ETHICS Fraud and the Family

Values are transmitted from one generation to another through families. As families spend less time together and are influenced more by outsiders, values transfer breaks down, according to Dr Ned C Hill, dean of Brigham Young University’s Marriott School of Management. And the process is exacerbated by the way business subjects are taught in business schools.
By the time graduates find themselves in business careers, then as executives and managers, other pressures kick in, such as the pressure to generate profits. Then, when they have opportunities to make or not make decisions, they lack the values-based foundation to keep them from acting fraudulently or unethically.
Hill’s travelling companion and the Marriott School’s associate dean and expert on corporate fraud, Steve Albrecht, had similar take on the argument. Fraud research suggests there are three elements common to all frauds; perceived pressure, perceived opportunity and some way to rationalise the fraud as acceptable and consistent with an individual manager’s personal code of ethics, he said.
But without the integrity and ethics you are more likely to rationalise, said Albrecht. “I’m only doing it once, and all those sorts of things.” There are, however lot of environment pressures and opportunities. “Wall Street, for example, puts enormous pressure on companies with their quarterly profit forecasts. And then, there is lot of greed which also creates pressure. And in America, the opportunities were enhanced by the very strong economy which people got used to in the 1990s and early 2000. Everybody was making money. And finally, the laxness in our corporate governance standards allowed frauds like Worldcom, Enron and Mutual Fund to happen.”
The problem of unethical business practices is not, however, confined to the US. The fraud triangle of pressure, opportunity and rationalisation, which comes easier to those with lower level of integrity and ethical values, is an issue for all societies, said Albrecht.
The academics use their fraud triangle to explain why Enron and others in the US, HIH in Australia and Parmalat in Italy happened and why we can expect more fraud of this magnitude in future. They also believe that nine factors came together to create what they call the “perfect fraud storm”.
The world’s, and particularly America’s, booming economy was the first element. It masked existing problems and unethical actions. All businesses, even the dot-coms, appeared profitable and “people made nonsensical investment and other decisions”. The booming economy had executives believing their companies were more successful than they indeed were and that this success was due, primarily, to their own outstanding management abilities.
Research, however, has found that in boom times firms frequently incorrectly “ascribe the reasons for their success”, said Albrecht. “Management usually takes credit for good company performance” whether it is true or not. And when things turn sour, boards expect similar results to those of the past without changing management styles or actions. “Since management didn’t correctly understand past reasons for success, they incorrectly think past methods will continue to work,” he added. When these don’t work CEOs can feel pressured and sometimes this pressure contributes to fraudulent financial reporting and other dishonesty.
The second element of the perfect fraud storm was, in Hill and Albrecht’s opinion, moral decay. “Whatever measure of integrity one uses, dishonesty appears to be increasing,” said Hill. Research by the Josephson Institute in the US found that, between 2001 and 2002, the percentage of high school students who admitted cheating on exams increased from 71 to 74 percent; the percentage of students who admitted lying to their parents increased from 92 to 93 percent; the percentage who said they would lie to get job jumped from 27 to 37, and the percentage who admitted shoplifting increased from 35 to 38 percent between 2002 and 2003. And study by the University of California at Berkely found 115 percent increase in reported cases of academic dishonesty between 1995 and 2000.
“Misplaced executive incentives” provided the third ‘perfect storm’ element. Executives of the most fraudulent companies received hundreds of millions of dollars in stock options and/or restricted stock which made it more important to keep the stock price rising rather than accurately report financial results. “The CEO’s attention shifted from managing the company to managing the stock price,” said Hill. “At the cost of countless billions of dollars, managing the stock price all too often turned into fraudulently managing financials. This approach had CEOs focusing on short-term results. We need to change the compensation system so that executives will have long-term view. We used to think executives needed to own stock to have long-term view. But if we only look at earnings to determine the stock price then we have short-term view,” he added.
The fourth element, and closely linked to the third, was the unachievable expectations of Wall Street analysts who targeted only short-term behaviour. Each quarter the analysts, often coached by companies themselves, forecasted what each company’s earning per share would be. Executives knew that the penalty for missing the “street’s” estimate was severe with stock prices falling even when expectations failed by only tiny margin. “The shorter the evaluation period becomes, the more executives are willing to compromise and the less meaningful ethics become. You don’t care about employees any more. You treat them as assets which can be bought and sold instead of people who need to be invested in and nurtured. Short-term perspective has lot of adverse effects,” said Albrecht.
Element five was debt and leverage. The huge debt, particularly of the fraudulent companies, placed enormous financial pressure on executives not only to have high earnings to offset high interest costs but, also to report high earnings to meet debt and other covenants.
The nature of US accounting rules accounted for Hill and Albrecht’s sixth storm element. In contrast to accounting practices in other countries, including New Zealand, US generally accepted accounting principles (GAAP) “are more rule-based than principles based”, said Albrecht. Because of this, when auditors and other advisers sought to create competitive advantages by identifying and exploiting possible loopholes, it was harder to make convincing case that particular accounting treatment is prohibited when it “isn’t against the rules”.
Then there was the opportunistic behaviour of some CPA (consulting and accounting) firms. “In some cases, accounting firms used audits as loss leaders to establish relationships with companies so they could sell more lucrative consulting services,” said Albrecht. “In many cases audit fees were much smaller than consulting fees for the same clients and accounting firms felt little conflict between independence and opportunities for increased profits.”
Element eight was pure and simple executive, investment and commercial bank and investor greed. “Each of these groups benefited from the strong economy, the high level of lucrative transactions and the apparently high profits of companies. None of them wanted to accept bad news,” said Albrecht. “As result, they sometimes ignored negative news and entered into bad transactions.”
The ninth and final element of Hill and Albrecht’s perfect storm was three educator failures.
“First,” says Hill, “educators did not provide sufficient ethics training for students. By not forcing students to face realistic ethical dilemmas in the classroom, graduates were ill-equipped to deal with real ethical dilemmas they faced in the business world.”
And second, educators failed to teach students about fraud. “Most business schools would not recognise fraud if it hit them between the eyes,” said Albrecht. “The majority of busines