As you have learned this week, effective management control systems align managers’ personal interests with those of the overall company. Such a system provides the procedures and policies ensure a firm’s employees can work to achieve the best possible results, and minimize the opportunities for personal gain and fraud. Two areas most vulnerable to the misalignment of individual employee interests are performance evaluation and compensation. According to a report by the Treadway Commission, the following pressures can lead to financial fraud:
Unrealistic budget pressures with emphasis on short-term results
Financial pressures that result from bonus compensation plans that depend upon short-term results
(Lanen, 2014, p.455)
If these issues are not adequately addressed within the Management Control System, the system itself can provide incentives to commit fraud.
Instructions
Read case study 12–55 about the fraud at GE’s Kidder Peabody Investment firm. The case is found at the end of chapter 12 in your textbook.
Please discuss the following questions in your initial post:
Suppose you were an accountant at Kidder Peabody and you realized the accounting system flaw. What would you do?
Discuss how the bonus program at Kidder Peabody contributed to the fraud.
Do you feel that the offer of GE managers to help “cover” the losses from Kidder Peabody were ethical?
Be sure to cite any sources that you use with APA. Wikipedia is not an acceptable source.
CASE
(LO 12-3, 5, 7) 12-55. Business Environment, Performance Measures, Compensation, and Ethics
In the late 1980s, General Electric Company (GE), whose CEO at the time was Jack Welch, acquired Kidder Peabody, an investment banking firm founded in 1824. In 1991, Kidder hired a bond trader named Joseph Jett. Jett’s job was trading STRIPS, which are securities linked to U.S. Treasury bonds.
The trades work as follows. Assume you own a 20-year Treasury bond with a face value of $1,000 and an interest rate of 12 percent, payable semiannually. This bond entitles you to 40 payments (20 years × 2 payments per year) of $60 (= $1,000 × 12% × 1/2). For various reasons, some companies and individuals want the payment stream to follow a different pattern. It is possible to convert the single bond described above into 41 separate zero-coupon bonds. (A zero-coupon bond is one without an explicit interest rate and no payments before maturity.) The resulting bonds are called STRIPS (Separate Trading of Registered Interest and Principal of Securities). The reverse transaction—converting separate bonds into a coupon bond—is referred to as a RECON, or reconstitution of the security.
This transaction has been compared to going to the bank and changing a dollar bill for four quarters. This transaction was done with the Federal Reserve Bank (Fed). Kidder made money on the business through fees and trading profits associated with the inventory of bonds it kept for transactions. As you might expect, there should be no profit in the transaction with the Fed.
Although at first he struggled in his job, Jett was soon generating enormous profits and earning large bonuses. He was able to do this because of an error in the internal Kidder accounting system that recorded the transaction improperly. Because the error would eventually correct itself (as the interest payment date approached), Jett was forced to trade larger and larger volumes. At the time this was discovered, approximately 95 percent of Jett’s trades were with the Fed.
Jett earned a bonus of $2 million in 1992 and $9 million in 1993, in addition to being named Kidder’s “Employee of the Year.” In 1994, Jett was generating in one month the profit he earned for the entire year in 1992 and Kidder executives began to investigate. Jett was fired in April 1994 and GE was forced to take a $350 million pretax charge against earnings.
Lanen, William. Fundamentals of Cost Accounting. McGraw-Hill Higher Education (US), 2019. [ECPI].