Chapter 6 The Role of Government Chapter Summary This chapter steps outside of the organizational framework and examines what legislation the government has put into place to enforce ethical conduct. The Foreign Corrupt Practices Act attempts to send a clear message that U.S. overseas corporations are based on price and product quality. The Defense Industry Initiatives has to deal with the growing public concern over “procurement irregularities.” The U.S. Federal Sentencing Guidelines was put into place in 1984 to hold businesses liable for the criminal acts of their employees and agents. The Sarbanes-Oxley Act has 11 titles that cover the financial management of business containing examples of corporate wrongdoing that preceded the establishment of the legislation. Learning Outcomes After studying this chapter, the student should be able to: 1. Identify the five key pieces of U.S. legislation designed to discourage, if not prevent, illegal conduct within organizations. 2. Understand the purpose and significance of the Foreign Corrupt Practices Act (FCPA). 3. Calculate monetary fines under the three-step process of the U.S. Federal Sentencing Guidelines for Organizations (FSGO). 4. Compare and contrast the relative advantages and disadvantages of the Sarbanes-Oxley Act (SOX). 5. Explain the key provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Extended Chapter Outline Frontline Focus “Too Much Trouble” Questions 1. The Sarbanes-Oxley Act created an oversight board for all auditing firms. Look at the outline of the act on pages 122–123 for more information on the Public Company Accounting Oversight Board (PCAOB). Would the PCAOB endorse trying to dump a prospective client in this manner? Students’ answers may vary. The PCAOB was created as an independent oversight body as an attempt to reestablish the perceived independence of auditing companies that the conflict of interest in Arthur Andersen’s auditing and consulting relationship with Enron had called into question. Also, the PCAOB was charged with maintaining compliance with established standards and enforcing rules and disciplinary procedures for those organizations that found themselves out of compliance. In this scenario, the PCAOB would not encourage the firm to take on a client that they could not accurately and adequately spend time auditing; however, it is not ethical to create such a high quote to drive away the client. 2. Is being too busy with other clients a justification for deliberately driving this customer away? Students’ answers may vary. Being too busy with other clients is not a justification for deliberately driving this customer away. If Steven is concerned about finding the future big fish and keeping up with a growing client base, then the firm needs to address the issue of hiring more auditors to take on more clients. 3. What should Susan do now? Students’ answers may vary. Susan should have a discussion with Steven about her comfort level regarding following through with his request as well as what will happen in the future when this happens again. Learning Outcome 1: Identify the Five Key Pieces of U.S. Legislation Designed to Discourage, if not Prevent, Illegal Conduct within Organizations. • For those organizations that have demonstrated that they are unable to keep their own house in order by maintaining a strong ethical culture, the last line of defense has been a legal and regulatory framework that offers financial incentives to promote ethical behavior and imposes penalties for those that choose not to adopt such behavior. • Since the 1970s, there have been several attempts at behavior modification to discourage, if not prevent, illegal conduct within organizations: o The Foreign Corrupt Practices Act (1977) o The U.S. Federal Sentencing Guidelines for Organizations (1991) o The Sarbanes-Oxley Act (2002) o The Revised Federal Sentencing Guidelines for Organizations (2004) o The Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) Learning Outcome 2: Understand the Purpose and Significance of the Foreign Corrupt Practices Act (FCPA). • The Foreign Corrupt Practices Act (FCPA) was a legislation introduced to control bribery and other less obvious forms of payment to foreign officials and politicians by American publicly traded companies. • By passing the FCPA, Congress was attempting to send a clear message that the competitiveness of U.S. corporations in overseas markets should be based on price and product quality rather than the extent to which companies had paid off foreign officials and political leaders. • The FCPA focuses on two distinct areas: o Disclosure—the FCPA requirement that corporations fully disclose any and all transactions conducted with foreign officials and politicians, in line with the SEC provisions. o Prohibition—the FCPA inclusion of wording from the Bank Secrecy Act and the Mail Fraud Act to prevent the movement of funds overseas for the express purpose of conducting a fraudulent scheme. • The FCPA was criticized for lacking any real teeth because of its formal recognition of facilitation payments. o Facilitation payments are payments that are acceptable (legal) provided they expedite or secure the performance of a routine government action. • The FCPA finds these payments acceptable provided they expedite or secure the performance of a routine governmental action. o Routine governmental action is any regular administrative process or procedure, excluding any action taken by a foreign official in the decision to award a new or continuing business. Examples include: ➢ Providing permits, licenses, or other official documents to qualify a person to do business in a foreign country ➢ Processing governmental papers, such as visas and work orders ➢ Providing police protection, mail pickup and delivery, or scheduling inspections related to transit of goods across a country ➢ Providing phone service, power, and water supply, loading and unloading cargo, or protecting perishable products or commodities from deterioration ➢ Performing acts of a similar nature • The key distinction in identifying bribes was exclusion of any action taken by a foreign official in the decision to award new or continuing business. o Such decisions, being the primary target of most questionable payments, were not deemed to be routine governmental action. • Figure 6.1 summarizes the fine lines between legality and illegality in some of the prohibited behaviors and approved exceptions in the FCPA provisions. o The Department of Justice can enforce criminal penalties of up to $2 million per violation for corporations and other business entities. o Officers, directors, stockholders, employees, and agents are subject to a fine of up to $250,000 per violation and imprisonment for up to five years. o The SEC may bring a civil fine of up to $10,000 per violation. o Penalties under the books and record-keeping provisions can reach up to $5 million and 20 years’ imprisonment for individuals and up to $25 million for organizations. Learning Outcome 3: Calculate Monetary Fines under the Three-Step Process of the U.S. Federal Sentencing Guidelines for Organizations (FSGO). • The U.S. Federal Sentencing Commission was established in 1984 by the Comprehensive Crime Control Act and was charged with developing uniform sentencing guidelines for offenders convicted of federal crimes. o In 1991, Chapter 8 was added to the guidelines. o Chapter 8 is more commonly known as Federal Sentencing Guidelines for Organizations. • Federal Sentencing Guidelines for Organizations (FSGO) hold businesses liable for the criminal acts of their employees and agents. o In its mission to promote ethical organizational behavior and increase the costs of unethical behavior, the FSGO establishes a definition of an organization that is so broad as to prompt the assessment that “no business enterprise is exempt.” o In addition, the FSGO includes such an exhaustive list of covered business crimes that it appears frighteningly easy for an organization to run afoul of federal crime laws and become subject to FSGO penalties. • Penalties under FSGO include monetary fines, organizational probation, and the implementation of an operational program to bring the organization into compliance with FSGO standards • If an organization is sentenced under the FSGO, a fine is calculated through a three-step process: o Step 1: Determination of the “Base Fine”—the base fine will normally be the greatest of: ➢ The monetary gain to the organization from the offense. ➢ The monetary loss from the offense caused by the organization, to the extent the loss was caused knowingly, intentionally, or recklessly. ➢ The amount determined by a judge based on an FSGO table. o Step 2: The Culpability Score—the culpability score is the calculation of a degree of blame or guilt that is used as a multiplier of up to four times the base fine. The culpability score can be adjusted according to the aggravating or mitigating factors. ➢ Aggravating factors ✓ High-level personnel were involved in or tolerated the criminal activity. ✓ The organization willfully obstructed justice. ✓ The organization had a prior history of similar misconduct. ✓ The current offense violated a judicial order, an injunction, or a condition of probation. ➢ Mitigating factors ✓ The organization had an effective program to prevent and detect violations of law. ✓ The organization self-reported the offense to appropriate governmental authorities, fully cooperated in the investigation, and accepted responsibility for the criminal conduct. o Step 3: Determining the Total Fine Amount—the base fine multiplied by the culpability score gives the total fine amount. ➢ In certain cases the judge has the discretion to impose a so-called death penalty. ➢ The death penalty is a fine that is set high enough to match all the organization’s assets and basically put the organization out of business. This is warranted where the organization was operating primarily for a criminal purpose. • In addition to monetary fines, organizations also can be sentenced to probation for up to five years. The status of probation can include the following requirements: o Reporting the business’s financial condition to the court on a periodic basis o Remaining subject to unannounced examinations of all financial records by a designated probation officer and/or court-appointed experts o Reporting progress in the implementation of a compliance program o Being subject to unannounced examinations to confirm that the compliance program is in place and is working • The best way to minimize an organization’s culpability score is to make sure that you have some form of program in place that can effectively detect and prevent violations of law—a compliance program. • The FSGO prescribes seven steps for an effective compliance program: o Management oversight o Corporate policies o Communication of standards and procedures o Compliance with standards and procedures o Delegation of substantial discretionary authority o Consistent discipline o Response and corrective action • In May 2004, the U.S. Sentencing Commission proposed to Congress that there should be modifications to the 1991 guidelines. The revised guidelines, which Congress formally adopted in November 2004, made three key changes: o They required companies to periodically evaluate the effectiveness of their compliance programs on the assumption of a substantial risk that any program is capable of failing. o The revised guidelines required evidence of actively promoting ethical conduct rather than just complying with legal obligations. o The guidelines defined accountability more clearly. Corporate officers are: ➢ Expected to be knowledgeable about all aspects of the compliance program ➢ Required to receive formal training as it relates to their roles and responsibilities within the organization Learning Outcome 4: Compare and Contrast the Relative Advantages and Disadvantages of the Sarbanes-Oxley Act (SOX) • The Sarbanes- Oxley Act (SOX) is a legislative response to the corporate accounting scandals of the early 2000s that covers the financial management of businesses. o It became law on July 30, 2003. The act contains 11 sections, or titles, and almost 70 subsections covering every aspect of the financial management of businesses. ➢ Title I: Public Company Accounting Oversight Board—the Public Company Accounting Oversight Board (PCAOB) is an independent oversight body for auditing companies. ➢ Title II: Auditor Independence ➢ Title III: Corporate responsibility ➢ Title IV: Enhanced Financial Disclosures ➢ Title V: Analyst Conflicts of Interest ➢ Title VI: Commission Resources and Authority ➢ Title VII: Studies and Reports ➢ Title VIII: Corporate and Criminal Fraud Accountability ➢ Title IX: White-Collar Crime Penalty Enhancements ➢ Title X: Corporate Tax Returns ➢ Title XI: Corporate Fraud and Accountability Learning Outcome 5: Explain the Key Provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. • The Dodd-Frank Wall Street Reform and Consumer Protection Act is a legislation that was promoted as the “fix” for the extreme mismanagement of risk in the financial sector that led to a global financial crisis in 2008-2010. o It was implemented on July 21, 2010. • The primary achievements of Dodd-Frank can be summarized as follows: o The Act created the Consumer Financial Protection Bureau (CFPB)—a government agency within the Federal Reserve that oversees financial products and services. o The Act established the Financial Stability Oversight Council (FSOC)—a government agency established that prevents banks from failing and otherwise threatening the stability of the U.S. economy. ➢ It is empowered to act if a bank with more than $50 billion in assets “poses a great threat to the financial stability of the United States.” o American economist and past Federal Reserve Chairman Paul Volcker proposed that there should be a key restriction in the legislation to limit the ability of banks to trade on their own accounts (termed proprietary trading). ➢ The original Volcker rule sought to stop the trading of derivatives (which are financial instruments based on the performance of other financial instruments) completely, but was scaled back to a compromise that, it is hoped, will limit the ethically questionable practices of banks taking opposing positions to trades that they are simultaneously promoting to their clients. Life Skills Governing your Own Ethical Behavior This Life Skills box discusses how our own personal value system represents the cumulative effect of a series of influences in our life. As such our ethical standards already represent a framework of the influences that makes us the person we are today. Developing a clear sense of personal values is as much about knowing what one isn’t willing to do as it is about knowing what one is willing to do. Understanding the difference allows us to remain grounded and focused while those around us wonder in search of someone to help them make a decision. Progress ✓ Questions 1. What was the primary purpose of the FCPA? The FPCA was introduced to control bribery and other less obvious forms of payment to foreign officials and politicians by American publicly traded companies. By passing the FCPA, Congress was attempting to send a clear message that the competitiveness of U.S. corporations in overseas markets should be based on price and product quality rather than the extent to which companies had paid off foreign officials and political leaders. 2. What was the maximum fine for a U.S. corporation under the FCPA? The Department of Justice can enforce criminal penalties up to $2 million per violation for corporations and other business entities. Officers, directors, stockholders, employees, and agents are subjected to $250,000 per violation and imprisonment for up to 5 years. The SEC may bring a civil fine of up to $10,000 per violation. Penalties under the books and record-keeping provisions can reach up to $5 million and 20 years’ imprisonment for individuals and up to $25 million for organizations. 3. Which two distinct areas did the FCPA focus on? The FCPA encompasses all the secondary measures that were currently in use to prohibit such behavior by focusing on two distinct areas: • Disclosure—the act requires corporations to fully disclosure any and all transactions conducted with foreign officials and politicians, in line with the SEC provisions. • Prohibition—the act incorporates the wording from the Bank Secrecy Act and the Mail Fraud Act to prohibit the movement of funds overseas for the express purpose of conducting a fraudulent scheme. 4. List four examples of routine governmental action. Examples of routine governmental actions include: • Providing permits, licenses, or other official documents to qualify a person to do business in a foreign company • Processing governmental papers, such as visas and work orders • Providing police protection, mail pickup and delivery, or scheduling inspections associated with contract performance or inspections related to transit of goods across a country • Providing phone service, power, and water supply; loading and unloading cargo; or protecting perishable products or commodities of deterioration • Performing actions of a similar nature 5. What are the three steps in calculating financial penalties under FSGO? If an organization is sentenced under FSGO, a fine is calculated through a three-step process: • Determination of the “Base Fine” • The Culpability Score • Determining the Total Fine Amount 6. What is the maximum fine that can be levied? The worst case scenario would be a fine of four times the maximum base fine of $72.5 million, for a grand total of $290 million. 7. What is the maximum term of organizational probation? The maximum term for probation is up to five years. 8. What is the “death penalty” under FSGO? The death penalty is a fine that is set high enough to match all the organization’s assets and basically put the organization out of business. This is warranted where the organization was operating primarily for a criminal purpose. 9. Explain the seven steps of an effective compliance program. The FSGO prescribes the following seven steps for an effective compliance program: • Management oversight—a high-level official must be in charge of and accountable for the compliance program. • Corporate policies—policies and procedures designed to reduce the likelihood of criminal conduct in the organization must be in place. • Communication of standards and procedures—these ethics policies must be effectively communicated to every stakeholder of the organization. • Compliance with standards and procedures—evidence of active implementation of these policies must be provided through appropriate monitoring and reporting. • Delegation of substantial discretionary authority—no individuals should be granted excessive discretionary authority that would increase the risk of criminal conduct. • Consistent discipline—the organization must implement penalties for criminal conduct and for failing to address criminal misconduct in a consistent manner. • Response and corrective action—criminal offenses, whether actual or suspected, must generate an appropriate response, analysis, and corrective action. 10. What are aggravating and mitigating factors? Aggravating factors: • High-level personnel were involved in or tolerated criminal activity. • The organization willfully obstructed justice. • The organization had a prior history of similar misconduct. • The current offense violated a judicial order, injunction, or condition of probation. Migrating factors: • The organization had an effective program to prevent and detect violations of the law. • The organization self-reported the offense to appropriate governmental authorities, fully cooperated in the investigation, and accepted responsibility for the criminal conduct. 11. Explain the risk assessments required in the 2004 Revised FSGO. Risks involved can be negative publicity for the organization, which could result in significant loss of sales, additional scrutiny from vendors, and even a drop in the organization’s stock price. 12. What were the three key components of the 2004 Revised FSGO? The revised guidelines, which Congress formally adopted in November 2004, made the following three key changes: • They required companies to periodically evaluate the effectiveness of their compliance programs on the assumption of a substantial risk that any program is capable of failing. They also expected the results of these risk assessments to be incorporated back into the next version of the compliance program. • The revised guidelines required evidence of actively promoting ethical conduct rather than just complying with legal obligations. For the first time, the concept of an ethical culture was recognized as a foundational component of an effective compliance program. • The guidelines defined accountability more clearly. Corporate officers are expected to be knowledgeable about all aspects of the compliance program, and they are required to receive formal training as it relates to their roles and responsibilities within the organization. 13. Explain the role of the PCAOB. The PCAOB is an independent oversight body for auditing companies. In addition, as an oversight board, it is in charge of maintaining compliance with established standards and enforcing rules and disciplinary procedures for those organizations that found themselves out of compliance. 14. Which title requires CEOs and CFOs to certify quarterly and annual reports to the SEC? Title III: Corporate Responsibility requires CEOs and CFOs to certify quarterly and annual reports to the SEC, including making representations about the effectiveness of their control systems. 15. Which title protects employees of companies who provide evidence of fraud? Title VIII: Corporate and Criminal Fraud Accountability protects employees of companies who provide evidence of fraud. 16. What are the five key requirements for auditor independence? The Sarbanes-Oxley Act introduced the following five key directives to enforce the independence of auditors and hopefully restore public confidence in independent audit reports: • Prohibits specific “nonaudit” services of public accounting firms as violations of auditor independence • Prohibits public accounting firms from providing audit services to any company whose senior officers (chief executive officer, financial officer, etc.) were employed by that accounting firm within the previous 12 months • Requires senior auditors to rotate off an account every five years and junior auditors every seven years • Requires the external auditor to report to the client’s audit committee on specific topics • Requires the auditors to disclose all other written communications between management and themselves Ethical Dilemma 6.1 – The Bribery Gap 1. Is it ethical for U.S. regulations to put U.S. companies at an apparent disadvantage to their foreign competitors? Explain why or why not. Students’ responses will vary. U.S. companies have regulations that are specific to the U.S. because of the values, morals, and ideals in U.S. culture. While it may seem that foreign competitors have an advantage, those firms most likely have a different set of regulations from their government. 2. If foreign companies pay bribes, does that make it OK for U.S. companies to do the same? Explain why or why not. Students’ responses will vary. Foreign companies may pay bribes, but this does not justify the U.S. companies doing the same because it is still illegal. Even if the U.S. companies are based in foreign countries and conducting business internationally, the firm is still subject to U.S. legislation. 3. If you could prove that new jobs, new construction, and valuable tax revenue would come to the United States if the bribe were paid, would that change your position? Explain your answer. Students’ responses will vary. The benefits and opportunities such as new jobs, new construction, and valuable tax revenue are what make unethical behavior seem attractive and justifiable. 4. It would seem that the playing field will never be level—someone will always be looking for a bribe, and someone will always be willing to pay it if she or he wants the business badly enough. If that’s true, why bother to put legislation in place at all? Students’ responses will vary. This is the argument of those who are against creating new legislation. There will always be those willing to break the laws to get what they want. However, the legislation attempts to prevent and make it much harder to do, and as a result, reduces the number of people who would have acted unethically without legislation in place. 6.2 – An Unethical Way to Fix Corporate Ethics? 1. SOX has introduced sweeping changes in the name of enforcing corporate ethics. Is it really a “fair” piece of legislation? Explain your answer. Students’ responses will vary. When comparing large versus small companies, the Sarbanes- Oxley (SOX) Act is not fair. Smaller companies without access to the internal resources to comply with SOX are being particularly hard hit by the legislation. Plus the transgressions that prompted the statute in the first place came from large, publicly traded organizations. Smaller firms still face their own ethical problems, but it seems that they are expected to carry an administrative burden that is equal to that of their much larger counterparts. 2. Do U.S. ethical problems give us the right to demand ethical controls from international companies based outside the United States? Students’ responses will vary. Ethical problems in the United States do not give the U.S. the right to dictate controls from international companies based outside the United States. These firms should be governed by international organizations such as the European Union, NAFTA, etc. 3. Does the decision to increase auditing requirements seem to be an ethical solution to the problem of questionable audits? Explain your requirements. Students’ responses will vary. The decision to increase the auditing requirements does not seem to be an ethical solution, but one that provides a limitation or reduction of corporate scandals. There will always be those firms or executives that will find a way to manipulate the legislation and continuously act in unethical ways. 4. If there were more than four large accounting firms in the marketplace, would that make the decision more ethical? Explain your answer. Students’ responses will vary. The number of accounting firms in the marketplace is irrelevant because each of these is required to follow the same auditing requirements. The fact that there are only four large accounting firms in the marketplace suggests it should be easier to monitor and regulate these firms. Frontline Focus “Too Much Trouble—Susan Makes a Decision” Questions 1. What could Susan have done differently here? Students’ responses will vary. Susan could have asked Thompson, if he would have liked her to put a small team together and wrap up the project quickly, rather than quoting a high price to the client altogether, thereby forcing them to leave. She should not have quoted such an abnormally high price that would just make it obvious to the client that something has gone wrong. 2. What do you think will happen now? Students’ responses will vary. The PCAOB will run an investigation on the matter and would like an explanation as to how the auditing firm arrived at the quotation figure. And this will bring negative publicity for the firm. 3. What will be the consequences for Susan, Steven Thompson, and their auditing firm? Students’ responses will vary. If Susan, Steven Thompson, and their auditing firm are found guilty of misrepresenting the quotation figure they might have to face disciplinary actions posed by the PCAOB. Key Terms Consumer Financial Protection Bureau (CFPB): A government agency within the Federal Reserve that oversees financial products and services. Culpability Score (FSGO): The calculation of a degree of blame or guilt that is used as a multiplier of up to four times the base fine. The culpability score can be adjusted according to aggravating or mitigating factors. Death Penalty (FSGO): A fine that is set high enough to match all the organization’s assets— and basically put the organization out of business. This is warranted where the organization was operating primarily for a criminal purpose. Disclosure (FCPA): The FCPA requirement that corporations fully disclose any and all transactions, conducted with foreign officials and politicians. Dodd-Frank Wall Street Reform and Consumer Protection Act: Legislation that was promoted as a “fix” for the extreme mismanagement of risk in the financial sector that led to a global financial crisis in 2008-2010. Facilitation Payments (FCPA): Payments that are acceptable (legal) provided they expedite or secure the performance of a routine governmental action. Federal Sentencing Guidelines for Organizations (FSGO): Chapter 8 of the guidelines that hold businesses liable for the criminal acts of the employees and agents. Financial Stability Oversight Council (FSOC): A government agency established to prevent banks from failing and otherwise threatening the stability of the U.S. economy. Foreign Corrupt Practices Act (FCPA): Legislation introduced to control bribery and other less obvious forms of payment to foreign officials and politicians by American publicly traded companies. Prohibition (FCPA): The FCPA inclusion of wording from the Bank Secrecy Act and the Mail Fraud Act to prevent the movement of funds overseas for the express purpose of conducting a fraudulent scheme. Public Company Accounting Oversight Board (PCAOB): An independent oversight body for auditing companies. Routine Governmental Action (FCPA): Any regular administrative process or procedure, excluding any action taken by a foreign official in the decision to award new or continuing business. Sarbanes-Oxley Act (SOX): A legislative response to the corporate accounting scandals of the early 2000s that covers the financial management of businesses. Review Questions NOTE: Some questions allow for a number of different answers. Below are some suggestions. 1. Which is the most effective piece of legislation for enforcing ethical business practices: FCPA, FSGO, SOX, or Dodd-Frank? Explain your answer. Students’ responses will vary. The FCPA is a legislation introduced to control bribery and other less obvious forms of payment to foreign officials and politicians by American publicly traded companies. SOX is a legislative response to the corporate accounting scandals of the early 2000s that covers the financial management of businesses. It delivers the tools and penalties to punish offenders with enough severity. FSGO refers to Chapter 8 of the guidelines that holds businesses liable for criminal acts of the employees and agents. Dodd-Frank is the legislation that was promoted as a “fix” for the extreme mismanagement of risk in the financial sector that led to a global financial crisis in 2008-2010. 2. “The FCPA has too many exceptions to be an effective deterrent to unethical business practices.” Do you agree or disagree with this statement? Explain your answer. Students’ responses will vary. Some of the students may not agree with this statement. They may say that this act encompasses all the secondary measures that were currently in use to prohibit such behavior by focusing on two distinct areas—disclosure and prohibition. However, others may agree with this statement under the argument that the FCPA lacks any real teeth because of its formal recognition of facilitation payments, which would otherwise be acknowledged as bribes. The FCPA finds these payments acceptable provided they expedite or secure the performance of a routine governmental action. 3. What issues prompted the revision of the Federal Sentencing Guidelines for Organizations in 2004? The Federal Sentencing Guidelines for Organizations (FSGO) was implemented after major fraud and scandals that occurred in the U.S. and abroad. The revisions were to the 1991 guidelines and it needed to provide key changes in corporate compliance programs. The changes require companies to periodically evaluate the effectiveness of their compliance programs on the assumption of a substantial risk that any program is capable of failing; require evidence of promoting ethical conduct rather than just complying with legal obligations; and require that guidelines define accountability more clearly. 4. Do you think the requirement that CEOs and CFOs sign off on their company accounts will increase investor confidence in those accounts? Why or why not? Students’ responses will vary. It seems as though many of the recent corporate scandals started with the CEO, CFO, or COO. Therefore, requiring the CEOs and CFOs sign off on company accounts will not necessarily reduce corporate scandals and investor confidence will remain volatile. 5. Why may the Sarbanes-Oxley Act of 2002 be regarded as one of the most controversial pieces of corporate legislation in recent history? Students’ responses will vary. Some of the students may argue that with all the financial scandals and accounting fraud that was happening, the Sarbanes-Oxley was an appropriate response. However, others may argue that those who are going to commit fraud will find a way to commit it even with regulations in place. Some of them may also feel that regulations simply make more work for those who are already acting in an ethical manner. 6. Based on the information in this chapter, can the Dodd-Frank Act of 2010 prevent “too big to fail”? Explain your answer. Students’ responses will vary based on their perception of the Act. Students should note that the Dodd-Frank Act of 2010 should prevent or counteract the corporate fraud and scandals at a Wall Street company with the achievements of the Consumer Financial Protection Bureau (CFPB), the Financial Stability Oversight Council (FSOC), and the Volcker Rule. It will take time to determine if the new act can actually prevent “too big to fail” but it should hopefully put a dent into the extreme mismanagement of risk in the financial sector. Review Exercises 1. Identify the ethical transgressions in this case. Students’ responses will vary. Universal Industries wants to further its international exposure and the COO made a connection with a former high school classmate to help do so. Universal Industries were willing to follow a “means justify the ends” philosophy. Several Universal operatives made unpublicized visits to the towns surrounding the base, and made it almost impossible for other contenders to meet the requirements of the RFPs through bribes. Apart from bribing, the senior management team also decided to adjust its fourth-quarter expenses, which included having the CEO and CFO sign the financial reports confirming their authenticity. 2. Which piece of legislation would apply to each transgression? The Foreign Corrupt Practices Act would apply to the bribery conducted by Universal. The Sarbanes-Oxley Act would apply to financial fraud and authorization of the financial reports. 3. What would be the penalties for each transgression? Students’ responses will vary. Under each of the legislations, the FCPA and SOX, violators will be held liable for their criminal acts as per the Federal Sentencing Guidelines for Organizations. Penalties under FSGO include monetary fines, organizational probation, and the implementation of an operational program to bring the organization into compliance with FSGO standards. 4. If Universal could prove that it had a compliance program in place, how would that affect the penalties? Students’ responses will vary. Universal would be subject to lower monetary fines if the firm could prove it had a compliance program in place. For example, a level 18 offense has a base penalty of a $350,000 fine. Based on numerous factors this can be greatly increased, but the minimum fine with mitigating circumstances such as having a compliance program, would place this fine in the $17,500 to $70,000 range. Internet Exercises 1. Locate the website for Berlin-based Transparency International (TI). a. What is the stated mission of TI? TI’s mission is to stop corruption and promote transparency, accountability and integrity at all levels and across all sectors of society. Its core values are: • Transparency • Accountability • Integrity • Solidarity • Courage • Justice • Democracy b. Explain the Corruption Perception Index. The annual Corruption Perceptions Index (CPI), first released in 1995, is the best known of TI’s tools. It ranks countries and territories based on how corrupt their public sector is perceived to be. The 2012 CPI measures the perceived levels of public sector corruption in 176 countries and territories around the world. c. Which are the least and most corrupt countries on the index? Denmark, Finland, and New Zealand are tied for being ranked as the least corrupt countries on the index and Somalia is listed as the most corrupt country. d. Explain the European National Integrity Systems Project. Because of the complexity of corruption, it is critical to dig deep to pinpoint exact threats to integrity and to offer realistic solutions, working towards a more transparent and fair Europe. With this in mind, Transparency International is building momentum, political will and civic pressure to reform the anti-corruption systems in Europe. During 2011 and 2012, it has been running a project to analyze 25 European countries, providing the most comprehensive assessment of the state of anti-corruption in Europe to date. The results are used to engage with the main decision-makers and the broader public to strengthen key national institutions so that they are better positioned to resist corruption and to promote integrity. By bolstering these systems, better governance can be expected from the leadership, and in turn, more just and equitable societies. 2. Using Internet research, review the involvement of Harvard law professor Elizabeth Warren in the Consumer Financial Protection Bureau (CFPB). a. What was Warren’s involvement in the government response to the collapse of the financial markets? Students’ responses will vary. Elizabeth Warren appeared in a variety of articles and news briefs about her involvement in the Consumer Financial Protection Bureau (CFPB). Ms. Warren proposed an idea about the need to implement a consumer financial regulation in 2007. This is the result of Americans’ need or want for an agency in Washington to promote the financial protection of individuals and groups. b. How is she connected to the CFPB? Warren was an early advocate for the creation of a new Consumer Financial Protection Bureau (CFPB). In anticipation of the agency’s formal opening, for the first year after the bill’s signing, Warren worked on implementation of the bureau as a special assistant to the president. c. What were the objections to her involvement with the CFPB? The CFPB was established by the Dodd–Frank Wall Street Reform and Consumer Protection Act signed into law by President Obama in July 2010. In anticipation of the agency’s formal opening, for the first year after the bill’s signing, Warren worked on implementation of the bureau as a special assistant to the president. While liberal groups and consumer advocacy groups pushed for Obama to nominate Warren as the agency’s permanent director, Warren was strongly opposed by financial institutions and by Republican members of Congress who believed Warren would be an overly zealous regulator. d. What is Warren’s declared agenda for the CFPB? Warren is tasked with recruiting staff for the agency, setting the policy mission, and to serve as the recognizable public figure for the new agency. Source: http://en.wikipedia.org/wiki/Elizabeth_Warren Team Exercises 1. Protecting your people at all costs. Your company is a major fruit processor that maintains long-term contracts with plantation owners in Central America to guarantee supplies of high quality produce. Many of those plantations are in politically unstable areas and your U.S.-based teams travel to those regions at high personal risk. You have been contacted by a representative from one of the local groups of Freedom Fighters demanding that you make a “donation” to their cause in return for the guaranteed protection of the plantations with which you do business. The representative makes it very clear that failure to pay the donation could put your team on the ground at risk of being kidnapped and held for ransom. Your company is proud of its compliance with all aspects of the FCPA and the revised FSGO legislation. Divide into two groups and argue your case for and against paying this donation. Students’ responses will vary. By paying this donation, the company would be safeguarding its plantations which supplies high quality produce. If the donation is not paid, then the company will remain in compliance with the FCPA and the FSGO legislation. 2. Budgeting for Bribes. You are a midlevel manager for the government of a small African nation that relies heavily on oil revenues to run the country’s budget. The recent increase in the price of oil has improved your country’s budget significantly and, as a result, many new infrastructure projects are being funded with those oil dollars—roads, bridges, schools, and hospitals—which are generating lots of construction projects and very lucrative orders for materials and equipment. However, very little of this new wealth has made its way down to the lower levels of your administration. Historically, your government has always budgeted for very low salaries for government workers in recognition of the fact that their paychecks are often supplemented by payments to expedite the processing of applications and licensing paperwork. Your boss feels strongly that there is no need to raise the salaries of the lower-level government workers since the increase in infrastructure contracts will bring a corresponding increase in payments to those workers, and, as he pointed out, “companies that want our business will be happy to make those payments.” Divide into two groups and argue for and against the continuation of this arrangement. Students’ responses will vary. The lower levels of administration deserve to have an increase in their salaries the same as other government workers, especially since they are already budgeted for very low salaries. Employees need to be valued in order to remain profitable and successful. Even these lower-level government workers made a difference in the success of this new wealth. On the other hand, if these workers will be paid from the infrastructure contract, then those companies can pay them an extra portion of their salary and save the money that would have been budgeted to their increase. 3. The pros and cons of SOX. Divide into two teams. One team must defend the introduction of Sarbanes-Oxley as a federal deterrent to corporate malfeasance. The other team must criticize the legislation as being ineffective and an administrative burden. Students’ responses will vary. Advocates of SOX hailed this act as “one of the most important pieces of legislation governing the behavior of accounting firms and financial markets since legislation in the 1930s.” Critics claimed this to be one of the most controversial pieces of corporate legislation and created an unnecessary administrative burden for ethical corporations. 4. The key components of SOX. Divide into groups of three or four. Distribute the 11 sections of SOX reviewed in this chapter. Each group must prepare a brief presentation outlining the relative importance of its section to the overall impact of SOX and the prohibition of unethical business practices. Students’ responses will vary. Title I: Public Company Accounting Oversight Board (PCAOB)—the PCAOB as an independent oversight body which was an attempt to reestablish the perceived independence of auditing companies that the conflict of interest in Arthur Andersen’s auditing and consulting relationship with Enron had called into question. Title II: Auditor Independence—introduced several key directives to further enforce the independence of auditors and hopefully restore public confidence in independent audit reports. Title III: Corporate Responsibility Title IV: Enhanced Financial Disclosure Title V: Analyst Conflicts of Interest Title VI: Commission Resources and Authority Title VII: Studies and Reports Title VIII: Corporate and Criminal Fraud Accountability Title IX: White-Collar Crime Penalty Enhancements Title X: Corporate Tax Returns Title XI: Corporate Fraud and Accountability Thinking Critically 6.1 – Ponzi Schemes 1. Charles Ponzi was a working-class Italian immigrant who was eager to find success in America. Bernard Madoff was already a multimillionaire before he started his scheme. Does that make one more unethical than the other? Why or why not? Students’ responses will vary. Some of them may say that this does not make one more unethical than the other. Different motives cause people to act in unethical manners, but struggling to make ends meet or to find success is not a justified reason for being unethical and neither is greed. 2. Explain how a Ponzi scheme works. The Ponzi scheme is the same as “robbing Peter to pay Paul.” This scheme is the practice of providing old investors above-average returns on their investment with funds raised from new investors, in absence of any real business operation to generate profits. 3. Does the SEC bear any responsibility in the event of the Madoff Scheme? In what way? Students’ responses will vary based on their individual perception of the case. Although the SEC responded on various occasions to complaints or irregularities, it only uncovered minor inconsistencies in his transactions. The students should note that the SEC should have been suspicious or implemented harsher punishments when they found irregularities. Students might also note the need for deeper scrutiny of audits and the need for improved legislation to prevent fraud and corruption. 4. Does the fact that Madoff offered less outrageous returns (10-18 percent per year) on investments compared to Ponzi’s promise of a 50 percent return in only 90 days make Madoff any less unethical? Why or why not? Students’ responses will vary. Some of them may say that the fact that Madoff offered less outrageous returns than Ponzi, does not make him less unethical because no matter what the offer or guarantee, they were still false, misleading, and ultimately lies. 5. Can the investors who put their money in Madoff’s funds without any due diligence, often on the basis of a tip from a friend or a “friend of a friend,” really be considered victims in this case? Why or why not? Students’ responses will vary. Some of them may say that anyone investing their money in Madoff’s funds can be considered victims. Madoff had strong, reputable credentials as the former chairman of the NASDAQ stock exchange, and an occasional consultant to the SEC on matters of investment regulation. 6. What should investors with Bernard Madoff have done differently here? Students’ responses will vary. Some of them may say that the investors should have made sure Madoff was insured with FDIC or other federal insurance organization and traded through a legitimate broker. The investors should have also requested the trade tickets for filing purposes to ensure the trades were actually being made. 6.2 – India’s Enron 1. Does Ramalinga Raju’s assertion that this fraud only “started as a marginal gap” change the ethical question here? Would the situation be different if there was evidence that there had been a deliberate intent to deceive investors from the beginning? Students’ responses will vary. Some of them may say that the assertion that this fraud only “started as a marginal gap” does not change the ethical question. Overstating profits and increased assets is illegal and unethical even if these overstated profits and assets are predictions of what the company plans on doing or purchasing in the future. If there was evidence that there was a deliberate intent to deceive investors from the beginning, the animosity towards Ramalinga Raju and the business would have been greater, but not any less unethical. 2. Why do you think Satyam’s board of directors refused to support the proposed purchase of the construction companies? Students’ responses will vary. Some of them may say that the board of directors probably refused to support the proposed purchase of the construction companies because of the issues faced in the prior few months with the World Bank. It is possible that the board had some idea of the unethical behavior and by refusing to support the proposal forcing the company to admit its wrongdoings. 3. Outline the similarities between the Enron scandal and Satyam Computer Services’ situation. Students’ responses will vary. Some of them may point out that in both cases, the company became too big and the beginning of the unethical decisions created a domino effect of new and more unethical decisions. Both companies had misrepresentations of assets. These misrepresentations lead to the demise of Enron, whereas, Satyam Computer Services survived. 4. Pricewaterhouse Coopers (PWC) made a public commitment to cooperate with investigators. Did the Satyam situation represent the same threat for PWC as Enron did for Arthur Anderson? Why or why not? Students’ responses will vary. It is the duty and obligation of the auditing company to ensure the accuracy of its client’s financial reports and accounts. Therefore, Pricewaterhouse Coopers will suffer the same fate as Arthur Andersen unless the firm can prove that Satyam somehow showed Pricewaterhouse Cooper an account with the appropriate cash. 5. Will the response of the Securities and Exchange Board of India be enough to prevent another scandal like Satyam? Explain. Students’ responses will vary. The Securities and Exchange Board of India made it mandatory for the controlling shareholders of companies to disclose when they were pledging shares as collateral to lenders—a direct response to the Satyam scandal. Hopefully, this kind of a scandal won’t happen again, however, when one wants to commit a crime or fraud they find loopholes to do it anyway. Stronger regulations which are difficult to bypass should be put in place so that it becomes difficult to bypass the law and commit such crimes. Some type of unethical scandal may occur again in the business. It is important for the new owners of Satyam to conduct frequent audits and oversee the financial operations of the business. 6. What benefits do Tech Mahindra and Mahindra Satyam hope to achieve with the announced merger? Explain. Students’ responses will vary. Tech Mahindra is the technology arm of Indian conglomerate the Mahindra group. Its merger with Mahindra Satyam, will lead to bigger market share, stronger competencies, it might also result in the creation of an offshore services leader. Source: http://www.techmahindra.com/news/techmahindra_press_release.aspx?PID=108 6.3 – “Walmart De Mexico” 1. Identify the ethical transgressions that took place in this case. Students’ responses will vary. When the first evidence of bribery by Walmart de Mexico was brought to the notice of the U.S. Walmart officials, they elected to shut the investigation down. Instead of taking strong actions against its chief executive—Eduardo Castro-Wright, identified by a former executive as the driving force behind years of bribery—he was promoted to vice chairman of Wal-Mart in 2008. The company also did not notify nor did it comply with the Department of Justice (DOJ) investigation. 2. Why would Walmart’s executive leadership refuse to comply with information requests from U.S. congressional oversight committees? What do you speculate they hope to achieve from this tactic? Students’ responses will vary. If Walmart’s executive leadership would have agreed to share the documents, or give access to the key witnesses to the U.S. Congressional committees, it would become evident that the company had been unwilling to act upon the evidence and take necessary action while there still was time to do some disaster management. However, it continued to support the acts of bribery in Mexico to gain ground and business in the country, and did not want the DOJ officials to find out about their activities. 3. Is this a “Walmart de Mexico” problem or a “Walmart corporate” problem? Why? Students’ responses will vary. It is a Walmart corporate problem, since the strings of business are pulled at the corporate level. The Walmart corporate takes the decision on opening new stores or any other such important decisions. 4. Has the FCPA legislation failed in this case? Why or why not? Provide evidence to support your position. Students’ responses will vary. FCPA has been a law that has often been overlooked, but which can have a major effect on exporters. There has been a lot of debate regarding its anti-bribery provisions, which forbid the use of “any means of instrumentality of interstate commerce in order to influence [a] foreign official in his or her official capacity.” Keeping the Walmart case in mind it can be argued that the FCPA law should be amended to tighten its application, recommending a defense for companies whose employees engage in corruption and bribery without the company’s knowledge. Source: http://www.nacmse.com/credittrends/articles/general/Walmart%20Bribery%20Case%20Puts%20 Spotlight%20on%20FCPA.htm 5. With 50 percent of Walmart stock owned by descendants of the company’s founder, Sam Walton, is there any hope of improved governance being achieved through shareholder activism? Why or why not? Student’s responses will vary. Even though 50 percent of Walmart’s stock is owned by the descendants of the company’s founder Sam Walton, it has been noticed that there has been a considerable amount of vote against the re-election of the CEO and Chairman of the company. Even though this vote was not enough to reform the board members but it sent a clear message of dissatisfaction with the company’s leadership. This will act as a stimulus for the board to act more responsibly in the future and improve the regulatory standards in the company and comply with the national regulations as well. 6. What steps should the executive leadership of Walmart take to restore investor confidence? Student’s responses will vary. It should proactively comply with the DOJ and the FCPA and also put stronger regulatory standards in place. In this case Walmart was more concerned with controlling the damage that had occurred instead of righting the illegal activity performed by the official in question. In future, it should be mindful of its business practices and be aware of the rules and regulations of foreign countries in which it is operating. Chapter 6 The Role of Government 6-2 Key Legislations • The Foreign Corrupt Practices Act (1977) • The U.S. Federal Sentencing Guidelines for Organizations (1991) • The Sarbanes-Oxley Act (2002) • The Revised Federal Sentencing Guidelines for Organizations (2004) • The Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) 6-3 The Foreign Corrupt Practices Act (FCPA) • Legislation introduced to control bribery and other less obvious forms of payment to foreign officials and politicians by American publicly traded companies • Prior to the passing of the law, the illegality of paying bribes was punishable through secondary sources of legislation 6-4 The Foreign Corrupt Practices Act (FCPA) • Securities and Exchange Commission (SEC) could fine companies for failing to disclose such payments under its securities rules • Bank Secrecy Act required the full disclosure of funds that were taken out of or brought into the USA • Mail Fraud Act made the use of the U.S. mail or wire communications to transact a fraudulent scheme illegal 6-5 The Foreign Corrupt Practices Act (FCPA) • Jointly enforced by the U.S. Department of Justice (DOJ) and the Securities and Exchange Commission (SEC) • Encompasses all the secondary measures that were currently in use to prohibit such behavior by focusing on: 6-6 The Foreign Corrupt Practices Act (FCPA) • Disclosure: Requirement that corporations fully disclose any and all transactions conducted with foreign officials and politicians • Prohibition: Inclusion of wording from the Bank Secrecy Act and the Mail Fraud Act to prevent the movement of funds overseas for the express purpose of conducting a fraudulent scheme 6-7 The Foreign Corrupt Practices Act (FCPA) • Criticized for lack of real authority because of its formal recognition of facilitation payments • Facilitation payments: Acceptable (legal) provided they secure the performance of a routine governmental action • Routine governmental action (FCPA): Any regular administrative process, excluding any action taken by a foreign official in the decision to award new or continuing business 6-8 Figure 6.1 - Illegal versus Legal Behaviors under the FCPA 6-9 Figure 6.1 - Illegal versus Legal Behaviors under the FCPA 6-10 The U.S. Federal Sentencing Guidelines For Organizations (FSGO) 1991 • Hold businesses liable for the criminal acts of their employees and agents • Penalties under FSGO • Monetary fines • Organizational probation • Implementation of an operational program to bring the organization into compliance with FSGO standards 6-11 MONETARY FINES UNDER THE FGSO • Process for calculating a fine • Determination of the base fine - Will be the greatest of: • Monetary gain to the organization from the offense • Monetary loss from the offense caused by the organization • Amount determined by a judge based on an FSGO table 6-12 MONETARY FINES UNDER THE FGSO • Culpability score: Calculation of a degree of blame or guilt that is used as a multiplier of up to 4 times the base fine • Can be adjusted according to aggravating or mitigating factors 6-13 MONETARY FINES UNDER THE FGSO Aggravating factors • High-level personnel involved in or tolerated the criminal activity • Organization willfully obstructed justice • Organization had a prior history of similar misconduct • Current offense violated a judicial order, an injunction, or a condition of probation Mitigating factors • Organization had an effective program to prevent and detect violations of law • Organization: • Self-reported the offense to governmental authorities • Cooperated in the investigation • Accepted responsibility for the criminal conduct 6-14 MONETARY FINES UNDER THE FGSO • Determining the total fine amount - Base score multiplied by the culpability score • Death penalty: Fine that is set high enough to match all the organization’s assets and put the organization out of business • Warranted where the organization was operating primarily for a criminal purpose 6-15 Organizational Probation • Organizations can be sentenced to probation for up to five years • Requirements for the status of probation • Reporting the business’s financial condition to the court on a periodic basis 6-16 Organizational Probation • Remaining subject to unannounced examinations of all financial records by a designated probation officer and/or court- appointed experts • Reporting progress in the implementation of a compliance program • Being subject to unannounced examinations to confirm that the compliance program is in place and is working 6-17 Steps for a Compliance Program • Management oversight • Corporate policies • Communication of standards and procedures • Compliance with standards and procedures • Delegation of substantial discretionary authority • Consistent discipline • Response and corrective action 6-18 Revised FSGO 2004 • Key changes • Required companies to periodically evaluate the effectiveness of their compliance programs on the assumption of a substantial risk that any program is capable of failing • Revised guidelines required evidence of actively promoting ethical conduct rather than just complying with legal obligations • Accountability more clearly defined 6-19 Sarbanes-Oxley Act (2002) • Legislative response to the corporate accounting scandals of the early 2000s that covers the financial management of businesses • Contains 11 sections relating to prominent examples of corporate wrongdoing • Public company accounting oversight board: Independent oversight body for auditing companies 6-20 Sarbanes-Oxley Act (2002) • Auditor independence • Corporate responsibility • Enhanced financial disclosures • Analyst conflicts of interest • Commission resources and authority • Studies and reports • Corporate and criminal fraud accountability 6-21 Sarbanes-Oxley Act (2002) • White-collar crime penalty enhancements • Corporate tax returns • Corporate fraud and accountability • SOX does not help you create an ethical corporate culture or hire an effective and ethical board of directors 6-22 Dodd-Frank Wall Street Reform and Consumer Protection Act 2010 • Legislation that was promoted as the fix for the extreme mismanagement of risk in the financial sector that lead to a global financial crisis in 2008–2010 • Consumer Financial Protection Bureau (CFPB): Oversees financial products and services 6-23 Dodd-Frank Wall Street Reform and Consumer Protection Act 2010 • Financial Stability Oversight Council (FSOC): Prevents banks from failing and otherwise threatening the stability of the U.S. economy • Volcker rule - Limits the ability of banks to trade on their own accounts in any way that might threaten the financial stability of the institution Solution Manual for Business Ethics Now Andrew Ghillyer 9780073524696, 9781260262513
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