Professional Ethics Forum October 30, 2007

GRETCHEN MORGENSON — Investigative Reporting on Business Practices Gretchen Morgenson is assistant business and financial editor and columnist at the New York Times. In 2002, she won both the Pulitzer Prize for her coverage of Wall Street, and the Gerald Loeb Award for excellence in financial commentary. In 2000, she won the American University School of Communication's Annual Journalism Award for excellence in personal finance reporting. When Rev. Ousley said he wanted to relaunch the Ethics for Professionals forum and invited me to speak I began thinking about the role of ethics in business, especially in the companies and industries I cover as a financial reporter. Keep in mind that I have been a business reporter for more than 20 years. So I have a long arc of experience to look back on. Not so long ago, I would not have considered ethics to be my beat. But even though there is, technically, no ethics beat in business journalism, the fact is, ethics permeates my coverage at The New York Times today. This has been the case in the scandal-charged post-Enron years. And yet, if you look around, ethics advice is so readily available it seems downright odd that I have to spend so much of my time writing about ethically-challenged folks in high places. There are ethics courses at business school, ethics guidelines on websites of almost every large company, ethics training classes and ethics newsletters. Just this afternoon, I received an invitation to the Conference Board's 2008 Ethics and Compliance Conference in California next March. Ethics are all over the Internet as well. Google the word ethics and you'll be festooned with potential purchases. For $199 plus shipping you can order from www.ethics.org the Business Ethics Toolkit, which helps you identify and solve ethical dilemmas. An interesting note: the toolkit was not among the website's ten most popular purchases. Over at a website operated by the Ethics & Policy Education Centre, you will find a "Combating Systemic Corruption Scanning Tool" and a "Sample Code of Conduct Worksheet." Interestingly, the Centre is located in that hotbed of morality, Las Vegas, Nevada. If that's not enough to frighten you, the United States government has even gotten into the ethics act. In May 2004, the U.S. Department of Commerce published a manual for corporate responsibility programs that integrates corporate governance, organizational ethics, and corporate responsibility. Talk about pots and kettles. Yet in spite of all these resources, business ethics seems to be something of an oxymoron. A 2005 study by the Ethics Resource Center found that 52 percent of American workers observed at least one type of ethical misconduct in their workplaces, a slight increase from the 2003 study. We won't have to wait long to see what has transpired in the past two years — the 2007 survey is due out next month. The rise in the 2005 percentage came, the study's analysts noted, in spite of an increase in workers' awareness of formal ethics programs. Once again, ethics courses, classes and advice are all around us. So why does there seem to be more misconduct in the workplace today? I think it is because we are in the midst of a crisis of character in the highest reaches of corporate America. The word ethics, remember, derives from the Greek — ethos, or character. That derivation is a crucial element to how I understand the lack of ethics that I see around us. Ethics takes character, it requires being able to think of others and put them before yourself. Ethics means turning down a temptation, no matter how exciting. For many of the whistleblower types who call me to identify wrongdoing at their companies, ethics means saying no to a way of doing business. It also means questioning superiors, speaking truth to power. All very hard to do. Because human nature does not change from eon to eon, it is hard to believe that executives are more ethically-challenged or larcenous nowadays than they were a generation or more ago. But I do see a disturbing sense of entitlement among CEOs today that lets them justify siphoning off massive wealth from their shareholders even when their performance is mediocre or worse. Exhibit A today is E. Stanley O'Neal, the ousted chief executive officer of Merrill Lynch. Here is a man whose rise and fall could be the subject of a gripping Harvard Business School case, even a made-for-TV movie. Born into an impoverished southern Black family, Mr. O'Neal clawed his way to the top of corporate America on hard work and smarts. But he also struck terror in the hearts of his colleagues and underlings, discouraging discussion or a different point of view of how Merrill should be managed and surrounding himself with yes men and woman. He appears to have gotten rid of his rivals, a la the KGB, and put in place a board of directors who didn't question his motivation and had no idea what he was doing. He was not a sharer — he insisted on being both chairman and chief executive of Merrill. O'Neal's drive seemed to be all about how the firm could make more money for its executives rather than how it could do a better job for its clients or shareholders. One reason why it is an especially disturbing scenario at Merrill Lynch is that this is the firm that brought Wall Street to Main Street. Therefore, it ought to be the firm that reflects Main Street values. But instead of focusing on doing the right thing, he's all over his people to roll the dice to make what Goldman Sachs makes, according to the Wall Street Journal. Then, when his company lays an $8.4 billion egg in the third quarter, he tries to sell Merrill to Wachovia, reaping $270 million in pay on such a deal, instead of the mere $159 million he stands to make if he is allowed to resign. If this is not emblematic of the ethics problem at the highest level of business today I don't know what is. In my view, Stan O'Neal has not earned the right to receive $159 million as he walks out the door. Thanks to the recent $8.4 billion loss, 20 percent of Merrill Lynch's net worth has evaporated. Why should he receive anything? In fact, why shouldn't he return to the company some of the $48 million he made last year? You can be sure that a good bit of it was so-called performance pay that resulted from big bets in mortgages that were working then but stopped working this year. Will Mr. O'Neal give back any of his pay? Forgive me for thinking he won't. It is my opinion that outsized greed IS more prevalent today in the executive suite. But I know it's hard to prove current behavior patterns are truly different from those of prior eras. Nostalgia has a way of making the past seem a sunnier place sometimes. Before I go any further, however, I want you to know that I am not against prosperity. I am not a socialist. I am an ardent capitalist and a big believer in free markets. I believe it is crucial that entrepreneurs be able to raise capital and that investors can share in the benefits of wealth creation. I also know that no country on Earth does this better than America. But it is because of these beliefs that I have grown so disturbed in recent years as people in high places have abused the system. It is an unfortunate truth that a few bad apples can spoil the entire barrel. That a few greedmeisters can wreck the trust in the free markets that is necessary for them to work. Populist capitalism like ours is hugely beneficial to the vast majority of people, but an ethical tradition is needed to make it all work. When you have senior executives walking away with hundreds of millions, leaving everyone else in the dirt, it becomes extremely dangerous. And as more and more high-paying jobs leave this country for foreign shores, the outsized pay amassed by corporate executives becomes more polarizing. The trouble today is that corporate America together with their co-conspirators on Wall Street have rigged the game so that executives can get immensely rich at the expense of their shareholders and often to the detriment of their workers. Ten years ago, for example, the average CEO made an annual figure that was 100 times what a rank and file worker at the same company made. Recently, this average rose to 500 times. As a perspective, during the early part of the century, J. Pierrepont Morgan, the powerful banker, uber-capitalist and Incarnation neighbor, said that CEOs should never make more than 20 times the earnings of their lower level workers. Overseas, the ratios of executive pay to workers' compensation are much smaller. In Japan, for example, the ratio is around 10 times greater for CEOs, in Europe it is around 20 times. America is in a class by itself as far as obscene CEO pay goes. Clearly, the Robber Barons are back and big time. Except this time around they did not amass their titanic wealth by building railroads, steel mills and oil refineries. This time the Robber Barons are the hired hands, the heads of corporations who pocket shareholder wealth through their vast compensation packages. I am not against prosperity, I promise you. I do however think that the imbalance of wealth that has resulted from excessive executive pay is pernicious and hurtful to our society. When the haves regularly collect so much more than the have-nots, when people are going hungry in the same zip codes where others are throwing 60th birthday parties for themselves that cost millions of dollars, it allows for the perception that the game has become rigged in America, that it is no longer the land of equal opportunity Because I write regularly about questionable practices on Wall Street, in corporate boardrooms and elsewhere, readers often ask me why I don't write more stories about companies doing the right thing. My answer is always the same: I would very much like to do so, not only to give recognition to companies with exemplary practices, but to prove that I am no nattering nabob of negativism. However, one key reason I don't write more celebratory stories is that I can't identify all that many companies whose practices reflect an ethical approach that is truly stem-to-stern. Costco Wholesale Corp., the big discounter, is one company that I have found to be exemplary. Its executive and founder, Jim Sinegal, seems to inhabit an alternate universe, where executive pay is concerned. His salary last year, $350,000, was not much different from the $300,000 he earned in 1994. He has refused a bonus in each of the last five years and last year took home no stock options or restricted shares. Unlike most chief executives, the terms of Mr. Sinegal's employment contract could fit on a cocktail napkin. The company has no change in control clauses that are so common in corporate American and that trigger massive amounts of money to executives as a result of a merger. Of course, as a Costco founder, Mr. Sinegal has amassed an enormous stake in the company: 2.4 million shares. At current prices, his holding is worth $161 million. While Mr. Sinegal keeps a lid on his own pay, his company is known for providing salaries and health care benefits to lower-level workers that are higher than average for the industry. For example, Costco pays 92.5 percent of employees' health care costs. One measure of how this approach succeeds is found in the rate of theft by customers and employees at Costco stores — what the retail industry calls shrinkage. Such losses run under two-tenths of 1 percent at Costco each year. Other companies have 10 to 15 times that amount of theft. When I interview Mr. Sinegal a few years ago, he told me his work ethic and management philosophy came from his mother and father and a Catholic school education. He said ethics is just good business. "If you're going to say to all the people that you're working with, 'We want you to treat the customers honestly; don't lie and don't cheat,' it is somewhat hypocritical if you're not following the same rules," he said. "Everybody is watching you every minute anyway. If they think the message you're sending out is phony, they're going to say, 'Who does he think he is?' It's again good business. But it is also an obligation." Why aren't there more people like Jim Sinegal? I wish I knew the answer. But I have a couple of ideas of things that are contributing to the paucity of leadership traits at high levels of business. First is the sickness I call short-termism, which permeates Wall Street and encourages executives to grab for all the gusto they can while they can. Gone is the idea that we are long-term stewards of a company or an industry, that we have the aim of leaving a company to our successors even better off than we found it. Take a look at the mortgage lending industry that is going through such a retrenchment and causing so many losses across the landscape. Why on earth did lenders make loans to people they knew could not repay them? Why did lenders design loans that required refinancing in two or three years? I can't help but conclude that these companies did so to create more fees for themselves when it came time to refinance. Why else would you build a mortgage that resets to a rate of over 11 percent after two years of a low teaser rate of say 6 percent? It is simply inconceivable that the designs of these exploding mortgages were not all about generating more fees to the people who were selling them. Never mind if it means, as we are seeing now, that people are forced from their homes and into bankruptcy. Most damaging of all, I think, is the view people seem to take more and more today that they don't have to do the right thing, the ethical thing, if they can instead do the legal thing, which means, strictly speaking that you don't go to jail if you are caught. In other words, people in high places seem to have replaced ethics, which involves character, with technical concepts of legality. I see this in corporate disclosures that don't disclose anything you absolutely do not have to. I see this in executives selling massive amounts of stock as their companies go down the tubes. I see this in executives' unwillingness to take losses on their books until they are absolutely forced to by their auditors. Is it legal? That seems to be the question that everyone is asking. Never mind this question: is it right? What these folks don't seem to recognize are the broad implications this view has when you are a leader. Leaders, after all, are supposed to be exemplars, they are supposed to act in an exemplary fashion. And yet what many of them do is act in a small, grasping, selfish manner. Me-Firsters, I call them in my columns. And theirs is conduct unbecoming a leader of any kind. I am not sure what it will take to bring a respect for ethics back into the highest reaches of all American companies. I will admit to being surprised that a lack of ethics persists in many places after the fallout from Enron and Worldcom and Tyco and Adelphia. But I am a hopeful person, an optimist. And I believe that over time more people will see the merit in behaving ethically and morally wherever they are. They will see the rewards in such actions, rewards that may not be monetary but far more meaningful. In the meantime, I've got my work cut out for me.

The Reverend J. Douglas Ousley Rector The Church of the Incarnation 209 Madison Avenue New York, NY 10016 telephone: 212-689-6350 fax: 212-689-7311 e-mail: info@churchoftheincarnation.org

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