This Document Contains Chapters 1 to 2 Part One: The Legal Environment of Business CONTENTS Chapter 1 Introduction to Law Chapter 2 Business Ethics and the Social Responsibility of Business Chapter 3 Civil Dispute Resolution Chapter 4 Constitutional Law Chapter 5 Administrative Law Chapter 6 Criminal Law Chapter 7 Intentional Torts Chapter 8 Negligence and Strict Liability ETHICS QUESTIONS RAISED IN THIS PART 1. Are all laws moral? Should all laws be moral? How should morality be determined? 2. Are laws always just? 3. Which is more important, morality or justice? 4. Why is there a difference between the treatment of cases brought under civil law and those brought under criminal law? Should there be a difference? 5. In some cultures being involved in a lawsuit is something about which to be ashamed. Our society has been criticized for being overly litigious. In fact, we even go on television to sue in "Judge Judy" and other similar shows. Is our culture “sue-happy?” Should access to the court system be restricted? 6. From an ethical perspective, what obligations does a person who has been harmed by another person or by a business have to attempt settlement of the matter through negotiation before resorting to a lawsuit? 7. The Bill of Rights was drafted to protect individuals from their own government, not from criminals. Because of this, the defendant in a criminal case has rights that are constitutionally protected. The victims of the crime do not have as many rights in the criminal trial as does the defendant. Should our legal system pay more attention to the victims of crime? How should the victim's rights be protected in a criminal trial? 8. Is a no-fault system covering torts ethically preferable to the fault-based negligence system we now have? 9. Are businesses morally responsible for injuries that are caused by products they sell or manufacture? What about copy-cat injuries? ACTIVITIES AND RESEARCH PROBLEMS 1. Have students draw a diagram of two overlapping circles, with one circle labeled “Moral” and the other labeled “Legal.” The area of overlap would be both moral and legal. Then list several controversial topics of current interest (e.g., abortion, capital punishment, marijuana smoking, etc.) for students to place within an area of the diagram (or outside the circles if it is neither moral nor legal). Can any of these issues be absolutely determined to be moral or immoral? 2. Are there any laws in our country’s history that have been repealed on the basis of their immorality? Are there any laws still in existence that should be repealed? Have students discuss their opinions. 3. How does American common law differ from English common law? 4. Have students write a fictitious case involving questionable ethics in a business decision. 5. For a general discussion of law, or preceding the study of criminal law and procedure recruit someone outside the class to rush in and commit a "crime" such as stealing the professor's textbook. After the stranger leaves, have the students write a description of what happened. Then compare the details of the eyewitnesses and discuss the legal implications of the event. 6. Have students make a list of the key events in their lives, then have them list and discuss laws that relate to those events. 7. Research the historic legal codes of other civilizations, such as the Hebrews and Babylonians, or of other societies around the world today, and compare the crimes, punishments, and criminal procedures to those in the United States today. 8. Have students prepare a survey form on crimes affecting businesses. The form could include types of crime that affect the business (such as customer theft, employee theft, and bad checks); the amount of loss; the cost of the crimes; and the cost of security. Then have the whole or part of the class interview the managers of businesses. Have the students report to the class and compare the results with local and national statistics available from law enforcement professionals. 9. In recent years many states have instituted victim's assistance programs and crime victim's restitution programs. Investigate to find whether your state has such programs. Compare programs in various states. Chapter 1 Introduction To Law Nature of Law [1-1] Sources of Law [1-3] Definition of Law [1-1a] Constitutional Law [1-3a] Functions of Law [1-1b] Judicial Law [1-3b] Law and Morals [1-1c] Common Law Law and Justice [1-1d] Equity Classification of Law [1-2] Restatements of Law Substantive and Procedural Law [1-2a] Legislative Law [1-3c] Public and Private Law [1-2b] Treaties Civil and Criminal Law [1-2c] Executive Orders Administrative Law [1-3d] Legal Analysis [1-4] Cases in This Chapter Ryan v. Friesenhahn (Given as an example of how to brief a case) Chapter Outcomes After reading and studying this chapter, the student should be able to: • Identify and describe the basic functions of law. • Distinguish between (1) law and justice and (2) law and morals. • Distinguish between (1) substantive and procedural law, (2) public and private law, and (3) civil and criminal law. • Identify and describe the sources of law. • Explain the principle of stare decisis. TEACHING NOTES Law concerns the relations between and among individuals as those relations affect social and economic order. It affects the rights and duties of every citizen and many non-citizens. Law is both prohibitory, meaning certain acts must not be committed, and mandatory, meaning certain acts must be done, sometimes in a set way. Additionally, law is permissive: certain acts are allowed, but not required by the law. 1-1 Nature of Law The law is a continuously changing process of developing a workable set of rules that balance the individual and group rights of an evolving society. 1-1a Definition of Law Legal scholars have defined law in various ways, including: • “predictions of the way that a court will decide specific legal questions” • “a rule of civil conduct prescribed by the supreme power in a state, commanding what is right, and prohibiting what is wrong” • a general command that a state or sovereign makes to those who are subject to its authority by laying down a course of action enforced by judicial or administrative tribunals. Most legal scholars would agree with Rosco Pound, that the term “law” has multiple meanings and that defining it is not a simple task. *** Chapter Outcome *** Identify and describe the basic functions of law. 1-1b Functions of Law The functions of law are to maintain stability in the social, political, and economic system through (1) dispute resolution, (2) protection of property, and (3) the preservation of the state while at the same time permitting ordered change. 1. Disputes are inevitable in a complex society and may involve criminal or non-criminal matters. Law provides rules to resolve disputes and avoid personal revenge. 2. Law protects ownership of property and allows for agreements (contracts) to exchange property. (This text deals with many aspects of this including contracts, sales, commercial paper, and business associations.) 3. Law preserves the state. It ensures that changes are result of elections, legislation, and referenda rather than revolution, sedition, and rebellion. 1-1c Legal Sanctions Sanctions are the means by which the law enforces the decisions of the court, such as fines, imprisonment and capital punishment. *** Chapter Outcome *** Distinguish between law and justice. Distinguish between law and morals. 1-1d Law and Morals Though law is affected by morals, law and morality are not the same. Some actions have no moral implications but have legal sanctions, whereas other actions have no legal sanctions but do have moral implications. Some actions have both moral impact and legal sanction. NOTE: See Figure 1-1: Law and Morals. 1-1e Law and Justice Law and justice are distinct but interrelated concepts. • Justice may be defined as “the fair, equitable, and impartial treatment of the competing interests and desires of individuals and groups, with due regard for the common good.” • Justice depends on the law, but the law does not guarantee justice, since laws can be unjust. (Think back to “legal” slavery and the “legal” actions of Nazi Germany or of the South African apartheid government.) 1-2 Classification of Law Because the law is vast, it is helpful to organize it into categories such as: (1) substantive and procedural, (2) public and private, and (3) civil and criminal. Basic to understanding these classifications are the terms right and duty. A right is the ability of a person, with the aid of the law, to require another person to perform or to refrain from performing a certain act. A duty is the obligation the law imposes upon a person to perform or to refrain from performing a certain act. Duty and right exist together: a person cannot have a right without some other person (or all persons) having the corresponding duty. NOTE: See textbook Figure 1-2 which outlines the classifications of law. *** Chapter Outcome *** Distinguish between (1) substantive and procedural law, (2) public law and private law,
and (3) civil law and criminal law. 1-2a Substantive and Procedural Law Substantive law creates, defines, and regulates legal rights and duties. Procedural law sets forth rules for enforcing those rights that are created by the substantive law. 1-2b Public and Private Law Public law is the branch of substantive law that deals with the government's rights and powers and its relationship to individuals or groups. Private law is that part of substantive law governing individuals and legal entities (such as corporations) in their relationships with one another. 1-2c Civil and Criminal Law Civil law defines duties and deals with the rights and duties of individuals among themselves. (It is part of private law.) NOTE: Civil law is not the same as a civil law system, discussed later in this chapter. Criminal law establishes duties and involves offenses against the community. (It is part of public law.) The purpose of the civil law is to compensate the injured party (plaintiff), while the purpose of criminal law is to punish the wrongdoer. Typically, the civil law awards money for damages or an order for the defendant to behave in a certain way, while criminal law imposes a fine or imprisonment on the guilty party. The party bringing a civil action has the burden of proof, which he must support with a preponderance of the evidence (meaning the greater weight). The government bringing a criminal case must proof the defendant’s guilt beyond a reasonable doubt, which is a significantly higher burden of proof than that in a civil case. NOTE: See textbook Figure 1-3, which compares civil and criminal law. *** Chapter Outcomes *** Identify and describe the sources of law. Explain the principle of stare decisis. 1-3 SOURCES OF LAW • Federal and state constitutions • Federal treaties (agreements between or among independent nations) • Federal and state statutes (laws passed by a legislative body such as the U.S. Congress or the legislature of a state) • Executive orders (legislation issued by a President or governor) • Ordinances of local municipal governments • Rules and regulations of federal and state administrative agencies • Federal and state court decisions NOTE: See Figure 1-3, Hierarchy of Law 1-3a Constitutional Law A constitution sets forth the basic principles by which a government is guided, as well as the limitations on governmental authority. The U.S. Constitution is the supreme law of the nation; a state constitution is the highest law within that state. Federal law is supreme in cases of conflict with state law. One of the fundamental principles of the U.S. Constitution is Judicial Review, which is the power of courts to determine constitutionality of all laws. 1-3b Judicial Law Case decisions establish precedent in our common law system and must also be consulted when researching a legal question. In the common law system, parties to a dispute initiate and conduct litigation (an adversary system). The principle of stare decisis requires that inferior courts stay consistent with prior decisions of higher courts on cases with similar facts. A civil law system, which is less prevalent than common law within the United States, depends on comprehensive legislative enactments (called codes) and an inquisitorial system of determining disputes. In the inquisitorial system, the court, rather than the parties, initiates litigation, investigates pertinent facts, and conducts the presentation of evidence. Common Law — a body of law established by previous rulings of courts in a common law system. These decisions serve as precedents for later cases. Equity — a supplementary system of judicial relief separate from the common law, based upon settled rules of fairness, justice and honesty. Remedies include: specific performance, injunction, reformation, and rescission. In most jurisdictions, a single court administers both common law and equity. Restatements of Law — The large and growing volume of court decisions in the United States led to the Restatements of Law, an orderly restatement of the general common law. It is now regarded as the authoritative statement of the common law of the United States. It covers many areas, including torts, contracts, agency, property, and trusts. The Restatements were written by the American Law Institute (ALI), a distinguished group of lawyers, judges, and law professors. Currently the ALI is made up of more than 4,300 members. 1-3c Legislative Law Legislative law consists of statutes passed by legislatures. Statutes may repeal judge-made law as long as the statute is not unconstitutional. Today, most new laws come through the legislative branch because they can choose the issues that need attention while courts can only deal with issues in the cases brought before them. The need for uniformity among state statutes led to the codification of large parts of business law. The most successful example of this effort is the Uniform Commercial Code (UCC), prepared under the joint sponsorship and direction of the ALI and the Uniform Law Commission (ULC), which is also known as the National Conference of Commissioners on Uniform State Laws. All fifty states, the District of Columbia, and the Virgin Islands have adopted the UCC. (Louisiana has adopted only part of the UCC.) The ULC has drafted more than 300 uniform laws including the Uniform Partnership Act, the Uniform Limited Partnership Act, and the Uniform Probate Code. The ALI has developed a number of model statutory formulations, including the Model Code of Evidence, the Model Penal Code, a Model Land Development Code, and a proposed Federal Securities Code. In addition, the American Bar Association has promulgated the Model Business Corporation Act. Treaties — Agreements between or among independent nations; if signed by the President and approved by the Senate, it has the legal force of a federal statute. Executive Orders — The President has the power to issue executive orders, which carry the authority of a law. 1-3d Administrative Law The branch of public law that governs the powers and procedures of governmental entities (other than courts and legislatures); often involves public health, safety and welfare. Administrative law is created by administrative agencies in the form of rules, regulations, orders, and decisions to carry out the regulatory powers and duties of those agencies. 1-4 Legal Analysis While all U.S. Supreme Court decisions are reported, not every case decided by the U.S. District Courts and the U.S. Courts of Appeals are reported. Each circuit has established rules determining which decisions are published. Decisions in state trial courts generally are not published but are filed in the office of the clerk of the court. Decisions of state courts of appeals are published in volumes called “reports,” numbered consecutively. Some states rely on a commercial reporter and no longer publish official reports. The decisions of courts in the federal system are found in a number of reports. For instance, Lefkowitz v. Great Minneapolis Surplus Store, Inc., 251 Minn. 188, 86 N.W.2d 689 (1957), indicates that the opinion in this case may be found in Volume 251 of the official Minnesota Reports at page 188; and in Volume 86 of the North Western Reporter, Second Series, at page 689; and that the opinion was delivered in 1957. Normally, the reported opinion in a case includes: 1. the essential facts, the nature of the action, the parties, what happened to bring about the controversy, what happened in the lower court, and what pleadings are material; 2. the issues of law or fact; 3. the legal principles involved; 4. the application of these principles; and the decision. A serviceable method by which students may analyze and brief cases after reading and comprehending the opinion is to write a brief containing the following: 1. the facts of the case 2. the issue or question involved 3. the decision of the court 4. the reasons for the decision Example of Briefed Case The following case is printed both in its entirety and in briefed form in the student’s textbook. It is printed only in briefed form here. The purpose of including this case is to give an example of how to brief a case. Brief of CASE Ryan v. Friesenhahn
I. Facts: Todd Friesenhahn, son of Nancy and Frederick Friesenhahn, held an open invitation party at his parent's home that encouraged guests to bring their own bottle. Sabrina Ryan attended the party, became intoxicated, and was involved in a fatal accident after she left the party. Sandra and Stephen Ryan, Sabrina’s parents, sued the Friesenhahns for negligence, alleging that the Friesenhahns were aware of underage drinking at the party and of Sabrina's condition when she left the party. The trial court granted summary judgment for the Friesenhahns. II. Issue: Is a social host who serves alcoholic beverages to a minor liable in negligence for harm suffered by the minor as a result of the minor’s intoxication? III. Decision: In favor of the Ryans. Summary judgment reversed and case remanded to the trial court. IV. Reasons: Accepting the Ryans’ allegations as true, the Friesenhahns were aware that minors possessed and consumed alcohol on their property and specifically allowed Sabrina to become intoxicated. The Texas Alcoholic Beverage Code provides that a person commits an offense if, with criminal negligence, he “makes available an alcoholic beverage to a minor.” A violation of a statute constitutes negligence per se if the injured party is a member of the class protected by the statute. Since the Alcoholic Beverage Code was designed to protect the general public and minors in particular, Sabrina is a member of the class protected by the Code. Therefore, we find that the Ryans stated a cause of action against the Friesenhahns for the violation of the Alcoholic Beverage Code In considering common-law negligence as a basis for social host liability, the Texas Supreme Court has held that there are two practical reasons for not imposing a third-party duty on social hosts who provide alcohol to adult guests: first, the host cannot reasonably know the extent of his guests' alcohol consumption level; second, the host cannot reasonably be expected to control his guests' conduct. However, this rationale does not apply where the guest is a minor. The adult social host need not estimate the extent of a minor's alcohol consumption because serving minors any amount of alcohol is a criminal offense. Furthermore, the social host may control the minor, with whom there is a special relationship, analogous to that of parent-child.
Chapter 2 BUSINESS ETHICS And the Social Responsibility of Business Cases in This Chapter (NOTE: These are not actual court cases, but original vignettes which pose ethical problems in business situations. A discussion guide for each is found prior to the answers to problems at the end of this instructor’s manual chapter.)
Pharmacon Drug Company Mykon’s Dilemma Oliver Winery, Inc JLM, Inc. Sword Technology, Inc. Vulcan, Inc.
Chapter Outcomes After reading and studying this chapter, the student should be able to: •Describe the difference between law and ethics. •Compare the various ethical theories. •Describe cost-benefit analysis and explain when it should be used and when it should be avoided. •Explain Kohlberg’s stages of moral development. •Explain the ethical responsibilities of business. TEACHING NOTES Ethics can be broadly defined as the study of what is right or good for human beings. It pursues the question of what people ought to do and what goals they should pursue. Business ethics is not a special set of ethics that applies only in business settings, but rather a subset of ethics. Business ethics, a branch of applied ethics, is the study and determination of right and good in business. Ethical questions apply to relationships among and between: • a business and its employees, its customers, and its owners • competing businesses • a business and society at large • businesses and countries at an international level In business ethics, it is helpful to employ a seeing-knowing-doing model in which the decision-maker follows these steps: • See (identify) the ethical issues in the proposed conduct and any alternative options • Know (resolve) which is the best option • Do (implement) the chosen option 2-1 Law versus Ethics *** Chapter Outcome *** Describe the difference between law and ethics. Law is strongly affected by moral concepts (ethics), but law and morality are not the same. Legality is often a reliable guide to ethical behavior, but it cannot be relied upon as a perfect standard. Legal acts may be immoral, illegal acts may be moral. 2-2 Ethical Theories *** Chapter Outcome *** Compare the various ethical theories. Certain ethical rules are based on theory rather than experimentation (a priori reasoning). 2-2a Ethical Fundamentalism Also called absolutism. Individuals look to a central authority or set of rules for guidance, e.g., the Bible, the Koran, the writings of Karl Marx. 2-2b Ethical Relativism A theory under which actions must be judged by what individuals subjectively feel is right or wrong for themselves. Although bearing some similarities, the doctrine of situational ethics differs substantially in that it requires one to judge another person’s actions by first putting oneself into that person’s situation. 2-2c Utilitarianism Those actions that produce the greatest net pleasure, compared to net pain, are better in a moral sense. Act utilitarianism assesses each separate act in order to determine whether it produces net pleasure over pain. Rule utilitarianism supports rules that at their inception would appear to be the best hope of producing maximum pleasure for the greatest number of people. *** Chapter Outcome *** Describe a cost-benefit analysis and explain when it should be used and when it should be avoided. Utilitarian notions of moral correctness are the basis for the general concept of making a cost-benefit analysis in a business or managerial decision. The purpose of a cost-benefit analysis is to choose the most cost effective method for pursuing a goal after comparing the direct and indirect costs and benefits of proposed alternatives. If increasing net wealth, especially on a short-term basis, is the goal, a sound cost-benefit analysis is a helpful tool. 2-2d Deontology From the Greek word deon, meaning duty or obligation; stresses that certain principles are always right or wrong, no matter the outcome. Actions should be judged by means and motives, rather than only results. NOTE: See textbook discussion of Immanuel Kant’s deontological theories. 2-2e Social Ethics Theories Focus on a person’s obligations to others and also on individual rights and obligations. Social egalitarians believe that society should provide all persons with equal goods and services irrespective of their contributions to the society’s overall wealth. Distributive justice also considers the needs and rights of all people, yet stresses the equality of opportunity, not of results. Libertarians claim that differences in wealth simply demonstrate different levels of skill in the marketplace. Taking wealth earned by some and giving it to others is unfair. 2-2f Other Theories Intuitionism holds that all rational people possess the ability to decide the rightness of an action, though some people have more insight into ethical behavior than others. The “good person” philosophy is similar, and declares that to act morally, we should emulate those who seem to always choose the “good” or “right” choice. Television Test" judges the appropriateness of a decision based on whether we would be comfortable with having that decision known by all the world, as if it had been broadcast on television. 2-3 Ethical Standards in Business *** Chapter Outcome *** Explain Kohlberg’s stages of moral development. 2-3a Choosing an Ethical System Kohlberg’s Stages of Moral Development provides insight into ethical decision-making. Under Kohlberg’s model, people progress through stages of moral development basically as a function of age and education. The pre-conventional or childhood stage, is one where a person’s moral perspective is based only on a punishment/reward concept. The conventional or adolescent stage is one where an individual conforms his behavior to meet group or peer expectations. Some people may reach the third, or post-conventional, adult level where individuals conform to internalized moral principles simply because they understand why the principles are right. NOTE: See Figure 2-1, Kohlberg's Stages of Moral Development Some psychologists assert that most people function in all three of Kohlberg's stages simultaneously. 2-3b Corporations as Moral Agents Because a corporation is a statutorily created entity, is not clear whether it should be held to a standard of moral accountability. 2-4 Ethical Responsibilities of Business Some regulation has always been necessary to check overreaching greed in our system of modified capitalism. *** Chapter Outcome *** Explain the ethical responsibilities of business. 2-4a Regulation of Business According to Adam Smith’s model for the perfect capitalistic system, governmental oversight is necessary, but should be limited. Beyond setting the rules and enforcing them, Smith felt government should stand aside. Increased governmental intervention has occurred, however, because this model cannot be relied on to achieve objectives such as national defense, conservation of natural resources, health and safety, and social security. Successful government regulation involves carefully balancing regulations to preserve competition and those that attempt to advance other social objectives. 2-4b Corporate Governance The demand for ethical and social responsibility of business also results from the sheer size, and therefore power, of individual corporations. Many people — and even members of the corporate community itself — believe that companies have an obligation to sponsor projects that benefit society in ways beyond the economics of producing goods and services. In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) was enacted, improving accountability and transparency in the financial system, protecting consumers from abusive financial services practices, and improving corporate governance in publicly held companies. 2-4c Arguments Against Social Responsibility Profitability — Since corporations are artificial entities established for profit-making, their only obligation should be to return as much money as possible to the direct stakeholders, the shareholders. Unfairness — Whenever corporations engage in social activities such as supporting the arts or education, they divert funds rightfully belonging to the shareholders and/or the employees to unrelated third parties. Accountability — A corporation may decide to support a variety of social causes but, unlike a governmental body, will be required to submit to little public scrutiny. Expertise — Although a corporation may have a high level of expertise in selling its goods and services, it may not be able to carry on social activities with the same degree of competence. 2-4d Arguments in Favor of Social Responsibility A corporation’s primary objective is to make a return on its investment by producing a quality product at a fair price. Most people agree, however, that corporations have obligations beyond making a profit and avoiding harm to others. The Social Contract — Since society allows for the creation of corporations and gives them special rights, including a grant of limited liability, this argument holds that corporations reciprocally owe a responsibility to our society. NOTE: See Figure 2-2, The Stakeholder Model. Less Government Regulation — When corporations act responsibly, regulation is unnecessary. In addition, by taking a more proactive role in aiding with society’s problems, corporations create a climate of trust and respect that may make government more lenient in regulations. Long-Run Profits — Corporate involvement in social causes has the effect of creating goodwill which simply makes good business sense from a long-run profit perspective. CASE Pharmakon Drug Company BACKGROUND William Wilson, senior vice president of research, development, and medical (RD&M) at Pharmakon Drug Company, received both his Ph.D. in biochemistry and his M.D. from the University of Oklahoma. Upon completion of his residency, Dr. Wilson joined the faculty at Harvard Medical School. He left Harvard after five years to join the research group at Merck & Co. Three years later, he went to Burroughs-Wellcome as director of RD&M, and, after eight years, Dr. Wilson joined Pharmakon in his current position. William Wilson has always been highly respected as a scientist, a manager, and an individual. He has also been an outstanding leader in the scientific community, particularly in the effort to attract more minorities into the field. Pharmakon concentrates its research efforts in the areas of antivirals (with a focus on HIV), cardiovascular, respiratory, muscle relaxants, gastrointestinal, the central nervous system, and consumer health care (that is, nonprescription or over-the-counter medicines). Dr. Wilson is on the board of directors of Pharmakon and the company’s executive committee. He reports directly to the chairman of the board and CEO, Mr. Jarred Swenstrum. DECLINING GROWTH During the previous eight years, Pharmakon experienced tremendous growth: 253 percent overall, with yearly growth ranging from 12 percent to 25 percent. During this period, Pharmakon’s RD&M budget grew from $79 million to $403 million, and the number of employees rose from 1,192 to 3,273 (see Figure 2-3). During the previous two years, however, growth in revenue and earnings slowed considerably. Moreover, in the current year, Pharmakon’s revenues of $3.55 billion and earnings before taxes of $1.12 billion were up only 2 percent from the previous year. Furthermore, both revenues and earnings are projected to be flat or declining for the next five years. The cessation of this period’s tremendous growth and the likelihood of future decline have been brought about principally by two causes. First, a number of Pharmakon’s most important patents have expired and competition from generics has begun and could continue to erode its products’ market shares. Second, as new types of health-care delivery organizations evolve, pharmaceutical companies’ revenues and earnings will in all likelihood be adversely affected. PROBLEM AND PROPOSED SOLUTIONS In response, the board of directors has decided that the company must emphasize two conflicting goals: increase the number of new drugs brought to market and cut back on the workforce in anticipation of rising labor and marketing costs and declining revenues. Accordingly, Dr. Wilson has been instructed to cut costs significantly and to reduce his workforce by 15 percent over the next six months. Dr. Wilson called a meeting with his management team to discuss the workforce reduction. One of his managers, Leashia Harmon, argued that the layoffs should be made “so that recent gains in minority hiring are not wiped out.” The percentage of minority employees had increased from 2.7 percent eight years ago to 8.3 percent in the previous year (see Figure 2-3). The minority population in communities in which Pharmakon has major facilities has remained over the years at approximately 23 percent. About 20 percent of the RD&M workforce have a Ph.D. in a physical science or in pharmacology, and another 3 percent have an M.D. Dr. Harmon, a Ph.D. in pharmacology and head of clinical studies, is the only minority on Dr. Wilson’s seven-member management team. Dr. Harmon argued that RD&M has worked long and hard to increase minority employment and has been a leader in promoting Pharmakon’s affirmative action plan (see Figure 2-4). Therefore, she asserted, all layoffs should reflect this commitment, even if it meant disproportionate layoffs of nonminorities. Dr. Anson Peake, another member of Dr. Wilson’s management team and director of new products, argued that Pharmakon’s RD&M division has never discharged a worker except for cause and should adhere as closely as possible to that policy by terminating individuals solely based on merit. Dr. Rachel Waugh, director of product development, pointed out that the enormous growth in employment over the past eight years—almost a trebling of the workforce—had made the company’s employee performance evaluation system less than reliable. Consequently, she contended that because laying off 15 percent of her group would be extremely difficult and subjective, she preferred to follow a system of seniority. Dr. Wilson immediately recognized that any system of reducing the workforce would be difficult to implement. Moreover, he was concerned about fairness to employees and maintaining the best qualified group to carry out the area’s mission. He was very troubled by a merit or seniority system if it could not maintain the minority gains. In fact, he had even thought about the possibility of using this difficult situation to increase the percentage of minorities to bring it more in line with the minority percentage of the communities in which Pharmakon had major facilities. ISSUES: The general issue is the appropriateness of affirmative action in the private sector. Does the use of affirmative action when a company is downsizing differ from when a company is hiring or conferring other benefits? The specific issue is how should Pharmakon implement its layoffs and what criteria should it use? OPTIONS: Layoffs and/or terminations should be based on which one or combination of the following? 1) Cause 2) Merit based on a newly established, reliable, and valid evaluation system 3) Seniority 4) Proportionate (maintain the current percentage of minority employees) 5) Enhancement of minority (increase the percentage of minorities) 6) Encourage voluntary retirement (either with or without incentives) 7) Lottery 8) Pay cuts across the board 9) Other ANALYSIS OF THE VARIOUS OPTIONS: How does each of the options impact the following goals of Pharmakon? 1) Productivity 2) Fiscal soundness 3) Minority presence and preservation of minority gains 4) Employee morale 5) Potential for lawsuits 6) Public and community reaction 7) Shareholder reaction 8) Balancing of rights of current employees against past corporate/societal discrimination DECISION: Have students justify their recommendations. ADDITIONAL DISCUSSION: • Affirmative Action: Discuss the benefits and costs of affirmative action. • Diversity: How does one place a value on diversity? How should a diversity policy be implemented? • Equality: How is equality determined—by outcome or by opportunity? • Political Correctness: What is political correctness? Is it appropriate? Is it relevant to the issues raised in Pharmakon? CASE Mykon’s Dilemma Jack Spratt, the newly appointed CEO of Mykon Pharmaceuticals, Inc., sat at his desk and scratched his head for the thousandth time that night. His friends never tired of telling him that unless he stopped this habit he would remove what little hair he had left. Nevertheless, he had good reason to be perplexed—the decisions he made would determine the future of the company and, literally, the life or death of thousands of people. As a young, ambitious scientist, Spratt had gained international fame and considerable fortune while rising quickly through the ranks of the scientists at Mykon. After receiving a degree from the Executive MBA program at the Kenan-Flagler Business School, University of North Carolina at Chapel Hill, he assumed, in rapid succession, a number of administrative positions at the company, culminating in his appointment as CEO. But no one had told him that finding cures for previously incurable diseases would be fraught with moral dilemmas. Although it was 3:00 in the morning, Spratt remained at his desk, unable to stop thinking about his difficult choices. His preoccupation was made worse by the knowledge that pressure from governments and consumers would only increase each day he failed to reach a decision. This pressure had mounted relentlessly since the fateful day he announced that Mykon had discovered the cure for AIDS. But the cure brought with it a curse: there was not enough to go around. COMPANY BACKGROUND Mykon, a major international research-based pharmaceutical group, engages in the research, development, manufacture, and marketing of human health-care products for sale in both the prescription and over-the-counter (OTC) markets. The company’s principal prescription medicines include a range of products in the following areas: antiviral, neuromuscular blocking, cardiovascular, anti-inflammatory, immunosuppressive, systemic antibacterial, and central nervous system. Mykon also manufactures other products such as muscle relaxants, antidepressants, anticonvulsants, and respiratory stimulants. In addition, the company markets drugs for the treatment of congestive heart failure and the prevention of organ rejection following transplant. Mykon’s OTC business primarily consists of cough and cold preparations and several topical antibiotics. The company seeks to expand its OTC business in various ways, including the reclassification of some of its prescription drugs to OTC status. Mykon’s OTC sales represented 14 percent of the company’s sales during last year. Mykon has a long tradition of excellence in research and development (R&D). The company’s expenditures on R&D for the last three financial years constituted 15 percent of its sales. Mykon focuses its R&D on the following selected therapeutic areas, listed in descending order of expenditure amount: antivirals and other antibiotics, cardiovascular, central nervous system, anti-cancer, anti-inflammatory, respiratory, and neuromuscular. Mykon sells its products internationally in more than 120 countries and has a significant presence in two of the largest pharmaceutical markets—the United States and Europe—and a growing presence in Japan. It generated approximately 43 percent and 35 percent of the company’s sales from the previous year in the United States and Europe, respectively. The company sells essentially the same range of products throughout the world. PRODUCTION Mykon carries out most of its production in Rotterdam in the Netherlands and in Research Triangle Park, North Carolina, in the United States. The latter is the company’s world headquarters. The company’s manufacturing processes typically consist of three stages: the manufacture of active chemicals, the incorporation of these chemicals into products designed for use by the consumer, and packaging. The firm has an ongoing program of capital expenditure to provide up-to-date production facilities and relies on advanced technology, automation, and computerization of its manufacturing capability to help maintain its competitive position. Production facilities are also located in ten other countries to meet the needs of local markets and to overcome legal restrictions on the importation of finished products. These facilities principally engage in product formulation and packaging, although plants in certain countries manufacture active chemicals. Last year, Mykon had more than 17,000 employees, 27 percent of whom were in the United States. Approximately 21 percent of Mykon’s employees were engaged in R&D, largely in the Netherlands and the United States. Although unions represent a number of the firm’s employees, the firm has not experienced any significant labor disputes in recent years, and it considers its employee relations to be good. RESEARCH AND DEVELOPMENT In the pharmaceutical industry, R&D is both expensive and prolonged, entailing considerable uncertainty. The process of producing a commercial drug typically takes between eight and twelve years as it proceeds from discovery through development to regulatory approval and finally to the product launch. No assurance exists that new compounds will survive the development process or obtain the requisite regulatory approvals. In addition, research conducted by other pharmaceutical companies may lead at any time to the introduction of competing or improved treatments. Last year Mykon incurred approximately 95 percent of its R&D expenditures in the Netherlands and the United States. Figure 2-5 sets out the firm’s annual expenditure on R&D in dollars and as a percentage of sales for each of the last three financial years. JACK SPRATT Every society, every institution, every company, and most important, every individual should follow those precepts that society holds most dear. The pursuit of profits must be consistent with and subordinate to these ideals, the most important of which is the Golden Rule. To work for the betterment of humanity is the reason I became a scientist in the first place. As a child, Banting and Best were my heroes. I could think of no vocation that held greater promise to help mankind. Now that I am CEO I intend to have these beliefs included in our company’s mission statement. These sentiments, expressed by Jack Spratt in a newsmagazine interview, capture the intensity and drive that animate the man. None who knew him was surprised when he set out years ago—fueled by his prodigious energy, guided by his brilliant mind, and financed by Mykon—for the inner reaches of the Amazon Basin to find naturally occurring medicines. Spratt considered it to be his manifest destiny to discover the cure for some dread disease. His search was not totally blind. Some years earlier, Frans Berger, a well-known but eccentric scientist, had written extensively about the variety of plant life and fungi that flourished in the jungles of the Bobonaza River region deep in the Amazon watershed. Although he spent twenty years there and discovered nothing of medical significance, the vast number and intriguing uniqueness of his specimens convinced Spratt that it was just a matter of time before a major breakthrough would occur. Spratt also had some scientific evidence. While working in Mykon’s laboratory to finance his graduate education in biology and genetics, Spratt and his supervisors had noticed that several fungi could not only restore damaged skin but, when combined with synthetic polymers, had significant effects on internal cells. Several more years of scientific expeditions and investigations proved promising enough for Mykon to send Spratt and a twenty-person exploration team to the Amazon Basin for two years. Two years became five, and the enormous quantity of specimens sent back eventually took over an entire wing of the company’s sizable laboratories in Research Triangle Park, North Carolina. Upon Spratt’s return, he headed up a group of Mykon scientists who examined the Amazonian fungi for pharmacological activity. After several years of promising beginnings and disappointing endings, they discovered that one fungus destroyed the recently identified virus HIV. Years later, the company managed to produce enough of the drug (code named Sprattalin) derived from the fungus to inform the Food and Drug Administration (FDA) that it was testing what appeared to be a cure for HIV. It was the happiest moment of Jack Spratt’s life. The years of determined effort, not to mention the $800 million Mykon had invested, would now be more than fully rewarded. Spratt’s joy was short-lived, though. Public awareness of the drug quickly spread, and groups pressured the FDA to shorten or eliminate its normal approval process, which ordinarily takes more than seven years. People dying from the virus’s effects demanded immediate access to the drug. THE DRUG Mirroring the insidiousness of HIV itself, the structure of Sprattalin is extraordinarily complex. Consequently, it takes four to seven months to produce a small quantity, only 25 percent of which is usable. It is expensive; each unit of Sprattalin costs Mykon $20,000 to produce. The projected dosage ranges from ten units for asymptomatic HIV-positive patients who have normal white blood cell counts to fifty units for patients with low white blood cell counts and full-blown AIDS. The drug appears to eliminate the virus from all patients regardless of their stage of the disease. However, it does not have any restorative effect on patients’ compromised immune systems. Accordingly, it is expected that asymptomatic HIV-positive patients will revert to their normal life expectancies. It is not clear what the life expectancy will be of patients with full-blown AIDS, although it is almost certain that their life expectancy would be curtailed. Supply of Sprattalin The company has estimated that the first two years of production would yield enough Sprattalin to cure 6 percent of all asymptomatic HIV-positive patients. Alternatively, the supply would be sufficient to treat 4 percent of all patients with full-blown AIDS. Children constitute 6 percent of all people living with HIV/AIDS. See Figures 2-6 and 2-7 for statistics on the HIV/AIDS epidemic. Interested parties have argued that the solution to production problems is clear: build larger facilities. However, even with production levels as low as they are, the bottleneck in supply occurs elsewhere. The fungus on which the whole process depends is incredibly rare, growing only in two small regions near Jatun Molino, Ecuador, along the Bobonaza River. At current harvesting rates, scientists predict that all known deposits will be depleted in three years, and many of them insist that production should be scaled back to allow the fungus to regenerate itself. Presently there are no known methods of cultivating the fungus in the laboratory. Apparently, the delicate ecology that allows it to exist in only one region of the earth is somehow distressed enough by either transport or lab conditions to render it unable to grow and produce the drug’s precursor. Scientists are feverishly trying to discover those factors that will support successful culture. However, with limited quantities of the starting material and most of that pressured into production, the company has enjoyed no success in this endeavor. Because of Sprattalin’s complexity, attempts to synthesize the drug have failed completely, mainly because, like aspirin, it is not known how the drug works; thus, Sprattalin’s effectiveness remains shrouded in mystery. Allocation of Sprattalin In response to the insufficient supply, a number of powerful consumer groups have made public their suggestions regarding the allocation of Sprattalin. One proposition advanced would use medical records to establish a waiting list of possible recipients based on the length of time they have been in treatment for the virus. The argument is that those people who have waited the longest and are most in danger of dying should be the first to find relief. Other groups propose an opposite approach, arguing that because supply is so drastically short, Mykon should make Sprattalin available only to asymptomatic HIV patients. They require the least concentrations of the drug to become well, thus extending the drug’s supply. They also have the greatest likelihood of returning to full life expectancies. Under this proposal, people who have full-blown AIDS would be ineligible for treatment. Such patients have previously come to terms with their impending mortality, have fewer psychological adjustments to make, and represent, on a dosage basis, two to five healthier patients. In meting the drug out in this manner, proponents argue, the drug can more readily meet the highest public health objectives to eradicate the virus and prevent further transmission. Others propose that only patients who contracted the virus through no fault of their own should have priority. This approach would first make Sprattalin available to children who were born with the virus, hemophiliacs and others who got the virus from blood transfusions, rape victims, and health-care workers. One member of Sprattalin’s executive committee has suggested a free market approach: the drug should go to the highest bidder. Pricing of Sprattalin In addition to supply problems, Mykon has also come under considerable criticism for its proposed pricing structure. Because of extraordinarily high development and production costs, the company has tentatively priced the drug at levels unattainable for most people afflicted with HIV. Perhaps never before in the history of medicine has the ability to pay been so starkly presented as those who can pay will live, while those who cannot will die. Even at these prices, though, demand far exceeds supply. Jack Spratt and the rest of the Mykon executives predict that the company could easily sell available supplies at twice the proposed price. A growing number of Mykon executives disagree with the passive stance the company has taken in pricing the product. In their view, a 20 percent markup represents a meager return for the prolonged risk and high levels of spending that the company incurred to develop the drug. Moreover, it leaves little surplus for future investment. Furthermore, eight years is too long to amortize the R&D expenses because Sprattalin, though the first, is unlikely to be the last anti-HIV drug, now that Mykon has blazed a path. Other, more heavily capitalized companies are racing to reverse engineer the drug, and the availability of competing drugs remains only a matter of time. Accordingly, the company cannot realistically count on an eight-year window of opportunity. Foreign markets further exacerbate the pricing perplexity. Other countries, with less privatized health care, have already promised their citizens access to Sprattalin at any price. Some first world countries, for instance, are willing to pay up to $2 million per patient. They do not, however, wish to subsidize the drug for the United States. At the same time, some voices in the United States insist that supplies should go first to U.S. citizens. On the other hand, countries with the most severe concentration of the HIV infection cannot afford to pay even Mykon’s actual costs. Some regions in Africa and Asia have experienced rapid growth of the disease, reporting 50 percent to 80 percent of their population at some stage in the HIV cycle. Jack Spratt feels a very real moral obligation to help at least some of these people, whether they can pay or not. MAKING THE DECISION In the past few months, Jack Spratt had seen many aspects of the most important project in his life become not only public knowledge but also public domain. Because of the enormous social and political consequences of the discovery, it is unlikely that the government will allow Mykon to control the destiny of either Sprattalin or ultimately the company. Addressing the public’s concern over access to the drug while ensuring future prosperity of his company had become like walking a tightrope with strangers holding each end of the rope. He knew of no way to satisfy everyone. As Jack Spratt sat at his desk, sleep remained an eon away. ISSUES: 1) Supply—How much fungus do you use immediately? How much do you conserve for future use? 2) Allocation—How should the drug be allocated? 3) Pricing—At what price should the drug be sold? ALLOCATION OPTIONS — The drug should be distributed on which one or which combination of the following criteria? 1) Based on how long a patient has been seeking medical assistance 2) Triage system—those that are in the most desperate condition get the medication first 3) Only to asymptomatic HIV patients 4) Based on fault —give priority to less culpable victims 5) Free market—the highest bidders 6) Lottery—(a) charge everyone who enters the lottery with the winners receiving the drug without additional charge or (b) an open lottery with the winners receiving the right to purchase the drug 7) Based on patient’s nationality— (a) by the percentage of the company’s business in that country; (b) by the percentage of patients in that country, (c) by the percentage of the company’s employees in that country, (d) by the percentage of stockholders in that country, or (e) by some other nationality-based criteria 8) Give priority to stockholders of the company 9) Give priority to citizens of the country in which the fungus grows 10) Relinquish the decision to a governmental or international body PRICING OPTIONS — 1) Free market 2) Like any other new drug 3) Free—to all or to some patients 4) A healthy profit margin—that is, a profit higher than the industry norm ANALYSIS OF THE VARIOUS OPTIONS: How does each of the options impact the following goals and concerns? 1) Fairness—to patients, stockholders, US citizens, other nationals, those who cannot afford to pay 2) What can or should be done to prevent a black market in the drug? 3) Can and should a sufficient quantity of the fungus be preserved for future research? DECISION: Have the students justify their decision. ADDITIONAL DISCUSSION: • Can this case be decided without determining who lives and who dies? • Who should make this type of decision: The company? A government? An international body? CASE Oliver Winery, Inc. BACKGROUND Paul Oliver, Sr., immigrated to the United States in 1930 from Greece. After working for several wineries, he started Oliver Winery, Inc., which eventually found a market niche in nonvarietal jug wines. Through mass-marketing techniques, the company established a substantial presence in this segment of the market. Ten years ago, Paul, Jr., joined the firm after receiving a degree in enology (the study of wine making). He convinced his father of the desirability of entering a different segment of the wine market: premium varietals. To do this, the company needed a large infusion of capital to purchase appropriate vineyards. Reluctantly, Paul, Sr., agreed to take the company public. The initial public offering succeeded, and 40 percent of the company’s stock went into outsiders’ hands. Also, for the first time, outsiders served on the board of directors. Although Paul, Jr., wanted to use a new name for the premium varietal to appeal to a more upscale market, his father insisted on using the name Oliver. BOARD MEETING The board of directors met, along with Janet Stabler, the director of marketing of Oliver Winery, Inc. In attendance were: Paul Oliver, Sr., Chairman of the board and founder of the company Paul Oliver, Jr., CEO, has an advanced degree in enology Cyrus Abbott, CFO, has an MBA Arlene Dale, comptroller, has a CPA with a master’s degree in accounting Raj Ray, COO, has a master’s degree in industrial engineering LaTasha Lane, VP Legal, has a J.D. degree Elisabeth Constable, union representative to the board, has a GED degree Rev. John W. Calvin, outside director, has a Doctor of Divinity degree Carlos Menendez, outside director, has an MFA degree Oliver, Sr.: The next item on the agenda is a proposal to develop a new line of wines. Janet Stabler will briefly present the proposal. Stabler: Thank you. The proposal is to enter the fortified wine market. It’s the only type of wine in which unit sales are increasing. We’ll make the wines cheaply and package them in pint bottles with screw-on caps. Our chief competitors are Canandaigua with Richard’s Wild Irish Rose, Gallo with Thunderbird and Night Train Express, and Mogen David with MD 20/20. We’ll market the wine with little or no media advertising by strategically sampling the product to targeted consumers. That’s it in a nutshell. Oliver, Sr.: Any questions before we vote? Menendez: Who’ll buy this wine? Calvin: From what I know about consumers of your competitors, it appears to me that it’s bought by homeless winos. Stabler: Not entirely. For example, pensioners on a fixed income would find the price of the wine appealing. Thunderbird has been recently introduced into England and has become very popular with the yuppie crowd. Calvin: Then why put it in pint bottles? Stabler: For the convenience of consumers. Menendez: Why would pensioners want a small bottle? Calvin: Homeless people want it in pints so they can fit it in their hip pockets. They obviously don’t have a wine cellar to lay away their favorite bottles of Mad Dog. Stabler: The pint size also keeps the price as low as possible. Calvin: Translation: The homeless don’t have to panhandle as long before they can make a purchase. Also, why would you increase the alcoholic content to 18 percent and make it so sweet if it weren’t for the wino market? Stabler: Many people like sweet dessert wines and 18 percent is not that much more than other types of wines that have 12 percent alcohol. Menendez: Is it legal? Lane: Sure. We sell to the retailers. It may be against the law to sell to intoxicated persons, but that’s the retailers’ business. We cannot control what they do. Calvin: Isn’t this product intended for a perpetually intoxicated audience that many people consider to be ill? Wouldn’t we be taking advantage of their illness by selling highly sugared alcohol that suppresses their appetite? I’ve spoken to drinkers who claim to live on a gallon of this type of product a day. Oliver, Jr.: What will this do to our image? We’re still trying to get our premium wines accepted. Stabler: Of course we won’t use the Oliver name on these wines. We will use another name. Menendez: Is it OK to do that? Stabler: Why not? Canandaigua, Gallo, and Mogen David all do the same thing. None of them put their corporate name on this low-end product. Abbott: We’re getting away from the crux of the matter. Profit margins would be at least 10 percent higher on this line than our others. Moreover, unit sales might increase over time. Our other lines are stagnant or decreasing. The public shareholders are grousing. Dale: Not to mention that our stock options have become almost worthless. I’m only a few years from retirement. We need to increase the profitability of the company. Ray: Operationally, this proposal is a great fit. We can use the grapes we reject from the premium line. It will also insulate us from bad grape years because any grape will do for this wine. We can fill a lot of our unused capacity. Constable: And hire back some of the workers who were laid off! Stabler: It’s a marketing dream. Just give out some samples to “bell cows.” Menendez: What are bell cows? Stabler: Opinion leaders who will induce other consumers to switch to our brand. Calvin: You mean wino gurus? Oliver, Sr.: Look, if we don’t do it, others will. In fact, they already have. Abbott: And they’ll get richer, and we’ll get poorer. Lane: Gallo pulled out of several of these skid row markets as did Canandaigua. Little good it did. The alcoholics just switched to malt liquor, vodka, or anything they could get their hands on. Dale: I think our concern is misplaced. These people are the dregs of society. They contribute nothing. Calvin: They’re human beings who need help. We’re profiting off their misfortune and misery. Oliver, Sr.: We can take that up when we decide on what charities to support. Anyone opposed to the proposal? Calvin: Is this a done deal? I believe we should contribute half of our profits from this product to support homeless shelters and other programs that benefit indigent and homeless people. If not, I must resign from this board. SOURCES Carrie Dolan, “Gallo Conducts Test to Placate Critics of Its Cheap Wine,” The Wall Street Journal, June 16, 1989, p. B3. Alix M. Freedman, “Winos and Thunderbird Are a Subject Gallo Doesn’t Like to Discuss,” The Wall Street Journal, February 25, 1988, p. 1. Frank J. Prial, “Experiments by a Wine Maker Fails to Thwart Street Drunks,” The New York Times, February 11, 1990, p. A29. ISSUES Should the company manufacture the new line of wine and, if so, under what conditions? OPTIONS 1) Do not manufacture 2) Do not manufacture and try to prevent others from manufacturing this type of wine 3) Manufacture without company’s name on the wine 4) Manufacture with company’s name on the wine 5) Manufacture and invest a percentage of the profits in education or rehabilitation 6) Manufacture and put a warning on the bottle 7) Manufacture and refuse to sell in certain neighborhoods ANALYSIS OF THE VARIOUS OPTIONS How do these options affect the following stakeholders? 1) Oliver Winery 2) Habitual drinkers 3) Non-habitual drinkers 4) Retailers 5) Community DECISION Have the students justify their decision. 1) Does this decision differ from the decision of a company that is already producing the wine as to whether it should continue to manufacture or not? 2) Does this decision vary or differ between a privately held company and a publicly traded company? ADDITIONAL DISCUSSION 1) What is the social responsibility of business? 2) What is the intent in this type of target marketing? 3) Is target marketing appropriate (a) in this case or (b) ever? 4) Should the Reverend resign? 5) If the company does not produce the wine, will the decision have any effect? 6) What would happen if all producers stopped producing this type of wine? 7) Does this situation differ from the sale of (a) Tobacco? (b) Guns, especially “Saturday night specials”? (c) Illegal drugs? (d) High cholesterol foods? CASE JLM, Inc. BACKGROUND Sitting in her office, Ellen Fulbright, director of human resources for JLM, Inc., thought over the decisions confronting her. To help her decide, she mentally reviewed how they had arisen. After receiving her MBA and J.D. degrees from a highly regarded university, she joined a prestigious New York law firm where she specialized in employment law. After seven years at the law firm, she was hired by one of the firm’s clients as general counsel. When that company was acquired by JLM, she joined its legal staff and within a few years had been promoted to her current position. Fulbright’s rapid advancement resulted from her having made a positive impression on Rasheed Raven, JLM’s CEO. Raven is a hard-driving, bottom-line-oriented pragmatist in his early forties. Raven, a graduate of Howard University, had begun his business career on Wall Street, which he astounded with his aggressive but successful takeover strategies. After acquiring fifteen unrelated manufacturing companies, he decided to try his hand at the turnaround business. He organized JLM as an umbrella for his acquired companies. Soon he earned the reputation as the best in the business by transforming JLM into the leader in the industry. JLM is a highly successful turnaround company. Typically, JLM purchases companies that are in serious financial trouble and manages them until they become successful companies. At that time, JLM either retains them in its own portfolio of companies or sells them off to other enterprises. REFERENCE LETTER POLICY About a year after Fulbright had become director of human resources (HR), Raven called her into his office and showed her a newspaper article. It reported, in somewhat sensational fashion, that several defamation suits had resulted in multimillion dollar judgments against companies that had written negative letters of references about former employees. Raven told her that he was concerned about this and that he wanted her to develop an HR policy covering letters of reference. In researching the issue, she discovered several articles in which the authors decried the recent spate of companies that had decided to stop writing letters of reference. According to their data, they believed that these companies had overreacted to the actual risk posed by defamation suits. Based on these articles and her own inclination toward full disclosure, she proposed that the company continue to permit letters of reference but that all letters with negative comments must be reviewed by her. Raven did not receive her proposal favorably and sought a second opinion from her old law firm. His analysis of the firm’s advice was: “We get nothing but brownie points for writing reference letters, but we face the possibility of incurring the cost of a legal defense or, worse yet, a court judgment. This is a ‘no-brainer.’ We have no upside and all downside.” Raven ordered that, henceforth, company employees would no longer write letters of reference but would simply verify dates of employment. Although Fulbright was personally and professionally miffed by his decision, she drew up the policy statement as directed. Fulbright believed that because JLM frequently took over companies that needed immediate downsizing, this policy would be unfair and extremely detrimental to longtime employees of newly purchased companies. TAKEOVER OF DIVERSIFIED MANUFACTURING, INC. After a number of years of steady growth, Diversified Manufacturing began experiencing huge financial losses, and its immediate survival was in serious doubt. After careful consideration, Raven decided that Diversified was an ideal takeover target in that its core businesses were extremely strong and presented great long-term economic viability. Upon acquiring Diversified, JLM quickly decided that it had to rid Diversified of some of its poorly performing companies and that it had to reduce the size of Diversified’s home office staff by 25 percent. Raven relentlessly orchestrated the reduction in force, but at Fulbright’s urging he provided the discharged executives with above-average severance packages, including excellent outplacement services. THE PROBLEM The reduction in force was disruptive and demoralizing in all the usual ways. But for Fulbright there was a further complication: the no-reference-letter policy. She was extremely troubled by its application to three discharged Diversified employees and to one discharged JLM employee. The Salacious Sales Manager Soon after taking over Diversified, Fulbright became all too aware of the story of Ken Byrd, Diversified’s then national sales manager. Ken is an affable man of fifty who had been an unusually effective sales manager. Throughout his career, his sales figures had always doubled those of his peers. He achieved rapid advancement despite a fatal flaw: he is an inveterate and indiscreet womanizer. He could not control his hands, which slapped backs so well, nor his tongue, which persuaded so eloquently. He had two approaches to women. With a woman of equal or superior rank in the company, he would politely, but inexorably, attempt to sweep her off her feet. With these women, he would be extremely charming and attentive, taking great care to avoid being offensive or harassing. In contrast, with a woman of subordinate rank, he would physically harass her. Less openly, but much too often, he would come up behind a woman, reach around her, and grab her. He invariably found this amusing—his victims, however, did not. Fulbright could not believe that such a manager had stayed employed at Diversified so long, let alone been continually promoted to positions of greater responsibility and power. As Fulbright investigated the situation, she discovered that numerous sexual harassment complaints had been filed with Diversified concerning Byrd’s behavior. To protect Byrd, Diversified dealt with these complaints by providing money and undeserved promotions to the complainants to smooth over their anger. Thus, Diversified successfully kept the complaints in-house and away from the courts and the Equal Employment Opportunity Commission. After JLM’s takeover of Diversified, Fulbright quickly discharged Byrd. Her satisfaction in getting rid of him was short-lived, however. His golden tongue and stellar sales record had landed him several job offers. Her dilemma was that she was uncomfortable about loosing this deviant on an unsuspecting new employer. But JLM’s policy forbade her from writing any letters or answering questions from prospective employers. The Fruitless Juice Melissa Cuthbertson had been a vice president in procurement for Diversified’s Birch-Wood division with direct responsibility over the ordering of supplies and raw materials. Birch-Wood manufactured a full line of baby food products, including fruit juices that were labeled “100% fruit juice.” To cut costs, Stanley Aker, the division’s president, had arranged for an unscrupulous supplier to provide high-fructose corn syrup labeled as juice concentrate. Because standard testing in the industry was unable to detect the substitution, the company did not get caught. Emboldened, Aker gradually increased the proportion of corn syrup until there were only trace amounts of fruit juice left in the “juice.” A company employee discovered the practice and after the takeover brought the matter to Fulbright’s attention through JLM’s internal whistle-blowing channel, which Fulbright had established. She referred the matter to Raven, who called in Aker and Cuthbertson and confronted them with the accusation. They admitted it all, explaining that nutritionally the corn syrup was equivalent to the fruit juice. But at 60 percent of the cost of fruit juice, the corn syrup made a big difference to the bottom line. Raven told them that such conduct was not permitted and that they must properly dispose of the adulterated juice. That night Aker and Cuthbertson had the juice moved from Birch-Wood’s New York warehouse and shipped to its Puerto Rico warehouse. Over the course of the next few days, the “juice” was sold in Latin America as “apple juice.” Aker reported to Raven that the juice had been properly disposed of and that Birch-Wood had sustained only a small loss during that quarter. When Raven discovered the truth, he immediately discharged Aker and Cuthbertson, telling them “that if he had anything to do with it, neither of them would ever work again.” Fulbright was to meet soon with Raven to discuss what should be done about Aker and Cuthbertson. The Compassionate CFO Jackson Cobb, JLM’s former chief financial officer, is a brilliant analyst. Through hard work he had earned an excellent education that honed his innate mathematical gifts. His natural curiosity led him to read widely, and this enabled him to bring disparate facts and concepts to bear on his often novel analyses of financial matters. But he had no interest in implementing his insights, for his only enjoyment was the process of discovering connections. Fortune—or fate—had brought him together with Raven, who is twenty years younger than Cobb. Theirs was definitely a case of opposites attracting. Raven cared little about ideas; he cared primarily about money. Cobb cared little about money; he cared primarily about ideas. Raven took Cobb’s insights and translated them into action with spectacular success. Their relationship brought new meaning to the concept of synergy. When Raven formed JLM, he brought Cobb on as chief financial officer and installed him in an adjoining office. Their relationship continued to flourish, as did JLM’s bottom line, until Cobb’s wife became terminally ill. During the eighteen months she languished, Cobb spent as much time as he could taking care of her. After forty years of marriage, he was unwilling to leave her welfare to the “kindness of strangers.” At his own expense, he installed a state-of-the-art communication center in his home. By virtue of computers, modems, video cameras, faxes, copiers, mobile telephones, and the like, he had available to him the same data and information as he had at his office. He could be reached by telephone at all times. But he was not in the office next to Raven; he was not present at Raven’s daily breakfast meetings; he was not on the corporate jet en route to business meetings. After their many years of working together, Raven was enraged at the loss of immediate access to Cobb. He felt that Cobb had betrayed him and demanded that Cobb resume his old working hours. Cobb refused, and Raven fired him. Because of his age, Cobb was experiencing difficulty in finding new employment, and Fulbright wanted to write a letter on his behalf. ISSUES The general issue is what policy should JLM adopt regarding letters of references. The specific issue is what should JLM do about the particular individuals involved. OPTIONS 1) Adopt a no reference policy 2) Adopt a policy that permits references to be written by certain specified employees 3) Allow references on a case by case basis 4) Permit references to be given 5) Provide (or not provide) references for each of the individuals involved 6) Allow employees to provide references as individuals but not as agents of the company ANALYSIS OF THE VARIOUS OPTIONS 1) What is the rationale behind a no reference policy? 2) What is the rationale in favor of providing references? 3) What are the ethics of each of these policies? Is not providing references deception by silence? 4) Should states adopt laws to protect companies from tort liability (defamation) for providing references? Explain. 5) Should a company be held liable for negligent hiring? When? 6) Should the law enforce an employee’s promise not to sue made in consideration of the employer’s providing a letter of reference? 7) Who is harmed by no reference policies? 8) Should JLM provide references for the particular individuals involved in this case? Explain. 9) For whom are you most inclined to provide a reference? The least inclined? Explain. 10) What is the cost to JLM of each option? What is the cost to society in general? DECISION Have students justify their recommendations. ADDITIONAL DISCUSSION • Employment at will—Is it fair? Explain. • Right to lie—Is it ever appropriate to lie in business? If so, when? • Society’s responsibility—Should there be laws regulating this area? Explain. CASE Sword Technology, Inc. BACKGROUND Sitting in his office, Stephen Hag, CEO of Sword Technology, Inc., contemplated the problems that had been perplexing him for some time. They had begun when he took his company international, and they kept coming. But today he was no more successful in devising a solution than he had been previously. Slowly, his thoughts drifted to those early days years ago when he and his sister Marian started the company. The company’s first product was an investment newsletter stressing technical analysis in securities investing. A few years later, he developed what became a “killer app”: a computer program that defines an entirely new market and through customer loyalty substantially dominates that market. His software program enabled investors to track their investments in stocks, bonds, and futures. By combining powerful analytical tools with an accessible graphical interface, it appealed to both professional and amateur investors. Moreover, it required users to download information from the company’s database. With one of the most extensive databases and the cheapest downloading rates in the industry, the company soon controlled the U.S. market. Sword then went public through a highly successful IPO (an initial public offering of the company’s common stock), and its stock is traded on the Nasdaq market. The company is required to file periodic reports with the Securities and Exchange Commission. The company used cash from sales of software, online charges, and the IPO to try to enter the hardware side of the computer industry. It began manufacturing modems and other computer peripherals. A nagging problem, however, plagued the company’s manufacturing efforts. Although Sword’s modem could convert data more quickly and efficiently than most of its competitors, because of high labor costs it was unable to market its modem successfully. To reduce manufacturing costs, especially labor costs, the company decided to move its manufacturing facilities overseas. And that’s when the trouble began. Stephen’s thoughts returned to the present. He reopened the folder labeled “Confidential: International Issues” and began perusing its contents. TRANSFER PRICING The first item he saw was an opinion letter from the company’s tax attorney. It dealt with Excalibur Technology, the first overseas company Sword established. Excalibur, a wholly owned subsidiary of Sword, is incorporated in Tolemac, an emerging country with a rapidly growing economy. To encourage foreign investment, Tolemac taxes corporate profits at a significantly lower rate than the United States and other industrialized nations. Excalibur manufactures modems for Sword pursuant to a licensing agreement under which Excalibur pays Sword a royalty equal to a specified percentage of the modems’ gross sales. Excalibur sells all of its output at a fair market price to Sword, which then markets the modems in the United States. Stephen had been closely involved in structuring this arrangement and had insisted on keeping the royalty rate low to minimize taxable income for Sword. Stephen reread the opinion letter: Section 482 of the Internal Revenue Code authorizes the Internal Revenue Service to allocate gross income, deductions, credits, and other common allowances among two or more organizations, trades, or businesses under common ownership or control whenever it determines that this action is necessary “in order to prevent evasion of taxes or clearly to reflect the income of any such organizations, trades, or businesses.” IRS Regulation 1.482–2(e) governing the sale or trade of intangibles between related persons mandates an appropriate allocation to reflect the price that an unrelated party under the same circumstances would have paid, which normally includes profit to the seller. The Regulations provide four methods for determining an arm’s-length price. In our opinion, under the only method applicable to the circumstances of Sword Technology, Inc., and Excalibur Technology, the royalty rate should be at least three times the current one. If the IRS were to reach the same conclusion, then the company would be liable for the taxes it underpaid because of the understatement of income. Moreover, the company would be liable for a penalty of either 20 percent or 40 percent of the tax deficiency, unless the company can show that it had reasonable cause and acted in good faith. Stephen had spoken to the tax attorney at length and learned that the probability of an audit was about 10 percent and that many multinational companies play similar “games” with their transfer pricing. The attorney also told him that he believed that if the company were audited, there was at least a 90 percent probability that the IRS would agree with his conclusion and at least a 70 percent probability that it would impose a penalty. Because the dollar amount of the contingent tax liability was not an insignificant amount, Stephen had been concerned about it for the six weeks since he had received the letter. CUSTOMS AND CUSTOMS Soon after Excalibur had manufactured the first shipment of modems, a new problem arose: getting them out of Tolemac. It took far too long to clear customs, thus undermining their carefully planned just-in-time manufacturing schedules. Stephen hired a local export broker, who distributed cash gifts to customs officials. Miraculously, the clearance time shortened and manufacturing schedules were maintained. The export broker billed the company for his services and the amount of the cash gifts. Although the broker assured Stephen that such gifts were entirely customary, Stephen was not entirely comfortable with the practice. THE THORN IN HIS SIDE Tolemac was not Stephen’s only problem. Six months after commencing operations in Tolemac, Sword began serious negotiations to enter the Liarg market. Liarg is an undeveloped country with a large population and a larger national debt. Previously, Sword had encountered great difficulties in exporting products to Liarg. Stephen’s sister, Marian, COO of Sword, took on the challenge of establishing a Liarg presence. They decided that setting up a manufacturing facility in Liarg would achieve two objectives: greater access to the Liarg marketplace and lower-cost modems. At first, the Liarg government insisted that Sword enter into a joint venture, with the government having a 51 percent interest. Sword was unwilling to invest in such an arrangement, countering with a proposal for a wholly owned subsidiary. Marian conducted extensive negotiations with the government, assisted by a Liarg consulting firm that specialized in lobbying governmental officials. As part of these negotiations, Sword made contributions to the reelection campaigns of key Liarg legislators who were opposed to wholly owned subsidiaries of foreign corporations. After the legislators’ reelection, the negotiations quickly reached a successful conclusion. On closing the contract, Sword flew several Liarg officials and their wives to Lake Tahoe for a lavish three-day celebration. All of these expenses were reported in the company’s financial statements as payments for legal and consulting fees. Marian then hired an international engineering firm to help design the manufacturing plant. Two weeks later, they submitted plans for the plant and its operations that fully complied with Liarg regulations regarding worker health and safety as well as environmental protection. But, as Marian had explained to Stephen, the plant’s design fell far short of complying with U.S. requirements. Marian noted that, under the proposed design, the workers would face exposure to moderately high levels of toxic chemicals and hazardous materials. The design also would degrade the water supply of nearby towns. However, the design would generate very significant savings in capital and operational costs as compared with the design used in their U.S. facility. Marian assured Stephen that all quality control systems were in place so the modems produced in this plant would be indistinguishable from their U.S. counterparts. Stephen and Marian have had long discussions about what to do about the plant. Stephen then took from the folder an article that had appeared in a number of U.S. newspapers. Children and Chips A twelve-year-old Liarg child recently spoke at an international conference in New York denouncing the exploitation of children in the Liarg computer chip industry. The child informed the outraged audience that he had worked in such a plant from age four to age ten. He asserted that he was just one of many children who were so employed. He described the deplorable working conditions: poor ventilation, long hours, inadequate food, and substandard housing. The pay was low. But, because their families could not afford to keep them at home, the children were hired out to the factory owners, who especially wanted young children because their small fingers made them adept at many assembly processes. Stephen had read the article countless times, thinking about his own children. He knew that if they set up a plant in Liarg, they would have to buy chip components from Liarg suppliers. He also knew that there would be no way for Sword to ensure that the chips had not been made with child labor. Another labor issue also troubled Stephen. Marian told him that she had met considerable resistance from the Liarg executives they had hired when she suggested that women should be hired at the supervisory level. They maintained that it was not done and would make it impossible to hire and control a satisfactory workforce at the plant. Moreover, they insisted on hiring their relatives as supervisors. When Marian protested this nepotism, they assured her that it was customary and asserted that they could not trust anyone not related to them. TO OUTSOURCE OR NOT TO OUTSOURCE Once again Stephen glanced over the cost data. Sword’s labor costs for supporting its database services and hardware were eviscerating the company’s profits. After racking his brain endlessly, he had concluded that wherever it made financial and strategic sense Sword should utilize business process outsourcing (BPO); that is, long-term contracting out of non-core business processes to an outside provider in order to lower costs and thereby increase shareholder value. Stephen had examined a number of potential countries on the basis of many factors including time zone, communications infrastructure, technical training, English language skills of the workforce, and—most critically—costs. Liarg had emerged as the optimal choice. He anticipated reducing labor and associated overhead costs by 45 to 50 percent. He planned to start by off-shoring half of the call center operations, soon to be followed by a third of the low-end software development such as maintenance and coding. Assuming all went as he envisioned, he expected to move offshore back-office operations and higher-level software development. As his imagination soared, he saw the potential to amplify the company’s operations with round-the-clock development. Stephen realized that embarking on this course would result in reducing the staffing at the company’s U.S. call centers. He expected he could achieve some reductions through attrition and reassignment, but considerable layoffs would be necessary. He hoped that outsourcing the low-end software development would enable the company to redeploy its software developers to higher-level and more profitable assignments. Moreover, the recent rollback in the number of visas had resulted in difficulty in hiring sufficient numbers of software developers with the necessary skills. If Sword were to offshore back-office operations, Stephen expected an impact on current employees comparable to off-shoring the call centers. On top of all these concerns had come a letter from the company’s outside legal counsel regarding payments made to foreign officials. Memorandum of Law The Foreign Corrupt Practices Act makes it unlawful for any domestic company or any of its officers, directors, employees, or agents or its stockholders acting on its behalf to offer or give anything of value directly or indirectly to any foreign official, political party, or political official for the purpose of 1. influencing any act or decision of that person or party in his or its official capacity, 2. inducing an act or omission in violation of his or its lawful duty, or 3. inducing such person or party to use its influence to affect a decision of a foreign government in order to assist the domestic concern in obtaining or retaining business. An offer or promise to make a prohibited payment is a violation even if the offer is not accepted or the promise is not performed. The 1988 amendments explicitly excluded facilitating or expediting payments made to expedite or secure the performance of routine governmental actions by a foreign official, political party, or party official. Routine governmental action does not include any decision by a foreign official regarding the award of new business or the continuation of old business. The amendments also added an affirmative defense for payments that are lawful under the written laws or regulations of the foreign official’s country. Violations are punishable by fines of up to $2 million for companies; individuals may be fined a maximum of $100,000 or imprisoned up to five years, or both. Fines imposed upon individuals may not be paid directly or indirectly by the domestic company on whose behalf they acted. In addition, the courts may impose civil penalties of up to $16,000. The statute also imposes internal control requirements on all reporting companies. Such companies must 1. make and keep books, records, and accounts, that in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; and 2. devise and maintain a system of internal controls that ensure that transactions are executed as authorized and recorded in conformity with generally accepted accounting principles, thereby establishing accountability with regard to assets and ensuring that access to those assets is permitted only with management’s authorization. Any person who knowingly circumvents or knowingly fails to implement a system of internal accounting controls or knowingly falsifies any book, record, or account is subject to criminal liability. ISSUES Should the company follow the legal and ethical practices of its home country or the legal and ethical practices of the host country?
SITUATION DISCUSSION
Transfer Payments • Is a cost/benefit analysis appropriate? • Is it significant that other companies do it?
Customs Expediting Is it legal and ethical in home country? In host country? (Probably is not a violation of Foreign Corrupt Practices Act.)
Campaign Contributions Is it legal and ethical in home country? In host country? (Probably is a violation of Foreign Corrupt Practices Act.)
Lake Tahoe Is it legal and ethical in home country? In host country? (Probably is a violation of Foreign Corrupt Practices Act.)
Design of Plant Is it legal and ethical in home country? In host country?
Child Labor • Is it legal and ethical in home country? In host country? • Who is causing the harm? Does that matter? • Is a cost/benefit analysis appropriate?
Discrimination • Is it legal and ethical in home country? In host country? • Is it fair?
Nepotism • Is it legal and ethical in home country? In host country? • Is it fair?
DECISION Have the students justify their decision. ADDITIONAL DISCUSSION • Does the decision whether to follow the home or host country’s practice depend on the level of economic development of each country? • Should a host country’s practice be permissible if the home country would do the same if it were at the same economic stage as the host country? • Are there moral minimums that must be satisfied in all countries? Are any of these moral minimums applicable to any of the ethical issues raised in this case? CASE Vulcan, Inc. THE COMPANY Vulcan, Inc. is a multinational Fortune 200 company engaging principally in the exploration for and extraction of minerals. It is listed on the New York Stock Exchange and has more than 615 million shares outstanding. THE MEETING (MARCH 7) On March 5, Stewart Myer, the company’s CEO, personally telephoned Martha Bordeaux, the VP for finance; Lamont Johnson, the chief geologist; and Natasha Bylinski, the VP for acquisitions, to arrange a March 7 meeting at the Atlanta airport. He emphasized to each of them the need for the utmost secrecy, directing them to arrange their travel to Atlanta as a connection to other and different destinations. When they all arrived at the meeting room, Myer reemphasized the need for complete secrecy. He then asked Johnson to present his report. THE REPORT Johnson read his report: Over the past few years we have conducted extensive aerial geophysical surveys of the areas west of the Great Plains. These revealed numerous anomalies or extreme variations in the conductivity of rocks. One appeared particularly encouraging, so late last year we began a ground geophysical survey of the southwest portion of the Z segment in Montana. This survey confirmed the presence of anomalies. Accordingly, on January 14 we drilled some core samples and sent them to our lab. The results were so extraordinarily promising that on February 10 we obtained more core samples and had them chemically assayed. On February 25, we received the assay, which revealed an average mineral content of 1.17 percent copper and 8.6 percent zinc over 600 feet of the sample’s 650-foot length. Johnson then commented, “In my forty years in the business I have never seen such remarkable test results. On a scale of one to ten, this is an eleven.” THE REACTION Bordeaux exclaimed, “Our stock price will go through the roof!” Bylinski retorted, “So will land prices!” THE STRATEGY Myer interrupted, “Look, we’re not here to celebrate. There are a lot of better places to do that. We can’t keep a lid on this for very long so we have to strike soon. We need to line up the right agents to acquire the land. We must fragment the acquisitions to keep the sellers in the dark. Most critical is maintaining absolute secrecy. No one else in the company must know this. I will decide who needs to know and I will tell them. It is your duty to the company to keep totally quiet. Now, let’s discuss the acquisition plan.” When asked how he had managed to obtain core samples without tipping off the owners of the land, Johnson explained, “We pretended to be a motion picture company looking for locations to remake the movie High Noon. We drilled the samples in isolated areas and quickly filled the holes. To further cover our tracks we drilled some barren core samples from land we owned and hid the cores on our land.” THE PLAN Bylinski outlined the plan to acquire the land. “We only own about 20 percent of the land we want and we have options on another 15 percent. However, we currently own none of the principal portion. So we have a lot of work to do. We will employ several agents to negotiate the purchases. We will instruct them not to disclose that they are acting for us. In fact, we will order them not to disclose they are acting for anyone. We need to acquire approximately twenty square miles of additional land.” Bordeaux asked, “What if the locals start getting curious?” Myer replied, “I’ll deal with that later if it arises.” STOCK OPTIONS On March 15 Vulcan issued stock options at $23.50 per share to thirty of its executives including Myer, Bordeaux, Johnson, and Bylinski. At this time neither the stock option committee nor the board of directors had been informed of the strike or the pending land acquisition program. THE RUMORS While the land acquisition plan was nearing completion, rumors about a major strike by Vulcan began circulating throughout the business community. On the morning of March 20, Bordeaux read an account in a national newspaper reporting that ore samples had been sent out of Montana and inferring from that fact that Vulcan had made a rich strike. Bordeaux called Myer and told him about the article. THE PRESS RELEASE Myer prepared the following press release, which appeared in morning newspapers of general circulation on March 21: During the past few days the press has reported drilling activities by Vulcan and rumors of a substantial copper discovery. These reports greatly exaggerate. Vulcan has engaged in normal geophysical explorations throughout the West. We routinely send core samples to verify our visual examinations. Most of the areas drilled have been barren or marginal. When we have additional information we will issue a statement to shareholders and the public. LAND ACQUIRED On April 6 Vulcan completed its land acquisition program. It had employed seven different agents. In total, it had acquired thirty-seven parcels from twenty-two different sellers at prices ranging from $300 to $600 per acre. The land cost a total of approximately $6 million. OFFICIAL ANNOUNCEMENT At 10:00 A.M. on April 11, Myer released on behalf of Vulcan an official announcement of a strike in Montana containing at least 30 million tons of high-grade copper and zinc ore. The release appeared on the wire services at 10:30 A.M. The price of Vulcan stock shot up eleven points to $38 by the close of business that day and continued to rise, reaching a price of $56 on May 16. (Figures 2-8 and 2-9 show the price and volume of Vulcan stock.) LOOSE LIPS Prior to the April 11 official announcement, a number of people purchased Vulcan stock with knowledge of the mineral discovery. Some people also purchased land adjacent to Vulcan’s holdings in Montana. These purchasers included the following: The Vulcan Executives Myer, Bordeaux, Johnson, and Bylinski each purchased shares or calls on several occasions during this time period. See Figure 2-10 for a listing of their purchases. The Eager Eavesdropper After leaving the March 7 meeting, Bordeaux and Bylinski went to the airport lounge to wait for their flights. They excitedly—and loudly—discussed what they had learned at the meeting. Several people overheard their remarks, and one of them, Rae Bodie, immediately called her broker and bought one thousand, five hundred shares of Vulcan stock. Ms. Bodie also purchased a large tract of land next to Vulcan’s site in Montana for approximately $600 per acre. The Crestfallen Security Guard On March 9 Johnson went into the home office very early to finish up the exploratory work on the new find. At the elevator he encountered Celia Tidey, one of the company’s security guards. Johnson knew her fairly well since they both had worked for Vulcan for more than fifteen years. Noting her despondent visage, Johnson asked her what was wrong. She related to him her tale of woe: her husband had become disabled and lost his job while her son needed an expensive medical procedure and their health insurance did not cover it. Johnson felt great empathy for her plight. He told her that big doings were afoot at Vulcan and that if she bought Vulcan stock soon she would make a lot of money in a month or so. She took her savings and bought two hundred shares of Vulcan stock, which were as many shares as she could buy. The Avaricious Agent William Baggio, one of the agents hired to acquire the land, inferred that whatever was up had to be good for Vulcan. Accordingly, on March 21 he purchased two thousand, five hundred shares of Vulcan and five thousand acres of land adjacent to the Vulcan property. The Trusted Tippee On March 8, Myer called Theodore Griffey, his oldest and dearest friend. After getting Griffey to swear absolute confidentiality, Myer told him all the details of the strike. After hanging up the telephone, Griffey immediately purchased fifteen thousand shares of Vulcan stock. Griffey then told his father and sister about the land; both of them bought fifteen thousand shares. The Scampering Stockbroker Morris Lynch, Myer’s stockbroker, was intrigued by Myer’s purchases of an unusually large volume of Vulcan shares. During the last two weeks of March he put a number of his other clients into Vulcan, telling them, “I’ve looked at this stock and it’s good for you.” About a dozen of his clients purchased a total of eight thousand shares. THE LAND GRAB After the official announcement on April 11, several of Vulcan’s competitors began exploring the area and purchased large tracks of land, bidding up the price of land to $2,250 per acre. Both Bodie and Baggio sold their newly acquired land to Vulcan competitors at this higher price. ISSUES What circumstances constitute insider trading? Is it ethical to use non-disclosed agents to buy land for a price lower than its known (but undisclosed) value?
ACTION DISCUSSION
Stock Options Was it ethical to issue stock options to the executives who knew about the impending land acquisition and mineral strike?
Misleading Press Release Although the press release issued in response to rumors was technically accurate, its downplaying of the situation is misleading. Is this a legal or ethical practice?
Land Acquisition Is it legal and ethical to use multiple non-disclosed agents to mask the volume and value of land purchases in order to obtain land at a price lower than its actual value? Is it ethical to buy land at a low price, knowing its value is going to go up, then sell it at the elevated price?
Stock Purchase by Executives Who Know About Mineral Find Is this insider trading?
Stock Purchase by Eavesdropper Who Does Not Know Executives Is this insider trading?
Stock Purchase by Security Guard Who Gets Tip From Executive Is this insider trading?
Stock Purchase by Agent Who Knows About Land Purchases Is this insider trading?
Stock Purchase by Friends and Family of Executives Who Know About Mineral Find Is this insider trading?
Stock Purchase by Stockbroker (and His Clients) Who Notices Other Unusual Purchases Is this insider trading?
DECISION Have the students justify their decision. ADDITIONAL DISCUSSION • Is there ever a time when it is ethical and legal to buy stocks based on insider information? Instructor Manual for Smith and Robersons Business Law Richard A. Mann, Barry S. Roberts 9781337094757, 9780357364000, 9780538473637
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