Reference no: EM131379797

On December 8, 2006, California's attorney general announced a settlement with Hewlett-Packard (HP) over its corporate spying scandal. The civil settlement involved a lawsuit that the state filed against the computer giant in Santa Clara County Superior Court. Under the agreement, HP paid $13.5 million to create a "privacy and piracy" fund to help state and local law enforcement fight privacy and intellectual property violations.

The company also paid $650,000 in civil penalties and $350,000 to cover expenses of the investigation. The scandal broke in September 2006 when HP acknowledged in an SEC filing that investigators probing internal HP leaks to the media had gained access to board members' personal phone records by impersonating the board members, a practice known as "pretexting." HP's investigators also conducted physical and electronic surveillance of board members and reporters, according to HP documents.

Pretexting violates a California criminal law banning the use of "false and fraudulent pretenses" to obtain confidential information from a phone company, stated Attorney General Bill Lockyer. California civil law also considers criminal acts unlawful business practices, which was the basis of the state's civil action. Mark V. Hurd, HP's chair and chief executive, hailed the deal. "We are pleased to settle this matter with the attorney general and are committed to ensuring that HP regains its standing as a global leader in corporate ethics and responsibility," he said. The HP Investigation An article in January 2006 by CNET reporter Dawn Kawamoto discussed confidential information available only to HP's board.

The CNET article reignited the leak investigation. Recognizing the potential legal problems that boardlevel leaks could pose for HP, chairwoman Patricia Dunn immediately initiated a new investigation of the leak and expressed her urgency to HP's general counsel, Ann Baskins. The second and far more intrusive investigation extended from January through March and included the following:

• Reviewing the company email accounts, company phone records, and computer hard drives of every member of HP's "Executive Council"

• Hiring a private investigation firm, which in turn subcontracted the job of obtaining the private telephone records of select board members and nine journalists, including Kawamoto

• Surreptitiously following Kawamoto and suspected board members in public (and apparently searching through their trash)

• Setting up a "sting" in which investigators sent Kawamoto an email containing fake tips about HP and an attachment whose tracking software would trace the email's path after it reached Kawamoto's computer Insider Trading HP investors sued some of the computer maker's directors, claiming they sold $38 million in company stock shortly before publicly acknowledging an internal probe into boardroom leaks.

The directors, including CEO Mark Hurd, exercised options and sold shares during a 2 ½-week period beginning August 21, 2006. HP began its internal investigation after boardroom discussions about ex-CEO Carly Fiorina were quoted in news stories. The flap over the probe cost chairwoman Dunn and two HP executives their jobs and sparked investigations by U.S. regulators. The company said on November 16 that the SEC stepped up its examination of the company's tactics and the Federal Communications Commission (FCC) had requested documents related to the leak probe. California prosecutors had charged Dunn, HP's former CEO, with conspiracy and fraud for directing the boardroom spying.

They also charged Kevin Hunsaker, an in-house lawyer and former director of ethics, as well as three private investigators who participated in the probe. Board members, worried about negative publicity over the leak probe, took steps to protect the company's stock by approving a $6 billion share buyback program less than a month before the spying became public. That brought the amount of shares that HP was authorized to buy back to $11.7 billion, according to the complaint. The investors alleged that the share buybacks were prompted by defendants' illegal misconduct.

Ethics Compliance Officer Having a chief ethics officer didn't help HP. Chairwoman Dunn lost her job after hiring private investigators to find leakers on HP's board. The spying scandal that ensued led to Dunn's indictment and an investigation by the House Energy and Commerce Committee. Even Hurd, who had replaced Dunn as chair, has been implicated in the scandal. And it all happened under the watch of Kevin Hunsaker, HP's senior counsel and chief ethics officer. He resigned in September 2006. Corporate Governance and Ethics Issues The original lawsuit claimed "breach of fiduciary responsibilities" by HP executives.

It alleged that the executives' spylike tactics to uncover boardroom leaks harmed the company, and that they engaged in insider trading just before news of the spying incident became public. Specifically, the suit claims that they sold off $41.3 million worth of stock two weeks before the scandal broke. The lawsuit also alleged that the executives approved stock buybacks in the months preceding the scandal in an effort "to keep the company's stock price propped up while insiders were selling." HP also agreed to strengthen in-house monitoring to ensure that future investigations launched by HP or its contractors would comply with legal and ethical standards and protect privacy rights. HP further agreed to hire an independent director, expand the duties of its chief ethics officer and chief privacy officer, beef up staff ethics training, and create a compliance council to set policies for ethics programs.

In the lawsuit, Attorney General Bill Lockyer was quoted as saying: With its governance reforms, this settlement should help guide companies across the country as they seek to protect confidential business information without violating corporate ethics or privacy rights. The new fund will help ensure that when businesses cross the legal line they will be held accountable. Fortunately, Hewlett-Packard is not Enron.

I commend the firm for cooperating instead of stonewalling, for taking instead of shirking responsibility, and for working with my office to expeditiously craft a creative resolution. The settlement's corporate governance reforms aimed to strengthen in-house monitoring and oversight to ensure compliance with legal and ethical standards, and protection of privacy rights, during any investigations launched by HP or outside firms hired by HP.

"This settlement creates a template for other companies seeking to protect confidential business information without violating corporate ethics or privacy rights," stated Lockyer. Major Governance Reforms The major governance reforms included the following:

• A new independent director will serve as the board's watchdog on compliance with ethical and legal requirements. The director will have specific responsibilities in carrying out that oversight function and report violations to the board, other responsible HP officials, and the attorney general.

• HP's chief ethics and compliance officer (CECO) will have expanded oversight and reporting duties. The CECO will review HP's investigation practices and make recommendations to the board on how to improve the practices by July 31, 2007. The CECO, who previously reported only to the general counsel, now also will report to the board's audit committee. In addition, the CECO will have authority to retain independent legal advisors.

• HP will expand the duties and responsibilities of its chief privacy officer to include review of the firm's investigation protocols to ensure that they protect privacy and comply with ethical requirements.

• HP will establish a new Compliance Council, headed by the CECO and also comprised of the chief privacy officer, deputy general counsel for compliance, head of internal audit, and ethics and compliance liaisons. The council will develop and maintain policies and procedures governing HP's ethics and compliance program, and provide periodic reports to the CEO, audit committee, and board.

• HP will beef up the ethics and conflict-of-interest components of its training program. The training redesign will be directed and monitored by the CECO, Compliance Council, independent director, and chief privacy officer. HP also will create a separate code of conduct, for use by outside investigators that addresses privacy and business ethics issues.

1. The original lawsuit filed in the HP case claimed that the executives breached their fiduciary responsibilities. What are the fiduciary responsibilities of executives and members of the board of directors to shareholders? How were these obligations violated in the HP case?

2. Describe how ethical fading influenced the actions taken in the pretexting scandal, including those identified in the HP investigation. Are there similarities between the actions of management in the HP case and those in the Challenger Shuttle Disaster?

3. Recently, in 2011, Hewlett-Packard Vice President and Chief Ethics and Compliance Officer Jon Hoak talked about renewing HP's commitment to a culture of integrity at a meeting with members of the Business and Organizational Ethics Partnership at the Markkula Center for Applied Ethics at Santa Clara University. In his presentation that addressed the pretexting scandal, Hoak said "The people involved were only concerned about whether pretexting was legal. Nobody asked, ‘Even if it's legal, is it the right thing to do?' What is the relationship between legality and what is the right thing to do in making business decisions.