Public Accountants Betraying Clients: Insider-Trading on Client Information

There are two basic types of conflicts of interest: personal and institutional. In any conflict of interest, two roles conflict in such a way that one role can compromise the other. The role compromised is the more legitimate of the two. In this essay, I distinguish the two types and situate the public accountants involved in insider trading in the personal rather than institutional type. I discuss two specific cases, both of which resulted in the auditors being prosecuted, in order to distinguish that outcome from the failure of society to come to grips with some of the most important ongoing institutional conflicts of interest.

The full essay is at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.

BuzzFeed’s Internal Firewall Falls to a Conflict of Interest

In spite of the fact that public-accounting firms rely on their respective audit clients’ decisions to be retained to perform the next year’s audit, society deems an unqualified audit-opinion to be independent. The assumption is that the audit firms can police themselves, keeping their financial pressures from influencing the audit opinions. The ongoing temptation is of course to produce a clean opinion so as to be retained as the client’s public accountants. Unfortunately, someone at a given CPA firm must have authority requiring attention both to audit opinions and the firm’s own financial performance; internal policies separating pressure from the latter from reaching the former can thus be easily overcome from the vantage point of that authority. This vulnerability was on display in 2015 in the “dot-com” industry in BuzzFeed.

The full essay is at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.

Leadership Funds: A Congressional Conflict of Interest

Congressional leadership funds constitute a loop-hole by which members of Congress can more easily use donations for personal expenses including vacations. To count on those very same members to turn off the sugar-water that they themselves enjoy is perhaps the epitome of naivety. A solution to a systemic conflict of interest cannot come out of the parties themselves, but must be from an exogenous or outside force. In this essay, I depict the conflict of interest and suggest places we might look to eliminate the conflict of interest.

The full essay is at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.

The Financial Crisis: A Systemic and Ethical Analysis

According to a study by the Dallas Federal Reserve, the financial crisis of 2007-2009 “was associated with a huge loss of economic output and financial wealth, psychological consequences and skill atrophy from extended unemployment, an increase in government intervention, and other significant costs.”[1] The study’s abstract goes on to “conservatively estimate that 40 to 90 percent of one year’s output ($6 trillion to $14 trillion, the equivalent of $50,000 to $120,000 for every U.S. household) was foregone due to the 2007-09 [sic] recession.”[2]

 

Interestingly, the Huffington Post “reports” the study’s finding in the following terms:  “a ‘conservative’ estimate of the damage is $14 trillion, or roughly one year’s U.S. gross domestic product. This is based on how much output was lost during the crisis and Great Recession, along with all the damage done to potential future economic growth.”[3] In fact, the article’s title claims that the crisis cost more than $14 trillion! Lest it be thought that the reporter and editor suffer from a learning or reading disability, the gilding here is notably in the direction of “selling more papers.”

 

Ironically, the Huffington Post also published an article pointing to the lack of accountability in that “the executives that [sic] were in charge of Bear’s headlong dive into the cesspool of subprime mortgage lending hold similar jobs at the most powerful banks on Wall Street: JPMorgan, Goldman Sachs, Bank of America and Deutsche Bank."[4]

 

The upshot is that those stakeholders who played a role in the crisis, most significantly the people running the government, the media, and the banks, have gone on, relatively unscathed, while the systemic risk remained or has actually become even greater.  As a first step toward recovery, a systemic map depicting the interrelated parts in the systemic failure and a related ethical analysis can provide a basis for reforms sufficient to thwart another major financial crisis.

 

 The systemic and ethical analysis

 

                                                         

1. Tyler Atkinson, David Luttrell, and Harvey Rosenblum, “How Bad Was It? The Costs and Consequences of the 2007-09 Financial Crisis,” Staff Paper No. 20, Federal Reserve Bank of Dallas, July 2013.

2. Ibid.
3. Mark Gongloff, “The Financial Crisis Cost More Than $14 Trillion: Dallas Fed Study,” The Huffington Post, July 30, 2013.

4. Lauren Kyger and Alison Fitzgerald, “Former Bear Stearns Executives Seemingly Unscathed by Financial Crisis They Helped Trigger,” The Huffington Post, July 31, 2013. The article was originally published by the Center for Public Integrity.

 

Reinsurance as a Shell Game: Another Bailout to Come?

In the stock market, investors can be quite fastidious in demanding a certain quarterly profit or internal rate of return. The increasing activism of institutional investors exacerbates this trend, as they have the wherewithal to investigate the companies in which they hold stock and the incentive given the number of shares they typically hold in a certain company. This pressure can tempt managements to “go outside the box” in developing novel ways to inflate revenue or hid expenses and risk. In theory at least, companies owned by their employees or customers do not have to contend with that sort of pressure, and thus can manage their books with more transparency and honesty. Has managerial capitalism become too reductionistic in relying so much on the corporate form of ownership? Have we as societies been opening ourselves up to too much financial risk as a result? Further, if shifting more regulatory authority from the state to the federal level in the US (and presumably in the EU as well), what would be the cost to the federal system? The answers for the U.S. and E.U. could differ, given where each union is in its development. The insurance industry in New York is a case in point.

The full essay is in Cases of Unethical Business, which is available at Amazon.

Bloomberg News "Speed" Journalists Exploiting Terminal Subscribers: On the Failure of Firewalls

In 2012, I was stunned to hear an official of Deloitte place all his faith in the internal firewalls that he had constructed in the CPA firm to inhibit the exploitation of the conflict of interest that exists between the auditing and consulting divisions. A year later, Matt Winkler of Bloomberg apologized because reporters in the news division had used clients’ proprietary information from the Bloomberg terminals to report financial news stories before other news organizations. The firewall between selling terminals and reporting news had not been sufficient to prevent exploitation of the conflict of interest. There is a lesson here for any multi-divisional company or bank that is relying on firewalls.


The full essay is at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.

 

Bad Directors at HP: Like Guests Who Overstay?

Lest it be thought that Congress ignoring the business lobby would result in laws capable of reforming corporate governance in the U.S. in the interest of stockholders, even putting the “objectionable” stuff back into legislation may not be sufficient. In this essay, I look at the proposed elimination of plurality voting in the original Dodd-Frank bill from the perspective of the case of HP. Put simply, the question is whether it would have made any difference had the proposal been retained in the bill.


The full essay is at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.

Fixing the Foreclosing Banks: A Hidden Conflict of Interest in Regulatory Compliance

After the financial crisis of 2008, regulators in the U.S. ordered banks to hire consultants to implement more than 130 “enforcement actions,” which represent 15% of the cases. In 2011 alone, regulators mandated that eleven banks hire consultants to determine whether mortgage borrowers had been wrongfully evicted. The consultants collected about $2 billion in fees, which amount to more than half of what homeowners were to receive under the $8.5 billion settlement that ended the consultants’ work. According to regulators, the consultants’ work was plagued with inefficiencies. This is probably the least of it, for virtually any expectations for “an industry that is paid billions of dollars by the same banks it is expected to police” are bound to be chimerical in nature.

The full essay is at Institutional Conflicts of Interest, available at Amazon.

SEC Goes After Chinese CPA Firms: Beyond Diplomacy

The Securities and Exchange Commission brought an administrative proceeding against the Chinese affiliates of five major CPA firms, including the “Big Four,” in 2012. Chinese companies had raised billions of dollars on American (and Canadian) exchanges only for the share prices of the companies to plummet due to questions about bookkeeping and disclosures. The SEC alleged that the CPA firms in China refused to hand over documents in connection with the investigation of alleged accounting frauds at nine Chinese companies. The SEC maintained that firms that audit U.S.-traded companies must follow U.S. law, and the Sarbanes-Oxley Act requires foreign audit firms to hand over documents about U.S.-listed clients at the SEC’s request. SEC Commissioner Luis Aguilar said that the investigations “have been hampered by the lack of access to relevant documents.” For their part, the CPA firms in China (affiliates of American-based CPA firms) pointed out that their audit papers are treated like state secrets in mercantilist China, and that the auditors could therefore be imprisoned for handing the material over a foreign government without permission from the Chinese state. 

The full essay is in Cases of Unethical Business, available at Amazon.com.  

Facebook’s IPO: Morgan Stanley’s Conflict of Interest

Morgan Stanley’s underwriting of Facebook’s IPO has been thought by some of the bank’s rivals to be incompetently managed.  According to the New York Times, “(r)ival bankers and big investors have complained that Morgan Stanley botched the I.P.O., setting the price too high and selling too many shares to the public.”[1] Interestingly, the incompetence is positively correlated with unethical policy decisions at the bank. Even as the bankers as underwriters were eager to sell lots of shares, they may have given some of their institutional customers—albeit only the most preferred, as per the bank’s other services—some privileged information. If this charge is true, the conflict of interest at the bank should be closely examined by Congress and any relevant regulators.

The full essay is at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.

1. Evelyn Rusli and Michael De La Merced, “Facebook I.P.O. Raises Regulatory Concerns,” The New York Times, May 22, 2012.

Conflicts of Interest and Paradigm-Shifts: The Case of Financial Regulation

It is perhaps all too easy to perceive a sea-change in perception when the reality of societal change is much more gradual. There is something to the argument that John D. Rockefeller’s reputation was salvaged in the 1930s not because the old man was passing out dimes, but, rather, simply because he had outlived his critics. Similarly, Thomas Kuhn, in his text on paradigm changes in scientific revolutions, bemoans that the advocates of a default theory must finally die off before their darling can finally be replaced by a new one. In other words, any given person is not apt to shift paradigms. The culprit, I suspect, is pride, which Augustine suggests in his writings is inherently self-idolatrous. I believe the human brain is capable of accepting inter-paradigmatic change, just as a person can be humble. That this is not the norm does not mean that we ought not raise our expectations to it.

The full essay is at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.

Deloitte: A Culture of Least Resistance

On October 17, 2011, the Public Company Accounting Oversight Board issued a statement saying audits should protect investors. “The board therefore takes very seriously the importance of firms making sufficient progress on quality control issues identified in an inspection report in the 12 months following the report,” the statement said. Not having seen such progress at Deloitte, the board made its 2008 report on the firm public. The report “cited problems in 27 of the 61 Deloitte audits it reviewed, including three where the issuing company was forced to restate its financial statements.” This was “an unprecedented rebuke to a major accounting firm. In too many instances,” the report stated, inspectors from the board “observed that the engagements team’s support for significant areas of the audit consisted of management’s views or the results of inquiries of management.” In some cases, “Deloitte auditors did not bother to even consider whether accounting decisions made by companies were consistent with accounting rules. Instead, auditors accepted management assertions that the accounting was proper, the board’s report said.”[1] As a very young auditor at that firm, I was told to do just that.  

The full essay is at "Deloitte: A Culture of Least Resistance" in Institutional Conflicts of Interest, which is available at Amazon.

1. I took the quotes for this paragraph from: Floyd Norris, “Accounting Board Criticizes Deloitte’s AuditingSystem,” The New York Times, October 17, 2011;  and Floyd Norris, “Audit Flaws Revealed, AtLong Last,” The New York Times, October 21, 2011

Limited Tenure For CPA Firms?

Arthur Levitt, who headed the Securities and Exchange Commission from 1993 to 2001, “sought to root out conflicts of interest at audit firms in 2000, and urged Congress to adopt auditor term limits in 2002 after the Enron and WorldCom scandals.”[1]  Levitt did not buy the argument made by companies that it would cost them a lot of money to change audit firms. To be sure, he acknowledged that some added cost would be entailed in a system of mandatory auditor “term limits,” but a long auditor relationship “raises the perception,” he maintained, “that the auditor is very much beholden to the company and not totally independent. An environment of skepticism should trump the fraternal environment that tends to occur after a relationship has developed over a period of years.”[2] Indeed, Arthur Andersen’s people were well ensconced at Enron by the time the energy giant went bust. In fact, the auditors even approved the questionable “partnership” accounting (used to hide debt).  Nor did the auditors communicate any misgivings to the audit committee of the company’s board of directors. The auditors were “in” with a rancid management. 


The full essay has been incorporated into "A Proposal: Limited Tenures for CPA Firms"  at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.  

1. Emily Chasan, “Keeping Auditors on Their Toes,” The Wall Street Journal, October 19, 2011.

2. Ibid.

Tax Avoidance at GE: On Corporate Income Taxation

In spite of $14.2 billion in global operating profit ($5.1 billion on U.S. operations) in 2010, GE paid no corporate income tax to the U.S. Treasury that year thanks to offsetting prior losses by GE Capital (i.e., bad loans).  In spite of that unit having received TARP funds from U.S. taxpayers, the corporation was able to avoid paying any income tax. This seems like Rousseau's social contract run amuck: corporate welfere in exchange for nada.  Such a modus operendi is in line with the corporate mission: to economize in the sense of maximizing (or satisficing) what is taken in while minimizing what must go out.  In other words, a corporation aims to turn itself from a productive, lean throughput to a concentration of capital in its own right.

The full essay is at "Tax Avoidance at GE."

Rating Moody’s and S & P: A Structural Conflict of Interest

For years, banks and other issuers have paid rating agencies to rate their securities. This is a bit like restaurants paying food critics to write on their food.  In the wake of the SEC’s charge that  people at Goldman Sachs built the Abacus investment to fall apart so a hedge fund manager, John A. Paulson, could bet against it, the Senate’s Permanent Subcommittee on Investigations questioned representatives from Moody’s and Standard & Poor’s about how they rate risky securities. Carl M. Levin, the Michigan Democrat who heads the Senate panel, said in a statement: “A conveyor belt of high-risk securities, backed by toxic mortgages, got AAA ratings that turned out not to be worth the paper they were printed on.” Throughout the testimony, the institutional conflict of interest was salient whereby credit-rating agencies put market-share considerations foremost in rating securities presented by the banks that are paying the agencies.

The full essay is at Institutional Conflicts of Interest, available at Amazon. 

Fraud as Fair: Lehman as Beneficiary of Society's Pro-Business Cultural Values

In April, 2010, Richard Fuld, the former CEO of Lehman Brothers, told a congressional committee that he had "absolutely no recollection whatsoever of hearing anything" about Repo 105 at the time of the transactions. Lehman's demise, he claimed, was caused by "uncontrollable market forces" and the U.S. government's unwillingness to rescue the firm. Of course, Henry Paulson, the U.S. Treasury Secretary in 2008, had tried in vain to get Fuld to accept a buyer offering a reasonable price; Fuld had been holding out for more in spite of the financial condition of Lehman. It is stunning that a man who had been allowed to reach such a pristine and lofty office in the business world would not even permit himself to acknowledge any contributory role in the downfall of the organization he had run. Such an attitude alone seems worthy of a prison sentence (and the return of his salary and bonuses); how he and his "team" had manipulated the books to make the bank look wealthier than it was would seem to make such a sentence inevitable.

The full essay is at "Essays on the Financial Crisis."

Lehman Bros: Insufficient Accountability in Corporate Governance

In an executive meeting at Lehman in the summer of 2008, Skip McGee told Richard Fuld and the other top executives that the market was demanding “that we hold ourselves accountable.”  Essentially, he was pushing for Gregory’s outster.  What strikes me is what he didn’t say–namely, something like, “the stockholders are holding us accountable!”[1]  Had he said this, Fuld might have laughed. Of course, Richard Fuld was a major stockholder, so he might have viewed it as “holding myself accountable to myself.”  Given the inherent ethical conflict of interest in such a statement, I don’t think we can rely on corporate governance as a check on excessive managerial risk-taking when executives hold a substantial share of the stock.  Therefore, in including stock options in executive compensation to align executives' incentives with medium and long-term firm performance, boards should add institutional safeguards or accountability mechanisms to corporate governance. In business-speak, there is a cost incurred that boards may not be aware of in aligning executive compensation (and firm ownership) with future profitability.

The full essay is in Essays on the Financial Crisis.

1. Grace Wong and Aaron Smith, "What Killed Lehman," CNN.com, March 15, 2010. 

Institutional Conflicts of Interest

Although conflicts of interest do not inevitably lead to unethical conduct, they raise the probability that it will occur. Just as a tornado watch indicates that conditions are favorable to the formation of a twister, a conflict of interest evinces conditions favorable to unethical decisions. Interests conflicting in a conflict of interest pit an obligation against either another obligation or self-interest. That is to say, such conflicts tend to involve deontology and egoism.


The full essay is at Institutional Conflicts of Interest, available at Amazon.