September, 2015 | Bottom Line Ethics

VWI was watching TV when a Volkswagen commercial came on. I found myself thinking, “Why on earth would I go in and test drive one of those?” You probably think this is irrational, because they are quality cars. But who trusts Volkswagen after this past week?

Volkswagen has admitted to installing software rigged to defeat emissions testing, apparently in 11 million vehicles. The software to blame for the scandal was intentionally designed. Unlike most automotive industry scandals, this was not a design flaw. In past controversies, whether it be Ford Pinto gas tanks or GM ignition switches or Toyota gas pedals, the car makers did not deliberately design systems intended to cause harm to customers. What has always been in question is what the companies did once they found out that they had a problem. And though the clarity of who is to blame has varied across cases, people have recoiled at evidence that car makers knew there was a problem, but decided not to act, because of a calculation that it would be less expensive to do nothing and to address lawsuits that might arise than it would be to recall cars or replace parts.

Volkswagen’s dishonesty may not directly threaten lives in the short run, but the software was intentionally designed to mislead not just the regulators, but the public. Volkswagen has built a very successful advertising campaign around clean diesel vehicles that will get over 800 miles per tank of gas. What they did not reveal is that the truth is that you can have EITHER a clean diesel vehicle OR get over 800 miles per tank of gas. Playing on their deep knowledge of the regulatory environments in Europe and the United States, they rightly calculated that their deception would not be detected. In fact, it was only because private testers were able to evaluate several vehicles that the issue was discovered at all. The intent of the American testers was to find clean vehicles with results that would allow them to put pressure on European regulators to adopt tighter standards. The testers were reportedly the most surprised people of all at their results.

When regulators and those involved in the testing tried to confront Volkswagen about it, executives repeatedly denied that there were any issues and questioned the competence of the testers. The company’s persistence in resisting the questions of the testers, and their refusal to conduct their own investigation to support their claims, give the impression in hindsight that Volkswagen executives were being deliberately misleading. This is why CEO Martin Winterkorn’s expression of shock about the systematic dishonesty in the company rings hollow. It was only when the EPA threatened not to allow the company to sell Volkswagen and Audi diesel models in the U.S. that they admitted to the problem. The German transport minister says that 2.8 million vehicles sold in Germany are affected.

Former Volkswagen CEO Martin Winterkorn

Acting VW Chairman Berthold Huber stated, “I want to be very clear, the manipulation of tests for diesel engines is a moral and political disaster.” That is exactly the right term, but it is more than that. It is an indictment of the very culture that has driven Volkswagen to become the number one automaker worldwide, having surpassed Toyota only a few months ago. According to a New York Times article, it wasn’t until September 3 that “a group of senior engineers” admitted the truth. The truth is that a large number of people within Volkswagen knew exactly what was going on; this was not some rogue employee. It was a result of the culture.

And this is almost always true in major corporate scandals. The fact that so many are involved gives each individual an excuse that “this is not me” doing this, but management, or the market pressure, or the strategy. It is why the second half of the Aggie Honor Code so often ignored by students—“or tolerate those who do”—is critical to living out ethics in the business world or in the public square. We actually have immense tolerance for those who do when they are close to us, part of the same company or the same institution with the same goals we have. But we ought not to.

The results of this tolerance are inevitable, and oft repeated, crash and burn events. Instead of catching things early, we only find out when the results are devastating. Instead of being able to adjust and let the air out of the balloon slowly, we get an explosion.

The results include Volkswagen taking a $7.3 billion charge to earnings in the third quarter, and EPA fines that could (but likely will not) reach $18 billion. There will be shareholder lawsuits after a two-day drop of 35 percent in the company’s share price, and plaintiffs’ lawyers are lining up for their share of class action suits from car owners.

And, inevitably, we get more regulation. This is sure to come after the Volkswagen affair. Of course, there are good by products of that regulation—in this case, perhaps, more truth-telling and cleaner air. But the entire market will bear the cost of that regulation; unjustly, that includes those who tell the truth and compete honestly and, ultimately, the consumer.

I may get emotional about this type of deception, but the market is perfectly rational in its response. That 35 percent share price drop is simply a shift in predictions about two things—significant decreases in future cash flows and more risk in the stock. What is unclear at this point is the long-term effect on diesel car sales, which represent about half of VW’s market in Europe, and on the costs and rigor of future testing.

But you can be confident of this: Volkswagen created a culture of dishonesty at the highest levels. We can argue about who knew what, when. But there is no transparency there. In fact, apparently the American arm of the company was kept in the dark about what was going on until right before the EPA announcement. This is what a high competence, low integrity environment looks like.

And if you trust Volkswagen, you do so at your own peril.

Categories: Uncategorized

Kyle FloodIt is the third week of Auditing class, and we have been discussing the seven threats to auditor independence from the client: familiarity, management participation, advocacy, self-review, adverse interest, financial self-interest and undue influence. Auditors, at all ranks, have to be particularly aware of being too familiar with or trusting a client too much. They also easily slip into participating in management to ensure their success if the client constantly asks for advice. At a firm level, auditors can undermine their independence by being advocates for or lobbying on behalf of their clients. There are relatively explicit rules regarding self-review, adverse interest (suing one another) and financial self-interest.

I explain to my students that professors, like auditors, also need to be independent of their students, even though the students are paying tuition. Like auditors, professors can fall prey to getting too familiar with their students, either in a deliberate compromising relationship or just by liking them. They may also try to ensure the success of students who ask their advice, and they often lobby for their students or provide recommendation letters to employers and grad schools.

But the threat that can be most damaging to both auditors and professors is the undue influence threat. Unlike familiarity, management participation, and advocacy, auditors and professors do not choose the undue influence threat. It is an outside hazard thrust upon them. It may be a gift, a threat or simply pressure applied to influence behavior. And the more important the person applying the pressure, the more effective it is. Resisting it usually requires a system designed to short-circuit the attempt, and a spine.

Which brings us to Rutgers University Head Football Coach Kyle Flood, who has apparently admitted to emailing and meeting with a professor in an attempt to get a better grade on a writing assignment for one of his players, Nadir Barnwell. Barnwell has since been arrested for aggravated assault, among other charges. According to the Rutgers investigative report, Flood communicated with the professor using a personal Gmail account “to ensure there will be no public vetting of the correspondence,” despite the professor’s earlier complaint to an academic advisor that Barnwell was “badgering me to change his grade.” The professor’s response to Flood’s email was responsive enough to trigger four more emails and a scheduled meeting at a site off campus.

The email exchange and planned meeting led to a call from Flood to an academic advisor on how a grade could be changed, and the advisor told Flood he could not have contact with the professor. The advisor claims that Flood said that their conversation was to stay between the two of them, and the advisor responded, “We never had this conversation…I want no part of this.” Flood claims that the advisor did not tell him he could not have contact with the professor. But Flood made sure not to wear Rutgers gear so that he would not be recognized when he went to the meeting. Quoting from the report, “The Professor conveyed to the investigator that she felt unable to resist the implied pressure from someone like Coach Flood and thus felt uncomfortable not agreeing to an additional assignment to allow the Student to become eligible.” This is the definition of the undue influence threat. The investigators concluded that “…it appears Coach Flood’s contact with the faculty member potentially violated the University Ethics Policy which generally prohibits a University faculty or staff member from using his position at the University to secure unwarranted privileges or advantages for himself or others.” Rutgers president Robert Barchi suspended Kyle Flood for three games and fined him $50,000. Ironically, President Barchi said, “Our faculty must have complete independence in executing their duties . . . .”

But Kyle Flood should have been fired. What he did, he did deliberately. He did it repeatedly. And he did it even though he was warned not to do it. That is cause for firing. However, the clincher is that he intentionally tried to cover up what he was doing by multiple means, making firing him a no-brainer. And the fact that the student-athlete was just arrested and charged with multiple felonies makes President Barchi’s choice a real head scratcher.

This is not the first time this has happened. Many corporate boards enable the behavior of top executives, but they usually do so only for successful ones. It is interesting to see President Barchi risking his reputation on Kyle Flood the same way Kyle Flood risked his reputation on Nadir Barnwell. But whether you are an auditor or a professor, it takes a spine to be independent. And when the system fails you, sometimes a spine is all you have to rely on.

Categories: Uncategorized

Perhaps I have been teaching auditing and ethics too long, but it seems like my life consists of reading story after story about rule benders and enablers. The latest and greatest example in the world of sports is the allegation by ESPN that NFL commissioner Roger Goodell ordered evidence destroyed that implicated the New England Patriots and coach Bill Belichick in a long-term cheating scandal prior to the famous Spygate game in 2007. The allegation is that if the public knew that the Patriots’ filming of other coaches’ signals was a multiyear, not a one-time, event, it would damage the image of the league and of one of its bellwether franchises. Goodell’s recent harsh punishment of quarterback Tom Brady and the Patriots for deflating footballs prior to last year’s AFC Championship Game was seen as him fulfilling his promise to harshly punish anyone who stepped over the line again. But Brady’s punishment was overturned by an arbitrator.

In this saga, the Patriots are the rule benders and Roger Goodell is the enabler. But the other 31 NFL owners, who allegedly knew of the document destruction, were also enablers if they acted to protect the value of the league and, thus, their own franchises. In my world, it is audit firms that enable their clients to misstate their financial statements and refuse to exercise the necessary professional skepticism to prevent frauds, like the recently announced sanctions against the auditors of General Employment Enterprises.

Major League Baseball seems hesitant to marshal any strong response to the FBI investigation of the St. Louis Cardinals’ hacking of the Houston Astros’ player evaluation database. The Cardinals fired their scouting director in early July, about two weeks after the hacking was announced. But two days after the announcement, an attorney hired by the Cardinals months before to investigate the hacking called a press conference to assert that there was no link to upper management. Major League Baseball waited until that investigation was done before the accusations became public. Of course, the FBI investigation and the Cardinals’ own internal review may lead to identifying all the culprits.

But I am not holding my breath. Stories indicate the fired scouting director may accuse Jeff Luhnow, the Astros’ general manager, of stealing the database from the Cardinals. If so, these issues would be in the papers for months. Major League Baseball and its owners, perhaps with the exception of one, want to move on and clear the decks. They appear ready and able to enable cheating in baseball, just as the NFL is alleged to have done with the Patriots. Who wants to talk about cheating with the playoffs coming up? They might do what’s right. But I am skeptical.

What triggered me writing this blog was a Twitter post claiming that it was unfair that last year’s U.S. Little League champions were stripped of their title for using players a mile out of their district, but Tom Brady got away with cheating. Those who bend the rules to their own ends rarely worry about the common good, and the way their stories are used by others to excuse their own cheating. But the Patriots and the Cardinals are simply the insider traders of professional sports. With insider trading, there is a stock exchange that is persuaded not to enable this behavior, and there is an SEC to investigate the traders, and to punish the stock exchanges if they cooperate with the traders. Unfortunately, in professional sports, the league is both the potential enabler and the investigator.

We already have an idea how well that worked with the NFL, and Major League Baseball is in the on-deck circle. But in a competitive world, cheaters get rich, and enablers get rich off the cheaters. For those people, it often smells like success. But for a society that values justice and fair play, it is corrosive. And, in my book, the enablers are just as bad as the cheaters.

Categories: Uncategorized

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