A case study for BWT-based corporate criminology

Wednesday, June 08 2005 @ 12:35 PM JST

Contributed by: Y.Yamamoto

As I preannounced in the May 24 TFP piece about my corporate criminology based on the Broken Windows Theory advocated by James Wilson and George Kelling, I am going to flesh it out here so you can visualize how typically a today's corporate crime will sprout out. But be prepared for a rather prosaic scenario because I have no intention to depict a full-blown and downright crime like in a crime novel. Neither do I have a plan to discuss the issue more in general terms so my criminology looks like a scholastic and esoteric theory. After all I'm dealing, here, with small-time crooks rampant across the corporate world of Japan, who don't really deserve my time for that.

Introductory Notes:

1) The characters and situations in my story are 120% fictitious and imaginary, and do not portray or are not intended to portray any actual persons or organizations.

2) If your area of expertise does not include accounting and finance, please do not try too hard to understand the accounting terminology these executives are showing off their knowledge of at the clubhouse. It's just that I cannot avoid using these words because there is no such corporate crime which has no financial implications in it. We won't call it a corporate crime if an employee kills his manager just out of a personal grudge.

3) Mr. Takeya, 42, is an executive vice president overseeing the entire sales operation in a software company named RZO Japan. He is under a constant pressure from the parent company based in Brussels, Belgium, RZO SA. But he is considered an heir apparent when the president of the subsidiary possibly steps down for whatever is the reason. That's why he was sent to HLC, a prestigious management school in Zurich, Switzerland, some 4 years ago.

4) The RZO is a global company group whose flagship product is a pricey CRM software. (See Note 5) below.) Its subsidiary in Japan has been committed to an annual sales budget of JPY 3 billion this year. Because RZO-J started up its business just 4.5 years ago, its annual sales budget accounts for less than 5% of the planned revenue figure for the entire group. But now the expectations are high in Brussels for the Japanese subsidiary to elevate its intra-group standing at least to the No. 3 slot, only next to the EU and the U.S., by the end of the next year. Already well into the last quarter of the fiscal year, it now looks as though it all hinges on a single account, Fuji Internet Retailer (FIR), whether or not the year's budget will be met.

5) CRM stands for Customer Relationship Management System. If you are not familiar with the abbreviation, the business model Amazon.com has pioneered in the 1990s is a good example of its use. A CRM software can accommodate both the e-commerce aspects (Business-to-Business, Business-to-Consumer, etc.) of online interactions with customers, and analysis of each customer's behavioral pattern which supposedly leads to an improved customer satisfaction, and more importantly, an increased sales. More specifically its advanced use, for instance, enables you to advise your customer who has bought Daniel Keyes' "The Minds of Billy Milligan" in the past that the same author has now published a novel titled "The Touch" in an automatically generated mail.

6) The RZO's pricing structure for its CRM is two-tiered: If you want to use the software just for e-commerce purposes, it will cost you a flat JPY 300 million in the initial license fee on the premise your previous year's sales was in the range between JPY 30 billion and JPY 99 billion. From the second year onward, all you have to pay is a fixed amount of JPY 45 million for possible version-upgrades and after-sale support. But if you opt to use the same software in a more sophisticated way, that will cost you some extra. The surcharge for becoming a licensee in terms of advanced use of the RZO's CRM software is 0.5% of your previous year's total sales, although this is subject to adjustment in case you see an upswing of more than a year-on-year 30% in your total sales.

7) Mr. Hosoda, 36, is an entrepreneur who founded FIR. Based in Tokyo, this Internet retailer is dealing in CDs, DVDs, books, low- to mid-end apparel products, smaller furniture and interior accessories. Although this company is as young as RZO Japan, it already boasts an annual sales of JPY 80 billion. And yet its business is still up-and-coming. Last year he signed a licence agreement with RZO Japan for the first layer of the CRM functionality. Now he is considering the second layer. He also studied at the same class of HLC as Mr. Takeya.

It's a balmy Saturday afternoon in November. The two young guys are already on their way home leaving Takeya and Hosoda at the "19th hole" of the country club, which the executive vice president of RZO Japan has frequented, to renew fond memories of the days they were studying together at HLC. The young ones were just mobilized to fill up the number because Japanese country clubs are obsessed with the idea that golf is a sport to be played in a foursome. Just like ballgame must be played by 18. Now Takeya and Hosoda sit tete-a-tete at the bar getting ready to intimately talk about this and that experience they shared in Switzerland, and some other things.

Takeya: "It's a real Indian summer day, isn't it?"

Hosoda: "Right. This sort of weather always reminds me of the early-summer day of 2001 Professor Baumberger took the two of us to his country club on the outskirts of Zurich. That was the first time we went golfing together. Wasn't it? What's missing here is the shower of snow-white blossoms falling off the white poplar trees, and the crisp air filled with the sweet scent from the false jasmine."

Takeya: "Yeah. Also this reminds me of your super tee shot at the 220-yard 16th of I forgot the name of the golf course. You dared to use the uno, braving the fairway as narrow as the forehead of a kitten, right?"
The caddy they hired at the Zurich golf course was a short guy from the Italian speaking area of the country. Every time they told him to give them the No. 1 wood, he said over and over, "Yes, uno. Yes, uno."

Takeya, casually, changes the topic: "Incidentally, have you already made up your mind?"

Hosoda chuckles, and says: "You mean the advanced use of the CRM?"

Takeya: "You bet I do."

Hosoda: "These guys, including my CIO, are still reluctant to go for the top layer of the CRM functionality. But, of course, it's a matter of time. Sooner or later they will realize we have to activate that part, which is already in our hands since the time I signed the contract. It's on the DVD. And all I have to do is just ask you to send me an engineer to install and activate it, right?"

Takeya, nodding: "Could you possibly sign a supplementary agreement (we call it a side-letter) by the end of the year? That won't hurt FIR in any way if it's just a matter of time that you put it to use."

Hosoda, wearing a nasty grin: "So that's what you invited me here for. That's why you paid me so many chocolates on top of the green fee."
Chocolates are an argot signifying the wager among Japanese golfers. One chocolate stands for a 1000-yen, or sometimes a 5000-yen bill.

Takeya: "Yeah, if you want to put it that way."

Hosoda: "I am afraid we cannot possibly afford this JPY 400 million this year because we are facing some budget constraint, expenses-wise, I mean."

Takeya: "That's a bad news. But the good news is: Most users of these pricey software products don't charge the licence fee to their Profit & Loss Statement outright because it's not tax-allowable here to expense it out in the fiscal year you purchase it."

Hosoda, brightening up instantly, exclaims: "So it doesn't affect our profit. Can't believe there's such a legitimate trick."

Takeya: "I said 'not directly.' It does affect the Balance Sheet and Cashflow, though. Usually it goes to the Balance Sheet as 'Deferred Charges' or something, only to be amortized over a 5-year period. The year's P & L impact is JPY 80 million, at most, or even much smaller, if you prorate your payment. Chances are, you can make it zero, if you sign the side-letter in the last month of the year."

Hosoda: "Is that so? That would make my life easier. And yours, too. Indeed, RZO should have promoted you to CFO, instead of COO. I'm still in the dark about debits and credits. How I hated to hear that lousy name of the Italian monk at HLC. Luca ... something."

Takeya: "Pacioli's the bastard's name."

Hosoda: "Professor Baumberger never failed to console me, saying if I wanted to be a CEO, I'd better forget about this trivial thing called accounting, every time I got a C from Professor Crivelli. I still do not understand how come a negative entry in the books should represent income."

Hosoda adds: "The lousy Pacioli stuff aside, I still wonder how come the tax authorities make it disallowable for tax purposese. One of Dr. Baumberger's favorite words was 'dog-year.' According to his definition 1 dog-year translates into 7 human-years. And today the elapse of time is measured by the dog-year, really. That means there's no reason the cost of a software product has to be amortized over a long 5-year period."

Takeya, now becoming a little jittery about the savvy CEO's remark that touches on the sticking point, decides to flatter: "That is a question Japanese accounting bastards would never ask.

Takeya: Raising his mug still filled with stale beer, goes on: "Toast to our alma mater. To tell the truth, however, this country has already run deficits of almost 1,000 trillion yen. Simply put, the tax authorities cannot afford to be that generous by treating IT-related investments in terms of dog-year. So, why don't we make some contribution to the failing government finances?"

Takeya, after a pause, asks: "Do you have a good accountant or two in your finance and accounting shop, if your CFO is, as you once confided to me, a spineless jellyfish?"

Hosoda: "Do they have anything to do with this deferred thing? You said it's legitimate."

Takeya: "Yeah, I did. But just in case ....."

Hosoda: "Don't worry. I have kicked out all these self-proclaimed professionals from the Accounting Department. All the guys who still remain on our payroll know very well they should behave in my company unless they are ready to set up their own accounting firms. Our Human Resource Department, as well, is doing a very good job in that respect. And the Legal Department, too. Last year they skillfully got all the guys in key positions to sign a 'Secrecy Agreement.' If one of them dares to reveal a piece of information which is damaging to us, I will take him to court."

Takeya: "What about your external auditors? They are from the ZX accounting firm, right?"

Hosoda: "They are spineless, too. Every time the chief of the crew starts to nit-pick over what they call a 'material irregularity,' I never fail to say: 'Do you want to lose this client?' And this always works. And it's a once-in-a-leap-year thing that Japanese shareholders sue an audit firm."

Takeya: "And the statutory auditor?"

Hosoda: "Oh, him. The dotard's a lameduck."

Hosoda, after a few seconds of contemplation, adds nonchalantly: "By the way, how long does it take? More importantly, how much does it cost? Approximately."

Takeya: "How long does what take?"

Hosoda: "I mean ..... how should I say ......what you guys mean by the word 'implementation.' Or was it 'configuration'?"

Takeya: Caught off guard as this question was asked too soon, gives an offhand answer: "That really depends."

Hosoda: "Depends on what?"

Takeya: "Depends on how far you want to exploit the sophisticated functionality of the software. But my ballpark figure is JPY 30 to 50 million. This also can be 'capitalized.' Well, I mean this won't directly affect your Profit and Loss, either."

Hosoda: "But this does the Balance Sheet and Cashflow, as you said, right?"

Takeya: "Right."

Hosoda: "Then I'm afraid this is going to be too much, at least cashflow-wise."

Takeya: "Approximately when are you going to put this second-layer functionality to use?"

Hosoda: "As I said, sooner or later. Or let me put it this way: I want to see the second-layer become up and running in the not-too-distant future. As I said I'm now ready to sign it by the end of this year. But can the implementation wait until the next year, or even the year after next?"

Takeya: "Absolutely."

Takeya, after a brief pause, says: "So the deal was done. The green fee and chocolates paid off."

Hosoda: "Not yet, my friend. Are you sure you won't face any major problem on your part? For instance I think there is a provision in the standard contract wording that says RZO reserves a right to audit the actual status with the use of the software."

Takeya brushes it off saying: "Forget about our audit. The article is there just for the sake of formaility. True, every once in a while, we might sue you if you are using functions that we haven't allowed you to use. But we couldn't care less if you are not using what we have allowed."

Hosoda: "Maybe I'm fretting over trifles. But my last question would be: What about our golfing together?"

Takeya: "Frankly, that's your headache, not mine, because I'm not violating our ethical code by inviting you to this golf course. We prohibit ourselves from being invited by our vendors. But it's quite OK, or even encouraged, if it's the other way around. I don't know why. Maybe we are so opportunistic as to use a double-standard at times. But never mind we are opportunistic. Besides, what I like most about our 'compliance' guys from Brussels: They invariably believe they are supposed to act like Monday morning quarterbacks. As long as we can keep it going, we'll never get caught in a trouble with these guys."

Hosoda: "The ethical code says exactly the same thing in FIR. That means I should have applied a suntan lotion or something to my face today so I can decolor my face by the time I sign that side letter."

Hosoda, with his itching conscience not fully intoxicated by the beer yet, adds as if to try to ease his own mind: "It's me that drew up the business ethics stuff. But only afterward, it dawned on me we couldn't afford a rigorous code of conduct such as ours. I really hate these self-righteous guys at our Internal Audit Department who keep telling us one don't after another. You say you sometimes interpret it opportunistically. But I think 'realistically' is the right word for that."

Takeya: "Are you feeling comfortable now?"

Hosoda: "More or less. Thanks for educating me. But keep in mind it's not the green fee and chocolates that bought you a 400 million contract. It's our 4-year-old friendship."

Takeya winds up their conversation over mugs of beer by saying: "One thing is for sure: We are not committing a crime. I've sold a state-of-the-art software product to a company headed by my old friend. And he's bought it because his company will most probably be using it in the near future. And once again, as long as we can keep it going, we can stay out of trouble with those hardheaded hypocrites at the Audit Department."

One hour or so later the Takeya's BMW pulls over to the roadside just in front of the Hosoda's residence. When Takeya drops the CEO of FIR there, he says: "Toi, toi, toi." He is all smiles now. Hosoda, looking equally lighthearted, responds over his shoulder, using the same words, "Toi, toi, toi." In Switzerland this funny interjection is uttered when you want to say, "Good luck!"

These scenes are so commonplace in this country that any white-collar employee of a Japanese company must have been involved in a similar situation. Unfortunately, though, these "insignificant" events often go unchecked by internal auditors, members of "compliance committees," statutory auditors or external auditors, until/unless they result in full-blown crimes, which is when it is to late.

And despite the ardent sales pitches otherwise by vendors of state-of-the-art bookkeeping software packages, there is no such crime-proof accounting system around that is able to prevent itself from being misused. So it's crucially important to that realize it all hinges on the overall quality of the people whether or not you can develop a crime-free corporate culture.

Don't take me wrong, though. I'm not insinuating at all that Japanese corporations should put in place a system in which the employees are spying on or busybodying each other on the false pretext that corporate crimes should be nipped in the bud.

Instead the centerpiece of my prescription for corporate crime prevention lies in the Human Resources Department. The single most important task for the HR manager is to articulate an uncompromising policy which is impeccably fair and unbiased, and put it into practice.

Wherever the HR Department has compromised on the hiring criteria, for instance, by making its commitment to being an EOE (equal opportunity employer) nothing more than an empty rhetoric, it can never ensure the overall integrity levels of those people on the company payroll.

Especially in Japan company managers and employees are so smart, inventive and collaborative among each other that it's a piece of cake for them to outsmart or circumvent any internal control system, or procedural rules associated with it.

The only workable way to nip a corporate crime in the bud is to prevent it at the real upstream point of the business. i.e. hiring of the people. The surest way, therefore, to tell how a business organization is susceptible to a corporate crime is to examine its HR Department, especially the person overseeing it.

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