Does size really matter?

At large companies do senior managers and the boards really know whether risks throughout their organizations, supply chains and distribution channels are fully identified and contained?

The recent troubles at Toyota, Massey Energy, Boeing (787 program delays), BP (Transocean, Ltd.), Goldman Sachs and others suggest that senior management and the board may not have the infrastructure in place to adequately identify, analyze, determine, contain and fully disclose risks.

BP Chief Executive Officer Tony Hayward’s initial reaction to the explosion on the Transocean rig in the Gulf was reportedly one of “what did we do to deserve this,” which suggests that he was either relying on luck to keep his promise to focus on safety “like a laser,” or BP lacks the infrastructure to identify and contain risks.

To identify risks you have to go directly to the source.  A new and innovative online information service (http://www.zethics.com) provides corporations, public and private, the tools to identify risks at the source.

Providing employees a structured process to disclose information about the company’s fundamental strengths and weaknesses is an internal audit best practice, and provides internal auditors the opportunity to analyze and determine the level of risk while providing management at all levels of the organization the opportunity to contain and fully disclose risks.

By disclosing risk information directly to stakeholders, the online forum allows shareowners and investors the opportunity to actively engage companies within their equity investment portfolios to accomplish responsible ownership goals and better position their portfolios to achieve long-term sustainable risk adjusted returns.

zEthics offers top management and the board a unique opportunity to gain investor confidence and trust by proving to shareowners, regulators and the public that risks have been identified, contained and fully disclosed.

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Rebuilding Goldman’s Social License

While millions of Americans remain unemployed, Warren Buffett and Goldman Sachs are doing pretty well.

At the annual shareholder meeting of Berkshire Hathaway, Inc., Warren Buffett was quoted, “We love the investment ($5 billion investment in Goldman Sachs Group Inc).  I do not hold against Goldman the fact at all” that the SEC sued. He said it did not fall “within my category” of where reputational issues would call into question the Berkshire investment (as reported by MSNBC.com, 01May10).

Why didn’t Warren Buffett just say, I don’t care how Goldman makes its money just as long as Goldman keeps making money, whether its legal or not.

The question remains, has Goldman endangered its most valuable intangible asset – it’s social license.  As defined by Daniel Gross (Newsweek, 03 May 2010), “Social license is… something like reputation. Social license describes how a company plays with others and how it responds to problems.”

British Petroleum, “which has followed up a disastrous refinery explosion with a disastrous oil spill in the Gulf of Mexico, is in the process of squandering its social license.”

A list of companies that have squandered their social license include Author Anderson, Enron, and Lehman Brothers, to name a few.

According to Gross, “Goldman makes most of its revenues from trading on its own accounts, but it made its name, and established its brand, in investment banking and asset management, two businesses that depend almost entirely on customers thinking they are getting good advice and treatment.”

So what can Goldman do to regain its social license and avoid the same fate as Author Anderson, Enron, and Lehman Brothers?

A startup offers Goldman a viable and cost effective alternative.  The online information service (http://www.zethics.com) provides U.S. corporations, public and private, the tools to identify, contain and fully disclose risks directly to shareowners and investors – improving the governance, control, and risk management process.

Providing employees a structured process to disclose information about a company’s fundamental strengths and weaknesses is an internal audit best practice.  The online forum allows investors to see across all departments, regions and silos of the enterprise to ensure top management is adequately addressing risk oversight, corporate strategy, transparency, and executive compensation.

The term “black box” is being bandied about by commentators, referring to the utterly mysterious ways that financial institutions like Goldman conduct their businesses — totally opaque to outsiders’ eyes, reveling in their secrecy, and resisting transparency that would allay suspicions of behavior “unfriendly” to markets in general and their trading partners in particular (Jim Kristie, editor and associate publisher of  Directors & Boards).

To quote Leon Mr. Panetta, “Exercising oversight in the sanctity of the boardroom and proving that you have done it are two different things. In order to restore trust, boards have to prove it, (Directors & Boards, 2003).”

zEthics offers top management and the board at Goldman a unique opportunity to restore trust by proving it to shareowners, regulators and the public.

In Goldman Sachs we Trust!

MSNBC news service recently reported, “Goldman Sachs executives asserted the bank would ‘never intentionally mislead anyone’ as it defended itself… against government civil fraud charges,” (MSNBC.com, April 2010).

How can the court of public opinion believe such a statement from Goldman Sachs executives after a second financial crisis in a decade has devastated working class American’s retirement portfolios, due in no small part to corporate corruption, fraud, and poor management (Enron, Tyco, Worldcom, AIG, GM, Lehman Brothers, etc., etc.)?

The Securities Investor Protection Corporation (SIPC) was set up by Wall Street to protect investors when broker dealers failed.  Essentially, SIPC is a nonprofit membership corporation funded by its members, including Goldman Sachs.  Until recently, the annual SIPC premium paid by Bear Stearns, Lehman, Goldman Sachs, JP Morgan, and others for more than the past decade was only $150.  It took only one failure to use up the money.  The Madoff scam devastated the SIPC fund.  To the public, this appears to be yet another fraud perpetrated by Wall Street on investors. 

The Financial Industry Regulatory Authority, Inc., or FINRA is a private corporation which functions as a self-regulatory organization (an organization that exercises regulatory authority over an industry or profession).  FINRA performs market regulation under contract with brokerage firms and trading markets.  It focuses on regulatory oversight of all securities firms that do business with the public.  FINRA regulates by adopting and enforcing rules and regulations governing its members’ business activities.

FINRA has displayed a potential massive conflict of interest in its dealing with its internal investment portfolio. A clear example is FINRA’s behavior with its Auction Rate Securities (ARSs).  Going into 2007, FINRA had $647 million dollars of ARSs.  FINRA sold its ARS holdings before the markets collapsed.  Meanwhile, investors got stuck with approximately $150 billion of ARSs.

“One would have to be exceptionally naïve to think FINRA officials did not have material, nonpublic information on the ARS market before it decided to sell its holdings. Having information about the securities and acting on it without that information being available to the public would potentially qualify as front-running and insider trading,” (Larry Doyle at Sense on Cents).

FINRA’s head at the time, Mary Schapiro, was called a ‘dear friend’ by Mr. Madoff.  Now Ms. Schapiro is the head of the U.S. Securities and Exchange Commission (SEC).  Congress and Mary Schapiro should be telling FINRA to provide transparency, but they’re not.  This is the power of Wall Street lobbying, it’s business as usual.  Wall Street has turned into a massive oligopoly.

When FINRA was formed, SEC Chairman Chris Cox said, “The consolidation of NASD’s and NYSE’s member firm regulatory functions is an important step toward making our self-regulatory system not only more efficient, but more effective in protecting investors.”

It’s all about confidence.  Americans may not know about FINRA, but they do know the financial system is plagued with corruption, and Goldman Sachs appears to be part of the problem.

Similarly, The Public Company Accounting Oversight Board (PCAOB) is a private-sector, non-profit corporation created by the Sarbanes-Oxley Act, a 2002 United States federal law, to oversee the auditors of public companies.  Its stated purpose is to “protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports.”

Yet auditors don’t find fraud.  How can you “protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports” if you don’t find and report fraud?

Caveat emptor (buyers beware), when a company fails, such as Lehman Brothers, the investors are at fault for not doing their due diligence; i.e., for not investigating further beyond the usual sources of material, public information. 

How can the American public truly believe Goldman Sachs executives “never intentionally mislead anyone?”

If Goldman Sachs were serious about earning the public’s trust, a group of finance and accounting professionals, with first-hand knowledge of corporate fraud, have created an online forum (http://www.zethics.com) that provides employees a structured process to anonymously disclose information about corruption, fraud and poor management to investors and the public.

Recent studies indicate that employees find more corporate fraud than regulators.  Providing Goldman Sachs’ employees an opportunity to anonymously disclose information about the business practices of the company and its executives is an internal audit best practice, and will go a long way to prove executives at Goldman Sachs can be trusted by the public.

The website also provides shareholders and equity investors the tools to build an ethical framework to accomplish responsible ownership goals by providing transparency into the companies they own.

According to Andrew KcKeon, Gus Levy, one of the legends of 20th Century finance and an icon in the growth of Goldman Sachs, in response to a question about his firm’s motivations once said, “Yes at Goldman we are greedy. But we’re long-term greedy.”

Perhaps it’s time Goldman Sachs put its money where it’s mouth is!

The fall of the Big Accounting Firms

A recent survey suggests some investors would like auditors to identify their clients’ key risks as well as highlight areas that could possibly have questionable estimates made by management (2008 Center for Audit Quality Institute survey).

“Investors want to know where the high risks are,” said Mary Hartman Morris, a California Public Employees’ Retirement System investment officer.

Unfortunately, the disclosure of financial problems at public companies tends to come after the fact.  Auditors don’t examine every transaction and event, so there is no guarantee that all ma­terial misstatements, whether caused by error or fraud, will be detected.

The audit report — which is the sole communication between auditors and investors on a particular company — explain the auditors’ role and their limitations in finding fraud, “If the discovery of material errors and fraud is not a major part of what the audit is about, it is not clear what value-added service the auditor offers the investor and capital markets,” (Andrew Bailey, University of Illinois accountancy professor emeritus).

So if the big accounting firms refuse to find fraud and ma­terial misstatements, then who will.

A group of finance and accounting professionals offer an innovative new solution to identify key risks as well as highlight areas that could possibly have questionable estimates made by management. Their online forum, http://www.zethics.com, provides employees a structured process to anonymously disclose information about fraud and ma­terial misstatements.

Investors need assurance that the companies within their portfolio will not be the next highly publicized failure. To give them that assurance, investors must have the ability to identify the potential causes of such failures.

Disclosing fraud and ma­terial misstatements online is an internal audit best practice and assures investors that the companies within their portfolio will not be the next highly publicized failure.

To investors, information is knowledge, and knowledge is power.  Improved internal transparency from an independent third party arms investors with comprehensive information about the quality of the business and strength of the management team.  This information serves as a check and balance against the information provided by management as well as auditors and outside consultants.

The online forum aims to demonstrate that transparency can work.  When information is relevant, standardized and public, it fosters intelligent decision-making.

Cost Effective Strategy to Accomplish Responsible Ownership Goals

A Manhattan federal judge recently dismissed a shareholder lawsuit accusing current and former American International Group Inc executives and directors of ignoring “red flags,” leading to the insurer’s near collapse and need for more than $180 billion in cash and loans it received from taxpayers.

Shareholders led by the Louisiana Municipal Police Employees’ Retirement System pension fund failed to show enough facts creating a reasonable doubt that the directors were disinterested and independent, or failed to properly exercise their business judgment.

In a written response to the lawsuit filed by shareholders in a New York federal court, AIG conceded that its executives were, at times, too optimistic, but denied any intent to deceive investors, “Being wrong or even unwise, in hindsight, is not the same as violating the securities laws.”

In defending itself against the shareholders’ lawsuit, AIG contended, “Statements of optimism about the future…that turn out to be wrong are simply not actionable. Even in times of market turmoil, the company need not presume the worst about its market prospects.”

To federal prosecutors, investment professionals and shareholders, how do you know where delusion ends and dishonesty begins; how do you distinguish the difference between incompetence and ill intent?

The Securities Act of 1933 requires that information provided to investors is accurate – Investors who purchase securities and suffer losses have important recovery rights if they can prove that there was incomplete or inaccurate disclosure of important information.

With this Act, Congress created the Securities and Exchange Commission. The Act empowers the SEC to require periodic reporting of information by companies with publicly traded securities.  The Act empowers the SEC to enact regulation to ensure transparency.

“The point of regulation is to increase transparency. You can call it regulation, but you’re just shining a light on a murky opaque process that, most recently, brought this economy down”

(Michael Oxley, Sarbanes-Oxley Act of 2002).

“If you read any of the books that have come out, from Hank Paulson’s book [On the Brink] to Too Big to Fail, the common thread is an incredible lack of transparency and no accountability.”

According to Richard Lochridge (Board Member, PetSmart, Lowes), “the board is a slow vehicle for figuring out when there is a problem and taking appropriate action. Management is hesitant to tell the whole truth; the board doesn’t know nearly what management knows; and, board members don’t always pay attention to all that’s going on.”

The burden to find out what really goes on inside a company rests solely with investors. Investors must do their due diligence to ensure that a company discloses the real state of the business.

Companies with more than $10 million in assets whose securities are held by more than 500 owners must file annual and other periodic reports. Public companies use these financial statements to communicate with investors.  Financial statements give investors a clear picture of the past – a look in the rear view mirror. 

But investors are also interested in where the company is going – a look out the windshield. Companies also use press and earnings releases to communicate with investors and the public. Unfortunately, earnings releases are currently unaudited and not subject to internal controls.

Today, transparency into publicly traded companies is amorphous.  Information is often incomplete, irrelevant or outright incomprehensible.

Investors need assurance that the companies within their portfolio will not be the next highly publicized failure. To give them that assurance, investors must have the ability to identify the potential causes of such failures.

Investors become very upset and pay attention to corporate governance only when they’re losing money. After a bull market has been underway for some time investors become confident and complacent, until once again they are blind-sided by corruption, fraud and poor management.

After a second financial crisis in a decade, some shareholder advocates are now pressuring Corporate America to rein in hazardous pay practices, hold directors of corporate boards more accountable, and improve oversight of risk.

“It’s time for lawmakers to hold the line and do what’s right for investors. . . . Reform should not be what is in Wall Street’s best interests,” said Amy Borrus, deputy director of the Council of Institutional Investors. “It’s not just enough to overhaul the regulatory architecture. We need market-based discipline. Investors need the tools to hold the directors’ feet to the fire.”

The key to their success will depend largely on improved internal transparency, preferably via an independent third party.

Employees have the highest success rate for uncovering fraud and find more corporate fraud than regulators, according to the latest research by Alexander Dyck, Adair Morse, & Luigi Zingales (September, 2009).

The Investor Protection Act making its way through Congress intends to expand the authority of the US Securities and Exchange Commission, in any action in which it levies sanctions in excess of $1 million, to compensate employees with up to 30% of the amount of the sanctions; i.e., employees share in awards up to $300,000 for every $1 million the SEC levies in sanctions. 

A group of finance and accounting professionals have created an online forum, http://www.zethics.com, where employees can submit information anonymously about the business practices of the company and its executives to share in these awards.

This online forum aims to demonstrate that transparency can work.  When information is relevant, standardized and public, it fosters intelligent decision-making.

To investors, information is knowledge, and knowledge is power.  Improved internal transparency from an independent third party arms investors with comprehensive information about the quality of the business and strength of the management team.  This information source serves as a check and balance against the information provided by management as well as auditors and outside consultants. 

Pension fund managers can now gain access to accurate and comprehensive information about the companies within their investment portfolio online at zEthics.com to formulate and execute a cost effective strategy to accomplish responsible ownership goals.

Armed with a valid information source, pension fund managers now have a “tool to hold the directors’ feet to the fire.” Investors who purchase securities and suffer losses now have the ability to prove when there is incomplete or inaccurate disclosure of important information.

After a second financial crisis in a decade, it’s more important than ever to position investment portfolios for enhanced performance while safeguarding investments against corruption, fraud and poor management.  Providing employees a structured process to disclose information about a company’s fundamental strengths and weaknesses is an internal audit best practice, and provides a unique opportunity to accomplish responsible ownership goals at a lower cost.

zEthics, Inc. is a participating member of the Business Integrity Alliance™.  The mission of this alliance is to influence positive and sustainable change to the governance and risk management principles and practices, which are so vital to organizations, their stakeholders, and the communities in which they operate. 

A sample report from the online service provider is available at http://www.zethics.com/investors.php.

The Myths Behind Good Corporate Governance

According to Richard Lochridge (Board Member, PetSmart, Lowes), “the board is a slow vehicle for figuring out when there is a problem and taking appropriate action. Management is hesitant to tell the whole truth; the board doesn’t know nearly what management knows; and, board members don’t always pay attention to all that’s going on.”

The recent financial crisis has raised serious questions about the effectiveness of boards of directors in exercising their fiduciary duties. Corporate governance requires that the board be a check and balance on the CEO and the executive team. The obvious question is whether directors of public companies properly oversee management and ensure management’s actions are in the best interests of shareholders?

The Council of Institutional Investors has long held that good corporate governance—defined to include general issues affecting market transparency, integrity and accountability and specific relationships between boards, management and shareowners—is in the best long-term interests of shareowners.

In his paper ‘Unblocking Corporate Governance Reform’ Dr. Lucian Bebchuk suggested “Because insiders gain the full benefits that arise through lobbying for lax corporate governance rules, while their firms bear most of the costs of such lobbying, insiders have an advantage in the competition for influence over politicians. Their lobbying, which is carried out at the expense of their companies, is subsidized by their shareholders” (Bebchuck, 2009).

In a written response to a lawsuit filed by shareholders in a New York federal court, AIG conceded that its executives were, at times, too optimistic, but denied any intent to deceive investors, “Being wrong or even unwise, in hindsight, is not the same as violating the securities laws.”

In defending itself against the shareholders’ lawsuit, AIG contends, “Statements of optimism about the future…that turn out to be wrong are simply not actionable. Even in times of market turmoil, the company need not presume the worst about its market prospects.”

To federal prosecutors, corporate directors, investment professionals and shareholders, how do you know where delusion ends and dishonesty begins; how do you distinguish the difference between incompetence and ill intent?

Today, transparency into publicly traded companies is amorphous.  Information is often incomplete, irrelevant or outright incomprehensible. This online forum aims to demonstrate that transparency can work.  When information is relevant, standardized and public, it fosters intelligent decision-making.

 “The point of regulation is to increase transparency.” (Michael Oxley, Sarbanes-Oxley Act of 2002, Fortune, March 24, 2010). “If you read any of the books that have come out, from Hank Paulson’s book [On the Brink] to Too Big to Fail, the common thread is an incredible lack of transparency and no accountability.”

Is it possible to ever close the loopholes in transparency? Unequivocally, Yes!

One viable means to find out what’s really going on inside a company is to improve internal transparency with reporting via an independent third party.

Improved internal transparency from an independent third party provides investors with comprehensive information about the quality of the business and strength of the management team.  The information would serve as a check and balance against the information currently disclosed by management as well as auditors and outside consultants.

Recent studies indicate that employees find more corporate fraud than regulators (Adair Morse, assistant professor of finance at the University of Chicago’s Booth School of Business).

Employees with knowledge of questionable business practices now have access to a reliable, structured process to disclose information without fear of reprisal or reprimand; to prevent executives from coercing employees into going along with risky corporate strategies; and, prevent misrepresentations by executives in public filings.

A new online information service provider offers an innovative solution to disclose illegal, unethical, or questionable practices of individual managers, while providing the Company an opportunity to take corrective actions to remedy non-conformances, and implement preventative measures to avoid recurrence.

Employees can initiate an Ethics Action Report (EAR) to document misconduct at work, which include but is not limited to: managerial mischief, fraud, unethical behavior, illegal activity, questionable business practices of individual managers, lying, falsification of records, sexual harassment, and drug and alcohol abuse.

Applying the Failure Modes and Effects Analysis (FMEA) based preventive action system to ethics and corporate governance provides the Company an opportunity to analyze misconduct, processes, and other activities for the detection and elimination of the causes of non-conformances.

The corrective action system provides the Company a structured process to search for the causes of non-conforming behavior and identify corrective actions. Preventive actions and controls can be initiated, after which a management review confirms the efficacy of the implementation. These are implemented with the goal of preventing recurrence.

It’s time for pension fund managers to draw the line with Corporate America. It’s not just enough to overhaul the regulatory architecture. Pension funds need market-based discipline. To succeed, investors will need tools that hold corporate directors’ feet to the fire. That includes improved internal transparency from an independent third party to safeguard investments against corruption, fraud, and poor management.

A sample report from the online service provider is available at http://www.zethics.com/investors.php.

Is Lehman a Sarbanes-Oxely Failure?

 “The point of regulation is to increase transparency. You can call it regulation, but you’re just shining a light on a murky opaque process that, most recently, brought this economy down” (Michael Oxley, Sarbanes-Oxley Act of 2002, Fortune, March 24, 2010). 

“If you read any of the books that have come out, from Hank Paulson’s book [On the Brink] to Too Big to Fail, the common thread is an incredible lack of transparency and no accountability.”

The reality is corporate management is hesitant to allow employees to tell the whole truth.

Is it possible to ever close the loopholes in transparency? Unequivocally, Yes!

Recent studies indicate that employees find more corporate fraud than regulators (Adair Morse, assistant professor of finance at the University of Chicago’s Booth School of Business).

One viable means to find out what’s really going on inside a company is to improve internal transparency with reporting via an independent third party.

Improved internal transparency from an independent third party provides investors with comprehensive information about the quality of the business and strength of the management team.  The information would serve as a check and balance against the information currently disclosed by management as well as auditors and outside consultants.

A sample report from an online service provider is available at http://www.zethics.com/investors.php.