Deontological ethics and auditor failures in the Adelphia scandal

Ethics

Cable provider Adelphia was one of the major accounting scandals of the early 2000s that led to the creation of the Sarbanes-Oxley Act. A key provision of the Act was to create a stronger ethical climate in the auditing profession, a consequence of the apparent role that auditors played in some of the scandals. SOX mandated that auditors cannot audit the same companies for which they provide consulting services, as this link was perceived to result in audit teams being pressured to perform lax audits in order to secure more consulting business from the clients. There were other provisions in SOX that increased the regulatory burden on the auditing profession in response to lax auditing practices in scandals like Adelphia (McConnell & Banks, 2003). This paper will address the Adelphia scandal as it relates to the auditors, and the deontological ethics of the situation.

Adelphia

Adelphia was once a privately-held firm of the Rigas family, but they took the firm public. When the firm went public, it became subject to a range of accounting regulations as it entered the jurisdiction of the Securities Exchange Commission. Adelphia was bound to adhere to generally accepted accounting principles (GAAP) in the preparation of its financial statements. As the scandal broke, it related primarily to the use of company funds for personal spending by the Rigas family. While such a practice might have been acceptable if the firm was family-run, it is not acceptable in a public corporation. The Rigas family and directors of the firm took steps to cover up this spending, including holding significant amounts of debt off of Adelphia's balance sheet. When one of its subsidiaries filed for Chapter 11 bankruptcy, Adelphia guaranteed the debt of that subsidiary, causing outrage among Adelphia shareholders who were unaware that this debt existed or that Adelphia was going to guarantee it (Barlaup, Dronen and Stuart, 2009).

As the investigation into the matter by regulators continued, more improprieties were revealed. There was a culture of lying about the financial condition of the company. Former executives revealed that figures were routinely invented in order that the company was able to meet the restrictive covenants on its debt, for example, allowing the Rigas family to continue to take out debt for the corporation and use that money to finance their own personal lifestyles. Complicit in this were the company's auditors, Deloitte.

Deloitte auditors were found lacking in their duties. As Barlaup (2009) notes, Deloitte ignored several red flags about Adelphia. In their audits, they should have encountered the suspiciously-luxurious lifestyle of the Rigas family, for example. Deloitte also ignored the fact that that company was often late with its financial statements, and failed to report key debt and other issues at all. When pressed to reveal certain information, Adelphia often refused. Deloitte failed to respond adequately to these events. It should have been more rigorous in its investigations of Adelphia, but it was not. As Barlaup (2009) notes, auditors have an obligation to treat with suspicion or at least skepticism all financial statement items, and to always remember that the possibility of fraud exists. Trained auditors, therefore, would have known that something was wrong with the statements of Adelphia, but approved of the statements anyway.

Adelphia

The acts of the Adelphia executives were in clear violation of the shareholders' trust and that of the general investing public. The closeness of the executive group and the Board to the Rigas family was cited as one of the red flags Deloitte failed to address. The executives are bound by a duty to the shareholders of the company to pursue those strategies and tactics to maximize shareholder wealth, as per basic agency theory and explained by Milton Friedman in 1970. While such strategies can take any number of forms, outright fraud is not one of them. When fraud is discovered, the company typically faces such strong sanctions from the SEC and negative reaction from the market that shareholder wealth is eroded. In the short-run, fraud preserves shareholder value but never in the long run. Thus, any executive engaging in fraud is necessarily violating the categorical imperative to take actions that increase shareholder value.

The directors and executives allowed the Rigas family to use the company as its piggybank. They also allowed for the routine falsification of company documents. This practice became so widespread that it was part of the corporate culture at Adelphia. It was entirely predictable that undertaking such illegal actions would bring about the downfall of the company -- this occurred in 2002 -- so the directors and executives who participated in this fraud or were aware of it are culpable for violating the categorical imperative that dictates they have a duty to maximize shareholder wealth. Where Barlaup (2009) seeks to draw a conclusion that better knowledge of ethical theories might have led to a different outcome, I find that conclusion to be far-fetched. The directors and executives at Adelphia knew that they were doing wrong. Their actions were illegal, and blatantly immoral. There is actually no grey area in the Adelphia case. As such, they acted willingly to violate the imperatives to which they had sworn themselves in accepting their duties with Adelphia, and this includes the owners of the company, who cannot even claim net personal benefit having been sentenced to extended sentences and had their assets seized.

What comes out of this case is that sometimes people willingly commit acts that are clearly against all known ethical principles. The deontological imperatives in this case are clear and they were willingly violated. It is important in this case to consider the role of the auditor as a safeguard against such behavior. Cases like this spurred a change in the legislative environment so that such sloppy auditing work is much less likely in the future.

Works Cited:

McConnell, D. & Banks, G. (2003). How Sarbanes-Oxley will change the audit process. Journal of Accountancy. Retrieved April 15, 2013 from http://www.journalofaccountancy.com/issues/2003/sep/howsarbanesoxleywillchangetheauditprocess.htm

Barlaup, K., Dronen, I. & Stuart, I. (2009). Restoring trust in auditing: Ethical discernment and the Adelphia scandal. Managerial Auditing Journal. Vol. 24 (2) 183-203.

Friedman, M. (1970). The social responsibility of business is to increase its profits. New York Times Magazine. Retrieved April 15, 2013 from http://www.colorado.edu/studentgroups/libertarians/issues/friedman-soc-resp-business.html