Ethics*
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definition - the rules of conduct recognized in
respect to a particular class of human actions or
a particular group, culture, etc.: professional ethics
All virtue is summed up in dealing justly.
Aristotle
Greek critic, philosopher, physicist, & zoologist (384 BC - 322 BC)
*1602, "the science of morals," pl. of M.E. ethik
"study of morals" (1387), from O.Fr. ethique, from L.L. ethica,
from Gk. ethike philosophia "moral philosophy,"
fem. of ethikos "ethical," from ethos "moral character,"
related to ethos "custom" .
The word also traces to Ta Ethika, title of Aristotle's work.
Ethic "a person's moral principles," attested from 1651.
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Since the scandals of the early 2000’s, Ethics
has become an important part of investment
Scandals to be mentioned
a) Enron
b) Tyco
c) Barings Bank
d) Bre-X
e) Harvard Capital
f)
g)
BCCI
Pfizer
Vocabulary
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Front-running
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Commingled funds
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Arm’s Length
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Insider trading
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Regulatory Avoidance
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Full Disclosure
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Misrepresentation
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Fiduciary Responsibilities
Front running – trading stocks at a more favourable price
before others without access the market can trade.
The practice is now considered illegal.
e.g. was frequent practice of some brokerage firms –
would buy or sell their own shares before
customers.
Commingled Funds – Frequently used in the financial
industry, the clients funds are not handled a
separate portfolio, but are mixed together with
funds belonging to the investment firm.
e.g. Barings Bank – Nick Leeson was trying to
cover losses by hiding them in a
commingled fund
Arm’s Length – The requirement that certain types
of service and verification should not be in
any way attached or interested in the other
party.
e.g. - Barings Bank – The wife of Nick Leeson was the
head of the accounting department that was
verifying his results
Insider Trading – The practice of using information about
a company which is not public and has been obtained
as part of a privileged position within the company to
make a gain or avoid a loss.
e.g. Enron – Executives at Enron, knowing the company
was in trouble, sold some of their shares, but
insisted that the employees pension fund keep
their shares without informing them of the
difficulties of the company.
Regulatory Avoidance – regulations are generally
a way of confronting and dealing with a
particular problem. Many people in the
market think that regulations are just no
good, and try to find ways around them.
e.g. There are examples of this Barings, Enron, and
Tyco. In Barings, for example, dealing in highrisk derivatives using commingled funds was
prohibited in London. That is why Nick Leeson
was in Singapore
Full Disclosure – A company has an obligation to fully
inform all stakeholders of situations which may
significantly affect the financial situation of
reputation of the company.
e.g. There are examples of this in almost every case.
Enron, for example did not disclose hidden
debt through guarantees to smaller entities.
Misrepresentation – This is simply the act of making a false
statement or claim to deliberately mislead a party
who has interest in the company.
e.g. Bre-X claimed to have gold assays well beyond the
imaginable. These later turned out to be false.
Enron
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Roots go back to 1931; founded in 1985 by Ken Lay
Was an energy company which classified itself as a utility
Became heavily involved in energy futures
• Wife of a Senator Phil Gramm had Energy futures
de-regulated (1992) and joined Enron board
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Senator Gramm waited for Republicans to win in 2000, and got
bill passed to allow free energy trades without disclosure
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Enron was later discovered to be behind many of the
“brown-outs that plagued California in 2001
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Energy futures required purchase & sale of energy
When sales didn’t take place, they were sold to off-shore
(and off-balance sheet) subsidiaries to hide losses and
fake profits on advice from accounting consultants.
Enron
Enron cont’d
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Enron’s HR policy was to classify 15% of employees
incompetent every year, and fire them
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Between 1998 and 2001, Ken lay sold 4M Enron shares
($184M) – some just before the company declared
bankruptcy
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Lay, Jeff Skilling, and Andy Fastow were all found
guilty of fraud and sentenced to jail
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Lay died of a stroke in 2006, still professing innocence
The Enron case lost all the employees their pension fund
Auditors, Arthur Andersen were also found guilty, and the
largest accounting firm in the world went bankrupt
Andersen’s Houston office made $25M in auditing fees
and $25M in consulting fees per year from Enron.
Remainder of Enron broken into smaller entities
Issues with Enron
1. Accounting and consulting being done by the same
firm is questionable
From paper written in 1999:
“Major accounting firms all have consultation services,
which frequently offer their services after an audit. The
May issue of the Journal of Accountancy refers to a body
called the Independence Standards Board, which
examines issues related to the independence of these
auditors, particularly in the face of growing SEC concerns.
Its first standard was to require an annual declaration of
independence from each auditor. Concerns arise involving
family relationships, clients hiring staff away from the
audit firm, as well as the use of ancillary services by
affiliated consultancies. This last point is critical, because
the auditor will sometimes be reviewing work done by a
subsidiary on behalf of the stakeholders.”
Issues with Enron
2. Accounting standards did not require full disclosure
3. Highly leveraged part of energy sector was unregulated
4. Status of pension plans investing solely in employer
5. Sarbanes-Oxley legislation (2002) would require
full disclosure – passed because of Enron
6. Question of relationship with political figures
e.g. Enron was a major contributor to G.W. Bush
7. Misrepresentation of status as utility
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Founded in 1960
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In 1999, rumors emerge about “accounting troubles”
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Acquisitions were booked “creatively” to show a profit
In 1992, Dennis Kozlowski became CEO. He
became known as “Deal-a-day” Dennis.
• By some accounts, between 1991 and 2001,
Tyco buys more than 1000 companies.
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Kozlowski was put on trial in 2004 for insider trading
and inappropriate use of company funds.
Kozlowski was forced in 2006 to return $600 million
in company funds, and was sentenced to no less than
8 and no more than 25 years in prison
Tyco continues today, and in spite of the problems
had no serious cash-flow problems.
Tyco filed to be broken into three companies on
Jan 25, 2007
Issues
1. Insider trading
2. Creative accounting: from the same 1999 paper:
“The bizarre case of industrial giant Tyco is one of the most curious
in recent years. Again, a merger appears to be at the centre of
this controversy. The acquisitions of U.S. Surgical and AMP Inc.
were questioned for their value, with certain individuals claiming
that the accounting practices of Tyco covered up a major loss on
the acquisitions, thereby overstating the value of the
shareholder’s equity. When this information was “leaked” to one
Floyd Norris of the New York Times, he felt free to quote his
source – a hedge fund trader who had “gone short” on Tyco in
the belief that there were accounting irregularities. Naturally, the
stock plunged in spite of efforts by analysts to show that there
was no sign of irregularity. Tyco has not come back to its
previous level as at the writing of this paragraph. Meanwhile,
where is the SEC when you want them?”
Barings Bank
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Barings was founded in 1762 - oldest merchant bank
in England
Helped finance the Louisiana purchase (1802)
Trades in futures in the name of the bank were forbidden
in London – operations sent to Singapore
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Unsupervised trader named Nick Leeson bet long on the
Yen in 1995. Whoops!!! (Kobe earthquake)
• Uses commingled funds to hide loss, tries to recuperate
loss – but loses more
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Wife was in charge of accounting
Lost 1.4 billion in futures - entire bank went under on
Feb. 26, 1995. Leeson flees, is caught and gets 6.5 years
in prison.
Barings Bank
Issues
1. Lack of Supervision
2. Regulatory avoidance
3. Abuse of Commingled Funds
4. Nepotism – wife doing the accounting
Bre-X
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Founded 1989 by David Walsh
Bought property in Indonesia said to have large
gold reserves – up to 8% of total in the world
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Stocks shot up in price from several pennies to $30.00
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Toronto Stock Exchange raced to put in on the TSE 300
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Found major vein in Indonesian property went from
potential 30 m. oz (1995) to 300m oz. (1997).
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Mar 19, 1997, geologist Michael de Guzman “falls”
from a helicopter (shares now worth $280)
• Mar 26, core samples turn out to be fake
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Billions lost – mostly pension funds. Walsh died 1998,
Guzman’s wives claim to have received money as recently
as 2005
Because the two main parties were dead, no charges
Bre-X
Issues
1. Misrepresentation
2. Regulatory Avoidance – Core samples not presented
as per assay regulations
3. Insider Trading – principals traded stocks when
they knew they were about to be found out
Harvard Capital and Consulting
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Started by Viktor Kožený during first voucher offering
• Vouchers were issued to bid for shares of state-owned
firms being privatized
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Kožený has $15,000, but offers 10,000 CZK to anyone
for their vouchers (1,000% return)
• Kožený announces a General meeting in a small newspaper
three days from the date , and requires notarized shares to
participate
• Few show up
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Calls an Emergency meeting to approve a merger with
Harvard Holdings, a Cypriot company
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Management has quorum, and assets “disappear” into
Harvard Holdings
• Kožený disappears – wanted on warrant in Czech
Republic and US
• Also suspected of trying the same scheme in Azerbaijan
in 1994
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Put on trial in June, 2010, found guilty – conviction &
sentence (10 years & 10 B CZK) upheld 17/10/2012
Harvard Capital and Consulting
1. No regulatory framework
2. No set accounting procedure
3. Custodial practices
4. Misrepresentation
5. Fiduciary responsibilities neglected
P.S. - Last word is that VK is in a prison in the Bahamas,
Where he was arrested in 2005, released 19 months later,
and will not be extradited to the US following a Privy Council
decision March 2012 in claiming no jurisdiction.
Bank of Credit and Commerce
International (BCCI)
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Founded in 1972 in Pakistan by Agha Hasan Abedi
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Funded by Sheikh Zayed al Nayhan in Abu Dhabi (77%)
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Funding also provided by Bank of America and
(rumoured) CIA
• Was presented as an “Islamic Bank”
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Bought American banks to get into US market
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Operated from London, with headquarters in Abu Dhabi
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Made most money from “fees”
e.g. transferring money to accounts in Switzerland
• Also funded Bin Laden, Mujahadeen,
CIA operations, Irangate
• Was exposed during an inquiry by Sen Kerry looking into
money laundering for drugs lords in Colombia
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Lent $25m to Harken Energy in 1988 (Dir GW Bush)
Bank of Credit and Commerce International
(BCCI) - Issues
1. Set up a complex series of subsidiaries and controlled
entities to avoid detection – see Enron
2.
Hid behind the the idea that it was religiously-based
3. Used big names (Sheikh Zayed, Clark Clifford, Bert Lance)
to enhance image of legitimacy
4.
Was used by competing parties (CIA, Noriega, Iranians)
5. Commingling of funds – Sheikh Zayed’s Private Department
and BCCI
Pfizer
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World’s largest pharmaceutical firm
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Involved in gigantic mergers Warner-Lambert (2000),
Pharmacia (2003), Wyeth (2009)
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First case of price-fixing – 1958
• 1961 - Justice Department files criminal antitrust charges
against Pfizer, 2 other cos. and top executives – Guilty 1967
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1957 – denounced for using fictitious doctors to shill produc
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1991 – misleading claims - Plax
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1996 – misleading & unauthorized claims - Zoloft
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2000 – false & misleading advertising – Celebrex & Lipitor
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2003 –pays $6m to settle Zithromax scandal
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2004 – pays 430 million for bribing physician in Neurotin
scandal, ordered to pay a further 142m in 2010
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2007 – Illegal marketing growth hormone Genotropin $34.7 m
2009 – pays 2.3 billion to settle criminal & civil charges in
Bextra case
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2011 - settles 14.5 million in Detrol case
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2012 – removes claims in ads regarding breast & colon cancer
to settle claim
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2012 – (Nov) takes $491 m charge for Rapamune
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1971 – today - has settled at least 9 environmental violations
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1999 – guilty in criminal anti-trust charges - $20m
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2002 – Forced to pay $49m for gouging on Lipitor
• 2003 –Pfizeer tries too block supplies from Canada where
• cheaper drugs are available
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Criminal activity has increased over years with growth
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Pfizer has paid massive fines
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Pfizer has also signed three Corporate Integrity Agreements
with the US government which it does not respect
As a corporate lobbyist, Pfizer is the 6th largest on Capitol hill
Pharmaceutical and Health Care are the largest lobbying
group on Capitol Hill
The company is a repeat offender by any definition
– cannot be jailed, and continues to make profits
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How should such companies be dealt with?
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Should a special category of offenders be established?
Conclusion – Lessons Learned
1. Play by the rules
2. Deal with others who play by the rules
3. Not playing by the rules can be profitable… but
4. In the end, you will get caught…or
5. There will always be someone smarter than you are!!!