TAXES

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.
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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.

But even though he was able to use the elusive language that was standard operating procedure in dealings like this--and tantamount to not saying anything about anything--the CEO was still grappling with having to make a decision without knowing all that he needed to know. "I was frustrated that we weren't in control of the problem," he says. "It was in control of us. It was far beyond us, far beyond us. One of my biggest fears was that the groundings wouldn't stop with those 11 planes and that it would spread to all the airlines. After a while I knew this wasn't likely to happen, but it was a real fear, and it still ate away at me."

But that was not reason enough for him to risk his company and disclose everything he did know. "If you have a business that's going to react to remote possibilities, then everybody's going to be nervous, and nobody's going to be able to do anything," says BDO Seidman's Graham. It's certainly true that the CEO's actions kept the company in operation. "I didn't inform everybody about everything," the CEO says. "Of course, the situation would have been different if an engine had exploded in air."

Not that that was likely to happen--or was it? At the time, press reports pointed out that there was the remote yet daunting possibility that engine fragments could break off, hit the fuselage, and cause a crash. A critical factor to consider, you would think, yet one the CEO admits he chose to ignore. Yes, he weighed the consequences of having his bankers and employees know. But as he tells it now, several years later, he never considered the lives that could be at stake. While he was valiantly fighting to save the jobs of his employees, shouldn't he have weighed his responsibility to passengers boarding other possibly defective planes? That, he claims, was the FAA's burden.

This CEO was concerned about the impact his decision would have on some of his constituencies--his bankers, his employees--but he neglected to consider the constituency with potentially the most to lose: airline passengers. As a frequent flier, a user of headache remedies, a driver of cars, a consumer of meals, I'd like to believe that standard ethical behavior calls for companies--and certainly the people at the top--to always consider the vulnerability of consumers in their decisions. Had he acknowledged that angle, would it have changed what he told his auditors? Not likely, and that, as it turns out, might have been appropriate, since the FAA exonerated his company of direct responsibility for the groundings and even concluded that passengers were never in danger. But safety should have been among his considerations before he signed that auditors' statement.

It's natural for leaders of fast-growing companies to become desensitized to certain outgrowths of their actions. But CEOs shouldn't allow themselves to become so numb that they can ignore situations in which the consequences are of potentially vast proportions.

Looking at every issue through the lens of a seasoned business owner who's conditioned to do what's necessary to keep a company alive and thriving, a CEO like this one can all too easily hide behind the regulator's responsibility, or boilerplate language, or standard operating procedures, and forget that sometimes there are much bigger issues to weigh in the equation. "What do I know about engines?" he asks now, by way of defending his reasoning. "As a businessman, I was looking at this in terms of my survival."

Jeffrey L. Seglin, an executive editor at Inc., has been named a 1998-99 fellow at Harvard University's Center for the Study of Values in Public Life.

Bulletin Board
Readers' Debate: Is it 'right' to go bankrupt?

April's Black and White feature (" Brother, Can You Spare 30¢ on the Dollar?") discussed the ethical implications of walking away from debt when your company goes bust--even when you have the personal assets to pay creditors back. George Naddaff, of Boston Chicken fame, defended his decision to pay about 30¢ on every dollar owed after liquidating an ill-fated coffee venture, arguing that he acted as the system requires. "When these laws were put into effect," he said, "you have to assume a lot of smart people gave thought to this." But do entrepreneurs in Naddaff's situation have a responsibility that extends beyond any legal requirements? Several company builders insisted that they do, arguing that it was just plain wrong not to pay people back in full, as they had chosen to do after their own ventures collapsed. "I have to sleep at night," noted one of them. In an on-line poll, voters sided with such pillow talk, with 58% of them agreeing that ethics demand that individuals make good on the debts their bankrupt companies leave behind. By comparison, 42% believed that assets other than those in the venture that goes belly-up aren't relevant. Here's a sampling from readers on both sides:

Todd Landrum, owner of Paladin Programming, a software developer in Denver, felt strongly that when a business tanks, its founders ought to suffer at least as much as any creditors: "George Naddaff is wrong, and he knows it. The law may be on his side, but he's confusing what is legal with what is right. Just one question for you, George: When the lawyers arranged for your creditors to be paid 30¢ on the dollar, did you adjust your salary accordingly?"

But Johnny Williams, president and CEO of Total Assets Recovery Inc., an asset-management company in Dallas, argued that the wisdom of bankruptcy law resides in the fact that it forgives those who fail: "You have to look at each bankruptcy individually. Too often we look at the past abuses of a few and often end up really hurting the ones that are truly using the system for what it was designed to do."

That's a noble sentiment, counters Larry Weindorf, president of Anchor Recoveries Inc., a Tampa debt-collection agency, but one that's tough to share when someone else's bankruptcy ripples through your business: "We all want to feel bad for someone or a business that has had to file for bankruptcy, but how do you feel when you can't collect on an invoice and your accounts receivable are down the tubes?"

Does the law, then, unduly punish the wronged parties? David Greenfield, president of Cetacea Productions, a company in Portland, Maine, specializing in multimedia and corporate videos, thinks so: "If the investors in a business are the ones taking the risks on a new venture, why are the vendors the ones losing money?"

But Don Phillips, a pool-and-spa-industry consultant in Orange County, Calif., argues that vendors should assess the inherent risk in taking on any start-up as a customer: "Although I feel sorry for the company that gets nailed with a bankrupt customer, it is, in the final analysis, the responsibility of the supplier to weigh the loss potential against the possible gain in dealing with a corporation. All too often a company will jump at the chance to sell their products and services without due diligence."

The following readers' comments appeared in a subsequent issue of Inc.

Readers' Debate

Was CEO 'morally vacant' to ignore potential loss of life?

July's installment of Black and White--"Would You Lie to Save Your Company?"--dissected the decision-making style of the CEO of an airplane-engine-repair company. After being notified that eight airplanes his company worked on had been grounded--a situation for which his company's parts could be responsible--the CEO had to decide how much to disclose to his bankers, his employees, his investors, and his auditors. Although he weighed many factors in deciding whom and how much to tell, the CEO admitted that he never once considered the lives that could be at stake. That, he felt, was the Federal Aviation Administration's burden. "What do I know about engines?" the CEO reasoned, by way of defending his oversight. "As a businessman, I was looking at this in terms of my survival." Readers looked at the situation from a wide range of perspectives:

As far as Alex Chompff, service manager for ComputerCare Inc., in Mountain View, Calif., was concerned, it would have been "irresponsible and foolish" for the CEO to act differently: "Why should the CEO of a company, whose goal it is to make that company survive and prosper, release speculative information voluntarily that would certainly destroy his company? The CEO took the necessary legal precautions."

William Bennett, vice-president of marketing for Alliance Underwriters LLC, in Woodstock, Ga., points out that the CEO didn't make the decision in a vacuum: "Companies have boards of directors, in addition to outside professionals, to direct them in times where critical issues are at stake. If you doubt their ability to give wise counsel, you need to make some changes." But, Bennett says, "I can't imagine that a person directing a company in this business wouldn't be thinking about the impact on lives as the critical issue."

Even so the CEO's own apparent disregard of any lives potentially at stake left Tim C. Mazur, vice-president of the Council for Ethics in Economics, in Columbus, Ohio, shocked at "the business and ethical ignorance" he saw displayed: "When he reasoned that the possibility of his personal financial survival was more important than the actual survival of potentially thousands of innocent airline passengers, he proved his priorities rank 100% self-interest and 0% ethics. His conclusion that the passengers' lives are 'the FAA's burden' is shortsighted, morally vacant, and an extraordinarily strong argument against free enterprise and capitalism, given that government regulation would severely increase in a market where businesspeople are completely devoid of any responsibility for safety."

"I am surprised at the stance you took, Tim," responded Bob Ballantyne, president and CEO of Genesis Laboratory Systems and Genesis Generations, in Palisade, Colo., and Clifton, Colo., respectively. "As a person who has designed and manufactured to the Food and Drug Administration's 510 specification, I can tell you it is a little different world than the local Pizza Hut franchise. The regulators take all your options away for public safety (for good reason). You are beholden to them and their procedure. If there was a real danger to public safety, you can bet the FAA would have grounded the fleet."

"What troubled me most about the CEO," adds Larry Grimes, Gresham Professor of Humanities at Bethany College, in Bethany, W. Va., "was that he never thought outside the organization; it was as if he made no product, had no contact with consumers, lived outside society. He called in the board, the accountants, the lawyers. He didn't call in the engineers. That omission scared me."

Last updated: Jul 1, 1998




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