Monitoring and Social Conduct

1. Monitoring and Social Conduct Ethics, Accounting and Finance

2. Background • Co-operative Bank in UK • Only investing/lending in/to “ethical” companies • Policy change to include social and ecological responsibility to develop “social” economy • Is there a role for banks in influencing ethical behaviour?

3. The Players • Who are the players that can influence the development of a “social” economy?

4. An Illustrative Case • Enron • Bank • Two years before Enron's 2001 collapse, Citibank loaned the company $2.4 billion • Citibank wanted to keep Enron afloat to help conceal its prior involvement in Enron's fraud • Auditor • Arthur Andersen covered up dubious accounting practices to keep Enron afloat to ensure continued revenue from consulting • Corporation • Enron’s excessive creative and highly complex accounting systems

5. Key Ethical Issues

6. Lessons – Banks • Lack of social responsibility • Drawing revenue from clients with unethical practices • Self interest • Uncertainty in sustainability of unethical clients could cause deception of stakeholders • Eg. Citibank created dubious venture (Yosemite) in the case of Enron • Fear of loss of business revenue • Unethical investments are high risk • Ethical investments balance risk and return

7. Supporting Ethical Investments

8. Supporting Ethical Investments

9. Lessons - Auditors • Conflict of Interest • Auditing / Consulting • Although different divisions it’s still the same firm • Eg. Enron was Arthur Andersen’s 2nd largest client and revenue was predominantly from consulting services • Relational Interests • Eg. Senior Managers at Enron were ex-Andersen employees • Vested Interests • Eg. Andersen was also the auditor for many of the energy trading firms which had relationships with Enron • Failure of Regulatory Monitoring • Lack of clarity in the regulations • SEC monitoring of independence of auditors

10. Types of Contracts between Enron and Arthur Andersen Implicit & Relational Contracts E.g. Andersen obligated to act according to Enron’s interests rather than those of the SEC’s to ensure sustained revenue Relative Impact on Decision Making Specific Investment by parties (Time and Effort) Other Explicit Contracts E.g. consulting and outsourcing services to Enron increased revenue for Andersen from on-selling opportunities Explicit Contract – Auditor Contract Standard Auditor’s contract between Enron and Andersen Enron employs Arthur Andersen Enron’s decline Time

11. Lessons - Corporation • Creative Accounting • Short-term benefit • Facilitates a positive valuation of corporation for investors • Standards developed to influence corporate behaviour • Could be misused by corporations • Financial statements not true and fair representation • Creative Accounting and Incentive Schemes • Increasing shareholder value as a pretence to senior manager’s increasing their own return through creative accounting • Eg. Enron senior managers had significant stock holdings • Excessive compensation for unsustainable increase in share value • Eg. Enron CFO paid bonuses for setting up special purpose entities • Creative Accounting and Corporate Governance • Lack of attention by members of the board • Eg. Enron

12. Changing Roles Banks - Policies to take into account ethical standing of future and current clientele • Engagement • Preference • Screening (Ethical Investment Research Services) • Triple Bottom-line. Profitability, Philanthropy, Social Responsibility • Increased scrutiny of clients • Sources of revenue and their sustainability • Controlling the use of funds (covenants) • Signalling effect • Any corporation that fails to receive credit due to unethical practices may cause share market reaction Needs Collaborative Effort!

13. Changing Roles Auditors • Separate auditing and consulting functions • Increased regulatory requirements for independence • Expand definition of “auditing” to encompass social considerations • Important to the development of the social economy. • Difficult to measure the extent of ethical compliance – needs clear definitions and more regulations • Extra cost and time burden on organisations

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