High flying startup Entellium crashed to the ground last Friday when the former CEO and CFO were arrested on fraud charges. Entellium had raised over $50 million in venture funding from top firms Ignition Partners and Sigma Partners on the potentially fraudulent bases.

According to a criminal complaint filed Wednesday morning in U.S. District Court in Seattle, Entellium reported to that board that it had received $15.4 million in revenue over the past three years. The U.S. Attorney’s office alleges that the actual revenue for that period was $3.7 million.Ex-Entellium execs appear in court; prosecutor tracking money - Puget Sound Business Journal (Seattle):

Assuming this really is fraud and not some colossal misunderstanding, this is more egregious than Enron — although smaller in that it only affects 190 employees.

A ridiculous number of people had to either be in on it or duped. If a $100,000 sale is reported as a $1,000,000 sale you have to cover your tracks with: the person who made the sale, sales management reporting sales numbers, whoever pays commissions to the sales person, the bookkeeper handling the accounts receivable, finance reporting the financials, anyone keeping the alleged second set of books, all board members and investors who were receiving revenue reports so inconsistent with what was really going on with customers–and who I bet let themselves get talked into either not doing an annual audit or having the audit done by the equivalent of the CFOs brother ….

What were they all thinking?! My hypothesis is that they worked hard to not think about it. They had a good thing going, why be the one to spoil it. Other rationalizations that may have floated around their heads include “it’s not my job,” or “there is probably a really good explanation for this behavior and I just don’t know what it is.” Rationalizations are not good. They are attempts to make something wrong appear not so bad. They cloud clear thinking

According to PEHUB, this all came to a head last week when an HR employee discovered suspicious financial information in the desk of a former sales VP. Their attorneys, Wilson Sonsini Goodrich & Rosati, got this information and brought it to the attention of law enforcement. Thankfully, someone had the guts and good sense not to get wrapped up in this and bring this to light.

The frequency of my blogging has dropped dramatically in the last week due to the launch of my book. It turns out you have a few weeks of fame when everyone pays attention to you and then you become old news. So, I have been making hay while the sunshines and have done six radio interviews, one phone talk, one TV interview, and a few email interviews.

Emeraldinsight.com, in their email interview, asked me a most interesting question:

The 2000 Enron annual report seemed to indicate that everything was going well. To quote some examples: “we work with customers and prospects openly, honestly and sincerely…” and “we are satisfied with nothing less than the very best in everything we do…” From an ethical perspective, do such improprieties suggest that more regulation should be in place with regard to annual reports and investor relations information?

This gets into the area of what part of your ethical code are you willing to impose on others by force. Here was my response:

Although Enron was a particularly egregious example of poor ethics, we are not fans of more regulation. Too often regulation creates unintended consequences, making the cure worse than the disease. Regulation takes the focus off doing what’s right and puts the focus on doing what is legal. Clever, aggressive executives can hide behind regulation, substituting compliance for ethics.

I believe a better solution would be an increased sensitivity in boards, investors, executives, employees, spouses, etc. to the importance of ethics. We have hope that with increasing transparency and access to information, ethical lapses will become more known and more shunned. Business leaders with integrity, who create open honest relationships with investors and customers, will more and more win in the game of business. As these feedback loops become stronger, ethics will become a more effective and authentic shaper of behavior than regulation ever could. 

Tags: Enron, ethics, Clint Korver, ethics for the real world

Comics and Editorial Cartoons: Non Sequitur on Yahoo! News

Tags: EthicsHumor, Clint Korver, Ethics for the Real World

Today is the official launch day of Ethics for the Real World. As part of the launch I am participating in a number of radio interviews. Here is a recording from one that occurred at 4am my time this morning–I may have to talk to my publicist about the ethics of scheduling.

YouTube - Broadcast Yourself.

There has been a lot more smoke found around these hedge fund managers (Matthew Tannin and Roger Cioffi) in the last few days. Here is a sampling from the WSJ Law Blog:

Before Cioffi and Tannin reassured investors that everything was just fine, Tannin

• told Cioffi they should close the fund. ““If we believe the [CDOs reports is] ANYWHERE CLOSE to accurate I think we should close the funds now.” He added, “caution would lead us to conclude the [CDO Report] is right — and we’re in a bad shape.”
• suggested to Cioffi that they retain outside counsel to help them with whatever might come
• used his personal email rather than his work email to express his doubts about the market (Tannin was a 1994 graduate of USF law school)

A WSJ article on Friday, suggested “Defense lawyers are likely to argue that debates about the economy and the stability of the credit markets were standard fare last year as U.S. housing prices began a long slide.

This is called the “everyone else was doing it” defense. While it may work legally, it doesn’t hold much water ethically. Just because other hedge funds may have been privately worrying and publicly confident, this doesn’t make it ethically any better.

Apparently Cioffi and Tannin did not remember their mother’s admonition not to be a lemming. With my mom it went something like “if everyone else were jumping off a cliff would you do it too?” It seemed like a dumb idea when I was little and it seems like even a dumber idea now that I’m older.

Tags: Cioffi, Tannin, Bear Sterns, Clint Korver, Ethics for the Real World, Lemmings

William Baker, a freelance writer and regular contributer to the Boston Globe, spent the last eighteen months blogging about ethics on BNET. In his last post today, he summed up what he has learned from this experience.

* Profit never outweighs wrong.

* The solution to a tricky ethical dilemma is often to just say “no.”

* The best way to deal with a bad idea is to come up with a better one.

* If your gut tells you something is wrong, it probably is. Listen to your instincts.

* There are some work environments that you can’t fix, so dust off your resume.

* You can’t blame anyone else if you get caught up in ethically questionable behavior. There are no victims when “no” is available.

* Tolerating poor ethical behavior is just as bad as doing it yourself.

* The ethical character of an organization is dictated from the top down. Establish an environment where employees know that cutting corners will not be tolerated, and they won’t.

* Your own ethical character is tied in with the companies you do business with. Not all clients are good clients.

* You are a citizen of humanity. Selfish goals cannot outweigh the greater good.

* Writing down a code of conduct is a good thing. Establishing it by example is even better.

Lessons of an Ethics Writer | Where’s the Line ? | BNET

Most of these are excellent. The only one I have a problem with is “You are a citizen of humanity. Selfish goals cannot outweigh the greater good.” I don’t know what it means. It sounds like a positive ethic (e.g. feed the hungry, shelter the homeless), which sound good, but create fuzzy ethical lines.

Overall Kudos to William Baker for his practical ethical insights.

Tags: WilliamBaker, BNet, Lessons of an Ethics Writer, Ethics for the Real World, Clint Korver,

The WSJ this morning ran a front page article on how the managers of the two Bear Sterns Hedge funds that lead to the collapse of Bear Sterns and were the front of the credit crunch wave may face indictments. At issue is whether the managers, Ralph Cioffi and Matthew Tannin, mislead investors. I don’t know if there is fire here, but there is definitely smoke. Here is a timeline of the 2007 events leading up to the issue.

March: three months before Cioffi’s riskier fund goes belly up, Cioffi takes out $2 million of his $6 million personal investment in the fund.

April: Cioffi exchanges emails with colleagues expressing concerns about the credit markets and the potential negative impact on his funds. Then, he turns around and tells investors in an April 25 call he is “cautiously optimistic” about his and Mr. Tannin’s ability to hedge their portfolio.

May: Cioffi and Tannin sell billions of dollars in bonds to keep the riskier fund viable. Some investors hear about this and desperately try to get their money out, but Coffi and Tannin refuse redemption requests.

June: Cioffi and Tannin leave the riskier fund to die, saddled with unrecoverable margin calls and notices of default.

To be blunt, hedge funds bug me. They are not an asset class. They are a compensation scheme. And the compensation scheme creates incentives for fund managers to engage in risky behaviors not aligned with investors expectations or interests.

In another post I will describe the mechanics, but suffice it to say the typical hedge fund compensation scheme creates unbalanced incentives. There is a huge upside financial incentive to take big risks and swing for the fences (this is how you become a billionaire hedge fund manager). However the incentives to avoid the downside are not nearly so great. If your hedge fund goes under (a more and more common occurance), you can take some of your money out (e.g. Cioffi) and then wait a year or two and just start another one.

If Cioffi and Tannin are found not guilty, I would bet big money they are leading another giant hedge fund in a year or two.

The feedback loops are broken in the hedge fund world, creating an ethical pressure cooker of temptation.

Tags: BearSterns, ethics, ethics for the real world, clint korver, hedge funds

The credit crunch of the last year has some potentially surprising implications for the student loan market. On Monday  the New York Times described how thIs crunch has caused some major banks, including Citibank, JP Morgan Chase, PNC, Suntrust and others to close their doors to students at some community colleges, for-profit universities and other less competitive institutions.

A few bloggers have picked up the story, claiming that these banks are discriminating against the nation’s neediest students and are therefore acting unethically. William Baker on BNET, even has a short survey going where 65% of his readers believe this is ethically wrong.

This is a great example for using ethical distinctions to sort out the ethical issues. First, we separate the legal and prudential issues:

Legally, banks must follow the Equal Credit Opportunity Act (ECOA), which says among other things, that when deciding to give someone credit, the bank may not consider your sex, marital status, race, national origin, or religion. Banks may not discriminate with individual borrowers, but they are legally allowed to choose  whether or not they go into the student loan business and also which college organizations they partner with.

Prudentially, pulling out of some colleges may or may not be a good strategy for Citibank. Citibank believes that lending to low loan volume, high default rate colleges is simply not a good business decision. Pulling out may have some costs as well. It may create a PR black eye. Regardless, these are all prudential considerations, not ethical ones.

Ethically, I don’t see any negative ethical issue violations–things you should not do like lying, stealing, and threatening or causing physical harm. The ethical issue, if there is one, must be a positive ethic. To make this an ethical issue, you would have to argue that Citibank has a positive ethical obligation to provide loans to certain college students. This positive ethic, like all positive ethics, has a major challenge in terms of clarity — how many students and under what conditions. What about loans for those learning to pole dance? Ok, you want just accredited colleges covered. What about for students that just party all of the time and never come to class. Ok, they have to be students in good standing, well what about … This is the problem with positive ethics. There is no clear line.

Positive ethics, while they may sound good, often do more harm than good. Their lack of clarity makes it seem ok for other ethics to be unclear as well. This is the problem with legislation in these arenas as well. They sound good, but there are so many unintended consequences that they often make the situation worse.

A more helpful approach would be for a bank to step into this gap and be the “do good for the world bank.” With little effort I think a bank could make create a lot of good will with potential customers by stepping in when others are stepping out. I would be surprised if some bank does not take advantage of this opportunity.

Tags: ethics, student loans, clint korver, ethics for the real world

In an internal auditor’s report released today from Société Générale claims that

Serious management failures by immediate superiors allowed a rogue trader at Société Générale to commit the biggest fraud in financial history. Paris Bank’s Managers Are Blamed in a Scandal - NYTimes.com

The part of the report I find most interesting is that Jerome Kerviel, the rogue trader who placed unauthorized best that led to $7.7 billion in losses claims he is being made into a scapegoat. William Baker wrote a provocative blog about it this morning pondering how he might just be right. Mr. Baker argues that

The ethical culture of a corporation needs to be dictated from the top down. When you have a failure like this, it can never be the work of just one person. Kerviel flunked his ethics because his supervisors were flunking theirs. They didn’t do their job, and it’s a shame they’re not going to take the fall along with the fall-guy. Societe Generale’s Fraudster Says He’s a Scapegoat | Where’s the Line ? | BNET.com

I think scapegoat is the wrong word and the wrong sentiment. It implies Mr. Kerviel is being punished for the errors of others. This is called rationalization. He is minimizing what he did. He is being investigated (and will likely be punished) for the choices he made. Société Générale lack of controls which made it easy for him to act unethically is no excuse in my book. It does not lessen or excuse what he did in the least.

The point I think he could make is that others in the bank were complicit–an ethically sensitive issue to be sure. In this case, he is not a scapegoat but rather an instigator that ethically brought down not only himself but others as well.

Tags: SociétéGénérale , business ethics, ethics, Jerome Kerviel, ethics for the real world, clint korver

AOL hits the ethics news again:

Six years after a scandal first erupted over AOL allegedly inflating its revenue during its merger with Time Warner Inc., U.S. regulators have concluded their investigation and filed civil-fraud charges against eight former executives.The former executives, including onetime Time Warner Chief Financial Officer John Michael Kelly and AOL’s high-profile former deal maker David Colburn, have been charged with helping to overstate advertising revenue by more than $1 billion from 2000 to 2002.

SEC Sues 8 in AOL Revenue Case - WSJ.com

I know people who have negotiated deals against David Colburn. He was nicknamed “the butcher” and for good reason. They were not surprised by these charges or the SEC’s findings.

Fraud at this extreme level indicates cultural problems. This is not about a small number of individuals doing bad things. This is about a culture that permits or perhaps even encourages this kind of behavior. With a guy nicknamed “the butcher” as your key deal maker, you just know something is bound to blow up in your face.

Tags: AOL, ethics, ethics for the real world, clint korver, business ethics