Ethics and Corporate Governance: Lehman Brothers - Essay Example

                                                                 Identify a current business issue in accounting or finance which has ethical /corporate   governance implications.      Lehman Brothers filed for bankruptcy on Sunday September 15, 2008, but the signs   of poor ethicality and governance were manifesting months in advance of that moment.   The company began operations in 1850, according to the New York Times (2010), in   Montgomery, Alabama, when the two younger brothers took over the business of their   recently deceased elder brother. The firm several years later, after the Civil War, moved   to New York City and became one of Wall Street investment giants.      However, after 158 years in operation, the company according to www.hbs.edu.com,   filed for chapter11 bankruptcy in the federal court, and had its assets subsequently sold to   firms like Barclays Public Liability Company and Nomura Holdings Inc.      Citing reasons for the failure of the company, a bank examiner points to bad mortgage   holdings and demands by rivals like JP Morgan and Citigroup, according to The New   York Times (2010). The ethical questions however were, who was responsible for   approving those loans, why JPMorgan and Citigroup were making such demands on   Lehman Brothers, and who has the fiduciary responsibility to ensure that the company   internal codes of ethics were not breached?      Dick Fuld, the chief executive officer of the company, blames the firm’s bankruptcy on   false rumors, solvency crises, uncontrollable market forces, and an unwillingness by   the federal government to come to its assistance, according to Clark (2010).      However, the Valukas Report painted a more detailed picture of the practices of this   corporate giant, prior to their filing of chapter 11 bankruptcy, according to the Economist   (2010).   Anton Valukas pointed that Lehman Brothers painted a misleading picture of the financial   situation, by manipulating the Repo 105 accounting principle.      The REPO 105 according to the Economist (2010), is an accounting device which permits banking institutions to bring down their first quarter leverage temporarily. Borrowers under repo105 agreements can then swap their collaterals for cash, and buy them back later, at the expense of a small premium. This form of short term financing the Economist (2005) informs, are very common, and has no effect on a firm’s leverage, because the borrowed funds and the commitment to repurchase cancels out each other in the process.      Lehman however, according to the Economist (2005), took advantage of an accounting   provision under the Repo 105, called SFAS 140, and reclassified the borrowings as sales.   They would regularly trade the collaterals for cash, and then remove them from the   balance sheet. This was easy because the transactions were recorded as sales. The company would then use the cash obtained to pay down on its debt, with the investing public not being aware, and would be left with the impression that Lehman’s Brothers had reduced its leverage. In reality however, the agreement to repurchase the assets at specific times in the future, were still valid.      At the end of the 1st and 2nd Quarters of 2008, Lehman used the Repo105 privilege to   remove $100b of its assets, according to the Economist (2005), at a time when there   where market jitters regarding its leverage. This was in addition to the $38.6b removed   in the 4th Quarter of 2007.    Lehman’s Repo105 report (07-08)   Date   Repo 105 usage ($b) Reported Net Leverage (%)  Leverage EX. Repo 105   Diff.   Q.4.    2007 38.6                              16.1                        17.8                                1.7                                                                                                                                                    Q.I.    2008 54.1                               15.4                        17.3                                1.9     Q.2.   .2008 50.38                               12.1                      13.9                                1.8       Joseph Denis was the Senior Vice President of Accounting Policy, during the times   these transactions were taking place, and may have been ethically concerned when   Joseph Cassano, the head of the most profitable division of the worlds largest and most   admired companies, told him bluntly, according to Brigham and Linsen (2003), “You   can’t attend this meeting. We are going to discuss things that you tell me that I shouldn’t   do. I don’t want that on the record, and you can’t stop me”.      Matthew Lee, the Lehman’s Holding Incorporated Senior Vice President, was discontent with the accounting practices of the company, and wrote a letter (later made public) to the company; expressing concerns about the senior managers were violating the internal code of ethics, by misleading investors and regulators about the true value of the company assets, according to Corkery (2008).  Lee wrote, “I believe the manner in which the firm is reporting (certain) assets is  potentially misleading to the public and various government agencies. Additionally, he   made known, according to Cox (2010), that he discovered that the company was under-   reporting its debt by about $5b at the end of each month.   He was later fired from his job, for challenging the ethicality of the senior manager of the   Company (Corkery 2008).      In another incident, David Einkorn of the hedge fund Green light Capital Inc., reported that Lehman Brothers’ action of writing up the value of KSK Energy Ventura (a power plant in India) from $400m to $600m during the 1st Quarter of 2008, was an unethical accounting practice, according to Corkery (2008). Lehman reacted by saying it was in anticipation of profits to be made.    The Sarbanes –Oxley Act, with all its preventative provisions were introduced from 2001, according to the Economist (2010), but despite this, Lehman was removing assets from its balance sheets, convincing accounting firms (including Ernest &Young) to approve unethical maneuvers, and holding assts like KSK Energy Ventures at inflated values against market prices according to the Economist (2010).       The actions of the senior managers cannot be understood with looking at the culture of   the company. According to Robinson (2009), Fuld was an arrogant leader, a risk taker   who constantly wields his power over the Board of Directors. He  also had a penchant for   aggressive outbursts, which was his way of getting his subordinates to submit to his   unethical wishes.      Lehman  leaders showed blatant disregard for interest of the public, dishonesty ,as well as  very high levels of egoism on September 10, 2008, when Ian Lowitz, the bank’s Chief Financial Officer, told investors that the liquidity of the company remained strong at $42b. However, according to the Economist (2010), a day earlier an internal document had revealed that Lehman had low ability to monetize almost 46% of its assets.    The level of abuse of their fiduciary responsibility was extremely high, as according to Valukas, its liquidity pool was designed to allow it to survive at least 12 months of stressed financial situations, but it only had cash and securities that had been assigned to its clearing bank (Economist 2010).     A look at Lehman’s financials for November 2007 and May 2008, according to McDonald (2009), revealed a total lack of compatibility with the requirement of the Sarbanes-Oxley Act of 2001.    Lehman’s Financials                                                November 2007                May 2008                                                        $m                                  $m    Income Statement                  59,003                             8,910   Revenue Earned                      57,678                             8,522   Gross Profit                             45, 759                            2,822   Operating Income                      4,192                            -2774   The company at the time had assets of $639 b, but in terms of liquidity was in a far worse   situation than Lowitz was reporting to the investors.       The root of Lehman’s problem lies in the leader of the organization, who rather than   becoming honest with the investors to whom he was responsible, came out blaming the federal government for not helping, false rumor, a solvency crises, and uncontrollable market forces according to the Clark (2010).      According to Robinson (2009), Dick Fuld who lived most of his business life on the 31st floor of the executive suite, was a man driven by a passion to head the no.1 investment bank ahead of Goldman Sachs, was often demanding more money to line his pockets, and regularly remove assets from the balance sheets without being aware of the operations and risks that were being set up in the organization.  As the housing bubble grows, so did his appetite concluded   Robinson (2009).       The ethics Lehman Brothers was questioned as far back as 2001, when a joint ABC News and New York Times investigation revealed that the company was doing business with a company suspected of writing fraudulent mortgage and cheating customers, but according to Ross, B. (2008), the company defended the relationship as appropriate.  However, a major the reason the company went into bankruptcy was because of its involvement in sub-prime mortgage going back to the time the accusation was made, and  Ross (2008) investigation provided evidence to show that Lehman’s had helped to bundle or package millions of dollars of mortgage put together by First Alliance Mortgage of California. First Alliance Mortgage of California, and a number of state attorneys were also accused by the Federal Exchange Commission of defrauding home owners; through predatory lending according to Ross (2008).   It seems Ross (2008) was totally convinced about the poor ethics of Lehman, because he further pointed out, that the company was responsible inventing the financing of the sub-prime mortgage from companies like First Alliance, by taking over the individual loans, and packaging them as high interest paying investment vehicles for Wall Street known as ‘securitization’.    Lehman Brothers according to Field (2010), started having problems as far back as 2006, when it used Repo 105 to cook its books so frequently that its employees became cultured to the act by referring to getting “105”d.  Lehman Brothers had also refused to improve its ethical standard, due to prevalence of  high  the levels of greed, manipulations, irresponsibility, corruption, dishonesty, and total disregard for the investing public. Ethics and good corporate governance had no room in a climate created by Fuld, and even at point of bankruptcy, poor ethics played a significant part.   In the closing chapter of the company, while  5000 UK employees were on the verge of losing their jobs, according to McDonald (2009), US judge James Peck was being pressured by the White House, the Treasury Secretary, and New York’s Mayor Michael Bloomberg, to quickly approve the sale of the company to Barclays. However from an ethical perspective according to McDonald (2009),  it was inappropriate for the courts to  become responsive to political pressure to sacrifice the due process of the law.  The Ethical Analysis   Ethically, Lehman Brothers was practicing the greatest good for the fewest in number, during the years of operations, this is the total opposite of the Utilitarianism Concept, which according to Berkowitz, et al (2000), is doing the greatest good for the greatest in number of people. The fact that Dick Fuld in particular, was always demanding more to line his pockets, and removing assets from the balance sheets as sales rather than a Repo105 transactions, and was able to influence his senior managers to comply with him, are ultimate proof of the fact that they were looking for the greatest good, without any consideration for the interest of the investing consumers.    A code of ethics, which is a formal statement of ethical principles and rules of conduct, according to Berkowitz et al (2000), was largely ignored in the daily operating of the business, and  according to Costa, came from the same template as Bears & Sterns. It was possible deep consideration was not given to the development of this vital guiding tool, and later led to the financial crisis that later developed.    When Code of Ethics is not developed by leaders embracing excellent ethical principles, the inherent poor quality will trickle down into the organization, so that respectable corporate image of the company will eventually not be seen by the investing community. This will negatively affect the volume of investment the company will attract.    Any company like Lehman Brothers that uses deception to impress the investing community, and lie continually to retain confidence, will eventually contaminate the entire working environment. According to www.definitions.us.legal.com , a properly formed Code of Ethics issued by a business, should serve as a form of legislation binding on its employees, with specific sanctions.    When a company ignores its own code of conduct, it will deteriorate morally, and may eventually break the law. According to Berkowitz et al (2000), ethics deals with personal moral principles, while the laws are society’s values and standards that are enforceable in a court system.    According to Edmonds et al, (www.higheredmcgrawhill.com), people who we become involved in unethical behavior usually do so un-expectantly. They start with small discretions that evolve gradually into more serious violations of trust. This seems to be the case with Lehman’s Brothers, and Donald Creassy after hundreds of cases in his research, found that there were three critical factors that were common in all cases. They were, (a) the existence of non-sharable problem, (b) the presence of opportunity, and (c) the capacity to practice rationalization (Edmonds et al).    Dick Fuld and his team of senior managers used the REPO105 to such an extent that the level of fraud became a non-sharable problem, and when Joseph Cassano prohibited Joseph Dean from the executive meetings; it reflected the level of rationalization and opportunity that they had to develop their own ethical views, which would only serve their own self interests. This may be symptomatic of several organizations that embrace this practice.    A recent study by of business executives, according to Berkowitz, et al (2000), revealed 40% had been implicitly or explicitly rewarded for engaging in ethically troubling behavior, while 31% of those who refuse to engage, were penalized through outright punishments or a lowering of status. The fear of being punished as well as the magnitude of the rewards being paid to the senior executives at organizations like Lehman’s Brothers, may no doubt have lead to  the closing of ranks around the leadership.     The absence of ethical leadership in any organization, and the concomitant lack of education of the employees in this area can also lead to its demise. The presence of such an authority among the senior levels of management, may have led to even the protection of whistleblowers like Matthew Lee, and the development of fear among those who are desirous of behaving unethically.    A whistleblower is justified, according to Dienhart and Curtnutt (1989), if he or she can (a) prove conclusively that the employer is planning, or has done something illegal or harmful, (b) that the harm is great enough to justify revealing proprietary information, and (c), had previously approached the employer about the issue. An ethics manager in any organization would be able to hear the case of each potential whistleblower, and measure it against the requirement standards, before taking appropriate actions. The fact that such a system existed would also help to prevent the company from going under.    Despite the presence of an Ethics Manager in a company however, there are no guarantee according to Dienhart and Curtnutt (1998), that individuals reporting improper conduct of the employees will not be harassed, demoted, intimidated, transferred, or even fired. So the decision to maintain excellent ethics in an organization that are not practicing it, is in indeed a lonely one that can lead to ruination of careers. Many employees may also become fearful and remain tolerant, thereby allowing the various unethical practices to continue.     Digital deception, which according to Hancock (2009), is the intentional control of information in a technologically mediated message, to create a false belief in the receivers message, may also be another reasons why Lehman’s Brothers was able to manipulate the investing public with its poor ethicality. Communication Technology is a powerful tool to perpetuate poor ethical behavior between a company and it s investors, Hancock (2009) continued, because all parties may at times not be in the same physical location at the times of interactions.    Lehman Brothers and other companies in the past, have used this platform to the maximum, to protect its fraudulent activities and in particular the action of Ian Lowitz regarding the liquidity status of the company, was one such case of using digital deception to manipulate the investing public.    The magnitude of power of the senior management of a company can contribute to poor ethics prevailing in some organizations. According to George Simniel (Mollery, G., 2009), “Almost compulsory power is attributed to trust, and to betray it requires positive meanness”. Positive meanness within any organization will cause unethical behaviors like removing assets from balance sheets, treating theft as borrowing, giving false information to the public, remunerating unethical practices, and punishing those who refuse to comply.    Mollery (2009), also remarked that betrayal of trust within any major organization, can cause damage beyond the ordinary loss of resources and opportunities, because trust is a moral value within societies.  Once trust is breached in any organization, especially those that have fiduciary responsibility to the public, the entity may never recover, and will travel irreversibly down a slippery slope, taking thousands of jobs, and financial gains with it. Trust was severely breached by Lehman Brothers. The attitude of the investing public to blindly trust some companies like in the case of Lehman Brothers, may also be one of the factors that led to thousands of innocent investors losing their life savings.    According to Domini (1984), no matter how good the company or investment vehicle, it must fit with the ethics, financial needs, and personality of the investor. In other words, investors should examine the operations of the company handling their investments continually, to ensure that there are conformances in all the relevant areas, and where there are variations, they should then take appropriate actions. Had this been done, cases like WorldCom, and Lehman Brothers may not have happened, and thousand of investors’ fortunes may have been saved.    Ethics has value, according to Dienhart and Curtnutt (1998), and once the poor ethicality of an organization start to manifest, it may end up bankrupt. Dick Fuld felt it the hard way, and may have been perfectly right in his conclusion that a lack of investor confidence was one of the reasons why the company failed.    According to Joseph Wells, a former FBI Agent and founder and chairman of the Association of Certified Examiners, “a hallmark of high level fraud is rationalization- the ability to call fraud by a nice name” (Callaghan, 2009). This can be done he said, by re-interpreting the accounting rule to give a struggling company more breathing space. Top officials Wells continued, who engage in fraud would also say, “I am doing this for the good of everybody. I am not stealing, I’m borrowing”(Callaghan 2004).    Companies operating in cultures like that described by Wells, have design their own ethics, and when that is coupled with the inherent power of the management, only whistle blowing activities like what Matthew Lee bravely did, can bring about any form of cessation.    There is a strong parallel between that what had happened to Scott Sullivan, the CFO  of WorldCom, and Dick Fuld. Scott Sullivan, according to Callaghan (2004) saw himself as a hero, trying to save the jobs of everybody, but had strong motive for fraud, since he was always seeking high pay packets which were always tied to the value of the stock on the market. Dick Fuld was in the same mold, and had a similar demise. This is relevant message to unethical leaders of organizations, big or small, who becomes trapped in the behavior, and try to keep the truth under cover by lying to staff, co-workers, family, investors, the media, and friends (Callaghan 2004), in order to remain favorably in the eyes of all; a demise of massive proportion is always waiting in the wings.   Reference   1. Berkowitz, E.N., Kerin, R.A., Hartley, S.W., Rudelius, W., (2000) Marketing  6th   Edition Irwin-McGraw-Hill Boston, MA pp.101-107   2. Brigham, A.F., Linsen, S., (2008) What is ethically wrong in the economic           collapse, Ethiosphere           www.ethisphere.com/what-went-wrong-ethically-in-the-economic-collapse ,           12/1010   3. Callaghan, D., (2004) The Cheating Culture Hartcourt Inc. Orlando FA pp.98-104   3. Clark, A., (09/01/10) Defiant Fuld blames false rumors and Fed for collapse            of Lehman, Guardian UK www.guardian.co.uk/business/2010        4. Code of Ethics Law &Legal definition (12/10/10)      www.definitions.us.legasl.com/c/codeofethics/   5. Corkery, M., (2008) Lehman Insider Letter warned about violating code of ethics            The Wall Street Journal               www.wsj.com/article/sb1000142605274870453490457132120222684184.html   6. Costa, J.D., (2010) Business Ethics as if Morally Mattered                    www.legatusmagazine.org/p=2540 12/11/10   7. Dienhart, J.W., Curtnutt, J.,(1998) Business Ethics ABC-CLIO Santa Barbara , CA   8. Domini, A.L., ,Kinder, P., (1984) Ethical Investing Addison –Wiley Publishing       Company   9. Duska, B.S., Duska, R.F., (2003) Accounting Ethics Blackwell Publishing Ltd.            Essex UK. pp.26, 45-47         9.  Economist (03/12/10) A Postmortem on Lehman’s Brothers                 www.economist.com/node/15695099 , 120/10/10   10. Edmonds, Edmonds McNair, Tsay, Importance of Ethics   www.highered.mcgrraw-hill.com/sdites/000735226770/student-viewed/ed 12/10/10   11.   Field, A., (2010) The Lehman Bankruptcy Report is a Road Map for Criminal           Charges 03/12/10 www.dailyfinance.com/story/investing/thelehman-bankruptcy            12/10/10   12. Hancock, J., Mollery, G., (2009) Deception Stanford University Press, Stanford          CA pp.110,146   13. Harvard Business School Lehman’s History ,            www.library.hbs.edu/hc/lehman/history.html, 12/10/10         14.  New York Times, (05/28/10) Lehman Brothers Holdings Inc.                     www.nytimes.com/top/news/business/companies/lehman-brothers-holding-inc.html                  12/1010   15. Robinson, M., (2009) Lehman Brothers :an exercise in risk management New            England College of Business and Finance           www.necb.edu/resource-lehman-brothers-an-exercise-in-risk-mmagement.asp           12/10/10   16. Ross, B., (2008) Lehman Had Long Relationship with suspect Mortgage Brokers           ABC News 2020 www.abcnews.com/bl;otter/story?id=5807408&page=1   17. Sayles, L.R., Smith, C.J. (2006) The Rise of Rogue Executive, Pearce Education              Publishing as Prentice Hall Upper Saddle River NJ   18. Velasquez, M., Andre, C., Shanks, T., S.J., Meyer, M. (1987) What is Ethics                   www.scu.edu/ethics/practicin/decision/whatisethics.html  12/10/10       Read More