Would You Lie to Save Your Company?
A business owner must decide if he should tell his auditors about a company-threatening problem--thereby ensuring the business's demise--or lie to them and wait the problem out.
Black &White
"I'm at my board meeting," begins the CEO of a $20-million company that repairs aircraft engines, "and I get this fax from the airline saying that eight aircraft my company had repaired engine parts for were on the ground. They were not going to let the jets fly because the turbines went kaput. And they were saying that our parts had caused the problem.
"Within a couple of hours," he continues, "I get another call saying that another aircraft is downed by another airline in another country for the same reason. Then an hour later, another call. And then another. In all, 11 planes were grounded because of what they were saying were our parts." If the airlines ultimately needed to lease aircraft to cover those routes--and if his company was indeed found negligent--this CEO was looking at a $40-million tab. Put delicately, his company would be ruined.
In decades as an engine-repair manufacturer, he'd amassed a stellar reputation for quality. His company, which worked with 15 airlines, had also been approved as a supplier by the Federal Aviation Administration and by all the major aircraft-engine manufacturers. "Oh, sure, I'd had incidents in the past," he says, "but nothing to this extent."
By the time he'd first heard about the problem, the FAA had already been notified by the airline and had started an investigation out of its local office. "If they wanted to," says the CEO, "the FAA could have decided to close not only the factory where those specific parts were repaired but all of our factories to scrutinize us, check our procedures, check all our people. Of course, that's what you want when you fly. You want to make absolutely 100% certain that the engines are safe. But for us as a business, such a companywide inspection would have been the end." And he could only imagine what might happen once word of such an investigation reached all of his lenders. "I had short-term loans with about eight banks for an amount of money equal to my equity in the business," he says. "They could have pulled those loans."
But--so far, anyway--the FAA hadn't notified his company of any such drastic impending action. And as much as the airline may have pointed the finger at his business as the likely culprit, the company's name had managed to stay out of the press accounts. As a result, the CEO reasoned that there was no compelling need for him to do anything but remain in a holding pattern until more details emerged. As a strategy, at least for the short term, it sounded workable. If not, that is, for an unfortunate accident of timing.
The company, it so happened, was in the midst of an annual audit. As part of that process, the chief executive officer and the chief financial officer must sign a letter assuring the auditors that they have been informed about any outstanding circumstances that more than likely could have a negative financial impact. "The document was sitting on my desk waiting for my signature," says the CEO. "I was going to have to decide whether or not to sign it or to tell the auditors about the extent of our problem."
The stakes couldn't have gotten any higher: coming clean on the audit statement about the exact details he had in hand would have likely set off a chain reaction that would have left his company in shards. But given the state of what he knew--wildly incomplete--it seemed premature to put the life of his company, and the livelihood of hundreds of employees, in serious peril. It was frustrating. "In my industry there's a very tight code of ethics about the use of drugs or alcohol by a manufacturer's employees," he says. "But there's nothing that tells you how you're supposed to deal with reporting information like this."
So there he was, with few guidelines to follow and a set of audit papers awaiting his signature. What should he do?
These days, of course, it's not all that unusual to have to make crucial business decisions based on information that ranges from incomplete (at best) to woefully inadequate. A fast-moving economy puts a premium on those who can act with a decisiveness that gains speed in proportion to the skimpiness of the information at hand. To take advantage of opportunities, you need to think and act fast. So, for example, do you risk going into new markets when you're not sure you have the capital to back you up if you fail? Do you bring on new employees before that new market is fully developed? Do you increase overhead further by leasing office space to accommodate those employees without really knowing if the new market opportunities are as sure a thing as you told your board or your investors or your employees they were? And so on.
This CEO, facing a monumental decision, wanted to do what he believed to be the right thing. The lens through which he naturally scrutinized the situation was the one he'd used over all the years he'd been running a business: How do I do what I need to do to keep my company alive and thriving and, at the same time, minimize my financial and legal exposure?
First he asked his board, with whom he had been meeting when that original fax came in. "My directors advised against doing anything that would raise more alarm that we were out of control about the issue than necessary," he says. Aside from talking to his own lawyers, he also hired lawyers and consultants who specialized in FAA investigations. From their input he fashioned a delicate response.
"When it came time," he reflects back now, "to sign the representation letter from the auditors asking if I had any unreported information that would affect the financial performance of the company, I withheld the information. I consulted my lawyers and wrote that we had a problem and that we were on top of that problem. I didn't get any more specific about it. And they didn't ask."
In a pending investigation like this one, such a disclosure is not all that peculiar, according to Lynford Graham, director of audit policy at the New York City office of BDO Seidman LLP. (BDO Seidman was not the audit firm representing this CEO.) "Since the investigation had just been started and no responsibility had been assumed by the company, it's pretty unlikely that anything more needed to be disclosed at that point," says Graham. It's not unusual, he says, for such broad statements to be included in a company's financial statements, particularly if the situation doesn't affect the finances for the year's books being audited. Such language has become almost boilerplate to cover the multitude of possible adverse conditions a company may face that aren't accounted for anywhere else.
