11.2 Doing Well by Doing Good

Corporate Scandals and Sarbanes-Oxley Act

Celebrity scandals often create “buzz” and actually make celebrities richer. But scandals in the business world often lead to the forfeiture of millions of dollars as well as prison sentences. We illustrate some notable corporate scandals below.

In the 1990s and early 2000s, several corporate scandals were revealed in the United States that showed a lack of board vigilance. Perhaps the most famous involves Enron, whose executive antics were documented in the film The Smartest Guys in the Room. Enron used accounting loopholes to hide billions of dollars in failed deals. When their scandal was discovered, top management cashed out millions in stock options while preventing lower-level employees from selling their stock. The collective acts of Enron led many employees to lose all their retirement holdings and their jobs, stockholders lost $74 billion, and many Enron execs were sentenced to prison. This scandal also caused the dissolution of Enron’s outside accounting firm, Arthur Anderson, one of the five largest accounting firms in the world at the time.

Around the same time as Enron, other corporate scandals created colossal damage. WorldCom, a telecommunications firm, inflated its assets. When discovered, shareholders lost $180 billion and 30,000 employees lost their jobs. Another famous one is Tyco, where the CEO and CFO stole $150 million and inflated the company revenues by $500 million. Before being discovered, the CEO threw a birthday party for his wife on a Mediterranean island that cost $2 million, paid with company funds. The CEO and CFO both went to prison.

In response to notable corporate scandals at Enron, WorldCom, Tyco, and other firms, Congress passed sweeping new legislation with the hopes of restoring investor confidence while preventing future scandals (Table 11.1). Signed into law by President George W. Bush in 2002, the Sarbanes-Oxley Act contained 11 aspects that represented some of the most far-reaching reforms since the presidency of Franklin Roosevelt. These reforms create improved standards that affect all publicly traded firms in the United States. The key elements of each aspect of the act are summarized as follows:

1. Because accounting firms were implicated in corporate scandals, an oversight board was created to oversee auditing activities.
2. Standards now exist to ensure auditors are truly independent and not subject to conflicts of interest in regard to the companies they represent.
3. Enron executives claimed that they had no idea what was going on in their company, but the Sarbanes-Oxley Act requires senior executives to take personal responsibility for the accuracy of financial statements.
4. Enhanced reporting is now required to create more transparency in regard to a firm’s financial condition.
5. Securities analysts must disclose potential conflicts of interest.
6. To prevent CEOs from claiming tax fraud is present at their firms, CEOs must personally sign the firm’s tax return.
7. The Securities and Exchange Commission (SEC) now has expanded authority to censor or bar securities analysts from acting as brokers, advisers, or dealers.
8. Reports from the comptroller general are required to monitor any consolidations among public accounting firms, the role of credit agencies in securities market operations, securities violations, and enforcement actions.
9. Criminal penalties now exist for altering or destroying financial records.
10. Significant criminal penalties now exist for white-collar crimes.
11. The SEC can freeze unusually large transactions if fraud is suspected.

The changes that encouraged the creation of the Sarbanes-Oxley Act were so sweeping that comedian Jon Stewart quipped, “Did Wall Street have any rules before this? Can you just shoot a guy for looking at you wrong?” Despite the considerable merits of the Sarbanes-Oxley Act, no legislation can provide a cure-all for corporate scandal (Table 11.2). As evidence, the scandal by Bernard Madoff that broke in 2008 represented the largest investor fraud ever committed by an individual. But in contrast to some previous scandals that resulted in relatively minor punishments for their perpetrators, Madoff was sentenced to 150 years in prison.

Did the Sarbanes-Oxley Act help reduce corporate scandals? Maybe, but unfortunately they have continued. Some more notable ones are HealthSouth (2003), Freddie Mac (2004), American Insurance Group AIG (2005), Lehman Brothers (2008), Bernie Madoff (2008). Accounting and financial misdeeds are not the only type or corporate scandals that still plague the corporate environment. Sadly, more recent scandals involved Volkswagen (emissions fraud), Uber (sexual harassment), Apple (deliberately slowing devices), Facebook (data harvesting without consent), Boeing (skirting FAA rules), and various pharmaceutical companies that unethically pushed sales of opiate medications, increasing the opioid epidemic. As noted, not all corporate scandals are financial in nature, but typically are driven by greed and provide a financial benefit for individuals or companies.

In the early 2000s, highly publicized fraud at Enron, WorldCom, Tyco, and other firms revealed significant issues including conflicts of interest by auditors and securities analysts, boardroom failures, and inadequate funding of the Securities and Exchange Commission. In response, Senator Paul Sarbanes and Representative Michael Oxley sponsored legislation that contained what former President George. W. Bush called “the most far-reaching reforms of American business practices since the time of Franklin D. Roosevelt.” We outline the 11 key aspects of the law below.

Ethics and CSR as Corporate Strategy

One positive outcome of the corporate scandals has been an increased focus by firms on corporate ethics. Many companies now have an Ethics and Compliance Officer and a detailed Ethics and Compliance Code. For example, Walmart’s Global Ethics and Compliance Program is provided online for the public and has numerous pages (Walmart, n.d.). Many firms provide annual training to all its employees on their company’s ethics and compliance standards.

Here is the Table of Contents for Facebook’s Code of Conduct. Although this is a typical approach to a Code of Conduct, it doesn’t mean a company is necessarily perceived as ethical. This is particularly true lately as Facebook contends with pressure to change its commitments to “free speech” with accusations of promoting hate speech.

Another form of regulation designed to prevent corporate misbehavior are “whistleblower” laws and policies. Many firms intentionally encourage employees to report any suspected misconduct by the firm, its managers, or employees. A “whistleblower” hotline is often provided where suspected violations can be reported anonymously. Anti-retaliation policies encourage employees to come forward to report misconduct without fear of retaliation or losing their job. Although all these measures are helpful, unfortunately, fraud and misconduct still occur.

In response to persistent “rule-breaking” by corporate actors, Corporate Social Responsibility (CSR) emerged in the 1970s to assert that a “social contract” exists between business and society. At its base is the assumption that businesses thrive when the society it relies on thrives, and therefore, firms have a duty to provide more than profit back to its environment. It is a business model that attempts to “give back” to the members of the community or society that help the firm succeed through the purchasing of its products or services. The goal of CSR is to enhance the success of a business by enhancing the society in which the organization operates. It can take the form of philanthropy or donating funds to causes it believes are important to its stakeholders. Some forms of CSR include corporate volunteerism, such as asking company employees to volunteer to build a Habitat for Humanity house on a Saturday. Improving environmental sustainability is one of the most recognized recent forms of CSR.

Many firms adopt the Triple Bottom Line approach to guide their CSR philosophy. In the triple bottom line, the company focuses on the three P’s; profit, planet, and people. CSR is discussed in more detail later in this chapter.