Tony Harris' address to ERBEI Forum, September 2001

Tony Harris

Journalist with the Australian Financial Review, Former NSW Auditor-General

Speech Delivered to Edmund Rice Business Ethics Initiative Forum, September 2001

Introduction

One of the outstanding principles I learned from the Christian Brothers at St Patrick's Strathfield is that gambling on a certainty was unethical.

This principle is another version of the ills of that most popular instrument, a two-headed coin.

A similar ethical issue arises when one party to a transaction seeks to profit from information that is not widely known. Under this principle, a house seller acts unethically by withholding information that is material or would usually be material to a buyer's decision. A stockbroker acts unethically by acting on insider information because he takes advantage of the ignorance of others to deny them benefits or to impose losses on them.

Nothing in the above is particularly extraordinary. These principles reflect long held values of the Australian community. And that is what ethics are. The term comes from the Geek concept that gave us the word ethos or community spirit. Ethics is merely that bundle of rules and beliefs that regulate how the members of a society behave towards each other. And ethics decrees that you should not profit from inside information.

Of course, most business people try to profit from knowledge that has limited circulation, and most business people try to profit from withholding information that is important to customers.

When legislation was introduced in Australia to ban inside trading of stocks and securities, you could hear the anguish of stockbrokers. How does the government think we can make any money if they ban insider trading?

Real Estate agents and developers also know that, from time to time, they can make money by using their professional position and knowledge to profit from a property being sold by a person who is unsure of its value. They can also profit from selling property to a person who has little knowledge of the market. Legislation in Queensland tries to protect people from other states who have a limited knowledge of the market and are too often convinced to buy property that is priced 20 per cent or more above market prices.

The Failure of Ethics

That there continues to be widespread use of inside information suggests that ethics is no longer a powerful force in Australian society.

Some might argue that it never was important in regulating behaviour, but I have a memory of a time when it was important to be known as a person whose word and reputation were important in the community.

These days it is much more important that you be known as a successful person, that is one who has accumulated considerable economic power.

And that is one of the causes of the failure of ethics. Materialism has taken hold at the expense of ethical behaviour.

Another cause of the demise of ethics is the want of institutions that promote ethical behaviour and are happy to be seen as the ethical watchdogs and the ethical police.

In a smaller less complex community, there might not be the same need for ethical spokespersons, but Australia is neither small nor simple and we cannot be sure that the majority of Australians share a common ethical framework unless there is a leading institution.

The pluralistic nature of our society adds to this size and complexity problem. We are so pluralistic that we cannot reach agreement on a basic issue such as abortion, so we should not be surprised that we do not have a shared view of what is important ethical action.

The third problem is that a shared understanding of ethics does not necessarily lead to compliance. There will always be individuals who are happy to trade their reputation for profit. But in our society, where unethical behaviour does not lead to retribution, the extent of unethical behaviour can be expected to be large. Indeed, one can see from the court actions of ACCC and ASIC that many a business person and many a corporation has succeeded in one sense of the word because of their failure to attend to ethics.

The late Christopher Skase is a poor example of this phenomenon, because he did pay somewhat for his deeds. But it is interesting that his daughter said at her father's funeral that his actions might have been unethical but they were not illegal. That sentiment was probably not accurate but it shows the disregard some have for the non-binding nature of ethics when the consequences are less serious than the benefits.

Growth in the Rule of Law

This indifference to ethics and the failure of ethics means that the rule of law has had to be expanded.

It used to be and always was unethical to conspire against consumers by dividing up territory in which products could be sold. But this did not stop the creation of the line through Wagga Wagga that divided markets between the Victorian and NSW breweries. North of that line, consumers could not buy any Carlton product and South of it no Sydney beer could be sold. This practice has now been made unlawful.

It used to be and always was unethical for used motor vehicle sellers to wind back the odometer, it is now specifically an unlawful practice.

Insider trading has not always been unlawful, it now is.

Secret commissions were always unethical because they hid from consumers information about conflicts of interest that was material or likely to be material to their decisions. Now they are unlawful, except for a limited time for some in the financial industry.

And the bevy of offences that have been created in the Trade Practices Act and in the Corporation Law were not always offences. They have been legislated because of the failure of ethics.

The substitution of government made law for community made ethics has accelerated in recent years. This can be seen from the amount of law passed by our legislatures that sets standards for behaviour.

The capacity of entrepreneurs, with the help of accountants and auditors, to make 1980 accounting standards mean whatever the entrepreneur wanted, and the misuse of those standards in the 1980s showed how inadequate they were.

Since then, accounting standards have increased in number and complexity. There are many more red letter rules than there used to be, and they offer far less discretion than they used to offer. Notwithstanding the lessons of the past, some leading accountants pine for the past when managers and accountants could decide what was true and fair, even when it was not.

Other accountants, and I am one, pine for the day when a sensible binding set of standards can be developed that further reduce the capacity of managers to mislead.

The Force of Competition

While the growth of materialism, the increased size and complexity of our society and the failure of sanctions for unethical behaviour are important reasons for the failure of ethics, there is another force, the growth of competition, that has contributed.

Decades ago, members of the professions, accountants, lawyers, valuers, even members of the medical profession, could be assured of an adequate income without having to resort too often to unethical behaviour.

These days an adequate income might not be sufficient, but there is an added issue, competition has made it difficult for any member of the profession to be assured of a satisfactory earning.

The increased sophistication of the financial market also means that companies must maintain growth in their profits if they are to attract and hold capital for the future and avoid being taken over by more efficient firms.

All of this puts pressures on individuals to ignore their ethical standards in pursuit of the customers' needs or the needs of the market.

Doctors are more willing to issue certificates that provide a sick day or to issue prescriptions that have little to do with the patient's medical condition. Lawyers are more anxious to find ways to avoid the requirement to pay tax. Accountants and auditors are more anxious to please management when it wants to report a profit that is higher than it might be.

It is too early to make judgements about HIH, OneTel and Harris-Scarfe, but the odds are great that management, directors, accountants and auditors and perhaps the odd lawyer, were it not for professional privilege, will find themselves implicated adversely in the fall of those companies.

Should the economy continue to falter, we will likely see further examples of business failure caused by unethical and unlawful behaviour. It is not likely that these problems in these three firms are merely incidental and atypical of the behaviour of a wider group of Australian corporations, managers and professionals.

None of this is an argument for reducing competition. Without it, Australia would, in material terms be a much poorer place.

It does argue that as competition is extended and strengthened, there is an associated need to strengthen and extend government made law.

Particular Weaknesses

The Commissioner of Taxation, Michael Carmody, has a most difficult job made worse by the failure of ethics. He lamented in this forum two years ago that lawyers have made a mockery of our taxation laws. And they have.

For many employees in the financial sector, tax has become a voluntary transaction. Investments in the M2 Motorway provided a return of 100 per cent in each of the first two years, notwithstanding that the M2 is yet to make a profit. The return was achieved by grossly manipulating the infrastructure bond designed to help new companies cope with investments in long-lived assets with delayed profits.

Lawyers will say, and there is some truth to their views, that it is upto the Taxation Office and Parliament to get the laws right. But the fanatical way lawyers search for advantage and our propensity to surrender the broad objective at the expense of the contrived construction will lead to an even worse legal solution than we have.

It is certain that we cannot simplify our tax laws because too many are intent on profiting from that simplicity. It is possible that we will have to surrender law for the kind of discretion that the Commissioner enjoys in determining transfers of profits within multinational businesses because taxation lawyers continue to pursue every advantage.

The growth in competition in the public sector has placed pressures on public officers that are similar to those faced in the private sector.

The outsourcing of some legal business from government lawyers to private sector lawyers has had a noticeable impact on the ethics of government lawyers.

Whereas private lawyers have long thought it was their duty to make the best case for their client, a duty which is not compatible with their role as an officer of the court, public sector lawyers have always thought it was their duty to make the best case.

Outsourcing means that government agencies can demand that lawyers now make the best case and governments are glad of this because they can attain their objectives more easily when they are less confined by the rule of law.

The Adequacy of Structures

While government has increased the amount of law that regulates behaviour, it must go further than this and examine the continued usefulness of old structures which have been shown to have flaws in this new world.

For a start, we ought to be acutely conscious of the corrosive effect of conflicts of interest.

Many persons in business decry this concept. They argue that too much emphasis is placed on the appearances of conflict when in practice there is none.

But, for all of the reasons discussed earlier, I have little faith in the power of ethics and more respect for the profits that conflicts of interest can generate when they are present.

And conflict of interest or the appearance of it is pervasive in business. It even has developed into a practice that is actively pursued and it has a term that is seen as a positive attribute, networking.

Networking can be portrayed as developing relationships that enable trust and understanding to replace competition. But it can also mean that the "old boy'' connections have blossomed into a new concept with the same weaknesses as the old practice.

Certainly personal relationships do not provide the independence in the business relationship that is often necessary if one wants a professional job.

The dangers of mixing business and personal relationships was seen in the Supreme Court's examination of the failure of AWA management and board to see that foreign exchange hedging would lead to that company's collapse.

Former Justice Andrew Rogers pointed out that it was not proper for the external auditor to develop a close relationship with the chief executive. Especially when such a relationship prevented the auditor from advising the board about weaknesses in AWA's systems of control which management had not rectified.

Indeed, in this discussion about conflicts of interest, it seems perverse that we expect external auditors to undertake their task with professional independence when we allow the auditees effectively to appoint the auditors.

The dependence of auditors on management for their audit contract, and thus their income and living standards, might expalin the breakdown of many audits in Australia and overseas.

It was recently reported in US media that the auditor of Sunbeam Corporation, a company managed at the time by Mr Dunlap of Chainsaw fame, detected a fraudulent presentation of profits that materially distorted the profit figure.

The auditor advised management that the fraud had been detected and that it had to be removed if Sunbeam was to receive a clear audit opinion on its general purpose financial reports. Management refused to amend the figures and the auditor provided a clear audit opinion. "I was merely asking'', he seemed to say.

A third area of concern for ethics and regulators is the break down of the standard price and the effect of multiple prices on the poor.

Most of us in this room can cope with the need to negotiate the fee that you pay, whether the negotiation is with the dentist for a crown or the bank for a mortgage or a managed fund for managing investments.

But the poor cannot cope with this kind of complexity. In part, this is not surprising for research has long showed that the poor pay more for most services than the rich.

This sad summary, however, suggests there is market failure in those markets occupied by the poor. And as we all know, in the absence of ethics, business make money from market failure and governments are meant to redress market failure if they can do so efficiently.

It is probably necessary to examine whether there are ways where corporations could be required to disclose more than they currently do about their pricing policies so that those in the community who have less commercial nous than we do can have more of the benefits that competition offers.

Governments have unwisely assumed that firms have ethics and they have encouraged firms, especially banks, to offer products at subsidised prices. It would be ironic if the poor, by paying higher charges for mortgages, for instance, paid more to the banks than they received n subsidised service charges.

Conclusion

We complain about the growth in the nanny state, often with good reason. But some of this intrusion of the state into our affairs is a response to the failure of our society to adhere to ethical standards. And unless the death of ethics is reversed, we should anticipate further government regulation of our behaviour.