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Sherri Cruz

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Digging Into Unethical Corporate Behavior

Sherri Cruz, Business Journalist 5/4/2012 23 comments
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In the past two decades, a parade of companies has imploded in the wake of unethical and fraudulent business practices, leaving investors shaken and scorched. Enron Corp. is perhaps most notorious. Executives embezzled funds from investors, and as Enron teetered on bankruptcy, it misrepresented its financials and may have even created a false energy crisis. Investors lost more than $70 billion.
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The charismatic Bernie Madoff, who was a well regarded and trusted financial investor and philanthropist to boot, fooled investors and got the best of the Securities & Exchange Commission, which has reportedly since tightened up. Madoff operated legal and illegal operations. His illegal entity ran a Ponzi scheme, using revenue from new investors to pay existing clients. Shareholder losses from Madoffs actions amounted to $20 billion. WorldCom and Tyco International have become synonymous with white-collar crime, thanks to unscrupulous behavior by a select few business executives within those companies. Bad executive behavior can lead to sales declines and tanking stock prices, and sometimes, a companys demise. Enron brought down itself and a former big five accounting firm, Arthur Andersen. Companies not in any danger of collapsing, but recently shown to have ethical lapses that could signal bigger problems within the company include Chesapeake Energy Corp. (NYSE: CHK), WalMart Stores Inc. (NYSE: WMT), and News Corp. (Nasdaq: NWS). The SEC is investigating Aubrey McClendon, chief executive and cofounder of natural gas company Chesapeake Energy, for borrowing as much as $1.1 billion in undisclosed loans to boost his financial stake in Chesapeakes oil and gas wells. The board now says it will end McClendons eligibility for the companys Founder Well Participation Program. The company is also replacing McClendon as chairman. Wal-Marts Mexican subsidiary allegedly bribed foreign officials to more quickly get building permits for new stores, which is illegal under the US Foreign Corrupt Practices Act. Wal-Mart isn't the only company being investigated for unethical behavior in foreign countries. The federal government is investigating 81 public companies. (Meanwhile, business trade groups who are no fan of the Foreign Corrupt Practices Act are calling for amendments and clarifications as to what constitutes improper behavior under the law.) The scandal also brings up a question for US companies operating globally: Should companies have different ethical standards depending on the country theyre operating in, or should they always be guided by one standard? The fallout of the scandal has been immediate, affecting WalMarts ability to open new stores in the US, which could eventually hurt business and shareholders. Nearly a year after London-based News Internationals phone-hacking scandal, its parent, News Corp., is still mired in muck. News Corp.s leader, Rupert Murdoch, was deemed unfit to run his company by a group of British lawmakers. The company has been accused of trying to cover up unethical behavior instead of tackling the problem head on, which can make matters worse. I would actually prefer a company that has had fraud, has had problems, and then you want to see how they clean it up, said Joan Pastor, chief executive and managing partner of JPA International Inc., which consults on preventing white-collar crime and other business issues. If a company swiftly addresses ethical issues, it can mitigate the damage, even put the company in a favorable light. Sometimes it seems unethical behavior is commonplace in business, especially considering the

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Sometimes it seems unethical behavior is commonplace in business, especially considering the subprime housing collapse, when an entire industry appeared to conspire to make a profit, without any ethical considerations. In the wake of the subprime meltdown in 2008, MBA students took to signing "The M.B.A. Oath" -- pledges that they would be ethical once they began their careers in business. What causes executives to become shareholder nightmares? Psychologists say most of us are capable of ethical lapses, and people in business are no different. Pastor, a licensed organizational and clinical psychologist, classifies white-collar criminals as one of two types: the normal person, with a moral conscience and a sense of empathy, who under certain circumstances might act unethically, and the person who has no moral conscience or empathy and is prone to be deceitful. The people who lack a conscience are the people who can do the most damage. Often motivated by money, theyre attracted to business and will seek out companies that are easy to exploit, ones with weak internal controls, says Pastor. They have a compulsion to gain for themselves, she says. Other characteristics of white-collar criminals include a lack of remorse, a tendency to blame their victims, and a sense of entitlement. They can be brilliant and charismatic. These people can be very charming, Pastor says. Some of these people are so bright, theyre just bored. Its not only the people at the top of the corporate ladder who can have ethical lapses. It can happen at any rung in business. But ethical lapses at the top can result in lax ethics throughout the company. Investors can look to a companys management team and corporate culture for warning signs. Does the company make ethics a priority? Do executives act swiftly when an ethical problem arises? Does the company have tight fiscal controls? Does the company have a lot of turnover? Does the company have a good corporate culture -- do people like working for it? Red flags can also be spotted in company financials, especially the footnotes, where crucial information often is buried. Footnoted.com is perhaps one of the best sources to check out before investing in a company. In 2009, Footnoted signaled Chesapeake Energys current problem with its post on the "worst footnote of the year." (Chesapeake spent $12.1 million to purchase McClendons antique map collection. Founded by Michelle Leder, and now part of Morningstar Inc. (Nasdaq: MORN), Footnoted explores the footnotes of companies earnings releases, 10-Ks (annual reports), 10-Qs (quarterly reports), and other financial filings, for signs that a companys financial outlook might not be as rosy as it appears. Company financial filings can be found in several places, including the most comprehensive site, the SECs Edgar. Related post: Investors Pay for Dubious Corporate Ethics
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Re: You can never cut a good deal with a bad guy philtheinvestor 5/12/2012 10:57:46 AM

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Is it safe to assume then that executives that exhibit the opposite of the characteristics are doing a GOOD job or are righting the ship at their companies? It still seems like a tough call.
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Re: You can never cut a good deal with a bad guy yalanand 5/7/2012 1:31:47 PM

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Like 5,430 people like Investor Uprising.

@Drivewaygirl, luckily i had a hedge position which reduced my losses. But still this kind of movements in the stock eats up all your investment.
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Re: You can never cut a good deal with a bad guy Drivewaygirl 5/7/2012 1:26:13 PM

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Joshua Mardanus Irobeyde Heather Wendy

Sorry to hear that @Yalanand. Fingers crossed, I've never had anything that bad yet!
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Re: You can never cut a good deal with a bad guy yalanand 5/7/2012 12:49:11 PM

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Top 10 IU Hot Topics

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@Scott, its called IRB infrastructure. It's one of the frontline infrastructure stocks listed in India. The stock lost more than 30% within a week when news came that the chairman of company is being investigated by police in connection with the murder.
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Re: You can never cut a good deal with a bad guy Value Hiker 5/7/2012 11:46:27 AM

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@yalanand, investment is about probability. There is no such thing called sure thing. All our efforts shall focus on improving our chance of winning. No matter how good and careful we are, we will make mistakes like one you mentioned. By screening the management team, we can lower the chance of being wrong, that is good enough.
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Re: You can never cut a good deal with a bad guy Noreen Seebacher 5/7/2012 11:20:03 AM

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But then there is Best Buy. Brian Dunn leaves abruptly under questionable circumstances last month and the stock tumbles just around 8%. It's almost like the market welcomed his departure.
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Re: You can never cut a good deal with a bad guy Noreen Seebacher 5/7/2012 11:15:39 AM

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Murder charges make Yahoo Chief Executive Officer Scott Thompson's resume lies look pretty innocuous!
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25 market-moving companies we're tracking

Re: You can never cut a good deal with a bad guy Scott Raynovich 5/7/2012 11:07:09 AM @yalanand,
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Investor Uprising 25 Agrium, Inc. America Movil S.A.B. de C.V. ADS Apple, Inc. Atwood Oceanics, Inc.

1045.17 +10.88 (+1.05%) 83.79 24.73 585.78 38.18 34.66 65.93 48.81 59.93 42.50 13.16 14.47 50.21 4.84 28.04 24.21 29.84 50.85 14.24 673.50 56.77 36.83 27.93 28.58 33.26 31.62 +1.62 (+1.97%) +0.62 (+2.57%) +11.65 (+2.03%) -0.76 (-1.95%) +0.38 (+1.11%) -0.23 (-0.35%) -0.17 (-0.35%) -0.57 (-0.94%) +0.23 (+0.54%) +0.30 (+2.33%) +0.52 (+3.73%) -0.08 (-0.16%) +0.01 (+0.21%) -0.17 (-0.60%) -0.66 (-2.65%) -0.18 (-0.60%) +0.57 (+1.13%) +0.13 (+0.92%) +14.09 (+2.14%) +0.27 (+0.48%) -0.02 (-0.05%) +0.55 (+2.01%) +0.18 (+0.63%) -0.02 (-0.06%) +0.61 (+1.97%)

Wow, that is quite a story. Which stock was that?

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Re: You can never cut a good deal with a bad guy yalanand 5/7/2012 5:28:12 AM

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Broadcom Corp Celgene Corp Cliffs Natural Resources Cognizant Technology Solutions Dolby Laboratories Inc. Cl A Eldorado Gold Corp.

Both Warren Buffett and Philip Fisher warned investor to check the integrity of management team before any investment.
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@Value Hiker, but its not easy to get the info about the integrity of management team. For example recently I invested in one stock after doing all the research, but the stock fell 35% in a single week after the CEO of the company was booked under murder charges. You can never know such facts about the CEO/CFO's.

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First Solar, Inc. Gilead Sciences, Inc.

Re: You can never cut a good deal with a bad guy yalanand 5/7/2012 5:21:08 AM

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GT Advanced Tech Johnson Controls, Inc. Marathon Oil Corp. Microsoft Corp Newmont Mining Corp.

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@Value Hiker, very good suggestions Value Hiker. One more important point is always track the CEO/CFO's on the board. Many a times when company is in trouble CEO/CFO quit suddenly. I have seen stocks in free-fall when the top-executives quit the company.

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Omnivision Technologies, Inc. Priceline.com, Inc. Qualcomm, Inc. Sandisk Corp Southwestern Energy Co. Suncor Energy, Inc. Veeco Instruments, Inc. VistaPrint NV

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