Financial scandals: the implementation of the UK Corporate Governance Code

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Introduction Financial scandals of a business would happen through complex methods of misusing funds or giving incorrect information to mislead public and many others way. The occurrence of financial scandal had brought huge impact to the economy, the revenue of the economy was reduced drastically, escalating unemployment rates and local governments suffer huge losses prior to these financial scandals. The confidence in the business system has been weakened by these incidents and people broached questions with regard to the effectiveness of corporate governance. A good work was done by Cadbury Committee to introduced UK Corporate Governance Code in year 1992 to lead the company as a guideline to perform effective, entrepreneurial and sensible management to deliver a long term success for the company. UK Corporate Governance Code is also implemented broadly by many companies to establish an effective management for sustainable success of the company. Financial Scandals Tyco There will be discuss about 3 cases of financial scandals that happened in the world; one of the financial scandals was cases of Tyco. There was a general belief that Tyco was a reliable blue chip investment, fabricating electronic components and safety products. The scandal happened in the year 2002 as CEO Dennis Kozlowski and CFO Mark Swartz were reported for siphoning off big sum of money from Tyco. $170 million was obtained by Swartz in unapproved loans and Kozlowski fraudulently sold 7.5 million shares of unauthorized stock, for a reported $450 million. The money was stolen from the conglomerate, usually concealed as executive bonuses. The money was used by Kozlowski to further his luxurious lifestyle, which included a birthday party of his wife which cost him 2 million. The executives got caught as questionable accounting practices were exposed. Tyco scandal might be avoided with the compliance of the current version of UK Corporate Governance Code. Kozlowski was the former chairman of Tyco’s board of directors. One of the main principles of the Code that could be apply to this case is leadership. According to the principle of leadership section A.2, the duties between the operation of the board and the executive should be divided plainly. No individual should possess unlimited powers of decision. The same person should not take on the roles of chairman and chief executive. The distribution of duties between the chairman and chief executive should be plainly established, presented in writing and approved by the board. Tyco could prevent the happened of scandal by adopting this principle. It is incumbent on the board to track the running of the company and to guarantee that it is being operated together with the mandate of the company and the desire of the shareholders. Since the CEO is the executive position accountable for facilitating those operations, possessing an integrated role leads to monitoring oneself. The CEO may abuse his or her position. As such, the ability of CEO to vote on his or her own compensation gives rise to a conflict of interest. Besides, the principle of leadership A.3 states that it lies with the chairman to lead the board and be always effective on all respects of its role. Culture of debate in the company should be encouraged by the chairman through stimulating the non-executive directors to contribute effectively and ensuring positive relations between executive and non-executive directors. The chairman should also provide correct, plain and opportune information to the directors. Not only is that, as a chairman there are responsible for communicating effectively with shareholders. Tyco should meet the important criteria that set out in A.3.1 which states that a chief executive should not continue to take on the role of chairman of the same company. If the board makes decision to appoint the chief executive as chairman in unusual circumstances, the board is necessary to ask the major shareholders for advice in advance and present the grounds of the appointment to shareholders in the appointment and what is more the next annual report. By implementing this principle into practice, conflict of interest could be avoided by Tyco. An independent individual should be the chairman of the board should not be the CEO of the company; it would be easier for Tyco to detect unethical behavior of the directors and professional misconduct. In addition, the principle of leadership section A.4 states that the non-executive directors who take part as the role of the members in unitary board should aggressively interrogate and contribute to the development of proposals on strategy. They should work out to ensuring the reliability and transparency of financial information and that financial management and systems of risk control are strong and appropriate. It is incumbent on the non-executive directors to set proper levels of remuneration of executive directors and they have a fundamental role in appointment and removal of the executive directors. There is no getting away from the fact that companies with inexplicable financial structures are more dangerous and worthless investments because the investors are not able to estimate the financial position of the companies and their bankruptcy risk. Without setting the appropriate levels of remuneration, Kozlowski could abuse the funds of company to improve his lifestyle. Furthermore, Tyco should fulfill the integrity criteria set out in C.3.5 which states that the audit committee should reassess the concerns raised by the employees of the company about probable dishonesty in financial reporting issues. Independent investigation of such issues should be carried out by the audit committee. Tyco could avoid the scandal by booking the transactions at the level above what the external auditors examined and internal auditors should take part in reassessing functions of the headquarters. Bayou Hedge Fund Group Next of the scandals that will be discussing is the case of Bayou Hedge Fund Group scandal. It was a funds group and founded in by Samuel Israel 3, $450m was raised from investors but the funds were misappropriated for personal use. The investors were conceal about the fund's returns, to cover up their misdeed a fake accounting firm was set up to provide fake auditing results by Samuel Israel 3 and CFO Daniel Marino. In July 2004, the officials were started alert about the company when an abnormally large transfer of $99 million was made into a Wachovia account in New Jersey, prompting the initial investigation and follow by the demise of Bayou. Both of them were pleaded guilty in year 2005 because the company started a fake accounting firm to perform an audit to themselves. Sam Israel led the Bayou hedge fund, and had stolen estimate around $300 Million from its investors. He convinced his clients that the fund was doing well by producing fake accounts, while they were under performing. According to the UK Corporate Governance Code, under section C accountability in the principle of C.1, it stated that financial and business reporting the board should present a fair, balanced and understandable assessment of the company’s position and prospects. It is the board's responsibility to present a correct assessment. They had intention to conceal their investors since the beginning, by overstating gains, understated losses. The principles of financial and business reporting state that the board should establish arrangements to ensure that the information presented is fair and understandable. Furthermore the annual report should also include the correct figure of the profit and loss of the company. If Bayou Company obeys the principles, there would not be happen that hiding the truth from the investors when they are generating a lost. Besides that, if Bayou Company obeys the rules that under section C accountability, a correct n fair assessment can be show to the directors and also their investors, so that a financial crime might be prevented. Furthermore, under section B effectiveness, section B5, information and support indicate that the board should be supplied in a timely manner with information in a form and of a quality appropriate to enable it to discharge its duties. For example the chairman is responsible and should ensure that the directors receive accurate timely and clear information. Management has obligation to provide accurate information but directors should seek clarification or amplification where necessary. In this case we can clearly see that Bayou Hedge Fund group did not obey the principles, the director Samuel Israel 3 did not present accurate information to directors. He claim that the company is generating profit while it is suffering lose. He also produces a fake account to hide it from the directors, but the actual is the company had never made any money.Israel has consistently sent out performance reports to investors and at one point claimed the fund was worth $450 million. He funneled all of thehedge funds trades through Bayou Securities, reaping huge commissions since hedge funds trade millions of dollars’ worth of stocks every day.So even as the hedge fund lost money, Israel still banked through his securities firm. If the director doesn’t produces a fake accounts the investors will not surfer such a great lose. Next, according to section A, A.1 the role of the board mention that every company should be headed by an effective board which is collectively responsible for the long term success of the company. Bayou Hedge funds does not have an effective board because of Samuel Israel 3 and James Marquez, they did not provide entrepreneurial leadership of the company and clearly did not have effective control of the company which lead to high risk high loss of the company. Risk has to be assessed and managed by having effective control of the company by the leaders. From our opinion, it shows that they are both ineffective leaders and the company will end up generating loss and have to create fake accounts to trick the directors is because of both of them which have no proper plan and direct direction of their company. This can be prevented if they obey UK corporate Governance Code section A leadership A.1 the role of the board. Enron Lastly, the final cases that would be discussed in this research is the cases of Enron Company. Enron company scandal cases had make a noise in the world, it consider is one of the most serious scandal in the world and also United States history. After merging of Natural Gas that based at Houston and InterNorth, Enron was formed in year of 1985 by Kenneth Lay, and the scandal was revealed in October 2001. The main players of the scandals include the former CEO Kenneth Lay and the CEO of Enron, Jeffrey Skilling, the fraud case had influence financial problem of Enron Company and lead to bankruptcy in December 2001. In the Enron financial scandals, they had tried to conceal the fraudulent of their financial report to continue enjoy the revenue from the investors that are doesn’t know about the true financial condition of Enron. Due to the fraudulent earnings report that report to public, it had attracted many new investors that are desired and willing to enjoy the apparent financial gains. The action of hiding the true of the financial conditions of Enron not only caused a huge loss to Enron it also affected all of the investors lost their money and thousands of employees lost their jobs. Arthur Andersen, auditors of Enron Company also founded guilty by giving inaccurate information and hiding the truth for Enron Company. The introducing of UK Corporate Governance Code could likely help to prevent these financial scandals, Enron as the example to explaining how the UK Corporate Governance Code might be prevented happened of the incident of Enron. Based on the main principle of effectiveness of UK Corporate Governance Code, under the B.1 the composition of the board, it stated that the board and the committees should have suitable and acceptable balance of skills, experience, independence and knowledge of the company to enable them to perform their duties and responsibility effectively. With the compliance of this principles, the board should be include with an proper combination of executive and non-executive directors to prevent there are individual or small group of people can control the board’s decision making. In the case of Enron, majority of the decision probably mostly taken Mr. Skilling, the chance of Enron to hiding the truth will be decrease if the company compliance this principles. Besides that, code provision had further explained that the board should identify the annual report of each non-executive independent director and indicate that the reasons if it is determined as independent person. If Enron obey the principles, there could hardly be hiding any truth from the public. Besides that, in the main principles of effectiveness, there is a concept of re-election. Re-election should be submitted for re-election for all directors at regular times to continue running the company with a satisfactory performance. Shareholders should take notice with the annual election for all directors; all directors should be subject to the elections after the first annual general meeting. The re-election should no more than three years. This could help to prevent there is directors or CEO trying to play a role of one man show to cover or hiding some truth such as Enron company. In additions, based on the principles of C3, audit committee and auditors, it stated that formal and transparent arrangements should considering by the board on how they should apply to reporting the risk management and internal control. It also stated that the board should maintain an appropriate relationship with the company’s auditors. One of the code provisions states that role and responsibility of audit committee should be written in term of references. If Enron Company has maintain an appropriate relationship with auditors, Arthur Andersen the auditors will not help Enron to cover and hide information. Significance of UK Corporate Governance Code In year 1992, the first version of the UK Corporate Governance Code had introduced by Cadbury Committee. The purpose that UK Corporate Governance Code introduced by Cadbury Committee is to provide effective, entrepreneurial and prudent management that drives the company for the long-term success. The UK Corporate Governance Code divided into five main principles such as leadership, effectiveness, accountability, remuneration and also relations with shareholders. Leadership is where an efficient leader is needed so that the operation of the company can flow nicely. The leader is responsible for the long term success of the company. Besides that, effectiveness is where every employee including the board and its members should have balance of skills and knowledge regarding the company in order to balance the operation of company. Furthermore all directors should allocate some time and regularly update skills to their company. Next of the main principles of UK Corporate Governance code is accountability, which is how important the board is in a business where they have to present a clear assessment of the company to the directors and to determine the risk and strategic the company have to use. In additions, remuneration is where a significant proportion of reward is needed time to time to the employees in order to attract and motivate directors to run the company, but no director can decide their own remuneration. Lastly, relationship with shareholders stated that shareholders should have a dialogue between them and communicate well where it is the board’s responsibility to make sure that a satisfactory communication takes place and helps the company run smoothly. This not only supported by company and the shareholder, it also had been imitated by internationally. From the understanding about the UK Corporate Governance Code, one of the most significant codes for the business is principles of accountability. In the code of accountability, it has 3 sections; it is financial and business reporting, risk management and internal control and also audit committee and auditors. From the section C1: financial and business reporting, it said that a fair, accurate and understandable report should be present by the board of directors. When preparing the annual reports, directors should be responsible to consider the necessary information regarding the company performance, business and strategy. If company comply this principle, company will more responsible to provide an annual report that include explanation of the basis and fair, balanced and understandable about their company information. Secondly, section C2 is about the risk management and internal control. This is about the responsible of the board to find out the nature and the importance of the risk that will be occurring in achieving company strategies objectives. Not only that, the board should also control and maintain the management and internal control systems. A review of the effectiveness risk management and internal control system of the company should report to the shareholders yearly. Review must be fair and clear which includes all materials control such as financial, operational and compliance controls. Without this code, the directors will be blurring about the company’s operation and result whether it is generating profit or loss. The board must inform the shareholders about the risk of company will be facing annually so that they can decide whether to continue invest in the company or to getting other way to reduce the risk of company. In section C3, audit committee and auditors stated a formal and transparent arrangement should establish for company to consider how to apply the report of company and risk management and internal control principles for maintaining an appropriate relationship with the company’s auditors. Main role and the responsible of the audit committee are to monitor the financial statements and the formal announcement about the company’s financial performance and the review of the significant financial reporting judgement. If a company can maintain an appropriate relationship with auditors so that a understanding and clear information can be present in the corporate yearly report. Overall, although accountability may are the significant principles in business, but to run and set up a business there are many dimension that should be look after to achieve a better performance, so that the other principles such as leadership, remuneration also playing an important role in business. Company is encouraging that to comply and explain the UK Corporate Governance Code to attain a better future. Conclusion In this research, we had reviews some company had failure in management system run by the high status companies, we also had discussed that the key components of the code which can lead to the avoidance of the scandals. In the UK Corporate Governance Code, we had learn that there are many importance and usefulness of the code such as effectiveness of the boards of directors, the role of audit committee, integrity of financial information, division of responsibilities at the head of the company are essential to the long-term success of the company. Therefore, the chances of preventing cases of financial scandals such as falsifying financial statements and embezzlement of funds will be outstandingly high if every institution complies with the UK Corporate Governance Code. This is because the Code plays a vital role in upholding the ethics that could produce everlasting success of the corporation. An overarching conclusion of this review, not amazingly, is that the severe conflicts of interest result in the failure of corporate governance.
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