Can Ethics be Legislated in Accounting? The role of SOX, the SEC and the ERM Framework

Post-hoc Editorial Comment: We are delighted to welcome the following contribution by Steven Mintz, the Ethics Sage. His photo, professional affiliation, and contact information are provided at the conclusion of his essay (below).

Government regulations, whistleblower protections, GAAP reporting standards, and internal control requirements are meaningless and not worth the paper they are written on if what has been promised is not done. A healthy financial reporting system depends on the enforcement of laws and the existence of an ethical culture in organizations that support accurate and reliable financial reporting.

These issues are relevant to the case of Tony Menendez, former Director of Technical Accounting Research at Halliburton, who blew the whistle on improper accounting for revenue. Menendez was hired by Mark McCullum, the chief accounting officer at Halliburton, who reportedly told him to serve as his “Smokey the Bear,” helping the company prevent accounting fires from flaring. That is what Menendez tried to do.

Back in 2005, Menendez identified improper accounting for bill-and-hold transactions where the company booked revenue before product was sent to customers, all the while holding it in its warehouse for future delivery. Menendez worked hard to convince his superiors of the errors in accounting. He sought out the help of KPMG, Halliburton’s auditors, to no avail. He informed the SEC, which seemed disinterested and chose not to get involved. The company retaliated against him once it found out about his reporting to the SEC. Menendez finally lodged a complaint with the Department of Labor under the whistleblower protections of the Sarbanes-Oxley Act. He then endured a nine-year battle to clear his name.

Two questions from Menendez’s experiences are: (1) Did SOX work as intended and protect Menendez as a whistle-blower under Section 806? (2) Did the SEC fulfill its oversight role of financial reporting and audits of financial statements? The answers are no and no. However, it’s not due to the ineffectiveness of SOX. Instead, Halliburton’s management had established a culture that this is the way things are done around here and Menendez should be a team player.

Absent an ethical culture, no law is likely to be effective in enforcing financial reporting standards and ensuring internal controls operate as intended. A good example is Halliburton’s own ethical requirement that purported to protect confidential complaints, which was ignored when the company outed Menendez after he informed the SEC.

The SEC failed in its responsibilities in the Menendez case. Overworked, underfunded, and, quite frankly, lacking in a commitment to ensure ethical behavior and GAAP-conforming financial reports, the Commission gave in to pressures from Halliburton and hastened the day of retaliation against Menendez.

The SEC has failed time and again to do something constructive by acting on detected fraud. We all remember that the Commission failed to follow up on years of complaints from Harry Markopolos, a Boston investigator, about Bernie Madoff’s financial activities. The SEC chose instead to treat him as a crank.

Now comes COSO’s recently updated ERM Framework, Enterprise Risk Management – Integrating with Strategy and Performance. Will it help to promote an ethical organization culture, the weak link in the internal controls of many companies that committed fraud in the early 2000s (i.e. Enron and WorldCom), Halliburton, and many financial institutions during the great recession?

The September 2017 revisions to the ERM Framework highlight the importance of enterprise risk management in strategic planning. According to COSO’s Chair, Robert B. Hirth Jr., COSO’s “overall goal is to encourage a risk-conscious culture.” PwC developed the framework and, according to Miles Everson, PwC’s Global Advisory Leader and Engagement Leader: “The Framework addresses the evolution of ERM, the benefits that can be achieved, and the need for organizations to improve their approach to managing risk.”

Drilling down on the Framework with respect to corporate culture, ERM suggests that each entity should link its culture – shared behaviors, emotions and mindsets in the organization – to its strategy and risk appetite. The problem here is the ERM framework does not place sufficient emphasis on the ethical dimension of making strategic decisions, opting, instead, for a focus on the entity’s “hunger” for risk in terms of its strategic objectives. This tail wagging the dog approach to developing an ethical culture allows management to create a culture in each situation after first determining its willingness to accept risk in developing strategic activities. This is ethical relativism at its worst.

The moral of the story is ethical behavior can’t be legislated. COSO can issue as many white papers as it wants, it still won’t guarantee an ethical outcome. Internal controls have limited value if management routinely overrides them. GAAP requirements are ignored when management’s goal is to tell its side of the story, rather than report the financial results in an accurate and reliable manner.

So, what’s the answer to the ongoing dilemma of getting management and the board of directors to establish a strong corporate governance system? There are no easy answers because ethical governance depends on an ethical culture and a tone set from the top that deviations from ethical standards will not be tolerated. This is the most effective way to embed ethics into the culture.

What about the accounting profession, in particular the auditors? Well, 2017 hasn’t been a good year for the profession. From Wells Fargo’s fake accounts to the ten-year investigation into accounting fraud at AIG, accountants and auditors were asleep at the wheel once again.

When will the profession live up to its responsibilities to put the public interest above all else, including the interests of one’s employer, the audit firm, and self-interest? This is an ongoing problem that hasn’t gotten better since the passage of SOX.

I fear we may be waiting for the other shoe to drop on the disclosure of another round of financial wrongdoing and failed audits. Why? Because at the end of the day, greed wins out over ethical decision-making by management, and soliciting, retaining, and building on client relationships has become the Holy Grail for the accounting profession.

Steve Mintz is a Professor Emeritus from Cal Poly San Luis Obispo. Steve blogs on ethics issues at Visit his website at


Anthony Menendez, Accounting Exemplar

Anthony Menendez, CPA, CFE is the recipient of the 2017 Accounting Exemplar Award of the Public Interest Section of the American Accounting Association (AAA). As a follow-up to his appearance at the 2017 AAA Ethics Symposium in San Diego, we asked Anthony to respond to four questions.

<1> For the benefit of our readers who didn’t attend our Symposium, how would you describe your career experience at Halliburton?

In 2005, during my interview with Halliburton’s Chief Accounting Officer (CAO), he appeared to appreciate the importance of Sarbanes-Oxley (SOX) and the challenges facing the profession. He told me he wanted to hire “Smokey the Bear” to prevent accounting fires. However, by the time I got there, Halliburton was already engulfed in flames.

Halliburton accountants were ignorantly violating one of the most basic accounting principles, that you should not recognize any revenue before you actually deliver a product to your customer. This was a stunning revelation because bill-and-hold transactions are widely recognized as wrong and venal and have been perennial triggers for SEC enforcement actions.

I elevated the problem throughout the organization. My boss, the CAO, told me that the company was going to correct the problem and “get the company back within the lines of what is appropriate”. However, the magnitude of the error soon became apparent and a correction would have required a costly and embarrassing restatement of the company’s historical financial statements.

So what happened? Instead of correcting the problem, Halliburton and its external auditors went to extraordinary lengths to cover up their failures. At the height of the cover up, the external audit senior manager told me to “save it for the subpoena.” I told him that I could not do that and I “blew the whistle” to the SEC.

I spent the next ten years fighting for my dignity and my rights under the whistleblower protection provisions of SOX. In 2015, I finally prevailed in the Fifth Circuit Court of Appeals, and my case has had a significant positive impact on that body of law, lowering the legal burdens facing corporate whistleblowers.

<2> Are you optimistic about the future of our profession?

I worry about the value of the audit today and the future of our profession. Congress mandated independent audits of public companies back in 1933 because members of the investing public were scammed out of their life savings, resulting in a catastrophe that helped usher in the Great Depression. At the turn of the millennium, the highly publicized financial scandals and the loss of public confidence in our profession forced Congress to reexamine the public company audit process. As a result, SOX was signed into law in 2002.

I believe that the public gave the profession a lifeline in the form of SOX. However, the 2008 financial crisis and the ensuing Great Recession gave the public little reason to believe that the current model is working well. As a profession, we need to evolve in an effort to serve the public interest. If we fail to do so, the public might decide that they don’t need private firms to provide public company audits.

<3> What role should our profession play in protecting the public interest?

Our profession exists to serve the public interest. It does not exist to serve public accounting firms’ own interests or the firms’ client interests. We are not Certified Professional Accountants. We are Certified Public Accountants, and that designation should only exist if we are serving the public interest.

<4> How well are we fulfilling that role?

Don’t get me wrong. There are many good CPAs out there, doing the right thing. But as a profession, we are not fulfilling the role of the public watchdog.

I see two obvious problems for our profession that need to be addressed. First, in the age of big data, predictive analytics, and social media, the audit report provides little to no value from an information standpoint. Second, the public expects external audits to identify and report financial statement fraud. I believe the so called “expectation gap” between what the public expects and what the profession provides should not exist.

Investors want to have assurance regarding the integrity of management and the reliability of the information that is provided by management. However, studies continue to highlight that the external audit is one of the least likely processes to help investors learn about financial statement fraud.

For example, the Association of Certified Fraud Examiners estimates that external audits report only 3% of all known fraud cases. And the PCAOB estimates that external audits are notoriously bad, producing an audit deficiency rate of 35% to 40%.

These findings must be considered in light of another recent survey result. CFOs have estimated that nearly 20% of companies manipulate their earnings by an average of 10%. These are truly shocking and disturbing statistics.

What do I believe is happening? Often, auditors don’t know of the existence of problems, or they don’t report them. Personally, I’m not confident that the profession can (or should) survive another wave of financial scandals. That is why, as a profession, we need to reexamine and challenge what we do and how we do it.

The Future of Carbon Emissions

How did you react when U.S. President Donald Trump announced America’s withdrawal from the Paris Climate Accord? Did it grab your attention?

And when Chinese President Xi Jinping declared his plan to develop the world’s largest market for carbon emissions? Did you take note of it too?

Many members of our Public Interest Section of the American Accounting Association perceived these developments as landmark events in the evolution of the fields of Corporate Social Responsibility, Sustainability, and Integrated Reporting. But how can our colleagues become more informed about the issue of carbon emissions?

They can attend the AAA’s Annual meeting, of course. Our Section will offer a series of concurrent session presentations regarding this issue.

For instance, Stephanie Liu of the Henley Business School of the University of Reading in England will present a study of the Financial Times Stock Exchange (FTSE) 100. Stephanie and her co-authors identified a number of intriguing relationships among carbon emissions, carbon disclosures, and financial performance.

Meanwhile, Chengzhang Wu of Rutgers Business School will present a study of A-Share Chinese listed companies. He and his co-author Junqin Sun from Xi’an Jiatong University in China found that governmental industrial policy and evaluation pressure yielded a positive impact on reduction performance.

In other words, Stephanie and Chengzhang are studying the effectiveness of different carbon initiatives from distant global regions with diverging approaches to achieving emission reductions. Whereas Stephanie is focusing on European market-based disclosure strategies, Chengzhang is addressing Chinese government-based policy strategies.

Will either approach succeed? And if both do so, will one eventually triumph over the other? You can bet that our colleagues in the audience will continue to debate these questions long after the conclusion of the Meeting.

In order to ensure that their opinions are well-informed, though, they’ll need to attend these presentations at the AAA Annual Meeting in San Diego CA. It might indeed be the ideal place on Earth this summer for accounting scholars from every region of the planet to come together and share their findings about carbon emissions.

The Public Interest

Welcome, colleagues! The members of the Public Interest Section of the American Accounting Association (AAA) are delighted to introduce our new social media platform.

Are you “… interested in the interface of accounting with social, economic, ethical and political consequences of corporate activity, and in exploring the social and ethical roles and responsibilities of the accounting profession …” ?

That’s a direct citation that we culled from the very first of our five Section Objectives. If you share our interests, you’ll certainly be interested in the content of our blog!

Furthermore, we take the “social” aspect of our social media platform very seriously. By subscribing to our blog, you’ll join a network of accounting professionals with a desire to engage in the full spectrum of meetings, publications, webinars, and other activities that the AAA promulgates about the public interest.

So we invite you to use the email app that is posted on our blog’s home page to subscribe to the platform. And we look forward to seeing you in sunny San Diego this August for our Ethics Symposium and other Annual Meeting events!