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INTERNATIONAL JOURNAL OF
CASE METHOD RESEARCH & APPLICATION
Ethics OR Corporate loyalty,
whICH would you CHOOSE?
Mark D. D’Antonio
Christopher T. Arra
Douglas J. Boe
Northern Virginia Community College
Woodbridge, VIRGINIA, U.S.A.
Volume XX, Issue No. 2
Volume I-XVI, 1988 – 2003
Selected Papers on Case Method Research & Application
THE JOURNAL OF THE WORLD ASSOCIATION FOR
CASE METHOD RESEARCH & APPLICATION
The International Journal of Case Method Research and Application (IJCRA) solicits and welcomes research across the entire range of topics encompassing the domain of case method research and application and interactive teaching methodologies. The Journal’s scope includes case writing and interactive teaching and learning, continuing and distance education that cross national, cultural and disciplinary boundaries.
IJCRA welcomes theoretical and empirical papers that advance social scientific research on teaching and learning. The International Journal of Case Method Research and Application is a methodologically pluralistic journal. Conceptual and theory-development papers, empirical hypothesis-testing papers, mathematical modeling papers and case studies are especially welcome. IJCRA has special interest in research addressing important issues that transcend the boundaries of single academic disciplines and corporate managerial functions. Therefore, IJCRA welcomes interdisciplinary scholarship and commentaries that challenge the paradigms and assumptions of single disciplines or functions. IJCRA solicits and accepts manuscripts on teaching materials and methods. Experimental, developmental work and book reviews will also be considered.
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within the case method and interactive learning.
Ethics OR Corporate loyalty,
whICH would you CHOOSE?
Mark D. D’Antonio
Christopher T. Arra
Douglas J. Boe
Northern Virginia Community College
Woodbridge, VIRGINIA, U.S.A.
This case study assists students in gaining an understanding of the conflict between ethical conduct and corporate loyalty. The case study tracks the career of a young CPA working in a growing corporation that has just completed an initial public offering. Topics discussed include the demands of financial reporting for a public corporation and the moral dilemmas created for employees. Students develop an understanding of corporate social responsibility, employee commitment, interests of multiple stakeholders, fundamental accounting principles and recent changes in accounting oversight requirements contained within the Sarbanes-Oxley Act. Finally, the case study also provides a format where students can learn through discussions of complex and multidimensional issues.
KEYWORDS: Initial Public Offering, Sarbanes-Oxley Act, Financial Accounting Standards Board, Securities and Exchange Commission, Revenue Recognition Principle, Enron, WorldCom, Corporate Social Responsibility, Employee Commitment, Stakeholders, Whistleblower Protections
ETHICAL AND CORPORATE LOYALTY CONSIDERATIONS:
Case Study Scenario CASE OBJECTIVES
The purpose of this case study is to construct a clear model of the frequent conflict between corporate loyalty and corporate ethics. The study is designed to present a tenured employee with an ethical dilemma related to accounting. The circumstances of the dilemma develop slowly and are not initially clearly defined. The case requires students to consider the fundamental tenets of corporate ethics, social responsibility, and employee commitment in relation to both the rules of accounting and the expanded oversight requirements of the Sarbanes-Oxley Act.
· The evaluation and multidimensional nature of ethical behavior, employee commitment, and corporate loyalty;
· The manifestation of corporate social responsibility;
· The implementation of fundamental accounting rules such as the revenue recognition principle,
· An understanding of how the expanded oversight provisions contained in the Sarbanes-Oxley Act have altered the manner in which accounting decisions are evaluated.
The case can be used for management, leadership, organizational behavior, human resource, psychology and accounting applications. Case questions are divided into different groups following the case.
Accounting fraud cases such as Enron and WorldCom resulted in the 2002 passage of the Sarbanes-Oxley Act. When implementing aggressive accounting alternatives corporate accounting professionals have also been forced to more seriously address ethical issues. Expanded reporting requirements and more assertive enforcement actions have profoundly altered the accounting field. Furthermore, numerous cases have come to light involving premature revenue recognition, improper deferral of expenses, and the overstatement of assets and understatement of liabilities.
This case study introduces and discusses the dilemma that employees face when they evaluate ethical accounting conduct in relation to corporate loyalty. This case highlights the conflicts between ethical conduct, the needs of the firm, and the need of the employee. Additionally, the nature of employee commitment is also examined.
NOVA Allied Inc (NAI) is a rapidly growing computer programming, networking, and support firm that works with private industry and government agencies in the Washington D.C. Metropolitan area. In 2007, NAI was in need of additional capital in order to expand its market share and bid on larger contracts. NAI had been privately owned from its inception in February of 1995 through October of 2007. In the summer of 2007, the firm formally filed paperwork with the Securities and Exchange Commission in order to complete a public offering of its equity securities. On November 1st, 2007 the initial public offering occurred at a price per share of $15. That same day, NAI CEO Larry Horton was allowed to ring the opening bell at the New York Stock Exchange where NAI was now listed.
Nina Nguyen held a degree in accounting, and had worked for NAI since her graduation in 1997. NAI had recruited Nina during an on-campus interview at her college. Nina was initially interested in the firm because they were a small but growing company where she would be able to become involved in multiple areas of accounting and financial management. Nina was ultimately offered a position in the accounting department at NAI’s Falls Church, Virginia headquarters by a Manager of Human Resources, Barbara Singer. Over the next ten years, Nina received four promotions including being elevated to her current position as Director of Accounting Policy. In that role, Nina was responsible for selecting and documenting appropriate accounting policies for NAI and for coordinating the annual audit by NAI’s independent accounting firm, Andrew Arthursen Inc. Nina’s position also required her to ensure NAI’s compliance with the recently enacted Sarbanes-Oxley Act. Specifically, Nina was responsible for implementing what was widely viewed to be Sarbanes-Oxley’s most onerous requirement; completing an annual management assessment of NAI’s internal controls. During her ten years as an employee, NAI had paid for her to earn an MBA at nearby George Mason University and reimbursed her for the expense of becoming a licensed Certified Public Accountant (CPA) in the Commonwealth of Virginia. Nina’s personal life had also undergone great change during her decade at NAI. She had gotten married and divorced and was now a single mother raising two young boys. In fact, Nina’s youngest son, Willie, was afflicted with a rare respiratory disorder. Nina was thankful that NAI’s insurance plan covered her son’s considerable medical expenses and grateful that she was always allowed time off to attend to her son’s medical needs. Nina frequently reflected on what a good choice she had made joining a smaller company like NAI where she was always treated like a member of the family.
Prior to its IPO, NAI had generally viewed the monthly reporting of financial results as a necessary formality. The Company had consistently reported quarter over quarter revenue and profit increases. In fact, one reason NAI was interested in completing an IPO was to reap the financial rewards that accrue to public companies that consistently achieve their financial targets. NAI also needed the proceeds of the IPO to finance growth. Larger firms often utilized the information technology skills of NAI to perform systems implementations on larger government and commercial contracts. Many of those firms were interested in subcontracting or partnering with NAI on even larger contracts because the Company always delivered quality work at an excellent price. However, NAI found that the up-front investment required to execute those larger deals was often prohibitive. It was for these reasons that NAI CEO Larry Horton decided that NAI should complete an initial public offering.
THE IPO BRINGS NEW CHALLENGES
Immediately following the IPO, Larry Horton called a senior staff meeting to discuss the evolution of NAI into a public company. Nina was both surprised and honored at being invited to the senior staff meeting. At the meeting, Nina found herself surrounded by individuals she considered to be mentors including NAI’s long time Chief Financial Officer, Mel O’Conner, and the woman who had hired her, Barbara Singer.
At the meeting, Horton addressed the transitions that were occurring now that NAI was a publicly owned entity. He spoke directly to various managers about the legal, logistical and financial changes required for NAI to flourish as a public company. Nina listened as Horton explained that he wanted employees to be well informed about the requirements and expectations of a publicly traded enterprise. Horton had a disarming way about her and Nina had always found him to be both approachable and likable. The CEO handed out small envelopes to each person present and asked that they not be opened until after the meeting was over. He said that he did not want the fact that the firm was now publicly traded to change the way NAI did business. Nina held her envelope and smiled as Horton emphasized that the highest ethical standards of the firm would be respected in this new era after the IPO. Horton summarized his presentation by projecting a power point slide on the conference room screen that listed the following bullet points:
· Employees should be informed, knowledgeable and involved in the changes resulting from the IPO;
· Employees should be excited about the IPO and their enthusiasm should create a commitment to the firm at all levels of the organization;
· Employees should share in the growth of the firm;
· All employees should continue to maintain the highest ethical standards in conducting the on going business of NAI.
After her presentation, Larry Horton proceeded to introduce a new executive, Harry Fontana, who had been hired to ensure that NAI’s IPO achieved success. Fontana gave a brief presentation in which he stressed that the IPO could only succeed if NAI successfully executed its business strategy in a manner that satisfied the expectations of Wall Street. He repeatedly emphasized that “Larry has made a commitment to The Street” which was an informal way of saying that NAI was expected by Wall Street investors to meet the financial targets that Horton had communicated to the New York investment firms that were tracking the progress of the NAI initial public offering. Fontana indicated that he would work closely with all individuals present at the senior staff meeting to ensure that everyone understood and dedicated themselves to achieving what he repeatedly described as “Larry’s commitment.”
After the meeting, Nina reflected on the coming process. Nina’s supervisor, Mel O’Conner, had previously told her that NAI would need her dedication and work ethic more than ever to continue to execute its strategy as a public company. As they left the meeting together, O’Conner told her that the contents of the envelope was a way of rewarding her past efforts and creating an incentive for her to continue to work hard in the future. When Nina opened the envelope she found it contained stock options allowing her to purchase 10,000 shares of NAI stock at $1 per share. She stopped in the middle of the hallway. Nina knew that the stock had gone public at a price $15.00 per share and that, therefore, the options were already worth $140,000. Nina felt both joy and satisfaction as she immediately thought, “I just paid for my sons to attend college.”
THINGS GET BUSY
Following the IPO, Nina’s job got a lot busier. She worked closely with her supervisor, Mel O’Conner, to document NAI’s accounting policies and prepare documentation for the upcoming audit by Andrew Arthursen Inc. Nina trusted Mel O’Conner. He had been her mentor since early in her career and as he was promoted to the CFO position he promoted Nina to be the chief architect of NAI’s accounting policies. Nina particularly appreciated the fact that Mel always stressed, above all other considerations, the importance of making ethically defensible accounting decisions. Both Mel and Nina were Certified Public Accountants and they both took great pride in being a member of what they considered to be a highly ethical profession.
The months of November and December also saw the stock price of NAI perform strongly. Most of the managers at NAI had been granted stock options similar to Nina’s and they monitored the price of the stock very closely. NAI even posted the previous days closing stock price next to the reception desk at NAI’s Falls Church headquarters. By mid-December the stock price increased another 33% from the IPO price, rising to over $20.00 per share. Nina’s options were now worth over $190,000 and she began planning a spring vacation to Disney World for herself and her two boys. But before she could begin her vacation Nina needed to support Andrew Arthursen Inc. in completing the year-end audit and assist Mel in filing the required 2007 audited financial statements with the Securities and Exchange Commission.
Nina noticed that during the two months following the IPO the level of stress exhibited by her fellow managers had risen considerably. The tension seemed to be particularly acute between her colleagues responsible for marketing and program management. Nina had heard from several of those managers that the firm’s newest senior executive, Harry Fontana, was incessantly pressuring marketing and program mangers to ensure that NAI booked and completed enough projects to met or exceed the revenue and net income forecast Larry Horton had provided to Wall Street. One program manager told Nina “All Fontana talks about is achieving Larry’s commitment to the Street for revenues and net income.”
A FINANCIAL CRISIS BRINGS CHANGES
During the first week of December, NAI experienced a significant financial crisis. The Company’s largest commercial customer, Macro Strategy Inc, abruptly filed for bankruptcy and immediately discontinued operations. Mel O’Conner had been concerned about the financial condition of Macro Strategy for quite some time because they had fallen several months behind in paying their bill to NAI. Now NAI was faced with a loss of nearly one month of revenue from Macro Strategy since work on the account was immediately suspended. The program manager on the Macro Strategy account estimated that this suspension of business would result in a revenue shortfall of twenty million dollars in the month of December. To make matters worse, at the date Macro Strategy filed for bankruptcy, NAI was owed over sixty million dollars on unsecured accounts receivable. The Washington Post reported that several Macro Strategy senior executives were indicted by the Securities and Exchange Commission for fraudulent financial reporting following the bankruptcy. Even worse, Government officials were quoted as saying that Macro Strategy had bilked investors and lenders out of nearly one billion dollars and that unsecured creditors like NAI were unlikely to recover any amount in the anticipated bankruptcy liquidation. An unnamed government source in the article described Macro Strategy as “a financial fraud very similar to Enron.”
Mel O’Conner immediately asked Nina to document the accounting impact of the Macro Strategy bankruptcy. In addition to the twenty million dollar revenue shortfall, NAI would need to record a bad debt loss for the entire sixty million dollars it was owed by Macro Strategy. Combined, these adverse events would result in a reduction of eighty million dollars in NAI’s 2007 pretax income. The timing of this adverse event could not have been worse; it was too late in the year to find an offsetting opportunity and it occurred just as NAI was reporting its first financial results as a public company. Nina felt sick about this turn of events. She knew that NAI would now report 2007 net income that was well below Wall Street’s expectations. Surely that would cause the stock price to plummet, lowering the value of the stock options that she and her colleagues in management had counted upon. Still, there was no denying that the eighty million dollar impact would have to be absorbed. Mel remarked that he was not looking forward to telling Larry Horton and Harry Fontana about the impact on NAI’s 2007 net income but added: “unfortunately generally accepted accounting principles leave us with no other alternative.”
Nina did not see Mel for the rest of the afternoon. He went to break the bad news to Horton and Fontana and she retired to her office to document the accounting impact of the Macro Strategy bankruptcy. That evening when Nina was at home she received a call from Mel. He told Nina that his meeting with Horton and Fontana did not go well and that he had “decided to accept a very generous severance package.” Nina was shocked. She asked Mel what had occurred and he replied that his severance package was conditioned upon his not discussing anything further with other NAI employees. Mel said only that “we had a disagreement about the direction of the company” and that he looked forward to taking some time off to spend with his family. Nina asked when Mel would be leaving NAI for good and he responded immediately, “I have already cleaned out my office.” She then asked Mel who would be his replacement as Chief Financial Officer. He told her that Harry Fontana was now the CFO of NAI. Mel thanked Nina for her years of hard work and wished her good luck in the future. Nina felt numb as she hung up the phone, realizing that she would no longer be working with Mel O’Conner, her long time supervisor and mentor.
Nina dreaded coming into the office the following day. Word had circulated regarding Mel O’Conner’s abrupt departure and most everyone was speculating that Mel had been blamed for the losses NAI had incurred as a result of the Macro Strategy bankruptcy. Nina was less certain about why Mel had been dismissed. She wondered if the reason for his departure instead had to do with his plan to record the entire eighty million dollar adverse accounting impact in the month of December, although Nina agreed with Mel that generally accepted accounting principles afforded no other alternative.
At three o’clock that afternoon, Nina received a call from Harry Fontana asking her to come to his office for a meeting to discuss her on-going role in his organization and accounting for the Macro Strategy bankruptcy. When Nina arrived at Fontana’s office she found that CEO Larry Horton was also in attendance. They asked Nina to sit down, “We have great news for you Nina” Horton stated. “We have decided to promote you to a newly created position: Vice President of Accounting.” Fontana chimed in “Now that I am the CFO, I will need someone with a strong accounting background as my chief accountant. Since I am not a CPA, you will be the highest-ranking accounting officer in the company. The position comes with a big raise- more than $35,000 per year to a new annual salary of $125,000. We will also be doubling your stock options to 20,000 shares. You will be moving into Mel’s old office and the entire accounting function will be under your control. I know this is a sudden change but you have been here for more than ten years and you have the utmost confidence of Larry and me. Congratulations Nina, you have earned this promotion.” Nina was at once both pleased and concerned. The promotion, the raise and the stock options sounded wonderful, but she was pretty sure there was something more required.
Larry Horton continued the discussion: “Nina now that you are our chief accountant, we are going to need to rely on your creativity. As you know we are facing a temporary crisis involving the Macro Strategy account. Harry has a plan to enable all of us to meet the financial commitments I just made to Wall Street. I will let him fill you in on the details.” Fontana stated “Although I am not a CPA, heck, I have never even taken an accounting course, I have been the CFO of a public company before and I know that the accounting rules are quite flexible.” Nina began to feel uncomfortable as Fontana sketched out his scheme: “We need to execute two accounting strategies. First, we will need to carefully document our rationale to the auditors for not writing off the sixty million dollar accounts receivable from Macro Strategy. As Larry indicated, Nina, we will need your creativity on this one. Second, we will need to replace the missing twenty million in revenue. I have been able to negotiate a one time twenty million dollar cash advance payment from one of our other commercial customers. I have got the check right here on my desk. We will record that as revenue in December and then we will all meet the commitments that Larry has already made to Wall Street. I know all the managers in the company are worried about the value of their stock options. Nina, with your help, we can meet our financial commitments and ensure investor confidence in the shares of NAI“.
Nina was immediately uncomfortable with Harry Fontana’s proposal. She cautiously remarked that she was concerned that Andrew Arthursen Inc might not agree to either of Fontana’s accounting tactics. “I am pretty certain that the auditors will view the accounts receivable as uncollectible and they probably will not allow us to recognize revenue on the advance payment since no work has yet been performed.” Fontana replied that he could handle the auditors stating emphatically: “I have known the audit partner on the engagement, Tom Lester, for over twenty years. I am certain that I can persuade him that this is a one- time situation. He certainly would not want our IPO to be a failure. After all we are not only one of their audit clients, we also employee Andrew Arthursen Inc. consultants on many of our largest contracts. In fact, I think we are one of the largest consulting clients of their local office”. Nina realized that there was no point in arguing the accounting issues with Fontana and Horton, at least not now. She thanked them for the promotion and exited the meeting. As she walked back to her office she thought to herself, “I never imagined that my job could become so complicated.”
Following the meeting, Nina returned to her office to reflect upon the situation. She was glad that it was Friday afternoon and that she would have the entire weekend to consider how she should deal with what she felt certain were illegal accounting methods proposed by Harry Fontana. Nina’s first thought was that she might want to meet with someone inside NAI who could potentially provide an independent look at the situation. She wisely concluded that her long time mentor, Barbara Singer the vice-president of human resources, was the best person at NAI with whom to hold a discussion of the situation. Nina called Barbara’s office and scheduled a meeting for 10 AM Monday morning. Nina also recognized that the situation involved legal issues related to securities law and Sarbanes-Oxley Act compliance as well as potential risks to her on-going employment with NAI. Nina correctly concluded that she, therefore, needed to consult an attorney. She remembered that the lawyer who handled her divorce, Lisa Reagan, also specialized in the area of employment law. Nina called Lisa and scheduled an appointment to meet with her early Saturday morning. Lisa asked Nina to prepare a list of relevant issues prior to the meeting.
When Nina arrived home that evening she began to prepare a list of items to discuss with her attorney. She listed the following issues:
1. There are two pending accounting proposals that would violate generally accepted accounting principles- the twenty million dollar premature revenue recognition and the eighty million dollar bad debt not written off in a timely manner.
2. How will these accounting proposals be reported to the outside auditors (Andrew Arthursen Inc.) and how can the auditors possibly approve?
3. How can NAI submit the report on internal controls to the Securities and Exchange Commission required by section 404 of the Sarbanes-Oxley Act if the improper accounting proposals are implemented? Nina is responsible for preparing this report.
4. If Nina refuses to participate in this accounting fraud how will it impact her employment? Is she entitled to the whistleblower protections that are included in the Sarbanes-Oxley Act? What must she do to be entitled to whistleblower protections if they become necessary?
5. Can she accept the promotion and additional stock options yet refuse to participate in the accounting fraud?
6. Can she exercise her stock options immediately considering that she has knowledge of an impending accounting fraud?
7. Should she discuss the matter with someone else at NAI (such as Barbara Singer) or should she keep the situation private? Should she contact Mel O’Conner to ask for more information and advice even though he has said he cannot discuss the matter further under the terms of his severance agreement?
8. Is she required as a Certified Public
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