The very real challenge of unethical business practices

Deep within the nebulous realm of human behaviour lie the fundamental concepts of ethics. It encompasses notions of morality, integrity, and right and wrong, but even the most detailed definition of ethics fails to capture the many shades of grey that colour the real world. And when it comes to the business world, ethics can take on a particularly murky hue.

While we’d hope that business leaders would know right from wrong, and always choose to do what’s right, recent history tells a different tale, says Dr Rosamund Thomas, director of the Centre for Business and Public Sector Ethics in Cambridge, UK. And things are getting worse.

“What is somewhat sad, and reflects the complexity of globalisation, is that ethical cases have increased greatly,” asserts Thomas, who spoke on business ethics and the accountancy profession at a CPA Australia event in Melbourne.

Thomas was The Gourlay Visiting Professor 2014 in the Ethics of Business at Trinity College in The University of Melbourne.

The corporate landscape has been tainted by numerous scandals since the Cambridge ethics centre was founded in 1988. The US saw the catastrophic collapse of Enron in 2001 and the exposure of Bernie Madoff’s fraudulent Ponzi scheme in 2008.

Japanese camera and endoscope maker Olympus is facing lawsuits from six banks seeking compensation over false financial statements issued by the company from 2000 to 2011. And the UK’s GlaxoSmithKline pharmaceutical company crossed the ethical line last year when it was found guilty of bribery in China.

In the US, the Sarbanes-Oxley Act of 2002 – conceived in the aftershocks of the Enron collapse – created new standards for corporate accountability. Other nations have enacted similar reforms to financial disclosure, including CLERP 9 in Australia, more formally known as the Corporate Law Economic Reform Program (Audit Reform & Corporate Disclosure) Act 2004.

Yet determining right from wrong is not always so black and white. And this prompts the question – to what extent can ethical behaviour be regulated? Tax evasion is illegal. Tax avoidance, while perhaps unethical, is not. Lying in court is a criminal offence. Lying by business leaders, while immoral, is not necessarily against the law.

“There’s quite a lot of lying that goes on in different ways,” says Thomas, who has assisted organisations from the Bank of England to British manufacturers with ethical and corporate social responsibility (CSR) issues.

“The tightening up after Enron made it harder to lie because there’s now more disclosure, so I suppose the answer to unethical behaviour is transparency. But that, too, has to be watched by the accountancy profession: Has a company disclosed everything that they ought to be disclosing?

“All the financial statements should be shown, yet with the Olympus Corporation in Japan, there was a lot of fraud proven in court and a lot of it was off balance sheet. So how much of this is still going on? Was that an isolated case with [Olympus]? With some companies having their offices offshore and passing money and profits back and forth, how much is really clear on the balance sheet and how much is it being passed through different jurisdictions?”

She insists that any effective framework for ethical conduct requires a combination of “hard” legal requirements and “soft” law including codes of practice, codes of ethics and conventions such as the UN Global Compact. Neither hard nor soft law is adequate on its own.

Hard law usually comes with a regulatory framework, but it takes time to enact and amend, compliance costs can be high and, as was the case with Sarbanes-Oxley, it’s often introduced after the horse has bolted.

As Thomas sees it, there’s a worrying lack of forethought. Governments tend to wait until the unethical behaviour has happened before they react.

“They’re not really being proactive to see that something is likely to be an issue in the future and that something should be done about it now, whether it’s through codes and soft law or through legislation,” she says.

“There’s that time lag where the unethical behaviour is not addressed, as is the case with tax avoidance loopholes.”

A prime example is the European tax loophole dubbed the “Double Irish with a Dutch Sandwich”. This allowed multinational companies – Google, Apple and Amazon among them – to avoid paying a significant proportion of tax by shifting profits made in one country to the accounts of a subsidiary in another lower taxing nation.

Profits would be sent through one Irish company, for example, then to a Dutch company, and finally to a second Irish company headquartered in a tax haven.

While the EU’s “anti-abuse” rule, designed to curb such aggressive corporate tax avoidance, was first flagged at the end of 2012, it took a full two years to implement – not coming into force in all member states until 31 December 2014. In the meantime, Amazon reportedly paid only £4.2 million in UK taxes in 2013, despite its sales of £4.3 billion.

“Who sets the laws?” asks Thomas.

“If it’s the legislators rather than professional bodies like accountants, have they really got it right? Do companies understand it? Could it be simpler?

“If you look at legislation today, it’s far too complex. It’s too long. It tries to put too many things in the same law and the legislation can be quite hard to follow. I suppose we are in a more complex global situation and so the legislation itself has become more complex, but I think it’s also that we’ve lost some of the quality of sharp, good drafting.”

She firmly believes the accounting profession has a key role to play in ensuring ethical behaviour.

“Accountants need to be working hard to ensure that they are speaking out when they see issues. It was clear in the Olympus case that there were malpractices going on,” she says. So should auditors be speaking out more? Thomas believes they should.

 

"Membership organisations are responsible for the standards of qualifications and ongoing education and training, so ethics must be an important part of that."

 

“There has been a separation between the advisory role of accountancy firms and the auditing role so that one doesn’t affect the other necessarily. But are individual auditors not speaking out when they see something because they’re afraid of losing the business or are they just not doing their job properly?”

Soft law is designed to encourage best practice, but it often lacks adequate monitoring, according to Thomas. At some companies, the mere act of crafting a code of ethics is seen as fulfilling their moral obligation; whether or not it’s followed is less of a concern.

“Companies often pay more attention to publishing CSR reports than they do to ensuring the ethical behaviour of their management and employees,” she observes.

Nor are CSR and ethics exactly the same thing.

“Business and professional ethics really deal with integrity, trust, fairness, honesty, morality. Corporate social responsibility is looking at the social, environmental and human rights aspects of doing business.”

She cites Quaker companies of the past – Rowntree, Cadbury, Barclays, Lloyds, Clarks and Friends Provident – as exemplars of corporate responsibility. “That was their ethos when they built model factories and [promoted] adult education. They really cared for their staff.

"That was until 1939. Somehow, with the war intervening, we moved in business to a quantitative method and we left behind some of the qualitative emphases.

“Although it took time to build up, companies now are very much aware that they do need to be demonstrating their CSR credentials. [However] it can be a public relations exercise to put a CSR report on your website – the same company can be doing unethical or perhaps illegal practices elsewhere.”

But some companies are taking a very positive, proactive approach to ethical conduct. For example, Norwegian energy company Statoil makes ethics and anti-corruption training mandatory for all employees. Other organisations, says Thomas, could benefit from that sort of education.

“To put that into the training and into the code of how you should behave is a good thing. There should be education and training and seminars to explore issues like what is aggressive tax avoidance and what is just good planning of tax for a company. Where is the middle line between those two?”

She believes that professional organisations for accountants and other finance specialists have a very important role to play in shaping ideal ethical and governance frameworks.

“Things are moving all the time. You can get quite ingenious people within companies and within government who will go ahead and move to new unethical issues, so it does mean being proactive and looking ahead rather than just taking the issue as it is at the moment.”

Values of honesty and integrity apply equally to the private and public sectors, declares Thomas. “The context in which they operate is different … but the fundamentals are the same and you’d think that some of our senior politicians who have fiddled their expenses would know that that is dishonest and not the way to go. The damage to reputation is simply not worth it.

“It’s temptation without thinking it through, and it’s the same with recklessness by bankers,” says Thomas, pointing to the Royal Bank of Scotland, which had to be bailed out with £45 billion of UK taxpayers’ money after poor management decisions, including a takeover of Dutch bank ABN Amro in 2007, left it with dangerously low levels of capital. ABN Amro had been heavily exposed to the Collateralised Debt Obligations (CDOs) built on subprime mortgages that sparked the 2007 global financial crisis.

“It was the desire of the Royal Bank of Scotland to grow into an important global bank – and it took over another bank without doing sufficient due diligence. This recklessness, which ultimately caused the bank to fail, was a case of succumbing to a short-term temptation to grow without looking at the long-term consequences,” she says.

“It really needs to come from the top,” Thomas adds. “How do you make good decisions and how do you look at the outcomes? Perhaps those at the top think they know it all.”

Ponzi plunders

Bernie Madoff's Ponzi Scheme 2008: New York business investment adviser Bernie Madoff fleeced investors in a Ponzi scheme that spanned decades. It all unravelled when investors started asking for their money back. It's estimated Madoff scammed US$20 billion from investors, using money deposited by new Ponzi victims to pay out "returns" to older investors. He revealed the truth to his sons in 2008, and in June 2009 was sentenced to 150 years in jail.

Googling Tax: Google Inc. is a healthy, wealthy company. So wealthy, that in 2012 it shifted US$9.8 billion of revenue to a shell company in Bermuda, which has no corporate income tax. According to Bloomberg, the amount Google shifted to Bermuda "was equivalent to about 80 per cent of Google's total pre-tax profit in 2011."

Picture This: Michael Woodford was appointed CEO of Japanese lens company Olympus in 2011, and quickly discovered the company was disguising its business losses as write-offs. (For example, US$700 million in "advisory fees" to an entity in the Cayman Islands.) Woodford found these unusual transactions stretched to the 1990s and totalled around US$1.7 billion. He was dismissed by the board.

When Giants Fall: Energy and services corporation Enron had been named "America's Most Innovative Compay" by Fortune, but its massive revenue claims had been supported only by institutionalised misleading accountancy and corruption. Its collapse in 2001 brought financial ruin to many smaller companies and individuals.

Chill Pill: In 2014, British pharmaceutical giant GlaxoSmithKline (GSK) was found guity of bribery and ordered to pay a fine of 3 billion yuan by a Chinese court. GSK sales executives were accused of paying Chinese doctors to use the company's pharmaceuticals.

Amazon's Luxembourg Trek: Amazon's British business had sales of £4.3 billion in 2013, but it paid just £4.2 million in tax. How? When a shopper in Europe made a purchase from one of the company's local websites, that payment was picked up by a subsidiary in Luxembourg - a low-tax jurisdiction.

Who inspires Dr Rosamund Thomas?

Dr Rosamund Thomas has spent much of her career examining ethical aspects of business. She is inspired by the ethical capitalism pursued by Quaker-owned businesses in the 19th and 20th centuries, and also by the writings of 1930s management theorist Chester Barnard (1886-1961).

The son of a mechanic, Barnard developed ideas in the real world of business. He worked for AT&T for 40 years, became president of the New Jersey Bell Telephone company in 1927, and in 1948 was elected president of the Rockefeller Foundation.

Barnard saw organisations as running on a cooperative system, and wrote that the main function of an executive was to develop effective communications. His ideas on how executives must manage them - although not popular in the 1930s - have now become an important part of corporate social responsibility and business ethics."