Ch 2 Ethics and Governance Scandals Flashcards
(102 cards)
1
Q
What is the typical pattern associated with scandals and resulting reforms?
A
- Scandal outrages public
- Public tolerance diminishes
- Credibility of corporations is eroded
- Lawmakers, regulators, directors, and professional bodies respond to restore confidence
2
Q
What was at the heart of the Enron scandal?
A
Failure of BOD
3
Q
What was at the heart of Arthur Andersen’s downfall?
A
An organizational culture gone awry
4
Q
What was at the heart of the WorldCom scandal?
A
Power in hands of one man
5
Q
What was at the heart of the subprime mortgage meltdown?
A
Greed without due diligence
6
Q
What were three key reforms in response to all the scandals?
A
- SOX
- Circular 230 (new professional standards on tax preparers and advisors)
- Dodd Frank Act
7
Q
In 1933, why was the Glass-Steagall Act passed?
A
To control bank speculation and protect investor deposits
8
Q
In 2010, what was the passage of the Dodd Frank Act in response to?
A
Response to subprime lending problems
9
Q
In 1999, what did the Gramm-Leach-Bliley Act repeal?
A
Glass-Steagall Act
10
Q
What was the stock market crash/great depression a result of?
A
- Widespread speculation
- Inadequate financial reporting
- Inadequate banking controls
11
Q
As a result of the spectacular stock market crash in 1929, the government implemented the Securities Act of 1933, the Securities Exchange Act of 1934, as well as which of the following acts:
a) Glass Steagall Act
b) Investment Advisers Act
c) Gramm-Leach-Bliley Act
d) All of the above
e) Two of the above
A
e) Two of the above (Glass Steagall and Investment Advisers Act)
12
Q
What does the Securities Act of 1933 require from companies raising money from the public?
A
- Register with SeC
- Follow SEC regulations reissuing securities, providing information to investors
- Requires audit certification by independent accountant
13
Q
What did the Securities Exchange Act of 1934 create?
A
Created regulatory framework for trading of stocks and bonds of registered companies
14
Q
What did the Glass-Steagall Act of 1933 separate?
A
Separates investment banks from commercial banks to prevent bank failures (i.e. to prevent commercial banks from engaging in speculative practices)
15
Q
What did the Investment Advisers Act of 1940 create?
A
Created framework for registration and regulation of investment advisors
16
Q
Between 1970 and 1990, what movements arose?
A
- Environmentalism
- Consumerism (e.g. Ralph Nader)
- Socially responsible investing
- Anti-bribery
- Regulation concerning child labor, fair wages, fair trade, sweatshops
- Corporate stakeholders
17
Q
Name a scandal related to accounting fraud.
A
- Aurora Foods
- Sunbeam
- WM
- Adelphia
- Xerox
18
Q
What did AA do in 1954 that started to shift its organizational culture?
A
Expanded from providing accounting and audit services to providing consulting services (to the very same firms it was auditing)
19
Q
True or false.
By 1984, AA’s consulting services revenue was greater than audit service revenue.
A
True
20
Q
What was the prime motivation behind the decisions of AA’s audit partners on the Enron, WorldCom, WM, and Sunbeam audits?
A
- Revenue generation and client retention
- Partners more interested in serving their own interest than serving the public
21
Q
During the 1980s, how did the culture of integrity at AA change?
A
- Revenue generation became key to promotion
- Focus was on providing non-audit services to management
- Pressure to reduce audit costs increased
- Audit partners allowed to override rulings of quality control partners
22
Q
Did the AA partner in charge challenge Enron’s accounting policies?
A
No
23
Q
True or false.
AA was providing both audit and consulting services to Enron, and was deriving more revenue from providing management services.
A
True
24
Q
Why should an auditor make decisions in the public interest rather than in the interest of management or current shareholders?
A
Auditors responsibility is to the public
25
Why didn't the AA partners responsible for quality control stop the flawed decisions of the audit partners?
- Tried via memos
- But firm's governance structure had earlier determined that audit partner in charge could override quality control partner's decisions
26
In March of 2002, what did the SEC announce?
It was investigating AA for audit deficiencies w/r/t Enron audit
27
What did AA's lawyer seem to encourage the Enron audit team to do?
Shredding documents
28
Should all of AA have suffered for the actions or inactions of under 100 people?
- Seems unfair to many innocent partners and staff
- Society was not well-served by loss of one of the Big 5
- But disappearance of AA sent a clear message
29
Which of AA personnel should have been prosecuted?
- Larger fine and imprisonment for AA decision makers like audit partners
- Plus a very large fine and sanctions for continuing firm
30
How was Enron founded?
Founded by Ken Lay in 1985 as a result of merger of two natural gas pipeline companies
31
Although Enron's core business was selling gas, what did it move into?
Energy futures market
32
How did Enron record revenues from the energy futures market?
Recorded revenue in current period rather than period in which gas delivered ("prepays")
33
Were the special purpose enterprises established to invest in Enron's capital-intensive energy projects independent of Enron?
No
34
What was the impact of Enron's aggressive accounting methods?
Artificially inflated revenues while understating liabilities
35
What did an internal and external investigation of Enron reveal?
BOD failed to provide oversight and governance
- Permitted Enron executives to not record material off the book liabilities through use of SPEs
- Paid executive compensation to senior executives, often w/o proper approval
- Permitted executives to engage in high risk accounting transactions and inappropriate conflicts of interest
36
True or false.
Enron BODs failed to ensure the independence of Enron's auditor's, AA, and chose to ignore the complaints of various whistleblowers.
True
37
What was the aftermath of the Enron scandal?
- Tens of thousands of employees lost jobs
- Millions of investors lost millions of dollars
- Ten key employees indicted and sent to prison although Ken Lay died before sentencing
- AA convicted of obstruction of justice w/i the year
- Congress would enact SOX
38
Ken Lay was the Chair of the Board and the CEO for much of the time. How did this probably contribute to lack of proper governance?
- Not an effective overseer of his own CEO actions as a good independent Chair of the Board should
- Inherent conflict of interest
39
At Enron, why didn't more whistleblowers come forward, and why didn't some make a significant difference?
- Fear of retaliation
| - Poor tone at the top
40
At Enron, what should the internal auditors have done that might have assisted the directors?
- Should have been alert for flaws in Enron's conflict of interest policies
41
What conflict of interest situations can you identify in Enron's SPE activities? AA's activities? executive activities?
Personal gain
42
How would you characterize Enron's corporate culture? How did it contribute to the disaster?
- Unethical culture
- Poor tone at top
- Executives ignored their fiduciary duty to the shareholders and other stakeholders
43
What ethical paradigm did Ken Lay, Jeff Skilling, and Andy Fastow follow?
Ethical egoism
44
Who created WorldCom and oversaw its growth through takeovers and false financial reporting?
Bernie Ebbers
45
What went wrong at Sunbeam?
- Turnaround artist Al "Chainsaw" Dunlap increased net income by fraudulently recording $62 million of sales
- Company went into bankruptcy protection in 2001
46
What went wrong at Adelphia Corporation?
- Founded by John Rigas
- Filed for bankruptcy in 2002
- As a result of internal corruption by Rigas and his family
47
What went wrong at Aurora Foods?
- In 2001, company found guilty of underreporting expenses
| - By $43.7 million to met analyst expectations
48
What went wrong at Global Crossing?
- Declared bankruptcy in 2002 (4th largest business failure in American history)
- Market capitalization fell from billions to millions
49
What went wrong at Waste Management?
- March 2001, SEC filed charges against senior officers of company for fraudulently overstating pretax income by $3.5 billion from 1992 to 1996
- AA paid a $7 million fine as a result of this audit failure
50
What went wrong at Xerox?
- April 2002, company fined $10 million (largest fine SEC ever levied) for fraudulently recognizing over $3 billion of equipment revenue from 1997 to 2000
51
In response to the crisis of confidence as a result of all the scandals, what was passed to close the barn door?
SOX
52
Was the enactment of SOX necessary?
- YES (needed to address scandal, outrage, and outdated legislation)
- NO (market should be allowed to self-correct; fraud was illegal even before SOX)
53
What are the three most important improvements in the governance structure that could result from SOX?
1) Requiring directors on key committees (audit and nominating) to be independent and knowledgable
2) Establishing direct criminal liability on the part of the CEO and CFO for manipulations and/or failure to have appropriate control systems
3) Enhanced independence of external auditors
54
SOX covers what three main areas?
1) Responsibilities of management
2) Conflicts of interest
3) Responsibilities of auditors and the audit committee
55
SOX. What are the responsibilities of management?
1) Implement IC system to ensure company's financial reports are
- accurate
- complete
- understandable
- transparent
2) Quarterly and annual financial reports must include certification
- by CEO and CFO
- attesting to scope, adequacy and effectiveness of company's IC concerning financial reporting
56
SOX. What does SOX require disclosure of in regards to conflicts of interest?
1) Disclosure of:
- management stock trades
- any dealings that management has w/ major investors
2) Publicly traded comanies to have a code of ethics
57
SOX. What are the responsibilities of the auditors and the audit committee?
- Directors who sit on audit committee be independent of management
- Audit committee have at least one member who is financial expert, others must be financially literate
- Audit committee have sufficient budget of time and money to complete work
- Auditor report to audit committee w/o management being present.
- Auditor may not provide any management services, other than tax and IT, to its audit clients
58
After SOX, which of the following is not a prohibited non-audit service for external auditors?
a) appraisal or valuation services
b) bookkeeping and other services
c) legal services
d) tax services
e) internal audit outsourcing
d) tax services
59
SOX established what entity?
PCAOB
60
How many members is the PCAOB composed of?
5 (appointed by SEC)
61
What is the PCAOB responsible for?
- Charged with establishing auditing and attestation standards
- Responsible for inspecting and disciplining accounting firms
62
Are tax shelters in the public interest?
NO
63
What are tax practitioners hired to do?
Provide advice to clients on how to pay maximize tax savings
64
What did the tax practitioners at EY and KPMG do?
- Too aggressive in designing tax strategies
- Recommended that clients invest in tax shelters later judged to be illegal
- Both firms fined
65
In response to EY and KPMG's tax shelters, what did the IRS implement?
Circular 230
66
Expand on EY's tax shelters.
- 1990s, EY designed and marketed tax shelters that would delay paying taxes on stock options for up to thirty years
- Aggressively marketed shelters to wealthy clients
- IRS deemed shelters a sham and disallowed the tax deductions
- Executives reassessed and had to pay millions in taxes and fines
- EY reached a settlement with government and paid fine of $15 million
67
Expand on KPMG's tax shelters.
- From 1996 to 2003, KPMG designed, implemented, and aggressively marketed tax shelters targeted at wealthy taxpayers
- Abusive tax shelters generated at least $11 billion of artificial tax losses that cost US government $2.5 billion of evaded taxes
- Government rejected shelters on basis that they had no economic purpose other than to reduce taxes
- Taxpayers reassessed, tax deductions disallowed, and they had to pay taxes otherwise payable along with fines and penalties
68
True or false.
KPMG's tax shelters were considered so egregious that some wanted to see KPMG put out of business, but the government fined KPMG $456 million instead to prevent the Big 4 turning into the Big 3.
True
69
In the wake of the EY and KPMG tax debacles, the IRS issued Circular 230 in Sept. 2007. Explain Circular 230.
- Est. rules and suggested best practices for tax professionals
- Basic rules are: 1) know client 2) serve client's needs 3) explain and disclose fully 4) propose strategies likely to succeed
70
True or false.
Circular 230 requires that any proposed tax strategy must have a better than 50 percent chance of success if there is a possibility that it will be challenged by the IRS.
True
71
What went wrong at Tyco?
- Widely known case of pervasive fraud perpetrated by top management
- Top management treated Tyco as their private bank, taking out hundreds of millions of dollars of loans and compensation
72
Who was the CEO of Tyco?
Dennis Kozlowski
73
Who was the CFO of Tyco?
Mark Schwartz
74
Who was the General Counsel of Tyco?
Mark Belnick
75
What were weaknesses in Tyco's governance processes?
- In an environment of deceit
- Too much trust by directors
- Low ethical awareness
- Opens door for unscrupulous executives to commit and conceal fraud
76
What was ex-Tyco CEO Dennis Kozlowski convicted of?
- Taking excessive bonuses totaling $430 million
- Tax evasion
- Stealing more than $100 million from Tyco
77
Tyco. The patterns and improper conduct described took place for at least 5 years prior to 6/3/2002. What red flags or governance mechanisms should have alerted Tyco management accountants to the problem?
- Lavish parties ($2 million for a birthday party)
- Unreasonable loans to executives
- Excessive executive compensation
78
Tyco. What red flags or governance mechanisms should have alerted Tyco internal auditors to the problem?
- Expense report for apartment (should've detected unusual expenses like $6,000 shower curtain)
79
Tyco. What red flags or governance mechanisms should have alerted Tyco external auditors to the problem?
- Should have detected very high executive expenditures
| - OR uncollected loans through their audit procedures
80
Tyco. What red flags or governance mechanisms should have alerted Tyco BOD to the problem?
- Should have monitored more closely managements' compensation
- Should have avoided conflicts of interest
81
Id and discuss the most important weaknesses in Tyco's internal controls and governance systems.
- Control environment did not have integrity, proper tone at top, and proper ethical values
- Internal controls did not provide reasonable assurance that fraud will be prevented or detected
82
Would a post-SOX whistleblowing program to the Audit Committee of the Board have eliminated the improper and illegal actions?
- Unclear
- Whistleblowing is the most common way by which fraud is uncovered (must be effective, independent, confidential, anonymous, non-retaliatory)
- There is no substitute control for a solid ethical culture w/i an organization
83
If you had been a professional accountant employed by Tyco during this time, and you wanted to blow the whistle, who would you have gone to with your story?
- Unclear who to go to
| - Maybe to SEC
84
Why were so many Tyco employees willing to go along quietly with the looting by senior executives?
- Bad example by senior management
- Lack of effective whistleblowing program
- Fear of retaliation from bosses
85
Tyco. How many years did Kozlowski serve for his white-collar crimes?
8 years and now out on parole
86
What does the Adelphia case offer a lesson about?
Importance of an independent and objective BOD that effectively challenges management w/ the necessary technical skills and knowledge to understand the business and its financial reporting
87
What does the Adelphia case focus on?
Focuses on fiduciary duty of managers, directors, and auditors
88
What was the key issue in the Adelphia case where the Rigas family treated the corporation as its own piggy bank?
What are the differences b/w family-owned and publicly-owned businesses
89
Who founded Adelphia in 1952 in Coudersport, PA?
John Rigas
90
True or false.
Rigas family members held 4 seats on a 7 member board.
True
91
True or false.
The Rigas family used Adelphia as their own piggy bank for a golf club construction, property purchases, and stock deals.
True
92
True or false.
Withdrawals coupled with bad management and rapid expansion led to a deteriorating financial position. This in turn led the Rigas family members to commit fraud.
True
93
What breaches of fiduciary duty does the Adelphia case raise?
- Board (both family and independent directors) had fiduciary duty to S/Hs
- Auditors owed a duty to Adelphia's S/Hs and general public
94
Why do you think the Rigas family thought they could get away with using Adelphia as their own piggy bank?
- Weak control environment
| - Family members occupied key posts
95
What allowed the Rigas family to get away with their fraudulent behavior for so long?
- It was their business
| - Small town, family owned
96
What does the HealthSouth case point out?
How key weaknesses in the corporate governance structure may allow accounting fraud to pass without detection
97
The HealthSouth case highlights how difficult it is to make CEOs and Directors accountable for fraud and for the ultimate loss of S/H value. How so?
- In spite of the overwhelming evidence of his involvements in the fraud, CEO Richard Scrushy was acquitted
- While the former CFO's were subject to penalties b/w 15 and 30 years in jail and fines totaling $11.2 million
98
What accounting fraud did HealthSouth perpetrate?
- Used accruals and adjusting journal entries in accounting fraud
- Accounting manipulations happened right after preliminary end-of-period results were reviewed in management meetings during the "off books" adjusting period
99
HealthSouth. Was the CEO's defense ethical?
- NO
| - Donated money to various charities to sway jury
100
HealthSouth. Why did all the people who knew about the irregularities keep quiet?
Poor tone at the top
101
HealthSouth. How, in accounting terms, did the manipulation of HealthSouth's financial statements take place?
- CEO says "fix it"
- At family meetings, senior accounting personnel discussed what false accounting entries they could make w/o getting caught
102
HealthSouth. What risk factors should EY have caught?
- CFO turnover
- Always meet earnings
- CFO also Chairman
- CEO past history
- Fast growth
