cooking the books

cooking the books

 

Cooking the Books and Other Ethical Dilemmas

Mar 1, 1996 Robert A. Parker | Business Finance

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Financial managers sometimes must choose between adhering to a personal code of ethics and meeting a CEO’s demands. The ethical issue can be black and white, but more often than not there are shades of gray — what’s legal and accepted isn’t always ethical. At the very least, succumbing to pressure could compromise your personal values. At worst, you could end up in the soup.

Making a DifferenceControllers are in a key position to make an impact on their companies’ ethical policies and practices. Here are some comments from Controllers interviewed for this article about their responsibilities as ethical role models in their organizations. The Controller can help best by providing accurate financial information to the CEO and CFO, so they can make meaningful decisions. How much will it cost to give a more lucrative settlement to displaced employees? What are the real costs of pension and medical programs? And the Controller can also provide meaningful information on the returns expected by shareholders and how certain actions would affect that return. — Jeffrey Barnett, Controller, Cilcorp, Peoria, Ill. The Controller is the gatekeeper in recognizing revenues and expenses. He or she must make sure that nothing is contrary to GAAP or company policy. If an action is not in his company’s long-term interest, he should speak up. —Jim Dahmus, Vice President/Controller, Cincinnati Bell, Cincinnati As a new Controller, I’m feeling my way. But my first step will be to proactively change certain corporate policies, such as slush funds and management incentives based on short-term goals. On the backside, if that has no effect, I can always impact what the auditor sees. When something troubles me, I can counterattack by getting support on the outside. — Cindy Dailey, Controller, Six Flags, Eureka, Mo. The CFO/Controller has to set the example. He has to set up internal controls that make it difficult to fall into bad habits. He has to make sure that outside auditors have access to all levels of management, and that all budget items are achievable. If the CEO asks him to do something unethical, he should point out that it appears to violate SEC codes, sound business practices or the company’s own code. If the CEO won’t listen, he should ask for a third party’s opinion, such as the chair of the ethics committee or the outside auditor. If the CEO still won’t listen, he has no choice but to resign and bring the matter to the attention of the board. — Cosmo Trapani, Executive Vice President and CFO, Unitrode Corp., Merrimack, N.H.

Once upon a time there were two CEOs and two Controllers. The first CEO, head of a savings and loan, cooks up a fictitious loan and pockets the money. When the loan is included in financial statements filed with the FDIC, the Controller knows the loan is false, but signs off under threat of losing his job. After the S&L goes bankrupt, government investigators discover the loan. The Controller goes to prison for knowingly filing a false report. But the CEO does not go to prison because the government has no evidence against him.

The second CEO, a contractor, sees a client cancel a $1 million electronic installation. But for financial statements to accompany a loan application, he orders his Controller to book the job as 100 percent completed, not the actual 10 percent. When the contractor cannot make good on the loan, the bank discovers the fraud. The CEO is prosecuted and sent to prison. The Controller is not prosecuted — in part because he testifies against the CEO, and in part because the CEO had initialed authorization to book the job as 100 percent completed.

While most of the ethical challenges financial managers will face are unlikely to be this dramatic, unsettling situations can arise, causing you to inadvertently commit a crime or at least violate your personal code of ethics.

“From tax returns to SEC filings, you sign under the penalty of perjury,” says Melvin Benson, managing director, forensic accounting, KPMG Peat Marwick, Atlanta. Fraud increases when a firm’s finances dip, he says. “Why sell your integrity to save a dying company? Or your job? How much is your integrity worth?”

Of course, deception can be more subtle. “You simply bury risky investments in the financial notes,” says Ed Petry, executive director, Ethics Officers Association, Bentley College, Waltham, Mass. “It’s all there, it’s legal, and it’s accurate. But it’s misleading. What is practiced and accepted and legal is not necessarily ethical.”

Corporate decision-making has an ethical dimension today it did not have 10 years ago. The causes are many. The scandals that rocked the financial world in the 1980s, the “me” decade, awakened the conscience of many. As did the defense industry procurement scandals. Then Federal Sentencing Guidelines were introduced in November 1991, requiring judges and prosecutors to reduce fines or probation when organizations have “an effective program to prevent and detect violation of law.” Meanwhile, corporate ethics programs mushroomed. Membership in the Ethics Officer Association increased from 30 members in 1992 to 250 today — 40 percent of the members being from a finance/auditing background. And a comprehensive survey by the Ethics Resource Center, Washington, D.C., revealed that 60 percent of responding companies now have ethical codes, 33 percent have ethics offices and 33 percent provide ethics training.

Why this increase in ethical awareness? “The true purpose may not be a concern for ethics,” says Jeffrey Barnett, Controller, Cilcorp, Peoria, Ill., “but to avoid lawsuits.”

Dangers of Short-Term Thinking

“One cause of corporations winding up in ethical or legal trouble,” says Michael Hoffman, executive director, Center for Business Ethics, Bentley College, Waltham, Mass., “is a concentration on short-term profits over a strategic long-term vision of what the company can be in the future. Short-term thinking puts pressure on otherwise ethical employees to sacrifice personal values to immediate corporate objectives.”

Downsizing may be considered by some to be another example of short-term thinking. “You hear about global competitiveness,” says Alan Stack, Controller, Kingsbury Inc., Philadelphia. “But I question whether we have to lay off as many employees as we do. There is a social consequence to this. Part of me agrees to the financial reasons, yet we have a responsibility to more than shareholders.”

To others, downsizing is not an ethics issue. “You won’t be around in the long term if you don’t conduct sound business practices in the short term,” says Cosmo Trapani, executive vice president and CFO, Unitrode Corp., Merrimack, N.H. “I don’t agree that short-term thinking fosters lower ethical standards.” Yet there are ethical implications when, as Trapani says, “any downsizing is an admission that management has made a mistake.”

“It’s not the short-term thinking itself that is the problem but management incentives based on short-term thinking,” says Cindy Dailey, Controller, Six Flags, Eureka, Mo. “That’s what encourages looser ethics.”

Assessing Ethics Programs How do 4,000 American managers and workers rank ethical misconduct in their companies? Those in administration (including finance), human resources and public relations are generally positive in their outlook, according to a 1994 study, Ethics in American Business, published by the Ethics Resource Center (ERC), Washington, D.C. In contrast, a negative perception of American business ethics is held by those in customer service, manufacturing and technology positions. “The closer you are to your product or your customer, the greater sense of responsibility you feel and the more contact you will have with ethical issues,” says Gary Edwards, Senior Fellow at the ERC. The study, begun when Edwards was ERC president, also reveals that employees who hold higher positions in a company are more positive about business ethics than those at lower levels. Senior managers see less misconduct and less encouragement of misconduct, whereas front-line supervisors feel the most pressure to engage in misconduct and also see more misconduct. “The pressure for misconduct flows downhill,” says Edwards. “What drives the poor opinion of ethics at lower levels is not customer contact but that at lower levels you deal with getting the product out on time and under budget.” Indeed, pressure to compromise a company’s ethical standards comes primarily from scheduling (54 percent) and overly aggressive financial or business objectives (39 percent). The study suggests that today’s commitment to ethics is often ambiguous. Ethics programs run by headquarters may make a lot of people feel good about their companies, but they do not have an impact where it counts. Yes, they heighten the awareness of ethical issues. The employees in a company with such programs have a higher opinion (65 percent to 55 percent) of the ethical conduct in their companies, while more believe (39 percent to 16 percent) unethical conduct has decreased in the past five years. But more significant is the finding that 29 percent of respondents feel pressure to engage in corporate misconduct. And of the 31 percent of respondents who have witnessed misconduct, fewer than one-half reported it, while only one-third of those who did said corrective action was taken. Thus, the seed of the problem lies in the fact that those who deal most directly with a company’s product have a different picture of business ethics than those who direct that business from the ivory tower of headquarters. “Ethical programs don’t do enough,” says Edwards, “when nearly half (43 percent) of the employees who responded from companies with ethics programs watch serious misconduct take place and just look the other way.” The reason these programs don’t do enough, he says, “is that the message given through our management system is that it doesn’t matter how you get there, only whether you get there.” — RAP

“Top executives are paid year to year,” says Cris Tarquinio, Controller, JM Tull Metals, Norcross, Ga. “They know if they don’t do [a good job], they may not be there next year. Another problem is stockholders wanting a quicker turnaround.” His own firm locks on the long term. “We don’t ask about the ethics. We ask if the goal goes in the right direction, and is it worth getting there.”

Many financial executives think today’s trend is leaning toward longer-term thinking. “The baby boomer generation is turning 50,” says Alan Kristal, Controller, Schantz, Schatzman, Aaronson, Cahan in Miami. “It realizes that today is not all that matters. It’s asking how it can shape a company for the next decade.”

Even downsizing is planned with compassion at many companies. “We try to mitigate the pain,” says Barnett. “We’ve enhanced retirement benefits and offered a lucrative severance. We try to mesh ethics and economics. Employees are more than cogs.” Stack’s company will soon put in new software that will eliminate jobs, “but we’ve discussed where there are other needs in the company and how we can retrain those affected.”

“It costs money to go that extra mile,” says Jerry Jensen, vice president/Controller, Lafarge Corp., Southfield, Miss., “but you save in the long run. So many companies don’t look at what downsizing does to employees who remain.” Not only does fair treatment improve their morale, it encourages thinking in the long-range interests of the firm.

A “societal ethic” needs to be addressed, says Jim Dahmus, Vice President/Controller, Cincinnati Bell. “Some restructuring may be necessary to be competitive in a global economy, but at times its purpose appears to be to jump the share price. I wonder at the long-term impact, especially in cities that are dominated by large corporations. Employees do a lot for those cities. Who will now commit to United Way, to school boards?”

But some societal implications can be good. As the business community cleans up its ethics, Trapani says, “It is educating the workforce about what makes an ethical person. It is stressing that what is ethically correct inside its four walls also applies outside.”

The Carrot and the Stick

Despite all the efforts by companies to improve the ethical conduct of employees, Gary Edwards, Senior Fellow at the Ethics Resource Center, says, “There seems to be an invisible barrier, an impenetrable wall that an ethics program can’t breach.”

He says the barrier is systemic, citing performance management systems, the strategic planning process, and incentive programs. “These are management tools,” he says. “They are not unethical; they are amoral. But business uses these tools with little reflection on the environment they create.”

Executives set impossible goals, Edwards explains, and then “create an incentive and rewards system that can make an employee think his or her future depends on achieving them. CEOs get caught up in the competitive environment. They try to get market share back and can’t. They drive an earnings per share goal that can’t be reached.

“So they turn up the pressure inside, telling people they can do it when they can’t,” he says. “The signal they send is, ‘do what it takes.’ That’s what causes decent people to create 33-day months and to ship items not fully tested. That’s the wall that ethics programs run into.”

The finance function is especially sensitive to such pressures, he says. “That’s why the financial executive has to keep a professional distance, even though the CEO is beating him over the head to get better numbers.”

The solution? Leadership, Edwards says, because management can’t fix these problems with ethics programs alone. “It must also,” he says, “take a hard look at how it sets goals and directs people to meet them.”

But is leadership enough? Labor Secretary Robert Reich has suggested in The New York Times another systemic change, because corporations as well as people may need incentives — at least to curtail downsizing. “Perhaps the benefits of incorporation,” he wrote in January, “should be reserved for companies that demonstrate such responsibility. Alternatively, … perhaps corporate income taxes should be reduced or eliminated entirely for companies that do so.”

But however the system changes, the need for ethics in business will not change. “Ethics must always be considered in making a management decision,” Dahmus says, “but it is not part of the decision. It is the overriding factor. It is not as if you can go 80 percent of the way and then compromise. You must satisfy the ethics completely before you implement your decision.”

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