Review of Accounting Ethics - Week 3
Alessio Brasile
Strayer University
Financial Accounting
ACC-557
Dr. A. Golding
April 28, 2013
Review of Accounting Ethics - Week 3
Given the corporate ethical breaches in recent times, assess whether or not you believe that the current business and regulatory environment is more conducive to ethical behavior: In the past several years, Enron, WorldCom, Tyco, and others have committed financial scandals, which caused the stock market to take a hard hit. Investors and lenders learned from these scandals in the past, and just recently, have become hesitant to invest in any company that they think, or know for a fact, the company is corrupted and/or unethical. “United States regulators and lawmakers were very concerned that the economy would suffer if investors lost confidence in corporate accounting because of unethical financial reporting. In response, Congress passed the Sarbanes-Oxley Act (SOX, or Sarbox)” (Weygandt, Kimmel, & Kieso, 2012, p. 7). SOX is in place to minimize unethical conduct in corporations and ultimately, scandals. “As a result of SOX, top management must now certify the accuracy of financial information. In addition, penalties for fraudulent financial activity are much more severe” (Weygandt et al., 2012, p. 7). With these standard rules and regulations in place, corporations are less likely to commit any fraudulent activity because there is more scrutiny from lawmakers. Also, corporations have a better chance to survive as a company if they are truthful with their investors and lenders upfront, than if they were to try to hide any fraudulent activity.
Based on your research, describe the organization, the accounting ethical breach and the impact to the organization related to ethical breach:
In recent years, you may have heard of companies like Enron, WorldCom, and Tyco who all performed unethical transactions, which ultimately drove each business to fail. One company that stands out, which became known to be the largest bankruptcy filing in the history of the United States, is Lehman Brothers; “total debts of $613 billion against assets of $639 billion” (Mamudi, 2008, para. 1). Lehman Brothers got themselves in trouble by the way they were handling their books at the end of each quarter. “The mismatch between short-term debt and long-term debt illiquid investments required Lehman to continuously roll over its debt, which increased the firm’s business risk” (Caplan, Dutta, & Marcinko, 2012, p. 442). Lehman was borrowing billions of dollars practically every day (Valukas, 2010, Volume 3, p. 751).
Lehman Brothers’ executives were exercising repurchasing agreements differently than what they were intended for. Lehman Brothers were selling securities to their lender and when repayment was made, the securities would be bought back by Lehman Brothers. Because they were selling and buying back the securities, these transactions created “a materially misleading picture of the firm’s financial condition” (Trumbull, 2010, para. 3). Standard practice for repurchasing agreements are that securities would be transferred, not sold, to the lender in exchange for a cash loan. This transaction would have a nominal fee, which would be paid when the loan is paid back to the lender. An agreement is established between a company and the lender on a repayment date. On the repayment date, the company would pay the loan back, and in exchange, the securities would be transferred back to the company (Caplan, Dutta, & Marcinko, 2012, p. 443-444). Lehman Brothers’ actions finally caught up with them, and led the company down a path no company ever wants to be. Lehman Brothers was acquired by Barclays, and impacted more than 9,000 employees ("Judge approves $1.3bn Lehman deal," 2008, p. 2).
Determine how the organizational ethical issue was detected and how management failed to create an ethical environment: In May of 2008, a few months prior to Lehman Brothers filing for bankruptcy, Senior Vice President, Matthew Lee, submitted a letter to Lehman Senior Leadership management, advising them of his findings. Mr. Lee identified several financial reporting practices that violated Lehman Brothers’ code of ethics. His letter included six allegations but one of his allegations regarding repurchasing agreements Lehman Brothers were executing was mentioned verbally when he was interviewed. He stated that Lehman was removing roughly $50 billion of inventory from the balance sheets for the end of the quarter, and about a week later, would return the inventory back to the balance sheets (Repo 105). Mr. Lee’s interview regarding his allegations on Repo 105 was never mentioned to the audit committee, nor Lehman’s internal audit director. (Caplan et al., 2012, p. 447-448). If Mr. Lee’s findings were brought up to the ethical director, as outlined in Section 301 of the Sarbanes-Oxley Act, then corrective action would have penalized the people responsible for the unethical behavior that occurred, prior to Lehman’s bankruptcy. There could have been other measures that could have taken place, to re-organize the corporation, and avoid the unfortunate event caused by some executives at Lehman Brothers.
Analyze the accounts impacted and/or accounting guidelines violated and the resulting impact to the business operation: According to the repurchasing agreement, the accounts that should correspond in the journal entries should be Cash, Collateralized Financing, Short-Term Borrowings and Interest Expense. Lehman Brothers’ journal entries consisted of Cash, Option to Repurchase, Short-Term Borrowings, Investment Securities, and Interest Expense (Caplan et al., 2012, p. 443-444). Since the transactions for the repurchasing agreements Lehman Brothers were posting appeared to be selling and buying of securities, the books did not illustrate that Lehman Brothers were executing repurchasing agreements. If they were inputting journal entries to Collateralized Financing, investors and lenders would notice the transactions Lehman Brothers were engaging in, and possibly corrective measures would have taken place prior to the events leading up to bankruptcy.
As a CFO, recommend which measures could have been taken to prevent this ethical breach and how each measure should be implemented in the future: Lehman Brothers’ management team wanted to increase the firm’s risk portfolio and pursue a higher growth strategy (Caplan et al., 2012, p. 442). It appeared that some ethical rules were in place, but never enforced. The company was losing money, and in an attempt to recover from their losses, they were burying themselves deeper in a black hole. The company appeared to be profitable on the books and to the public eye, but realistically, they were becoming more of a risk factor.
As a CFO, I would highly enforce any ethical rules that are in place, set by Board of Directors, and Ethical Committee. All managers and executives would have to comply with the Sarbanes-Oxley Act (SOX). If any rules are broken, corrective measures would be taken to rectify the issue, by means of termination of employment and re-organization of the company Termination of the employee is key for those who think it is ok to mislead the public with information/data that is incorrect. Reorganization is required if losses outweigh profits, so the company can become profitable and achieve sustainable growth for the near future. By implementing ethical standards and following by these rules that are set, it is easier for a company to fix any issues upfront, rather than risking possible bankruptcy and affecting thousands of people’s future and welfare.
References
Caplan, D. H., Dutta, S. K., & Marcinko, D. J. (2012). Lehman on the Brink of Bankruptcy: A Case about Aggressive Application of Accounting Standards. ISSUES IN ACCOUNTING EDUCATION, 27, 441-459.
Judge approves $1.3bn Lehman deal. (2008). Retrieved April 25, 2013, from http://news.bbc.co.uk/2/hi/business/7626624.stm
Mamudi, S. (2008). Lehman folds with record $613 billion debt. Retrieved April 25, 2013, from http://www.marketwatch.com/story/lehman-folds-with-record-613-billion-debt?siteid=rss
Trumbull, M. (2010). Lehman Bros. used accounting trick amid financial crisis – and earlier. Retrieved April 25, 2013, from http://www.csmonitor.com/USA/2010/0312/Lehman-Bros.-used-accounting-trick-amid-financial-crisis-and-earlier
Valukas, A. R. (2010). Lehman Brothers Holdings Inc. Chapter 11 Proceedings Examiner Report. Retrieved from http://jenner.com/lehman/
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2012). Financial Accounting (8th ed.). Hoboken, NJ: John Wiley & Sons, Inc.