Question: Unethical and/or illegal? 1533

  • If a manufacturing(M) company is dealing with a vendor(V) that allows defective claims up to a certain dollar amount and the M for some reason was not making the claims for several months, is it unethical and/or illegal for M to start submitting all requests for replacement items from V as ‘defective’ in order to make up for the missed claims that M didn’t make in the previous months? The claims for replacement items do include defective items, but also include items that were damaged by M. If this is illegal, is it covered under Sarbanes Oxley? What should be done by the employee who is aware of this situation?

  • Q1. Is it unethical and/or illegal for the manufacturing concern to start submitting all requests for replacement items from the vendor as ‘defective’ in order to make up for the missed claims that the manufacturer didn’t make in the previous months?
    A1. When in doubt if something is ethical, the rule of thumb is NOT to do it as it generally would be considered inappropriate. Making false claims with a vendor regardless of the ‘justification’, on its surface, appears to be an unethical practice.
    Q2. The claims for replacement items do include defective items, but also include items that were damaged by the manufacturer. If this is illegal, is it covered under Sarbanes-Oxley?
    A2. Illegal or inappropriate practices is generally considered when assessing the Control Environment when applying the COSO Framework. Although the Sarbanes-Oxley Act does not directly address specific acts that are considered illegal, applying the COSO Framework to achieve compliance with SOX establishes a nexus between fraud, illegal acts, etc., as considered under the COSO Framework and compliance with SOX.
    Q3. What should be done by the employee who is aware of this situation?
    A3. An employee who has knowledge of fraudulent financial reporting practices or other inappropriate acts that may have impact on the quality, reliability, and accuracy of the financial statements, should report the act(s) to the level sufficient to initiate an investigation if appropriate. If a reporting channel is in place (fraud repoting hotline), it should be used. The SOX act provides for certain protections to ‘whistleblowers’. However, as with all sensitive matters and particularly those involviing improper acts at the workplace, you should proceed with caution and act rationally.

  • Hi lulu and welcome to the forums 🙂
    I’d simply say ‘YES’ as answers to both questions. The illegality aspects may be minor in scope to something like the Enron case. If folks are distorting the official accounting records of the company in a sereptious manner as described – this ain’t SOX compliant.
    Secondly as milan suggested, I’d advise proceeding with caution. I’d work directly and privately with your manager on this issue if they’re not directly involved. If they want to escalate this, then you shouldn’t be impacted.
    Whistle blower protection exists to protect employees who report things directly to the SEC. Still, in an ‘at will’ employment state, you can also be fired for ‘any reason’. I’m not personally convinced that ‘whistle blowers’ would enjoy complete immunity, after inviting an SEC investigation into a company?
    For example, if a ‘whistle blower’ were late for work a few times some months later, they might be unfairly dismissed, for non-related SOX reasons? Their future salary increases, career paths, etc. might be affected?
    The whistler blower approach might work if those violating the principles are let go. In fact in a highly ethical company they could be seen as a hero. Still, all individuals need to weigh the potential consequences very carefully in taking this next step.
    I’d also theorize that a good auditor or someone on the SOX compliancy team could potentially find this, so I’d be very careful and not jeapordize your career, particularly if you’re working for a good company overall

  • From the NY Post -
    January 12, 2006 – The Securities and Exchange Commission has opened an informal investigation into allegations of inflated payments that Home Depot collected from suppliers to cover the cost of damaged merchandise, The Post has learned.
    The payments, known as return-to-vendor charges, helped Home Depot pad store profit, according to current and former employees, who detailed the practice in two Post articles.
    One former employee, Michael Davis, filed a complaint with the United States Department of Labor alleging that he was wrongfully terminated when he resisted going along with the practice.
    Davis’ case is scheduled to go to trial later this month, according to his lawyer Mark Schwartz.
    Jeffrey Leasure, a lawyer with Cleary Gottlieb, which is representing Home Depot in the SEC inquiry, referred all calls to Home Depot.
    Jerry Shields, a spokesman for Home Depot, declined to comment. John Heine, an SEC spokesman, also declined to comment.
    Since The Post stories were published in August, Home Depot has introduced a new computer system that makes it more difficult for store employees to manipulate return-to-vendor charges, one source said.

    The SEC investigation and legal action at Home Depot mirror similar complaints against other retailers, notably Saks Inc. and Federated Department Stores, which are accused of overcharging suppliers in a variety of ways.
    In the case of Home Depot, the USD73 billion retailing giant is accused of overbilling suppliers for goods that were damaged during shipping, according to Davis and other employees.
    For instance, Philips Lighting Company, a unit of Royal Philips Electronics, provided the Home Depot store in Aspen Hill, Md., with a USD1,000 monthly credit to cover the cost of damaged light bulbs, according to Davis.
    As long as the amount didn’t exceed USD1,000, Philips would accept the charge, no questions asked.
    Davis said he was told by his superiors to charge Philips slightly less than the USD1,000 ceiling each month, even if the actual damages totaled less than that amount.
    Inflating return-to-vendor charges allowed Home Depot stores to reduce shrinkage, the amount of merchandise lost to theft, damage or receiving mistakes, and thereby boost profitability, sources said.
    The practice one source called it ‘washing the numbers’ was done at multiple stores in different regions of the country, sources said.
    Suppliers have largely been unwilling to speak out for fear of losing Home Depot’s business.
    But one vendor who sells to Home Depot stores throughout the country and who spoke on the condition of anonymity for fear of reprisals said she suspected the practice was done on a national level, though not at all stores at all times.

    This sounds similar to the situation that you are describing. You need to do the right thing for you. Personally, I would not want to work for a compnay that condoned this type or practice. It may be limited in scope or more widespread. It does appear to be illegal, though only the vendor could press charges as he is the only one to suffer potential damages. The impact to the financial statements is probably not material, so SOX impact may be minimal. I would see this more as a tone at the top issue if management condones the practice, which would potentially require larger sample sizes for control tests.

  • To echo what the other guys have said, I think the case you’re describing is both unethical and illegal - it is fraud .
    I would also agree that you should proceed with caution. Consider whether the acts being carried out would be regarded as appropriate or not be senior management as this will ultimately dictate how you should proceed. If you are unlikely to have management support then you might want to have your resume up to date before you proceed.
    Also, consider whether it is possible to raise your concerns anonymously.

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