Senior executives at Fannie Mae manipulated accounting to collect millions of dollars in undeserved bonuses and to deceive investors, a federal report charged. On May 22, 2006, the government‐sponsored mortgage company was fined $400 million.

The blistering report by the Office of Federal Housing Enterprise Oversight, the result of an extensive three‐year investigation, was issued as Fannie Mae struggled to emerge from an $11 billion accounting scandal. Also Tuesday, the housing oversight agency and the Securities and Exchange Commission announced a $400 million civil penalty against Fannie Mae in a settlement over the alleged accounting manipulation.

Of that amount, the $350 million assessed by the SEC – one of the largest penalties ever in an accounting fraud case – will go to compensate Fannie Mae investors damaged by the alleged violations.

The company also agreed to limit the growth of its multibillion‐dollar mortgage holdings, capping them at $727 billion, and to make top‐to‐bottom changes in its corporate culture, accounting procedures and ways of managing risk. Thirty executives and employees at the company as well as others who have left – including Daniel Mudd, the current president and CEO – will be reviewed for possible disciplinary action or termination.

Washington‐based Fannie Mae neither admitted nor denied wrongdoing under the settlement but did agree to refrain from future violations of securities laws.¹

The Fannie Mae case is typical of the worst scandals in accounting history. This financial information is critical: How much is a company worth? What are its assets? What are its liabilities? What sorts of internal auditing procedures are in place? How do you know? It is the task of the financial accountant or the management accountant to determine those matters and to report them accurately, honestly, and transparently.

A management accountant or financial accountant works for a particular company, either as the chief financial officer or controller, as a line accountant performing any number of possible tasks, or even as a consultant doing specific jobs that contribute to the company’s financial picture. Management accountants can operate as financial managers, accountants, or internal auditors, depending on their position in the company and the organization’s size and nature. Accountants who work for a firm have many of the same obligations as other accountants, but their relationship to the firm gives them a different set of responsibilities from those of the auditor. The Independence Standards Board (ISB) clearly delineated the responsibilities of internal management, including internal management accountants, as compared to outside auditors:

Management is responsible for the financial statements, and responsibility for the choices and judgments inherent in the preparation of those financial statements cannot be delegated to the auditor or to anyone else. Whatever the service being provided, the auditor must understand the level of management’s expertise and must be satisfied that management has taken responsibility for the assumptions and judgments made during the course of the work, and for the results produced.²

The accountants within the firm, whether financial officers, valuations experts, or bookkeepers, have the duty to portray the firm’s financial picture as correctly and truthfully as possible, even if it is detrimental to the company. Although management accountants have a responsibility to the firms that employ them, their overriding obligation is to disseminate the truth.

The “Standards of Ethical Conduct for Practitioners of Management Accounting and Financial Management,” which is the Institute of Management Accountants’ code of ethics, defines the scope of obligations: “Practitioners of management accounting and financial management have an obligation to the public, their profession, the organization they serve, and themselves, to maintain the highest standards of ethical conduct.”³

In accord with the primary principle of this book, any accountant’s first obligation is to do his or her job. For the management accountant, that is to aid in the accurate representation of a company’s financial picture, including assets and liabilities, or to present the most reliable advice based on that picture to all those entitled to it.

It takes little imagination to see how the accountant can be influenced by factors other than accurate reporting. Consider the following story:

It is obvious why company executives act the way Gateway did. If they have a favorable quarterly retained earnings report, the value of the company stock goes up, the board is pleased, the bank is more likely to grant a loan, and prospective investors are attracted to the company. Last but not least, favorable reports have a positive effect on the president’s year‐end bonus. In short, painting such a favorable picture has many benefits.

If, however, the picture is a deliberate distortion, doesn’t creating that picture constitute unethical behavior? Isn’t the accountant either lying or complicit in telling a lie? Even if this behavior benefits the company – a big if – isn’t it still unethical? Clearly, it is unfair to prospective investors, stockholders, and board members who need to make decisions about the company and are entitled to know its true financial condition.

Suppose, for example, the company CEO wants the accountant to paint as rosy a picture as possible to impress the board of directors who are considering renewing the CEO’s tenure. Obviously, not complying with the CEO’s request will jeopardize the accountant’s position in the company. There is a great temptation, therefore, to follow the CEO’s request. It is clear, however, that doing so violates ethical principles, specifically one of the standards in the code of ethics for managerial accounting – the responsibility to be objective.

Let’s address the code provisions more specifically in respect to members in business. First is the Integrity and Objectivity Rule.⁵ This rule requires the management accountant to avoid both actual and apparent conflicts of interest and to refrain from activities that would prejudice the accountant’s ability to execute ethical duties. The accountant must refuse gifts and favors that could influence his or her actions, and should not subvert the organization’s legitimate objectives. The rule further requires that the accountant admit to professional limitations, communicate favorable and unfavorable information, and refrain from behavior that would discredit the profession. Additionally, the rule specifies that the member in business present a fair representation of financials in accordance with GAAP and not intentionally mislead users of the financials. The rule also restricts the member in business from subordination of judgement.

In addition to the Integrity and Objectivity Rule,⁵ the code presents four standards of ethical conduct under the General Standards Rule,⁶ as follows:

• Professional Competence. Undertake only those professional services that the member or the member’s firm can reasonably expect to be completed with professional competence.
• Due Professional Care. Exercise due professional care in the performance of professional services.
• Planning and Supervision. Adequately plan and supervise the performance of professional services.
• Sufficient Relevant Data. Obtain sufficient relevant data to afford a reasonable basis for conclusions or recommendations in relation to any professional services performed.⁶

If the accountant in the example above complies with the CEO’s request, can the accountant “communicate the information fairly and objectively”? We have already discussed the concept of “fair” in Chapter 7. But a brief review may be helpful. Black’s Law Dictionary defines “fair” as “having the qualities of impartiality and honesty; free from prejudice, favoritism, and self interest; just; equitable; evenhanded; equal as between conflicting interests.”⁷ We can conclude, therefore, that the accountant above could not communicate the information fairly and objectively if it is presented as the CEO wishes. It would not be impartial; it would not be honest; it would not be free from favoritism or self‐interest; it would not be even‐handed or free from conflicts of interest. It fails on all counts to be fair. It also fails to disclose fully relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations.

We have repeatedly emphasized that appropriate full disclosure is required for informed consent in a market economy. If the distorted report is supposed to impress the board of directors, it may lead its members to make a recommendation on the CEO’s tenure that it might not otherwise make. If the report is meant to impress the stock market, it, again, may cause activity that would probably not have resulted, had the report been more accurate. Obviously, there is a conflict of interest here between the management accountant’s self‐interest and the interests of others, including the CEO. But this example should also cause us to reflect on the constituencies other than the CEO or the company to which the management accountant is responsible.

When we examine the ethical requirements that the standards impose, we see that the basic function of accountants does not change from auditor to managerial accountants. Bill Vatter, in his introductory comments to Managerial Accounting, published in 1950, succinctly articulates this point:

One of the basic functions of accounting is to report independently on the activities of others, so that information concerning what has happened may be relevant and unbiased. The major function served by both public and managerial accountants is to use their independent judgment with complete freedom; thus they may observe and evaluate objectively, the fortunes and results of enterprise operations. … This is a highly important aspect of accounting, and it is one of the reasons for the separation of the accounting function from the rest of the management process. The detached and independent viewpoint of the accountant must be kept in mind.⁸ (Italics in original.)

Because of the management accountant’s obligation to fair reporting, the accounting function should be kept separate from the rest of the management process. This is not only ethically sound but also managerially wise. To make decisions about a company, it is important, even for those within the company, to have as accurate a picture as possible of the company’s financial condition. In the scenario above, it is in the CEO’s interests (misguided, though they may be) to misrepresent that picture. Concealing the true picture of the company’s worth is not, however, in the best interest of the company, the stockholders, or anyone else. Hence, the accountant has a responsibility to the company and its stakeholders that should override the responsibility to do what the CEO asks.

We all remember the story “The Emperor’s New Clothes,” in which two weavers make the emperor a suit of cloth that is invisible to anyone deemed unfit or stupid. The emperor’s sycophants pretend to admire his new outfit, afraid that telling him the truth – that he is naked – will put them in jeopardy. The health of a business enterprise depends on the truth. If the business is naked, it is best to know. That is the accountant’s task. In some cases, meeting this responsibility may not win the accountant too many friends. In the long run, however, the management accountant does no one a favor by cooking the books. It is interesting to speculate, therefore, about why an internal accountant would misstate a company’s financial picture.

Reasons Used to Justify Unethical Behaviors

A remarkable article by Saul W. Gellerman⁹ gives four rationalizations that managers use to justify suspect behavior. Management accountants can use these rationalizations as guides to warn against misrepresenting financial statements.

Blowing the Whistle

This brings up another issue: whistle‐blowing. The “Standards of Ethical Conduct for Practitioners of Management Accounting and Financial Management” offer this advice:

… When faced with significant ethical issues, practitioners of management accounting and financial management should follow the established policies of the organization bearing on the resolution of such conflict. If these policies do not resolve the ethical conflict, such practitioner should consider the following courses of action:

• Discuss such problems with the immediate superior except when it appears that the superior is involved, in which case the problem should be presented initially to the next higher managerial level. If a satisfactory resolution cannot be achieved when the problem is initially presented, submit the issues to the next higher managerial level. … Except where legally prescribed, communication of such problems to authorities or individuals not employed or engaged by the organization is not considered appropriate.
• Clarify relevant ethical issues by confidential discussion with an objective advisor (e.g. IMA Ethics Counseling service) to obtain a better understanding of possible courses of action.
• Consult your own attorney as to legal obligations and rights concerning the ethical conflict.
• If the ethical conflict still exists after exhausting all levels of internal review, there may be no other recourse on significant matters than to resign from the organization and to submit an informative memorandum to an appropriate representative of the organization. After resignation, depending on the nature of the ethical conflict, it may also be appropriate to notify other parties.²²

In an episode of Chicago Hope, the television show about doctors at a Chicago hospital, a patient died in the recovery room after undergoing liposuction from a particularly greedy doctor, who would schedule two or three surgeries simultaneously. One of the ethical issues raised was what fellow doctors should do to prevent him from acting that way again. Doctors are professionals, and one of the ethical obligations of professionals is to police their professions.

Although not as dramatic, there is an analogous problem among accountants. Consider the following scenario: You are an accountant for a large insurance company. As you begin an internal audit of the company books, you discover that a manager was replacing virtually every policy that he had sold with his previous carrier – with no analysis, no 1035 exchanges, and no replacement forms. He was also writing smokers as well as nonsmokers. What should you do? Are you obliged to blow the whistle? Suppose company officials refuse to do anything about the manager’s shady practices. Do you need to go further?

As we saw in Chapter 4, one of the necessary characteristics of professionalism, according to Solomon Huebner, founder of The American College, is as follows: “The practitioner should possess a spirit of loyalty to fellow practitioners, of helpfulness to the common cause they all profess, and should not allow any unprofessional acts to bring shame upon the entire profession.”²³ If a professional should not allow unprofessional acts to bring shame on the profession, it follows that there may be a time when he or she is obliged to set aside loyalty to a fellow practitioner or company and blow the whistle.

In the context of business ethics, whistle‐blowing is the practice in which employees who know that their company or a colleague is engaged in activities that (i) cause unnecessary harm, (ii) violate human rights, (iii) are illegal, (iv) run counter to the defined purpose of the institution or the profession, or (v) are otherwise immoral, inform superiors, professional organizations, the public, or some governmental agency of those activities.

Two questions remain: When is it permissible to blow the whistle? And when is it an ethical obligation to blow the whistle?

There is a strong judgment against whistle‐blowing. Early in life, we learned not to “tell on others.” This behavior is characterized by such words as “finking,” “tattling,” “ratting,” “stooling,” or some other pejorative term. Not only do people hesitate to blow the whistle, therefore, but they also think it's wrong. Note that in sports, from which the word derives, whistle‐blowing is the function of a neutral referee who is supposed to detect and penalize the illicit behavior of players of both teams. In competitive team sports, it is neither acceptable nor ethically obligatory for a player to call a foul on teammates. Thus, whistle‐blowing is viewed as an act of disloyalty, and there is a presumption against it. If the analogy holds, what is unacceptable in sports is also unacceptable in business – whistle‐blowing is considered wrong.

In spite of our early training, however, there are times when whistle‐blowing is acceptable. There is an ethical obligation for human beings to prevent harm in certain circumstances. If the only way to prevent harm is to blow the whistle, then whistle‐blowing becomes an obligation. The obligation to prevent harm to the public overrides the obligation of loyalty to a person’s profession or company.

When do such times occur? Whistle‐blowing is an obligation when it is based on the following conditions:

• The proper motivation. Whistle‐blowing should be done from the appropriate moral motive – not from a desire to get ahead, for example, or out of spite. Unfortunately, businesspeople often blow the whistle on another person simply because they think the other person has stolen some business away. The proper motivation for blowing the whistle is an illegal or immoral action.
• The proper evidence. The whistle‐blower must be sure that his or her belief that inappropriate actions have occurred is based on evidence that would persuade a reasonable person.
• The proper analysis. The whistle‐blower should act only after a careful analysis of the harm that can result from the inappropriate action. Questions to ask include the following: How serious is the moral violation? (Minor moral matters need not be reported.) How immediate is the moral violation? (The greater time before the violation occurs, the greater chance that internal mechanisms will prevent it.) Is the moral violation one that can be specified? (General claims about a rapacious supervisor, obscene bonuses, and actions contrary to public interest simply will not do.)
• The proper channels. Except in special circumstances, the whistle‐blower should exhaust all internal channels before informing the public. The whistle‐blower’s action should be commensurate with his or her responsibility to avoid or expose moral violations. If there are personnel in the company whose obligation it is to monitor and respond to immoral and/or illegal activities, it is their responsibility to address those issues. Thus, the first obligation of the potential whistle‐blower is to report the unethical activities to those personnel. The whistle‐blower should inform the general public only if the company does not act.

The conditions above speak to the acceptability of blowing the whistle. The next question is when it is morally required (obligatory) for a professional to blow the whistle on a fellow professional? In our society, there is a moral obligation to prevent harm. For example, if you see a small child drowning in a wading pool and no one is helping her, you have a moral obligation to prevent the child from drowning. We can refer to this example as we enumerate the four general conditions for this obligation, developed by John Simon, Charles Powers, and Jon Gunneman in The Ethical Investor.²⁴ The situation must meet all of these four conditions:

• Need. The child will drown without help. Thus, there is a need. If there is no harm occurring or about to occur, there is no ethical obligation.
• Capability. Most people are capable of pulling a child out of a wading pool. If the child is drowning in a deep lake, however, a person who cannot swim lacks the capability to prevent harm in that situation and so is not obliged to save the child.
• Proximity. Even though you did not cause the child to be in the wading pool, you have an obligation simply because you happen to be there. You are in a position to help because you are close by. You are not obligated to help everybody in the world. That brings us to the next condition.
• Last resort. If the parents of the child are there and capable, saving the child is their responsibility. That is the division of responsibility that society establishes. Unless the parents panic or are otherwise unable to act, you are not responsible for the child. If however, everyone there panics and cannot act, you become the last resort. In your professional capacity, if you are the only one who knows of a colleague’s unethical activity, you are the last resort for blowing the whistle. If the colleague’s superior knows of the activity, it is his or her responsibility to stop it. If, however, the superior does not act, from whatever motive – whether it is dereliction or inability – you become the last resort, and the responsibility falls to you.

As it relates to whistle‐blowing, we need to add to a fifth condition to the four developed by Simon, Powers, and Gunneman. The fifth condition is the likelihood of success.

The whistle‐blower should have some chance of success. If there is no hope in arousing societal, institutional, or governmental pressure, then the whistle‐blower needlessly exposes himself or herself (and perhaps others to whom the whistle‐blower is related) to hardship for no conceivable moral gain. The obligation arises from the duty to prevent harm. If no harm will be prevented and there is no other ground for the obligation, there is no obligation. If nothing is accomplished except bad feelings toward the whistle‐blower, there is hardly an obligation to blow the whistle.

Hence, we can summarize the responsibility to blow the whistle as follows: If you are in a proximate position, you are capable of preventing harm (the need) without sacrificing something of comparable moral worth, and you are the last resort, it is more than acceptable to blow the whistle – you have an obligation to blow the whistle to prevent such harm.²⁵

In the business world, in which companies and fellow practitioners are seen as a team, loyalty is expected and rewarded. Leaving the team to function as a detached referee – to blow the whistle – is viewed as disloyal and cause for punitive action. Whistle‐blowing, therefore, requires moral heroism. It will not be easy, and the consequences can be dire. Nevertheless, given that society depends on whistle‐blowers to protect it from unscrupulous operators, it is sometimes required. Sherron Watkins, vice president for corporate development at Enron, sent a letter to Kenneth Lay, Enron’s chairman, in August 2001, questioning Enron’s financial activities and reporting behaviors. Warning that improper accounting practices threatened to destroy the company, Watkins has emerged as a hero in the Enron debacle.

Professionals must accept that upholding the standards of their profession may require them to blow the whistle. Accountants have a fiduciary responsibility – an ethical obligation – to report certain illegal or potentially harmful activities. This obligation arises from the accountant’s status as a professional and from the human duty to prevent harm under the conditions of need, proximity, capability, and last resort. If accountants are to be true professionals, there will be times, when they will be obliged to blow the whistle, as difficult as that may be.

In conclusion, let us summarize the management accountant’s responsibilities. The first responsibility is to do his or her job – that is, to execute whatever accounting function he or she was hired to perform. The second is to do so with objectivity, honesty, and integrity, overcoming temptations from business pressures and intimidation by leaders to tamper with the books. Finally, the management accountant may have the unfortunate and difficult responsibility to blow the whistle on wrongdoing, but only under the circumstances described above.

The next chapter, Chapter 9, examines the role of the tax accountant.

Discussion Questions

1. Explain the similarities and differences in obligations for an auditor and a management accountant. What are the implications of these for the management accountant?
2. What are the various rationalizations to justify unethical behaviors? For each of these rationales, discuss situations that a management accountant might invoke them? Develop a plan to internally combat the temptation to justify unethical behaviors.
3. When is a management accountant obligated to whistle‐blow and what are the required steps to be gone through once the decision to whistle‐blow is made? Give an example of an activity in management accounting that would require whistle‐blowing.