent of the annual income for older-age households, unchanged since 1984. The retirement benefits, which are indexed for inflation, have been a consistent source of income even as safety-net benefits for other groups such as low-income students have failed to keep up with rising costs.

Paul Taylor, director of Pew Social & Demographic Trends and co-author of the analysis, said the report shows that today's young adults are starting out in life in a very tough economic position. "If this pattern continues, it will call into question one of the most basic tenets of the American Dream — the idea that each generation does better than the one that came before," he said.

Other findings:

— Households headed by someone under age 35 had their median net worth reduced by 27 percent in 2009 as a result of unsecured liabilities, mostly a combination of credit card debt and student loans. No other age group had anywhere near that level of unsecured liability acting as a drag on net worth; the next closest was the 35-44 age group, at 10 percent.

— Wealth inequality is increasing within all age groups. Among the younger-age households, those living in debt have grown the fastest while the share of households with net worth of at least $250,000 edged up slightly to 2 percent. Among the older-age households, the share of households worth at least $250,000 rose to 20 percent from 8 percent in 1984; those living in debt were largely unchanged at 8 percent.

The Pew survey is a wake-up call for our elected officials that social security and Medicare must be fixed, and sooner rather than later. We are not likely to emerge from the recent economic downturn anytime soon. I believe it will take at least another five years to be anywhere close to where we were before the 2008 meltdown. That would mean a ten-year period of slow or no growth accompanied by a continued loss of jobs overseas, dependence on unreliable foreign sources of oil, and an appetite for war that seems to send our brave soldiers to the most troubled areas of the world with little chance to make a sustainable difference in how those countries are run or the quality of life for the population.

If the U.S. continues down the same path we’ve been on since Bush invaded Afghanistan and Iraq and corporate American and Wall Street took greed to an unfathomable level, then I fear this country may become susceptible to an infiltration by groups that want to destroy the American dream. Where are our politicians on these important issues? Where is the discussion and debate in the current election cycle? I’m still waiting.

Blog posted by Steven Mintz, aka Ethics Sage, on February 23, 2012

Communitarianism as a Solution to our National Divide

Virtue and Communitarianism as the Antidote to Modern Capitalism

I posted a blog last week about our inalienable right to pursue happiness and how virtuous behavior enables us to achieve that goal. One definition of virtue, based on the Aristotelian concept of dispositions or tendencies, is to be able to act in a certain way for a certain reason – for the good of man and to advance society. Virtue enables us to live rightly. Virtue requires us to not only act in particular ways, but to feel in particular ways and to act according to right reason. Traits of character such as honesty, integrity, and trustworthiness enable a person to act with virtue. Integrity is the whole of virtue in that it calls for principled behavior and the courage to not give in to pressure to do something other than what brings oneself inner happiness.

We develop virtue over time and with practice. An honest person becomes honest because he or she acts honestly in all behaviors. Lying in one instance can lead to a cover-up in the next and a gradual descent down the proverbial “ethical slippery slope.” A person becomes trustworthy because they are consistently reliable and tells the truth. To be an ethical person you can’t pick and choose when to be honest; when to act with courage; and when to do the right thing.

Our society is a community that seeks the inalienable rights of life, liberty, and the pursuit of happiness. We are a society of laws and hold up justice as the cornerstone of our legal system because it is essential to bring about liberty. The Aristotelian sense of community praises the inner goods of a life well led through virtuous behavior. We should strive for that inner feeling of having done a good thing; helped people to advance their circumstance; acted responsibly; and engaged in principled behavior.

One problem in society during the past thirty years is we have lost sight of the inner goods and focused on external goods as the road to happiness. We pursue our self-interests without due regard for the interests of others – a basic breakdown in the community that is (was) America. Our goal is to be rich, become famous, obtain power, and influence others not through virtuous behavior but by one’s position or lot in life. Throw in starring in one’s own reality TV show and you basically have an inner glimpse into the soul of America in the decade of the 2000s. Doing right has been replaced by self-gratification. Some would say we have become a nation of narcissists.

We have come to a turning point in our nation’s history. Do we continue to go down the road of hedonism that began in the 1960s when the mantra was to “do your own thing.” Or, do we follow the path of virtue and communitarianism espoused by Amiatai Etzioni to counteract the “me-first” attitude of the 1980s.

Communitarianism can establish a common ground between liberals and conservatives, thus bridging the continual divide in our country. It emphasizes the connection between the individual and the community. The movement works to strengthen the ability of all aspects of the community including the families and schools in order to introduce more positive values. In addition, it aims to get people involved in positive ways in all levels of the community and ensure that society progresses in an orderly fashion.

I have written many times before on the decay of capitalism as envisioned by Adam Smith who thought of it as a moral system. The reason is the emphasis on individualism over communitarianism – the personal good over societal good. Individualism is the view that each individual (but only individuals) has, and should regard herself as having, moral significance and inalienable rights. Communitarianism is the view that communities also have moral significance and certain rights. Modern capitalism has morphed into the belief that by acting in one’s self-interest, all benefits will trickle down throughout society. I challenge anyone to prove this to be the case.

In reflecting on the problems of capitalism today I am reminded of something once said by Gandhi: “Capitalism as such is not evil; it is the wrong use that is evil.”

Blog posted by Steven Mintz, aka Ethics Sage, on February 9, 2012

Republicans Ready to Obstruct Obama’s Housing Plan

John “no can do; no way” Boehner Exemplifies Ignorance and Insensitivity of Republicans

Speaker of the House John Boehner (R-OH) reacted negatively (no surprise there) and insensitively (less of a surprise) to the news that President Obama is proposing new legislation that would expand on a refinancing plan announced last October by directing federal mortgage giants Fannie Mae and Freddie Mac to allow refinancing for mortgage-holders even if their homes are underwater by any amount. But the plan could not be offered to homeowners with mortgages privately held by banks. The new legislation would allow those homeowners to refinance as well, with the associated costs covered by a fee on major lenders.

Boehner criticizes the plan because “none of the president’s previous proposals to help the housing market has worked.” That may be true and the Obama administration is to blame. However, what Boehner doesn’t seem to get is the current proposal is designed to help homeowners with underwater mortgages that have been making their monthly payments on time and are up to date. While previous plans also were designed to help homeowners with underwater mortgages, the loan-to-house-value was limited to 125%. That covers only a small percentage of homeowners who have watched while home values have tanked during the past four years.

I am one of those with a loan-to-house-value greater than 125%. My FICO score is above 800. Yet, I can’t refinance and take advantage of historically low interest rates because of the arbitrary loan-to-house value limitation of the current program.

Homeowners like me have played by the rules whereas other targeted plans to help homeowners were designed to help those in foreclosure by reducing the principal so it becomes a “freebie” for the homeowner, or lower the interest rate. These folks have not played by the rules because they missed payments or just decided not to make them yet these are the folks helped by current government mortgage assistance programs. The problem here is most of these homeowners have gone through or are at the door of foreclosure and in no position to continue to make mortgage payments even after loan modification.

Speaker Boehner, I ask whether you have ever heard of “moral hazard?” Moral hazard occurs when a party protected from risk behaves differently than it would if it were fully exposed to the risk. It arises because an individual or organization does not take full responsibility for its actions so that the consequences of bad behavior do not befall on that party. Instead, responsibility passes to another party (the banks; the public) that covers the cost of the risky behavior. The recent bailout of troubled homeowners in foreclosure is an example of moral hazard.

Why should a homeowner who can stop making payments and modify their loans continue to make the payments? In fact, there is a whole new cottage industry that has been created to help such homeowners skirt their responsibilities. The best known is “Strategic Default.”

Homeowners like me are not asking for a bailout or loan modification. We simply ask for fairness – a subject that is anathema to Republicans. We simply ask to be able to refinance our underwater mortgages without being told by Fannie or Freddie that we can’t because the loan-to-home value is greater than 125%. We simply ask to be able to take advantage of today’s historically low interest rates just like homeowners in foreclosure.

I believe President Obama missed the boat to turn around the economy in the first few months of his administration with regard to housing because programs were developed to help those who, at best, would be in a marginally better position to pay their mortgages on time. Moreover, whatever money they saved on monthly payments after loan modification was probably used to keep them out of any future foreclosure situation. That doesn’t help to stimulate the economy and provide the necessary boost  through an improved housing situation. What’s worse is it simply delays the foreclosure process that is needed before home values can start to recover.

Those of us patiently waiting during the past four years for some help know that the money we save on our monthly payments will be used in large part to stimulate the economy and the economic effect will be ten times greater than heretofore. We are the ones who have paid our monthly mortgages on time and will use the money to buy things. You know, maybe do that home remodeling project long delayed and help create jobs in housing and construction. Maybe we’ll buy a new flat screen TV or computer and provide jobs in the private sector.  Isn’t that what we need to jump-start the economy? We are the ones who will do it because we have the financial wherewithal to continue making our mortgage payments without government assistance.

The Republicans have become so blinded by their desire to defeat President Obama that they have lost touch with average Americans. They think they know what is best for us, but it seems to me they are more concerned with things like the banks having to absorb the money lost by administering the new housing program by paying a fee. Their raison d'être is to beat Obama without regard to how their intransigence harms the average American.

The mind set of Republicans reminds me of an old Zen saying:  “If you understand, things are just as they are; if you do not understand, things are just as they are.”

Blog posted by Steven Mintz, aka Ethics Sage, on February 6, 2012

KPMG Disclaims an Audit Opinion on Chinese Company

Ethical Culture of Chinese Businesses Raise Doubts about Financial Reports

Chinese-style western capitalism has been spreading to virtually every continent as China seeks to form joint ventures in Africa, South America, and elsewhere to ensure reliable access to needed natural resources to feed China’s hunger for economic growth and development. In recent years it has spread its “currency reserve wings” into the US through Chinese state-owned and private enterprises. The question for the investing public is whether Chinese financial statements can be relied on and, correspondingly, whether Chinese businesses can be trusted as they flex their economic muscle. A good example of the perils of outright trust is Sino-Forest Corp., a Chinese company that was charged with allegations of accounting abuses and fraud, burning investors including John Paulson, the billionaire whose hedge fund said in June it lost $468 million on Sino-Forest.

I have previously addressed the growing questions about Chinese accounting principles and the reliability of the financial statements produced by state-owned and private enterprises. I called it "The Dark Side of Chinese Capitalism". I've also looked at regulation of Chinese companies doing business in the US. In this blog I look at a recent event where the Big-4 international accounting firm, KPMG, withdrew from the audit of a Chinese company because it couldn't trust the information provided for those reports.

Just last week it was announced that after issuing a “disclaimer of opinion” with respect to China Forestry Holdings’ financial statements for the year ended December 31, 2010, KPMG has opted not to stand for reappointment as the company’s auditor. KPMG resigned as auditors of the Company as of January 5, China Forestry disclosed to the Hong Kong Stock Exchange.

First, let me dispense with a disclaimer of opinion. According to generally accepted auditing standards, an auditor should not issue such an opinion unless the firm has been unable to gather a sufficient amount of credible evidence to support the numbers in the financial statements prepared by company management. KPMG’s disclaimer “was due to the irregularities we identified during our audit and limitation in the scope of our work,” KPMG told the company in a letter.

Scope restrictions are a valid reason for a disclaimer. I’m more concerned about the former – irregularities found during an audit. My concern is not so much from an audit opinion perspective but whether the ethical culture of Chinese companies is such that American investors should follow the old adage when contemplating investment in Chinese companies – “buyer beware”.

Returning to China Forestry, the company describes itself as “one of the three largest, privately-held, naturally regenerated and plantation forest operators in China”. On its website, it claims to own and operate more than 171,000 hectares of forest land in Yunan and Sichuan provinces. It reported a loss of RMB2.7 billion (US$429 million) in 2010, in the report that KPMG issued a disclaimer of opinion.

The company admitted that for the 2011 financial year, KPMG asked that “a number of other matters will need to be resolved”. These are verification of the ownership and valuation of plantation assets, valuation of lease prepayments, valuation and ownership of inventories of logs and related sales and purchase transactions, and estimation of payables for plantation assets and taxation matters. In other words, the accuracy and reliability of all company financial statements are in doubt. China Forestry had apparently not come through on these demands, resulting in KPMG’s decision to resign.

When I look at the way Chinese companies are run I am not surprised by the increasing level of disclosure of financial wrongdoing. I find that Chinese companies have not built a strong ethical base in their state-owned and private companies. Chinese companies are not used to being questioned about what they do and why they do it because they existed so long under the Chinese communist system where the government ran the businesses. Moreover, secrecy is an important value in Chinese society so their perspective is to disclose as little as possible about a company’s financial status. Contrast that with the full disclosure notion for US companies and you can see why there is what I call a “believability GAP” in Chinese financial reports.

In the US and all western-style capitalist nations, internal controls are the bedrock of accurate and reliable financial reports. In China, the notion of internal controls has yet to take hold as questions of management about their controls can meet with stares of mistrust about the motives of an auditor who questions the believability of the financial statements.

The next great financial scandal may be waiting in the wings with respect to financial statements by Chinese businesses. In a sense the expansion of capitalism and potential for greed is one step ahead of developing and enforcing rules to prevent such occurrences and creating the kind of ethical culture that helps to prevent fraudulent financial reporting.

Blog posted by Steve Mintz, aka Ethics Sage, on January 9, 2012

Financial Statement Fraud at Olympus

Japanese Cultural Values May Have Enabled the Cover-up of Fraud

Most financial statement frauds extend for about 3-5 years before someone blows the whistle, the company makes a mistake, or it all catches up with them as the house of cards that built the fraud collapses. Not at Olympus Corporation, the Japanese maker of cameras and medical imaging equipment, where the fraud lasted more than two decades.

The Olympus fraud has a real life whistle-blower – Michael C. Woodford – the newly appointed president and CEO at the time of the fraud. It is quite unusual for the top manager to blow the whistle on his company’s fraud; kudos to Woodford for doing the right thing.

It turns out the motivating factor for the fraud was an effort to make the company’s books accurate — at least in terms of its balance sheet — that led to the suspicious transactions noticed by Woodford. He thought they showed theft from the company by its chairman, and he confronted him. Instead, the chairman had only tried to clean up an accounting mess without damaging the reputation of Olympus. The chairman felt there was no need to tell Woodford about what had happened because the fraud was finally behind the company when Woodford took the job.

New York Times reporter Floyd Norris points out that a report by an investigating committee shows that two changes in accounting rules, one caused by the Enron scandal, eventually led to the collapse of the scheme. It shows that KPMG AZSA, the Japanese affiliate of the international accounting group, failed to notice what was going on for years but finally did complain about the somewhat clumsy transactions intended to put the losses on Olympus’s books. Ernst & Young Sjin Nihon, a Japanese affiliate of that network, was brought in and did sign off.

The scandal also highlights the controversy over mark-to-market accounting. The Financial Accounting Standards Board (FASB), the U.S. accounting standard-setter, started to require it for some financial instruments in 1997. However, the fraud had begun seven years earlier so covering up the losses was easy. One reason is took so long to uncover the fraud was  at the time accounting rules in Japan, as well as in other countries, allowed investments to be carried at cost. Theoretically, there should eventually have been a write-down to a lower market value, but there never was.

At Olympus, it appears the company held at hope that with additional risky investments, the losses could somehow be made up. They were not. Over time, the company tried securities speculation and private equity investing in promising start-up companies. It didn’t work and eventually the losses grew to more than $1 billion.

Olympus seems to have been content to sit on the losses until 1997, when accounting rules required some investments had to be marked to market. To hide the fraud, the company developed a plan to “sell” the losing investments, at original cost, to shell companies (off-balance-sheet-entities) set up by Olympus for that purpose. The sales were financed with loans from banks, which received cash from Olympus to secure the loans. Under lenient accounting rules at the time, those shell companies did not have to be consolidated with Olympus, so the losses could remain hidden. These rules were tightened after the Enron fiasco.

The plan was to phase out the losses, either by more investments or through overpriced acquisitions, with the extra cost of the acquisitions going to the off-balance-sheet-entities to make them whole. That was done through a variety of means, one of which was retaining the shell companies as high-priced investment advisers. The “cost” would appear on the company’s balance sheet as good will, and eventually written off. When that was done, the balance sheet would show an accurate value for Olympus.

From 1999 to 2003, Olympus managed to get out of some losses, or at least to convert them to good will. No one outside the company was the wiser. KPMG, the auditor, did not notice, the committee report says, in part because some of the information it received was false.

However, in 2003 the FASB changed the rules for off-balance-sheet entities controlled by sponsoring entities (i.e., Olympus) so that these entities would have to be consolidated on the sponsor’s books and losses could no longer be hidden. One of Olympus’ ways to manufacture phony profits was to “sell” assets to the off-balance-sheet entities it controlled, and to book profits on those sales. That technique was negated by the new rules.

In Japan, the rules changed in 2007 and the fraud started to unravel. The off-balance-sheet-entities would have to be consolidated. Olympus had until March 31, 2008, the end of its fiscal year, to clean up its books. Efforts to continue to hide the fraud fell apart when in April of that year Woodford became president and chief executive in September. He was told to not worry about such history, but he did. With the assistance of PricewaterhouseCoopers, he unraveled the transactions but not their purpose, and concluded that company money was being stolen. He confronted the chairman and was fired. He forced an investigation, which resulted in the December 2011 report.

The report says the top officers of Olympus knew what was going on throughout and that new presidents always accepted the decisions made by their predecessors. It does not say why Woodford evidently was not told, but some have speculated that it was some combination of not trusting a foreigner who had not worked in Japan and a belief that, with the balance sheet now reflecting reality, there was no need to involve him.

On December 20, 2011 -- nearly two months after Woodford blew the whistle -- Japanese authorities raided the company’s headquarters in Tokyo, emerging several hours later with boxes of documents. The company’s stock market value had already dropped by 50 percent. Foreign investors had started to question the culture of old-style Japanese companies that attempt to thwart disclosures of negative information.

The eventual Olympus salvage plan could be a Japan-wide effort. Last week, the Nikkei business daily reported that Olympus might issue about 100 billion yen (about $1.3 billion) in new preferred shares, and that Japanese technology companies like Fujifilm or Sony might be possible buyers. Those two companies, though, denied that any such investment was in the works.

Top Olympus executives acknowledged in November 2011 that the company had conducted a decades-long effort to cover up $1.7 billion in investment losses in a global scheme that sparked public investigations on three continents. Last month, Olympus acknowledged some of the losses in five years’ worth of revised statements. Three executives implicated in the scheme have left the company. But the rest of the Olympus board has been scrambling to retain control. Backing them are the country’s biggest banks, which have significant influence over top Japanese corporations, serving as major lenders and as major shareholders.

The ethics lesson to be learned from the Olympus affair is that a lack of underlying ethical values trumps full disclosure even in the post-Enron era of transparency. In fact, underlying cultural values such as secrecy may continue to rule the day in countries like Japan that seem to place not “losing face” ahead of ethical values such as full disclosure and the rights of investors and creditors to be fully informed about both good and bad financial dealings.

Blog posted by Steven Mintz, aka Ethics Sage, on January 6, 2012  

Has Andrea Jung Been Treated Ethically by Avon Products?

Longest-serving Female CEO to Continue as Executive Chairman of Avon

You may have heard by now that Avon Products CEO Andrea Jung, the longest-serving female CEO currently in the Fortune 500, will depart as CEO of the company but stay on as executive chairman thereby dividing the two roles. There has been a great deal of criticism of her decision to stay on for at least two years as executive chairman.

Some former board members fear that her continued presence would make it hard to attract a new leader. According to Wall Street Journal reporters Hannah Karp and Joann Lublin, James Preston, once one of Jung's closest mentors, took the unusual step of writing a letter to the board two days after the shake-up. He criticized Jung's leadership, stressed that departing CEOs should step aside and called on the board to replace her with someone with deep experience in the direct-selling world.

"I have long held the belief that once a CEO leaves that position, he or she should make a 'clean break' and not question or second-guess the actions of his successor," wrote Preston, who ran Avon from 1989 to 1998. "I have held true to that belief, even though in recent years I have become increasingly concerned—and saddened—by the declining fortunes of the company."

Fred Hassan, Avon's independent lead director, defended having Jung remain executive chairman for two years after the new CEO arrives. "Given the specific nature of the company and the specific nature of the board, we have very strong confidence that we can make this transition work”.

Ms. Jung was lauded by investors for her management of Avon during the early part of her tenure but more recently she has come under fire for generating poor results. The board last month succumbed to the growing criticism after Avon reported a disastrous third-quarter earnings report, tossed out its sales targets as unreachable, and said it faces a pair of SEC inquiries. The company's stock is down about 40% this year.

Avon has been the subject of an SEC investigation since 2008 for possible violations of the Foreign Corrupt Practices Act including bribing officials overseas. The inquiry began with Avon’s operation in China and has now spread to a number of other countries where its beauty products are sold, a $10 billion annual business. The SEC is looking into “travel, entertainment, gifts, use of third-party vendors and consultants and related due diligence, joint ventures and acquisitions, and payments to third-party agents and others.” Still, no action has been taken against the company by the SEC.

Historically, from a corporate governance perspective, it has not been uncommon for the same person to wear both hats – chairman of the board and CEO. After all, the CEO needs to sit on the board to answer questions about a company’s operations and explain recent actions and those going forward. It is also true that recently it has become more common to split these roles in the aftermath of the accounting frauds at companies such as Enron, WorldCom, and Tyco and the passage of the Sarbanes-Oxley Act. Indeed, the New York Stock Exchange requires such independence-inducing action.

In 2004, only 27% of the companies in the S&P 500 had split the roles of chairman and CEO between two individuals.  In 2011, 40% of the S&P 500 companies have appointed a separate board chairman to serve alongside the CEO on the board.  Furthermore, about a fifth of all S&P 500 companies now have an independent board chairman, up from under a tenth in 2004. This trend may have accelerated in part because the SEC and the Dodd-Frank Act now require public companies to explain to investors their reasoning behind either appointing an independent chair or allowing the CEO to handle both jobs in the boardroom.

In evaluating the ethics of the treatment of Andrea Jung we must recognize that Jung is no slouch. In addition to being the longest-serving female CEO currently in the Fortune 500, she also sits on the boards of Apple and GE.  Prior to joining Avon, Jung was executive vice president of Neiman Marcus and senior vice president, general merchandising manager, for I. Magnin. In other words she knows about women beauty products.

Jung joined Avon in 1994 as the company's president in its product marketing group. She became president of global marketing in 1996 and executive vice president/president of global marketing and new business in 1997. She has been on the company's board of directors since 1998. In November 1999, Jung was promoted to chairman and CEO.  

I have to question James Preston’s criticism of his successor at Avon. Preston served as Chairman of the Board from 1989 to May 6, 1999, and Chairman and CEO from 1989 to June 1998. The fact that Jung will continue as executive chair may be nothing more than a useful way to smooth the transition. It has also been reported that Jung wants to help identify a qualified woman to take on the role of CEO. I can understand her position given the nature of the products sold by Avon.

Let’s also recognize that while women have made some progress in assuming CEO roles in corporate America, they still have made little progress in breaking the glass ceiling on corporate boards of directors. Jung may have a spotty record of success but there is no denying the decline in profits and stock price is a reflection of our continued economic woes and it’s no surprise that women’s beauty products have been significantly affected during the decline.

Blog posted by Steven Mintz, aka Ethics Sage, on January 2, 2012

The Ethics of Fracking

A Cost-benefit Analysis of Fracking

I always tell my ethics students that there are two sides to every issue from an ethical perspective and they need to identify both in making a cogent argument for or against a particular action or decision. Oftentimes the ethical issues are subtle; they don’t jump out at you. A good example is fracking.

Fracking, which is short for ‘hydraulic fracturing,’ refers to a method of recovering oil and gas from shale rock. Here is how it works. An oil company would drill down and then push under great pressure liquids sideways into oil and gas-rich shale rock. Millions of gallons of water, mixed with brine or chemicals, is injected into the shale and the resulting pressure fractures the rock layers which releases natural gas or oil. A proppant (propping agent), usually sand, is injected into the fractures to keep the fissures open and the oil or gas flowing.

According to the Interstate Oil and Gas Compact Commission, 90 percent of all oil and gas wells in the U.S. are “fracked” to boost production. Fracking usually occurs just after a new well is drilled, but many wells are fractured numerous times to get as much production out of a profitable site as possible.

Fracking is controversial because the chemicals, mixed with water, may find their way into aquifers which supply drinking water. Oil companies say that fracking is safe and poses no threat to drinking water. Right now, few groups are calling for an outright ban on fracking. However, shareholders want companies to issue full disclosure about individual fracking operations and the chemicals used during the process. Some companies counter that they already abide by environmental laws and regulations and that further disclosure is not necessary.

Shareholders of two large gas producers — ExxonMobil, and Chevron - recently voted not to require company officials to disclose more information about fracking. Exxon and Chevron had urged shareholders to vote against disclosure. Even so, 30 percent of ExxonMobil shareholders and 41 percent of Chevron shareholders voted for increased disclosure.  ExxonMobil spokeswoman Karen Matusic said that while the company supports the disclosure of chemical composition of hydraulic fracturing fluid, management has urged shareholders to vote against the activists’ resolution. “We believe state-level oversight of oil and gas operations, including hydraulic fracturing, is the most effective approach for protecting human health and the environment, since it best accounts for local geology and other local factors,” she said.

The public has a right to be concerned about fracking. Last July thousands of gallons of fracking fluid spilled following an accident at a natural gas well in Pennsylvania. The well blew near the surface, spilling thousands of gallons of frack fluid over containment walls, through fields, personal property and farms, even where cattle continue to graze.

Two weeks ago the EPA found that compounds likely associated with fracking chemicals had been detected in the groundwater beneath Pavillion, a small community in central Wyoming where residents say their well water reeks of chemicals. The fracking occurred below the level of the drinking water aquifer and close to water wells, the EPA said. The EPA did emphasize that the findings are specific to the Pavillion area. The agency said the fracking that occurred in Pavillion differed from fracking methods used elsewhere in regions with different geological characteristics. Elsewhere, drilling is more remote and fracking occurs much deeper than the level of groundwater that would normally be used.

There are those who support fracking including landowners who have the most to lose if royalties stop flowing because of restrictions on fracking. Some landowners — such as a group with more than 10,000 acres combined in Oneida and Madison counties in New York State — have formed a formal partnership aiming to allow hydrofracking on their land, but they want control how it’s done.

From an ethical perspective we might look at the harms and benefits of fracking. In other words, do the potential dangers of fracking, including contamination of water supplies, outweigh the potential benefits of producing badly needed oil and gas resources at a time when our national security may be in jeopardy because of our continued reliance on unreliable sources of energy. Is U.S. energy independence more important than the potential for harm to those affected by fracking procedures? Do jobs and economic growth trump health and safety concerns?

There can be no doubt that additional studies are needed, more tests must be done, and the industry should be better regulated. (In 2005 the Bush administration chose to keep the industry virtually unregulated). In the meantime, why not release all available information to the public about safety risks and let the public decide? Full disclosure is a basic tenet of ethical behavior. From a “Rights Theory” perspective, those potentially affected by fracking operations have an ethical right to know about the potential harm to their drinking water and other environmental effects.

Energy decisions abound where safety versus economic benefits are pitted against each other. We have been debating the issue for years with respect to offshore oil drilling and now the debate focuses on whether we should extend the Keystone Pipeline that would carry 830,000 barrels a day of crude oil from northern Alberta to refineries on the Gulf Coast of Texas, crossing the U.S. states of Montana, South Dakota, Nebraska, Oklahoma, Texas and Kansas.

The bottom line on these issues, including practices such as fracking that has transformed the U.S. energy industry, is that energy independence comes at a cost. Increasingly, we as Americans, will be faced with tradeoff-decisions between sacrificing some health and safety concerns in the name of providing economic benefits, including jobs and increasing exports to countries like China that crave safer natural gas energy supplies for its growing economy. It’s a painful decision but one that must be made. We need a national conversation on the issue but, regrettably, the issue is largely on the back-burner this election cycle.

Blog posted by Steven Mintz, aka Ethics Sage, on December 19, 2011

Unintended Consequences of Occupy Movement

Port Disruptions Not the Way to Go for the Occupy Movement

Some believe the Occupy Wall Street movement seems to be all about socially engineering our country so that the rich get poorer and the poor get richer. Certainly, there are those in the movement who believe in a more socialistic society and wealth redistribution. Personally, I don’t think this was the genesis of the movement. It was to speak out about corporate greed and hold banks and investment firms accountable for the financial meltdown of 2008 that still causes pain for so many. Nevertheless, a valid question to ask is what motivates the hard core protesters that remain and disrupt work at ports of entry and block roads and streets.

Just this past Monday, thousands of demonstrators forced shipping terminals in Oakland, Portland, and Longview, Washington, to halt parts of their operations. Protesters claim they targeted the ports to focus on the "economic engines for the elite." Protesters are most upset by two West Coast companies: port operator SSA Marine and grain exporter EGT. Investment banking giant Goldman Sachs Group Inc. owns a major stake in SSA Marine and has been a frequent target of protesters.

Demonstrators say they are standing up for workers against the port companies, which have had recent high-profile clashes with union workers. Longshoremen in Longview, for example, have had a longstanding dispute with EGT, which employs workers from a different union to staff its terminal. The longshoremen's union says the jobs rightfully belong to them.

I’ve been a strong supporter of the Occupy movement from the beginning based on its message of protesting greed and the growing inequality of incomes in society caused mainly by the rich, such as corporate CEOs, earning millions while the average working Americans' wages stay stagnant or decline. Moreover, some CEOs earn millions in severance packages even after their company has failed. There is no denying the actions of banks and financial institutions, aided by government-sponsored entities such as Fannie Mae and Freddie Mac, created a housing bubble that has cut personal wealth by 50% in some cases. Those actions also have contributed to our persistently high jobless rate and disgruntled workers leaving the workforce.

The other side of the issue is that protesters have to think carefully about how their actions affect others – a basic tenet of ethical behavior. By disrupting work at ports and in business communities they may get their message across and bring attention to their cause but it may lead to business slowdowns that ultimately cost jobs and other economic costs.

Few consider the strain the protests put on municipal government. Police details are costly with police union’s often demanding overtime pay for such assignments. In New York City alone, the NYPD reported $2 million in extra security costs due to the protests. Atlanta estimated its costs for policing its own homegrown Occupy movement at $300,000. Oakland, the site of the most violence, claimed costs of $700,000.

Local businesses feel the costs as customers seek alternatives. Unfortunately, it seems the small businesses are hurt the most – the very groups we should be supporting during the economic downturn.

These are “unintended consequences” of the Occupy movement and that seem to be negatively affecting public support for the cause. According to a Gallup Poll taken November 19-20, support for the movement declined from the previous month from 25% to 20% while disapproval went from 20% to 31%. It’s quite possible the results will be lower when the next poll is taken.

I believe the Occupy movement has to take it to the next level and identify positive changes in the way our economy is run. Be a force for change, not disruption. It’s one thing to constantly stare down the opposition. It’s another to formulate solutions to the very problems the movement protests against. And, find a way to get your message across without disrupting the normal flow of economic activity and hurting the very people we should be helping.

Blog posted by Steven Mintz, aka Ethics Sage, on December 15, 2011

Is Corzine a Fraudster or just Incompetent?

Corzine Feigns Ignorance in Questioning about MF Global

Is Jon S. Corzine, the former U.S. Senator, New Jersey governor, and Goldman Sachs CEO, a fraudster who is trying to absolve himself of any responsibility for the meltdown at MF Global by feigning ignorance, OR is he the most incompetent CEO ever to come out of the C-Suite? You make the call.

MF Global filed for bankruptcy protection on October 31 after a disastrous bet on European government debt. In just a week, stock investors lost about $585 million. More than $600 million in clients' money is still missing. Regulators say MF Global moved the money out of client accounts within days as the firm's cash dried up.

MF Global didn't list the European debt on its balance sheet for all to see. Instead, those holdings were shifted to the company's "off-balance sheet," deep in its financial statements. Some separate filings with regulators excluded the European debt entirely.

Under a 2002 anti-corporate fraud law (Sarbanes-Oxley Act) — which Corzine co-wrote as a U.S. senator — CEOs of public companies must personally certify the accuracy of their company's financial statements. If client money was used by the firm for its own purposes, Corzine could be held responsible, according to Thomas Ajamie, an attorney who specializes in financial fraud cases. "That would be the house gambling with customers' money," Ajamie said.

The direct costs of the failure include $1.2 billion in supposedly segregated retail investor accounts that have not been identified and 2,900 people lost their jobs. The real costs go way beyond and include a further rupturing of the trust in the securities industry on the part of the American public and concerns about whether our regulatory systems are capable of monitoring banks and securities firms to identify problem firms while the fraud is occurring and take action against such firms after the fact.

Corzine appeared before Congress last Thursday having been subpoenaed to testify about his role as the former CEO of MF Global. Here are some of Corzine’s explanations and responses to questions from the Congressional panel. It’s worth noting that Lawmakers had previously heard from farmers, ranchers and small-business owners who are missing money deposited with the firm. Agricultural businesses use brokerage firms to help reduce their risks in an industry vulnerable to swings in oil, corn and other commodity prices.

• In his prepared testimony submitted before the hearing, Corzine said he could not explain what happened to “many hundreds of millions of dollars” that the firm was holding for customers. "I simply do not know where the money is, or why the accounts have not been reconciled to date," he told the House Agriculture Committee, adding that he was "stunned" when he heard of the missing funds.
• Under pointed questioning by members of the House Committee, Corzine said he “would not rule out the possibility that someone at the firm misinterpreted him as suggesting that the struggling firm tap into investors’ funds.”
• Asked why there was a shortfall in customer funds, Corzine said that “many transactions… occurred in those last chaotic days.” He said he was not aware of all of those transactions and that “as a consequence it would be very hard for me to speculate why or where that shortfall took place.”
• Asked if he authorized a transfer of customer funds, Corzine responded, “I never intended to break any rules, whether it dealt with the segregation rules or any of the other rules that are applicable.”
• When asked if he was aware of any transfers, authorized or unauthorized, out of customer accounts, Corzine said, “I’m not in a position, given the number of transactions, to know anything specifically about the movement of any specific funds.”

Janet Tavakoli, an expert on the transactions MF Global specialized in, said Corzine's remarks seemed to divert attention from the firm's fundamental flaw under his leadership: It lacked the cash to cover its bets after investors started to fear that a major European nation would default.

Rep. David Scott, D-Ga., said it was the "height of disbelief" to think that Corzine knew nothing about the $1.2 billion. "We've got to get better answers from you because you [were] the CEO," he said. Rep. Tim Johnson, R-Ill., said that "people who live in the real world" have "suffered dramatically" from MF Global's downfall, and he asked Corzine whether he'd be willing to pay back those people with his own personal fortune. Corzine dodged the question, saying he was confident the money would be found. Seriously?

In his testimony to the House Agriculture Committee, Corzine sought to deflect blame for the company's collapse, arguing that he inherited a firm already doomed by his predecessors' bad financial decisions. Let me get this straight. Here is a former Senator, Governor, and CEO of Goldman Sachs taking a position as CEO of a failing company. Why would he do that? It doesn’t pass the smell test unless he saw it as a vehicle to stoke the burning fire that is his ego. Perhaps Corzine saw it as a way to personally enrich himself and he didn’t consider the possible consequences of his actions. That seems to be a recurring theme in the business frauds and financial meltdown that has plagued our country since the late 1990s.

Blog posted by Steven Mintz, aka Ethics Sage, on December 12, 2011

Is Ethical Capitalism an Oxymoron?

Is Capitalism a Moral Economic System?

I write an opinion editorial for the Pacific Coast Business Times, a business publication covering the three-county area of Los Angeles, Ventura, and San Luis Obispo. Today's blog appeared in the Pacific Coast Business Times on December 2.

It is quite popular these days to reflect on whether capitalism as an economic system does more harm than good. Critics of capitalism, such as those in the “Occupy Wall Street” movement, claim that the actions of corporate America and Wall Street investment firms contributed to the financial meltdown in 2008 that still affects our ability to recover economically. I have previously written about corporate greed when I supported the OWS movement in an opinion editorial in the Business Times on October 21.

Can capitalism be an ethical system that promotes economic growth and improves the economic standing of all in society? In other words, can the actions of the managers of a corporation (e.g. the CEO and CFO) still lead to the maximization of shareholder wealth and “trickle down” to benefit all of society?

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.

I believe that what is missing from business today is ethical decision making. We must ask: What are the rights of shareholders and other stakeholders, including employees, customers, suppliers and the general public, and what are the obligations of CEOs and boards of directors to these parties?

The nature of the present economic crisis illustrates the need for departures from uncontrolled self-dealing for the good of society. Smith had a diagnosis for this: he called such promoters of excessive risk in search of profits "prodigals and projectors,” an appropriate description of many of the promoters of credit default swaps and sub-prime mortgages in the recent past. Yet, more government regulation is not the answer. The fact is we cannot regulate ethical behavior. It comes from within each one of us as individuals and corporate managers who are supposed to act as agents for shareholders.

The Josephson Institute of Ethics identifies six pillars of character. I believe there are Six Pillars of Ethical Capitalism: honesty, trustworthiness, fairness, integrity, responsibility (and accountability), and civic virtue.

Honesty

• Do not lie or deceive stakeholders in conducting business operations
• Fully disclose all the information that stakeholders have a right to know

Trustworthiness

• Act in a reliable manner by exercising diligence in business decision making
• Be consistent and dependable in word and deed

Fairness

• Judge performance in the workplace in an unbiased manner
• Act in accordance with established standards of behavior (i.e. code of conduct)

Integrity

• Keep promises and carry through decisions with ethical action
• Act to prevent improper behavior or to stop it once it has been detected

Responsibility

• Meet obligations to stakeholders
• Accept the consequences of decisions and act to improve corporate behavior

Civic virtue

• Follow the laws and customs of society
• Act in a socially responsible manner

It has been more than forty years since Milton Friedman proclaimed in his in seminal piece, “The Social Responsibility of Business is to Increase Profits,” that any businessman who thinks a corporation should take “seriously its responsibilities for providing employment, eliminating discrimination, avoiding pollution and whatever else” was “preaching pure an unadulterated  socialism.” I suppose this is the basis for criticisms by Republicans of the OWS movement.

Friedman later wrote in his book Capitalism and Freedom that in society, "there is one and only one social responsibility of business–to use it resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud."

This is precisely the problem – fraud has been rampant in corporate America for years going back, at least in recent history, to the late 1980s and the failure of 1,043 savings and loan institutions that cost the public about $150 billion. Fast forward to the late 1990s and early 2000s when massive accounting frauds at companies such as Enron, WorldCom and dozens more wiped out hundreds of billions of dollars in corporate assets, shareholder and personal wealth. Just a few years later the financial system collapsed under the weight of self-serving, manipulative actions that were designed to enrich the few at the cost of the many (99%ers)?

The problem today is that we have lost our moral compass. Nowhere is this more apparent than in corporate America.  Ethical standards of behavior are set aside for the pursuit of self-interest. Reliable financial reporting is lost in the fog of misinformation and the ambiguous reporting of facts. The traditional notion of corporate social responsibility has morphed into a belief that if the rich simply get richer, all of society will benefit because the movers and shakers in the corporate world will then invest their “hard earned” money in creating jobs and advancing economic development. Anyone who believes this is quite naïve.

The answer to our national dilemma is to first agree on what are the standards of behavior for corporations – the engines of economic development in America and across the world? I don’t mean corporations as entities; instead, my standards apply to the managers of such businesses. It is with this goal in mind that I submit my “Six Pillars of Corporate Character.”

Blog posted by Steven Mintz, aka Ethics Sage, on December 8, 2011

 

The G(ing)RI[N]CH who stole Christmas

Newt Says: Poor kids don't work "unless it's illegal"

“I think I’m going to be the nominee, proclaimed Newt Gingrich.” All I can say is “OMG.” Has the Republican Party totally lost its collective minds? Do they WANT to lose to President Obama?

With the holiday season upon us, the G(ing)RI[N]CH who stole Christmas boasted to ABC news "It's very hard not to look at the recent polls and think that the odds are very high I'm going to be the nominee." Thanks, Newt, for spoiling all my post-holiday primaries fun.

Newt Gringrich is the G(ing)RI[N]CH who stole Christmas for a number of reasons but the one that irks me most are the comments he made at a pit stop in Iowa last week that: "really poor children have bad work habits and no knowledge of how to make an income unless it’s illegal." In case you missed it, here is the "best" of Newt. I’d say his comments are akin to an outtake in the screening of a movie but, I’m afraid, for Newt it’s truly an in-take.

Newt proclaimed that children in poor neighborhoods should be employed as janitors in schools and argued that "the best way to teach children in poor neighborhoods good working habits is to put them to work as soon as possible. Start with the following two facts, really poor children in really poor neighborhoods have no habits of working and have nobody around them who works, so they literally have no habit of showing up on Monday. They have no habit of staying all day. They have no habit of ‘I do this and you give me cash’ unless it’s illegal."

Gingrich said every successful person he knows started working at an early age in explaining his position that schools should hire poor children in their neighborhoods for part-time jobs as assistant librarians or assistant janitors. Seriously?

Newt, have you ever heard of Oprah Winfrey? She grew up in poverty. I don’t think she was a janitor growing up. Instead, she grew up in an abusive household and ran away at home at the age of 13. She worked hard in school aided by the Upward Bound program. Her story is one of going from rags to riches formed by hard work in school and a determination to succeed.  Born into abject poverty in rural Mississippi, Winfrey went from being a young girl clothed in potato sacks to the richest and most powerful female media mogul in the world.  She has been ranked the richest African American of the 20th century and the greatest black philanthropist in American history. YOU SEE, NEWT, POOR KIDS CAN RAISE THEMSELVES BY THEIR BOOTSTRAPS IF GIVEN THE CHANCE AND SUPPORTED BY WELL-THOUGHT-OUT  SOCIETAL PROGRAMS AND THE AMERICAN PEOPLE!

Here’s a bit about Gingrich’s early years. He was raised in Hummelstown near Harrisburg, Pennsylvania, and on military bases. Today, the median family income in Hummelstown is about $53,000 while the national poverty level is $22,000. I don’t think Newt was a janitor growing up. In fact, at the age of 18 he graduated from high school and became interested in politics during his teen years while living in Orléans, France. That’s right – Orléans, France, not New Orleans.

He was disciplined in January 1997 by the House of Representatives for ethics accusations, although a full hearing was avoided. He resigned from the House on November 5, 1998, three days after being elected to his 11th term. Newt acknowledged that "In my name and over my signature, inaccurate, incomplete and unreliable statements were given to the committee." The House Ethics Committee concluded that inaccurate information supplied to investigators represented "intentional or ... reckless" disregard of House rules.

Now, I ask you: Who had a more privileged up-bringing? Who worked harder under more arduous circumstances? Who is a person of greater character – Oprah Winfrey the world- renowned-philanthropist or Newt Gingich, the greedy who was paid $1.5 million as a consultant for Freddie Mac, a government-sponsored entity that has drawn $72.2 billion from government funds for its bailout and has just asked for $6 billion more?

Newt has no right to criticize "really poor children." For the record, based on poverty statistics, children represent a disproportionate share of the poor in the US; they are 24 percent of the total population, but 36 percent of the poor population. In 2010, 16.4 million children, or 22.0 percent, were poor.

In his last speech, the late Hubert H. Humphrey said "...the moral test of government is how that government treats those who are in the dawn of life, the children; those who are in the twilight of life, the elderly; those who are in the shadows of life; the sick, the needy and the handicapped." This was Humphrey’s version of a statement made earlier by Mahatma Ghandi: "A nation's greatness is measured by how it treats its weakest members."

Sorry, Newt, you’re not quite in the category of Oprah Winfrey, Hubert Humphrey, or Mahatma Gandhi. The fact that the Republican Party is seriously considering nominating you to be its “standard-bearer” says more about the Party’s view about character and ethics than anything else.

Let me close with the famous quote by Martin Luther King in his “I have a Dream” speech. “I have a dream that my four little children will one day live in a nation where they will not be judged by the color of their skin, but by the content of their character.”

Newt, if you are reading this piece, have you gotten the message yet?

Blog posted by Steven Mintz, aka Ethics Sage, on December 5, 2011

 

Should Insider Trading by Congress be Banned?

Congressional Ethics and Insider Trading

I’ve dealt with all kinds of issues in my blogs but none as unexpected as insider trading in Congress. I don’t mean to be overly-facetious but don’t they already use their influence in enough marginally appropriate ways and sufficiently trade-off on their political positions to adequately line their pockets? I mean, when is enough, enough? Here is a list of the ten wealthiest members of Congress as developed by the Capitol Hill newsletter, Roll Call.

1. Sen. John Kerry (D-Mass.) --- $188.37 million      

2. Rep. Darrell Issa (R-Calif.) --- $160.05 million

3. Rep. Jane Harman (D-Calif.) --- $152.62 million

4. Sen. Jay Rockefeller (D-W.Va.) --- $81.50 million

5. Rep. Michael McCaul (R-Texas) --- $73.75 million

6. Sen. Mark Warner (D-Va.) --- $70.19 million

7. Rep. Jared Polis (D-Colo.) --- $56.49 million

8. Rep. Vern Buchanan (R-Fla.) --- $55.47 million

9. Sen. Frank Lautenberg (D-N.J.) --- $49.70 million

10. Sen. Dianne Feinstein (D-Calif.) --- $46.07 million

Let’s get back to the point at hand. It took a recent report on “60 Minutes” to galvanize Congress into action after the program criticized members who made profitable securities trades based on information they had learned on Capitol Hill. In a recently published book, “Throw Them All Out,” (a sentiment I wholeheartedly supported in a previous blog), Peter Schweizer asserted that members of Congress may be exempt from some insider trading laws. House and Senate committees plan to hold hearings soon on bills that would prohibit trading on information “relating to any pending or prospective legislative action” to address this perceived gap in the law. The House bill, titled the Stop Trading on Congressional Knowledge (STOCK) Act, was first introduced in 2006, but it went nowhere. Not to be too pessimistic but I wonder how such a law would be enforced? As the saying goes, “the devil is in the details” and that is why Congress is likely to build in loopholes that enable most of them to escape punishment. They don’t have a 9% approval rating by the public for nothing.

Before the “60 Minutes” report, the House bill that would outlaw the practice of insider trading only had nine co-sponsors. In the week following the “60 Minutes segment,” that number jumped to 92. Of the 83 additions, 19 are facing competitive reelection races as defined by the Cook Political Report. That’s not surprising. Those in Congress routinely fail the integrity test: not supporting a worthy bill up front because of the lack of public awareness of the problem but jumping on the bandwagon once the practice becomes public knowledge.

In playing down the substantive importance of the STOCK Act, Andrew Eggers, a lecturer in government at the London School of Economics, and Jens Hainmueller, assistant professor of political science at MIT, point to the fact that congressional ethics rules already prohibit the practice. The House Ethics Manual states that "all government employees, including officeholders" should "never use information received confidentially in the performance of governmental duties for making private profit." The authors believe the purpose of the new law probably will be to help salvage whatever credibility Congress has left. I guess their approval rating could even go from 9% to 9.5%.

This whole issue got me thinking. What is the point of banning any illegal or immoral practice by those in Congress? We know they will find a way around any restrictions and those who do get caught will receive a pat on the wrist – at worst a reprimand, the same sanction imposed on Representative Barney Frank for fixing parking tickets for his boyfriend.

The moral of this story is that we, the public, should exercise our fundamental right to vote next November and “throw all the bums” out of office. The Super Committee was a super failure; unemployment is stuck at historically high levels; the government has done nothing to ameliorate the housing crisis; the middle class continues to get pinched; and not one program passed by Congress since the crisis began in 2008 has made any meaningful difference.

Blog posted by Steven Mintz, aka Ethics Sage, on November 28, 2011

Should lobbyists be Banned from Giving Gifts to Federal Employees?

Banning Gifts to Lobbyists: Who Represents the Public Interest?

Here are some numbers for you to think about – 65%, 36%, 16%, 15%, and 9%.

According to CBS News, ten years ago, as many as 65% of Americans actually liked their elected officials. But as Congress has gotten more and more dysfunctional, its popularity has fallen dramatically to today's all-time low - a 9%  approval rating.

Even the hated IRS has an approval rating four times that (36%)!

At the height of the oil spill, the BP oil company - at 16% - had a higher approval rating than Congress.

So does Paris Hilton, who scores 15%.

These findings came before "60 Minutes" aired the story a couple of weeks ago revealing that Congress has given its members the right to use inside information not available to the public to buy and sell stocks and bonds. Moreover, it follows the colossal failure of the Super Committee, and Congress failed the test of representing the people's interests. Is it possible that the next survey might show Congresses approval rating at or near 0%? I still think that would be too high.

Business groups are attacking the Obama administration over a plan that would bar lobbyists and their employers from giving gifts to federal employees — including picking up the tab for government workers to attend conferences and trade shows. The proposal is aimed at preventing lobbyists from exerting undue influence over executive branch employees charged with regulating everything from automobile safety to air quality, but trade groups have launched an all-out offensive to kill the proposal.

"It's a slap in the face of business from an administration that says it wants to work with industry to create more jobs," said John Graham, president and CEO of the American Society of Association Executives, which represents about 23,000 trade-group executives. Graham's organization has launched a website, along with Twitter and Facebook campaigns, to fight the measure. More than 450 groups have signed onto the organization's letter of protest, including the U.S. Chamber of Commerce and National Association of Realtors.  

The ethical question is why not let businesses pick up the tab for federal government employees to attend conferences and trade shows? It’s simply this. Any federal government employee who might become involved in decision-making that affects specific businesses or business groups must be beyond reproach with respect to making unbiased, independent decisions. A conflict of interest exists when a member of Congress hears testimony and votes on an issue that affects organizations that used lobbyists to influence the way the member votes.

In a 1992 decision, Quill v. North Dakota, the U.S. Supreme Court ruled that retailers are exempt from collecting sales taxes in states where they have no physical presence, such as a store, office, or warehouse. Let’s assume Congress is debating whether to require all states to impose sales taxes on e-commerce (e.g. Amazon) to level the playing field with brick and mortar businesses. Right now it’s up to each state government to make that decision. If one state imposes such a tax while another does not, Amazon simply threatens to move its distribution center to a tax-free friendly state.

Let’s further assume that a lobbyist representing Amazon’s interests -- and we can include other e-commerce vendors such as overstock.com – decides to pay the expenses of key Congressional decision-makers to attend a trade show that features purveyors of on-line merchandise. The expenses include coverage of airfare, the best hotel in town, and a $1,000 per day food and sundry items allowance. Can the member of Congress (let’s call him Sneaky Pete) make an objective decision on the taxing issue? In my mind it doesn’t matter. Independent decision-making is based as much on the appearance whether Sneaky will, in fact, make an objective decision. We won’t know if the decision made was based on objective decision-making until after the decision is made. The point is to avoid the possibility that a biased decision will be made by banning gifts to lobbyists up front.

According to a report by the Government Accountability Office (GAO), $3.51 billion was spent on lobbying in 2010. This money does not improve our economy in any meaningful way especially at a time when we are swimming in a sea of debt. Who represents the public interest in these matters – you and me?  Who are our lobbyists? Certainly not those we vote into office as our Senators and Representatives. If that were the case, Congress would not have a 9% approval rating.

Blog posted by Steven Mintz, aka Ethics Sage, on November 28, 2011

Obama’s "America Has Become 'Soft and Lazy'" Comments

Declining Work Ethic Threatens Economic Competitiveness in America

You may have heard President Obama’s recent statement with respect to the decline of American economic influence around the world and lagging efforts to promote foreign investment – “We've been a little bit lazy, I think, over the last couple of decades." I want to share my thoughts with you as to why this might be the case.

First, there has been a consistent decline in the work ethic in America over a number of years. One reason is an unwillingness to sacrifice short term benefits for the long term good of society. We all want instant gratification and material possessions fueled by a culture whereby events occur with the click of a button. Our culture no longer emphasizes building the American dream. Instead, we emphasize obtaining it. That was the message of the subprime loans and financial meltdown that have negatively affected so many.

In Democracy in America, Alexis de Tocqueville worried that free, capitalist societies might develop so great a “taste for physical gratification” that citizens would be “carried away, and lose all self-restraint.” Tocqueville believed that the genius of America in the early nineteenth century was its pursuit of “productive industry” without a descent into destructive materialism. He pointed to a common set of civic virtues that celebrated not merely hard work but also thrift, integrity, self-reliance, and modesty – virtues that grew out of a sense of morality that informed American democracy and free markets.

Going forward, how can we maintain our preeminence as an economic power in the world? Like an addicted person we must first admit we have a problem. The problem is we have become soft as a nation. This is another point made by President Obama recently when he said: "The way I think about it is…this is a great, great country that had gotten a little soft and…we didn't have that same competitive edge that we needed over the last couple of decades. We need to get back on track."

Obviously, the President did not mean all Americans have become soft and lazy. However, we must recognize that we have morphed into a “what’s in it for me” culture influenced by reality TV programs, over-the-top media advertising, government corruption, and business fraud. These negative images have, I believe, affected our willingness to work hard. I see it all the time as a university professor when students shy away from the difficult fields of study in science and mathematics that are so crucial to our global competitiveness and creating sustainable advances in research and development that fuels technological innovation and economic growth.

We need to start a national debate on these issues before it is too late. We need to develop concrete plans to do what it takes to restore the work ethic that existed when this country first thrived and became an economic role model for the rest of the world. Perhaps no issue more than this is crucial to the future of America.

Blog posted by Steven Mintz, aka Ethics Sage, on November 22, 2011

What should be the Next Step for the OWS Movement?

Citizen Watchdog Groups Have an Important Role to Play in the OWS Movement

It’s been one month since the Occupy Wall Street (OWS) movement set off a chain of events that have literally spread throughout the world. I believe the motivation for the movement comes from two sources: (1) the efforts of those involved in the “Arab Spring” to bring about meaningful and lasting change in the way their government operates and how they treat citizenry and (2) the ongoing economic crisis in the U.S. that has affected many in the ‘99%’. Just consider the effects of the financial crisis that ushered in a recession in 2008 and motivated the ‘99%’ to protest nationwide.

• Millions have lost their jobs or been forced to work beneath their skill level, accept less hours on the job, no pay raises, and increases in their share of health plan costs
• Millions have been unable to prevent their houses from going into foreclosure because of the downward spiral of home prices, underwater mortgages, and stagnant or a decline in in their personal wealth over a number of years
• Millions have seen their retirement accounts (i.e. IRAs, 401-Ks) go down in value or increase only marginally due to declines in stock prices over a number of years

I haved previously blogged about the growing gap in income in America. Studies show that the 400 richest families in America, who saw their wealth increase by some $400 billion during the Bush years, have now accumulated $1.27 trillion in wealth. At the same time, working families have watched as median family incomes dropped nearly $2,200, the third year in a row we have witnessed such a decline. In a recent report issued by the U.S. Census Bureau on poverty in America, 46.2 million Americans are now living in poverty.  The number of those living in poverty in America has grown by 2.6 million in just the last 12 months, and that is thelargest increase that we have ever seen since the U.S. government began calculating poverty figures back in 1959. Back in the year 2000, 11.3% of all Americans were living in poverty.  Today, 15.1%  of all Americans are living in poverty.  The last time the poverty level was this high was back in 1993.

Participants in the OWS movement point to the gap between rich and poor, use of public funds to bail out failing companies (i.e., the GM, Chrysler, and AIG), and greed on Wall Street and in corporate America as evidenced by a survey by salary.com that shows the average salary and benefits paid to the CEOs of the Standard & Poor’s top 500 companies in 2010 was $11.4 million. We are rapidly becoming a country of haves and have-nots and that is a recipe for civil disobedience, or worse. Add to the mix the public distrust of government and politicians who place partisan interests ahead of acting for the public good, and you can understand why our individual angst has now spread throughout the country.

Critics of the OWS movement believe it has been hijacked by groups that have self-serving interests such as the Services Employees International Union (SEIU), labor unions, and those just looking for a warm place to sleep. No doubt, there is some truth in these charges and other (fringe) groups and individuals have given the movement a bad name. But this is to be expected in a Vietnam-type environment where disenchantment among the populace has motivated a movement for change in the way “the powers that be” drive the political and economic agenda in America.

The OWS movement needs to identify where they want to go with their legitimate complaints. The Tea Party organized into a powerful representative group with a common point of view – no new taxes, reductions in entitlement payments, and cleaning up America’s economic mess that, as of November 18, created an outstanding public debt of more than $15 trillion and climbing --  which is over $48,000 for each citizen of the U.S. based on a population of about 312 million.  

I recommend that government watchdog groups take the lead in identifying a unifying message for the OWS movement. Most of these groups have missions that are complimentary to that of OWS. Here are some groups I think could lead the way:

Citizens for Responsibility and Ethics in Washington: an organization dedicated to promoting ethics and accountability in government and public life by targeting government officials who sacrifice the common good to special interests.

Common Cause: an advocacy organization that serves as a vehicle for citizens to make their voices heard in the political process and to hold their elected leaders accountable to the public interest. 

Corporate Accountability International: a group that challenges corporate abuse and demands direct corporate accountability to public interests.

The Project On Government Oversight: a watchdog group that champions good government reforms and  investigates corruption, misconduct, and conflicts of interest to achieve a more effective, accountable, open, and ethical federal government.

These are four groups that can best lead the charge to promote ethics in government, accountability from our elected officials, public interest decision-making, and corporate responsibility. Many other groups are equally worthy to lead the way, but the effort must be limited and focused on common goals to have a meaningful impact on the OWS movement, create true and lasting change, and to advance the endeavor to the next level of true reform in government and corporate America.

Blog posted by Steven Mintz, aka Ethics Sage, on November 19, 2011

Madoff, Mets, and Clawbacks

Trustee Picard on the Losing End of Clawback Lawsuits

Unless you’ve been living on a remote island since December, 2008 where communication with the outside world is difficult, and if so please pass along the details, Bernie Madoff was arrested on December 11, 2008 in the largest Ponzi scheme ever devised. In March 2009, Madoff pleaded guilty to 11 federal felonies and admitted to turning his wealth management  business into a massive Ponzi scheme that defrauded thousands of investors of about $65 billion. The irony is, if Madoff  hadn’t faced $7 billion in redemptions, the Ponzi scheme might not have been discovered. On June 29, 2009, he was sentenced to 150 years in prison, the maximum allowed.

Perhaps you saw Madoff’s wife and son on 60 Minutes a week ago. Talk about a woman in denial. She looked like she had just taken a dose of Propofol. It’s hard to feel sorry for members of the family who deny any knowledge of the fraud. “Burying your head in the sand" is not a defense to standing by as thousands of investors lose billions of dollars, many their life savings.

Irving Picard was appointed the trustee to unravel Madoff’s finances. The trustee has filed about 1,000 lawsuits worth some $100 billion against individuals and companies accused of profiting from Madoff's scheme including multibillion-dollar lawsuits against  mega financial firms JP Morgan, UBS nad HSBC. That's five times the $20 billion that Madoff is believed to have cheated from his clients while masquerading as an investment firm. Ironically among those sued was Madoff’s son Mark, who hung himself in his Manhattan apartment on the same day, the two-year anniversary of his father’s arrest. "Mark Madoff  had made it clear that he felt his family ... would be better off without 'this' hanging over them all, forever," a source told the NY Daily News.

The basis for the “clawback” lawsuit is that some investors profited handsomely from Madoff’s scheme gaining large returns while others lost everything. The suits aim to force those who profited by the “ill-gotten gains” to return these amounts for distribution to the losers.

For those of you sports fans out there, Picard also sued the owners of the New York Mets baseball team for the return of profits earned from their Madoff investments. Mets owners Fred Wilpon and Saul Katz and associated individuals and firms, received $300 million from the scheme according to the lawsuit. Wilpon and Katz have "categorically rejected" the charges.

Helen Chaitman of Becker & Poliakoff represents more than 300 investors who had accounts with Bernard Madoff. For more than two years she’s hammered away at one particular argument in federal bankruptcy court, in Congress, even on YouTube: Madoff bankruptcy trustee Irving Picard of Baker & Hostetler shouldn’t be allowed to demand the return of profits that Madoff investors pulled out of their accounts as long ago as 2002, six years before the Ponzi scheme imploded in December 2008. Two weeks ago, Chaitman finally found vindication, even though it wasn’t in any of her cases. Manhattan federal judge Jed Rakoff, ruling in Picard’s fraud case against the owners of the New York Mets, concluded that a section of the federal bankruptcy code precludes Picard from attempting to claw back money Madoff investors pulled out of the Ponzi scheme before 2006.

The decision is a boon to the Mets owners. The judge left standing only one of Picard’s fraud counts against the Mets, limiting the Madoff trustee’s potential recovery to no more than $386 million, rather than the nearly $1 billion in principal and profits Picard wanted. Moreover, for Picard to get his hands on any of the Mets owners’ principal, he will have to prove they were “willfully blind,” a prospect Judge Rakoff doesn’t seem to consider very likely. “This is something I’ve been saying from the beginning,” Chaitman said. “Anyone who didn’t withdraw their money in the last two years…is out completely.”

On November 2, a federal judge threw out most of a $19.9 billion lawsuit against JPMorgan Chase & Co and a $2 billion case against UBS AG. According to the ruling, Picard lost the right to demand $19 billion in damages from JPMorgan, for victims of Madoff's fraud. The decision by U.S. District Court Judge Colleen McMahon in Manhattan is one of the largest setbacks for the trustee, Irving Picard, who has spent nearly three years liquidating Bernard L Madoff Investment Securities LLC. On November 10, Picard asked for an expedited appeal of her ruling to finally determine his claims were viable. “Permitting an immediate appeal would provide much-needed finality for the trustee and the BLMIS estate as to the viability of these claims,” he said, asking her to enter a final judgment in the case, which will make it easier for him to appeal her ruling. BLMIS refers to Madoff’s firm.

Perhaps in the most unfair ruling on October 27, Madoff’s family would keep about $82 million of “other investors’ money” under a ruling that limited a bankruptcy trustee to claiming from the owners of the Mets only two years of withdrawals from the Ponzi scheme, according to a court filing.

Madoff’s family took out $141 million in the six years before Madoff’s firm went bankrupt in 2008, of which less than $59 million was taken in the two years before the bankruptcy, trustee Picard said in a filing. Many other investors are trying to hang onto “stolen” money that belongs to customers who took losses in the fraud, he said.

In a previous blog I pointed out that while it may seem clear that clawback suits are the right thing to do, there are ethical issues that should be considered. If the investors did not know the returns were based on fraudulent activities, should they be penalized? What if the investors used their returns to invest in the stock market and lost everything in the meltdown, should this be taken into consideration in deciding whether to file clawback suits against them and how much should be redistributed? What is the key ethical principle that should guide trustee Picard’s actions? It would seem to be fairness. That is, the losses should be spread proportionately to investors who lost all their money and those who received some returns. Fairness provides that equals should be treated equally; unequals, unequally. Of course, the devil is in the details.

Blog posted by Steven Mintz, aka Ethics Sage, on November 16, 2011

Achieving Happiness through Ethics

Happiness, Ethics and the Occupy Movement

I teach my accounting students about the Greek philosophy of ethics because I believe it provides a roadmap for living the good life. Today’s students are searching to find what will make them happy. However, they all too often look in the wrong places. Most turn to social media to connect with others and hope that it leads to happiness, or at least self-satisfaction. Some go looking in a bottle of beer, wine, hard alcohol, or drugs. Many will grow up believing the attainment of wealth will make them happy. Others will look for fame perhaps by starring in their own reality television show.

The point is young people today lack the moral compass to know that happiness comes from actions taken and goals achieved that benefit others as well as oneself. It’s a feeling that you did something good; helped someone out; achieved success in a worthy endeavor; fought for a just cause; or found the right person in life. Happiness is something fulfilling not something we happen to desire or want. We of course desire to be fulfilled, but the point is not every desire that occurs to us will necessarily fulfill us.  Desires must be examined and tested. Happiness is an internal good not something we measure in dollars and cents or the achievement of power or fame.

According to the ancient Greeks, happiness is the highest good and the end at which all our activities ultimately aim. Aristotle defines the supreme good as an activity of the rational soul in accordance with virtue. Virtue for the Greeks is equivalent to excellence. A virtuous person is someone who performs the distinctive activity of being human well. And this is why virtue eludes so many in today’s society. To achieve excellence through virtue and gain happiness a person must have a strong work ethic. A person must be willing to work hard to achieve a worthy goal even at the sacrifice of self-gratification. The decline in the work ethic of young people has been discussed before and readers might be interested in my take on the issue.

Happiness is a “contact sport.” It is difficult to achieve the state of happiness when we’re too busy texting, tweeting and updating our Facebook page. We need to be engaged in direct communication. We need to be involved with others in a community of like-minded people. We need to take positive actions to achieve happiness. This is why I believe the “Occupy” movement is spreading rapidly to all parts of the world. It gives people who feel disenfranchised an opportunity to speak out with members of their community.  

The just man is happy, and the unjust man is miserable,” Plato declares in The Republic. A noble thought, to be sure, but Socrates’ most famous student didn’t have data to back up his belief. Harvey James, on the other hand, does. The University of Missouri economist finds a relationship between life satisfaction and low tolerance for unethical conduct. He discussed his findings with Miller-McCune staff writer Tom Jacobs.

“I found a correlation between how people responded to ethics questions and their satisfaction with life. As part of the 2005-06 wave of the World Values Survey (which examines attitudes around the globe), respondents were asked in face-to-face interviews: On a scale of 1 to 10, how satisfied are you with your life? There were also four ethics questions that ask how acceptable or unacceptable they felt a particular practice is: claiming government benefits to which you are not entitled; avoiding paying your fare on public transportation; cheating on taxes; and accepting a bribe.

James found that people who believe that these particular ethical scenarios are not acceptable also tend to indicate they are more satisfied with life. That’s with controlling for other factors that scholars have shown are also correlated with happiness, including relative wealth. James concluded from his study that happiness is derived from doing well, and from meeting psychological rather than material or hedonistic needs. He states that “While income, personal characteristics and societal values play a role in affecting happiness, so do personal ethics.” James believe that “if the goal of public policy is to improve subjective well-being, and if subjective well-being increases when people are just, then efforts to improve the moral behavior of people will also improve overall societal well-being.”

This is the problem in America today. We do not recognize the importance of ethical behavior to achieve a just, better society for all. We are fighting against the traditional capitalistic ethic that all of society will benefit by allowing corporations to pursue their own best interests guided only be the “invisible hand” of the marketplace. However, the pursuit of self-interest by corporations has brought misery to many and that is why we have the Occupy movement. The answer is not more government regulation. The answer comes from within each of us to commit to being a good person; to treat others the way we want to be treated; to engage in civic virtue; and to act in a way that betters society. I often ask my students: When you die what do you want to be written about you on your tombstone? Is it that you were a powerful, wealthy person who achieved materialistic success? OR: Is it that the world is a better place for your having been in it?

Blog posted by Steven Mintz, aka Ethics Sage, on November 7, 2011

The Role of Business Schools and MBAs in the Occupy Wall Street Movement

Reform of Capitalism Should be the Underlying Message of OWS

We’ve heard it all before. Corporations have no soul. Critics complain that those with a Master of Business Administration (MBA) degree act out of self-interest and not those of employees who work for them, the community affected by its actions, and society as a whole. The bottom line is that corporate social responsibility has been relegated to a secondary role far behind maximize corporate profits and shareholder wealth as the guiding principles of corporate behavior. The problem is these goals are achieved at the same time the wealthy become wealthier, the middle class, poorer, and more and more low income Americans fall into poverty. Does it sound right to you that top corporate officials earn as much as $16,000 per hour, while workers earn well below $16 per hour. Is it right that the average corporate executive earns 350 times the average worker? When is enough, enough?

So I ask in this blog: What role should business schools and MBA students play in the OWS movement? We can draw parallel to the anti-Vietnam War experience when peace movements consisted largely of college and graduate students, and mothers, as well as anti-establishment "hippies".  The first major student demonstration against the Vietnam War took place on May 2, 1964 when hundreds of students marched through Times Square in New York City, while another 700 marched in San Francisco. Smaller numbers also protested in New York; Seattle; and Madison, Wisconsin. Sound familiar?

On October 21 the invasion of The Wharton School’s Huntsman Hall at the prestigious University of Pennsylvania by Occupy Wall Street protestors opened the door to MBA bashers who chided the students for trying to shout down the protesters who were airing their grievances against corporate America and Wall Street investment firms. Wharton students taunted protesters with chants of "Get A Job!" and a banner which read "Get Into Our Bracket" a take-off from the slogan of the protesters that they are in the 99 percent majority.

A posting on "Think Progress" about the 99% movement  includes the following evaluation of what happened at Wharton: “While the students who jeered the protesters certainly do not necessarily represent all Wharton students, it’s important to understand the context of the elite status they likely either come from or graduate into,” the writer of the article noted. “Wharton graduates much of the nation’s corporate elite, with the median starting salary for an MBA graduate being $145,000 — six times the poverty level for a family of four. The school’s Board of Overseers is staffed with multiple Goldman Sachs executives and high-ranking employees of a wide variety of financial firms. Meanwhile, its Graduate Executive Board is staffed with senior employees of Bank of America, Blackstone Financial Management, and PMC Bank. Wharton’s endowment is $888 million, greater than that of many large public universities. Essentially, the students jeering the protesters represented the future financial elite.”

The Occupy Wall Street protests have grown into one of the most powerful grassroots social movements since the Great Depression and has gone international fueled by the power of social media. It seems the movement is picking up steam as Democrats use it for political gain and Republicans brandish the protesters as those who “hate America”. I believe the message of the movement must remain loud and clear that our free market capitalistic system is failing us and must be reformed before it is too late.

Corporate greed, fraudulent financial statements, and Ponzi schemers have wiped out vast amounts of wealth for the average American through job layoffs, massive losses in stock and retirement accounts, and plunging home values fueled by greed driven home mortgage lending practices that shift the risk of homeowner default to outside investors through the packaging and sale of collateralized debt obligations.  

There is no doubt that some individuals and groups have tagged along with the OWS movement to get their message across. The theme of their protest seems to be to rant against income inequality in America. However, this is a symptom and not the crime and it fails to get to the root cause of the problems facing America. We need to reform our capitalist system. 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. What is missing from the calculation of recent economic decision making is ethical decision making. We must ask: What are the rights of shareholders and other stakeholders and what are the obligations of CEOs and boards of directors to those parties? How is it in the best interest of shareholders for CEOs to walk away with multi-million severance packages even after leaving a failed firm?

The bottom line is ethical behavior cannot be legislated. It comes from within and a desire to do what is right for society and not to act solely in one’s own self-interests. This is where graduate business schools that train tomorrow’s corporate leaders have an important role to play. The curriculum of every business school should include courses in ethics, leadership, and corporate social responsibility. Even today some of the best schools follow the historical model of teaching the technical skills while shying away from the “touchy-feely” material. Yet it is the latter that plays an integral role in returning America to its core role of promoting economic welfare for all.

The nature of the present economic crisis and Wall Street protests illustrates the need for departures from uncontrolled self-dealing that has infected corporate America and Wall Street. As they say in Texas, “That Dog Won’t Hunt.”

Blog posted by Steven Mintz, aka Ethics Sage, on November 4, 2011

Top 250 Delinquent Taxpayers

CA Franchise Board Posts List of Delinquent Taxpayers

The California Franchise Tax Board released its list of the top delinquent taxpayers and it is quite an eye-opener. The authority to publish this list is pursuant to California Revenue & Taxation Code Section 19195. The complete list can be accessed at the Franchise Tax Board website.

While nearly 90 percent of taxpayers pay the taxes they owe, the rest are delinquent in the amount of $6.5 billion, which represents about one-third of the persistent budget deficit in California during the past few years. When taxpayers do not pay their fair share, it places an unfair burden on those of us who do.  Those of us who play by the rules are harmed by those who don’t because the tax shortfall has led the state to cut essential services, lay off workers, and dial back on infrastructure plans that might stimulate the economy.

The list shows the top 250 individual and business taxpayers with state income tax liens where the total balance owed is greater than $100,000. Bear in mind there are lot more below the $100,000 threshold. The Franchise Tax Board encourages whistle-blowers to come forward and assist the Board in its collection efforts. Good luck with that!

As of October 13, 2011, the amount due on this list totals $152,377,555.74. The Board of Equalization is required by law to post this information every quarter, removing amounts that are being addressed through payment arrangement, bankruptcy, litigation, or appeal. Each taxpayer is notified 30 days before their information is posted. Since the inception of the posting program, the Board of Equalization has received a total of $5.2 million from 37 qualifying taxpayers that came forward to take care of their debts: 26 through installment payment agreements and 11 by making payment in full.

Here is the “Top Ten” of the list of 250 deadbeats published by the Board: (1) Halsey M. and Shannon Minor (L.A.), $14.2 million: (2) Aviv Mizrahi (L.A.), $9.4 million; (3) Van Rex Gourmet Foods (Thousand Oaks), $4.4 million; (4) Randall E. Cohn (L.A.), $3.8 million; (5) Neil A. Scott (Solana Beach), $3.1 million; (6) Scott A. and Kelli A. Walchek (Alamo), $2.9 million; (7) Robert J. McNulty (Henderson, NV), $2.9 million; (8) Stuart J. Gourlay, M.D. a Professional Corporation (Pinole), $2.7 million;  (9) Ilena Joyce Blicker, M.D., a Medical Corporation (Glendale), $2.6 million; and (10) Ronald and Diane Lessem (San Diego), $2.6 million.

Our resident income tax expert at Cal Poly, Professor Rodney Mock, has an interesting perspective on the posting of tax delinquencies. Professor Mock points out that this published “shame list” has become increasingly popular among the various states. However, he wonders whether or not such is “ethically appropriate” for a state entity to publish a tax delinquency list since it may be due to extenuating circumstances such as loss of business, loss of employment, medical crisis, and phantom income. Professor Mock makes a good point. Of course, the opposite argument is that we all have problems to deal with and if everyone who owed taxes stopped paying because of personal circumstances, then the California budget deficit might be $250 billion.

On October 4, 2011, Governor Jerry Brown signed Assembly Bill 1424, The Delinquent Taxpayer Accountability Act, into law. The bill was introduced by Assembly member Henry T. Perea (D-Fresno) as a way to help the state Franchise Tax Board and Board of Equalization collect some of the $6.5 billion owed to the state that goes unpaid each year. AB 1424 allows the state to suspend the professional and/or driver's licenses of the state's worst delinquent tax debtors until they make payment arrangements. Debtors will have their license reinstated after making payment arrangements with the state or if they demonstrate a financial hardship.

I support the law and note it does allow for financial hardship. Those of us who play by the rules are sick and tired of allowing those who don’t get restructured mortgages, forgiven debt, and selectively enforced tax collection laws. There is a moral hazard element in how the government has made concessions to some during the financial crisis while others are unable to refinance their home mortgage loans at a lower interest rate because of having an underwater mortgage, even though they have made their payments on time and in full. Neither the federal nor state government should be in the business of picking “winners” and “losers.” I say let the free market take care of these problems.

Blog posted by Steven Mintz, aka Ethics Sage, on November 2, 2011

 

AMERICA, CHANGE IT OR LOSE IT

Government Ineptness Underlies Occupy Movement

This is the second in a series of blogs I’ll post on Fridays from now until election day to address critical issues facing our country. My blog last week dealt with the issue of who is to blame for class warfare (Blame Corporate America and Wall Street for “Class Warfare.”). This week I look at the role of our political system and how it creates distrust of our government.

Critics of the “Occupy Wall Street (OWS)” movement rail against what they perceive to be obnoxious protesters looking for a place to vent, and even sleep and eat. Critics charge there is a segment of the protesters who want to tear down capitalism and our government. They miss the point that the underlying goal is to reform capitalism so that it works for all in society and not a chosen few who tend to act in their selfish interests without regard to the consequences of their actions on the public.

There is a meaningful analogy to be made between the protesters in the Vietnam War and those in OWS. Many in the public criticized Vietnam protesters as unkempt, loud, a nuisance, and generally wanting nothing more than to tear down our government. Sound familiar?  Today we look at those protesters in a much different light as ushering in a period of peace and ending an unjustified and, perhaps, unwinnable war. I’ve taken the title of this blog from one of the slogans chanted during the Vietnam War protests – “America, change it or lose it.” The chant was in reaction to anti-protesters whose slogan, “America, love it or leave it,” articulated the view that those who don’t like what America is doing should leave the country.

Much of the criticisms lodged against OWS protesters have the same underlying theme. The anti-protesters are trying to minimize the valid and well-meaning message that corporate greed and government ineptness is to blame for the harm that has befallen so many in society. Millions have lost their jobs not because they no longer can do the job or don’t want to work, as the OWS opposition would have us believe. Let’s not forget that it was financial institutions and investment banks that brought down our financial system thereby leading to massive layoffs. The government through Fannie Mae and Freddie MAC, both of which engaged in accounting fraud, created a bubble in the housing industry that burst and caused the loss of millions in home value. The combined efforts of the perpetrators of the financial disaster that began in 2008 led to the destruction of a massive amount of stock market wealth for the average citizen whose IRAs and 401Ks plummeted in value.

In a poll taken between October 19 and 24 by Real Clear Politics, only nine percent of the public approves of the job Congress is doing, a 75 percent drop in support since the last poll. How could Congress not expect the public to protest with these numbers? I’d be surprised if there were no protests as it would indicate a complacency in society that is not healthy to our tradition of speaking out about wrongdoing. Moreover, compare these results to an Association Press-Gallup Poll that 37 percent support the Wall Street protesters and 58% say they are furious about America’s politics.

Protesters against the Vietnam War changed the public’s opinion about it just as the protesters in New York City and other places will change the public’s position on the rightness of their cause. However, it behooves the protesters to get better organized; keep in check those who are there for their own agenda; and control troublemakers that always latch on to any protest movement.

The legitimacy of the Vietnam protesters who were branded hippies was enhanced when the group Students for a Democratic Society came along and organized into a political force. SDS developed a political manifesto that suggested a series of reforms, some of which are relevant to today’s protesters: it proclaimed a need to reshape the political parties to attain greater representation, for stronger power for individuals through citizen's lobbies, for more substantial involvement by workers in business management, and nonviolent civil disobedience as the means by which student youth could bring forth a "participatory democracy." This was a unifying message. OWS protesters also must develop a unifying message to be successful in the long run.

The support for the anti-war movement was low at first but grew as the war wore on and more and more Americans questioned the values of their government, much as do OWS protesters. Support for the war went from a high of 52 percent in August 1965 to a low of 28 percent in May 1971.

A Fox-News poll taken the week of October 24 indicates that 76 percent of Americans are not satisfied with the direction our country is headed. This is a serious matter. How can Republicans and other critics dismiss the protest movement in light of the lack of support in the public for the political process and results? The unemployment rate has been over nine percent for about thirty months with no decrease in sight. Programs to alleviate the pain have not worked. None of the Wall Street fat cats were charged with any crimes for their role in the financial meltdown. The government is stalemated and we can’t move forward. Some say it will change after the election. I doubt it as our recent past indicates that political posturing by the party not in power will begin the day after we elect a new President. Politicians are more concerned with the ends – get re-elected; get control of Congress; and change the party of the President – than the means used to achieve those ends. This is an unethical approach to decision-making because it ignores how the public may be harmed by the political games played to achieve a goal.

Blog posted by Steven Mintz, aka Ethics Sage, on October 28, 2011

Chinese Companies Financial Reporting Practices Escape US Regulators

Can We Trust the Financial Statements of Chinese Companies?

I have previously addressed the growing questions about Chinese accounting principles and the reliability of the financial statements produced by state-owned and private enterprises. I called it “The Dark Side of Chinese Capitalism.” Questions continue to be raised about the value of those statements to investors looking to obtain a piece of the growing Chinese economic pie. In this blog I look at how Chinese companies look for ways to avoid U.S. regulators including the SEC.

China is dealing with charges of fraud in financial statements. I blogged about how U.S.-style capitalism may be infecting Chinese companies with the “fraud bug.” A good example is Sino-Forest Corp. that has been charged with allegations of accounting abuses and fraud, burning investors including John Paulson, the billionaire whose hedge fund said in June it lost $468 million on Sino-Forest.

Two reporters for Bloomberg on line, Dune Lawrence and Gary Putka, identify a common corporate structure that has allowed dozens of Chinese companies to get listed on U.S. exchanges but may run afoul of U.S. regulations. Chinese Internet companies such as Sina Corp. and Baidu Inc. have used so-called variable interest entities, or VIEs, to work around Chinese restrictions and seek foreign investors since 2000. In case you have forgotten, these are the same self-created off-balance sheet entities used by companies such as Enron to keep debt of the balance sheet and make a company look more liquid than it really is thereby misleading investors and other users of the financial statements.

The VIE structure, which allows firms to set up contractual relationships that mimic equity ownership, may carry its own risks, according to Joseph St. Denis, director of research and analysis at the Public Company Accounting Oversight Board. The PCAOB, which oversees auditors of U.S. public companies, has begun to look at VIEs’ audit implications.

“China has blocked our inspections of firms in their region, but we think VIEs are a risk area,” St. Denis said. “We can’t know, without going to inspect, how much risk they represent.” Last month, the Chinese government signaled it may create new rules for VIEs, which have helped enable the boom in overseas listings of Chinese stocks.

Reporter Tom Schoenberg points out that financial software maker Longtop Financial Technologies Ltd., disclosed that it may face SEC civil claims related to accounting abuses and whose U.S. shares have lost more than 99 percent of their value this year, used a VIE structure. The company is conducting an independent investigation into allegations made by its auditor, Deloitte Touche Tohmatsu CPA Ltd. The auditor resigned in May, saying Longtop’s chairman had admitted there was fake revenue and cash on the company’s books.

Deloitte has its own problems. Mark Lanpher, an SEC lawyer, believes the company should be ordered to appear in a U.S. Court for rejecting a SEC demand for documents related to an investigation of its former client Longtop Financial Technologies Ltd. Lanpher claims Longtop has refused to respond to a court filing seeking documents that the regulator claims are “critical” to its probe of possible fraud at the company.

The key take-away is that China must play by SEC rules if it is to audit affiliates of US companies that are subject to inspection by the Public Company Accounting Oversight Board and if Chinese companies are to list their stock on U.S. exchanges. All foreign c companies that list stock in the US are subject to such inspections. China should not be treated any differently. If China wants to be a key player and become a force in the international financial markets, then it must learn to play by the rules of regulators outside their own country even if it seems to run counter to cultural norms whereby such regulations and inspections might be interpreted as demonstrating a lack of trust in Chinese management.

Blog posted by Steven Mintz, aka Ethics Sage, on October 26, 2011       

Blame Corporate America and Wall Street for “Class Warfare”

Occupy Wall Street Protesters Motivated by Corporate Greed and Fraud

This blog first appeared as an opinion editorial in the online version of the Pacific Coast Business Times on October 21, 2011.

At the Value Voters Summit on Friday, October 7, Rep. Eric Cantor (R-Va.) said he is "increasingly concerned" by "Occupy Wall Street" demonstrations which began in New York and spread to other major cities. Cantor used part of his address to attack the Occupy Wall Street protests, and he condemned political leaders who are supporting them.

"This administration's failed policies have resulted in an assault on many of our nation's bedrock principles," he said. "If you read the newspapers today, I, for one, am increasingly concerned about the growing mobs occupying Wall Street and the other cities across the country. And believe it or not, some in this town have actually condoned the pitting of Americans against Americans. But you sent us here to fight for you and all Americans."

Unfortunately, some have joined the protesters for their own reasons and to vent their individual anger. Others have used the park near Wall Street at which they are protesting as a place to eat, sleep and generally make a mess of the area. This is wrong and disrupts innocent people going about their daily work. Still, we should not lose sight of what the protests are really about. Cantor, like so many Republicans, has misread the true message of the protesters. I add my voice to the protestors and believe the underlying motivation is to speak out about what is the true cause of the economic decline in the U.S., the financial difficulties facing our nation, high unemployment, and the general malaise that exists on Main Street about the future of our country. It is the greed that infected corporate America in the 1990s and early 2000s by the Enron’s and WorldCom’s. It is the fraud and corrupt policies of these companies and institutions such as Fannie Mae and Freddie Mac. It is the hyped securitized mortgages that were sold off by financial institutions to unsuspecting investors. It is the ill-advised mortgages made by commercial banks that ignored home buyer ability to repay the mortgage because the banks sold off these mortgages along with the related risk of default. Wall Street investment firms that held these securities hedged their bets by purchasing credit default swaps from AGI thereby betting on both sides of the coin. It is the Ponzi-schemers such as Bernie Madoff. I could go one but you get the point.

If there is a class warfare that has developed in the U.S. it is because the selfish policies of these institutions caused the financial meltdown, economic recession, and massive loss of jobs – all through no fault of us who play by the rules. The unemployed didn’t cause the crisis. Sure, some people overspent and got too deeply in debt, but that was due in part to the belief fostered by the actions of these institutions that the good times would keep rolling along. Instead, the bubble burst and it was the average American that was left holding the bag.

The Republicans attack over-regulation in the form of Dodd-Frank and Sarbanes-Oxley that, they claim, has created an uncertainty and unwillingness to expand economically by the very companies being regulated. That may be so and there is no denying it is a problem. However, the Republicans need to look in the mirror of those being regulated to see the face of who created the need for more regulation.

Our free market capitalistic system is based on the notion that by acting out of self-interest, business will create a better economic climate for all Americans. Well, it is just not working out as intended by Adam Smith. According to a survey by salary.com, the average salary and benefits paid to the CEOs of the Standard & Poor’s top 500 companies in 2010 was $11.4 million. The average CEO earned 343 times more than typical workers.

Very little has been said this election year cycle about how much the financial crisis has cost the average American in lost wealth. Well, hold on to your chairs as you look at the data provided by The Pew Charitable Trust that covers the period between 2008 and 2009:

• $100,000: Cost to the typical American family in combined losses from declining stock and home prices
• $5,800: Average household income loss resulting from declining economic growth
• $14,200: Average household loss in wealth caused by plunging real estate prices
• $66,200: Average stock market losses for households from July 2008 to March 2009
• $2,050: Average household cost to pay for TARP, the main government program to shore up the economy

Oh, and Representative Cantor, his net worth went from $2.2 to $7.6 million during 2008 to 2009, and he ranks 60^th in the House with respect to personal wealth.

Blog posted by Steven Mintz, aka Ethics Sage, on October 24, 2011

Does Teaching Ethics to Business School Students Improve Ethical Decision-Making?

Aspen Institute Study Provides Encouraging Data on B Schools Ethics Programs

Post-financial meltdown, business schools are trying to make their graduates more responsible. But does taking one class on ethics work, or does a new ethical model need to permeate the curriculum?

Many industry watchers saw business schools as contributing factors in the financial crisis, arguing that they failed to challenge orthodoxies and mostly taught the technical material but not the “soft skills” such as leadership and ethics. But what about now? Have b-schools changed?

Yes, and no, according to a survey by the well-regarded Aspen Institute of how schools are teaching social, environmental, and ethical topics. On the one hand, MBA programs are teaching more social, environmental, and ethical content than ever. Four-fifths now require students to take a business and society course, compared to just 34% in 2001, when the Aspen Institute first conducted its Beyond Grey Pinstripes survey.

“The financial crisis caused schools to be more introspective about what they are teaching,” says Judy Samuelson, Aspen’s director of business and society. “They were criticized for being part of the problem, and not part of the solution. And that has created an environment where faculty can innovate and make change.”

On the other hand, schools have yet to significantly reform “core” subjects like finance and accounting. “We put weight on how courses think about these issues in the real business lens, not just as philanthropy, CSR, or social enterprise. We still have a ways to go in the traditional teaching of accountancy and finance, where it’s often about metrics that aren’t future-oriented, and that don’t embrace full cost-accounting.”

The report ranks 149 schools in 22 countries, with only a few major institutions not participating (Harvard Business School and Chicago-Booth, notably). Stanford’s Graduate School of Business comes out on top, followed by the Canadian York University’s Schulich school, IE University in Spain, and Mendoza College at Notre Dame. Yale, Northwestern and Cornell also feature in the top 10.

Whether schools are embracing changes often comes down to individual faculty, and attitudes amid certain disciplines, says Samuelson. “These institutions are not like corporations where CEOs drive the firm. Academics have standing in their field, because of how they are viewed. All of that contributes to what gets taught.”

Samuelson says b-schools continue to “lag rather than lead” business practice. But she does think schools have become more responsive to what students are asking for. “The reason we are seeing change is that the 'millennials' are demanding it. These students want business to be seen in the context of the big issues of our day.”

One reason to focus on b-schools is that they are “hugely influential” in defining attitudes, Samuelson says. About a quarter of graduate degrees, and 20% of undergraduate ones, are business-related. And their impact extends beyond what is taught in the classroom.

From my experience many instructors are reluctant to teach ethics. Some feel uncomfortable doing so. Others are concerned about becoming too preachy. Still others do not believe ethics can be taught. Let me refute each argument against teaching ethics to business school students.

First, business school graduates will become tomorrow’s business leaders and we must ensure they are committed to being and bringing a strong ethic into the workplace. The degree of comfort level in teaching ethics is a product of one’s knowledge in this area, which can be gained through self-learning, and an awareness of the importance of the task. The latter is where business school deans have an important role to play.

Ethics need not be taught in a preachy manner. What I do is expose students to different ethical theories and explain how they can be used in business to make better decisions. I tell my students there is no one best method; each has a role to play in ethical decision-making. For example, utilitarianism emphasis harms and benefits of actions and tends to be quite often used in business decisions where costs and benefits are evaluated. Lastly, we’ll never know if teaching ethics has made a difference. As American journalist, historian, academic and novelist Henry Brooks Adams once said, “A teacher affects eternity; he can never tell where his influence stops.”

Blog posted by Steven Mintz, aka Ethics Sage, on October 14, 2011

Deloitte Sued for $7.6 Billion, Accused of Missing Fraud

Are CPA Firms Finally Being Held to Account for the Financial Meltdown?

Deloitte Touche Tohmatsu Ltd, the world's largest accounting and consulting firm, was accused on September 26 of failing to detect fraud during its audits of one of the biggest private mortgage firms to collapse during the U.S. housing crash. This was the latest lawsuit to hit one of the major accounting firms over their role in the credit crisis. Pricewaterhouse Coopers, KPMG and Ernst & Young are also facing accusations about their auditing standards by investors who collectively seek to recoup billions of dollars lost in the financial meltdown.

A trust overseeing the bankruptcy of Taylor, Bean & Whitaker Mortgage Corp, or TBW, and one of the company's subsidiaries filed complaints in a Miami Circuit Court claiming a combined $7.6 billion in losses. Deloitte spokesman Jonathan Gandal said the "claims are utterly without merit."

Lee Farkas, the former chairman of Taylor, Bean and Whitaker, was sentenced to 30 years in prison in April for masterminding what U.S. officials described as one of the biggest bank frauds ever. U.S. Justice Department officials said Farkas ran a $2.9 billion fraud scheme that led to TBW's downfall and the collapse of one of the largest U.S. regional banks, Colonial Bank. Farkas was accused of running a wide-ranging scheme to cover up large losses at Taylor, Bean, which was based in Ocala, Florida, by moving funds between accounts at Colonial Bank and also by selling mortgage loans that did not exist, were worthless or had already been sold.

The complaint filed by Neil F. Luria, a plan trustee of Taylor, Bean & Whitaker Trust, claims losses of approximately $6 billion. A second complaint by Ocala Funding, a wholly owned TBW subsidiary which served as a lending facility, claims losses of $1.6 billion.

"Deloitte missed this fraud because it simply accepted management's conflicting, incomplete and often last-minute explanations of highly-questionable transactions, even though those explanations made no sense and were flatly contradicted by the documents in Deloitte's possession," according to the complaint by Ocala Funding. Furthermore, “Ocala relied on Deloitte to detect material misstatements in the financial statements due to error or fraud.

According to Generally Accepted Auditing Standards (Statement on Auditing Standards No. 99), "The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.” The key always has been the interpretation of “reasonable assurance” and auditor responsibilities to examine evidence. Generally, evidence provided by the client is less reliable than that gained by auditor communications with third parties and by applying accepted audit procedures. Deloitte apparently relied too much on management’s explanations and did not do its due diligence in collecting and analyzing data. Plaintiffs' lawyers argued that as gatekeepers, auditors have a duty to be vigilant at rooting out fraud.

One question that arises is whether Deloitte missed the red flags that fraud may be present. According to Jacob Zamansky, founder of Zamansky & Associates, a law firm specializing in securities fraud, “If [auditors] see something they need to report it. If they consciously ignore red flags, they could be held responsible as an aider or abettor to the fraud."

 

Auditors are expected to exercise professional skepticism in making professional judgments on the extent and scope of evidence to be gathered and in evaluating its usefulness in rendering an opinion on the fairness of presentations in the client’s financial statements.

From the auditor’s point of view they can take solace in a newly emerging legal defense called "in pari delicto," or equal fault principle, used when a company being audited was equally to blame for wrongdoing. It is very fast becoming a law of this nation, which is a tremendous protection for the Big Four." However, Steven Thomas, an attorney for the plaintiffs, said his case rests on solid legal ground. He said that a key bankruptcy decision holds that under Florida law, the in pari delicto defense does not apply in cases in which the auditor has a duty to detect fraud and in which there were innocent board members who could have been alerted about the fraud. "They (Deloitte) had a public duty to detect the fraud," Thomas said. "They didn't do their job, and that's what we're going to prove."

Deloitte has also been named in other big lawsuits stemming from the credit crisis, including one involving its audits of Bear Stearns, which collapsed after suffering enormous mortgage losses, and another involving Washington Mutual, the biggest bank to fail during the credit crisis. Critics have argued that the independent auditors should have predicted the dramatic and unprecedented decline in the housing market that shocked the entire industry.

Are auditors finally going to be held accountable for their role in the financial meltdown? Time will tell but there can be no doubt some must have missed the red flags and, more important, ignored the changing business model and risks inherent in dealing with financial instruments such as sub-prime mortgages and credit default swaps. Auditors are supposed to understand the environment in which their clients operate and use that knowledge and related risk assessment to determine proper audit procedures. It appears that Deloitte failed to do so and there may be other cases waiting in the wings.

Blog posted by Steven Mintz, aka Ethics Sage, on September 30, 2011