ethical issues in finance

7/29/2019 Ethical Issues in finance

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Ethical issues in Finance

and Accounting

Group Members Roll No.Nazbul Hasan Khan 85

Kaustubh Mahajan 86

Roma Mantri 87

Juhi Maurya 88

Krupa Mehta 90


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Introduction

Accounting and finance provides fair and accurate

reporting of the financial position of a business.

The major ethical issues occur in accounting and

finance are reporting false income, falsifyingdocuments, allowing or taking questionable

deductions, illegally evading income taxes,

engaging in frauds etc.


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Ethics and Law

Both law and ethics focus on defining the perfecthuman behavior, butthey are not the same.

Law is the governments attempt to formalize rightful

behavior, but it is rarely possible to enforce writtenlaws.

It depends on individual or business ethics to reduce

unlawful incidents.

Ethical concepts are more complex than written rules

since it deals with human dilemmas that go beyond

the formal language of law


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The Equity Funding Fraud of 1973

Equity Funding Corporation of America(Equity)

During nine year period at least $143 million

of fictitious pretax income was generated

Reported Net income $76 million instead of

the real pretax losses totaling more than $67

million.

Carried out by 10 executives includin CEO,

CFO, controller and treasurer


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Mayawatis brother Anand Kumar

The Economic Times 28th Jan 2013

Rs. 760 crore

Only one company rest six after 2007

Sources of Funds unclear

Issue of shares at huge premium

Creation of cash reserves by forfeiture of

advances paid by third parties Sale of undisclosed investments

Issue of dividends


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The Enron Scandal


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Brief history about ENRON

ENRON was formed during 1985 by KennethLay after merging Houston NaturalGas and InterNorth.

It became the largest gas and electricity trader inNorth America.

ENRON became the global leader in trading gas,electricity, broadband and even weather related

derivatives. The companys earnings grew double digits every

year for many years.


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Good old days

The companys market capitalization

approached $30 billion in august 1999.

Later in 2000 ENRON became the 7th largest

company in America with a market

capitalization of nearly &70 billion


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Causes of downfall

ENRON's complex financial statements were confusing toshareholders and analysts.

In addition, its complex business model and unethical practicesrequired that the company use accounting limitations tomisrepresent earnings and modify the balance sheet to indicate

favorable performance. According to McLean and Elkind in their book The Smartest Guys in

the Room, "The ENRON scandal grew out of a steady accumulationof habits and values and actions that began years before and finallyspiraled out of control.

In an article by James Bodurtha, Jr., he argues that from 1997 untilits demise, "the primary motivations for ENRON's accounting andfinancial transactions seem to have been to keepreported income and reported cash flow up, asset values inflated,and liabilities off the books."


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The combination of these issues later resulted in the bankruptcy ofthe company, and the majority of them were perpetuated by theindirect knowledge or direct actions of Lay, Jeffrey Skilling, AndrewFastow, and other executives.

Lay served as the chairman of the company in its last few years, and

approved of the actions of Skilling and Fastow although he did notalways inquire about the details.

Skilling, constantly emphasized meeting Wall Street expectations,advocated the use of mark-to-market accounting (accounting basedon market value, which was then inflated) and pressured ENRONexecutives to find new methods to hide its debt.

Fastow and other executives "...created off-balance-sheet vehicles,complex financing structures, and deals so bewildering that fewpeople could understand them."


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What ENRON has done

Engaged in unhealthy heavy borrowing andthe dishonest practice of the CEOs:Unacceptable.

Deliberately inflating the future cash flow:deceiving the business partners.

By collaborating with the accounting firm,

Arthur Anderson, in providing false financialstatements to shareholders, investors, thepublic and the US government.


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4 slides


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EMPLOYEES AND SHAREHOLDERS

ENRON's shareholders lost $74 billion in the four yearsbefore the company's bankruptcy ($40 to $45 billion wasattributed to fraud).

As ENRON had nearly $67 billion that it owed creditors,employees and shareholders received limited, if any,assistance aside from severance from ENRON.

To pay its creditors, ENRON held auctions to sell assetsincluding art, photographs, logo signs, and its pipelines.

More than 20,000 of ENRON's former employees during

May 2004 won a suit of $85 million for compensation of $2billion that was lost from their pensions. From thesettlement, the employees each received about $3,100.


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Sarbanes-Oxley Act

An act passed by U.S. Congress in 2002 to protect investorsfrom the possibility of fraudulent accounting activities bycorporations.

The Sarbanes-Oxley Act (SOX) mandated strict reforms toimprove financial disclosures from corporations andprevent accounting fraud.

SOX was enacted in response to the accounting scandals inthe early 2000s. Scandals such as ENRON, Tyco, andWorldCom shook investor confidence in financialstatements and required an overhaul of regulatorystandards.


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Learnings from the ENRON case

You make money in the new economy in the same ways you makemoney in the old economy - by providing goods or services thathave real value.

Financial cleverness is no substitute for a good corporate strategy.

The arrogance of corporate executives who claim they are the best

and the brightest, "the most innovative," and who presentthemselves as superstars should be a "red flag" for investors,directors and the public.

Executives who are paid too much can think they are above therules and can be tempted to cut ethical corners to retain theirwealth and perquisites.

Government regulations and rules need to be updated for the neweconomy, not relaxed and eliminated.


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The Issue

Coal allocation scam is a political scandal concerning

the Indian government's allocation of the nation's coal

deposits to Public Sector Entities (PSEs) and private

companies.

In a draft report issued in March 2012, the Comptroller

and Auditor General of India (CAG) office accused the

Government of India of allocating coal blocks in an

inefficient manner during the period 2004-2009.


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1972-2010- BACKGROUND TO

COALGATE: HISTORY OF COAL

ALLOCATIONS IN INDIA


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FIRMS ELIGIBLE FOR A COAL

ALLOCATION

Historically, the economy of India could becharacterized as broadly socialist, with thegovernment directing large sectors of theeconomy through a series of Five-year Plans.

In keeping with this centralized approach,between 1972 and 1976, India nationalized itscoal mining industry, with the state-owned

companies Coal India limited(CIL) andSingareni Collieries Company (SSCL) beingresponsible for coal production.


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This process culminated in the enactment of the Coal Mines(Nationalisation) Amendment Act, 1976, which terminatedcoal mining leases with private lease holders. Even as it didso, however, Parliament recognized that the nationalizedcoal companies were unable to fully meet demand, and

provided for exceptions, allowing certain companies to holdcoal leases:

1976. Captive mines owned by iron and steel companies.

1993. Captive mines owned by power generationcompanies.

2007: Captive mining for Coal gasification and liquidfaction.


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THE COAL ALLOCATION

PROCESS In July 1992, Ministry of Coal, issued the instructions for constitution of a

Screening Committee for screening proposals received for captive mining by

private power generation companies.

The Committee was composed of government officials from the Ministry of

Coal, the Ministry of Railways, and the relevant state government.

A number of coal blocks, which were not in the production plan of CIL and

SSCL, were identified in consultation with CIL/SSCL and a list of 143 coal

blocks were prepared and placed on the website of the MoC for information of

public at large.

Companies could apply for an allocation from among these blocks. If they

were successful, they would receive the geological report that had been

prepared by the government, andthe only payment required from the allocatee

was to reimburse the government for their expenses in preparing the geological

report.


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COAL ALLOCATION GUIDELINES

The guidelines for the Screening Committee suggest that preference be given to the

Power and Steel Sectors (and to large projects within those sectors).

They further suggest that in the case of competing applicants for a captive block, afurther 10 guidelines may be taken into consideration:

status (stage) level of progress and state of preparedness of the projects;

net worth of the applicant company (or in the case of a new SP/JV, the net worth

of their principals);

production capacity as proposed in the application;

maximum recoverable reserve as proposed in the application;

date of commissioning of captive mine as proposed in the application;

date of completion of detailed exploration (in respect of unexplored blocks only) as

proposed in the application;

technical experience (in terms of existing capacities in coal/lignite mining and specifiedend-use);

recommendation of the administrative ministry concerned;

recommendation of the state government concerned (i.e., where the captive block is

located);

track record and financial strength of the company.


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RESULTS OF COAL

ALLOCATION PROGRAMGiven the inherent subjectivity in some of the allocation guidelines, as well as the

potential conflicts between guidelines it is unsurprising that in reviewing theallocation process from 1993 to 2005 the CAG says that "there was no clearlyspelt out criteria for the allocation of coal mines.

2005: the Expert Committee on Coal Sector Reforms provided recommendationson improving the allocation process,

2010: the Mines and Minerals (Development and Regulation) Act, 1957Amendment Bill was enacted, providing for coal blocks to be sold through a systemof competitive bidding.

The foregoing supports the following conclusions:

The allocation process prior to 2010 allowed some firms to obtain valuable coalblocks at a nominal expense

The eligible firms took up this option and obtained control of vast amounts of coalin the period 2005-09

The criteria employed for awarding coal allocations were opaque and in somerespects subjective.


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Allegations of the CAG Report

First charge The most important assertion of the CAG Draft Report :

Government had the legal authority to auction the coal, butchose not to do so.

Any losses as a result of coal allocations, then, between 2005 and

2009 are seen by the CAG as being the responsibility of theGovernment.

Second Charge If the most important charge made by the CAG was that of the

Government's legal authority to auction the coal blocks, the one thatdrew the most attention was certainly the size of the "windfall gain"accruing to the allocatees. On pp. 3234 of the Draft Report, theCAG estimates these to be 1,067,303 Crore.


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Reactions

Media report (TOI Report)

Allegations against different people involved

S. Jagathrakshakan

Ajay Sancheti

Premchand gupta

Naveen Jindal

Opposition Party


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Investigations that followed

CBI Investigation

IMG

Final CAG Report Governments response

Matter reaches Supreme Court

Parliamentary session

Charges against Reliance


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WHY HAS CAG RAISEDQUESTIONS?

CAG says Anil Ambani owned Reliance

power got undue benefit of Rs. 29,033crore when govt. allowed use of surpluscoal from blocks allotted to Sasan Power

Plant for its other project.

Why was a third mine allocated to SasanProject by snatching it from State-ownedNTPC, when it was not established that

two previous mines would be insufficientto generate 3,960 MW of Power.

Chitrangi Plant would supply power at

higher tariff Rs.2.45-Rs.3.702 per unitthan Sasans Rs.1.196 per unit, though it

would get coal at same price as Sasans

UMPP.


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OBSERVATIONS

Government unduly benefitted Private PowerDevelopers in awarding ofUMPPs.

Developers misused and diverted coal made availableto them.

Of the four UMPPs currently operational, three areowned by Anil Ambanis Reliance Power (RPL) andone by Tata power.

Mundra and Krishnapatnam UMPPs have land inexcess of 1538 acres and 1096 acres.

EGOM allowed the excess land to be retained by thedevelopers instead of utilizing the same for other publicpurpose.


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What Law states

Regulatory authorities CBI

SERIOUS FRAUD INVESTIGATION OFFICE

Central Vigilance Commission

Central Economic Intelligence Bureau

Directorate of Enforcement

Economic Intelligence Council


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Offences

Fraud

Bribery and corruption

Insider Dealing and Market abuse

Money laundering and Terrorist financing

Financial record keeping


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Conclusion

Duty of Government

Duty of opposition

Duty of Company

Duty of investors

Duty of corporate

Auditors and investment bankers

Duty of regulatory authorities

Duty of individuals

ethical issues in finance

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