The Ethical Barometer

The story began when one Chrysler dealer, Napleton Automotive Group, sued Chrysler for “strong-arming” dealers into reporting higher sales volumes. The suit alleged that those dealers were rewarded. The strategies were creative. Some dealers would record cars as sold, but all they did was move them to the “used” category. Other dealers would include sales that were later reversed.

The SEC began investigating the sales issue in 2016, and Fiat-Chrysler just paid a $40-million fine for fake sales numbers that were later “unwound or reversed.” Fiat-Chrysler said that the fine will not result in a material effect on its overall financials. Well, we can all breathe a sigh of relief on that. Immaterial fraud fines are a different beast all together.

Mylan had an interesting marketing strategy for its treatment for severe allergies (the EpiPen), a device-with-a-drug that the company purchased in 2007 from Dey Laboratories. Here’s how it went. For purposes of Medicaid billing, if the device-with-a-drug was classified as generic, Milan was required to offer the government a 13% discount. If, however, the device-with-a-drug was a brand-name drug, Mylan had to offer the government a 23% discount. So, for purposes of Medicaid sales, EpiPen was generic. However, for everyone else, EpiPen was a brand-name drug. Over a six-year period after MyLan’s acquisition, the price went from $100 to $600, that’s 400%, which lands us near Martin Shkreli and Turing territory.

During a Senate investigation into drug-price increases, EpiPen popped up because of the price increase. Actually, the prices popped up in a survey by the National association of Medicaid Directors on EpiPen price increases. Then Political Pro figured out the “having it both ways” strategy.

Here’s the real story. The drug in the EpiPen, epinephrine, has been a cheap generic for some time. However, Mylan, through Dey, held the exclusive right to sell the drug in its patented auto-injector. So, while the drug was generic, the drug in the EpiPen was not. One understands the classification dilemma. What one does not understand is why the two options? One leans toward the price structure as the explanation.

The Amoral Technician Approach

When companies make these decisions, they are in a legalistic mindset. A lawyer could support a sort of “Who knows?” theory and go along with the dual price structure. Now, try explaining that to a public that just plays by the rules and a sense of fairness in interpreting and applying those rules.

But, beyond legal and ethical difficulties, let’s look at costs. The EpiPen pricing and discount issues emerged in 2016. Mylan settled the over-billing charges with the federal government for $465 million. Just last week Mylan, without admitting or denying the allegations, settled SEC charges that related to its failure to disclose to investors the possible loss that could come from the classification debate. That was another $30 million. Mylan did not share the possible losses before settling in October 2016.

Additional Background, the Mylan Culture, and Ms. Bresch and Her Family

Some history on Mylan is helpful:

In 2014, the board of directors approved a compensation plan that would require 16% growth in annual earnings growth. That goal was a challenge because Mylan, at that time, was operating with a product buffet that was 90% generic.

At the time, the dual classification was uncovered EpiPen was generating 10% of Mylan’s revenue and 20% of its profits.

Mylan moved to new headquarters outside Pittsburgh to a building that was partially owned by the board’s leading outside director and chairman of its compensation committee. That director transferred his interest in the building to his partner before Mylan made the purchase.

Mylan paid a writing consultant to work with a clinical doctor on supporting Mylan’s plan to reduce co-pays and deductibles as the means for dealing with high drug prices.

Heather Bresch, the CEO of Mylan, is the daughter of Joe and Gayle Manchin, as in former governor (current senator) and First Lady of West Virginia. Gayle Manchin was director of the National Association of State Boards of Education in 2012 and headed an initiative to require school to purchase medical devices for life-threatening allergic reactions. The White House gave funding preference to the EpiPen and 11 states passed laws requiring auto-injector epinephrine devices in the school. Mylan had the only such device, and the FDA had denied Teva approval for its similar device. Teva received approval in 2018 — Mylan has a competitor now.

The Barometer has followed Ms. Bresch since she was made COO of Mylan. Here is an excerpt from the Barometer’s text in the 8th edition of her text, “Business Ethics: Cases and Selected Readings.”

When Ms. Bresch was named to the position of COO, the press release indicated that she had received her MBA from West Virginia University. A reporter for the Pittsburgh Post-Gazette discovered when he called to verify Ms. Bresch’s credentials that she had completed only 22 credit hours of the 48 credit hours required for the MBA degree. Provost Gerald E. Lang and business school dean, R. Stephen Sears had awarded Ms. Bresch the degree retroactively. An investigation revealed that Ms. Bresch and others (the original total was 70) may have been given their degrees despite not having completed the necessary courses.

University president Mike Garrison would not denounce the award of the degrees and, because of student protests during graduation (“Garrison Must Resign” written on their hats), was forced to resign. In 2008, a special panel reviewed the University’s degrees and conducted an audit. The panel concluded that some degrees should have been awarded and that others were not justifiably awarded. Ms. Bresch’s degree was one the panel concluded was not awarded properly

Ms. Bresch claimed there was disparity in treatment between her case and that of the other students/graduates (?). Shortly after the MBA controversy, Ms. Bresch was promoted to Mylan’s CEO slot.

Stanford has identified $770,000 in its sailing program that came from payments Rick Singer made to the coach for sailing in order to secure admissions for the children of the wealthy. And there are other educational institutions around the country in the same boat, as it were. Yet, they are hanging on to the money. Their communications-director responses are that there is a federal investigation pending and that they need to wait. Maybe so, but tainted money is tainted money. There should be a plan for the money, such as using it to fund scholarships for those young people whose parents could not lay down the scratch for a “side door” admissions path.

Federal District Court Judge Indira Taiwani in sentencing a third parent, Stephen Semprevedo, to 4 months in prison, a $100,000 fine and 500 hours of community service. Mr. Semprevado paid $400,000 to get his son into Georgetown as a phony tennis recruit. The “side door” was operated by Rick Singer, a man who collected $25 million from parents and then doled it out to coaches, test proctors, and test takers. In exchange, the takers gave extra time on admissions tests, took the admissions tests, or altered answers to improve test scores. Coaches used their discretionary spots to get the fake athletes admitted.

Judge Taiwani also took issue with the phrase “terrifying admissions process” that parents used as a means of explaining the desperate and illegal measures in the Springer criminal enterprise. “Think about how terrifying that process is for the applicant whose parents didn’t even go to college.”

U.S. Federal District Court Judge Indira Taiwani during a sentencing hearing for Devin Sloane. Mr. Sloane is one of the parents indicted under the federal investigation, Operation Varsity Blue, for paying Rick Singer to get their children into elite schools. Mr. Sloane paid Mr. Singer $250,000 to get his son into USC as a fake water polo player. Mr. Sloane even staged pictures of his son in their pool to make it look like he was a water polo athlete.

Judge Taiwani was on a roll. She expressed her concern that the parents offered as their excuse that they did it for their children. In Judge Taiwani’s mind, the parents were not providing food or other care taking. Their efforts were not even about access to higher education. Instead, the judge noted that wealthy parents were focused only on getting their children into elite colleges. The judge even expressed frustration because Mr. Sloane did not appear to understand that the real ones hurt in the admissions frauds were those who were not admitted because Mr. Sloane’s son was.

Judge Taiwani sentenced Mr. Sloane, the owner of a water treatment company, to four months in prison, a fine of $95,000, and 500 hours of community service. The first of the parents to plead guilty, Felicity Huffman was sentenced to 14 days in prison. However, she had only paid $15,000 to Rick Singer to get her daughter’s test scores raised.

The good judge raises an important question: What was the motivation of the parents?

Blue Cross and Blue Shield of North Carolina has a problem. The company’s CEO, Patrick Conway, was arrested for drunken driving in June. There had been an accident because Conway allegedly swerved out of his lane on I85 and hit the rear corner of a truck. Neither Conway nor his daughters were hurt. Conway has been charged with driving while impaired and misdemeanor child abuse. Mr. Conway went to 30-day inpatient substance abuse treatment program.

BCBS did not notify State Insurance Commissioner, Mike Causey, because its policies provide for the chief operating officer to take over when the CEO is on temporary extended leave. BCBS also told Commissioner Causey that the company was protecting Conway’s right to privacy and due process. Mr. Conway has a court appearance on October 8 related to the charges.

Commissioner Causey said that he was “disappointed” that there was no notification, and that he “expected better from our state’s largest insurer.” Mr. Causey is right — BCBS relied on compliance with technical rules instead of asking themselves, “Should be let the regulator know?” Very much an ethical issue. Now BCBS has two problems — the ongoing DUI case and the loss of trust with its regulators.

In yet another California-dreaming moment, California (as of 2023) will permit its student-athletes to accept money off their names, images, and likenesses despite NCAA prohibition of such. Wall Street Journal columnist Jason Gay, a fine writer, sees no problem with unleashing college athletes into the world of too much money too early in life. The Barometer has two words in response to Mr. Gay: Antonio Brown. There is all that needs to be said about a sixth-round draft choice who became the highest paid receiver in the NFL. A life with talent, a life with wealth, and a life with a raft of domestic abuse calls, suits, and sexual harassment claims. And now a professional career in shambles. Yes, let’s sic that curse of easy money early on the young college athletes. What could possibly go wrong?

We have suffered through Richard Scrushy (HealthSouth), Dov Charney (American Apparel), Elon Musk (Tesla), Travis Kalanick (Uber), Martin Shkreli (Turing Pharmaceuticals), Elizabeth Holmes (Theranos), Jeff Dachis (Razorfish), and the list is long and becoming boring. Now comes Adam Neumann (WeWork, now just We). These entrepreneurial CEOs with great ideas are dynamic, energetic, forward-thinking, and stubborn. They can take an idea and see it through to great financial success. Then something happens. Perhaps their downfall comes from too much recognition and too much money too early in life. Perhaps the downfall comes because they have no one to rein them in. Yet somehow they manage to get their companies into trouble, cause questions to be raised about their companies, and/or just keep pushing the envelope on personal behavior.

Mr. Neumann was profiled in the Wall Street Journal. One example was a private jet flight for Mr. Neumann and his friends to Israel. The gang smoked marijuana on the flight over the Atlantic, and the crew found a stash of the drug placed in a cereal box — planning ahead for the trip back. The owner of the private jet recalled the plane. That company wanted no part of the young CEO’s adventures. Mr. Neumann wants managers to fire 20% of their employees because he believes they have hired too many mediocre folks. The conflicts of interest revealed in preparation for an IPO were stunning — family, friends, and Mr. Neumann all benefited privately from We’s work. Mr. Neumann borrowing money from the company with his options as collateral — conduct that public companies can no longer do thanks to Bernie Ebbers and his WorldCom disaster.

Yet, in the article, there are still analysts proclaiming that this kind of conduct is what resulted in the company meeting its “outlandish” targets. Yes, indeed, they will meet the targets when you are firing at a rate of 20%. However, that does not mean that the numbers are real. That info will be percolating. The We board seeks to remove Mr. Neumann — good luck with that one. See the stories of the CEOs listed.

History repeats because another thing these young buckeroos have in common is that they never learn the lessons of those who have taken similar paths with their companies. Neither do the analysts. The boards have tried, but the obstacle is that the buckeroos have majority control.

First, there was this year’s Kentucky Derby with the disqualification. Country House, a 65-1 odds horse, won the Derby after Maximum Security was disqualified because of a lane foul. Now we learn that Justify, the 2018 Triple Crown winner, tested positive for for scopolamine, a banned substance that can enhance performance. The drug can clear the airway and optimize the heart rate. However, the trainer of Justify, Bob Baffert, and owner said that scopolamine can be found in jimsyn weed, which can grow in the wild where dung is found and hay and straw are produced. Horses eat hay and straw! Jimsyn weed gets mixed in and straight to the horse’s mouth. “Environmental contamination” is a defense when horses test positive. The Barometer is stunned that Lance Armstrong did not think of this one.

The failed drug test was conducted on April 7, 2018. By the time the test results were returned, it was April 18, 2018, two weeks before the Derby.The amount found was 300 nanograms per milliliter, which was excessive. However, in fairness, it seems that all of the horses tested positive for scopolamine, just not at the Justify level. At the time of the test, Justify was undefeated and just had one more race prior to the Derby (Santa Anita) to qualify. Justify qualified, but let’s just add that the pony was lucky to make it alive out of that facility. They lost 30 horses in six months there.

At any rate, an investigation into an environmental defense takes two months. The California Horse Racing Board had five to eight days to get such an investigation done. Bob Baffert, Justify’s trainer was notified on April 28, 2018 of the positive test, as is provided under the regulations, he asked that another sample from the test be sent to an approved independent lab. The sample was sent to an independent lab on May 1, and the results were confirmed on May 8. The Kentucky Derby was on May 5, 2018, a race Justify won.

No one ever filed a complaint with the California Horse Racing Board, so there was never a hearing. Rick Baedeker, the executive director of the Board, took the case directly to the commissioners of the Board. In a private executive session (something that had never been done before), the Board voted unanimously not to proceed with the case against Bob Baffert. In addition, The Board changed the penalty for a finding of scopolamine from disqualification and forfeiture of the purse to a fine and suspension.

The interesting thing about the Board is that it is made up of folks who own horses and employ Baffert as their trainer. The Board members regulate the jockeys and trainers that they employ. When the regulators are the regulees, there is a bit of a conflict. Sounds like rigorous oversight is not the game. Baffert was investigated in 2013 when seven horses he was training died within a 16-month period. The horses had been given a thyroid hormone without a diagnosis of any thyroid problems. Baffert said that he gave the horses the drug to build them up. The drug can cause weight loss. No action was taken against Baffert then. The Board says that it exercised reason and common sense and saved the taxpayers money by not pursuing the case.

Justify is currently in Australia, doing stud things for $450,000 per day. Not bad work if you can get it. No word on jimsyn weed intake.

David Middendorf, the second-in-command for KPMG’s audit practice, said at the sentencing hearing that “never in my wildest imagination” did he think that obtaining the names of those KPMG clients that the Public Company Accounting Oversight Board (PCAOB) was targeting for audit-quality review was criminal. Let’s see — obtaining information from a quasi-government enforcement agency that is not public is not somehow on your list of no-nos? Mr. Middendorf added that what had already happened to him (being taken away in shackles at 5:45 AM, etc) was sufficient deterrent for any auditors out there thinking up such scams. The judge did not buy, and off to prison he goes. Safety tip for sentencing hearings? Pull a Felicity Huffman — contrition, tears, and apologies to those who got cheated. 14 days for fraud on that one. Saying, “I had no idea!” is not a sentence-reducer.

Notice, Mr. Middendorf did not say he did not think it was cheating. The goal here was to do a better job on those company audits than the ones that PCAOB was not going to review. Sort of defeats the whole goal of quality audits, does it not? KPMG assures that it has learned: it has now invested in new software to improve audit quality. Ironic, is it not? If only they had spent the money first instead of attempts at gaming the system.

A supervisor offered this rationalization. What had happened is that auditors had discovered that a salesman was was submitting to have three meals per day reimbursed by the company. The salesman always billed $24.99 for each meal, just below the company’s $25 receipt requirement. The company then lowered the receipt requirement to $15. The salesman’s three receipts then came in at $14.99. When told of the conduct by auditors, the supervisor opted for doing nothing. Enforcement is to organizations what integrity is to individuals. The auditors are going to have their hands full now.

Thanks to Sue Shallenberger of the Wall Street Journal for her expose on expense reports and cheating. September 10, 209, p. A9. Other examples include employees submitting for reimbursement for the cost of a pogo stick and bed-bug removal.

Finally, investors are taking to heart the lessons of the dot-com bubble. Following questions about We’s truth net worth and its corporate governance (documented here last week in what is curtly, but accurately described as, “Conflicts galore!”), the IPO has been postponed. The net worth, touted as $47 billion is believed to be more like $15-$20 billion. And, is a giant leap for corporate governance advocates everywhere, We has agreed to have a lead director who is independent. We may need more than one independent director to rein in CEO Adam Neumann, but when an elephant flies, you do not fault it for not staying up long enough. Oddly for We, but logically for the rest of the business world, We’s net worth might improve if the conflicts were eliminated.

Michigan State has settled with the U.S. Department of Education for its failure to report and address claims of sexual abuse by Lawrence G. Nassar. Dr. Nassar was the physician for the USOC WOmen’s Gymnastic Program. He is in prison for 40-175 years. Education Secretary Betsy DeVos said, “What transpired at Michigan State was abhorrent, inexcusable, and a complete failure to follow the law and protect students. Michigan State will now pay for its failures.”

The findings of the Department Education indicate that William Strampel, the former dean of the university’s College of Osteopathic Medicine, knew about the abuses and failed to take action. He is serving a year in jail for his failure to report or address the abuse. The investigation also found that Dr. Lou Anna K. Simon, the former MSU president, also failed to take action. She has been charged with lying to investigators.

The new president,Samuel Stanley, accepted the resignation of June Youatt, the provost because of the findings in the report, including an e-mail which Dr. Youatt sent a one-line summary of the issue to the HR VP that included a smiley-face emoji. Why do people put these things in e-mail?

MSU has already settled civil suits brought by the victims for $500 million.

With a public offering pending, We had to come clean on the types of relationships (aka conflicts) that are no-no’s in publicly traded companies. Here is a summary:

CEO Adam Neumann — We purchased the trademark “We” from Neumann for $6 million
We promised to undo the transactions
Neumann owns four of the properties where We leases space
We promises to phase out Mr. Neumann’s ownership
In July 2019, Mr. Neumann borrowed more than $740 million from We using his shares as collateral (Bernie Ebbers (worldCom)pulled this kind of stunt and SOX
prohibits these loans) — about half of the loans were for the exercise of stock options
Rebekah Neumann — an executive with We and co-founder
Ms. Neumann’s brother-in-law — chief product officer
Mr. Neumann’s brother-in-law — runs We Fitness
Michael Gross vice chairman — his parents served as the real estate brokers on a building lease in Miami
Arash Gohari co-head of real estate — — owns one building leased by We
UA Contractors — doing We renovation work as well as renovations on two of the Neumann homes. The three brothers who own UA have a blended relationship with We. Employees are not sure if they are a separate firm or working for We or both. We says it is phasing out We contracts with UA.

The Barometer has seen some serious conflicts in her time, but these are the kinds of sloppy operations that have to be cleaned up before going public. This is pre-2000 corporate governance. Some caution is in order here.

For more, go to Eliot Brown, “We Work Draws Worries of Conflicts,” Wall Street Journal, September 7, 2019, p. B1.