Case study (Chapter 14)

Should Terry blow the whistle?

Many companies listed on the Hong Kong Stock Exchange are family firms with a minority of the
voting shares available to the public.5 Under the Listing Rules of the Stock Exchange, public
companies must have a minimum of three INEDs on the board, at least one of whom must have
professional qualifications in accounting or financial management expertise.

LTN Manufacturing was a typical case. Founded by K. L. Lee in the 1970s, the company started
as a furniture maker in the Wan Chai district of Hong Kong, but over the years had developed into
a significant shop-fitting business and supplier of stands for exhibitions. Mr Lee, who was the
major shareholder and chair/managing director, had a paternalistic management style and
continued to play a hands-on role in the day-to-day management. The Lee family held 59 per cent
of the voting shares, the balance being held by international and local institutional investors and
Hong Kong people.

Terry, Tam Tat Sing, joined the company in 2002 as internal auditor, reporting to Mr Lee. Terry had
trained with one of the Big Five accounting firms and was a member of the Hong Kong Institute of
Certified Public Accountants (HKICPA).

To his surprise, Terry received an anonymous letter, alleging that the head of the purchasing
department had incorporated a company, which was invoicing LTN with goods that were not
being supplied. The head of the purchasing department, K. K. Poon, was an executive director of
the company. He was also married to Mr Lee’s sister. However, Terry knew that if these allegations
were true, this was a serious situation, and as internal auditor he needed to investigate.

With the help of his staff, Terry began checking the goods-inwards records with invoices. After a
while it became clear a company was being paid for goods that had not been delivered. All the
invoices from this company had been approved by Mr Poon but entries in the goods-inwards
records were missing. Terry traced the fraudulent payments for the past two years and had a
colleague double-check his figures. Now what should he do?

He wrote a confidential report to Mr Lee, explaining the situation, suggesting that it was serious
and should be referred to the board of directors, including the INEDs, for a decision on the
appropriate action to be taken. Alternatively, he proposed that the independent external auditors
or the firm’s lawyers should be notified.

Terry was surprised at his managing director’s reaction. Lee defended Poon, accused Terry of
acting without proper authority, and said he had been over-zealous. Lee said:

You should have referred the anonymous letter to me immediately. I would then have decided how
to react. Remember this is a family business. My family and I own most of the shares and we
decide how to treat issues like this. Personally, I ignore people who write anonymously. Clearly
they lack the courage of their convictions. It must have been somebody in the company. I want
you to find out who it is, tell me, and I’ll make sure they don’t cause any more trouble.

Lee went on to say that he did not want the matter taken any further and certainly not referred to
the board. He said:

Mr Poon has worked for this company for many years and is a respected member of staff, and of
my family. I have studied your report in detail and, in fact, the amounts involved are not
significant. There is no need to involve the board at all in any of this.

As a trusted employee, Terry did as he was told: he did not involve the board, he did not inform
the auditors or the lawyers, neither did he seek the advice of his professional organization, the
HKICPA. Instead, as instructed, he began an inquiry into all the employees who could possibly
have known about the alleged fraud. And he found the whistle blower. Under cross-examination
she admitted writing the letter. Now what should Terry do?

He gave the details to Mr Lee, who said that the company wanted to keep the matter private and
that the whistle blower should be offered a substantial payment if she resigned from the company,
having signed an agreement not to disclose the matter to anyone.

Discussion questions

1. Why did the whistle blower make the original claim?

2. Did Terry do the right thing in just informing Mr Lee?

3. What should Terry do, if anything, about Mr Lee’s decision to pay off the whistle blower?