Case Studies

Case Study 10 – A Question of Professional Ethics

Industry: Professional Services - Eastern Europe

Company: Dominant Big 4 Professional Accounting firm

Objective: To take over office management in four countries in Eastern Europe

Results:

Background:

The Professional Services firm had a long and honored tradition, having started in the UK in the middle of the 19th century, and by the end of the second millennium employing thousands of professionals globally. It had been voted as one of the top 10 preferred employers in the USA recently. The offices in this particular region of the world had been established shortly after the countries concerned had gained independence from the former USSR. The partners located in Prague had decided that a new regional partner was required to take the business forward and to allow the previous incumbent to move on to better things.

Unknown to the new incumbent, the firm had previously sailed close to the wind in terms of professional ethics and risk management, and was embroiled in a major legal case, in which the government was taking the current regional partner and the firm to court over alleged mis-management of a bankrupted pyramid bank which was under administration by the firm. The partner had allegedly managed to transmit several millions of dollars from the accounts of the bank under his administration to a financial institution in Liechtenstein.

These matters only came to light when the incumbent regional partner had joined the firm and was working in its local offices, in spite of prior questions about the motivations for the current partner to move. Any answers to such "due diligence" questions had been about changing personal circumstances of the existing partner, rather than personal risk related to the high profile court case or other matters which subsequently came to light.

Using a senior professional position for personal gain

Soon after arriving in the office, the new partner was having hand over discussions with the existing partners to discuss the move to new premises which were required to accommodate the continuous and rapid expansion of the office. The existing regional partner suggested that the partners might wish to work together and purchase a building to be rented by them collectively to the professional services firm, to provide them additional opportunities for rental income and capital gain. In addition, it was suggested that any private requirements for home furnishings would also be financed from the firm's local revenues through accounting adjustments.

The new building, located in a premium location in the old town, belonged to a local church which had suffered substantially during the lengthy communist occupation, when churches had been banned. After the country's independence, the church had regained some of its former properties, after some adjustments, and the building targeted for the professional services firm to rent had therefore become available.

On first glance the building looked suitable, until the new partner did a number of projections based on the latest budgets and forecasts for the coming years, after which it became obvious that, based on international standards and ratios (square meters per employee) the office space would soon be insufficient for the needs of the firm.

Unknown to the new partner, the existing regional partner also had a penchant for heavy gambling, which not only increased his personal needs for a substantial cash flow but also put him in contact with some interesting characters about town, many itinerant international businessmen, wanting to try their luck in the new wild west.

This included a Northern European who owned properties in Belgrave in London as well as Monaco and drove a Rolls Royce, had perfected a number of techniques which allowed him to not only break the bank at several casinos locally (from which he was thereafter banned), but had also been able to identify weaknesses in the national banking system related to credit and risk management. At that time, financial institutions in this part of the world were in their infancy, and valuations on properties from third party valuers were accepted without question.

This businessman contacted his gambling contact from the casino and asked him to prepare a valuation for a central city building in a prime location. The market value of the building was around GBP 1 million. The normal valuation costs for a building, including valuation report, were at that time around GBP 4,000. The two "partners" agreed that a building valuation of GBP 3 million would be more appropriate, for a professional fee of USD 70,000, well above the going rate.

The bank duly advanced the loan funds based on a GBP 3 million valuation. The Regional Partner received USD 70,000. The Scandinavian businessman paid around GBP 1 million to the former owner of the building and kept GBP 2 million to perfect his gambling techniques in the local casinos. Unfortunately, finances were not sufficient to cover gambling losses, and the businessman soon planned another money making scheme related to the church building previously referred to.

Further evidence of unusual business practices turned up frequently, but the new partner was nevertheless still very shocked when the chairman of the firm in this region suggested the firm pay a "sweetener" to the president of a target client, the national railways company of this country, to win a substantial IT (SAP) Implementation project. The new partner brought the matter to the attention of the Eastern European (CEE) Partner (A US National) as a matter for urgent consideration and was told that this practice, although not to be officially condoned, was a usual way of doing business in this part of the world. The region concerned was one of the few in the Eastern European operations that created substantial profits to support further expansion and development of CEE networks.  The CEE Partner's remuneration package contained a discretionary bonus in the millions of $ USD, on achievement of certain targets. A better way suggested by the CEE partner was to employ a family member of the president of the railway company as a "consultant" to be paid "consulting fees" over the life of the project.

Inappropriate use of racial imbalances

Another example of the way corners were cut in the pursuit of short term profits was the exploitation of  racial imbalances in the country where the firm's head office was located. Subsequent to the independence of this country, the Russian minority, which had been introduced into the country as a deliberate policy of the Soviet Union to slowly "nationalize" the region and make it less susceptible to western influences during the period of the Cold War, had come under pressure economically and politically.

Many Russian aspiring professionals in different fields were finding it hard to get the required experience in well known multinational professional services firms. To get their foot in the door, they had learnt to acquiesce and accept worse employment conditions, including salaries, then their national counterparts in other firms. Consequently, when the new partner arrived, almost 90 % of the employees of the firm were  Russian, working in extremely cramped situations, with deficient technical tools affecting their health, and extremely long working hours including train travel to all parts of the four country region.

In one example the new partner learnt that employees were routinely provided insufficient daily allowances to rent minimal standard hotel accommodation, requiring them to occupy rooms in twos or threes. A hotel manager raised this issue with the new partner on his arrival on site, especially as his hotel provided single rather than double beds on these occasions where rooms were shared. The partner raised this issue with his colleagues and the regional partner and was told that staff who had been sharing the same hotel room were no doubt gay, and that, related to any other required improvements suggested there was no need to worry because the employees represented a captive audience by virtue of their racial background as they would have few options to find alternative options with other multinational services firms.

Lessons Learnt

In spite of the international image and reputation of multinationals, national and international laws and regulations (Foreign Corrupt Practices Act) as well as corporate ethics and governance frameworks, there remain substantial pressures in emerging and developing markets to adapt to local customs and become flexible, in order to meet expectations of stakeholders.  It is normal that these exist as different countries evolve to adapt new governance and management techniques.  This evolution does not happen overnight. 

However, management needs to be well aware of these pressures and challenges as well as the risks facing the organization in developing new markets and put in place appropriate measures to minimize these type of situations.
To counter and minimize the irregularities, such as described previously, management needs to focus on:

1. Establishment and enforcement of a clear international ethics and integrity framework, including Codes of Conduct, regardless of the economical pressures to do otherwise.

2. Recruitment and retention of high caliber professionals with clear and unquestionable ethics and values.

3. Objectives and targets for any new investments in developing markets need to be conservative and understand the delays inherent in doing business in such markets as well as the substantial on going investments required to build firms to an international status in a matter of a generation rather than the 6 generations it took for the mother firms to develop.

4. Similarly, firms should shy away from narrowly focused personal bonus systems which emphasize short, rather than long term gains.

5. On going monitoring of results must be undertaken and any anomalies, such as exceptional profits in a developing market, unless supported by clear and rational evidence, should be investigated promptly, to ensure business practices are in line with the firm's ethics and codes of conduct.

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