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C. Gopinath

IN THE last wave of scandals to hit Corporate America, we saw the top management of companies such as Enron, Tyco, and WorldCom exposed on account of their financial irregularities. New legislation was introduced to oversee the public accounting companies and the corporate CEO was made personally responsible for certifying the financial results.

It was hoped that this would increase accountability and already one big fish has been caught in the net of the new legislation. Mr Richard Scrushy, the former Chairman of a health-care rehabilitation company that he founded, named HealthSouth, is in court facing criminal charges for falsifying accounts, tax fraud and money laundering to the extent of $3 billion (Rs 13,800 crore).

Just as we were all heaving a sigh of relief, it is now the turn of the mutual finds. Putnam, the country's fifth largest mutual fund with about $270 billion (Rs 12,42,000 crore) in assets, has been charged by the State of Massachusetts with civil fraud for market timing in international mutual funds. Putnam has admitted that six of its managers indulged in this during 2000 and profited to the extent of $700,000 (Rs 3.2 crore). They had been admonished but were not asked to return the money. The State has charged that the activity has continued and that senior officials were aware of it. Putnam is also accused of allowing outsiders, who were clients, of allowing such trading. Since the scandal hit the headlines, various institutions have begun pulling funds out of this firm. Mr Lasser, the head of the firm who is credited for building a `hard-charging' culture of growth and expansion in the last five years in the firm (for which he received bonuses amounting to $100 million or Rs 460 crore) has since resigned.

Alliance Capital is a large asset management firm. It has been charged with market timing trading of its mutual funds in return for investors placing money in its hedge funds. Two employees of this firm have been suspended pending enquiry.

Prudential Securities, owned partly by the insurance giant Prudential, is accused of late trading of mutual funds. Brokers at the firm are also said to have indulged in improper trading of shares by misrepresenting their identities or those of their customers.

Five brokers have been charged with fraudulently circumventing rules against market timing. The State of Massachusetts in its complaint against the company is charging that senior executives at the firm knew this activity was going on and did little to prevent it because they did not want to lose their big clients. Late trading is illegal. Normally, when an investor places an order to buy or sell mutual-fund shares after 4 pm, the deal is concluded at the next day's price.

But in late trading, the order gets the same day's price which enables the trader to react to news or market events ahead of the others. Say, a trader would submit a list of orders before 4 pm, then wait to hear of any late breaking news such as announcement of earnings, mergers, and so on, that may be made by companies after close of trading, and then call after 4 pm with instructions as to which of the list submitted earlier should be executed.

The other problem is that of market timing. Here, a trader rapidly buys and sells a mutual fund shares to take advantage of any price difference between the price of the fund and its underlying share holdings. For instance, if the fund holds equity of, say, a German company, knowing the closing price of the stock in the German market (due to the time difference), one could quickly buy the US fund share and then sell after its price gets adjusted to reflect the changes that have taken place in the value of the German stock. This is a form of arbitraging and although not illegal, most fund companies have rules to prevent such trading since it hurts long-term shareholders of the fund. If companies permitted such trading even though they had rules to the contrary, then they could be guilty of violating securities laws.

These revelations have shaken one of the important pillars of the capitalist system. Regulators are beginning to take a look at various other operations such as trading in variable annuities where a lot of retirement savings are held. Clearly, we have not heard the end of the story. Individual investors expect a very high level of probity in the functioning of firms who manage assets and mutual funds since the individuals place their savings in the hands of these firms based on trust.

Why does a person earning significant sums of money want a bit more by cutting ethical corners? I attended a talk by a former broker who had spent five years in jail for being part of a kickback scheme. He provided a series of reasons by which he says he convinced himself that it was ok, even as he continued to slide along the slippery slope. He started with greed, an intense desire to make more money. Such driving ambition is not bad for there is plenty of evidence to show that it has produced great enterprises. But the other layers or reasons he had piled on top of this greed did him in. He looks back and sees several small ethical violations in his dealing with customers as he began his career. Each time he got away, he was more emboldened. This feeds the bravado of ``I'm too smart to get caught.''

Then, of course, there is the other reason: ``Everybody is doing it. Why shouldn't I.'' One begins to feel that it is a part of the system and who am I to stand apart. And another factor he pointed out was the feeling of entitlement. He felt his contribution was not being recognised and rewarded sufficiently by the firm, so if he had to grab some of the goodies himself, so be it.

The underlying premise of capitalism is that there is that there is nothing wrong in the pursuit of wealth. If you can make use of your talents to build your assets, you deserve the rewards. But can positions of influence or power be a part of that set of talents that one leverages to build assets? Or does blinding desire for personal gain make the fine line of ethical behaviour too fuzzy to be recognised?

Motorola's CEO, Mr Christopher Galvin, who is also the son of the founder, was asked to step down in September 2003 as the board was unhappy with his performance record. He has managed to negotiate a severance package that amounts to $29 million (Rs 133.4 crore). Two items in the list intrigued me. He will receive a two-year consulting position with the company for unspecified work that will amount to $3.8 million (Rs 17.5 crore).

Here is a company that is firing him for poor performance and wants to retain him as a consultant? The second intriguing item in his compensation package is that he will retain the company car and the home security system provided by the company. He is walking out with $29 million and is negotiating to keep a home security system? I can well imagine the next step. The party of the second part would stand up to shake hands at the conclusion of the negotiation while the party of the first part says, "No. We have one more item to discuss. We would like to keep the stapler and the pencil eraser too."

We had just completed a class discussion of the recent revelations in the financial services industry. I asked my students if they thought that ethical violations were pervasive in our corporate world. A majority put up their hands. I then asked how many of them might even slightly consider changing their intentions of business careers because they did not want to be a part of the mess they perceive. No hands went up.

It was an unfair question. Business organisations are so all pervading in our society that there is really no place else to go. Which is all the more important that since one cannot run, building one's ethical standards and living by it is perhaps the next best way to cope.

(The author is a professor of international business and strategic management at Suffolk University, Boston, US. His Internet address is cgopinat@suffolk.edu)

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