Read the case study and answer three questions below:

Patti Smith looked up at the bright blue Carolina sky before she entered the offices of Horizon Consulting. Today was Friday, which meant she needed to prepare for the weekly status report meeting. Horizon Consulting is a custom software development company that offers fully integrated mobile application services for iPhoneTM, AndroidTM, Windows Mobile® and BlackBerry® platforms. Horizon was founded by James Thrasher, a former marketing executive, who quickly saw the potential for digital marketing via smartphones. Horizon enjoyed initial success in sports marketing, but quickly expanded to other industries. A key to their success was the decline in cost for developing smartphone applications, which expanded the client base. The decline in cost was primarily due to learning curve and ability to build customized solutions on established platforms. Patti Smith was a late bloomer who went back to college after working in the restaurant business for nine years. She and her former husband had tried unsuccessfully to operate a vegetarian restaurant in Golden, Colorado. After her divorce, she returned to University of Colorado where she majored in Management Information Systems with a minor in Marketing. While she enjoyed her marketing classes much more than her MIS classes, she felt the IT know-how acquired would give her an advantage in the job market. This turned out to be true as Horizon hired her to be an Account Manager soon after graduation. Patti Smith was hired to replace Stephen Stills who had started the restaurant side of the business at Horizon. Stephen was “let go” according to one Account Manager for being a prima donna and hoarding resources. Patti’s clients ranged from high-end restaurants to hole-in-wall mom and pop shops. She helped develop smartphone apps that let users make reservations, browse menus, receive alerts on daily specials, provide customer feedback, order take-out, and in some cases order delivery. As an Account Manager she worked with clients to assess their needs, develop a plan, and create customized smartphone apps. Horizon appeared to be a good fit for Patti. She had enough technical training to be able to work with software engineers and help guide them to produce client-ready products. At the same time she could relate to the restaurateurs and enjoyed working with them on web design and digital marketing. Horizon was organized into three departments: Sales, Software Development, and Graphics, with Account Managers acting as project managers. Account Managers generally came from Sales, and would divide their time between projects and making sales pitches to potential new clients. Horizon employed a core group of software engineers and designers, supplemented by contracted programmers when needed. The first step in developing a smartphone application involved the Account Manager meeting with the client to define the requirements and vision for the application. The Account Manager would then work with a Graphic User Interface (GUI) designer to come up with a preliminary story board of how the application would function and look. Once the initial concept and requirements were approved the Account Manager was assigned two pairs of software engineers. The first pair (app engineers) would work on the smartphone side of the application while the second pair would work on the client side of the application. Horizon preferred to have software engineers work in tandem so they could check each other’s work. The two app engineers would typically work full time on the application until it was completed while the other engineers would work on multiple projects as needed. Likewise, GUI designers would work on the project at certain key stages in the product development cycle when their expertise was needed. The head of Graphics managed the GUI designers’ schedule while the head of Software managed the software engineer assignments. At the end of each project Account Managers submitted performance reviews of their team. The Director of Sales was responsible for the Account Managers’ performance reviews based on customer satisfaction, generation of sales, and project performance. Horizon believed in iterative development, and every two to three weeks Account Managers were expected to demonstrate the latest version of applications to clients. This led to useful feedback and in many cases redefining the scope of the project. Often clients wanted to add more functionality to their application once they realized what the software could do. Depending upon the complexity of the application and changes introduced once the project was under way, it typically took Horizon two to four months to deliver a finished product to a client. Patti was currently working on three projects. One was for Shanghai Wok, a busy Chinese mom and pop restaurant located in downtown Charlotte, North Carolina. The owners of Shanghai Wok wanted Horizon to create a smartphone app that would allow customers to order and pay in advance for meals they would simply pick up at a walk-up window. The second project was for Taste of India that operated in Kannapolis, North Carolina. They wanted Horizon to create a phone app that would allow staff at the nearby bio-tech firms to order food that would be delivered on-site during lunch and dinner hours. The last project was for Nearly Normal, a vegetarian restaurant which wanted to send out e-mail alerts to subscribers that would describe in detail their daily fresh specials. James Thrasher was an admirer of Google and encouraged a playful but focused environment at work. Employees were allowed to decorate their work spaces, bring pets to work, and play ping-pong or pool when they needed a break. Horizon paid its employees well but the big payoff was the annual Christmas bonus. This bonus was based on overall company profits, which were distributed proportionately based on pay grade and performance reviews. It was not uncommon for employees to receive a 10–15 percent boost in pay at the end of the year.

STATUS REPORT MEETING

As was her habit Patti entered the status report meeting room early. David Briggs was in the midst of describing the game-winning catch John Lorsch had made in last night’s softball game. Horizon sponsored a co-ed city league softball team which most of the Account Managers played on. Patti had been coaxed to play to ensure that the requisite number of “females” were on the field. She balked at the idea at first; softball wasn’t really her sport, but she was glad she did. Not only was it fun, but it gave her a chance to get to know the other managers. James Thrasher entered the room and everyone settled down to business. He started off as he always did by asking if anybody had important news to bring to everyone’s attention. Jackson Browne slowly raised his hand and said, “I am afraid I do. I just received notification from Apple IOS that they have rejected our TAT app.” TAT was a phone app that Jackson was the project lead on that allowed subscribers to reserve and see in real time what swimming lanes were available at a prestigious athletic club. This announcement was followed by a collective groan. Before an Apple app could go operational it had to be submitted and approved by Apple. Usually this was not a problem, but lately Apple had been rejecting apps for a variety of reasons. Jackson went on to circulate the list of changes that had to be made before Apple would approve the app. The group studied the list, and in some cases ridiculed the new requirements. Ultimately, James Thrasher asked Jackson how long it would take to make the necessary changes and resubmit the app for approval. Jackson felt it would probably take two to three weeks at most. Thrasher asked who the engineers that worked on this project were. Patti’s heart fell. One of the app engineers who had developed the TAT app was working on her Shanghai Wok project. She knew what was going to happen next. Thrasher announced, “OK everyone, it only makes sense that these engineers are the best ones to finish what they had started so they are all going to have to be reassigned back to the TAT project. Those affected are going to have to get together after this meeting and figure how you are going to replace them.” The meeting then proceeded as planned with all the account managers reporting the status of their projects, and sharing relevant issues with the group.

POST-MEETING

As everyone filed out, Patti looked around to see who else was in her same boat. There were three other Account Managers as well as Jackson Browne. Resource assignments were a reoccurring issue at Horizon given the nature of their work. Horizon had developed a policy where decisions were made based on project priority. Each project was assigned a Green, Blue or Purple designation based on the company priority. Priority status was based on the extent the project contributed to the mission of the firm. The Shanghai Wok project given its limited size and scope was a Purple project, which was the lowest ranking. The list of available software engineers was displayed on the big screen. Patti was only familiar with a few of the names. Leigh Taylor who had the only Green project immediately selected Jason Wheeler from the list. She had used him before and was confident in his work. Tom Watson and Samantha Stewart both had Blue Projects and both needed to replace a mobile app engineer. They both immediately jumped on the name of Prem Mathew, claiming he was the best person for their project. After some friendly jousting, Tom said, “OK, Sam, you can have him; I remember when you helped me out on the Argos project; besides my project is just beginning. I’ll take Shin Chen.” Everyone looked at Patti; she started by saying, “You know, I am only familiar with a few of these names; I guess I’ll go with Mike Thu.” Jackson interjected, “Hey everyone, I am really sorry this happened, and I am sure Mike is a good programmer, but I recommend you work with Axel Gerthoff. I have used him before, and he is a very quick study and a joy to work with.” This was a relief to Patti and she quickly took his advice. They left to submit a report to Thrasher detailing the decisions they each had made and the impact on their projects.

1. How successful was the post-meeting?

2. What factors contributed to the success or failure of this meeting?

3. What kind of project management structure does Horizon use? Is it the right structure? Explain.

Small Business Management

QUESTION:

What will be the evaluation for the proposed low-cost marketing activities for enhancing the generation of the future bookings and the brand awareness of this small business?

Critically assess.

CASE STUDY

The children's party market is no jelly and trifling matter. "It's a huge industry," Tim Jenkins writes after his interview with Amanda Frolich from

Amanda's Action Kids. According to Frolich, "People spend an absolute fortune on their children's birthday parties and fortunately the recession hasn't affected our business."

Like Paul Lindley, founder of Ella's Kitchen, who used his parenting experience to launch a successful start-up, the party business with low barriers-toentry sees numerous parent small business concepts. Michelle Hill incorporated her own party business called The Land of Make-Believe after spending hours creating props, themed food, and thinking up games suitable for her five-year-old son's shared birthday party. This birthday spectacular experience helped her identify a clear gap in the market.

According to Tim Jenkins, a modest £50 party spend per UK child equates to an annual £35 million for a single school-year group. With £250 not

untypical for an outsourced party service, it is easy to value the industry in the hundreds of millions.

The Land of Make-Believe party concepts include themes for cheerleaders, pirates, and fairies; cowboys and Indians; witches and wizards; Fairy Godmother, Teddy Bear picnic, glamor, and Grease the musical with Pink Ladies and T-Birds. Party concepts that tend to appeal more to boys, perhaps relying less on dressing up and dancing, include club energy sports, go-karting, football, army games, reptiles and pets, and fire engine-themed parties. Leisure venues also offer some stiff competition with swimming pool visits, laser quest, bowling, cinema, and restaurant visits also popular. Business Model Essentials Successful party concepts need a certain "wow" factor that is popular with the children, but also satisfies parents' social needs too. Thus, it is important to also consider appropriate services for parents. Maslow's hierarchy of needs framework perhaps offers some useful cues: shelter, comfort, psychological self-actualization—be that social linger space, self-service hot beverages, a glass of wine, or a latte bar. Party providers need to balance novelty with tried and tested formulas, perhaps offering evolving theme linkages that might anticipate new film releases, particularly sequels. They look to reduce parental hassle with branded off-the-shelf invitation cards and party bags that appeal particularly to cash-rich, often time-poor, parents. Entrepreneur.com neatly summarizes the party service offering: "You'll plan the theme, provide costumes (unless guests arrive wearing their own), décor, food, favors and other assorted goodies, entertainment, and clean up afterward so parents can enjoy the festivities instead of running themselves ragged."

The business model usually has relatively low start-up costs—a website and a telephone number will generally suffice. Wardrobe, props, and base supplies are not insignificant items and should be carefully considered in financial planning. There is some wide variation in the complexity of offerings in the sector from a light touch and self-contained entertainer magician or comedian whose equipment might be limited to a costume, a music system, and some props that fit into a large suitcase or two to the full-service party-planning-solution provider offering a venue, full catering, the all-important candle-covered cake, decorations, and party bags. Three core components are required for a successful party operation, namely venue, catering, and entertainment. Fixed costs can be kept low, but are dependent on avoiding the purchase of a specialized vehicle and/or long-term premises by using a client-arranged venue. Children's party planning is clearly not a job for someone craving regular Monday through Friday, 9 a.m. to 5 p.m. hours. The ability to successfully interact with children and their parents, balancing controlled fun and calm authoritativeness, is particularly important but often rather taken for granted.

Marketing Communication Angles

A reputation for running successful parties is crucial to stimulate positive word-of-mouth referrals via parental social networks, accentuated by frequent contact at school pick-ups and drop-offs, but also on social media, and in particular parenting website communities such as mumsnet.com, which offers local listings, discussion boards, and advice-based content. In addition to successfully hosting enjoyable parties, which should drive positive referrals, a number of low-cost marketing activities can be implemented to help generate future bookings such as

-      Arranging to share a business card or small colour flyer via the party bag that is often given to departing guests. -     Posting flyers at local clubs and church halls.

-      Advertising in directories (telephone and web).

-      Donating a free party to a school/community charity auction.

-      Writing advertorial content accompanied by strong images in the local press (note parental permission and ethical issues around publishing photos of children).

-      Creating a website and social media presence on key sites.

-      Performing at community group/school events.

-      Printing car stickers to build brand awareness and share web and telephone contacts.

Rugged Earth Adventures

One ex-army officer's start-up inspiration led to a birthday party business centered on a military outdoor adventure theme. Having experimented with a number of temporary locations, the business finally settled on a large piece of underutilized agricultural land that comprises a mix of scrub land, combined with lines of commercially unsuccessful shrubs and trees.

The customer segment that this business proposition appeals to is mostly parents of boys—approximately 75 percent of participants are male, aged between 6 and 10 years. The children participate in a two-hour party that sees them run around outside in a natural environment. Issued with a foam bullet Nerf gun and protective glasses, participants are initially put into two teams, jungle versus desert, utilizing authentic British army terminology. A second game, the less frenetic snipers-and-seekers, is a form of hide-and-seek using realistic camouflage costumes. Then the young people are carefully instructed on how to thoroughly cook their own sausage, which is served as a hot dog, and the party concludes with toasted marshmallows. During one of the well-timed rest periods, a picnic basket is offered to the participants around the campfire with a variety of foods—an array that is low in chocolate and big on fruit and vegetables, which is appealing to parents, but it also includes less healthy but popular cupcakes and crisps. With overprotective parents, toy guns that fire projectiles, and an open fire, the safety briefing is taken very seriously and uses a highly authoritative army style. Children are regularly reminded about safe behavior requirements around the fire pit, particularly when wearing flammable costumes. Compliant use of safety glasses is paramount, with regular and direct reinforcement of the safety rules taking place. Hosting and supervising parents are made to feel at ease, provided with access to self-service hot and cold drinks and a place to perch. An informal satisfaction polling takes place just prior to the end around the campfire; positive responses are anticipated, thanks to a fairly simple formula that is well executed. The opportunity afforded to parents to relax while watching a group of children enjoy a totally stress-free afternoon is actually quite enjoyable. The business income comes predominantly from weekend parties, with the current site offering a capacity of three or possibly four parties per day. Each party can entertain 10 to 24 young people and costs between £120 and £295 (£12 to £20/child, excluding cake and party bags, which are £5 per child extra). Activity days, attractive for dual working parents, are also offered during the Easter and summer school holidays, priced at £26 to £34 per day. The revenue generated covers operating costs after a very short operational period.

Fukui Prefecture is situated on the northwest coast of Japan, over 400 kilometers west of
Tokyo. In 2014, over 95 percent of Japanese-produced eye-glass frames were made in Fukui
Prefecture, principally in the cities of Fukui and Sabae. In the early 20th century, the Fukui
economy was dominated by agriculture. Taking advantage of the seasonal lull in
employment during the winter months, Mr Masunaga Gozaemon and his brother Kohachi
started a business in the village of Shono to manufacture celluloid eye-glass frames.
Initially, the quality of Fukui-made eyeglasses was low. To raise standards, Mr
Gozaemon established a guild like system in which full-fledged craftsmen could set up their
own businesses. Production took off during World War I, and by 1937, the Fukui industry
comprised 70 factories employing 800 workers, and producing 1.5 million pairs of eyeglasses
a year.
In the 1980s, Fukui manufacturers perfected the production of titanium frames. These
are light and sturdy, and cause fewer allergies than conventional metals, but require
considerable skill to make. The strong tradition of craftsmanship in Fukui enabled the
production of titanium frames.
Mr Shoji Gozaemon, great grandson of the pioneer, Masunaga Gozaemon,
emphasized, “One of the characteristics of Japanese craftsmanship is a kind of redundancy of
detail. There is a tendency to pay careful attention to the minutest details. The spirit of
Japanese craftsmanship often involves spending more time and effort over producing
something than is strictly necessary” (Nippon.com 2012).
Besides manufacturers of eye-glass frames, the Fukui industry also includes
manufacturers and suppliers of lenses, sunglasses, reading glasses, parts, materials such as
titanium wire and preformin, and machines and tools.
With the entry of low-cost Chinese manufacturers into the market, the manufacturing
of eye-glasses in Fukui prefecture peaked in 1992. Within twenty years, by 2012, 40 percent
of Fukui eye-glass manufacturers had gone out of business, and employment and production
dropped by one-third. Another challenge is demographic. Japan is a rapidly ageing society.
In just eight years between 2011-17, the working population of Sabae fell by 11 percent to
30,000.
One possible response is automation. Fund manager, Howard Smith, asserts that
“with chronic depopulation challenges in rural areas, most companies must adapt or die. That
involves planning for succession and investing heavily in automation” (Financial Times,
2018).
(c) 2018. I.P.L. Png. This case is based in part on “Sabae, Fukui: A Town with an Eye for Design”,
Nippon.com, 24 April 2012, “Luxottica Group Invests in ‘made in Japan’”, Press Release, Luxottica
Group, 6 March 2018, and “Made in Japan: can handcrafted glasses survive an automated world?”
Financial Times, 4 April 2018.
2
Mr Ryozo Takeuchi is chairman of Takeuchi Optical, founded in 1932 and presently
employing 80 persons. Mr Takeuchi is also president of the Fukui Optical Association. He
describes automation as a buzz-word, and maintains that metal frames must be finished by
hand. In his factory, titanium frames pass through the hands of ten different workers and are
then polished for 72 hours in a bath of pulverized walnut shells.
Another response has been to shift away from the previous OEM (original equipment
manufacturing) model, in which Fukui produced eye-glasses and parts for international
brands such as Prada and Dior. In 1996, Fukui manufacturer Boston Club launched its own
brand, Japonism, and followed up in 2002, by opening a retail store in the fashionable
Minami-Aoyama district of Tokyo.
Chief designer of Boston Club, Kasashima Hironobu, remarked, “Traveling to
international fairs overseas … brought home to me that constantly emphasizing the technical
know-how we have built up over the years is not enough to make us internationally
competitive. ... We need to promote the worldview expressed by our brand and appeal to the
consumer by emphasizing the values that lie behind it” (Nippon.com 2012).
Boston Club’s previous strategy had been to design products that could only be made
with Japanese technology. Turning design convention on its head, Boston Club decided to
emphasize durability – to produce eyeglasses which could be used for life. It developed the
new Rudder Hinge which can be detached and replaced when necessary. With replaceable
parts, the frames can be used almost indefinitely.
In 2003, over 20 Sabae manufacturers joined to develop an industry brand, “291.” In
2008, they opened Glass Gallery 291, a retail outlet in the Aoyama district of Tokyo and then
another outlet in the Megane Museum at Sabae. In 2017, Masunaga Optical, the company
founded by pioneer Masunaga Gozaemon, employed 173 workers at its factory, and operated
retail stores in Tokyo, Osaka, Nagoya, and Nara.
However, not all Fukui eye-glass manufacturers have been able to adapt. Some lack
the managerial expertise or capital. Looking out from his factory, Mr Takeuchi pointed to
three businesses that had recently gone bankrupt.
Some owners are selling. Founded in 1966, Fukui Megane presently employs 170
workers and specializes in making titanium and solid gold frames. It pioneered multi-colored
gold frames and is still the only the producer in the world. In March 2018, Fukui Megane
sold a 67 percent stake to multinational eyeware manufacturer, Luxottica, which owns brands
including Ray Ban and Oakley, and manufactures for brands such as Chanel, Prada, and
Giorgio Armani.
Luxottica Group Executive Chairman, Mr Leonardo Del Vecchio, explained that “The
acquisition of Fukui Megane represents a first step for the entry of our Group in the world of
Japanese production. We intend to continue investing to recreate a productive pole of
excellence in Sabae, in line with the Luxottica model. For the first time in the history of
3
eyewear, we will have under the same roof two great artisan schools such as the Italian and
the Japanese ones” (Luxoticca 2018).
The aging ownership of other Fukui eye-glass manufacturers without successorship
plans presents an opportunity for mergers and acquisitions. Specialists, Nihon M&A Center,
M&A Capital Partners, and Strike, can help find buyers and consolidate and automate the
industry.
In 2007, former investment banker, Mr Kenzo Matsumura, bought five companies
that were spun off from the merger of Japanese toy manufacturers Tomy and Takara. Among
them was a trading house that sold reading glasses through a television shopping channel. Mr
Matsumura expected that, in a fast ageing society, the demand for reading glasses would
boom. However, the reading glasses were bad and hardly profitable. The cost of production
was 3,300 Yen, the trading house charged a wholesale price of 3700 Yen, while the television
channel priced the glasses at 10,000 Yen.
The condition of the factory in Sabae was parlous. In Mr Matsumura’s words, “The
machinery was battered and looked 40 years old. There were women doing lens coatings by
hand. Everything was manual. The defect rate was 30 percent” (Financial Times, 2018).
Major lens manufacturers like Hoya and Nikon outsourced production to China and
Thailand. Mr Matsumura criticized their strategy, “If you fully automate a factory, you can
be in Japan running that factory more productively and at lower cost than in China”
(Financial Times, 2018).
He set up an automated factory in Chiba prefecture, east of Tokyo, which produces
Hazuki reading glasses at a rate of 20,000 a day. Shrouded in secrecy, with further
automation, the factory is expected to triple the rate of production.
Hazuki has also repositioned the product as a sophisticated fashion item, while
maintaining the retail price at 10,000 Yen. In February 2018, during the Winter Olympics,
Hazuki spent US$5 million on television advertising, which led to a spectacular boost in sales.

Questions:

1. With reference to the Japanese eye-glass manufacturing industry, discuss why productivity differs within an industry.
2. What does a buyer get from acquiring a Fukui manufacturer of eye-glass frames?
Compare the benefits to Luxoticca vis-à-vis a private equity firm.
3. Do you agree with Mr Takeuchi that automation is a buzz-word?
4. If you were Mr Matsumura, where would you locate your factory? Discuss the advantages and disadvantages of locating in a cluster.

Instruction: please summarize this entire case study in three pages. (The Bill & Melinda Gates Foundation)

The Bill & Melinda Gates Foundation Growing up in Seattle, William H. Gates III was a slender, intense boy with a messy room and a dazzling mind. At age seven or eight he read the entire World Book Encyclopedia. At his family’s church the minister challenged young congregants to earn a free dinner by memorizing the Sermon on the Mount, a passage covering Chapters 5, 6, and 7 in the Book of Matthew. At age 11 young Bill became the only one, in 25 years of the minister’s experience, ever to recite every word perfectly, never stumbling, never erring. 1 Yet Christianity itself never attracted Gates. Years later he would remark, “There’s a lot more I could be doing on a Sunday morning,” an incongruous conviction for one who would become devoted to serving the poor. 2 His brilliance, however, was lasting. At private Lakeside prep school he was a prodigy, often challenging his teachers in class. Obsessed with computers in their then-primitive form, he stayed up all night writing code, a routine that would stay with him. He also read biographies of great historical figures to enter their minds and understand how they succeeded. After high school he attended Harvard University hoping to find an atmosphere of exciting erudition. Instead, he grew bored and left to pursue a fascination with computers. At age 19, Gates founded Microsoft Corporation with his Lakeside School friend Paul Allen. As its leader he was energetic, independent, and confrontational. He developed the reputation of a fanatical competitor willing to appropriate any technology and crush market rivals. He built a dominant business and by 1987, at age 31, he was a billionaire. Microsoft’s stock took flight, making more billions for Gates. However, even as he became the world’s richest man he remained absorbed in running the corporation.

References :1 James Wallace and Jim Erickson, Hard Drive: Bill Gates and the Making of the Microsoft Empire (New York: HarperBusiness, 1992), pp. 6–7. 2 Garrison Keillor, “Faith at the Speed of Light,” Time, July 14, 1999, p. 25.

He put little energy into charity, thinking it could wait until he grew old. But the world expected more. Requests for good deeds and contributions poured in. Gates responded with the help of his father, who worked in a home basement office handling his son’s donations. In 1994, Gates formalized his giving by creating the William H. Gates Foundation and endowing it with $94 million. His father agreed to manage it from the basement. Eventually, this arrangement evolved into the Bill & Melinda Gates Foundation, which included the name of his wife and was run by a professional staff from its new headquarters in Seattle. A foundation is essentially an organization with a pool of money for giving to nonprofit and charitable causes. It is not taxed if it gives out at least 5 percent of its funds each year. Bill Gates gave his foundation $16 billion in Microsoft stock in 2000. Since then he has given more. Today the Foundation is endowed with $37 billion, making it the world’s largest. It has two parts. One part decides what projects to fund. So far, more than $25 billion has been given out. The other part manages the endowment by investing the money to make it grow. The Gateses are deeply involved in the foundation’s work, which is based on a pair of “simple values” that inspire them. One is that “all lives—no matter where they are being led—have equal value,” and the other is that “to whom much is given, much is expected.” Giving is tightly focused on three areas—global health, poverty in developing nations, and U.S. public education. Because the foundation’s endowment is unprecedentedly large, more than the gross domestic products (GDPs) of 107 countries, its goals are ambitious. One is to correct market signals that cause modern medicine to neglect diseases of the poor, thus failing to value all lives equally. Pursuing this goal, the foundation has spent more than $3.8 billion on basic vaccinations for newborns in countries with low GDPs, preventing so far an estimated 3.4 million deaths. 3 It purchases such massive amounts of vaccines that prices fall, allowing doses for millions more children. It spends billions more to create new vaccines for tropical parasitic diseases and to fight a resurgence of polio in Africa. Bill Gates is characteristically intense, impatient, and direct in the quest to save lives. Learning that the global health staff was paying big travel grants for people to fly to meetings, he issued a curt memo about “rich people flying around to talk to other rich people.” He lectured the staff: “Our net effect should be to save years of life for well under $100, so, if we waste even $500,000, we are wasting 5,000 years of life.”

References: 4 Bill Gates at 31, already a billionaire. Source: © Ed Kashi/CORBIS. 3 Statement of Helen Evans, “State of the World’s Vaccines and Immunization Report 2009,” GAVI Alliance, October 31, 2009, at www.gavialliance.org. 4 Quoted in Andrew Jack, “Gates Foundation: Smaller Funds, Hard Decisions,” FT.com, September 30, 2009, at www.ft.com.

In 2006 Bill Gates’ friend Warren Buffett, chairman of Berkshire Hathaway and, at the time, the world’s second-richest man, decided to give most of his wealth away and made a bequest of 10 million shares of Berkshire Hathaway to the Gates Foundation. He believed Bill and Melinda Gates were doing such a superior job he could do no better and, rather than manage billions of dollars of giving on his own, he left his legacy in their hands. At the time, his gift was worth $31 billion, a sum that roughly doubled the Gates endowment. It arrives in annual installments of between $1 billion and $2 billion. The Gates Foundation confronts enormous social problems. Poverty and disease defy solution. Spending large sums in poor nations is a challenge. Corruption diverts funds. Agencies lack capacity. When infant lives are saved by vaccination, more people live to seek ordinary care. Some nations struggle to provide even the most basic care due to shortages of doctors and nurses. Thus, children are saved from diphtheria only to die in large numbers from common diarrhea. 5 Improving education is another nightmare. After spending $1 billion over six years to make small high schools better, an analysis showed that attendance, graduation rates, and test scores on basic subjects were lower than at similar schools not funded by the Gates Foundation. 6 Despite its magnificence, the Gates Foundation attracts critics. It is directed by only three trustees–Bill and Melinda Gates and Warren Buffet–putting its multibilliondollar expenditures in the hands of just two families. 7 It has been called an elitist, antidemocratic institution subsidized by taxpayers (through its tax exemptions) but having no accountability to society. 8 Suspicions are raised that its grants, being so big, shape the world’s health agenda and distort research priorities, for example, by overemphasizing vaccines for tropical diseases as opposed to other forms of treatment. 9 However, the Gateses and Warren Buffet want to extend the example set by their philanthropy. In 2009 they arranged a series of small, confidential dinners attended by fellow billionaires. Guests were asked to pledge the majority of their wealth to charity, either during their lifetime or at death, each one determining which causes to fund. Over the next year this initiative was formalized in a “Giving Pledge” joined by 40 billionaires. 10 Their pledges are moral commitments; they are not monitored or enforced as legal contracts. The Gateses and Buffet hope to spread the initiative to other nations. Their goal is to divert wealth from the very rich to enlarge the scope of global philanthropy for generations to come.

References :5 Laurie Garrett, “The Challenge of Global Health,” Foreign Affairs, January/February 2007. 6 The National Institutes of High School Transformation, Evaluation of the Bill & Melinda Gates Foundation’s High School Grants Initiative: 2001–2005 Final Report (Washington, DC: American Institutes for Research, 2006), pp. 9–10. 7 Pablo Eisenberg, “The Gates-Buffett Merger Isn’t Good for Philanthropy,” Chronicle of Philanthropy, July 20, 2006, p. 33. 8 “Philanthropic World Voices Mixed Reaction on Buffett’s Gift to Gates Fund,” Chronicle of Philanthropy, July 20, 2006, p. 12, comment of Rick Cohen. 9 David McCoy, et al., “The Bill & Melinda Gates Foundation’s Grant-Making Programme for Global Health,” The Lancet, May 9, 2009, p. 1652. 10 Carol J. Loomis, “The $600 Billion Challenge,” Fortune, July 5, 2010.

Philanthropy is one method for converting wealth to social value. Bill Gates and Warren Buffet follow a long tradition of rich capitalists who make fortunes, then later in life spend their wealth on works of kindness. In this chapter we will expand on the subject of philanthropy. First, however, we look at how managers implement social responsibility efforts within their firms. Social responsibility, like any other corporate goal, must be systematically planned, organized, and carried out. We will set forth a model of how this can be done

Based on the article:

Question: Write a short description of the possible functions of lipid droplets.

"Expanding the roles for Lipid droplets."

Lipid droplets are the intracellular sites for neutral lipid storage. They are critical for lipid metabolism and

energy homeostasis, and their dysfunction has been linked to many diseases. Accumulating evidence suggests

that the roles lipid droplets play in biology are significantly broader than previously anticipated. Lipid

droplets are the source of molecules important in the nucleus: they can sequester transcription factors and

chromatin components and generate the lipid ligands for certain nuclear receptors. Lipid droplets have also

emerged as important nodes for fatty acid trafficking, both inside the cell and between cells. In immunity, new

roles for droplets, not directly linked to lipidmetabolism, have been uncovered, with evidence that they act as

assembly platforms for specific viruses and as reservoirs for proteins that fight intracellular pathogens. Until

recently, knowledge about droplets in the nervous system has been minimal, but now there aremultiple links

between lipid droplets and neurodegeneration: many candidate genes for hereditary spastic paraplegia also

have central roles in lipid-droplet formation and maintenance, and mitochondrial dysfunction in neurons can

lead to transient accumulation of lipid droplets in neighboring glial cells, an event thatmay, in turn, contribute

to neuronal damage. As the cell biology and biochemistry of lipid droplets become increasingly well understood,

the next few years should yield many new mechanistic insights into these novel functions of lipid

droplets.

Introduction

Lipid droplets are the sites where cells store neutral lipids, such

as triglycerides, steryl esters, and retinyl esters [1–3]. These

stored lipids can then be used in times of need to generate

energy, membrane components, and signaling lipids. Impairment

of the machinery that makes or degrades lipid droplets

has severe physiological consequences [1,4–6], demonstrating

that lipid droplets play central roles in cellular and organismal

energy homeostasis, in particular, and overall lipid metabolism

in general.

Lipid droplets also allow cells to safely sequester otherwise

toxic lipids. For example, as amphipathic molecules, overabundant

fatty acids can severely compromise membrane integrity.

Once turned into triglycerides and incorporated into lipid droplets

(Figure 1A), they are relatively inert, stable, and harmless.

This protective function is probably the reason for the abundant

accumulation of lipid droplets in many disease states characterized

by aberrant lipid supply and metabolism, such as obesity,

atherosclerosis, and fatty liver disease [1,6,7].

Lipid droplets are particularly important in tissues specialized

for energy storage or lipid turnover, such as adipose tissue,

the liver, and the intestine [2,3,8], yet they also accumulate in

skeletal muscle, the adrenal cortex, macrophages, and mammary

glands [1]. They control lipid signaling in immune cells

and are the targets of attack by pathogens [9]. Finally, they

have been observed in most cell types and occur throughout

the animal kingdom, in plants, and in unicellular organisms.

Recently, it has become apparent that lipid droplets play even

broader cellular roles than previously appreciated. For example,

they modulate the availability of proteins and signaling lipids in

the nucleus, act as hubs for fatty acid trafficking, are used by

viruses as assembly platforms, and their dysfunction in neurons

and glia may lead to neurodegeneration. This review summarizes

key recent findings into these emerging roles of lipid droplets,

with the aim of sharing these exciting developments with researchers

beyond the lipid-droplet field. Lipid droplets are still

relatively understudied organelles and, given the versatile functions

already revealed, it seems likely that further roles in new

areas of biology will be discovered.

Some Basic Concepts in Lipid-Droplet Biology

In the last few years, there has been an explosive growth in our

understanding of the structure, biogenesis, and turnover of lipid

droplets, which have been extensively covered in many excellent

recent reviews [1,5,10–15]. Among cellular organelles, lipid

droplets have a unique structure (Figure 1A): a central core of

hydrophobic (neutral) lipids is surrounded by a single layer of

amphipathic lipids and proteins (reminiscent of half a membrane

bilayer). The triglycerides in the hydrophobic core are generated

by an elaborate biosynthetic pathway (for a summary, see [10]),

with the final step being catalyzed by the acyl-CoA:diacylglycerol

acyltransferases DGAT1 and DGAT2 (Figure 1A), converting

diacylyglycerol (DAG) and fatty acids, first activated to

acyl-CoA, into triglycerides. Both enzymes are located in the

endoplasmic reticulum (ER), where triglycerides accumulate at

privileged sites that represent nascent lipid droplets [16]; mature

lipid droplets are generated by continuous growth of these

structures and finally become distinct from the ER, likely via aprocess resembling budding [10,13]. DGAT2 is only inserted

into one leaflet of the ER membrane and can therefore diffuse

onto the surface of lipid droplets, promoting triglyceride synthesis

and continued droplet growth locally [17]. The hydrophobic

core can also contain steryl esters, the synthesis of which is

catalyzed by acyl-CoA:cholesterol acyltransferases. Depending

on cell type and conditions, steryl esters or triglycerides may

predominate.

Breakdown of the droplet triglycerides can occur by two

distinct pathways. Cytoplasmic triglyceride lipases bound to

the surface of lipid droplets hydrolyze triglycerides to DAG and

fatty acids. DAG can be further broken down, in two steps, into

fatty acids and glycerol (Figure 1C). In adipose tissue and

many other cells, the bulk of triglyceride hydrolysis is catalyzed

by a single lipase, adipose triglyceride lipase (ATGL) [5]. Lipid

droplets can also be turned over by autophagy (Figure 1C):

like other cellular organelles, lipid droplets are taken up by autophagosomes,

which fuse with lysosomes to form autolysosomes.

The hydrolytic enzymes delivered from lysosomes then

break down the autophagosome content; triglycerides, in particular,

are predominantly hydrolyzed by lysosomal acid lipase

(LAL) [5]. Discovered in hepatocytes [18], autophagy of lipid

droplets (‘lipophagy’) appears to make varied contributions to

triglyceride breakdown, depending on cell type and physiological

conditions [5].

Lipid Droplets as Modulators of Nuclear Functions

Lipid droplets arise from the ER and typically reside in the cytoplasm,

often at considerable distance from the nucleus. Nevertheless,

recent studies have uncovered intimate connections

between lipid droplets and nuclear events. There is emerging

evidence for a nuclear population of lipid droplets, which has

been proposed to directly modulate lipid metabolism in the nucleus.

In addition, lipid droplets in the cytoplasm can sequester

transcription factors, enzymes, and chromatin components —

and possibly many other proteins—and thus control their availability

in the nucleus.

Nuclear Lipid Droplets

Two different groups have reported the presence of lipid droplets

inside nuclei [19,20]. Using dyes specific for neutral lipids, small

spherical structures were identified in the nuclei of cultured cells

as well as in biochemically isolated nuclei [20]. Electron microscopy

of serial sections revealed that at least some of these

structures truly reside inside the nuclear compartment [19].

Biochemical fractionation suggests that these structures differ

in their lipid composition from the lipid droplets in the cytoplasm

[20]; however, they resemble cytoplasmic lipid droplets in their

morphology and in the presence of neutral lipids and were thus

named ‘nuclear lipid droplets’. It is not yet known how these lipid

droplets arise, what proteins they associate with, or what their

functional significance is. However, it is an intriguing possibility

that they contribute to nuclear lipid homeostasis and locally

modulate the availability of signaling lipids.

Exchange of Proteins between Lipid Droplets and Nuclei

Cytoplasmic lipid droplets can also profoundly affect nuclear

events. For example, lipid droplets have been implicated in suppressing

the activity of a transcription factor by keeping it out of

the nucleus [21]. The lipid-droplet protein Fsp27, also known as

CIDEC, is expressed in adipocytes and promotes fusion between

droplets, causing the formation of a single droplet per

cell [22,23]. A yeast two-hybrid screen revealed the transcription

factor NFAT5 (nuclear factor of activated T cells 5) as a potential

Fsp27 interaction partner. NFAT5 is cytoplasmic under hypotonic

conditions and translocates to the nucleus upon hypertonic

stress to activate osmoprotective genes [24]. The physical interaction

between Fsp27 and NFAT5 was confirmed in vivo, and

Fsp27 knockdown in adipocytes led to expression of NFAT5

target genes even in the absence of hypertonic stress [21]. To

examine the underlying mechanism, Fsp27 was ectopically expressed

in the heterologous HEK293 cell line; under these conditions,

Fsp27 was observed broadly throughout the cytoplasm.

Fsp27 overexpression reduced the amount of nuclear NFAT5, as

determined both by imaging and biochemistry, and blunted the

expression of NFAT5 target genes when cells were exposed to

hypertonic stress [21]. These results suggest that Fsp27 is able

to sequester NFAT5 in the cytoplasm and interferes with its

nuclear trafficking; since endogenous Fsp27 is associated with

lipid droplets in adipocytes, this interaction would retain

NFAT5 at the droplet surface (Figure 2A), something that remains

to be demonstrated directly. It will be interesting to determinewhether the interaction between Fsp27 and NFAT5 is regulated,

for example, by signaling pathways controlling lipolysis.

In Drosophila embryos, lipid droplets are associated with large

amounts of specific histones [25] via the histone anchor Jabba

[26]. This association is first detected during oogenesis and

makes it possible for females to build up massive histone stores

in the developing eggs (Figure 2B,C). Wild-type embryos contain

enough excess histones for thousands of diploid nuclei, whereas

mutants lacking Jabba have drastically reduced histone stores

[26]; indirect evidence suggests that extranuclear histones not

bound to lipid droplets are degraded. Transplantation experiments

revealed that in the embryo droplet-bound histones

can transfer to nuclei [25] and presumably support chromatin

assembly. Surprisingly, embryos lacking this droplet-bound histone

supply develop largely normally [26,27]. This is possible

because of the intricate regulation of histone metabolism in early

embryos (reviewed in [28]), which also contain abundant levels of

histone messages deposited during oogenesis. When new synthesis

of histones in the embryo is even mildly impaired, Jabba

mutants cannot sustain development and die very early [26].

Thus, in this case, lipid droplets sequester a nuclear protein for

long-term storage. This sequestration allows the organism to

build up histone stores during oogenesis and keep them available

for when they are needed later for chromatin assembly

(Figure 2C).

Lipid droplets of early Drosophila embryos also appear

to affect histone metabolism in the short term, by buffering

the histone supply [27]. When droplets are transplanted

between embryos, the donor droplets can bind histones

from the recipient embryo, suggesting that histones can be

loaded onto droplets even in embryos. In Jabba mutants,

the synthesis of histone H2A and its variant H2Av are

imbalanced, and H2Av overaccumulates in the nuclei, an

event linked to DNA damage [27]. This nuclear overaccumulation

does not occur in wild-type embryos, presumably because

here lipid droplets can trap histones produced in excess and

prevent their unregulated entry into nuclei. Whether other

species use similar droplet-based histone buffering remains

to be determined, although histones have also been detected

on lipid droplets in housefly embryos, rat sebocytes, and

mouse oocytes [25,29,30]

The enzyme CCT1 also displays dramatic exchange between

lipid droplets and nuclei. CCT1 is one of two isoforms of

CTP:phosphocholine cytidylyltransferase, an enzyme that catalyzes

the rate-limiting step in the synthesis of the phospholipid

phosphatidylcholine. In cultured fly cells, CCT1 is usually present

in the nucleus, but, under conditions in which cells synthesize

new triglycerides and expand the hydrophobic core of droplets,

CCT1 accumulates at the droplet surface [31,32] (Figure 2D). The

presence at the droplet surface is critical to expand the droplet

surface in concert with growth of the core: droplet binding activates

the enzyme and thus leads to an increase in the cellular

phosphatidylcholine supply. Whether CCT1’s presence in the

nucleus in the basal state is functionally important remains unclear.

Nuclear accumulation is apparently not a mechanism to

prevent access to the droplet surface: fluorescence recovery

after photobleaching (FRAP) experiments revealed that CCT1

is not immobilized inside nuclei, but rapidly exchanges with a

cytoplasmic pool. And overexpression of CCT2, an isoform

exchanging between the cytoplasm and droplets, can fully

rescue the effect of CCT1 depletion on droplet growth [31].

High nuclear accumulation and consequent low cytoplasmic

pools of CCT1 might possibly modulate the kinetics of relocalization

to droplets.

Prp19 is a subunit of the NineTeen Complex, which is involved

in a number of nuclear events, including spliceosome activation

and transcription elongation [33]. In mouse adipocytes, Prp19

was also found associated with lipid droplets, and Prp19 knockdown

resulted in reduced triglyceride accumulation [34]. It is not

clear whether this dual localization to lipid droplets and to thenucleus represents distinct functions of Prp19, or whether the

two populations are connected. Initial experiments with inhibitors

of nuclear export revealed no changes in overall intracellular

Prp19 distribution [34].

Modulation of Lipid Signaling

Peroxisome proliferator-activated receptors (PPARs) are transcription

factors bound and activated by lipid ligands, including

fatty acids and their derivatives. In oxidative tissues, such as the

mammalian heart and liver, PPARa promotes the expression of

proteins involved in lipid homeostasis [35]. In principle, fatty

acids from exogenous sources or synthesized de novo might

activate PPARa directly. However, free fatty acids are typically

channeled, via activation to acyl-CoA, into specific metabolic

pathways [36] and thus are not readily available for signaling.

Studies in mice uncovered that PPARa signaling is severely

compromised in the hearts of animals lacking ATGL [37]. Given

that lack of ATGL function in the heart causes many profound

changes (such as massive lipid accumulation and mitochondrial

dysfunction), the effect on PPARa signaling might conceivably

be indirect. Yet pharmacological stimulation of the PPARa

pathway is sufficient to reverse these phenotypes, establishing

PPARa signaling as a primary defect in these mutant hearts

and suggesting a direct link between lipid droplets and PPARaactivation [37]. It was proposed that

ATGL-mediated triglyceride hydrolysis

generates the ligands for PPARa [37]

(Figure 3A). This pathway may be tissue

specific because liver-specific knockdown

of ATGL impaired the expression

of PPARa target genes in this tissue, but PPARa agonists failed

to reverse this effect [38].

Lipid Droplets as Hubs for Fatty Acid Trafficking

Lipid droplets act as a sink for overabundant fatty acids, and they

can release lipids when needed for energy production, synthesis

of membrane components, or signaling. It is becoming increasingly

apparent that lipid trafficking to and from droplets is highly

regulated in space (Figure 3A). Fatty acids from triglyceride hydrolysis

signal to nuclear receptors (as discussed above); fatty

acids released during autophagy are shuttled through lipid droplets,

as a way station before import into mitochondria for ATP

production; production of steroid hormones in flies requires lipid

exchange between the ER, lipid droplets, and mitochondria; and

within a population of cells, high accumulation of droplets in a

subset of cells has been proposed to protect the rest of the cells

from fatty acid overload.

Lipid Trafficking between Lipid Droplets and

Mitochondria

In starved mammalian cells, fatty acids fuel ATP production, via

b-oxidation in mitochondria. These fatty acids could be derived

from triglycerides (Figure 1B,C) or from various membranous

organelles. To follow the flux of fatty acids through variouscompartments, mouse embryonic fibroblasts (MEFs) were

allowed to incorporate fluorescently labeled lipids into either lipid

droplets or membranes, and their fate during starvation was

monitored by imaging and biochemistry [39]. Fatty acids present

as triglycerides in lipid droplets moved to mitochondria fairly

quickly and were readily broken down. When ATGL (Figure 1B)

was knocked down, transfer of fatty acids was dramatically

reduced and mitochondrial oxygen consumption rates dropped.

Under the starvation conditions employed, lipophagy (Figure 1C)

was not induced and autophagy made no detectable contribution

to the transfer of fatty acids from droplets to mitochondria

or to mitochondrial oxygen consumption rates.

The rapid relocalization of fatty acids to mitochondria is presumably

accomplished by direct transfer. Lipid droplets and

mitochondria indeed display close physical associations [40–

42], and direct channeling of fatty acids from their site of release

(droplets) to the site of consumption (mitochondria) would minimize

the risk of toxic effects elsewhere, such as disruption of

cellular membranes or inappropriate nuclear signaling.

Curiously, during starvation, the number and size of lipid droplets

increased and total cellular triglyceride levels went up [39].

Using fluorescently labeled phospholipids and inhibition of

autophagy pathways, this effect was traced to autophagic

breakdown of membranous organelles. Presumably, fatty acids

from phospholipid breakdown in autolysosomes are employed

to replenish triglyceride stores in droplets upon starvation

(Figure 3A).

Mitochondria can be remodeled by fusion and fission [43],

allowing them to form highly interconnected networks or individual

fragments. In starved cells, mitochondria were highly fused, a

state that is apparently critical for efficient fatty acid import: usually

labeled fatty acids from lipid droplets are homogenously

distributed throughout the mitochondria, but when mitochondria

were fragmented, the label was distributed unevenly [39]. As a

result, fatty acids could not be metabolized as efficiently;

although cells with either fused or fragmented mitochondria upregulate

b-oxidation upon starvation, only those with fused mitochondria

were able to maintain these levels of b-oxidation. For

cells with fragmented mitochondria, levels of b oxidation and,

as a result, total mitochondrial respiration, dropped off with

time, presumably because not all mitochondria had a sufficient

supply of fatty acids (Figure 3B). The likely reason is that there

are many fewer lipid droplets than mitochondrial fragments,

and that only the mitochondria in direct physical contact with

lipid droplets can take up fatty acids efficiently. In fused mitochondria,

those fatty acids can diffuse through the entire

network. In support of this interpretation, when glutamine was

used as an alternative fuel, the fusion state of the mitochondria

did not matter; as glutamine diffuses through the cytoplasm,

its import into mitochondria is not restricted to a limited number

of sites, unlike the supply of fatty acids from lipid droplets. Presumably

because an oversupply of unmetabolized fatty acids is

dangerous, fatty acids were re-exported from the mitochondria,

and either accumulated back in lipid droplets or were released

from the cells into the extracellular space [39].

Efficiency of lipid exchange between mitochondria, ER, and

lipid droplets may also underlie a recent observation that

promotion of mitochondrial fusion is important for lipid-droplet

formation and steroid signaling in Drosophila. Mitochondrial

associated regulatory factor (Marf), the fly ortholog of mammalian

mitofusins, is a small GTPase that promotes fusion of

the outer mitochondrial membrane; thus, loss of Marf leads to

small, round mitochondria [44]. Marf-deficient flies show a

particularly dramatic phenotype in the ring gland, an endocrine

tissue responsible for hormone secretion [45]: mitochondrial

morphology is altered, the ER is fragmented, and lipid-droplet

number is dramatically reduced [44]. Ring gland lipid droplets

receive sterols from the ER and store them as steryl esters;

these, in turn, are the precursors for the production of the steroid

hormone ecdysone in the mitochondrial matrix. Efficient storage

and turnover of steryl esters therefore presumably requires intimate

contacts between the three organelles; in Marf mutants

the contacts between all three organelles were severely reduced

[44]. Lack of Marf in the ring gland also greatly impairs ecdysone

production, with dramatic organism-wide consequences [44].

Mitochondria may not be the only organelle for which close

contacts with lipid droplets promote efficient transfer of fatty

acids. Breakdown of fatty acids is not restricted to mitochondria,

but can also occur in peroxisomes. In the yeast Saccharomyces

cerevisiae, b-oxidation is even entirely restricted to peroxisomes.

Here, lipid droplets and peroxisomes display intimate physical

connections, which have been proposed to promote efficient

coupling of triglyceride breakdown with peroxisomal fatty acid

oxidation [46].

Lipid-Droplet Specialization across a Cell Population

The role of lipid droplets as buffers for fatty acid availability may

even extend to lipid exchange between cells in the same tissue.

A recent study identified a surprising heterogeneity in lipiddroplet

content in hepatocytes [47]: in mouse liver, some cells

have substantially larger numbers of lipid droplets than neighboring

cells (Figure 3C); this variability is especially apparent

under conditions of high overall lipid storage in the liver. Similar

variability was observed in primary hepatocytes in culture and

with a cultured cell line of liver origin (AML12), suggesting that

it is due to cell-intrinsic properties, rather than a reflection of

overall tissue structure.

Such heterogeneity might arise if some cells have acquiredmutations in lipid metabolism. However, a cell sorting strategy

demonstrated that heterogeneity is reversible and appears to

be a population property. After growth on fatty-acid-rich media,

cells were separated by flow cytometry into a low-lipid and a

high-lipid subpopulation. After culture in standard media to promote

breakdown of the stored lipids, the two populations were

again grown under fatty-acid-rich conditions. Remarkably,

both cultures showed the same broad distribution in lipid content.

Inhibitor studies indicate that heterogeneity arises from

fluctuations in biochemical networks controlling lipolysis, fatty

acid oxidation, and protein synthesis.

At the level of a whole organism, heterogeneity of lipid-droplet

content is very common. Many animals have adipose tissues

specialized for storing lipids. It was proposed that heterogeneity

within a single cell population similarly sets aside a subpopulation

of cells that collects lipids particularly well, stores them,

and releases them to their neighbors when needed [47]. To

test this idea, high-lipid cells were isolated in which lipid droplets

had accumulated fluorescently labeled fatty acids. After co-culture

with low-lipid cells (marked with a different fluorescent dye

to distinguish the two original populations), the high-lipid grouphad lost — and the low-lipid group had gained — some of the

labeled fatty acids. Thus, the high-lipid cells can indeed supply

lipids to their neighbors (Figure 3D).

But what is the point of setting aside a subpopulation of cells

with especially high lipid stores if — in the long run — the lipids

are presumably needed equally across cells? One possibility

has to do with the fact that overaccumulation of free fatty acids

is dangerous, both because of disruption of membranes and

because of toxic metabolites generated by fatty acid breakdown.

The high-lipid subpopulation indeed showed higher levels

of oxidative damage, as seen by levels of reactive oxygen species

(ROS; Figure 3C). Importantly, when fluorescently marked

low-lipid cells were co-cultured with either low-lipid or high-lipid

cells (unmarked) and challenged with fatty-acid-rich media, the

marked cells displayed lower ROS levels in the presence of

high-lipid cells. Thus, the presence of high-lipid cells protected

their low-lipid neighbors. High-lipid cells may remove fatty acids

more efficiently from the media, and thus the flux of free fatty

acids into the low-lipid cells is reduced. Remarkably, in the coculture

experiment with high-lipid cells, ROS levels were not

only reduced for the marked low-lipid cells, but also for the population

as a whole.

Although the detailed mechanisms underlying these protective

effects remain to be worked out, the reported experiments

nicely demonstrate a novel strategy, namely heterogeneity in

lipid-droplet accumulation, to alleviate risks from overabundance

of lipids. By accumulating more lipid droplets and more

ROS, the high-lipid subpopulation reduces the overall risk of lipotoxicity.

It is not yet clear how the high-lipid population is able to

handle its increased risk: these cells may induce specific protective

mechanisms, or they might repair their damage during the

time when they find themselves in the low-lipid state (which

will occur sooner or later, due to the stochastic nature of the

heterogeneity). Since heterogeneity has been observed in

cultured cells of various origins [47], this protective strategy

may be employed not just by hepatocytes, but more generally

in other cell types.

Lipid Droplets and the Fight against Pathogens

It has been long known that lipid droplets play important roles in

the immune system. They are sites of synthesis of eicosanoids,

signaling lipids important for inflammation, host defense against

pathogens, and cancer [48]. Various pathogens have, in turn,

evolved strategies to tap into the lipid droplets of the host

to ensure a sufficient lipid supply [49,50]. Recent years have

uncovered how certain viruses appropriate lipid droplets as

assembly platforms and how cells use lipid droplets in novel

ways to fight back.

Lipid Droplets and Viral Assembly

Infection with hepatitis C virus (HCV) is a global public health

threat and can lead to liver cirrhosis and liver cancer [51]. For

part of its life cycle, HCV crucially depends on lipid droplets

(see [52,53] for recent reviews): after infection, two newly expressed

viral proteins transiently accumulate on lipid droplets:

core protein, which is the major structural protein of the virus,

and NS5A, a regulator of viral replication. Droplet-bound viral

proteins then interact with the sites of viral RNA replication, a

process facilitated by the droplet-localized Rab18 [54] and

by dynein-mediated intracellular relocalization of lipid droplets

[55]. For the final maturation, the virus hijacks the pathway

responsible for secretion of the very-low-density lipoprotein

(VLDL) particles, and virions are released into the extracellular

space as low-density lipoviroparticles [56], whose lipids may

ultimately be derived from lipid droplets. HCV is not unique in

its use of lipid droplets; several other viruses assemble with

the help of lipid droplets [57,58].

Droplet accumulation is a necessary step for virus maturation;

if the interaction between core protein and lipid droplets is disrupted,

either with mutations in core protein or via pharmacological

approaches, core protein stability is greatly reduced and

virion assembly is impaired [59,60]. Thus, preventing the recruitment

of viral proteins to droplets is an attractive target for disrupting

the viral life cycle. Droplet targeting requires cis-acting

sequence motifs in both core protein and NS5A [61,62], but

also trans-acting host factors. In particular, DGAT1, one of the

two enzymes mediating triglyceride synthesis (Figure 1A), plays

a crucial role: DGAT1 binds to both NS5A and core protein,

and this interaction mediates recruitment of both proteins to

droplets and is required for efficient virion assembly [63,64].

Interestingly, inhibiting the enzymatic activity of DGAT1 is sufficient

to prevent droplet targeting of these proteins. Since

DGAT1 generates only a subset of lipid droplets (the others

depend on DGAT2; Figure 1A), it was proposed that DGAT1 concentrates

the viral proteins at the sites where it promotes lipiddroplet

formation and thus guides the viral proteins onto just

these lipid droplets [64] (Figure 4A).

Lipid Droplets as Stores for Antiviral and Antibacterial

Proteins

Viperin (which stands for virus inhibitory protein, ER associated,

interferon inducible) is an interferon-induced protein with broad

antiviral activity [65,66]. Viperin is targeted to the cytoplasmic

face of the ER and is also enriched around lipid droplets [62];

targeting to both locations is mediated by an amino-terminal

amphipathic a-helix [62]. Intriguingly, two of the viruses combatted

by viperin, HCV and Dengue virus, employ droplets for

their assembly. Using confocal microscopy and fluorescence

resonance energy transfer (FRET), viperin was shown to interact

with the HCV nonstructural protein NS5A at the droplet surface,

via its carboxy-terminal region [67]. This interaction as well as theamino-terminal droplet-targeting helix are required for viperin’s

antiviral activity against HCV [67]. For Dengue virus, in contrast,

while a physical interaction with the viral protein NS3 was important,

droplet binding was dispensable for the anti-viral effect [68].

The amino-terminal a-helix in viperin was also important to

restrict the replication of chikungunya virus, though presumably

through localization at the ER, rather than at lipid droplets [69].

Thus, at least in some cases, viperin apparently targets a

droplet-dependent step of viral replication and its enrichment

on the droplet surface is necessary for its activity (Figure 4A).

As discussed earlier, lipid droplets can be associated with histones.

This observation potentially has implications for immunity

since histones are increasingly recognized as antibacterial

agents [70,71]: in vitro, histones have broad antibacterial activity

[72], and histones present in extracellular secretions have been

reported to contribute to protection against bacterial pathogens

[73,74]. Analysis in Drosophila suggests that histones bound to

lipid droplets can similarly provide a defense against intracellular

bacterial invaders [75]. Droplets biochemically purified fromDrosophila embryos are associated with high levels of certain

histones [25] and are highly bactericidal in vitro [75]. A number

of independent approaches, including using histone antibodies

and mutations in the histone anchor Jabba [26], showed that

this killing activity of droplets was due to histones.

To test whether droplet-bound histones are protective in vivo,

wild-type and Jabba mutant embryos were injected with GFPlabeled

Escherichia coli; while bacterial numbers diminished in

the wild type, they dramatically increased in the mutants [75]

(Figure 4B). In the same injection assay, wild-type embryos

also showed significantly higher levels of survival when challenged

with a number of Gram-positive and Gram-negative bacteria.

This new immune mechanism may also operate at other

developmental stages: when adult flies were infected with the

intracellular pathogen Listeria monocytogenes, Jabba mutants

were impaired in restricting bacterial titers and were killed

much more readily than wild-type flies [75]. Loading up lipid

droplets with histones to kill bacterial invaders may be a

conserved innate immunity mechanism, since when mice were

challenged with lipopolysaccharide — to mimic bacterial infections

— the levels of droplet-bound histone H1 increased in the

liver [75].

Lipid Droplets and the Nervous System

Lipid metabolism plays crucial roles in the nervous system, for

many membrane functions and signaling events [76–78]. Yet until

recently, there has been only sparse and unconnected information

on the role of lipid droplets in neurons and other cells

of the nervous system. For example, lipid droplets have been detected

in the axons of Aplysia neurons cultured in vitro [79] and in

cultured neurons and brain sections of Huntington’s disease

models [80]. There are also links between a-synuclein, a protein

whose dysfunction or overexpression can cause Parkinson’s

disease, and lipid droplets: a-synuclein has been reported to

bind to lipid droplets in vitro [81] and in cultured cells [82], and

overexpression in yeast promotes droplet accumulation [83],

but the relevance of these observations for a-synuclein’s in vivo

function and for neurodegeneration has yet to be explored. However,

recent papers have identified the presence of lipid droplets

in neurons and in glia under certain disease conditions and suggest

that disrupted lipid-droplet function can contribute to neurodegeneration.

Hereditary Spastic Paraplegias and Lipid Droplets

Hereditary spastic paraplegias (HSPs) are inherited disorders

characterized by motor-sensory axon degeneration, weakness

in lower extremities, and spasticity [84]. Mutations in over 50

loci can cause HSP, and the cellular functions of the encoded

proteins show a surprising heterogeneity. Recently, a number

of HSP candidate genes have been shown to have crucial roles

in lipid-droplet biology: atlastin, REEP1, seipin, spartin, spastin,

and kinesin-1. Atlastin mediates fusion of ER tubules and also

controls the size of lipid droplets [85]. REEP1 maintains the

high curvature of ER tubules and, when overexpressed together

with atlastin, increases lipid-droplet size [85,86]. Seipin, an integral

membrane protein at the ER–droplet junction, is important

for lipid-droplet formation and maintenance [87,88]. Spartin

localizes to lipid droplets, interacts with E3 ubiquitin ligases,

and modulates the turnover of lipid-droplet proteins [89–91];

spartin knockout mice have increased lipid-droplet numbers in

their adipose tissue [92]. Spastin is a microtubule-severing protein

that mediates remodeling of the cytoskeleton; in mammalian

cells, a particular spastin isoform harbors a lipid-droplet targeting

sequence, and depletion of spastin in Drosophila or

C. elegans alters lipid-droplet number and cellular triglyceride

content [93]. KIF5A encodes the microtubule motor kinesin-1;

the same motor powers the motion of lipid droplets in Drosophila

[94]. Finally, several of the HSP candidate genes encode enzymes

implicated in phospholipid or fatty acid metabolism

[95,96]; their dysfunction might therefore alter the supply or

composition of the lipids stored in lipid droplets. These observations

raise the intriguing possibility that aberrant lipid-droplet

biogenesis or function might contribute to axonal degeneration.

However, since all of these proteins also have functions unrelated

to lipid droplets (such as controlling ER structure or promoting

vesicle trafficking), the link between lipid droplets and

HSPs remains tentative.

A much more direct connection to lipid droplets has recently

emerged from the analysis of the HSP gene DDHD2 [97]. Patients

with mutations in DDHD2 exhibit very early onset of the disease

(<2 years) and are often intellectually disabled [98]. The DDHD2

gene is highly expressed in the brain and encodes a serine

hydrolase that displays phospholipase activity in vitro. To determine

its function in vivo, DDHD2 activity was abrogated genetically,

using knockout mice, as well as pharmacologically, withselective inhibitors [97]. In both cases, adults accumulated large

amounts of triglycerides in the brain and the spinal cord, but

there was little to no effect in other tissues; brain phospholipid

content was unchanged. These observations suggest that

DDHD2 has a specific function in triglyceride metabolism of

the central nervous system. It likely acts as a triglyceride lipase

since recombinant DDHD2 expressed in cultured cells displays

triglyceride hydrolase activity and, compared with wild type,

total triglyceride hydrolase activity is significantly reduced in

brain lysates of DDHD2 mutant mice [97]. Finally, the main triglyceride

hydrolase in the fat body of the moth Manduca sexta

shares extensive sequence homology with DDHD2 [99].

The brains of DDHD2 knockout mice displayed abundant lipid

droplets, while lipid droplets were only rarely detected in wildtype

brains [97]. They accumulated predominantly in neurons

and were present in cytoplasm, dendrites, and axons. The

DDHD2 knockout mice also exhibited deficits in motor coordination

and cognition [97], reminiscent of the defects in the human

patients [98]. Intriguingly, in the patients, cerebral magnetic resonance

spectroscopy revealed an abnormal spectrum, with a

peak characteristic of lipid accumulation [98], though it is not

yet known whether this peak represents triglycerides. While

the mechanisms that link droplet accumulation and neuronal

impairment remain obscure, one intriguing observation is that

in the DDHD2 knockout mice some of the large droplets

observed were associated with noticeable swellings of the

neuronal processes and thus might present obstacles to intracellular

trafficking in the relatively thin axons and dendrites.

Glial Lipid Droplets

Glial cells are non-neuronal cells that surround neurons and play

important supportive roles in the central and peripheral nervous

system. Lipid droplets have been observed in culture in primary

glia as well as in glia-derived cell lines [100,101]. When carnitine

palmitoyltransferase 2 (CPT2), a mitochondrial enzyme necessary

for b-oxidation of long-chain fatty acids, is abolished in flies,

massive amounts of triglycerides accumulate specifically in the

brain of adults; glial cells, but not neurons, accumulated abundant

lipid droplets [102]. This seems to be a cell-autonomouseffect because CPT2 is expressed predominantly

in glia and CPT2 expression

solely in glia is sufficient to reverse triglyceride

accumulation in the brain. Flies lacking

CPT2 have a dramatically reduced

lifespan, and glial-specific CPT2 expression

was able to partially rescue this

defect, indicating that triglyceride metabolism

in glia may make an important contribution to overall

organismal energy metabolism.

Lipid droplets can accumulate in glia also non-cell-autonomously,

in response to mitochondrial dysfunction in neighboring

neurons [103]. For a subset of Drosophila mutants known to

cause neurodegeneration in adult photoreceptors [104], abundant

lipid droplets transiently accumulate in the glial cells next

to photoreceptors, prior to or concomitant with the onset of

neurodegeneration. No droplets were observed in the wild type

or in the neurons of mutant animals [103] (Figure 5A,B). The

mutants that showed accumulation of droplets in glial cells all

affect mitochondrial function and, in particular, cause increased

levels of ROS. Elevated ROS are indeed critical for droplet formation

in glia because pharmacological or genetic reduction of

ROS prevented droplet accumulation. Lipid droplets were also

detected in glial cells in a mouse model of neurodegeneration

caused by mitochondrial dysfunction, suggesting an evolutionarily

conserved pathway.

How do ROS promote the accumulation of glial lipid droplets?

The full pathway has yet to be worked out, but activation of

c-Jun-N-terminal kinase (JNK) and sterol regulatory element

binding protein (SREBP) pathways are critical; JNK mediates

stress responses [105] and SREBP controls transcription of

many metabolic genes and, in particular, promotes lipogenesis

[106,107]. Although droplets accumulate in glia, the trigger for

accumulation originates in neurons: when the mitochondrial

genes identified were knocked down in glia, there was no effect;

knockdown only in neurons was sufficient to promote glial lipid

droplets. In addition, expression of an antioxidant enzyme or

knockdown of JNK solely in neurons was able to reduce glial

droplet accumulation. Thus, mitochondrial dysfunction and

elevated ROS in photoreceptors cause accumulation of lipid

droplets in glia in a non-cell-autonomous manner.

Damage to neurons resulting from mitochondrial dysfunction

therefore leads both to transient formation of lipid droplets in

glia and to neurodegeneration. Are these lipid droplets an ultimately

futile protective response, do they promote neurodegeneration,

or are they innocent bystanders? Activation of JNK orSREBP in neurons in the absence of ROS still leads to glial lipid

droplets, but not neurodegeneration [103]. Thus, glial lipid droplets

per se are not detrimental for neurons. The culprit might

be lipids damaged by ROS, given that the mutants leading to

neurodegeneration displayed dramatically elevated levels of

peroxidated lipids. Furthermore, expression of two different

lipases, the ATGL homolog Brummer or the LAL homolog Lip4

(Figure 1B,C), dramatically reduced both lipid-droplet accumulation

and the levels of peroxidated lipids and also delayed neurodegeneration

(Figure 5C) [103]. These observations strongly

suggest that neurodegeneration is driven by altered lipid metabolism,

although the exact role of lipid droplets remains to be

elucidated.

The fatal neurodegenerative disease amyotrophic lateral sclerosis

(ALS) has recently also been linked to lipid droplets.

A particular subtype of ALS is caused by mutations in the human

VAMP (vesicle-associated membrane protein)-associated protein

B (hVAPB). Equivalent mutations in the fly ortholog DVAP,

when ectopically expressed, lead to degeneration of fly photoreceptors.

In genetic screens for enhancers and suppressors of this

phenotype, one of the most represented functional categories

was proteins linked to lipid droplets, including proteins involved

in droplet biogenesis and droplet motility [108]. The proteins

such identified will provide a rich source for follow-up studies to

dissect how lipid droplets might impact neurodegeneration.

Perspective

The crucial roles of lipid droplets in energy homeostasis and lipid

metabolism have focused a lot of recent attention on these still

relatively understudied organelles. Yet the examples discussed

above show that lipid droplets play even broader roles and touch

on biological processes only loosely connected to their traditionally

studied functions.

In particular, lipid droplets contribute to protein trafficking and

protein maturation in the cell. They exchange proteins with the

nucleus, modulate protein stability, and allow concentrated

accumulation of antiviral and antibacterial proteins. We do not

know enough to judge whether these processes have independently

evolved and all just happen to take advantage of lipid

droplets or whether they are indicative of a general cellular

pathway of protein trafficking. Lipid droplets have been proposed

to act as general protein sequestration sites [109]; such

sequestration might modulate the ability of these proteins to

interact with binding partners, promote assembly of protein

complexes, store damaged proteins safely before degradation,

or allow moving droplets to deliver proteins [109,110]. As many

published lipid-droplet proteomes contain proteins from other

compartments, there are ample candidates for testing how widespread

protein sequestration on droplets is. For the verified examples,

much work needs to be carried out to understand how

the sequestered proteins are targeted to lipid droplets, whether

they are bound stably or dynamically, and how release from

droplets is controlled. And why are these proteins sequestered

on lipid droplets and not elsewhere in the cell? Is droplet localization,

say, of histones, just an accident of evolution, or do lipid

droplets provide a unique cellular niche?

The emerging roles of lipid droplets as hubs for fatty acid trafficking

(Figure 3) suggest that the pathways that fatty acids take

from and to lipid droplets are highly regulated. But, apart from

some insights into the importance of direct contacts between

lipid droplets and mitochondria [42], little is known about the

molecular mechanisms controlling this trafficking. For fatty

acid trafficking modulated by droplet heterogeneity between

cells (Figure 3C,D), there are intriguing hints that heterogeneity

is a regulatable property since the extent of heterogeneity is

different between cells of different origin [47], but the control

pathways remain to be worked out.

For lipid droplets in the nervous system, it is now established

that both neurons and glia can accumulate lipid droplets under

certain disease conditions. But what role they play under these

conditions and whether droplets are normally present in the nervous

system is far from clear. For example, in the fly models of

neurodegeneration (Figure 5), it was proposed that accumulation

of lipid droplets in glia promotes neurodegeneration, as long as

high ROS levels provide a second insult [103]. However, lipase

overexpression in glia only mildly delayed neurodegeneration,

whereas lipase overexpression in neurons, where no droplets

were detected, had a much stronger protective effect. It will be

very interesting, in these examples and in the mouse models of

HSP, to examine whether ablation of droplet biogenesis in specific

cell types modulates the disease phenotypes, for better or

for worse, and how these effects compare to disruption or upregulation

of turnover pathways (Figure 1B,C). Real-time imaging

of the trafficking of labeled fatty acids (as in [39]) and characterization

of the lipidomes and proteomes of these droplets will provide

complementary information to characterize exactly how

lipid metabolism is derailed in the disease conditions.

Given the diverse novel roles proposed for lipid droplets, droplets

should be on the radar screen of many a biologist trying to

uncover the mechanistic basis of an ill-characterized process.

With the recent insights into biogenesis and turnover of lipid

droplets [14], one can now systematically determine how a process

is affected if droplets are entirely absent, are structurally

abnormal, or cannot be degraded. Because lipid droplets are

ubiquitous organelles but have been carefully studied in only a

few cell types, it seems likely that, as our understanding of these unique and dynamic organelles deepens, their cellular and physiological

roles will keep expanding.

Based on the article:

Question: Write a short description of the possible functions of lipid droplets.

"Expanding the roles for Lipid droplets."

Lipid droplets are the intracellular sites for neutral lipid storage. They are critical for lipid metabolism and

energy homeostasis, and their dysfunction has been linked to many diseases. Accumulating evidence suggests

that the roles lipid droplets play in biology are significantly broader than previously anticipated. Lipid

droplets are the source of molecules important in the nucleus: they can sequester transcription factors and

chromatin components and generate the lipid ligands for certain nuclear receptors. Lipid droplets have also

emerged as important nodes for fatty acid trafficking, both inside the cell and between cells. In immunity, new

roles for droplets, not directly linked to lipidmetabolism, have been uncovered, with evidence that they act as

assembly platforms for specific viruses and as reservoirs for proteins that fight intracellular pathogens. Until

recently, knowledge about droplets in the nervous system has been minimal, but now there aremultiple links

between lipid droplets and neurodegeneration: many candidate genes for hereditary spastic paraplegia also

have central roles in lipid-droplet formation and maintenance, and mitochondrial dysfunction in neurons can

lead to transient accumulation of lipid droplets in neighboring glial cells, an event thatmay, in turn, contribute

to neuronal damage. As the cell biology and biochemistry of lipid droplets become increasingly well understood,

the next few years should yield many new mechanistic insights into these novel functions of lipid

droplets.

Introduction

Lipid droplets are the sites where cells store neutral lipids, such

as triglycerides, steryl esters, and retinyl esters [1–3]. These

stored lipids can then be used in times of need to generate

energy, membrane components, and signaling lipids. Impairment

of the machinery that makes or degrades lipid droplets

has severe physiological consequences [1,4–6], demonstrating

that lipid droplets play central roles in cellular and organismal

energy homeostasis, in particular, and overall lipid metabolism

in general.

Lipid droplets also allow cells to safely sequester otherwise

toxic lipids. For example, as amphipathic molecules, overabundant

fatty acids can severely compromise membrane integrity.

Once turned into triglycerides and incorporated into lipid droplets

(Figure 1A), they are relatively inert, stable, and harmless.

This protective function is probably the reason for the abundant

accumulation of lipid droplets in many disease states characterized

by aberrant lipid supply and metabolism, such as obesity,

atherosclerosis, and fatty liver disease [1,6,7].

Lipid droplets are particularly important in tissues specialized

for energy storage or lipid turnover, such as adipose tissue,

the liver, and the intestine [2,3,8], yet they also accumulate in

skeletal muscle, the adrenal cortex, macrophages, and mammary

glands [1]. They control lipid signaling in immune cells

and are the targets of attack by pathogens [9]. Finally, they

have been observed in most cell types and occur throughout

the animal kingdom, in plants, and in unicellular organisms.

Recently, it has become apparent that lipid droplets play even

broader cellular roles than previously appreciated. For example,

they modulate the availability of proteins and signaling lipids in

the nucleus, act as hubs for fatty acid trafficking, are used by

viruses as assembly platforms, and their dysfunction in neurons

and glia may lead to neurodegeneration. This review summarizes

key recent findings into these emerging roles of lipid droplets,

with the aim of sharing these exciting developments with researchers

beyond the lipid-droplet field. Lipid droplets are still

relatively understudied organelles and, given the versatile functions

already revealed, it seems likely that further roles in new

areas of biology will be discovered.

Some Basic Concepts in Lipid-Droplet Biology

In the last few years, there has been an explosive growth in our

understanding of the structure, biogenesis, and turnover of lipid

droplets, which have been extensively covered in many excellent

recent reviews [1,5,10–15]. Among cellular organelles, lipid

droplets have a unique structure (Figure 1A): a central core of

hydrophobic (neutral) lipids is surrounded by a single layer of

amphipathic lipids and proteins (reminiscent of half a membrane

bilayer). The triglycerides in the hydrophobic core are generated

by an elaborate biosynthetic pathway (for a summary, see [10]),

with the final step being catalyzed by the acyl-CoA:diacylglycerol

acyltransferases DGAT1 and DGAT2 (Figure 1A), converting

diacylyglycerol (DAG) and fatty acids, first activated to

acyl-CoA, into triglycerides. Both enzymes are located in the

endoplasmic reticulum (ER), where triglycerides accumulate at

privileged sites that represent nascent lipid droplets [16]; mature

lipid droplets are generated by continuous growth of these

structures and finally become distinct from the ER, likely via aprocess resembling budding [10,13]. DGAT2 is only inserted

into one leaflet of the ER membrane and can therefore diffuse

onto the surface of lipid droplets, promoting triglyceride synthesis

and continued droplet growth locally [17]. The hydrophobic

core can also contain steryl esters, the synthesis of which is

catalyzed by acyl-CoA:cholesterol acyltransferases. Depending

on cell type and conditions, steryl esters or triglycerides may

predominate.

Breakdown of the droplet triglycerides can occur by two

distinct pathways. Cytoplasmic triglyceride lipases bound to

the surface of lipid droplets hydrolyze triglycerides to DAG and

fatty acids. DAG can be further broken down, in two steps, into

fatty acids and glycerol (Figure 1C). In adipose tissue and

many other cells, the bulk of triglyceride hydrolysis is catalyzed

by a single lipase, adipose triglyceride lipase (ATGL) [5]. Lipid

droplets can also be turned over by autophagy (Figure 1C):

like other cellular organelles, lipid droplets are taken up by autophagosomes,

which fuse with lysosomes to form autolysosomes.

The hydrolytic enzymes delivered from lysosomes then

break down the autophagosome content; triglycerides, in particular,

are predominantly hydrolyzed by lysosomal acid lipase

(LAL) [5]. Discovered in hepatocytes [18], autophagy of lipid

droplets (‘lipophagy’) appears to make varied contributions to

triglyceride breakdown, depending on cell type and physiological

conditions [5].

Lipid Droplets as Modulators of Nuclear Functions

Lipid droplets arise from the ER and typically reside in the cytoplasm,

often at considerable distance from the nucleus. Nevertheless,

recent studies have uncovered intimate connections

between lipid droplets and nuclear events. There is emerging

evidence for a nuclear population of lipid droplets, which has

been proposed to directly modulate lipid metabolism in the nucleus.

In addition, lipid droplets in the cytoplasm can sequester

transcription factors, enzymes, and chromatin components —

and possibly many other proteins—and thus control their availability

in the nucleus.

Nuclear Lipid Droplets

Two different groups have reported the presence of lipid droplets

inside nuclei [19,20]. Using dyes specific for neutral lipids, small

spherical structures were identified in the nuclei of cultured cells

as well as in biochemically isolated nuclei [20]. Electron microscopy

of serial sections revealed that at least some of these

structures truly reside inside the nuclear compartment [19].

Biochemical fractionation suggests that these structures differ

in their lipid composition from the lipid droplets in the cytoplasm

[20]; however, they resemble cytoplasmic lipid droplets in their

morphology and in the presence of neutral lipids and were thus

named ‘nuclear lipid droplets’. It is not yet known how these lipid

droplets arise, what proteins they associate with, or what their

functional significance is. However, it is an intriguing possibility

that they contribute to nuclear lipid homeostasis and locally

modulate the availability of signaling lipids.

Exchange of Proteins between Lipid Droplets and Nuclei

Cytoplasmic lipid droplets can also profoundly affect nuclear

events. For example, lipid droplets have been implicated in suppressing

the activity of a transcription factor by keeping it out of

the nucleus [21]. The lipid-droplet protein Fsp27, also known as

CIDEC, is expressed in adipocytes and promotes fusion between

droplets, causing the formation of a single droplet per

cell [22,23]. A yeast two-hybrid screen revealed the transcription

factor NFAT5 (nuclear factor of activated T cells 5) as a potential

Fsp27 interaction partner. NFAT5 is cytoplasmic under hypotonic

conditions and translocates to the nucleus upon hypertonic

stress to activate osmoprotective genes [24]. The physical interaction

between Fsp27 and NFAT5 was confirmed in vivo, and

Fsp27 knockdown in adipocytes led to expression of NFAT5

target genes even in the absence of hypertonic stress [21]. To

examine the underlying mechanism, Fsp27 was ectopically expressed

in the heterologous HEK293 cell line; under these conditions,

Fsp27 was observed broadly throughout the cytoplasm.

Fsp27 overexpression reduced the amount of nuclear NFAT5, as

determined both by imaging and biochemistry, and blunted the

expression of NFAT5 target genes when cells were exposed to

hypertonic stress [21]. These results suggest that Fsp27 is able

to sequester NFAT5 in the cytoplasm and interferes with its

nuclear trafficking; since endogenous Fsp27 is associated with

lipid droplets in adipocytes, this interaction would retain

NFAT5 at the droplet surface (Figure 2A), something that remains

to be demonstrated directly. It will be interesting to determinewhether the interaction between Fsp27 and NFAT5 is regulated,

for example, by signaling pathways controlling lipolysis.

In Drosophila embryos, lipid droplets are associated with large

amounts of specific histones [25] via the histone anchor Jabba

[26]. This association is first detected during oogenesis and

makes it possible for females to build up massive histone stores

in the developing eggs (Figure 2B,C). Wild-type embryos contain

enough excess histones for thousands of diploid nuclei, whereas

mutants lacking Jabba have drastically reduced histone stores

[26]; indirect evidence suggests that extranuclear histones not

bound to lipid droplets are degraded. Transplantation experiments

revealed that in the embryo droplet-bound histones

can transfer to nuclei [25] and presumably support chromatin

assembly. Surprisingly, embryos lacking this droplet-bound histone

supply develop largely normally [26,27]. This is possible

because of the intricate regulation of histone metabolism in early

embryos (reviewed in [28]), which also contain abundant levels of

histone messages deposited during oogenesis. When new synthesis

of histones in the embryo is even mildly impaired, Jabba

mutants cannot sustain development and die very early [26].

Thus, in this case, lipid droplets sequester a nuclear protein for

long-term storage. This sequestration allows the organism to

build up histone stores during oogenesis and keep them available

for when they are needed later for chromatin assembly

(Figure 2C).

Lipid droplets of early Drosophila embryos also appear

to affect histone metabolism in the short term, by buffering

the histone supply [27]. When droplets are transplanted

between embryos, the donor droplets can bind histones

from the recipient embryo, suggesting that histones can be

loaded onto droplets even in embryos. In Jabba mutants,

the synthesis of histone H2A and its variant H2Av are

imbalanced, and H2Av overaccumulates in the nuclei, an

event linked to DNA damage [27]. This nuclear overaccumulation

does not occur in wild-type embryos, presumably because

here lipid droplets can trap histones produced in excess and

prevent their unregulated entry into nuclei. Whether other

species use similar droplet-based histone buffering remains

to be determined, although histones have also been detected

on lipid droplets in housefly embryos, rat sebocytes, and

mouse oocytes [25,29,30]

The enzyme CCT1 also displays dramatic exchange between

lipid droplets and nuclei. CCT1 is one of two isoforms of

CTP:phosphocholine cytidylyltransferase, an enzyme that catalyzes

the rate-limiting step in the synthesis of the phospholipid

phosphatidylcholine. In cultured fly cells, CCT1 is usually present

in the nucleus, but, under conditions in which cells synthesize

new triglycerides and expand the hydrophobic core of droplets,

CCT1 accumulates at the droplet surface [31,32] (Figure 2D). The

presence at the droplet surface is critical to expand the droplet

surface in concert with growth of the core: droplet binding activates

the enzyme and thus leads to an increase in the cellular

phosphatidylcholine supply. Whether CCT1’s presence in the

nucleus in the basal state is functionally important remains unclear.

Nuclear accumulation is apparently not a mechanism to

prevent access to the droplet surface: fluorescence recovery

after photobleaching (FRAP) experiments revealed that CCT1

is not immobilized inside nuclei, but rapidly exchanges with a

cytoplasmic pool. And overexpression of CCT2, an isoform

exchanging between the cytoplasm and droplets, can fully

rescue the effect of CCT1 depletion on droplet growth [31].

High nuclear accumulation and consequent low cytoplasmic

pools of CCT1 might possibly modulate the kinetics of relocalization

to droplets.

Prp19 is a subunit of the NineTeen Complex, which is involved

in a number of nuclear events, including spliceosome activation

and transcription elongation [33]. In mouse adipocytes, Prp19

was also found associated with lipid droplets, and Prp19 knockdown

resulted in reduced triglyceride accumulation [34]. It is not

clear whether this dual localization to lipid droplets and to thenucleus represents distinct functions of Prp19, or whether the

two populations are connected. Initial experiments with inhibitors

of nuclear export revealed no changes in overall intracellular

Prp19 distribution [34].

Modulation of Lipid Signaling

Peroxisome proliferator-activated receptors (PPARs) are transcription

factors bound and activated by lipid ligands, including

fatty acids and their derivatives. In oxidative tissues, such as the

mammalian heart and liver, PPARa promotes the expression of

proteins involved in lipid homeostasis [35]. In principle, fatty

acids from exogenous sources or synthesized de novo might

activate PPARa directly. However, free fatty acids are typically

channeled, via activation to acyl-CoA, into specific metabolic

pathways [36] and thus are not readily available for signaling.

Studies in mice uncovered that PPARa signaling is severely

compromised in the hearts of animals lacking ATGL [37]. Given

that lack of ATGL function in the heart causes many profound

changes (such as massive lipid accumulation and mitochondrial

dysfunction), the effect on PPARa signaling might conceivably

be indirect. Yet pharmacological stimulation of the PPARa

pathway is sufficient to reverse these phenotypes, establishing

PPARa signaling as a primary defect in these mutant hearts

and suggesting a direct link between lipid droplets and PPARaactivation [37]. It was proposed that

ATGL-mediated triglyceride hydrolysis

generates the ligands for PPARa [37]

(Figure 3A). This pathway may be tissue

specific because liver-specific knockdown

of ATGL impaired the expression

of PPARa target genes in this tissue, but PPARa agonists failed

to reverse this effect [38].

Lipid Droplets as Hubs for Fatty Acid Trafficking

Lipid droplets act as a sink for overabundant fatty acids, and they

can release lipids when needed for energy production, synthesis

of membrane components, or signaling. It is becoming increasingly

apparent that lipid trafficking to and from droplets is highly

regulated in space (Figure 3A). Fatty acids from triglyceride hydrolysis

signal to nuclear receptors (as discussed above); fatty

acids released during autophagy are shuttled through lipid droplets,

as a way station before import into mitochondria for ATP

production; production of steroid hormones in flies requires lipid

exchange between the ER, lipid droplets, and mitochondria; and

within a population of cells, high accumulation of droplets in a

subset of cells has been proposed to protect the rest of the cells

from fatty acid overload.

Lipid Trafficking between Lipid Droplets and

Mitochondria

In starved mammalian cells, fatty acids fuel ATP production, via

b-oxidation in mitochondria. These fatty acids could be derived

from triglycerides (Figure 1B,C) or from various membranous

organelles. To follow the flux of fatty acids through variouscompartments, mouse embryonic fibroblasts (MEFs) were

allowed to incorporate fluorescently labeled lipids into either lipid

droplets or membranes, and their fate during starvation was

monitored by imaging and biochemistry [39]. Fatty acids present

as triglycerides in lipid droplets moved to mitochondria fairly

quickly and were readily broken down. When ATGL (Figure 1B)

was knocked down, transfer of fatty acids was dramatically

reduced and mitochondrial oxygen consumption rates dropped.

Under the starvation conditions employed, lipophagy (Figure 1C)

was not induced and autophagy made no detectable contribution

to the transfer of fatty acids from droplets to mitochondria

or to mitochondrial oxygen consumption rates.

The rapid relocalization of fatty acids to mitochondria is presumably

accomplished by direct transfer. Lipid droplets and

mitochondria indeed display close physical associations [40–

42], and direct channeling of fatty acids from their site of release

(droplets) to the site of consumption (mitochondria) would minimize

the risk of toxic effects elsewhere, such as disruption of

cellular membranes or inappropriate nuclear signaling.

Curiously, during starvation, the number and size of lipid droplets

increased and total cellular triglyceride levels went up [39].

Using fluorescently labeled phospholipids and inhibition of

autophagy pathways, this effect was traced to autophagic

breakdown of membranous organelles. Presumably, fatty acids

from phospholipid breakdown in autolysosomes are employed

to replenish triglyceride stores in droplets upon starvation

(Figure 3A).

Mitochondria can be remodeled by fusion and fission [43],

allowing them to form highly interconnected networks or individual

fragments. In starved cells, mitochondria were highly fused, a

state that is apparently critical for efficient fatty acid import: usually

labeled fatty acids from lipid droplets are homogenously

distributed throughout the mitochondria, but when mitochondria

were fragmented, the label was distributed unevenly [39]. As a

result, fatty acids could not be metabolized as efficiently;

although cells with either fused or fragmented mitochondria upregulate

b-oxidation upon starvation, only those with fused mitochondria

were able to maintain these levels of b-oxidation. For

cells with fragmented mitochondria, levels of b oxidation and,

as a result, total mitochondrial respiration, dropped off with

time, presumably because not all mitochondria had a sufficient

supply of fatty acids (Figure 3B). The likely reason is that there

are many fewer lipid droplets than mitochondrial fragments,

and that only the mitochondria in direct physical contact with

lipid droplets can take up fatty acids efficiently. In fused mitochondria,

those fatty acids can diffuse through the entire

network. In support of this interpretation, when glutamine was

used as an alternative fuel, the fusion state of the mitochondria

did not matter; as glutamine diffuses through the cytoplasm,

its import into mitochondria is not restricted to a limited number

of sites, unlike the supply of fatty acids from lipid droplets. Presumably

because an oversupply of unmetabolized fatty acids is

dangerous, fatty acids were re-exported from the mitochondria,

and either accumulated back in lipid droplets or were released

from the cells into the extracellular space [39].

Efficiency of lipid exchange between mitochondria, ER, and

lipid droplets may also underlie a recent observation that

promotion of mitochondrial fusion is important for lipid-droplet

formation and steroid signaling in Drosophila. Mitochondrial

associated regulatory factor (Marf), the fly ortholog of mammalian

mitofusins, is a small GTPase that promotes fusion of

the outer mitochondrial membrane; thus, loss of Marf leads to

small, round mitochondria [44]. Marf-deficient flies show a

particularly dramatic phenotype in the ring gland, an endocrine

tissue responsible for hormone secretion [45]: mitochondrial

morphology is altered, the ER is fragmented, and lipid-droplet

number is dramatically reduced [44]. Ring gland lipid droplets

receive sterols from the ER and store them as steryl esters;

these, in turn, are the precursors for the production of the steroid

hormone ecdysone in the mitochondrial matrix. Efficient storage

and turnover of steryl esters therefore presumably requires intimate

contacts between the three organelles; in Marf mutants

the contacts between all three organelles were severely reduced

[44]. Lack of Marf in the ring gland also greatly impairs ecdysone

production, with dramatic organism-wide consequences [44].

Mitochondria may not be the only organelle for which close

contacts with lipid droplets promote efficient transfer of fatty

acids. Breakdown of fatty acids is not restricted to mitochondria,

but can also occur in peroxisomes. In the yeast Saccharomyces

cerevisiae, b-oxidation is even entirely restricted to peroxisomes.

Here, lipid droplets and peroxisomes display intimate physical

connections, which have been proposed to promote efficient

coupling of triglyceride breakdown with peroxisomal fatty acid

oxidation [46].

Lipid-Droplet Specialization across a Cell Population

The role of lipid droplets as buffers for fatty acid availability may

even extend to lipid exchange between cells in the same tissue.

A recent study identified a surprising heterogeneity in lipiddroplet

content in hepatocytes [47]: in mouse liver, some cells

have substantially larger numbers of lipid droplets than neighboring

cells (Figure 3C); this variability is especially apparent

under conditions of high overall lipid storage in the liver. Similar

variability was observed in primary hepatocytes in culture and

with a cultured cell line of liver origin (AML12), suggesting that

it is due to cell-intrinsic properties, rather than a reflection of

overall tissue structure.

Such heterogeneity might arise if some cells have acquiredmutations in lipid metabolism. However, a cell sorting strategy

demonstrated that heterogeneity is reversible and appears to

be a population property. After growth on fatty-acid-rich media,

cells were separated by flow cytometry into a low-lipid and a

high-lipid subpopulation. After culture in standard media to promote

breakdown of the stored lipids, the two populations were

again grown under fatty-acid-rich conditions. Remarkably,

both cultures showed the same broad distribution in lipid content.

Inhibitor studies indicate that heterogeneity arises from

fluctuations in biochemical networks controlling lipolysis, fatty

acid oxidation, and protein synthesis.

At the level of a whole organism, heterogeneity of lipid-droplet

content is very common. Many animals have adipose tissues

specialized for storing lipids. It was proposed that heterogeneity

within a single cell population similarly sets aside a subpopulation

of cells that collects lipids particularly well, stores them,

and releases them to their neighbors when needed [47]. To

test this idea, high-lipid cells were isolated in which lipid droplets

had accumulated fluorescently labeled fatty acids. After co-culture

with low-lipid cells (marked with a different fluorescent dye

to distinguish the two original populations), the high-lipid grouphad lost — and the low-lipid group had gained — some of the

labeled fatty acids. Thus, the high-lipid cells can indeed supply

lipids to their neighbors (Figure 3D).

But what is the point of setting aside a subpopulation of cells

with especially high lipid stores if — in the long run — the lipids

are presumably needed equally across cells? One possibility

has to do with the fact that overaccumulation of free fatty acids

is dangerous, both because of disruption of membranes and

because of toxic metabolites generated by fatty acid breakdown.

The high-lipid subpopulation indeed showed higher levels

of oxidative damage, as seen by levels of reactive oxygen species

(ROS; Figure 3C). Importantly, when fluorescently marked

low-lipid cells were co-cultured with either low-lipid or high-lipid

cells (unmarked) and challenged with fatty-acid-rich media, the

marked cells displayed lower ROS levels in the presence of

high-lipid cells. Thus, the presence of high-lipid cells protected

their low-lipid neighbors. High-lipid cells may remove fatty acids

more efficiently from the media, and thus the flux of free fatty

acids into the low-lipid cells is reduced. Remarkably, in the coculture

experiment with high-lipid cells, ROS levels were not

only reduced for the marked low-lipid cells, but also for the population

as a whole.

Although the detailed mechanisms underlying these protective

effects remain to be worked out, the reported experiments

nicely demonstrate a novel strategy, namely heterogeneity in

lipid-droplet accumulation, to alleviate risks from overabundance

of lipids. By accumulating more lipid droplets and more

ROS, the high-lipid subpopulation reduces the overall risk of lipotoxicity.

It is not yet clear how the high-lipid population is able to

handle its increased risk: these cells may induce specific protective

mechanisms, or they might repair their damage during the

time when they find themselves in the low-lipid state (which

will occur sooner or later, due to the stochastic nature of the

heterogeneity). Since heterogeneity has been observed in

cultured cells of various origins [47], this protective strategy

may be employed not just by hepatocytes, but more generally

in other cell types.

Lipid Droplets and the Fight against Pathogens

It has been long known that lipid droplets play important roles in

the immune system. They are sites of synthesis of eicosanoids,

signaling lipids important for inflammation, host defense against

pathogens, and cancer [48]. Various pathogens have, in turn,

evolved strategies to tap into the lipid droplets of the host

to ensure a sufficient lipid supply [49,50]. Recent years have

uncovered how certain viruses appropriate lipid droplets as

assembly platforms and how cells use lipid droplets in novel

ways to fight back.

Lipid Droplets and Viral Assembly

Infection with hepatitis C virus (HCV) is a global public health

threat and can lead to liver cirrhosis and liver cancer [51]. For

part of its life cycle, HCV crucially depends on lipid droplets

(see [52,53] for recent reviews): after infection, two newly expressed

viral proteins transiently accumulate on lipid droplets:

core protein, which is the major structural protein of the virus,

and NS5A, a regulator of viral replication. Droplet-bound viral

proteins then interact with the sites of viral RNA replication, a

process facilitated by the droplet-localized Rab18 [54] and

by dynein-mediated intracellular relocalization of lipid droplets

[55]. For the final maturation, the virus hijacks the pathway

responsible for secretion of the very-low-density lipoprotein

(VLDL) particles, and virions are released into the extracellular

space as low-density lipoviroparticles [56], whose lipids may

ultimately be derived from lipid droplets. HCV is not unique in

its use of lipid droplets; several other viruses assemble with

the help of lipid droplets [57,58].

Droplet accumulation is a necessary step for virus maturation;

if the interaction between core protein and lipid droplets is disrupted,

either with mutations in core protein or via pharmacological

approaches, core protein stability is greatly reduced and

virion assembly is impaired [59,60]. Thus, preventing the recruitment

of viral proteins to droplets is an attractive target for disrupting

the viral life cycle. Droplet targeting requires cis-acting

sequence motifs in both core protein and NS5A [61,62], but

also trans-acting host factors. In particular, DGAT1, one of the

two enzymes mediating triglyceride synthesis (Figure 1A), plays

a crucial role: DGAT1 binds to both NS5A and core protein,

and this interaction mediates recruitment of both proteins to

droplets and is required for efficient virion assembly [63,64].

Interestingly, inhibiting the enzymatic activity of DGAT1 is sufficient

to prevent droplet targeting of these proteins. Since

DGAT1 generates only a subset of lipid droplets (the others

depend on DGAT2; Figure 1A), it was proposed that DGAT1 concentrates

the viral proteins at the sites where it promotes lipiddroplet

formation and thus guides the viral proteins onto just

these lipid droplets [64] (Figure 4A).

Lipid Droplets as Stores for Antiviral and Antibacterial

Proteins

Viperin (which stands for virus inhibitory protein, ER associated,

interferon inducible) is an interferon-induced protein with broad

antiviral activity [65,66]. Viperin is targeted to the cytoplasmic

face of the ER and is also enriched around lipid droplets [62];

targeting to both locations is mediated by an amino-terminal

amphipathic a-helix [62]. Intriguingly, two of the viruses combatted

by viperin, HCV and Dengue virus, employ droplets for

their assembly. Using confocal microscopy and fluorescence

resonance energy transfer (FRET), viperin was shown to interact

with the HCV nonstructural protein NS5A at the droplet surface,

via its carboxy-terminal region [67]. This interaction as well as theamino-terminal droplet-targeting helix are required for viperin’s

antiviral activity against HCV [67]. For Dengue virus, in contrast,

while a physical interaction with the viral protein NS3 was important,

droplet binding was dispensable for the anti-viral effect [68].

The amino-terminal a-helix in viperin was also important to

restrict the replication of chikungunya virus, though presumably

through localization at the ER, rather than at lipid droplets [69].

Thus, at least in some cases, viperin apparently targets a

droplet-dependent step of viral replication and its enrichment

on the droplet surface is necessary for its activity (Figure 4A).

As discussed earlier, lipid droplets can be associated with histones.

This observation potentially has implications for immunity

since histones are increasingly recognized as antibacterial

agents [70,71]: in vitro, histones have broad antibacterial activity

[72], and histones present in extracellular secretions have been

reported to contribute to protection against bacterial pathogens

[73,74]. Analysis in Drosophila suggests that histones bound to

lipid droplets can similarly provide a defense against intracellular

bacterial invaders [75]. Droplets biochemically purified fromDrosophila embryos are associated with high levels of certain

histones [25] and are highly bactericidal in vitro [75]. A number

of independent approaches, including using histone antibodies

and mutations in the histone anchor Jabba [26], showed that

this killing activity of droplets was due to histones.

To test whether droplet-bound histones are protective in vivo,

wild-type and Jabba mutant embryos were injected with GFPlabeled

Escherichia coli; while bacterial numbers diminished in

the wild type, they dramatically increased in the mutants [75]

(Figure 4B). In the same injection assay, wild-type embryos

also showed significantly higher levels of survival when challenged

with a number of Gram-positive and Gram-negative bacteria.

This new immune mechanism may also operate at other

developmental stages: when adult flies were infected with the

intracellular pathogen Listeria monocytogenes, Jabba mutants

were impaired in restricting bacterial titers and were killed

much more readily than wild-type flies [75]. Loading up lipid

droplets with histones to kill bacterial invaders may be a

conserved innate immunity mechanism, since when mice were

challenged with lipopolysaccharide — to mimic bacterial infections

— the levels of droplet-bound histone H1 increased in the

liver [75].

Lipid Droplets and the Nervous System

Lipid metabolism plays crucial roles in the nervous system, for

many membrane functions and signaling events [76–78]. Yet until

recently, there has been only sparse and unconnected information

on the role of lipid droplets in neurons and other cells

of the nervous system. For example, lipid droplets have been detected

in the axons of Aplysia neurons cultured in vitro [79] and in

cultured neurons and brain sections of Huntington’s disease

models [80]. There are also links between a-synuclein, a protein

whose dysfunction or overexpression can cause Parkinson’s

disease, and lipid droplets: a-synuclein has been reported to

bind to lipid droplets in vitro [81] and in cultured cells [82], and

overexpression in yeast promotes droplet accumulation [83],

but the relevance of these observations for a-synuclein’s in vivo

function and for neurodegeneration has yet to be explored. However,

recent papers have identified the presence of lipid droplets

in neurons and in glia under certain disease conditions and suggest

that disrupted lipid-droplet function can contribute to neurodegeneration.

Hereditary Spastic Paraplegias and Lipid Droplets

Hereditary spastic paraplegias (HSPs) are inherited disorders

characterized by motor-sensory axon degeneration, weakness

in lower extremities, and spasticity [84]. Mutations in over 50

loci can cause HSP, and the cellular functions of the encoded

proteins show a surprising heterogeneity. Recently, a number

of HSP candidate genes have been shown to have crucial roles

in lipid-droplet biology: atlastin, REEP1, seipin, spartin, spastin,

and kinesin-1. Atlastin mediates fusion of ER tubules and also

controls the size of lipid droplets [85]. REEP1 maintains the

high curvature of ER tubules and, when overexpressed together

with atlastin, increases lipid-droplet size [85,86]. Seipin, an integral

membrane protein at the ER–droplet junction, is important

for lipid-droplet formation and maintenance [87,88]. Spartin

localizes to lipid droplets, interacts with E3 ubiquitin ligases,

and modulates the turnover of lipid-droplet proteins [89–91];

spartin knockout mice have increased lipid-droplet numbers in

their adipose tissue [92]. Spastin is a microtubule-severing protein

that mediates remodeling of the cytoskeleton; in mammalian

cells, a particular spastin isoform harbors a lipid-droplet targeting

sequence, and depletion of spastin in Drosophila or

C. elegans alters lipid-droplet number and cellular triglyceride

content [93]. KIF5A encodes the microtubule motor kinesin-1;

the same motor powers the motion of lipid droplets in Drosophila

[94]. Finally, several of the HSP candidate genes encode enzymes

implicated in phospholipid or fatty acid metabolism

[95,96]; their dysfunction might therefore alter the supply or

composition of the lipids stored in lipid droplets. These observations

raise the intriguing possibility that aberrant lipid-droplet

biogenesis or function might contribute to axonal degeneration.

However, since all of these proteins also have functions unrelated

to lipid droplets (such as controlling ER structure or promoting

vesicle trafficking), the link between lipid droplets and

HSPs remains tentative.

A much more direct connection to lipid droplets has recently

emerged from the analysis of the HSP gene DDHD2 [97]. Patients

with mutations in DDHD2 exhibit very early onset of the disease

(<2 years) and are often intellectually disabled [98]. The DDHD2

gene is highly expressed in the brain and encodes a serine

hydrolase that displays phospholipase activity in vitro. To determine

its function in vivo, DDHD2 activity was abrogated genetically,

using knockout mice, as well as pharmacologically, withselective inhibitors [97]. In both cases, adults accumulated large

amounts of triglycerides in the brain and the spinal cord, but

there was little to no effect in other tissues; brain phospholipid

content was unchanged. These observations suggest that

DDHD2 has a specific function in triglyceride metabolism of

the central nervous system. It likely acts as a triglyceride lipase

since recombinant DDHD2 expressed in cultured cells displays

triglyceride hydrolase activity and, compared with wild type,

total triglyceride hydrolase activity is significantly reduced in

brain lysates of DDHD2 mutant mice [97]. Finally, the main triglyceride

hydrolase in the fat body of the moth Manduca sexta

shares extensive sequence homology with DDHD2 [99].

The brains of DDHD2 knockout mice displayed abundant lipid

droplets, while lipid droplets were only rarely detected in wildtype

brains [97]. They accumulated predominantly in neurons

and were present in cytoplasm, dendrites, and axons. The

DDHD2 knockout mice also exhibited deficits in motor coordination

and cognition [97], reminiscent of the defects in the human

patients [98]. Intriguingly, in the patients, cerebral magnetic resonance

spectroscopy revealed an abnormal spectrum, with a

peak characteristic of lipid accumulation [98], though it is not

yet known whether this peak represents triglycerides. While

the mechanisms that link droplet accumulation and neuronal

impairment remain obscure, one intriguing observation is that

in the DDHD2 knockout mice some of the large droplets

observed were associated with noticeable swellings of the

neuronal processes and thus might present obstacles to intracellular

trafficking in the relatively thin axons and dendrites.

Glial Lipid Droplets

Glial cells are non-neuronal cells that surround neurons and play

important supportive roles in the central and peripheral nervous

system. Lipid droplets have been observed in culture in primary

glia as well as in glia-derived cell lines [100,101]. When carnitine

palmitoyltransferase 2 (CPT2), a mitochondrial enzyme necessary

for b-oxidation of long-chain fatty acids, is abolished in flies,

massive amounts of triglycerides accumulate specifically in the

brain of adults; glial cells, but not neurons, accumulated abundant

lipid droplets [102]. This seems to be a cell-autonomouseffect because CPT2 is expressed predominantly

in glia and CPT2 expression

solely in glia is sufficient to reverse triglyceride

accumulation in the brain. Flies lacking

CPT2 have a dramatically reduced

lifespan, and glial-specific CPT2 expression

was able to partially rescue this

defect, indicating that triglyceride metabolism

in glia may make an important contribution to overall

organismal energy metabolism.

Lipid droplets can accumulate in glia also non-cell-autonomously,

in response to mitochondrial dysfunction in neighboring

neurons [103]. For a subset of Drosophila mutants known to

cause neurodegeneration in adult photoreceptors [104], abundant

lipid droplets transiently accumulate in the glial cells next

to photoreceptors, prior to or concomitant with the onset of

neurodegeneration. No droplets were observed in the wild type

or in the neurons of mutant animals [103] (Figure 5A,B). The

mutants that showed accumulation of droplets in glial cells all

affect mitochondrial function and, in particular, cause increased

levels of ROS. Elevated ROS are indeed critical for droplet formation

in glia because pharmacological or genetic reduction of

ROS prevented droplet accumulation. Lipid droplets were also

detected in glial cells in a mouse model of neurodegeneration

caused by mitochondrial dysfunction, suggesting an evolutionarily

conserved pathway.

How do ROS promote the accumulation of glial lipid droplets?

The full pathway has yet to be worked out, but activation of

c-Jun-N-terminal kinase (JNK) and sterol regulatory element

binding protein (SREBP) pathways are critical; JNK mediates

stress responses [105] and SREBP controls transcription of

many metabolic genes and, in particular, promotes lipogenesis

[106,107]. Although droplets accumulate in glia, the trigger for

accumulation originates in neurons: when the mitochondrial

genes identified were knocked down in glia, there was no effect;

knockdown only in neurons was sufficient to promote glial lipid

droplets. In addition, expression of an antioxidant enzyme or

knockdown of JNK solely in neurons was able to reduce glial

droplet accumulation. Thus, mitochondrial dysfunction and

elevated ROS in photoreceptors cause accumulation of lipid

droplets in glia in a non-cell-autonomous manner.

Damage to neurons resulting from mitochondrial dysfunction

therefore leads both to transient formation of lipid droplets in

glia and to neurodegeneration. Are these lipid droplets an ultimately

futile protective response, do they promote neurodegeneration,

or are they innocent bystanders? Activation of JNK orSREBP in neurons in the absence of ROS still leads to glial lipid

droplets, but not neurodegeneration [103]. Thus, glial lipid droplets

per se are not detrimental for neurons. The culprit might

be lipids damaged by ROS, given that the mutants leading to

neurodegeneration displayed dramatically elevated levels of

peroxidated lipids. Furthermore, expression of two different

lipases, the ATGL homolog Brummer or the LAL homolog Lip4

(Figure 1B,C), dramatically reduced both lipid-droplet accumulation

and the levels of peroxidated lipids and also delayed neurodegeneration

(Figure 5C) [103]. These observations strongly

suggest that neurodegeneration is driven by altered lipid metabolism,

although the exact role of lipid droplets remains to be

elucidated.

The fatal neurodegenerative disease amyotrophic lateral sclerosis

(ALS) has recently also been linked to lipid droplets.

A particular subtype of ALS is caused by mutations in the human

VAMP (vesicle-associated membrane protein)-associated protein

B (hVAPB). Equivalent mutations in the fly ortholog DVAP,

when ectopically expressed, lead to degeneration of fly photoreceptors.

In genetic screens for enhancers and suppressors of this

phenotype, one of the most represented functional categories

was proteins linked to lipid droplets, including proteins involved

in droplet biogenesis and droplet motility [108]. The proteins

such identified will provide a rich source for follow-up studies to

dissect how lipid droplets might impact neurodegeneration.

Perspective

The crucial roles of lipid droplets in energy homeostasis and lipid

metabolism have focused a lot of recent attention on these still

relatively understudied organelles. Yet the examples discussed

above show that lipid droplets play even broader roles and touch

on biological processes only loosely connected to their traditionally

studied functions.

In particular, lipid droplets contribute to protein trafficking and

protein maturation in the cell. They exchange proteins with the

nucleus, modulate protein stability, and allow concentrated

accumulation of antiviral and antibacterial proteins. We do not

know enough to judge whether these processes have independently

evolved and all just happen to take advantage of lipid

droplets or whether they are indicative of a general cellular

pathway of protein trafficking. Lipid droplets have been proposed

to act as general protein sequestration sites [109]; such

sequestration might modulate the ability of these proteins to

interact with binding partners, promote assembly of protein

complexes, store damaged proteins safely before degradation,

or allow moving droplets to deliver proteins [109,110]. As many

published lipid-droplet proteomes contain proteins from other

compartments, there are ample candidates for testing how widespread

protein sequestration on droplets is. For the verified examples,

much work needs to be carried out to understand how

the sequestered proteins are targeted to lipid droplets, whether

they are bound stably or dynamically, and how release from

droplets is controlled. And why are these proteins sequestered

on lipid droplets and not elsewhere in the cell? Is droplet localization,

say, of histones, just an accident of evolution, or do lipid

droplets provide a unique cellular niche?

The emerging roles of lipid droplets as hubs for fatty acid trafficking

(Figure 3) suggest that the pathways that fatty acids take

from and to lipid droplets are highly regulated. But, apart from

some insights into the importance of direct contacts between

lipid droplets and mitochondria [42], little is known about the

molecular mechanisms controlling this trafficking. For fatty

acid trafficking modulated by droplet heterogeneity between

cells (Figure 3C,D), there are intriguing hints that heterogeneity

is a regulatable property since the extent of heterogeneity is

different between cells of different origin [47], but the control

pathways remain to be worked out.

For lipid droplets in the nervous system, it is now established

that both neurons and glia can accumulate lipid droplets under

certain disease conditions. But what role they play under these

conditions and whether droplets are normally present in the nervous

system is far from clear. For example, in the fly models of

neurodegeneration (Figure 5), it was proposed that accumulation

of lipid droplets in glia promotes neurodegeneration, as long as

high ROS levels provide a second insult [103]. However, lipase

overexpression in glia only mildly delayed neurodegeneration,

whereas lipase overexpression in neurons, where no droplets

were detected, had a much stronger protective effect. It will be

very interesting, in these examples and in the mouse models of

HSP, to examine whether ablation of droplet biogenesis in specific

cell types modulates the disease phenotypes, for better or

for worse, and how these effects compare to disruption or upregulation

of turnover pathways (Figure 1B,C). Real-time imaging

of the trafficking of labeled fatty acids (as in [39]) and characterization

of the lipidomes and proteomes of these droplets will provide

complementary information to characterize exactly how

lipid metabolism is derailed in the disease conditions.

Given the diverse novel roles proposed for lipid droplets, droplets

should be on the radar screen of many a biologist trying to

uncover the mechanistic basis of an ill-characterized process.

With the recent insights into biogenesis and turnover of lipid

droplets [14], one can now systematically determine how a process

is affected if droplets are entirely absent, are structurally

abnormal, or cannot be degraded. Because lipid droplets are

ubiquitous organelles but have been carefully studied in only a

few cell types, it seems likely that, as our understanding of these unique and dynamic organelles deepens, their cellular and physiological

roles will keep expanding.

1. An effective supply chain system is of critical importance, especially to a manufacturing company operating in a highly competitive and trend-setting industry. Discuss Nike’s inventory management.

2. What is the importance of integrating new systems with legacy systems and processes in the organization for their effective functioning?

3. What benefits did the company expect to achieve by implementing a new supply chain system? and What are the risks involved in taking up projects of considerable magnitude without establishing effective control systems?

Inventory Problems at Nike

NI KE'S PROFITS FALL

In Febntary 2001, Phil Knight (Knight), the co-founder and CEO of Nike Inc (Nike), announced that the company's profits for the third quarter of the fiscal year ending May 2001 would fall short of expectations by almost 24 percen t. The reason for the shortfall was a failure in the supply chain software that Nike had implemented in June 2000. The supply chain software, implemented by i2 Technologies Inc (i2)4 had fa llen prey to technical glitches that affected the company's inventory systems adversely, leading to a supply chain failure. Resultantly, Nike's production facilities around the world ended up manufacturing a far greater number of a less popular shoe model and not enough of those models that were in high demand.

In the finger pointing that followed, Nike 's management laid the blame for the prob lem squarely at the door of i2. During a press meet, Knight compEained, "This is what we get for our $400 million, h uh?"5 On the other hand, i2 claimed that the mismatch was a result of Nike's haste in using the incomplete system and its unwillingness to use i2's standard systems and procedures. Regardless of who was to blame, Nike's reputation in the market took a beating. The company also lost considerable market share to rivals like New Balance6 and Reebok7• One of the leading sports goods companies in the world, Nike manufactured high quality athletic shoes for a variety of sports including baseba ll, athletics, golf, tennis, volleyball and wrestling. In addition to footwear (which accounted for almost 60 percent of the company's sales), Nike also manu factured fitness equipment, apparel and accessory products. The company's products were sold in over 140 countries around the world . Headquartered in Beaverton, in the state of Oregon, Nike had production facilities scattered around the world and had a complicated supply chain system that extended from Nike factories in developing count1ies in Asia to uptown stores in the US and other parts of the developed world.

BACKGROUND NOTE

The future co-founders of Nike met in 1957, when Knight was an undergraduate student and middle-distance athlete at the University of Oregon (which was known for having the best trnck program in the country) and Bi ll Bowerman (Bowerman), the athletics coach. In the early 1960s, when Knight was doing his MBA at Stanford University, he submitted his marketing research dissertation on the US shoe man ufactiiring indusirry. His assertion was that low cost, high quality running shoes could be imported from labor-rich Asian count1ies like Japan and sold in the US to end Germany's domination in the industry.

In 1962, while on a world tour, Knight met the management of the Onitsuka Company (Onitsuka) of Japan, which manufactmed high quality athletic shoes under the brand name ;Tiger'. He airnnged for these shoes to be imported to th e US for sale under the name 'Blue Ribbon Shoes' (BRS). (When the management of Onitsu ka asked him about which company he represented, he thought up this name. BRS became the forerunner of Nike). ln late 1963, Knight received his first shipment of 200 Tiger shoes. In 1964, Knight and Bowerman formed a partnership, with each of them cont1ibutin g $500, and BRS formall y came into being. The first shoes were sold from the basement of Knight's house and the backs of trucks and cars at local track events. The a.th letes wbo wore the shoes were asked for feedback to improve future shoe designs. By the end of 1964, BRS had sold 1300 pairs of shoes and generated $.8000 in revenues.

In 1965, the paitners hired Jeff Jobnson (Johnsoo), the first full time employee of BRS. Johnson was formerly a salesperson for Adidas shoes8 bn 1966, Johnson helped open the first exclusive BRS store in California. Sales of the shoes grew and in 1969, Knight resigned from his job as a professor at the Portland University and devoted himself to BRS full time. By the end of the 1960s, BRS had 20 full time employees and several retail stores.

By 1971, BRS staited manu facturing its own line of athletic shoes in addition to selling Tiger shoes. For the new line of shoes, Johnson thought up the name Nike9• Carolyn Davidson, an acquaintance of Knight, designed the 'Swoosh ' symbol, which was a graphic representation of the wing of Goddess Nike (Refer Exhibit-I). In ret11m for what became one of the most recognized symbols in adve1tising, Knight paid her $35.

The first shoe with the Swoosh logo came out in early 1972. In the same year, following distribution differences, BRS patted ways with Onitsuka and from then BRS only sold shoes manu factured under the Nike brand. T-shirts, wiith the Nike name and logo printed across them were introduced at the Pre-Olympic trials in 1972, marking the beginning of the company's foray into the apparel business.1n the same year, BRS also introduced the ';Futures" booking program , which allowed production forecasters to "make to order" and pre-finance while reducing risks of over inventory . Knight was one of the first businesspersons to allow retailers to pre-order inventory. This was a revolutionaiy business decision that soon became standard among other businesses.

During the first halfof the 1970s, sales of Nike shoes grew from $10 million to $270 million . The growth was facilitated by the creation of revolutionruy shoe designs like the waffle sole and the air cushioned sole system, known as Nike Air. DUJin.g the 1970s, BRS opened production faci lities in Taiwan and Korea. Sales in other pmts of the world, like Europe, Australia and Asia also increased. In 1978, BRS officially changed its name to Nike Inc, in keeping with the populaiity of its brand . Nike rapidly expanded its product line during the 1970s and early 1980s and in b·od uced a wide variety of shoes for different spo1ts. Models such as Nike-Air and Air Force I for basketba ll, and the Nike-Air and Air Ace shoes for tennis were introduced over the years. (By the early 1980s, the company had over 200 shoe models in its prod uct line).

In 1980, Nike went for a public issue of 2 million shares of common stock. It also opened a Spo1ts Research and Development Lab in Exeter, New Hampshire, US. By 1981, Nike shoes were manu factured in 1 1 coLmtJies around the worldl, and the company employed more than 3000 people. In the same year, Nike International Ltd. was formed to serve a growing overseas market. At the Olympics in 1984, 58 Nike-sponsored athletes from around the world won 65 medals in all, generating immense publicity for the company.

In 1985, the company signed a contract with Michael Jordan, an NBA 10 player for the Chicago Bu lls11 who went on to become one of the most successful celebrities ever to endorse Nike.Nike introduced a range of shoes called 'Air Jordan', named after the player. In 1986, the revenues of th e company crossed the one bi llion dollar mark for the first time. In 1987, Nike introduced the first cross-training shoe, which could be used for mnning as well as indoor sports. In 1988, Nike adopted a new punch-line which said "Just Do It". A series of advertising campaigns highlighting the new punch-line were made.

By 1991, Nike had become the world's first sports and fitness-equipment company to sw·pass $3 billion in total revenues. The year J 992 saw the opening of the first Niketown in Chicago. Niketown was a specialized store showcasing the different products developed by Nike over the years. Nike Asia was fot1'l'led in 1997. In 1999, tbe company embarked on a huge IT project to implement a new supply chain system and several new applications in Customer Relations Management (CRM). The new system experienced teething troubles, causing Nike to experience some problems in the fiscal year ended May 200 I. However, the company made necessaiy modifications to bounce back and regain its position as tbe number one sports goods manufacturer in the world. In the fiscal year ended May 2003, Nike's revenues exceeded $ 10 billion . (Refer Exhibit-II for Income Statement).

NEW SYSTEM'S TEETHING TROUBLE S

Nike built its original demand management system in the mid-1980s, as it moved towards becoming the number one sports shoes retailer ii n tbe world. During that period, Nike had also b·emendous ly increased the number of its man u fact11ring units around the world. The demand management system was designed and implemented by over one hundred information specialists within the company.This system was designed to run the Futures program inhuduced by Nike in the 1970s, which was supposed to help Nike manage invento1y more effectively. Under this system, Nike's retail partners placed orders with the company six months before the required delive1y date.These orders were then forwarded to the manufactu1ing units around the world .

The system worked well enough in the initial years. However, as Nike grew, it found that the system was not equipped to deal with the increasingly complicated operations. The number and complexity of orders began increasing at a very fast pace and the length of the product line also increased tremendously. Manufacturing of products also became very com plicated and some of the populru·models like the A ir Jordan sneaker requi red over 130 individual steps to manufacture. ln the meantime, the company had also entered into conh·acts with several new manufacturers, all of whom had to be incorporated into the system . To deal witb the increased scope of operations, the system was constantly modified over the years by Nike's in-house technicians.The programmers made thousands of adjustments to accommodate busier manufactuiing schedules, tighter shipping dates, and growth in the consumer list. These constant adjustments made the system more complicated and susceptible to breakdown. "It's been modified thousands and thousands of times. These Little arcane changes had to create seiious prob lems as Nike moved to a whole new system,"said one former employee of Nike12•

In 1999, Nike embarked on an IT project that involved the creation of a new supply chain system that was more suitable to the requirements at hand . The IT overhaul was designed to sb·eamline communications with buyers and suppliers and lower operating costs. The supply chain project was clubbed with CRM applications that would help take orders from customers and other systems of inventory management. The company expected the new supply chain system to reduce orde1to delivery time by about 50 percent. Nike contracted i2, to install the main system, and SAP AG and Siebel Systems Inc. for the other CRM applications. The enti re project, which was to take five years to complete, was estimated to cost $400 million, of which the price of i2's software was $40 million. In implementing the system however, Nike refused to use the templates and methodology developed by i2, prefeffing instead to customize the system to match its existing demand management software. Therefore, the new system was customized to accommodate the eccenh·icities of the oiiginal system . This customization and modification slowed down the new application considerably and made it more complicated to use. A nalysts said that these modifications resulted in users waiting as long as ;three minutes for a single screen to load.

In addition to this, increased employee turnover also harmed the project. For instance, the CIO involved in the decision to initiate the supply-chafo renovation left the company before the system was properly installed.The company also did not use third patty integrators to help implement the software and bad trouble integrating the new system with the company's processes and with the SAP software being implemented simultaneously.

In 2000, when the project was only a year old, Nike began using it to send orders to its manufacturers in the Far East. However, because the system was not completely developed, the glitches led Nike to overestimate demand for some shoes while underestimating demand for others, creating major invento1y problems.The system sent flawed data to the manufachJrers in the Far East, causing some of them to receive double orders for the same shoes and not enough orders for other, sometimes more popular models. "The solution wasn't stable at the time they slatted using it,"said Katrina Roche (Roche), i2's chief marketing officer13

By late 2000, it was discovered that Nike's manufoctu1ing units were producing too many shoes of ce1tain models and not enough of others. Therefore, the com pany was also not in a position to meet retailers' demands for some fast selling models. Nike and i2 staffers soon tracked down the problems and developed ways to get around them,either by changing operational procedures or by writing new softwa re. However, by the time the problems were tracked and rectified, it was too late and Nike found itself with serious inventory problems on ha nd. In early 200 I, Nike warned that "complications"caused by the implementation of the i2 software had led to product sho1tages and excesses as well as late deliveiies. Soon after that,Nike posted a profit of $ 97 million for the third quaiter ending in Februruy.This was almost 24 percent lower than what was estimated earlier.The prices of Nike shru·es also fell shru"Ply, sending investors into frenzy.

THE CONSEQUENCES OF THE BREAK DOWN

The breakdown of the new system had several adverse consequences on Nike. It u pset the supply chain system and caused the company to be bogged down by a large number of unpopular models, while not having enough of the popular ones. Not being able to cater to the market demands, Nike's reputation suffered and it lost considerable market share to rivals like New Balance and Reebok. New Balance especially gained on Nike in market share. In retail-dollar sneaker sales, New Balance went from less than four percent market share in the first quarter of 1999 to over nine percent in the same quarter of 2000. During that period, Nike's share dropped from over 48 percent to about 39 percent. (Refer Exhibit-Ill). "For some reasoa, Nike took its eye off styling content and, when added with these inventory problems, that has cost the company not only market share but valuable shelf space,"said Wells Fargo Van Kasper analyst John Shanley.14

The huge number of unpopular models manufachtred had to be sold at highly discounted prices, resulting in a decline in profits for the company. When the scarcity of popular models was discovered, the company had to get them manufactured very rapidly and ship them to retailers to meet at least part of the demand.Consequently, the company incurred additional shipping costs as it had to airfreight the shoes at a cost of $4 to $8 a pair compared with about 75 cents by sea. The liq uidation of the excess inventory took Nike six to eight months. The delay in shipping the shoes also soured relations between Nike and several of its major retailers. Footlocker, the biggest retailer of Nike shoes in the US, reduced the shelf space allotted to Nike in all its stores. fn addition, it also began selling several Nike shoes at less than half the marked price to liq uidate excess slow moving inventory soon after the suppl y chain fiasco. Footlocker also entered into several lucrative contracts with Nike's rival New Balance.

Nike laid the blame on i2 saying that the company failed to provide quali ty service. The supply­ chain software was supposed to reduce the amount of rubber, canvas and other materials that Nike needed to produce its shoes. It was also supposed lo help Nike bui lt more of the shoes customers wanted and fewer of the ones they did not. Paradoxically , Nike was left with far too many of the wrong shoes and not nearly enough pairs of its hottest sellers. Nike maintained that i2 did not deliver the functionality that it promised to deliver and that the defective software provided by the company was entirely to blame for the delivery of wrong orders that led to the under­ manufacturing of some models and the over-manufacturing of others. Officia ls at i2, however, said that Nike did not implement the software properly.They claimed that the applications generated bad data because Nike refused to use standard templates and modified the applications in an indiscriminating manner. "We recommend that customers follow our guidelines for implementa.tion--we have a specific methodology and templates for customers to use--but Nike chose not to use our implementation methodology," said Roche.15

Analysts opined that another important reason for the failure was that neither Nike nor i2 brought in a third-party integrator.The Nike supply planning application had replaced an older application that did not meet the requirements any longer. However, the application was implemented in a h urry by the Nike staffers and the i2 consultants. Neither Nike nor i2 thought of using a third-party integrator to adapt the systems to the organizational processes . Analysts felt that using a third­ party integrator was of critical importance, especially in large scale projects like the one at Nike. A neutral third-pa1ty perspective from an integrator would have exposed flaws in the project, which might have been overlooked by people closely involved with it. Analysts also felt that both Nike and i2 moved too fast without taking the appropiiate cautionary measures. They also did not test the system, which would have revealed the glitches at a much earlier stage. Fwther, Nike extended the new system to its thousands of dispersed suppliers and dish·ibutors simultaneously. Analysts felt that a piecemeal implementation of the system would have reduced the magnitude of the problem considerably.

Another problem was that Nike implemented two major projects simultaneously. Both projects (supply chain and CRM) were company-wide initiatives and had to cover the large number of suppliers and customers who interacted with Nike. Each project by itself would have been difficult to implement, but Nike took u p both of them simultaneously, creating unnecessary complications for itself in the bargain .i2 was also relatively inexpeiienced in providing .supply chain software for the apparel industry . It had earlier worked with Dell Com puter Corporation '6, 3M 17, and other manufacturers and helped them garner considerable cost savings. However, Nike was the first apparel compa ny that it worked with, therefore, it was not prepared to dea.I with the dynamics of the apparel indust1y."The biggest lesson we learned was that we need to have more communication with the customer before we begin designing the supply-chain software," said Pallab Chatterjee, president of solutions operations at i2."We're su pply-chain experts, not shoe experts."18 Piene Mitchell, an analyst at AMR Research, suggested that the blame rested partly with Nike's control systems. "Phil Knight makes it sound like it's a surpiise to him," he said. "If he doesn't have checkpoints for these kinds of projects, i f be doesn't know where $400 million of his company's money is going, then he doesn't have control of his company."19

CONCLUSION

Both, N ike and i2 came out the worse for the supply chain failure.Analysts felt that, the negative publicity and the washing of dirty linen in pu blic affected both companies even more adversely than the monetary losses and the production complications.However, Nike continued to work with i2 on the five-year long project and by the end of 2003 (the proj ect was to end in mid-2004), had made considerable progress. ln September 2003, the company announced that its ability to closely monitor the movement of goods from raw materials through factories to retailers was fina lly paying off.

By 2003, Nike had managed to reduce its inventory levels and boosted gross margins and profits. In the quarter ending August 2003, the company obtained gross margins of 43 percent, which was up from 41 percent in the same quaiter the previous fiscal. The implementation of the new system also helped Nike streamline its orders for footwear. According to a report by BusinessWeek, a leading business magazine, before the new system was implemented, about 30 percent of the total volume of Nike's footwear orders was based on speculation and guesswork. By the end of 2003, when the system was over 75 percent complete, the orders based on speculation had reduced to just three percent. The futures orders had also in.creased by 10 percent over the previous year in mid-2003.Analysts expected Nike to benefit fu1ther after the project was fully functional.

Read “It's Time for Principles-Based Accounting Ethics” which can be accessed through the DeVry online library. In 3-4 pages (12-pt type, double-spaced) answer the following questions:

Do you agree with the authors that a code of ethics should do more than establish minimum acceptable standards? Why or why not?

Describe the five cardinal virtues of professional accountants that the article’s authors discuss.

We’ve talked about rules-based versus principles-based accounting standards. Should we have rules-based ethics standards? Why or why not? Should they tell you exactly what to do in specific ethical situations?

Compare and contrast the AICPA’s Code of Professional Conduct and the IFAC Code of Ethics for Professional Accountants.

This has had the advantage of providing clarity to accounting professionals, as well as a precise standard of care that has served in the defense of accountants and managers when they have been sued by plaintiffs charging them with accounting negligence. Detailed accounting protocols have not served the profession or its stakeholders well in the long run. Corporate managers have honed their skills at finding and using loopholes and technical exceptions to complex rules, so they have been able to finesse the rules and augment their financial results. The result has been financial statements that comply with the technical rules of GAAP, but do not provide a fair representation of the corporation or other economic entity. This, in turn, has served to camouflage problems at reporting entities, until those problems become so large that the entity itself is swallowed up by them. And so the drive toward principles-based accounting standards, as part of the convergence of U.S. GAAP and iGAAP is, in part, an effort to improve financial reporting in the United States and elsewhere. Principles-based accounting is intended to allow reporting standards to be more closely aligned with the objectives of financial reporting, such as relevance and usefulness. They are intended to be based on a carefully crafted and consistently applied conceptual framework that minimizes exceptions and avoids loopholes. An appropriate amount of implementation guidance is necessary and expected, within the principles-based approach, but a balance is sought between generalized and abstract concepts, on one hand, and very specific, almost mechanical, rules, on the other (Benston et al. 2006). Along with the movement from rules-based accounting standards to principles-based accounting standards, there is an opportunity for the accounting profession in the United States to improve its ethical standards. In fact, the AICPA has committed to conforming its Code of Professional Conduct to an international Code of Ethics for Professional Accountants, but has yet to complete that project (AICPA 2008a). Just as academic research has served to enliven and assist the discourse among accountants and their constituents in the area of convergence of financial reporting standards (Fu¨lbier et al. 2009), we offer some suggestions to enhance the ethical standards of the accounting profession. The AICPA’s Code of Professional Conduct The AICPA is the national professional organization of certified public accountants in the United States. Its code of conduct serves as the ethical standard for purposes of selfregulation within the profession. The AICPA code consists of a set of principles and a set of rules (AICPA 2008a). Each will be discussed briefly in the following. It should be noted, however, that the bylaws of the AICPA require that members adhere to the rules, but not the principles. Principles The principles section sets forth the objectives of the code in somewhat lofty, if not compulsory, language. It is suggested, for example, that accountants should ‘‘exercise sensitive professional and moral judgments in all their activities,’’ and should seek to ‘‘continually demonstrate their dedication to professional excellence.’’ Service to the public trust ‘‘should not be subordinated to personal gain an advantage,’’ and members should ‘‘maintain objectivity and avoid conflicts of interest.’’ Other ideals, such as competence, cooperation with other members of the profession, and self-governance, are also commended. Although some of the text of the principles section includes language that seems to be mandatory and authoritative, such as the assertion that integrity requires AICPA members to be honest and candid within the constraints of confidentiality, the principles themselves are nonbinding. Rules There are eleven rules of the AICPA code, and most of the rules are supported by interpretations. The AICPA also provides short hypothetical ethics rulings that serve to provide additional interpretation. Some of the rules are relatively brief, and can only be understood by reference to the AICPA interpretations. Rule 101—Independence simply requires that accountants maintain independence from their clients when performing such attestation services as audits or reviews. The AICPA interpretation 101-1, however, is a complex and lengthy document that details such relationships as immediate family and close relatives (for example, grandparents are and domestic partners are included, but aunts, uncles, cousins, and in-laws are not). It prescribes those circumstances in which an accountant may own or hold one share of stock in the firm’s attestation client, and when he or she may not. Rule 101 is further bolstered by a separate ‘‘conceptual framework’’ document that prescribes procedures for gauging independence in situations where the interpretation provides insufficient guidance. Rule 501—Acts Discreditable is another very short rule backed up by various interpretations and rulings. The rule simply requires that AICPA members not commit an act ‘‘discreditable to the profession.’’ The term ‘‘discreditable’’ is not defined, but the interpretations of Rule 501 provide examples of such acts. For example, interpretation of 501-1 is a lengthy set of instructions pertaining to how accountants ought to respond requests by clients and former clients for records. The interpretation provides, among other things, that client records prepared by an accountant should 50 A. D. Spalding Jr., A. Oddo 123 be provided to the client, unless there are fees due to the accountant. Unfortunately, some accountants have from time to time been tempted to increase their final fees charged to a departing client, and then hold the client’s records ransom. For all its detail, the interpretation 501-1 encourages, rather than discourages, this type of ‘‘discreditable’’ behavior. Other rules are poorly drafted. Rule 102—Integrity and Objectivity, for example, mandates that AICPA members ‘‘shall be free of conflicts of interest.’’ In fact, accountants face conflicts of interests nearly every day of their working lives, and are required to navigate those conflicts in a way that optimizes their professionalism. Unfortunately, the AICPA code does not provide insight or guidance in regard to this necessity. Similarly, the same rule prohibits members from subordinating their judgment to others (except, presumably, the requirements of the AICPA and other authoritative bodies affecting the work of the accountant). The idea of honesty is also clumsily addressed. Rule 102 establishes a very low ethical watermark by requiring that AICPA members ‘‘not knowingly misrepresent facts.’’ Of course, dishonesty and deceit is not limited to outright lies. On its face, this rule leaves open the possibility of misleading others by omission, deliberate vagueness, circumlocution, or purposeful efforts to confuse without outright misrepresentation. Oddly, Rule 502—Advertising sets a higher standard than does Rule 102. There, accountants are prohibited from advertising ‘‘in a manner that is false, misleading, or deceptive.’’ As written, the code holds accountants to a stricter standard of honesty in their advertisements than in their work and other communications. The AICPA code has come under other criticism as well. Neill et al. (2005), for example, suggested that the enforcement of the code was ineffective because it was largely dependent on grievances filed by clients, former clients, and other accountants. As a result, no comprehensive system is in place to assess whether members are acting in compliance with the code. The lack of compliance assessment by the AICPA (or third parties) not only weakens the effectiveness of the code in transforming the professional behavior of accountants but also deprives the public from access to data regarding whether AICPA members are complying with the code. These criticisms remain relevant today. Through its enforcement process, the AICPA investigates members who are accused of violating the code and imposes sanctions as it deems appropriate. Sanctions range from the assignment of required ethics education, to a temporary suspension of membership, to a termination of membership. If, for example, a member has been disciplined by a governmental agency or other organization that has oversight authority (such as the Securities and Exchange Commission, or the Public Company Accounting Oversight Board), the AICPA routinely takes action to sanction that member by requiring ethics education or by suspending membership. If a complaint is filed against the member by a client, another accountant, or third party, the AICPA joint ethics enforcement panel and joint trial board will conduct an investigation to determine whether similar sanctions should apply. As Neill et al. (2005) observed, the AICPA maintains a peer review process whereby accounting firms visit each other and assess the quality of each other’s work. However, the subject matter of this review process is limited to quality control concerns in regard to compliance with technical accounting standards. Ethical problems, and its risks of potential ethics violations, are not explicitly addressed. The IFAC Code of Ethics for Professional Accountants The International Federation of Accountants (IFAC) includes 157 accounting organizations from 123 countries and jurisdictions worldwide. IFAC develops and promotes highquality international accounting standards and facilitates collaboration and cooperation among its member bodies. The IFAC maintains an International Ethics Standards Board for Accountants (IESBA) as an independent standard-setting board. The IESBA has recently established a Code of Ethics for Professional Accountants (IESBA 2009). The IESBA develops ethical standards and guidance for use by all professional accountants under a shared standard-setting process involving the Public Interest Oversight Board, which oversees the activities of the IESBA, and the IESBA Consultative Advisory Group, which provides public interest input into the development of the code. Some jurisdictions may have requirements and guidance that differ from those contained in the IFAC code. Professional accountants in those jurisdictions are required to comply with the more stringent requirements and guidance unless prohibited by law or regulation. The code contains three parts. Part A establishes fundamental principles of ethics for professional accountants and provides a conceptual framework that professional accountants shall apply to: • Identify threats to compliance with the fundamental principles • Evaluate the significance of the threats • Apply safeguards to eliminate or reduce threats Safeguards are necessary when the professional accountant determines that the threats are not at a level at which a reasonable and informed third party would be likely to conclude, weighing all the specific facts and circumstances available to the professional accountant at that time, that compliance with the fundamental principles is not compromised. It’s Time for Principles-Based Accounting Ethics 51 123 Parts B and C of the code describe how the conceptual framework applies in certain situations. They provide examples of safeguards that may be appropriate to address threats to compliance with the fundamental principles. They also describe situations where safeguards are not available to address the threats, and consequently, the circumstance or relationship creating the threats should be avoided. Part B applies to professional accountants in public practice. Part C applies to professional accountants in business. Professional accountants in public practice may also find Part C relevant to their particular circumstances. The IFAC code establishes ethical requirements for professional accountants and provides a conceptual framework for all professional accountants to ensure compliance with five fundamental principles of professional ethics. Under the IFAC framework, all professional accountants are required to identify threats to these fundamental principles and, if there are threats, apply safeguards to ensure that the principles are not compromised. A member body of IFAC, such as the AICPA, may not apply less stringent standards than those stated in the IFAC code. Fundamental Principles The IFAC code requires that a professional accountant shall comply with the following fundamental principles: Integrity To be straightforward and honest in all professional and business relationships. Objectivity To not allow bias, conflict of interest, or undue influence of others to override professional or business judgments. Professional competence and due care To maintain professional knowledge and skill at the level required to ensure that a client or employer receives competent professional services based on current developments in practice, legislation, and techniques and act diligently and in accordance with applicable technical and professional standards. Confidentiality To respect the confidentiality of information acquired as a result of professional and business relationships and, therefore, not disclose any such information to third parties without proper and specific authority, unless there is a legal or professional right or duty to disclose, nor use the information for the personal advantage of the professional accountant or third parties. Professional behavior To comply with relevant laws and regulations and avoid any action that discredits the profession. Conceptual Framework Approach The IFAC code establishes a conceptual framework that requires a professional accountant to identify, evaluate, and address threats to compliance with the fundamental principles. The conceptual framework approach assists professional accountants in complying with the ethical requirements of the code and meeting their responsibility to act in the public interest. It accommodates many variations in circumstances that create threats to compliance with the fundamental principles and can deter a professional accountant from concluding that a situation is permitted if it is not specifically prohibited. When a professional accountant identifies threats to compliance with the fundamental principles and, based on an evaluation of those threats, determines that they are not at an acceptable level, the professional accountant shall determine whether appropriate safeguards are available and can be applied to eliminate the threats or reduce them to an acceptable level. In making that determination, the professional accountant shall exercise professional judgment and take into account whether a reasonable and informed third party, weighing all the specific facts and circumstances available to the professional accountant at the time, would be likely to conclude that the threats would be eliminated or reduced to an acceptable level by the application of the safeguards, such that compliance with the fundamental principles is not compromised. A professional accountant shall evaluate any threats to compliance with the fundamental principles when the professional accountant knows, or could reasonably be expected to know, of circumstances or relationships that may compromise compliance with the fundamental principles. The following illustration outlines the conceptual framework approach. Conceptual Framework Identify threats to fundamental principles Evaluate the threats Apply safeguards to eliminate or reduce threats 52 A. D. Spalding Jr., A. Oddo 123 Revised Code The IESBA has issued a revised Code of Ethics for Professional Accountants, clarifying the requirements for all professional accountants and significantly strengthening the independence requirements of auditors. The revised code has been released following the consideration and approval by the public interest oversight board (PIOB) of due process and extensive public interest consultation. The revised code, which is effective on January 1, 2011, includes the following changes to strengthen independence requirements: • Extending the independence requirements for audits of listed entities to all public interest entities • Requiring a cooling off period before certain members of the firm can join public interest audit clients in certain specified positions • Extending partner rotation requirements to all key audit partners • Strengthening some of the provisions related to the provision of nonassurance services to audit clients • Requiring a pre- or post-issuance review if total fees from a public interest audit client exceed 15% of the total fees of the firm for two consecutive years • Prohibiting key audit partners from being evaluated on or compensated for selling nonassurance services to their audit clients The revised code maintains the principles-based approach supplemented by detailed requirements where necessary, resulting in a code that is robust but also suffi- ciently flexible to address the wide-ranging circumstances encountered by professional accountants. The International Federation of accountants’ statements of membership obligations have as a central objective the convergence of a country’s national code with the Code of Ethics for Professional Accountants. Furthermore, the requirements specify that member bodies should not apply less stringent standards than those stated in the code. Virtues as Ethical Principles Both the AICPA and IFAC codes contain ethical standards, but the content of the latter is more principles based than that of the former. In regard to honesty, for example, Rule 102 of the AICPA code prohibits intentional misrepresentation. This rule begs the interpretation of the extent to which actions are ‘‘willful,’’ and the extent to which actions constitute ‘‘misrepresentation.’’ The emphasis is on the element of wrongdoing associated with behavior of the accountant. To determine whether an accountant has violated Rule 102, it becomes necessary to examine whether a specific statement made by the accountant constitutes a willful misrepresentation. Section 110 of the IFAC code, by comparison, brings more focus to the character of the professional accountant as a person. Honesty is associated with ‘‘straightforwardness.’’ Accountants are prohibited from being associated with reports, returns, communications, or other information that contains statements or information furnished recklessly, or omits or obscures information in a way that would be misleading. In other words, the emphasis is on the accountant’s responsibility for the overall quality of his or her work. Each of these two codes also provides a different approach to conflicts of interest. Rule 102 of the AICPA code states that accountants shall be free of conflicts of interest when rendering professional services. To make any practical application of this part of Rule 102, the definition of ‘‘conflict of interest’’ must be so circumscribed and limited that it does not take into account the complexity of commerce in the twenty-first century (or the even greater complexity of the accounting discipline within a globalized society). Some readers of the AICPA code, who are mindful of the fact that auditors are usually compensated by their own audit clients, may reasonably conclude that the profession’s notion of conflict of interest is driven by its own myopic manner of defining its code language. The IFAC offers no pretense about the fact that accountants are then faced by a myriad of real or potential conflicts of interest in many circumstances. The IFAC code does not prohibit the existence of conflicts of interest or undue influence. Instead, it requires that accountants not allow conflicts of interest, undue influence of others, or even their own personal bias to override professional or business judgments. This is a more realistic standard that speaks to the professional accountant as a person, and challenges the accountant to rise above the realities of such conflicts. Among the differences between the AICPA code and the IFAC code is a greater emphasis, within the latter, on those qualities and behavior patterns that characterize the ‘‘ethical accountant.’’ Such virtues as honesty and integrity are described in greater detail, and held out as the ideal ethical standards to which accountants ought to aspire. The IFAC code tends to point toward the highest levels of excellence and professionalism, rather than to simply delineate minimally acceptable ethical standards. This emphasis on personal character is consistent with the ‘‘virtue theory’’ approach to business and professional ethics that has gained greater currency in recent years. As Whetstone (2001) notes, moral philosophizing during the last half century or so has tended to focus either on actoriented theories (such as the consequentialism of Bentham’s utilitarianism and the deontology of Kant’s rational It’s Time for Principles-Based Accounting Ethics 53 123 ethics) or on virtue-oriented theories. When applied, the former focuses on normative rules, whereas the latter tends to result in the articulation of ethically optimal habits and characteristics. Whetstone suggests that both are important, but that principles-based ethics (PBE) has the advantage of emphasizing the promotion of virtuous judgment. Dawson and Bartholomew (2003) expand on Whetstone’s approach by suggesting that an important role of business ethics generally, and codes of conduct in particular, is the promotion of those virtues that, in turn, foster human flourishing. Bertland (2009) offers an additional insight by taking into account the extent to which the advocacy of virtues, and virtuous judgment, can not only promote human flourishing in general but can also enhance the use of human capabilities in particular. Indeed, some have argued that it is the cultivation of character or virtue that is a precondition to any reasonable expectation that rules would be respected and understood as minimum standards of behavior (Arjoon 2000). That is, in part, because virtue ethics emphasizes both behavior and motives, rather than behavior in isolation from motives (Blackburn and McGhee 2004). Here, we consider the implications of this emphasis on virtue-oriented PBE on the professional ethics of accountants. We draw from traditional concepts of Aristotelian virtue theory. As Graafland (2010) explains, virtues, under this classical view, are habits of character that constitute a ‘‘golden mean’’ between the vices of deficiency, on one hand, and excess on the other. For example, the Aristotelian virtue of courage represents an optimal balance between its deficiency (cowardice) and its excess (recklessness, boorishness, or overconfidence). The proper roles of ethical epistemology and the development of ethical protocols (such as codes of conduct and codes of ethics) are to enhance such virtues and move them to higher levels of excellence and prudence. The intellectual project of virtue ethics is the identification of the most desirable virtues, as well as the development of disciplines and habits that will foster such virtues. The bell curve in Fig. 1 depicts the optimization of virtues and the block arrow represents the development of skills and disciplines that foster such virtues. Ethical rules, by comparison, tend to delineate the vices. To the extent that codes of conduct establish the boundaries between acceptable and unacceptable behavior, they emphasize the negative. That is, they emphasize the crossover point at which behavior becomes impermissible. The intellectual project of rule making is the identification and justification of such crossover points. Figure 1 depicts this tension and interaction between rules and virtues. The vertical lines represent the rules, or boundaries, beyond which an accountant’s actions are ethically unacceptable. They are the outer limits of allowable behavior. Virtues are those habits and characteristics that result in actions at or near the midpoint between the two extremes. Virtues are enhanced, or made more excellent, by disciplines such as ethical ‘‘best practices’’ that foster ethical habits. Codes of conduct can focus on the rules that delineate acceptable behavior, or they can emphasize the cultivation of virtues. Five Cardinal Virtues of Professional Accountants If both the AICPA and the IFAC codes are examined through the lens of virtue ethics, five ‘‘cardinal virtues’’ for professional accountants seem to emerge. These are integrity, objectivity, diligence, loyalty, and professional behavior. All five of these virtues are addressed in the ‘‘Principles of Professional Conduct’’ that comprise the preamble to the rules of the AICPA code of conduct. As noted above, this preamble is not employed or enforced as part of any disciplinary self-regulation by the AICPA. These five virtues are reflected to some extent in the rules themselves, but only in terms of minimum standards. They are more clearly articulated in the IFAC code, which is generally organized around them. Integrity As used within the context of the accounting profession, the concept of integrity has two elements: honesty and courage. Accountants are communicators: They communicate information derived from data with which they work. For this reason, accountants must be truth tellers first and foremost. This requires not only competence in truth seeking but also courage in the telling of truth. One of the greatest temptations faced by accountants, or any other communicators of information, is the temptation to discount, exaggerate, or otherwise mold the communication process so as to please (or, at least, to avoid displeasing) the receiver of the information. As described earlier, the critical element of truth telling is poorly articulated in Rule 102 of the AICPA code. To Fig. 1 Virtue as the development of excellence establish a standard of honesty that is limited to the 54 A. D. Spalding Jr., A. Oddo 123 avoidance of willful misrepresentation is to overlook the critical role that honesty plays within the accounting discipline. To be fair, some of the AICPA’s interpretations of Rule 102, and some other pronouncements by the AICPA, expand the notion of honesty beyond this minimal threshold, but the rule itself is largely unhelpful as a standard that encourages optimal honesty by accountants. As also described above, the IFAC code, like the preamble to the AICPA rules of conduct, does a better job of articulating what it means for an accountant to strive for optimal, if not absolute, truth telling in his or her professional work. As a virtue, integrity in the telling of truth requires a balance. Often, the vice of dishonesty results in misleading, if not false, financial information. But there can be too much information disclosed by an accountant. For example, the duty of confidentiality in regard to trade secrets and other information properly owned and protected by an employer or client must not be disclosed. For the professional accountant, the finding of a proper balance between transparency and improper disclosure requires a certain amount of skill and wisdom. Objectivity To be objective is to acknowledge that there is an external standard by which one measures his or her work or communication. Within the accounting discipline itself, for example, the objective standard for financial reporting is a ‘‘fair representation’’ of the economic activities of a particular business or other organization. Accounting standards serve as the objective principles by which the quality, reliability, and usefulness of financial reports are measured. Compliance with such standards is not only a technical issue but also an ethical issue: Accountants who attest that their work comply with such standards are making a claim that has both technical and ethical content. The ethical content is the assurance that their work is consistent with those standards, at least to the best knowledge and belief of the accountant. The AICPA code does not define objectivity per se, but it requires that conflicts of interest be avoided, and that the judgment of accountants is not subordinated to others. Presumably, this latter requirement means that judgment is not subordinated to others, except to comply with such external standards as GAAP and IFRS. This is separately addressed in Rule 202—Compliance with Standards, and Rule 203—Accounting Principles of the AICPA code. Similarly, Sect. 120 of the IFAC code avoids any definition of objectivity, but acknowledges that the principle of objectivity imposes an obligation on all professional accountants not to compromise their professional or business judgment because of bias, conflict of interest, or the undue influence of others. Professional judgment allows, and sometimes requires, an accountant to supplement, modify, or even deviate from, financial accounting standards, in appropriate circumstances. These departures from established standards must be disclosed in the interest of transparency, but the fact that such departures can occur shows that objectivity in accounting means more than mere compliance with accounting standards. It demonstrates that financial accounting strives to meet an ideal that is largely but not entirely articulated within the standards. By striving to find an optimal balance between noncompliance with standards and legalistic over-compliance with standards, the accountant is exhibiting true objectivity. Diligence In accounting, diligence is expressed mostly by the virtue of truth seeking. Accountants cannot be effective truth tellers unless they are truth seekers. This requires an intention as well as the skills to implement the intention. Mere curiosity will not suffice, nor will mere data gathering without an alert and informed focus on the purpose of the data gathering. Accountants must be aware of, and must be ready to identify, sort, prioritize, and address, red flags that signal potential weaknesses, fraud, or other problems within an accounting information system. In the AICPA code, diligence is addressed in Rule 201—General Standards, wherein accountants are required to ensure that their work reflects professional competence, due professional care, planning and supervision, and the gathering of sufficient relevant data. Section 130 of the IFAC code, similarly, details the concepts of professional competence and due care by emphasizing such qualities as professional knowledge and skill, sound judgment, thoroughness, timeliness, carefulness, and transparency in the performance of accounting services. Prudence in the area of diligence requires that accountants avoid both negligence, on one hand, and obsessive perfectionism, on the other. Accounting is an art, not a science, and it is an art that must be practiced within the confines of the marketplace. For example, there can be no such thing as a ‘‘perfect’’ financial audit, if for no other reason than the reality that the market (that is, the audit client) will not pay for an audit that is guaranteed to uncover every possible defalcation, departure, or defi- ciency within an accounting system. And so the notion of diligence requires the seeking of an Aristotelian Golden Mean between competency and overkill. Loyalty For professional accountants, loyalty involves a balance between faithfulness to an employer or client, on one hand, It’s Time for Principles-Based Accounting Ethics 55 123 and to society on the other. Loyalty to the client or employer most often includes the necessary maintenance of confidentiality of information about that client or employer. Although most legal jurisdictions do not provide for an accountant–client (or accountant–employer) privilege similar to that of physician–patient, lawyer–client, or clergy–parishioner, the premise behind the duty of confi- dentiality is similar to the reasoning behind these privileges. That is, an accountant must have the complete confidence of his or her employer or client, to promote communication between them. As noted above, the work of the accountant is as much about truth seeking, as truth telling. The truth-seeking function necessitates that barriers be removed in the discourse between the accountant and his or her employer or client. The duty of confidentiality, articulated in a similar manner in both the AICPA and IFAC codes (as well as in statutes and court cases in many jurisdictions), supports this openness of communication between the accountant and his or her employer or client. In addition to a duty of loyalty to his or her client, the professional accountant owes a larger duty of loyalty to society as a whole. That is because many tasks of professional accountants involve financial statements, tax returns, or the providing of other information that is used by investors, creditors, employers, consumers, government entities, and other stakeholders and elements within society. To some extent, this duty to the public is often met as long as the accountant maintains integrity, objectivity, and diligence. That is, telling the truth is not inherently wrong or unethical, unless that telling discloses confidential information. And so the protection of confidential information, out of loyalty to employer or client, can sometimes be harmful to society. A tax return that fails to disclose taxable income, financial statements that fail to disclose related party transactions, and any number of other circumstances can become the fulcrum in the balancing of the accountant’s loyalties. To assist with the balancing of these interests, both the AICPA and the IFAC codes permit the duty of confidentiality to be set aside in some circumstances, such as when an accountant responds to a court subpoena or testifies in open court under oath. The IFAC code, in addition, offers guidance for the accountant to use in deciding whether to disclose confi- dential information, taking into account the interests of all parties, the type of communication involved, and the extent to which parties to whom the communication is addressed are appropriate recipients. Professional Behavior Trustworthiness is a key foundation for any ethical system (Schwartz 2002), and it can be argued that the overriding meta-virtue for accountants is trustworthiness. Each of the four preceding virtues supports the trustworthiness of the accountant, and generally pertains to the accountant’s work as such. Accountants who maintain integrity, objectivity, diligence, and a proper notion of loyalty can be, and are, more readily trusted than accountants who do not develop, maintain, and optimize these virtues For accountants who are engaged in attestation services, such as audits and reviews, the appearance of independence from the client is necessary for the accountant to have the credibility required to render an opinion. An accountant might be honest and loyal and diligent, but if those who might rely on his or her opinion find it difficult to believe in the accountant’s honesty, loyalty, objectivity, or diligence, because of the accountant’s closeness or relationship with the client, the virtuousness of the accountant will not matter. The accountant’s opinion will not carry the weight and impact, even if it is correct and proper. The AICPA has expended a great deal of time and effort developing rules regarding independence. The AICPA code requires that accountants who work on attestation engagements must be independent in the performance of those services as required by standards promulgated by the AICPA and other authoritative bodies. This simple onesentence requirement is supported by 15 interpretations composed of more than 18,000 words, and further supported by a ‘‘conceptual framework’’ document that is intended to cover situations not sufficiently or specifically addressed by the interpretations. All of this is in support of the notion that even if an accountant is capable and willing to perform services objectively and with the highest integrity, an impression of a lack of independence, created by too much relational proximity to the client, can sabotage the credibility of the accountant and the attestation engagement. In this regard, the appearance of independence is important, but it is as much impression management as it is ethics. This may help to explain why the IFAC addresses independence for audit and review engagements, and for other assurance engagements, separately from its articulation of fundamental principles of ethics for professional accountants. This fifth virtue of professional behavior also adds to the preceding four by directly pointing to the overall character of the individual. An accountant may, for example, perform his or her work in a manner that is entirely consistent with these virtues, but may not be considered trustworthy because he or she engages in activities that discredit him or her, and/ or the profession. Accountants who do not take care to file their own tax returns, for example, or accountants who make exaggerated claims for the services they are able to offer, may actually perform good work, but nevertheless engender a lack of trust and credibility. The AICPA code addresses this concern by simply prohibiting the committing of any act discreditable to the profession. The term ‘‘acts discreditable to the profession’’ is not defined in the code, but that 56 A. D. Spalding Jr., A. Oddo 123 prohibition, found in Rule 501, is supported by various interpretations that serve as examples of such discreditable acts. Section 150 of the IFAC code takes a similar approach, requiring that professional accountants not bring the profession into disrepute. Trustworthiness is inevitably determined by others. John may try to assure Sally that he is trustworthy, but at the end of the day only Sally can decide whether John is worthy of her trust. Similarly, an accountant may be a truthful reliable good citizen of high character, but this does not guarantee that the accountant is considered credible or trustworthy by every member of society. For this reason, the virtue of professional behavior does not require that accountants live perfect lives that would somehow meet anyone’s standard for professionalism and trustworthiness. It does, however, require that accountants be mindful of their professional reputation, and the credibility of the accounting profession, as they go about their work and their decisions that are likely to reflect on their professionalism. Table 1 summarizes these five cardinal virtues for professional accountants. Each deficiency and excess represents habits and behaviors that violate the ethical principles of the respective virtues. Most of the deficiencies and excesses violate both the AICPA and the IFAC codes. When an accountant does not avoid the deficiencies or excesses associated with each virtue, the accountant is also at risk for violating the CPA licensure regulations of most states. Civil and sometimes criminal liability can also result when an accountant does not avoid these extremes. As noted above, the primary difference between the AICPA code and the IFAC code is that the former focuses on excesses and deficiencies, whereas the latter emphasizes the virtues themselves and the underlying principles represented by those virtues. Moving Toward a Principles-Based Professional Ethics Process Under a rules-based code of conduct, such as the AICPA code, the ethical goals of the organization are promoted through a disciplinary process that pays attention to noncompliance with the rules. Avoiding noncompliance is the primary objective, with the hope that by minimizing noncompliance within the organization, the overall ethos of the profession will be improved. Under this approach, the AICPA, and each of its state associations or societies, maintains ethics panels that receive and investigate complaints about members. If a member is found to have violated one of the ethics rules, that number is warned, chastised, or sanctioned. The IFAC code requires more than mere rule enforcement. In support of the fundamental principles of its code of ethics, the IFAC requires accountants to be aware of circumstances, habits, behaviors, or other conditions that would threaten adherence to the fundamental principles. This conceptual framework is designed to foster more than mere compliance with a minimal set of rules. Instead, it guides the accountant toward the optimal ethical principles that are being sought by the profession and requires the accountant to consider how to improve his or her habits and practices so that they better reflect those principles. The AICPA has adopted this conceptual framework approach, but not in regard to ethical principles. Instead, the AICPA has focused on one rule in particular, Rule 101—Independence and has required that in addition to the 15 interpretations of that rule (described earlier), its members consider risks or threats to independence above and beyond the restrictions set forth in those interpretations. In some ways, this is an unusual application of the threats-and-safeguards approach of the IFAC. That approach is designed to foster continuous improvement toward ethical principles, but it is used by the AICPA as a backup procedure to support a single rule (that, in turn, is less an ethics principle than an impression management protocol). The professional ethics division of the AICPA did propose, in 2007, an interpretation of Rule 102—Integrity and Objectivity, that would require AICPA members to apply the threats-and-safeguards approach to the fundamental ethical principles as found in the preamble to the code (AICPA 2007). In other words, the AICPA attempted to shoehorn the preamble into an interpretation of one of its rules, thereby overriding the organizational bylaws and Table 1 Five cardinal virtues of professional accountants Deficiency Optimal ethical Excess Integrity Misleading statements Honesty and transparency Too much disclosure Objectivity Unreliable statements Fair and reliable representations Rules-based statements Diligence Negligent misrepresentation Statements based on relevant data Excess costs Loyalty Breach of confidentiality Useful work product Too little disclosure Professional behavior Untrustworthiness Credibility Inflexibility It’s Time for Principles-Based Accounting Ethics 57 123 making the preamble enforceable. That proposal was never developed beyond the exposure draft phase, and the exposure draft is still outstanding at this time. In 2008, the AICPA published some threats-and-safeguards guidelines to be considered for the purposes of compliance with Rules 102 through 505 of the code (AICPA 2008b). In other words, having already adopted the conceptual framework approach of the IFAC to enforce its independence standard, the AICPA proffered the same approach to enforce the remaining rules of its code. However, there is one major difference: independence under the conceptual framework is enforceable, whereas the remaining rules of the code are not enforceable, with the conceptual framework serving only as a recommended guide. For this reason, any violations of the guidelines are not investigated or addressed by the ethics disciplinary processes of the AICPA or its affiliated state organizations. Recommendations The AICPA is continually engaged in assessing, developing, and codifying ethics standards, in part to bring its code into closer alignment with the IFAC code. We recommend that the process should rise above prior efforts to adapt the principles-based emphasis of the IFAC code to the rulesbased structure of the AICPA code. To move toward a principles-based code of ethics, the AICPA needs to adopt two fundamental changes: First, define what it means for an accountant to be an ethical professional (that is, by what virtues a professional accountant should be characterized). Second, develop a continuous improvement process that helps accountants to foster those virtues. Recommendations for the former have already been presented above. A recommendation for the latter is discussed next. The ethics panels and disciplinary processes that are in place at the AICPA and its state affiliates continue to be necessary to address the most obvious and worst-case situations involving unethical behavior by accountants. But these damage-control mechanisms, while necessary, are no longer sufficient. The AICPA will need to develop other procedures and processes that serve to foster a revised code of ethics that emphasizes virtues and principles. The notion of helping accountants to identify threats to the highest standards of professionalism is not new within the accounting profession. It already has a peer review system in place, but that peer review system applies only to accounting standards and the quality of accounting services, and not to ethical standards per se. To retain their membership in the AICPA, members who are engaged in the practice of public accounting are currently required to participate in a practice-monitoring program. These peer reviews are not designed to be punitive, but rather to enhance and ensure the quality of the accounting, auditing, and attestation services provided by public accounting firms. These peer review efforts also contribute to the quality and effectiveness of accounting firms. Although independence, integrity, objectivity, and due professional care are required on the part of accountants who participate in peer reviews, adherence to those standards by the firms being reviewed is not explicitly addressed as part of the review process. Firms and individual accountants enrolled in the AICPA peer review program are required to have a peer review of their accounting and auditing practice once every 3 years (AICPA 2009). Peer reviewers within the AICPA peer review system tend to focus on ways in which the reviewed firm can improve the quality of their accounting services. A typical report by such a peer reviewer makes recommendations regarding such matters as how the staff employed by the accounting firm can be trained and supervised better, how the firm’s partners can be more involved in the planning of engagements, or how checklists and other tasks and tactics can be employed to improve the quality of work. These types of suggestions are made by reviewing the firm, irrespective of whether the reviewed firm actually ‘‘passes’’ or ‘‘fails’’ the peer review. This reflects the profession’s emphasis on improvement rather than punishment. We recommend that the accounting profession in the United States develops a peer review process for professional ethics. This process, like the peer review process for accounting standards, should focus on ways in which participating firms can reduce the roadblocks to the development of a highly ethical ethos within the reviewed accounting firm. The threats-and-safeguards language of the IFAC code can serve as a foundation for such a review. Over time, however, a best practices approach could develop guidelines to reduce threats of unethical behavior, and increase the prospects for an ethical culture within accounting firms (and within the profession generally) that more closely reflects the virtues to which the accounting profession continues to aspire. Conclusion In their comparison of the differences between the original 1917 code of conduct and the 1988 version that continues to serve the AICPA today, Preston et al. (1995) noted the increasing specificity and number of rules. They concluded that these rules ‘‘at best regulated minor points of professional conduct,’’ and ‘‘act as a benchmark from which malfeasance may be judged’’ (p. 536). Our current critique of the AICPA code leads us to the same conclusions about the shortcomings of the rules-based approach. A code of ethics should, in our view, do more than establish minimum acceptable standards. As part of their 58 A. D. Spalding Jr., A. Oddo 123 survey of codes of ethics of professional business organizations, Gaumnitz and Lere (2002) considered the role of a code of ethics. In their literature review, they noted the importance of ethics codes in providing guidance for individuals and firms in novel situations, especially when explicit norms and external regulations offer insufficient guidance. For the accounting profession, most licensing jurisdictions and many federal agencies, such as the securities and exchange commission, have rules that establish minimum behavioral requirements. As a common example, these external rules prohibit accountants from knowingly and willfully misrepresenting facts as part of their professional services. And so a professional code of ethics for accountants may properly address such problems as deception and the falsification of accounting information, but it should do more. It should provide guidance for the achievement of the highest ethical standards. In our effort to find ways to improve the AICPA code, we have compared that code of conduct to the Code of Ethics for Professional Accountants as recently amended by the IFAC. This latter code is more principles based, and can serve as a model for the development of a principlesbased code of ethics for U.S. accountants. A truly effective, relevant, and useful code of ethics for professional accountants, in our view, will require both a careful articulation of those virtues or qualities that characterize an ethical accountant or accounting firm and a continual improvement process similar to the peer review system already in place in the U.S. References AICPA. (2007). Exposure draft proposal of professional ethics division: proposed interpretation 102-7, other considerations: meeting the objectives of the fundamental principles, and proposed framework for meeting the objectives of the fundamental principles, pp. 1–12. http://www.aicpa.org/down load/ethics/May_15_2007_Exposure_Draft.pdf. 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