Practical analysis for investment professionals
11 October 2012

The Case of Empresas la Polar: Encouraging Whistleblowers Can Serve a Firm’s Interest

Last month I participated in an ethics seminar in Santiago, sponsored by the future CFA Society of Chile. One of the hottest topics of discussion was the accounting scandal that recently engulfed Empresas la Polar S.A. (LAPOLAR), a Chilean retailer, and has became the largest fraud in Chilean history. The case of La Polar is more than a story about improper accounting and misleading financial statements, however. It is also a story about an organizational culture in which employees either looked the other way in the face of wrongdoing or quietly succumbed to pressure from supervisors and management to commit wrongdoing. The ethics lessons are enduring and worth reviewing.

The tale of La Polar began in 2003, when the company was taken public by the private equity firm that had purchased it in 1999, after it had declared bankruptcy. La Polar soon became the darling of the investment community because of its strategic focus on the middle- to lower-end of the retail market, which represents 55% of the Chile’s population, its lack of a controlling shareholder, and its growing financial services business. With 43 stores and 12.4% of the retail market by sales, La Polar soon became the fourth largest department store in Chile.

Because the Chilean retail industry is one of the most competitive in South America, many retailers have established consumer lending businesses to offset the low margins that they earn on the merchandise they sell. To boost it sales and profits, La Polar offered shoppers “Tarjeta La Polar,”  a store credit card, which they could use to pay for all of their purchases of electronics, clothing, and home furnishings. Before long, “Tarjeta La Polar” became a substantial contributor to La Polar’s earnings before interest, taxes, depreciation, and amortization (EBITDA), and a key driver of its growth.

But trouble was brewing. Chile’s retail sector was deeply affected by the 2008 global financial crisis, whose effects were exacerbated in early 2010 by a major earthquake. Even though many retailers were reporting declining revenues, increasing credit card delinquencies, higher loan loss provisions, and net losses in quarterly earnings, La Polar appeared to be weathering this perfect storm better than its peers. That’s because, quite simply, the company was cooking its books by, well, frying its credit card customers. In the face of rising credit delinquencies, it refinanced customers’ delinquent credit card debt without their knowledge or approval, charging these customers a fee, rolling this fee and any delinquent payments into a new principal balance, and then assigning larger minimum monthly payments to cover the higher principal balance. This enabled La Polar to report higher fee income and lower write-offs, delinquencies, and loan loss provisions — all of which increased the size of its credit card portfolio.

This scheme began to unravel in July of 2010 when SERNAC, the Chilean national consumer service, began receiving complaints from La Polar’s customers about the company’s “credit management program.” By May of 2011, the number of customer complaints had grown to such a level that a group of shareholders filed a complaint with Chilean regulators to investigate the company’s credit card portfolio. In June 2011, the company announced that “practices for managing its credit portfolio have come to light that have not been authorized by the board and that are contrary to the company’s parameters and standards.” Management then forecast that loan loss reserves would increase by $421 million, to $521 million, or more than eight times what it earned ($64 million) in the prior year. A week later, this estimate was doubled to $884 million, and eventually rose to $1.13 billion.

Within a week of the company’s initial announcement, La Polar’s stock price declined by more than 80%, wiping out more than $1 billion of its market value. The yield on its 2016 bonds increased from 3.87% to 37.60%. Because pension plans were among the larger investors in La Polar, the price declines in its securities had a direct impact on the pension savings of many Chileans. Fearing a round-trip into bankruptcy, La Polar shareholders eventually approved a share issuance plan that raised US$200 million, which the company used to finance short-term working capital obligations and keep it operating. New management at the company estimates that approximately US$1 billion of delinquent credit bills were “refinanced,” affecting more than 400,000 customers. Since the scandal was revealed, an additional 15,000 complaints have been received from customers.

So far, 18 former La Polar executives, including 11 senior officials, have been charged with providing false financial information, and the majority of top management as well as the board of directors have either been fired or tendered their resignations. In addition, La Polar’s auditor, PriceWaterhouseCoopers, has been charged with selling its shares in the company after learning about its “credit management” policies.

Although the La Polar scandal is eerily reminiscent of US corporate scandals, such WorldCom and Enron, the big difference here is that at La Polar there was no one inside the company who blew the whistle. There was no Sherron Watkins (Enron) and no Cynthia Cooper (WorldCom), even though the fraud had been taking place for almost five years and involved employees at all levels of the company. There were most certainly many well-placed employees who either saw what was going on and said nothing, fearing retaliation, or reported it to management to no avail.

Notwithstanding what happened at La Polar, research has shown that employees are an increasingly important source for detecting wrongdoing. It is therefore in a company’s strategic, financial, and legal interest to create an environment in which employees feel comfortable reporting suspected wrongdoing or unethical behavior. So how can companies encourage their employees to speak up?

In a study entitled “From Inaction to External Whistleblowing:  The Influence of the Ethical Culture of Organization on Employee Responses to Observed Wrongdoing” Muel Kaptein, a professor of business ethics at the Rotterdam School of Management, asserts that there are four actions that companies can take to create a culture that encourages employees to take action when they observe unethical behavior.

According to Kaptein companies must:

  1. Ensure that the values, norms, and principles that they want their employees to follow are concrete and understandable. When values and norms are clearly communicated, not only do employees feel responsible for upholding them, there is also a greater likelihood that when they observe wrongdoing they will do something about it.
  2. Encourage employees to identify with the ethical values of the firm. The more employees identify with the ethical values of the firm, the more motivated they will be to comply with them as well as to take action to stop or correct wrongdoing.
  3. Discuss ethical issues, dilemmas, and alleged wrongdoing with employees. Creating a dialogue and feedback loop, and expressing empathy will increase employees’ willingness to report wrongdoing because it preserves the prevailing norm of openness and is appreciated.
  4. Sanction unethical behavior to show employees that the behavior will not be tolerated and will be punished.

After reading about what happened at La Polar, I can only wonder if the scandal could have been prevented or its impact reduced if the company had taken Kaptein’s message to heart — and more importantly, operationalized his corporate ethics framework so that an employee might have stepped forward.


Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

About the Author(s)
Michael McMillan, CFA

Michael McMillan, CFA, is director of Ethics Education at CFA Institute, where he was responsible for creating, sourcing, and developing educational content for CFA Institute members and investment professionals in the area of ethics and professional standards. Previously, he was a professor of accounting and finance at Johns Hopkins University’s Carey School of Business and George Washington University’s School of Business. Prior to his career in academia, McMillan was a securities analyst and portfolio manager at Bailard, Biehl, and Kaiser and at Merus Capital Management. He is a certified public accountant (CPA) and a chartered investment counselor (CIC). McMillan holds a BA from the University of Pennsylvania, an MBA from Stanford University, and a PhD in accounting and finance from George Washington University. Topical Expertise: Financial Statement Analysis · Standards, Ethics, and Regulations (SER)

1 thought on “The Case of Empresas la Polar: Encouraging Whistleblowers Can Serve a Firm’s Interest”

  1. Gordon Ross says:

    Michael, this is the most important work done under the CFA brand.

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