A FRAUD WITH AN EXIT STRATEGY

Go figure, according to the NY Times, a key figure in the Swiss banking tax evasion matter has been sentenced to 4 years in a prison. He is also applying (suing?) for a whistleblower's award of billions of dollars based on the IRS collection of taxes based on the information he gave.

He is apparently trying to sneak through a small loophole. His attorney appears to be very pleased with himself and is looking forward to arguing the matter. Should the attorney really be proud of himself for championing this effort? Go figure.

Cheers, Mike

NURTURE CORPORATE CULTURE

Mike's post on October 20 Oh, The Culture, combined with the questions we get at many of our leadership session including the one we recently did at West Point, have caused me to spend a significant amount of time thinking about corporate culture. Mike ended his post with the following two sentences. "In a crisis, you reap what you sow from your culture. Address the culture now so it will serve you well in the crisis." As usual, I completely agree.

This post is about the need to nurture the culture and reinforce the values or risk an erosion of the company's culture that can eventually cause the crisis. Let me share some of my research and thoughts on this topic. We should probably start with a definition of corporate culture.

The easiest way I have found to describe corporate culture is how your employees act and the decisions they make when no one is watching. I found two articles with more in depth definitions. Corporate Culture Definition is quite good in describing the various layers within culture. Another article Definition of Corporate Culture is also good and uses an analogy of culture as the invisible energy field or electricity that runs throughout a company and either enables or restricts its ability to achieve strategic objectives. I would submit that the invisible energy source known as culture needs to be constantly reinforced and nurtured or you run the risk of erosion particularly in the area of values and ethics. Another interesting article is about corporate culture and brand entitled Corporate Culture is Brand, and Brand is Corporate Culture which highlights that how your employees act is much more the brand than any logo or advertisement. Lastly, my research uncovered some articles on measuring corporate culture, although I did not find anything that provided REAL measures. The two articles I liked were Human Resources: Measuring Corporate Culture which differentiates artifacts, espoused values, and basic underlying assumptions. This article refers to corporate culture as the Other Bottom Line. In my experience, the erosion happens within the basic underlying assumptions that can change over time. It is fine if it is an intentional change but lax risk management and not reinforcing the values will erode the culture even if not intentional. The other article Corporate Culture covers small businesses and culture definitions. The reason I included it here with measurement is that there were a few questions that are very helpful to assess what the culture is and could over time help you to measure any changes. The five questions are:

• What 10 words best describe your company?
• What is really important around here?
• Who gets promoted here and why?
• What behaviors get rewarded here?
• What type of people are the "in" crowd and the "not in" crowd?

During my 30 years in the consulting industry, I learned that I needed to understand two things at each of my clients in order to be successful- what was their corporate culture and how they compensated their executive team. If I knew these two things I would know what they would and would not buy, how to handle myself in meetings, and what problems I could and could not recover from with them and how to do it. In addition to observing the cultures at each of my clients that enabled or restricted performance, I watched a strong culture at Arthur Andersen that truly was the other bottom line (it may have even been the cause of the true bottom line) erode over time and cause the crisis that destroyed the firm. Hindsight has allowed me to see now the signs that were there before the crisis. At Bearingpoint I saw a culture that destroyed value. I know first hand what can and does happen if you do not nurture the right corporate culture. BTW, does anyone know of any good measurement tools for corporate culture?

This is NOT soft stuff. Companies need strong, healthy cultures and CEO's need to focus on nurturing it or the culture will erode and so will profitability and corporate sustainability.

Until Next Time,

Gail

GALLEON, HEDGE FUND IN CRISIS?

On Friday, the founder of Galleon was arrested and charged with insider trading. Put aside whether he is guilty or innocent. The remaining managers of the fund have to deal with the resultant crisis.

In a crisis such as this, the remaining managers must decide what individual or small group of individual should be in charge of the fund in the interim. They must realize that the fund is a separate and distinct entity from its founder. Each party will have their own legal issues to address.

Next the management must get the right team on board. This will include at least, special counsel, a crisis public relations firm and a financial crisis expert. One part of the management team should be dedicated to dealing with the crisis and one part of the management team needs to address the day-to-day operations of the fund.

All of the stakeholders have to be identified and addressed. The stakeholders will include, investors, employees, lenders, companies invested in by the fund, SEC, state regulatory agencies including the attorney general, and other parties.

The communications from the firm must be carefully managed and critically previewed with counsel. All the stakeholders will have questions, some of which can be answered and some of which cannot be answered at this time. All employees need to be briefed with a list of questions and answers and instructed to send parties to a central communication point. If this does not occur, misinformation will cause additional problems that will have to be addressed.

The interim fund management may also have to decide whether it must pursue its own internal investigation. This will be a very sticky wicket which will require constant legal advice every step of the way.

It is not what the innocent managers bought into. But it doesn't matter that they don't like it, they have to deal with it. Such is the challenge of dealing with a crisis.

Cheers, Mike

WHERE ARE THE REGULATORY LEADERS?

Before we get into the leadership question, we should step back and revisit the mission of regulators. Let's at least address the SEC and the Federal Reserve. According to their websites, the mission are as follows:

SECURITIES AND EXCHANGE COMMISSION:
The mission is to protect investors; maintain fair, orderly , efficient markets; and facilitate capital formation necessary to sustain economic growth.

FEDERAL RESERVE:
The central bank of the US provides the nation with a safe, flexible & stable monetary and financial system.

I think it is safe to say that both regulators and many others in countries all over the world failed to achieve their mission resulting in this global financial disaster. No need to beat this drum any more. The question is where do we go from here to correct the problems.
Leaders have a responsibility to look forward, to be able to prioritize and allocate resources, and to stay laser focused. Leaders have many demands on their time and attention. One of the important skills for a leader to possess is to properly set priorities and then stay focused to resolve the issues.

There are three articles in today's WSJ to read:
SEC Squanders a Shot at Overhaul
SEC Policing Some New Beats
Bank Stress Tests

I do not see the regulators stating their priorities and then staying focused to resolve the issues. Now don't get me wrong, many regulatory reactions are really political window dressing that often cost much more than they are worth. Think Sarbannes Oxley. But clearly we need some changes. The current bank stress tests are a good start. Even if you disagree with the process of the metrics, it is a start. But isn't that what we thought the Federal Reserve was doing all along? What are the capital requirements that have existed for many years if not to make sure the banks were adequately capitalized? What have they learned in the stress test process that should be included in the ongoing capital requirements?

Oh, and let's not forget AIG. Has anyone heard any news about the insurance regulators looking at any required improvements? The only thing I am hearing from the National Association of Insurance Commissioners (NAIC) is about testimony about national health care. Why not? They did such an outstanding job with AIG let's give them more responsibility.

Leadership. We are in desperate need of leadership everywhere in the world. Regulatory bodies are no exception. I do not want them to restrict growth as the global economy needs help not more problems but we need reform and follow through. The balance in setting the rules and the focus on follow through is critical. That takes strong leadership skills. So far, I see no leadership. Let us all hope leaders emerge.
Until next time,
Gail

RATING AGENCIES

The WSJ did an article on possible changes in regulation and compensation of the rating agencies entitled SEC Puts Rating Agencies On Notice.

Every time there is a major fraud at a public company or some other event that causes a rapid decline in a company's stock, there is an outcry that the rating agencies did not do there job and changes are required. Then just as soon as some other event diverts our attention, the rating agency business model continues largely unchanged. Until the next crisis.

The issue once again is the perceived lack of independence of the credit rating agencies as they are paid by the company being rated. The SEC has told the rating agencies that there is more to do in regulating the credit rating firms.

The article includes the following paragraph:

"Ms. Schapiro on Wednesday said the performance of rating firms in mortgage-backed securities has "shaken investor confidence to its core." She was referring to criticism that firms gave overly optimistic ratings to mortgage-backed debt and were slow to make downgrades when defaults by homeowners rose."

I agree that the regulators need to look at the entire economic mess started with the mortgage backed securities and re-evaluate the regulatory rules and processes.

However, I also believe strongly in market demand. Where is the demand, from those that rely on these agencies for ratings, for more accurate and independent evaluations? If there was more market demand, there would be a quicker and better answer than we are likely to get solely from regulatory demand.

So here is a wild thought.

What if accounting firms issued a risk rating in addition to their audit opinion? This could be an overall business risk applied to debt and stock or separate risk evaluations.

I know, the accounting firms have their own issues.

But what a new mouse trap!

Thoughts? Alternative ideas?

Until Next Time,
Gail

RESPONSIVENESS TO WHISTLE BLOWERS AND EARLY WARNING SIGNS

There are several root cause reasons for why we find ourselves in this global economic mess and a few critical improvements needed to learn from our mistakes and reduce future risk.

One thing that I feel must be done after reading about the Madoff and other frauds, as well as Mike's post on Wednesday Leaders Do The Right Thing, Even At Personal Risk is more serious and timely response to whistle blowers/early warnings.

There is now evidence that there were both whistle blowers and early warning signs about the Madoff mess that went unanswered. There have been several others over the years. Why bother to have the SEC enforcement and investigations groups or company hotline systems, if there is not timely follow up on the issue?

But I believe an even bigger issue is when people raise early warning signs and are ignored. Have you ever been in a meeting in which everyone has fallen in love with an idea and you or someone else questions it? You quickly feel alone and as an outcast.

What is great about early warning signs is the word early. That way you can actually do something to correct the issue before it goes too far. But that only works if people are willing to raise the issues.

In this case, I am discussing early warning signs in the broadest manner. Someone challenging an idea; questioning the assumptions; coming at the issue from a new/different perspective; raising concerns about the level of risk; making statements such as this doesn't seem right; etc.

This seems a good time for us all to ask ourselves the following questions:

Are you as a leader creating a culture in which people feel free to raise their concerns and challenge the popular point of view?

Are you as a leader comfortable that these questions or concerns are given serious consideration and not cast aside too quickly?

Are you as a leader comfortable with your organization's process and handling of whistle blower reports?

More to come on the root causes of this crisis and some of the future changes needed to reduce future risk.
Until next time,
Gail

BERNIE PROMISED OVER 40% RETURNS?

If Bernie started to promise people 40%+ returns, it must have happened toward the end when he desperately needed money and the markets were generating 20%+ returns for a couple of years. If this is true, he was speeding towards his demise at the end.

A 40% return doubles the principle in TWO years! Even for Bernie it was going to be impossible to bring in enough new money if some of it was supposed to double in two years. This further explains the enormous level of false profits in the size of the fraud.

It should be interesting to see what the prosecutors and the trustee have uncovered to explain all that happened over the past years.

Cheers, Mike

UBS SUED BY WEALTHY AMERICANS NOT TO GIVE THEIR NAMES TO THE IRS

How crazy is this article from the NY Times. A group of wealthy Americans, who have allegedly been evading Federal income taxes with bank accounts at UBS in Switzerland, have sued UBS to prevent the bank to disclosing their names to the IRS. This is unbelievable!

Apparently the Swiss banking secrecy laws are pretty serious. UBS did disclose the names of a few hundred individuals pursuant to illegal tax shelters that UBS set up. But now the government wants the names of all US citizens with accounts at UBS. There may be as many as 50,000 people who have such accounts.

I don't know about you, but I don't know anyone who has admitted having a Swiss bank account. Are there really 50,000 Americans with such accounts? If so, these are presumably very wealthy people. And therefore, presumably in senior positions at various firms and institutions.

Oy, another massive fraud sitting out there??

Cheers, Mike

IT IS THE SEASON OF FRAUDS

One of the characteristics of recessions is that they reveal frauds. This is very typical and over the past 25 years, every industry downturn has been accompanied with some spectacular frauds.

There was the Penn Square Bank in the 1980's that brought down Continental Illinois National Bank. There were all of the scandals of the Savings and Loan debacle in the late '80's and early '90's. There were real estate frauds in 1990's and of course, the new century was kicked off by Enron, Worldcom and others.

As long as companies underperform, there will be managers who feel backed into a corner and then resort to fraudulent activities. The continued underperformance gets them almost every time.

This Stanford fraud is following on the heels of Madoff, Drier, other hedge fund types and Peanut Corp. of America. We should all expect that there will be more frauds exposed over the next two years.

Once again, how do they think will end when they start?

Cheers, Mike

PEANUT CORP. OF AMERICA - A DEADLY FRAUD

The president of Peanut Corp. of America had allegedly committed a deadly fraud. Apparently, president Stewart Parnell, according to an AP report posted on Yahoo.com, knew that the peanut butter being sold was tainted. Allegedly this peanut butter has lead to numerous people falling ill and several deaths.

Parnell took the 5th in front of a House investigations committee. I read elsewhere that there was speculation that sales were low and Parnell could not risk scrapping the product and losing sales.
So, he sold a deadly product instead? This was the answer to lower sales???

Most of the frauds I have reviewed have one common item. How did the perpetrator of the fraud think it was going to end? How were they going to get out of the mess they were in?

In people contemplating fraud could stop to think of an exit strategy, they would not find one. And then, they might not commit the fraud in the first place. But hope springs eternal. They believe that something will happen that will make it all right.

Remember, during times of financial crisis, the frauds are exposed and more frauds occur. Some are out of greed and some are out of fear.

Cheers, Mike

SATYAM - HE MADE UP EMPLOYEES?

SATYAM - HE MADE UP EMPLOYEES?

This is quite funny. The CEO of Satyam allegedly made up the number of employees. He publicly stated the number of employees was 53,000. It now appears the real number of employees was closer to 40,000. How does that happen?

(courtesy of Business Week)

Further, Chairman and CEO Raju allegedly made up fictitious employees and collected their paychecks. He actually cashed paychecks up to $4 million per month from these fake employees (Financial Times).

This reminds me of a story. When I was an audit intern for Touche Ross & Co. when I was in college, I worked on the audit of a construction company. While performing an audit test on payroll, I noticed that week after week, certain payroll checks were signed by the same green pen in the same handwriting. I investigated further and we found out that it was a group of fake employees. After that, the audit senior made me sit near the window so the rest of the team wouldn't be exposed to any acts of retribution.

At least he is in custody. Why isn't Bernie? Perhaps tomorrow I will return to Madoff. Where has he been all week?