Question

Roger McDaniels sat in front of his computer pondering his immediate future. He had just finished an impromptu meeting with Beth Sullivan from the internal audit department and his confidence was shaken. Both Roger and Beth left the meeting wondering if their recent decisions were for the best.
Roger's accounting career began approximately ten years ago when he became a CPA. Over the last decade, Roger had been successfully employed in a variety of accounting positions. It therefore came as no surprise to Roger when three months ago, he was contacted by an executive recruiter and offered the CFO position at Solodor Pharmaceuticals (SP). SP's mission was to conduct tests on Celenza, a new drug that had been developed to fight acute lymphoblastic leukemia. If successful, Celenza had the potential to increase the average life expectancy of affected patients by up to six years. Celenza offered terminal patients the most hope of any drug in over a decade. Although not stated publically, it was known in the industry that other pharmaceutical companies did not want to incur the significant costs associated with developing a similar drug because sales of a new drug would merely cannibalize sales from their current, but less effective medications.
Upon accepting the employment offer from SP, Roger felt very exhilarated. If SP's mission was successful, not only would Roger be handsomely rewarded (as his compensation package provided him with numerous stock options, which in themselves would likely make Roger a millionaire), but Roger would also play a part in extending the lives of numerous terminally ill patients. Given the history of death in his family from various forms of cancer, more specifically the death of his father from leukemia when he was only a child, Roger was all too aware of the pain and mental anguish associated with terminal illnesses.
Upon starting his new position, Roger was not surprised to learn that, similar to other new pharmaceutical companies, SP was currently experiencing severe cash flow problems. Thus, the immediate priority for Roger was to procure a round of additional equity financing. If Celenza was shown to be successful, it had the potential to be a cash cow. However, in its current state, SP had no expectations of any Celenza sales occurring for at least two more years because extensive testing was needed before the FDA's Center for Drug Evaluation and Research would even consider approving the drug. Without obtaining a minimum of $5,500,000, SP would run out of money and be forced to liquidate within the next four months. This would not only leave Roger unemployed but would make his stock options worthless. It would also put Celenza's future in jeopardy.
Roger recently held meetings with three different financiers and pessimistically awaited their responses. Due to the weak economy, raising significant equity financing was an extremely difficult task. Therefore, when Steve Butler called to arrange a breakfast meeting, Roger was anxious.
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Steve Butler was a senior vice-president of Cambridge, a venture capital firm with access to over a billion dollars. If SP's management team impressed Steve, Roger knew the firm's current financial woes would be solved. However, if SP's management team failed to impress...well, Roger chose not to concentrate on that option.
The breakfast meeting between Roger and Steve came and went with Steve appearing to be extremely intrigued with the market potential of Celenza. At the end of breakfast, Steve suggested that Cambridge would potentially be willing to invest up to $5,500,000 but only after conducting a thorough analysis of Celenza's research progress.
Accordingly, two weeks after the breakfast meeting, scientists from Cambridge spent ten days examining the research that SP had conducted to date on Celenza. Roger was feeling cautiously optimistic because Steve's team seemed to be impressed. However, as weeks went by Roger's pessimism began to return. It had been three weeks since the team had visited SP and Roger had yet to hear from Steve.
Two days later the phone rang in Roger's office. After realizing it was Steve calling, Roger attempted not to act apprehensive. During the call, Steve explained that his firm was in the process of preparing a share purchase agreement in which Cambridge would purchase up to 55 percent of SP. Cambridge was willing to pay $100,000 for each 1 percent of SP ownership, conditional on obtaining a controlling interest in SP. After hanging up, Roger exhaled deeply and exhaustively leaned back in his chair as he considered Cambridge's proposal. On the positive side, the news of an equity purchase could not have come at a better time since SP's creditors were phoning daily requesting payment. On the negative side, obtaining the required $5,500,000 meant Cambridge would effectively control SP. Cambridge had a reputation for replacing the management teams in firms that it acquired and for pursuing a high-price/low-volume marketing strategy. The possibility of being fired would be catastrophic for Roger since he had to be employed by SP for at least one year before his stock options would fully vest. Cambridge's marketing strategy would also be in contrast to the desires of SP's current management team who wanted to maximize profits—but also planned on being socially responsible by implementing a low price/high volume marketing strategy. Roger clenched his jaw in agony because he knew that a high-price/low-volume strategy meant that Celenza would only be available to the wealthy and not available to those who were covered by traditional health insurance policies.
After waiting a sleepless week during which no draft agreement appeared, Roger became increasingly agitated. Roger did not want to act hastily but after he could wait no longer he phoned Steve's office. Although Steve was out of the office, Roger reached Steve's assistant and asked to see a draft of the purchase agreement. The assistant agreed to overnight a hard copy of the deal.
Upon returning from lunch the next day, Roger noticed a UPS package resting on the corner of his desk. As he tore open the document Roger's heart palpitated with nervous excitement. As he glanced over the first sheets he immediately noticed that this was not
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a draft of the agreement between Cambridge and SP but a final copy of a deal between Cambridge and Dugas Incorporated that was to be announced the next day.
Roger's first instinct was to throw away the draft without reading it because it was obvious to Roger that Steve's assistant had made a mistake and sent him a copy of the wrong deal. However, curiosity got the best of Roger so he decided to read over the entire document. Afterward, Roger checked the Internet for details of Dugas Incorporated. There did not seem to be any public information available about a deal between Cambridge and Dugas Incorporated. Now consumed with interest, Roger noticed that Dugas Incorporated was currently trading on the New York Stock Exchange at $3.14 per share, down from a yearly high of $28.45. He next reviewed a few financial news articles that expressed concern regarding Dugas Incorporated's cash flow. The articles also expressed doubt that Dugas Incorporated would be able to obtain the additional financing it needed to stay afloat.
Roger reclined in his chair realizing that he was privy to a very significant piece of information. In less than 24 hours Dugas Incorporated would announce Cambridge's investment. This news was sure to have a significant impact on the price of Dugas Incorporated's stock. Roger contemplated just how high their stock price would go, maybe $10, maybe $15, maybe even past its yearly high.
Roger could not believe his good fortune. A grin slowly crept across Roger's mouth as he accessed SP's operating account and used every last dollar to purchase 470,000 shares in Dugas Incorporated. Roger was actually giddy with excitement and found that he could barely contain himself. With the profits that SP would make once the news regarding Dugas Incorporated went public, he had single handedly prevented SP from surrendering control to Cambridge. He had never felt better about himself. Roger was now fully confident that he would remain at SP long enough for his options to vest. As Roger left his office that day he realized that his actions would stop Cambridge from imposing a high-price/low-volume marketing strategy on SP such that only the very wealthy could afford Celenza. Roger found it satisfying to help people who so desperately needed it.
A month later, Roger's actions were discovered by Beth Sullivan, an internal auditor at SP, while performing a routine test on a stratified sample of cash transactions. Beth discovered that Roger used SP's operating funds to purchase shares in Dugas Incorporated just one day before the stock price skyrocketed. This discovery led Beth, who was unsure if she should further investigate the transaction, to request an impromptu meeting with Roger. Beth chose to discuss the situation with Roger rather than her immediate superior because SP's corporate structure was such that the head of the internal audit department ultimately reported to Roger, the CFO.
The meeting had only begun when Roger somewhat aggressively instructed her to simply drop the transaction from her sample. To underscore his point he made sure to mention that he was her boss's boss, and ultimately the person in charge of the internal audit department. Sensing that Beth was uncomfortable with his instructions, Roger
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slumped forward exhaustively and elaborated on his heartfelt reasons for having used corporate funds to purchase the shares in Dugas Incorporated. After her meeting with Roger, Beth experienced an uneasy feeling in the pit of her stomach.
It was now two months since Beth's meeting with Roger but Beth still felt queasy when she contemplated Roger's actions. She had lain in bed the previous night tossing and turning unable to sleep. As she showered that morning she considered that it was important to ensure that she acted legally in spite of ethicality. People were thrown in jail for violating the law not for violating ethics. She resolved that in spite of thinking that perhaps Roger had behaved ethically, she had to behave rationally. If she reported Roger's actions, there was no way by which she could be held legally responsible for any of Roger's actions. There was also no means by which Roger or SP could fire her, for the Sarbanes-Oxley Act of 2002 (SOX, U.S. House of Representatives 2002) provided her with protection from their retribution. She never realized that reading the Occupational Safety and Health Administration (OSHA) fact sheet in SP's lunchroom would help her resolve such a significant dilemma. After many bored lunch breaks she could now recall the fact sheet verbatim:
An employer covered under SOX may not discharge or in any manner retaliate against an employee because he or she: provided information, caused information to be provided, or assisted in an investigation by a federal regulatory or law enforcement agency, a member or committee of Congress, or an internal investigation by the company relating to alleged mail fraud, wire fraud, bank fraud, securities fraud, violation(s) of SEC rules and regulations, or violation(s) of federal law relating to fraud against shareholders. (OSHA 2011)
As Beth arrived at work that morning, after a brief stop at the local coffee shop, she confidently wrote a letter to SP's Board of Directors informing them of Roger's actions.
Answer the following Questions:

1. Identify and briefly discuss the key issue(s) in the case.
2. What was the ethical dilemma faced by Beth Sullivan?
3. Do you think Beth acted ethically? Why or why not?
4. Are there any other alternative courses of action possible for Beth?

Answer 1

1 Identify and briefly discuss the key issue(s) in the case.

The key issues in this case study are two.

The first issue :whether Roger’s action of using Cambridge’s confidential information concerning their investment plans in Dugas Incorporation to divert the consequences of selling the supreme ownership and control rights to Cambridge is justifiable. Or, whether this action is possibly to be deemed as insider trading and/or tipping. According to the SEC, insider trading is whereby an employee without being authorized breaches the fiduciary duty and uses confidential information regarding the company’s stock which is not yet publicly declared to trade. Tipping is whereby an insider discloses such information intentionally to third parties, such as family and friend, and provides them with stock information so that they may be the first to benefit most before the stock is publicly declared (which is illegal). This two issues are not there as the secretary was not in any way whatsoever connected to Rogers and had sent those documents by mistake. We also do not find it as tipping and even the stock information concerning the prices is accessed by Rogers online. We can therefore find Roger’s actions under Regulation D qualifying as a sophisticated investor and accredited investor. Private placements under the SEC’s Regulation D aren’t illegal and the SEC maintains that can have obtained the information through such accidental means as Rogers did and the risks involved fall barely on the investor.

The second issue: Whether Beth should disclose the matter to the Board of Directors or not, and in that case how would she be found not to act ethically? In order to examine whether she acted ethically or not, it’s important to understand that there’s a protocol that is followed in an office; the chain of command and the chain of power. That may be a bleach of ethics or it may not be under certain circumstances

2 What was the ethical dilemma faced by Beth Sullivan?

The ethical dilemma in this case is where Beth put so much weight into the matter and thought of talking it over with her senior-most boss before talking it over with her immediate boss, and whether she should report the matter to the Board of Directors.

3 Do you think Beth acted ethically? Why or why not?

I strongly argue that Beth acted ethically with Rogers. If a CPA finds out that there are some threats that are not at an acceptable level, the member is allowed to discuss such findings with their appropriate higher-level superiors within the organization. The auditor isn’t limited to discuss such findings with only her immediate superior but can approach the superior too. Rogers is definitely threatening the independence rule of the auditor as an auditor is just nor an ordinary employee but someone who is also governed by the special code of conduct for the auditors such as AICPA.

4 Are there any other alternative courses of action possible for Beth?

What Beth didn’t follow is that she didn’t report this matter to her immediate boss and could therefore not approve of her actions or actions taken against her. The mentioned code also states that if the member finds out that there was no action taken to resolve his/her concerns, then he or she must take the appropriate safeguards that protect the firm against any further threats to an acceptable level. The issue might have been resolved by other parties before being forwarded to the Board of Directors. The alternatives as the AICPA describes should include that she determines whether the company’s internal procedures and policies are being abused by her, determine whether she is responsible for talking with other third parties such as the company’s external accountant of former auditor, consult with her attorney whether her actions bare any legal concerns, and document her understanding of the code of conduct, facts and other relevant principles that were discussed.