Does a Traffic Ticket Mean You're More Inclined to Fraud? Maybe....

I'll be the first to admit that I have been known to exceed posted limits on the highway. By how much? Hmmm. Maybe I'd better lay claim to the Fifth on that.

Oh and I can justify my speeding, of course: I'm just keeping up with traffic! Statistics have shown that being an outlier on either end of the bell curve (driving significantly more slowly than traffic or driving significantly faster) is much more dangerous than flowing along with the rest of the vehicles on the road.

So it's not really that I want to go fast: I want to be safe.

Yeah, and I've got a bridge to sell you.

But now I may have to rethink my vehicular behavior.

The New York Times' Floyd Norris has a fascinating article in today's paper, based on an academic report written and recently published by Robert Davidson (Georgetown University), Aiyesha Dey (University of Minnesota), and Abbie Smith (University of Chicago), that suggests that "off-work" behavior can give a strong clue about "at-work" behavior. An abstract of the paper, which is to appear in the Journal of Financial Economics,  is available here; a .pdf of the full paper is also available there.

The authors explored whether two forms of "off-work" behavior by senior corporate executives -- living "high on the hog", and having any kind of criminal record (including traffic violations) -- were correlated to misfeasance or malfeasance on the job:

We predict and find that CEOs and CFOs with a legal record are more likely to perpetrate fraud. In contrast, we do not find a relation between executives’ frugality and the propensity to perpetrate fraud. However, as predicted, we find that unfrugal CEOs oversee a relatively loose control environment characterized by relatively high probabilities of other insiders perpetrating fraud and unintentional material reporting errors. 

 Wow.

First of all, I wasn't aware that people with criminal records could even be CEOs or CFOs. Norris reports that

Of the 109 chief executives of companies found to have committed fraud, 12 had previous encounters with the law that were more serious than a speeding ticket. The academics counted eight felony drug charges, four case of domestic violence and four traffic violations so serious that they were lumped under the heading of reckless endangerment. (Some of the bosses had more than one item on their record.)

The professors had turned to SEC fraud cases dating from 1992 to 2004, and then looked for companies as similar to those, but with fraud filings, as possible: similar in size, in the same industries, similar (pre-fraud filing) stock market performance, etc.

So, what kind of legal record had the CEOs and CFOs of the non-fraud companies have? None of them had anything more serious than "an ordinary traffic violation." And even there, the differences were compelling. Norris notes:

Of the 109 chief executives from nonfraudulent companies, just five had traffic tickets. Sixteen of the fraud company chief executives had such tickets. Some of them had more serious violations. Altogether, 22 of the 109 had some previous violation.

As the paper's authors state,

we interpret an executive’s prior legal infractions, including driving under the influence of alcohol, other drug-related charges, domestic violence, reckless behavior, disturbing the peace, and traffic violations, as symptoms of a relatively high disregard for laws and lack of self-control. We predict and find a direct, positive relation between CEOs’ and CFOs’ prior records and their propensity to perpetrate fraud....

Or, as Norris puts it, more simply: "What this could indicate is that people who are willing to violate one set of social norms are more likely to be willing to violate far more serious ones."

I've written before of our human capacity for self-delusion (e.g., here, writing about the need to get rid of the "gimmes"). While I don't think that a speeding ticket on my record should automatically mean that I couldn't be a great CEO (on the other hand, felony drug charges? Really?), I do think that before the board offers me the job, they should do a background check. And look for answers more compelling, and less self-serving, than "I was just keeping up with traffic."

If Greed is Good, Is Speed Even Better?

To coin a phrase: The early bird catches the worm.

Being first with the news is an obvious advantage, and not just if your livelihood comes from trading either stocks or gossip. If you're in the market for a Manhattan apartment, knowing that a friend-of-a-friend is about to sell and move out to the 'burbs can mean landing that perfect (tiny) West Village condo.

Sometimes being first is just good luck.

Sometimes it comes from greasing the right palm, a.k.a. insider trading, which is illegal -- although proving the illegality can be tough.

And between pure luck and insider trading, there's a lot of grey.

As Nathaniel Popper reports in today's New York Times, "first access" has become a profitable business model.

He writes, "Dow Jones recently announced the creation of DJ Dominant, a program that will release news articles two minutes early to subscribers who pay more."

Another examples Popper cites is

a service that the Nasdaq market and Chicago Mercantile Exchange introduced in May, which promises to get Nasdaq's market data to customers in Chicago -- and Chicago data to the East Coast -- 2 milliseconds faster than it is otherwise available thanks to the use of microwave transmission. The cost for the advantage is a reported $20,000 a month.

Similarly, Thomson Reuters has offered clients information about the University of Michigan's influential consumer confidence index "a full two seconds" before its "early" release, itself two minutes before the official release.

As trading is increasingly computer-driven and high-speed, even two seconds can make a significant difference.

But Thomson Reuters has just suspended its early-early release, under pressure from the New York attorney general's office, which is reportedly taking a "broad look" at the practice. According to a New York Times DealBook article by Peter Lattman (published Monday), the state's "investor protection bureau" is looking into the question of "whether preferential disclosure of data is a fair and appropriate business practice."

The New York attorney general's office has considerable power over Wall Street, thanks to the Martin Act, which gives "the attorney general broad powers to pursue either criminal or civil actions against companies... [and] does not require the government to show proof that a company intended to defraud anyone."

Popper quotes state attorney general Eric Schneiderman as saying, "The securities markets should be a level playing field for all investors and the early release of market-moving survey data undermines fair play in the markets."

Since I'm not a lawyer, I can't speak to the legality of Thomson Reuters' behavior (nor that of Dow Jones, the Nasdaq, et al.). But I can speak to the ethics.

The stock market is often held up as an example of a perfectly level playing field -- if you can spot a great investment opportunity before your neighbor can, it doesn't matter that she's a high-powered hedge fund manager and you're a day trader working from your home office: You'll win.

But if that hedge fund manager can pay to get information about that potential opportunity two seconds before you can ... Just how level is that playing field, really?

Want to Get Paid? Pay a Fee.

How many more ways can we find to make it seem reprehensible to be poor?

The working poor used to be admired for their grit and perseverance in the face of remarkable road-blocks. People talked about the "dignity" of working poverty (this was generally said by those who had never experienced the soul-corrosiveness of genuine poverty).

Today, we seem to specialize in finding new ways to nickel-and-dime the people who are barely making it by as it is.

Today's New York Times has a lengthy, depressing, but valuable article by Jessica Silver-Greenberg and Stephanie Clifford on the new way to pay workers: not with a paper check, or by direct deposit, but prepaid cards, similar to a debit card.

Companies and card issuers, which include Bank of America, Wells Fargo and Citigroup, say the cards are cheaper and more efficient than checks — a calculator on Visa’s Web site estimates that a company with 500 workers could save $21,000 a year by switching from checks to payroll cards.

Savings like that can get the attention of corporate financial officers. 

The cards are particularly popular with retailers and restaurants, which have large numbers of minimum-wage employees. According to the Times, "$34 billion was loaded onto 4.6 million active payroll cards [in 2012], according to the research firm Aite Group." And the total is expected to grow to $68.9 billion( and 10.8 million cards) by 2017.

But what does it mean for the workers? In theory, it should be just as easy to use as a debit card. In practice... not so much:

...In the overwhelming majority of cases, using the card involves a fee. And those fees can quickly add up: one provider, for example, charges $1.75 to make a withdrawal from most A.T.M.’s, $2.95 for a paper statement and $6 to replace a card. Some users even have to pay $7 inactivity fees for not using their cards. These fees can take such a big bite out of paychecks that some employees end up making less than the minimum wage once the charges are taken into account...

As an example, the Times reporters spoke to a young man who works at a McDonald's in Milwaukee, earning $7.25 an hour (which is the current minimum wage in Wisconsin). He gets paid via a prepaid card, and spends "$40 to $50 a month on fees associated with his JPMorgan Chase payroll card."

Do the math. $7.25 per hour for a standard 40-hour week is $290. Multiply that by 52 for a year, without any vacation time, and you're up to $15,080. Forget about Social Security or other payroll tax deductions for the moment, and you try living on that. $45 a month in fees adds up to $540, which is more than 3.5% of his gross earnings, and a substantially higher bite on net earnings. Do the math backwards, and this young man is now earning $6.99 an hour. A 3.5% drop in earnings may not sound like much, but when you're living this close to the edge, it can easily mean the difference between having enough to eat and not.

To be fair, it's worth noting that some 10 million American households are now "unbanked", and

Some employers and card issuers say that the payroll cards are useful for low-wage workers who do not have bank accounts. They also say that the fees on the cards are usually lower than those associated with check-cashing services, which are often the only other option for people who do not have bank accounts. 

But I think the more important factor for the issuing banks is that prepaid cards have been virtually untouched by recent financial regulation.

The lack of regulation in the payroll card market, while alluring for some of the issuers, can potentially leave cardholders swimming in fees. Take the example of inactivity fees that penalize customers for infrequently using their cards. The Federal Reserve has banned such fees for credit and debit cards, but no protections exist on prepaid cards. Cards used by more than two dozen major retailers have inactivity fees of $7 or more, according to a review of agreements. 

Some employees can also be hit with $25 overdraft fees, called “balance protection,” on some of the prepaid cards. Under the Dodd-Frank financial overhaul law, banks with more than $10 billion in assets are barred from levying overdraft fees on customers’ checking accounts [but not on prepaid cards].

So the people who are least able to pay the fees are the ones getting hit with the fees. And those cost savings for the companies? If you're wondering where they go, I suggest you check out a headline on page-one of the business section in Sunday's New York Times: "That Unstoppable Climb in CEO Pay".

The Toxic Legacy of Tax-Avoidance Schemes

As an ethicist, I suppose I shouldn't indulge in schadenfreude -- the delight in someone else's misfortunes -- but then, I'm human too.

In this particular instance, however, the pain doesn't fall on the right party.

New York Times business reporter Floyd Norris writes today that "Tribune Company, the publisher of The Chicago Tribune and The Los Angeles Times, among other publications, ... seems likely to have to pay hundreds of millions of dollars in taxes that it would never have owed had it not tried to be so clever."

The shenanigans began with the 2007 takeover of the Tribune Company by real estate billionaire Samuel Zell, a man with essentially zero experience in the media business.

(Aside: Back at the dawn of time, when I worked -- briefly -- as a journalist, most newspapers were owned by people who actually gave a damn about journalism. Sigh.)

The initial $8.2 billion transaction was complicated enough (the Chicago Tribune ran a lengthy piece in January, by Michael Oneal and Steve Mills, unfurling the whole long sad tale), and things got more complicated still, and quickly.

To be fair -- not that I really want to be -- not everything was Zell's direct fault: the 2008 financial collapse effectively prevented Zell from selling off assets that would have buoyed his plans. Advertising was already weakening under the digital onslaught, and it was about to get much worse.

The Tribune Company slid into bankruptcy about a year after Zell's acquisition, emerging in 2012 a shadow of its former self, with thousands fewer employees than in its heyday (many of whom had given up contributions to a retirement pension in exchange for agreeing to a now-worthless Employee Stock Ownership Plan). And the future does not look bright, thanks to the huge tax bill that the company now faces.

The key shenanigan in the whole deal -- which is now coming back to haunt the Tribune in a very very big way -- revolved around taxes. Or more to the point, how not to pay them.

Those of you who have read more than a few of my posts know that I am a big believer in taxes and regulation, that I am firmly in the Justice Oliver Wendell Holmes Jr. camp ("Taxes are the price we pay for a civilized society.").

This is what happens when you structure a deal entirely to avoid paying taxes. As Oneal and Mills wrote,

Taxes were a special problem for anyone hoping to take control of Tribune Co. by using a lot of borrowed money. Federal income taxes reduced the company's cash flow each year by hundreds of millions of dollars, limiting the amount available to pay interest. And while the company boasted many prize assets like the Chicago Cubs that could be unloaded to pare down the acquisition debt, selling them piece by piece would trigger huge capital gains taxes because Tribune Co. had owned most of the assets for so long.

The Zell team's brainstorm was to take the company private and convert it into what's known as an S-Corp ESOP, a Subchapter S corporation owned by an employee stock ownership plan. Because an ESOP is officially a retirement vehicle, the structure immediately eliminates corporate income tax. 

So far, so good, right?

Floyd Norris quotes tax analyst Robert Willens: "In conception, it was brilliant... It would have been probably the greatest tax avoidance structure ever devised, had they earned income."

The catch is that, as Norris notes, a company that converts "to S status may still be subject to capital gains taxes if it sells assets within 10 years after the conversion. If that happens, it owes taxes on the gain in value that accrued before the company converted."

The Tribune did sell some assets, and Zell apparently had another "clever way" to handle that potential tax problem. 

The Internal Revenue Service is now questioning many Tribune Co asset sales, but especially the sale of Long Island, NY-based Newsday and that of the Chicago Cubs. Norris notes drily that the IRS concluded that Zell's gimmick was "so outrageous that it added a 20 percent 'accuracy related penalty' to the $190 million tax that should have been paid when Tribune sold ... Newsday to Cablevision in 2008. Under the law, that penalty is reserved for transactions that show 'negligence or disregard of rules or regulations,' or are 'lacking economic substance.'"

Fortune senior editor-at-large Allan Sloan wrote a few days ago, 

I used to consider Zell and his tax avoidance schemes sort of amusing. But the amusement -- and congeniality -- are both long gone.

I'm sure that after litigation or the threat of it, Tribune will ultimately settle [for] considerably less than the $600 million likely total of the claims, penalties and interest. However, my bet is that Tribune will ultimately fork over more than $100 million to pay for the tax games Zell played with Newsday (one of my former employers) and the Cubs.

That's just what the company, struggling to survive in a hostile landscape for media companies, needed in its new life -- a big, fat tax bill from the past. Thanks a lot, Sam.

I believe in taxes. I don't believe in totally simplistic one-size-fits-all flat taxes. But I want a system that rewards companies and employees, not $1,000-an-hour lawyers who can figure out ways to avoid paying taxes. If Zell had been a little less clever, or a lot more ethical, ... well, a person can dream, can't she?

"Brand You" Really Does Belong to You!

It's taken several years for the case to wend its way to the Supreme Court, but today, thankfully, the Court ruled unanimously that your genes are your own.

Seems obvious, doesn't it?

More than three years ago, I commented on round one of this case, when US District Court Judge Robert W. Sweet struck down seven patents held by Utah-based Myriad Genetics that were the basis of tests that looked for mutations of the BRCA 1 and 2 genes. Those mutations are associated with a substantially greater risk for breast and ovarian cancer. The only way to know whether you have the mutations is to pay approximately $3000 for the Myriad Genetics test; Myriad has refused to license the test to other companies. The suit had charged that by doing so, Myriad kept prices artificially high and prevented woman from getting a second opinion from another testing company.

Myriad had argued that without the potential for significant financial gain that the patents represent, there would be no incentive to invest in potentially life-saving research.

As I wrote then: "I think that many of us, who are not genetic scientists, find it hard to understand (and more than a little ambiguous morally) that a corporate entity could own genes that come from our own bodies."

The Supreme Court today, as reported by the New York Times' Adam Liptak, ruled that "isolated human genes may not be patented." (Full article, here)

Writing for the Court, Justice Clarence Thomas stated, "A naturally occurring DNA segment is a product of nature and not patent eligible merely because it has been isolated. It is undisputed that Myriad did not create or alter any of the genetic information encoded in the BRCA1 and BRCA2 genes."

There's some wiggle room left for companies like Myriad, however: The manipulation of a gene "to create something not found in nature" would be patentable.

Chairman _and_ CEO? Or Chairman _or_ CEO?

If I were the chief executive officer of a major financial institution, I would want to be chairman, too. Not just for the extra pay -- tho' I probably wouldn't turn it down -- but mostly for the extra power. No one checking over my shoulder except those pesky board members (and I can usually keep them quiet).

If I were a shareholder of a major financial institution? You bet that I'd want an independent chairman overseeing operations.

For a few years now, some JP Morgan Chase shareholders have wanted to split the offices of chairman and chief executive officer, held by Jamie Dimon. In 2012, 40% of shareholders voted to have the offices split. This year? In a victory for Dimon, the support for splitting the offices fell to 30%.

As noted by Jessica Silver-Greenberg in yesterday's New York Times, the (non-binding) shareholder resolution was positioned as a way to improve the bank's governance, but "it soon became tangled up in how Mr. Dimon handled last year’s trading blowup. The surprising loss at the chief investment office unit in London felled some of Mr. Dimon’s top lieutenants and helped lay bare broad risk and control weaknesses throughout the vast bank." (Full article, here)

Dimon's victory didn't come easily -- a lot of intense lobbying was involved, according to an earlier New York Times article by Silver-Greenberg and Susanne Craig:

At its Park Avenue headquarters, JPMorgan assembled a war room where executives kept close tallies as shareholder votes began streaming in, according to two people briefed on the matter. To sway investors, these people said, influential board members were paired with large shareholders....

Reports say, however, that as little as two weeks ago, the resolution was on the verge of winning. The bank lobbying swung into high (fear) gear, warning that Dimon might leave, that the bank stock price would therefore be deeply damaged, and so on. The real turning point, Silver-Greenberg and Craig reported, came when "an influential shareholder advisory firm" recommended that shareholders blame the bank's directors:

In a scathing 33-page report, the firm faulted three directors, saying they lacked risk expertise. By zeroing in on the board members, several people close to the bank said, the advisory firm effectively gave shareholders an alternative. They could register their dissatisfaction with JPMorgan without going after Mr. Dimon....

I don't blame Dimon for pulling out all the stops to hold onto the power base he's built. I don't even really blame the shareholders for falling for the scare tactics.

But the victory for Dimon wasn't just that; it was a defeat for good corporate governance.

 

"Legal" is Not a Synonym for "Ethical"

It appears that we need a refresher course in the difference between "legal" and "ethical", at least from reading a lead story in today's New York Times by Nelson Schwartz and Charles Duhigg on the "web of tax shelters" that allowed Apple to escape from billions of dollars in US tax payments.

The US tax code may have Byzantine rules that encourage gaming the system, and I'm sure that Apple will argue that keeping its taxes as low as possible was the responsible thing for the company to do for its shareholders.

But if I am going to pick one of two short-hand phrases about taxation by which to live, I'll go with the late Supreme Court Justice Oliver Wendell Holmes ("Taxes are the price we pay for a civilized society") over the also-late but unlamented Leona Helmsley ("Only the little people pay taxes"). Apple apparently went with the Queen of Mean.

Schwartz and Duhigg explained:

Even as Apple became the nation’s most profitable technology company, it avoided billions in taxes in the United States and around the world through a web of subsidiaries so complex it spanned continents and went beyond anything most experts had ever seen, Congressional investigators disclosed on Monday....

... [They] found that some of Apple’s subsidiaries had no employees and were largely run by top officials from the company’s headquarters in Cupertino, Calif. But by officially locating them in places like Ireland, Apple was able to, in effect, make them stateless — exempt from taxes, record-keeping laws and the need for the subsidiaries to even file tax returns anywhere in the world. 

The investigators are not claiming that Apple broke any laws, nor is it the only major corporation using all kinds of arcane schemes to keep its tax bill as low as possible. But Apple's "gimmicks" and "schemes" (words used by US lawmakers) were on a whole new scale. The Times journalists quote a University of Southern California law professor on the Apple strategy: "There is a technical term that economists like to use for behavior like this: Unbelievable chutzpah." I might have used a stronger term.

Corporate tax avoidance on this scale encourages those of us who pay our own fair share -- willingly or not! -- to feel like chumps.

Meanwhile, technology companies like Apple are lobbying hard for changes in immigration legislation to permit them to hire more foreign engineers and computer scientists due to the (alleged) lack of sufficient US talent. But it is taxes that pay for long-term research and development, that support the colleges and universities that train engineers and other scientists, that underwrite the infrastructure that delivers products from the port (since most while designed in the US, are built elsewhere) to the retail stores.

Legal, sure (although I'd like to see these rules changed!). Ethical? Not hardly.