7 signs of internal fraud and unethical practices by businesses, nonprofits, organizations. By Rolf Neuweiler, Rolf Neuweiler, A2ZCFO (image: broken chess set)

The Seven Signs of Ethical Collapse: How To Spot Moral Meltdowns in Organizations

In the book “The Seven Signs of Ethical Collapse” by Marianne Jennings, JD., these seven signs are listed for spotting an organization’s ethics crisis that can bring down corporations like Enron and other businesses and nonprofits:

  1. Pressure to maintain the business numbers 
  2. Culture of fear and silence 
  3. A “bigger than life” CEO and awe-struck direct reports who won’t go against their leader 
  4. Ą weak board of directors 
  5. A practice of conflicts of interest 
  6. A belief that the organization is above the law 
  7. That goodness in some areas (such as corporate giving) atones for evil in others

Sign #1: Pressure to Maintain Those Numbers

Falsify revenues, earnings per share (EPS), expenses and costs, manipulate stock prices, twist accounting practices including changing numbers in a direction to serve certain stakeholder on the expense of other stakeholders… these practices of cooking the accounting books can be the result of unreasonable and unrealistic obsession with meeting quantitative goals and can lead to ethical collapse of businesses, non profit organizations, educational institutions, and even governmental organizations, particularly during economic downturns or fierce competition when profitability and stock prices are threatened. Even if some practices may be legal, they are not ethical. 

Sign#2: Fear and Silence

“He who keeps silent of the truth is a mute devil,” says an Arabic adage. “The culture of ethical collapse is one that does not encourage dissent, or even discussion,” (Jennings, 2006, p. 59.) The fear of losing one’s job, paycheck, status, leadership position, financial wellbeing, visa status… can create sycophants in companies and organizations. Shortsightedness in protecting one’s immediate economic interest at the expense of one’s organization’s long term health is a common human trait.

Intimidating subordinates into silence, bullying accountants to falsify numbers, buying the silence of officers and employees about internal fraud are ways for sustaining the culture of fear.    

Sign # 3: A Bigger-than-Life CEO and awe-struck direct reports who won’t go against their leader 

“More than most agents, leaders have reason to believe that they are not bound by the requirements of morality.” (P. 130, Price, T.L.(2004). Explaining ethical failure of leadership. In Ciulla, J.B (Ed.), Ethics, the heart of leadership. Westport, CT: Praeger Publishers. )   

“The structured component that fuels fears and silence and numbers pressure is the presence of iconic CEO who is adored by the community, media, and just about anyone at a distance. Iconic CEOs are not necessarily adored by employees”. (Jennings, 2006, p.98). Employees and the young and inexperienced managers often act like sycophants following blindly their “kings” and “icons”, – the bigger-than-life CEOs whose egos often expand in gross disproportion with their leadership skills, capabilities and ethics.

 Sign # 4:  A Weak Board of Directors

Rather than having a board of true talents counseling about strategies, watching out for red flags and guiding an organization beyond mere compliance, a weak board have characteristics such as conflict of interests if board members also do business with the company, poor participation and attendance, self dealings, favoritism, coziness with management that impinges on board’s duties and a lack of devotion of time, interest and experience.

Sign # 5: A Practice of Conflicts of Interest

The author argues that the conflicts are not the challenge, but the challenge is the inherent conflicts with the in-house analysts and the complicated relationships between internal auditors and analysts, investment brokers, underwriting syndicates, mutual fund managers, and investors, especially when compensations of many of those are based on commission or value of traded stocks. 

Arthur Andersen’s consulting and auditing services are examples of conflicts of interest. Arthur Andersen advised Enron to do the right things and at the same time was auditing Enron to look for noncompliance. The auditor was a personal friend of the finance man for managing certain financial transactions at Enron. The two men traveled together, golfed together and cooked the books together.  

Sign # 6: A belief that the organization is above the law

Some Founders and CEOs believe in “winning” at all cost and “losing” is not an option. Some believe they are “kings” and won’t be caught for their deception, fraud, and lies. Many of their companies were built on great innovations. The challenges in growing a successful business at a fast speed can invoke their “creative” minds to find “shortcuts”, or even cheating the system with new methods to survive and thrive.

“Companies barreling toward ethical collapse fancy themselves as being above the fray, below the radar, and generally not subject to the laws of either economics or gravity,” (Jennings, 2006, p. 203). An organization needs to be firmed based on its brand essence, values, and implement a culture of honesty and candor to stay on the right track for the long term health and growth.

 Sign #7: Goodness in Some Areas, Atones for Evil in Others

The companies with cooked books, fraud, insider trading often maintain a facade of philanthropic and social goodness inconsistent with their internal activities for the ethical collapse. 

CEO of Enron, Mr. Fastow, was an active member of his local Jewish community, leading fundraising for the Houston Holocaust Museum. “Enron was recognized in the social responsibility and business ethics community for its global corporate citizenship. Enron had a fifty-four page award winning code of ethics,” (Jennings, 2006, p.239). 

A business cannot be doing well by doing good. Economic, financial, accounting and business principles must be adhered to on the foundations of ethics to safeguard integrity and health.

a2zCFO, both the Right and Left Arms for your organization:

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