Corporate Scandals and Sarbanes-Oxley Act
Celebrity scandals often create “buzz” and actually make celebrities richer. But scandals in the business world often lead to the forfeiture of millions of dollars as well as prison sentences. We illustrate some notable corporate scandals below.
|Notable Corporate Scandals|
|Ponzi schemes are named after Charles Ponzi, who in the 1920s paid returns to investors using money from new investors rather than firm profits. Inevitably this kind of scheme falls apart because it becomes impossible to attract enough new investors to pay existing ones.||Enron executives used accounting loopholes to create shell companies to hide billions in debt from failed deals and projects. Although these smug executives thought they were always “the smartest guys in the room,” the loss of $11 billion in stock value and the prison time served by many of them proves otherwise.||Corruption was a family affair at Adelphia Communications Corporation, which was named after the Greek word for brothers. Adelphia was the fifth largest cable company in the United States until father and son team John and Timothy Rigas were found guilty on securities violations tied to their theft of $100 million. Another Rigas son, Michael, pled guilty to falsifying financial reports.|
|After two crashes that took hundreds of lives, Boeing grounded their 737 Super Max airliner. Their $20 million fine was small compared to the financial losses related to loss of confidence and loss of future sales, as it was discovered that Boeing had failed in several ways with FAA rules, inspections, and training pilots on its software changes.||Although Chiquita Brands sells healthy snacks, their corporate actions upset many stomachs in 2007 when they were fined $25 million by the US Justice Department for having ties to a Colombia paramilitary group on the department’s list of foreign terrorists organizations.||The Madoff investment scandal that broke in 2008 provided a modern twist on the classic Ponzi scheme. NASDAQ chairman Bernard Madoff pled guilty to eleven federal crimes that constituted the largest investor fraud ever committed by an individual. Madoff was sentenced to 150 years in prison.|
In the 1990s and early 2000s, several corporate scandals were revealed in the United States that showed a lack of board vigilance. Perhaps the most famous involves Enron, whose executive antics were documented in the film The Smartest Guys in the Room. Enron used accounting loopholes to hide billions of dollars in failed deals. When their scandal was discovered, top management cashed out millions in stock options while preventing lower-level employees from selling their stock. The collective acts of Enron led many employees to lose all their retirement holdings and their jobs, stockholders lost $74 billion, and many Enron execs were sentenced to prison. This scandal also caused the dissolution of Enron’s outside accounting firm, Arthur Anderson, one of the five largest accounting firms in the world at the time.
Around the same time as Enron, other corporate scandals created colossal damage. WorldCom, a telecommunications firm, inflated its assets. When discovered, shareholders lost $180 billion and 30,000 employees lost their jobs. Another famous one is Tyco, where the CEO and CFO stole $150 million and inflated the company revenues by $500 million. Before being discovered, the CEO threw a birthday party for his wife on a Mediterranean island that cost $2 million, paid with company funds. The CEO and CFO both went to prison.
In response to notable corporate scandals at Enron, WorldCom, Tyco, and other firms, Congress passed sweeping new legislation with the hopes of restoring investor confidence while preventing future scandals (Table 11.1). Signed into law by President George W. Bush in 2002, the Sarbanes-Oxley Act contained 11 aspects that represented some of the most far-reaching reforms since the presidency of Franklin Roosevelt. These reforms create improved standards that affect all publicly traded firms in the United States. The key elements of each aspect of the act are summarized as follows:
- Because accounting firms were implicated in corporate scandals, an oversight board was created to oversee auditing activities.
- Standards now exist to ensure auditors are truly independent and not subject to conflicts of interest in regard to the companies they represent.
- Enron executives claimed that they had no idea what was going on in their company, but the Sarbanes-Oxley Act requires senior executives to take personal responsibility for the accuracy of financial statements.
- Enhanced reporting is now required to create more transparency in regard to a firm’s financial condition.
- Securities analysts must disclose potential conflicts of interest.
- To prevent CEOs from claiming tax fraud is present at their firms, CEOs must personally sign the firm’s tax return.
- The Securities and Exchange Commission (SEC) now has expanded authority to censor or bar securities analysts from acting as brokers, advisers, or dealers.
- Reports from the comptroller general are required to monitor any consolidations among public accounting firms, the role of credit agencies in securities market operations, securities violations, and enforcement actions.
- Criminal penalties now exist for altering or destroying financial records.
- Significant criminal penalties now exist for white-collar crimes.
- The SEC can freeze unusually large transactions if fraud is suspected.
The changes that encouraged the creation of the Sarbanes-Oxley Act were so sweeping that comedian Jon Stewart quipped, “Did Wall Street have any rules before this? Can you just shoot a guy for looking at you wrong?” Despite the considerable merits of the Sarbanes-Oxley Act, no legislation can provide a cure-all for corporate scandal (Table 11.2). As evidence, the scandal by Bernard Madoff that broke in 2008 represented the largest investor fraud ever committed by an individual. But in contrast to some previous scandals that resulted in relatively minor punishments for their perpetrators, Madoff was sentenced to 150 years in prison.
Did the Sarbanes-Oxley Act help reduce corporate scandals? Maybe, but unfortunately they have continued. Some more notable ones are HealthSouth (2003), Freddie Mac (2004), American Insurance Group AIG (2005), Lehman Brothers (2008), Bernie Madoff (2008). Accounting and financial misdeeds are not the only type or corporate scandals that still plague the corporate environment. Sadly, more recent scandals involved Volkswagen (emissions fraud), Uber (sexual harassment), Apple (deliberately slowing devices), Facebook (data harvesting without consent), Boeing (skirting FAA rules), and various pharmaceutical companies that unethically pushed sales of opiate medications, increasing the opioid epidemic. As noted, not all corporate scandals are financial in nature, but typically are driven by greed and provide a financial benefit for individuals or companies.
In the early 2000s, highly publicized fraud at Enron, WorldCom, Tyco, and other firms revealed significant issues including conflicts of interest by auditors and securities analysts, boardroom failures, and inadequate funding of the Securities and Exchange Commission. In response, Senator Paul Sarbanes and Representative Michael Oxley sponsored legislation that contained what former President George. W. Bush called “the most far-reaching reforms of American business practices since the time of Franklin D. Roosevelt.” We outline the 11 key aspects of the law below.
|11 Key Aspects of the Sarbanes-Oxley Act of 2002|
|Accounting firms were complicit in some fraudulent events. In response, SOX created a board to oversee auditing activities within these firms.||To restore investor confidence in securities analysts, SOX expands the SEC’s authority to censure or bar them from acting as a broker, advisor, or dealer.|
|Concerns about conflicts of interests arising from accounting firms acting as consultants and auditors for the same firm led SOX to establish standards to ensure that auditors would be truly independent.||The comptroller general and the SEC are now required to carefully monitor any consolidation among public accounting firms, the role of credit agencies in securities market operations, securities violations, and enforcement actions.|
|Senior executives must take individual responsibility for the accuracy of their firms’ financial reports and they must forfeit the benefits arising from any non-compliance.||To preserve potentially incriminating documents, SOX creates criminal penalties for altering or destroying financial records.|
|To create more transparency, SOX enhances reporting standards for off-balance-sheet transactions and requires timely reporting of material changes in a firm’s financial condition.||In the past, white-collar crimes often received a proverbial slap on the wrist. SOX significantly increased the penalties associated with white-collar crimes and conspiracies.|
|Securities analysts must disclose any conflicts of interest involving a firm.||In response to past fraud and records tampering, the SEC can temporarily freeze transactions deemed unusually large.|
|The CEO is required to sign his/her firm’s tax return. This may prevent CEOs from claiming that they did not know tax fraud was occurring within their firms.|
The ethics of business. Where and why it can go wrong [10:55]
This video explains the ethics of business, and where and why it can go wrong.
You can view this video here: https://youtu.be/vAtu_iBbknY.
Ethics and CSR as Corporate Strategy
One positive outcome of the corporate scandals has been an increased focus by firms on corporate ethics. Many companies now have an Ethics and Compliance Officer and a detailed Ethics and Compliance Code. For example, Walmart’s Global Ethics and Compliance Program is provided online for the public and has numerous pages (Walmart, n.d.). Many firms provide annual training to all its employees on their company’s ethics and compliance standards.
Here is the Table of Contents for Facebook’s Code of Conduct. Although this is a typical approach to a Code of Conduct, it doesn’t mean a company is necessarily perceived as ethical. This is particularly true lately as Facebook contends with pressure to change its commitments to “free speech” with accusations of promoting hate speech.
|Table of Contents|
|2. Conflicts of Interest|
|5. Public Disclosures|
|6. Financial Integrity and Responsibility|
|7. Confidential Information|
|8. Protection of User Data and Personnel Data|
|9. Protection and Use of Facebook Assets|
|10. Compliance with Laws|
|11. Reporting Violations|
|12. Policy Prohibiting Retaliation|
|14. Amendment and Waivers|
Another form of regulation designed to prevent corporate misbehavior are “whistleblower” laws and policies. Many firms intentionally encourage employees to report any suspected misconduct by the firm, its managers, or employees. A “whistleblower” hotline is often provided where suspected violations can be reported anonymously. Anti-retaliation policies encourage employees to come forward to report misconduct without fear of retaliation or losing their job. Although all these measures are helpful, unfortunately, fraud and misconduct still occur.
In response to persistent “rule-breaking” by corporate actors, Corporate Social Responsibility (CSR) emerged in the 1970s to assert that a “social contract” exists between business and society. At its base is the assumption that businesses thrive when the society it relies on thrives, and therefore, firms have a duty to provide more than profit back to its environment. It is a business model that attempts to “give back” to the members of the community or society that help the firm succeed through the purchasing of its products or services. The goal of CSR is to enhance the success of a business by enhancing the society in which the organization operates. It can take the form of philanthropy or donating funds to causes it believes are important to its stakeholders. Some forms of CSR include corporate volunteerism, such as asking company employees to volunteer to build a Habitat for Humanity house on a Saturday. Improving environmental sustainability is one of the most recognized recent forms of CSR.
Many firms adopt the Triple Bottom Line approach to guide their CSR philosophy. In the triple bottom line, the company focuses on the three P’s; profit, planet, and people. CSR is discussed in more detail later in this chapter.
What is business ethics? [04:08]
The video for this lesson explains personal business ethics.
You can view this video here: https://youtu.be/IEmUag1ri6U.
What is Ethics? What is Business Ethics? [04:35]
This second video for the lesson focuses on business ethics.
You can view this video here: https://youtu.be/vmVu66Fpd9U.
- Firms can have a positive or negative impact on society. Corporate scandals have caused tremendous losses for shareholders, employees, and other stakeholders. The government has passed various regulations such as the Sarbanes-Oxley Act in attempts to thwart unethical and illegal company behavior, yet this behavior continues. Company boards of directors have the ultimate responsibility of ensuring ethical behavior on the part of the organization and its CEO. Senior management may be tempted to act in their own interest instead of the best interests of the firm, which is called the agency problem. On the positive side, many firms have adopted the philosophy and activities of corporate social responsibility or creating shared value. Ethical issues will confront firms and their leadership teams. Adhering to the companies’ core values and keeping the best interests of the firm as the priority will help guide leaders to the best decisions.
- Divide into groups of 4 or 8, and discuss actions boards of directors can take to help ensure ethical behavior is maintained by the company leadership and the employees. Come up with several ideas to share with the class.
- You work for Deloitte in Tyson’s Corner in Northern Virginia. You have been selected to serve on a team to come up with ideas on how your office can implement corporate social responsibility. What specific CSR ideas will you share with the team?
Table 11.3 Facebook. (2019, June 10). Adapted from “Code of Conduct” https://s21.q4cdn.com/399680738/files/doc_downloads/governance_documents/2019/Code-of-Conduct-(June-10-2019).pdf.
Walmart. (n.d.) Global Ethics & Compliance. https://corporate.walmart.com/our-story/global-ethics-compliance.
Cranfield School of Management. (2010, July 13). The ethics of business. Where and why it can go wrong [Video]. YouTube. https://youtu.be/vAtu_iBbknY.
Global Ethics Solutions. (2019, November 1). What is business ethics? [Video]. https://youtu.be/IEmUag1ri6U.
Markkula Center for Applied Ethics. (2010, October 1). What is ethics? What is business ethics? [Video]. https://youtu.be/vmVu66Fpd9U.