Module-2: Ethics in Functional areas of Business-Financial Management (Part-2)

 

Why unethical behavior is occurring? Violations are driven by the potential personal gain of the investment professional.

•       Everybody else is doing it

•       Its not that big of a deal

•       Its necessary (the end justifies the means)

•       Its not going to hurt anyone

•       Its legal

•       I deserve this

•       It’s for the benefit of company or somebody else

•       Nobody will know.

Threats also cause unethical behavior

•       Self-interest Threats

•       The threat that a financial or other interest will inappropriately influence the professional accountant’s judgment or behavior

•       Self-review Threats

•       The threat that a professional accountant will not appropriately evaluate the results of a previous judgment made or service performed by the professional accountant, or by another individual within the professional accountant’s firm or employing organization, on which the accountant will rely when forming a judgment as part of providing a current service

•       Advocacy Threats

•       The threat that a professional accountant will promote a client’s or employer’s position to the point that the professional accountant’s objectivity is compromised

•       Familiarity Threats

•       Familiarity threat occurs when, by virtue of a close relationship with a client, its directors, officers or employees, an auditor becomes too sympathetic to the client’s interests.

•       Intimidation Threats

•       The threat that a professional accountant will be deterred from acting objectively because of actual or perceived pressures, including attempts to exercise undue influence over the professional accountant

Harms of Unethical Environment include among others:

•       Loss of Repute

•       Loss of Company in monetary terms.

•       Loss of Country

•       Restrictions in International Markets

•       Pressure on Organizational Stakeholders

Following are some of the major unethical practices :

A.    Window Dressing

 

In finance, window dressing refers to the efforts taken to make the financial statements  of a business look better before they are publicly released.

Every business wants their financial information to look as appealing as possible. It is what attracts new business opportunities, investors , and even consumers.Window dressing comes with at least a slightly negative connotation. This is because it can – and sometimes does – involve making unethical or even illegal changes to numbers, charts, timelines, orders, etc., in order to make the financial picture of a company look the most appealing to outsiders.

Historical events

1.      Enron Corporation, USA

•       The Enron Corporation was a huge energy company that went bankrupt in 2001. It employed 22,000 people and had innumerable shareholders. It collapsed due to an accounting scandal, or "cooking the books," perpetuated by its own auditing firm, Arthur Andersen, one of the premier accounting firms in the U.S. at that time, which also collapsed.

•       Tens of thousands of employees were left without a job and more shareholders were left with a retirement portfolio full of worthless Enron stock.

2.                Satyam Computers, India

 

•      The Satyam scandal was a Rs 7,000-crore corporate scandal in which chairman Ramalinga Raju confessed that the company’s accounts had been falsified.

•      On January 7, 2009, Ramalinga Raju sent off an email to SEBI and stock exchanges, wherein he admitted and confessed to inflating the cash and bank balances of the company.

•      Weeks before the scam began to unravel with his famous statement that he was riding a tiger and did not know how to get off without being eaten. Raju had said in an interview that Satyam, the then fourth-largest IT company, had a cash balance of Rs 4,000 crore and could leverage it further to raise another Rs 15,000-20,000 crore.

•      Raju also manipulated the books by non-inclusion of certain receipts and payments, resulting in an overall misstatement to the tune of Rs 12,318 crore, shows an analysis of findings of Sebi’s probe.

•      As many as 7,561 fake bills which were even detected in the company’s internal audit reports and were furnished by one single executive.

•      Merely through these fake invoices, the company’s revenue got over-stated by Rs 4,783 crore over a period of 5-6 years. The probe itself continued for almost six years and found that fictitious invoices were created to show fake debtors on the Satyam books to the tune of up to Rs 500 crore.

•      After the fraud came to the light, the government had ordered an auction for sale of the company in the interest of investors and over 50,000 employees of Satyam Computers.

•      Acquired by Tech Mahidra, and was then renamed as Mahindra Satyam, and was eventually merged into the parent company. The Satyam saga eventually turned out to be a case of financial misstatements to the tune of approximately Rs 12,320 crore, as per Sebi’s probe then. Citibank froze all its 30 accounts in 2009.

 

B.     Misleading Financial Analysis


C.     Insider Trading

Illegal insider trading refers generally to buying or selling asecurity, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include “tipping” such information, securities trading by the person “tipped,” and securities trading by those who misappropriate such information

Insider trading is prohibited for listed companies and there are penalties (sections 12A and 15G, SEBI Act 1992).

The SEBI (Prohibition of Insider Trading) Regulations 2015, applicable to listed companies, define insider trading as dealing in any securities of a company by an insider who is either a connected person, or is a person in possession of or having access to unpublished price-sensitive information. It also sets out various disclosure requirements for directors possessing shares of the company on which they serve on the board, including certain restrictions on trading shares during specific periods (trading windows) to prevent leakage of any unpublished price sensitive information.

Rajat Kumar Gupta & Insider Trading

•       Rajat Kumar Gupta is an Indian-American businessman who, as CEO, was the first foreign-born managing director of management consultancy firm McKinsey & Company from 1994 to 2003.

•       A hedge fund named Voyager was started to raise money for healthcare in India in association with Raj Rajaratnam and others. Egged on by his financial advisers, whenever Gupta tried to ask Raj about the status of his investment and the state of the Voyager fund, the Galleon CEO and founder evaded him keeping the calls short and sketchy.

•       A retired managing director of McKinsey, Gupta sat on the boards of Goldman Sachs and Procter and Gamble. The board meetings sometimes dealt with inside information, such as a planned investment by Warren Buffet’s Berkshire Hathaway, a sign of confidence in Goldman Sachs, amid the 2008 financial crisis. Gupta called Galleon International founder Raj Rajaratnam. seconds after the meeting and confirmed the latter’s enquiry about the Berkshire investment, without giving it much thought.

•       This 15-second conversation would prove to be Gupta’s Waterloo. US Attorney Preet Bharara’s team pinned a buy and sell of Goldman shares by Galleon, timed to cash in on the price change after the Berkshire announcement, on this phone call. 

In 2012, he was convicted for insider trading and spent two years in jail.

Franklin Templeton Mutual Fund & Insider Trading

 

D.    Churning

 

•       Excessive or inappropriate trading for clients account by a broker who has a control over the account with intent to generate commissions rather than to benefit client

•       Credit card Churning

•       It’s just a term for what many of us do on a regular basis. Does exploiting all the introductory offers on your new Credit Card and then closing it without paying the annual fee sound familiar? Well, that’s what Credit Card churning means.

•       Credit Score deteriorate

•       Insurance companies and their agents will no longer be able to churn insurance policies, i.e., replace existing life policies with new ones, unless it is in the interest of the customers. This, too, they can do only after explaining all the benefits and consequences of the move. Add to that, insurers will also need to advise their customers against replacing their policy in the contract agreement itself.

•       These and more are some of the measures included in the draft guidelines outlined by the Insurance Regulatory and Development Authority (IRDA) on 18 June 2014

 

 

 

 

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