REL 228/MGT 228



REL 228/MGT 228

Business, Ethics, and Society

Prof. Douglas Lamont

WEEK SEVEN: LECTURE/DISCUSSION

Theme for the week: Long before the public scandals, the financial scams were well known among Wall Street institutions. They were making it possible with debt finance. Scams and work.

I. Financial scams as work.

Parmalat. Calisto Tanzi, the founder of Parmalat SpA spent his life selling milk and brokering power. His long-lasting milk filled glasses around the world. In Italy, he financed politicians, bailed out fellow industrialists, and renovated cathedrals. Over the years Tanzi spent at least $120 million on contributions that were marked as regulatory fees. Years of fraud. It includes a $4.7 billion phantom Bank of America bank account (in the Cayman Islands) that buried Parmalat under $17 billion in debt. This is Europe’s greatest white collar crime. In Italy (one of the G-7 countries), since the 1960’s, Tanzi prospered by pulling the levers of power: politics, banking, and the Catholic Church. Today, he and his two children Francesca and Stephano Tanzi, and his brother Giovanni Tanzi are in jail. Parmalat USA Corp. has filed for Chapter 11 bankruptcy.

Tanzi imported technology for preserving milk without refrigeration for six months. Parmalat charged a premium for what had been a commodity product. Tanzi became the first to exploit sports marketing, such as ski contests, Formula One racing, and FIFA soccer football. Tanzi played spizzichino, an Italian card game, with important Christian Democrat politicians; his contributions were so numerous to the party that the Italian government gave him a knighthood. Parmalat bought 17 companies in 1993 alone. With newly privatized Italian banks less willing to finance Parmalat, foreign bankers, such as Bank of America, placed $8 billion bonds over ten years. Losses piled up because of inefficient factories, poorly managed inventory, and costly acquisitions. Annual losses of $420 million to $540 million from 1995 to 2001 were concealed. Money was being transferred from Parmalat to other companies owned by the Tanzi family, such as Paramtour, SATA, AC Parma, etc. Calisto Tanzi always wanted to grow, grow, grow. It was like a disease, said his spiritual advisor. Tanzi, a devout Catholic, made a pilgrimage to the Fatima shrine in Portugal before being handcuffed by police in central Milan and driven to jail.

Italian bankruptcy law. A bankrupt company can revoke transactions conducted up to two years before a bankruptcy filing if the counterparty knew that the company could not service the debt. Lawyers for Enrico Bondi, Pamalat’s government appointed administrator, have approached CSFB, UBS, Deutsche Bank, Banca Intesa, and Morgan Stanley to negotiate a settlement or face court action of the structured finance and private placement deals completed in 2001-2003. Did the banks know Parmalat was insolvent? It will be hard to prove, but the threat could force the banks to give more credit to Parmalat as it comes out of bankruptcy.

Bank of America. Evidence is mounting the Bank lowered its standards to win business from companies controlled by wealthy families. (1) The hedge fund run by Edward Stern to trade mutual funds. (2) Adelphia run by the Rigas family. (3) Parmalat fun by the Tanzi family. Bank of America loans debt money to these families/firms to gain future lucrative investment banking business. This is known as cross-selling. A former broker at Bank of America got the bank to give Stern access to the Bank’s trade clearing software which made it possible for him to engage in rapid trading of BofA mutual funds, as well as those of third parties. The bank dismissed the employee, repaid its shareholders, and took a $100 million charge on its books. BofA admitted its wrong doings. However, it paid Richard Demartini, president of BofA’s asset management, $4.5 million in 2004 even though he was no longer working for the bank; and he had supervised the employee who gave Stern trading privileges at the bank, the loans to the Rigas family, and the sale of bonds by Parmalat. Shareholders are up in arms about Demartini’s termination package.

Source: Alessandra Galloni and Yaroslav Trofimov, “Behind Parmalat Chief’s Rise: Ties to Italian Power Structure,” The Wall Street Journal, March 8, 2004, pp. A1, A12. Fred Kapner, “Parmalat in claw-back move,” Financial Times, March 4, 2004, p.20. David Wells, “BofA falls foul of family favorites,” Financial Times, March 5, 2004, p. 21.

Enron and Fastow’s work. Andy was ruthless at exploiting Wall Street’s greed. J.P. Morgan Chase knew about Fastow’s SPE partnerships. In 1999 Chase invested $10 million in one of the partnerships on the grounds that Fastow would reward the bank with investment-banking fees from Enron. Today, J. P. Morgan Chase, Citigroup, and Merrill Lynch no longer deny they helped enable the Enron fraud. They paid $366 million in fines. The new management of Enron and shareholders are suing these three banks and others for billions of dollars in damages; because the latter helped the old management generate personal fortunes. Bank documents show the banks helping Enron mask debt as cash flow from operations and create phony profits at the end of a quarter; they also show how they put money into Fastow’s partnerships.

Hiding the debt. By the end, Enron had piled up $38 billion in debt of which only $13 billion was on its balance sheet. Enron was always desperate for cash after the merger of two natural-gas pipeline companies and with its new business trading paper products and creating a global broadband network. Many of these businesses never made money, but Enron never admitted this to the public. So the price of its stock soared. And the stock options held by Fastow, Skilling, and others became ever more valuable. Therefore, Enron needed a steady cash flow. This is what the banks provided in “disguised loans” to hide the debt from equity analysts. Both the banks and Enron made misrepresentations to Arthur Andersen to justify the prepays’ bogus accounting treatment. Under Skilling, the prepays soared from $200 million to $5 billion.

Structured finance. Prepays are known as structured finance, and they are legal as a device for taking risk off the balance sheet. Insurance companies set up separate entities to finance large construction projects and off load the risk of something going wrong. The banks used structured finance—these giant loans—to get investment banking business. According to whistleblowers at Enron, Andy Fastow knew so little about accounting that he “could not dissect a balance sheet” nor did he have a “risk-control bone in his body.” However, he cooked up around $20 billion in capital a year for Enron, and gave Chase $96 million and Citi $99 million in fees. Andy played one bank against the other to get more cash. He gave them ratings of which one was doing the most for Enron and how each came through when Enron needed them. Morgan Stanley and Goldman Sachs, both of which have conservative lending rules, were ranked in the bottom Tier III category.

The 3% solution. Under accounting rules, SPEs are legal as long as 3% of the capital is independent and truly at risk. The banks provided the 3% equity. Was this equity truly at risk? Enron cut side deals guaranteeing the banks that their investment would be repaid. This is a loan, and not equity at risk. Therefore, fraud. Unfortunately, Enron employees, Wall Street analysts, and Arthur Andersen accountants were seduced by the Enron mystique. When Fastow was fired by Enron, all of these folks awoke from their deep sleep, and Enron in need of more cash became the supplicant of the banks. The banks refused to loan more money.

Source: Bethany McLean and Peter Elkind, The Smartest Guys in the Room. Excerpted in “Partners in Crime, Fortune, October 27, 2003, pp. 79-100.

Other types of work. Legal “scams” as work. Joseph F. Rice, a leading class-action lawyer, accepts a $20 million fee from the parent of a company that he is suing in addition to the fees that he will collect from his clients for settling their claims against that very company. The fee will be paid by ABB for the bankruptcy of Combustion Engineering, a subsidiary that used asbestos in its boilers. Discrimination “scams” as work. Wal-Mart practices show a big gap in the status of men and women. The sex discrimination suit covers 500,000 women. Many workers are under the heel of executives, lawyers, and big business.

Source: Ruth Rosenbaum, “Under the Heel of Business, Sojourners, 29:1 (January-February 2000): 24-25.

II. Personal views of instructor

Question: Does corporate social responsibility require that corporations and the people who work within them not just respond to the requirements of the law but also to high moral standards?

Discussion.

Enron, Tyco, WorldCom, and others tried manic efforts to raise the price of their stock in the short term at the expense of genuine shareholder value. Earnings targets and soaring stock prices were frequently met by fiddling the figures of doing damage to some other aspect of the business.

Outside shareholders, such as mutual funds, pension funds, and individuals, are being squeezed out of their ownership rights in the information technology sector by the very generous granting of stock options to directors, executives, and other employees. Thus profits of the company are flowing to those who are holding the stock options, and when the options are sold the profits are removed from the shareholders and given to the insiders (directors, executives, and employees). Example: Microsoft has issued options totaling $11 billion (in the year to end-June 2000) and this would have absorbed 77 percent of the published pre-tax profit.

Although this looks like a failure of ownership, shareholders are not the ultimate risk-takers and the value of their input is not great. In today’s economy, especially in the technology sector, It may be unrealistic to argue that giving the shareholder the ultimate right to the profits of the business is unrealistic and unfair. Human capital—that is, the skills acquired by employees through education or experience at work—is more scarce than financial capital, which is now a mere commodity.

Therefore, the old categories of capital and labor, with a layer of management to mediate between the two, no longer makes sense. We need a new model. We need to enable knowledge managers and workers to be incorporated into the corporate governance system.

Problem: How do we measure realistically the inputs of managers and employees against those of shareholders? These are intangible assets. Most valuation models are subjective in nature. Stakeholders, such as employees, should have a say in corporate governance, but how?

Going forward: We have left an era of impatient capital as the magic bullet for the world, and we have entered a period of back to capitalism as usual—workplace, performance, and productivity issues tied in with the rigorous enforcement of laws on discrimination, pollution, etc.

III. The Workplace.

Character and integrity of the person in a business organization Even in a pluralistic open society such as the US our ethical legacy from ancient Greece (Aristotle) and the Bible are rooted in the concept of personal moral responsibility. The context includes moral questions about sexuality, friendship, athletics, citizenship, business ethics, professional ethics, and so on. Corporations are nestled within the larger national community, and they owe their safety and opportunities to it, and they are restrained and supported by it.

Cognitive dissonance between moral heritage and current situation.

1) Today’s workplace organization often allows only a small part of the thinking feeling and moral decision-making capacities of a good morally responsible employee. Instead, the workplace requires merely obedience and productivity without voice or comment, or, even worse, that employees knowingly condone lying, low standards of practice, wrong-doing, deception, or abuse of authority. The political system that oversees corporations gives them first amendment rights for their advertising (commercial speech). Aristotle’s person-in-community model is difficult to find in corporations today.

2) Within corporations tasks are sub-divided, specialized, and delegated. Moral responsibility is diffused so thoroughly throughout a trackless maze of legal and organizational rules as to eliminate it altogether. Some harmful policies are beyond the reach of moral responsibility (Bhopal). It could be that the idea of moral agency is so removed from daily experience that it rings hollow. Instead, praise or blame are hard to conceive; they are seen as arbitrary, abstract and distant, or a sheer grab for power.

3) Therefore, the only moral culture within corporations is ad hoc, whatever the traffic allows, either within existing laws, or in accord with whatever else might be approved by the firm’s directors, executives, auditors, and lawyers.

Failures and achievements in organizational ethics.

Most firms have a culture, a language or technical jargon, customs, and practices. However, most employees have no moral feedback and responsibility.

Peter Drucker, the management guru, says nothing can be done about the “nine to five” workplace. Others disagree.

Moral culture of workplace organizations.

If the ethos of the corporation is one which seeks and encourage people of integrity and good moral character, inventing policies and setting work criteria which enable these people to function and interact truthfully, then no large moral problem would afflict the organization.

In the worst case, things are just the opposite. “Go along to get along.” “Fit in.”

Cannot maintain two separate moral selves, one of integrity and one corrupt. The entire history of ethics, from Plato, ancient Greek tragedies and the Old Testament to modern psychology and today’s philosophers agree on this. Madness, drugs, suicide, depression, anger, violence, an inner numbness and disassociation, and other horrible pathologies stem from this attempt to live a lie—that is being a person of integrity at home, and a corrupt person at work.

IV. Civil Liberties in the Workplace, see Shaw, BE, pp. 202-208.

Widespread absence of civil liberties in the workplace. Prevalence of authoritarianism in the workplace. Rise of professional management and large corporations. Employer has a free hand in hiring and firing employees. Employment at will. Union membership. Discrimination. Constitutional protections.

V. Employee Rights.

Corporations are goal oriented and often hierarchically organized, which places a premium on efficiency and employee obligations of loyalty, obedience, and confidentiality. Today, employees have certain rights that cannot morally be overridden on grounds of efficiency. Here is short list:

Right to work. The right to meaningful work. Hiring ethics: job analysis, job description, job specification, tests, interviews. Reverse discrimination: equal opportunity, affirmative action. Diversity.

Safe and healthy work environment.

Job security and due process in disciplining, demoting, promoting, and firing. 14th amendment to US Constitution.

Privacy. Employees who use computers and telephones can be legally monitored by their employers. Computerized methods of obtaining, storing, retrieving, collating, and communicating information have made it possible for employers to collect and keep personal information about their employees. Psychological privacy includes a person’s thoughts and plans, personal beliefs and values, feelings, and wants. Physical privacy in bathrooms.

Workmen’s compensation for injury.

Equal treatment without regard to race and gender.

Unions and collective bargaining. Strikes.

No sexual harassment.

Living wage. What is the law? What is the prevailing wage in the industry? What is the community wage level? What is the nature of the job itself? Is the job secure? What are its prospects? What are the employer’s financial capabilities?

What are other employees inside the organization earning for comparable worth? See Shaw, BE, pp. 218-219.

Whistle blowing.

See Shaw, BE, pp. 208-219. Negligent hiring. Tests: validity and reliability. Interviews. Promotions: seniority, inbreeding, nepotism. Discipline and discharge. Wages.

VI. Unions. See Shaw, BE, pp. 219-226. History. Ideals. Tactics: direct strikes, sympathetic strikes, boycotts.

VII. Cases in Shaw.

AIDS.

Malt.

Union discrimination.

Old Smoke.

VIII. Organizational influence in private lives.

See Shaw, BE, pp. 237-241. Equal Employment Opportunity Commission (EEOC). Male exotic dancer. Gun. “Mooning.” Involvement in civic activities. Health programs. Intensive group experience.

IX. Obtaining information.

See Shaw, BE, pp. 243-251. Informed consent. Polygraph tests. Personality tests. Monitoring employees on the job. Drug testing.

X. Working Conditions.

Discussion topic: OSHA is a toothless tiger that has moved from beat cop to social worker. Should character and integrity within organizations determine the health and safety of the workplace?

McWane has an extensive record of environmental violations. McWane plants have been found in violation of pollution rules and emission limits at least 450 times since 1995. Workers who protest dangerous work conditions are often bull’s-eyed—marked for termination. Supervisors routinely run roughshod over safety and environmental laws that interfere with production in the slightest. They dump polluted water under cover of night. They bully injured workers. They intimidate union leaders.

See Shaw, BE, pp. 250-256. Health and safety. OSHA, New health challenges. Management style. Day care and maternity leave.

XI. Redesigning Work.

See Shaw, BE, pp. 256-260. Dissatisfaction on the job. Quality of work life (OWL).

XII. Cases from Shaw.

Testing for Honesty.

She Snoops to Conquer.

Protecting the Unborn at Work.

The Mommy Track.

Prof. Douglas Lamont, 2/21/03, revised 3/10/04.

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