NewsNotables – Issue 68

Deloitte Focuses on Ethics

The Wall Street Journal, November 19, 2009

Deloitte Touche Tohmatsu is aiming to redefine how its employees can be socially responsible and to centralize its message about the company’s societal obligations. It’s part of a larger effort at the accounting giant to push corporate social responsibility up the priority ladder.

The company-wide focus is on developing education programs for young people. Early in 2010, Deloitte plans to gather 20 high potential managers for a year-long program aimed at helping schoolage students build skills like ethics, innovative thinking and global awareness. These issues are often left out of typical school curricula. The program will be called Deloitte21, a reference to the idea of building skills for the 21st century.

Each participant will lead a local education project, through an existing education nonprofit in their region. They will also be charged with getting additional employees involved. Implementing the program has helped involve top firm leaders and drum up interest and investment in corporate social responsibility initiatives. Mr. Aijala, a global managing partner, states, “When you look at what clients expect of an organization like ours, there is actually not a choice. If you want to be successful it requires placing social initiatives right at the core.” Deloitte hopes to increase the fellowship class to 60 in the next five years.

Comment: Most of the “News Notable” articles I comment on are situations where ethics have been ignored resulting in consequences that damage our society and virtually destroy the people involved. Deloitte’s new program is refreshing and one that I hope is very successful and expanded internally and through other organizations.

I confess to being biased in that I spent the first eight years of my work life at Touche, now part of Deloitte. Congratulations on being forward thinking stepping out with a promising program.

Lawyer Pleads Guilty to Tax Evasion

The Seattle Times, December 11, 2009

Mathew Krane, a Hollywood tax lawyer, who is a potential witness in what Internal Revenue Service officials have called a “staggering” cheat of the tax system, has pleaded guilty to a single count of tax evasion involving nearly $36 million in undeclared income.

Krane appeared before U.S. District judge in Seattle and entered the pleas to tax evasion, as well as falsely attempting to obtain a passport. As part of the deal, Krane has agreed to cooperate with federal prosecutors in exchange for a sentence of no more than five years in prison for the convictions.

Krane has pleaded guilty for failing to pay taxes for 2002, which is the year prosecutors allege he hid $35.9 million in overseas accounts. That money, according to the indictment unsealed last summer, was allegedly given to Krane as a kickback by two former officials of the Seattle investment firm Quellos Group for allegedly steering one of his wealthy Hollywood clients to Quellos.

Krane has agreed to cooperate with federal prosecutors in the case against former Quellos CEO Jeffery Greenstein and his business partner, Charles Wilk, according to court filings. Prosecutors say that Greenstein and Wilk were the architects of an investment plan called POINT first offered by Quellos in 1999. Over the next three years, six investors, including Krane’s client, placed a total of $1.6 billion into POINT.

POINT was scrutinized by Senate investigators looking at wealthy tax evaders and was found to be based on billions of dollars worth of fake securities transactions that were used to generate billions in capital losses, which POINT clients could then use to offset taxes that should have been paid for legitimate capital gains. Krane maintained that the money he was paid was a fee for his services.

Comment: There are many “ethical frauds” here. First, Krane cheated the government by not reporting $35.9 million of income. It makes no difference if Krane received the money as a kickback or as a fee for services – he didn’t report it as income and pay taxes. Second, Krane hid the money in overseas accounts, and I assume has not paid investment earnings on the money (since it was hidden) since 2002.

Third, he falsely attempted to obtain a passport. Fourth, he directed his clients money to a fraudulent investment firm Quellos. Fifth, Quellos faked security transactions to generate billions in false capital losses to enable their clients to offset legitimate capital gains. Sixth, the wealthy clients cheated on their tax returns reporting the false capital losses.

Need I say more? What a mess! Letting Krane plea bargain to serve “no more than five years” in prison is much too soft for the crimes he has committed.

Microsoft Giving Software to Curb Child Porn

USA Today, December 16, 2010

Microsoft has created new software that makes it easier to remove child pornography from the Internet. This program should help protect children who have been and are being sexually abused when their photos have been circulated online. Microsoft, which developed the PhotoDNA software, is now donating it to the National Center for Missing & Exploited Children [LINK], a non-profit group that will use it to protect the abused children.

Every week, the center reviews 250,000 images of child pornography and sends what it considers the most egregious to online service providers to be removed. The new technology will allow the center’s computers to find more images that match an initial picture, even though it may have been altered. “It will make a huge difference,” says Ernie Allen, president of the center, which receives funding from the Justice Department [LINK ] to work with police agencies.

The center has helped identify nearly 2,700 child pornography victims, most of whom were “prepubescent kids” abused by someone they knew and trusted. Allen said even though it’s impossible to prosecute every sex offender, at least the distribution of their photos can be reduced.

Hany Farid, a professor of computer science at Dartmouth College [LINK ] who worked with Microsoft on PhotoDNA said, “It’s very much like DNA, and identifies a photo’s unique characteristics and, unlike previous software, remains accurate even if the size changes by as much as 50%.” Brad Smith, Microsoft’s general counsel, said “These children have been through enough and we can’t allow people to keep trading these horrifying images online when we have the technology to do something about it.”

Comment: I applaud Microsoft [LINK ] for creating this software and for giving it to the National Center for Missing & Exploited Children to help fight this kind of child abuse. We know that it’s probably impossible to eradicate child pornography completely, but trust this software will have a measurable effect in the fight against this abuse of children. Child pornography is almost beyond my comprehension, but I realize it is on the increase and everything we can do to turn it around is a plus for our society. My hats off to Microsoft.

Big, in Banks, Is in the Eye of the Beholder

The New York Times, January 18, 2010

Can a bank be too big? This question has been asked many times in the last couple years as many banks have suffered financial set-backs during the down economy. The question was raised again during the Financial Crisis Inquiry Commission hearing in early January. “Some have suggested that size alone, or the combination of investment banking and commercial banking, contributed to the crisis,” Jamie Dimon, J.P. Morgan CEO, said to the commissioners. Dimon argues that there was no clear correlation between size and problems. But there is a loud chorus of people that disagree with Diamond arguing that the sheer size of the banks (and worries about the effect of any of them failing) helped bring about the financial crisis.

Dimon believes, “The solution is not to cap the size of the financial firms. We need a regulatory system that provides for even the biggest bank to be allowed to fail, but in a way that does not put taxpayers of the broader economy at risk.”

The concern of size alone, have led many people to question the 1999 repeal of the Glass-Steagall Act, the law enacted during the depression era to prevent investment and commercial banks from combining. Alan Greenspan has argued that a simple test should settle should settle issue, “if they’re too big to fail, they’re too big.” Greenspan also has stated that “private regulation generally has proved far better at constraining excessive risk-taking than has government regulation.”

Shrinking the size of these companies may create other problems for the economy, particularly for huge corporations. Examples given are, If Pfizer needs to raise $20 billion for a takeover bid, or Verizon needs to raise billions to lay fiber optic cable for its FIOS service, they cannot efficiently go to 20 different banks to raise the money. Many large U.S. companies operate globally employing millions of people. These companies need banking partners that also operate globally and can offer a full range of products and services and provide financing in the billions of dollars.

Comment: The question of “can a bank be too big ‘ is very difficult to answer. When a large bank fails, then many people think it was obviously too big, but that’s hindsight and may have nothing to do with the size but rather the quality of management. A piece of legislation currently in Congress involves “resolution authority,” which would give the government the ability to put a too-big-to-fail financial company into a conservatorship in much the same way the Federal Deposit Insurance Corporation is able to unwind a commercial bank without putting it into bankruptcy. If adopted, a failed bank’s shareholders would lose their value, and unsecured creditors would be a risk and might be wiped out. A regulator might also be able to terminate management and boards and liquidate assets.

Such a “solution” would probably come with a high cost, especially to responsible banks. Since financial institutions would have to be assessed fees to cover costs associated with failures, responsible banks would be paying for the failure of irresponsible banks. This has been the case for many years for the insurance industry where well run companies pay for failed insurance companies. The end result is that these increased costs eventually have to be borne by their customers.

No Worries About “Morality” in Biggest Real Estate Default in History

Yahoo Finance, January 25, 2010

Over the past few months, arguments have raged about whether it is “immoral” for homeowners to send banks the keys to their houses and walk away from mortgages that don’t make sense for them to keep paying (since many times the mortgage is greater than the fair market value of the home).

Recently, Tishman Speyer and BlackRock Reality, the owners of the huge New York residential real estate complex Stuyvesant Town, have decided to hand over the keys and walk away, dumping the depressed property on lenders who provided some $4.4 billion in loans.

Stuyvesant Town is now estimated to be worth less than half of what Tishman and BlackRock paid for the property four years ago. Tishman will be feeling much less pain since they only put up $112 million of equity (less than 3%) when they purchased the property. Other investors, such as California Public Employees’ Retirement System, a Florida pension fund, the Church of England, and the bondholders, will suffer the vast majority of the loss.

In none of the articles reporting this decision was the question of “morality” ever mentioned or discussed. It was simply assumed, as it usually is with corporate transactions, that the parties had reached their agreement at arms-length and that default was always a possibility.

Much of the mortgage industry usually tries to convince homeowners that they have a “moral obligation” to pay up when corporate borrowers many times don’t, since this sense of responsibility and guilt induce more homeowners to pay. But it’s not fair. There are dozens of good reasons not to default on your mortgage, but “morality” isn’t normally considered.

Comment: This argument kind of reminds me of the old saying, “what’s good for the goose is good for the gander.” The discussion above can also be applied to going bankrupt.

Many people say to just file for bankruptcy and start over. Of course this leaves the lenders and/or creditors with little or nothing. Doesn’t the person filing bankruptcy also have a “moral” obligation to pay the lenders back over time? It’s always amazed me how little capital many real estate operators put in a new project. It’s certainly a lot less risky to use other people’s money. Of course these operators usually share heavily in the upside, if any.

By Roger Eigsti
Board President,
Institute for Business, Technology and Ethics