ENVS 1500 Chapter 18: ENVS 1500 Chapter 18 Notes

Ethics Case: Facebook's 'Unfriendly' Privacy Policies (adapted from Spinello, R. (2017). Cyberethics: Morality and law in cyberspace. Jones & Bartlett Learning)

Facebook CEO, Mark Zuckerberg, couldn't quite believe all the attention he was getting. Facebook was on the verge of its initial public offering (IPO), and it seemed that the media couldn't get enough of this Cinderella story. Zuckerberg had created a primitive version of the Facebook application in his Harvard dorm room. Thanks to its immediate popularity, he commercialized this product and founded Facebook, a pioneer in social networking. There were 1.4 billion active users on Facebook and the company's revenue exceeded $12 billion. As Zuckerberg traveled around the country to promote the IPO, the press followed him everywhere. The Facebook IPO took place on May 18, 2012, making many of its brash and talented managers instant millionaires by the end of 2014.

Most people at the social network company welcomed the publicity and attention surrounding the IPO. But over the years Facebook has attracted negative publicity and unwelcome attention for its controversial privacy policies. Facebook has had to deal with several embarrassing missteps as it struggles to reconcile user privacy with an open network. The company's policies have been the object of scrutiny by the FTC, which has investigated a number of privacy-related complaints. In a recent ruling, the FTC persuaded€ both Google and Facebook to consent to a biennial audit of their privacy policies and practices for the next 20 years. What were Facebook's most contentious privacy policies, and why are key regulators still threatening to block the social media company from carrying out its strategy of boosting advertising revenue by leveraging its user information? The following is a brief historical overview.

Facebook first caught the attention of privacy advocates in 2007 when it implemented a technology known as the 'News Feed'€. This feature was designed to display in real-time changes a person makes to her user profile on the home pages of all of her online friends. To the surprise of the company, users balked at this innovation and Facebook had to abandon this default feature. In that same year, Facebook also joined a commercial venture known as the Beacon program so that every member would be notified immediately as soon as one of their friends made an online purchase. Beacon also seemed to clearly violate users' privacy expectations. As resistance mounted, Facebook abruptly ended the program.

In December 2009, Facebook once again shocked many of its users by suddenly changing its privacy settings. A person's 'friends'€ could no longer be kept concealed from the public or from each other. As a result, information that was once private such as one's profile picture, name, gender, address, professional networks, and so forth, became publicly available by default. According to Rebecca MacKinnon, these changes were motivated by the company's need to monetize this 'free'€ service and were consistent with Zuckerberg's strong personal conviction that people everywhere should be open about their lives and actions. Facebook's decision to make previously confidential information publicly available€ was reversed thanks to public protest, and users now have the capability to control access to most of their personal information.

In 2010 the company took public its instant personalization€ scheme, which allows partner websites to access Facebook information as soon as a Facebook user visits the site. This all happens by default before the user gives consent to the sharing of his or her information. In that same year, the company introduced social plug-ins, including a social widget known as the 'Like' button, that appeared on other websites (like Amazon.com); if a user likes an item she sees, she clicks on this button and the item appears in a list of things she likes in her profile. This plug-in architecture, a further evolution of cookie technology functions as follows. When a user logs into a social networking site like Facebook, the site sends a cookie to the user's browser, which is disabled only when the user logs out of his her Facebook account. As the user visits various websites, the Like architecture will report back to Facebook whether the user has clicked on the Like button (even if the user doesn't click on this button, Facebook knows that you've been to this site and looked at this item). This social widget provides a history of a user's web-browsing habits that can be linked to personally identifiable information. The social plug-in architecture has the potential to be an especially powerful mechanism for behavioral advertising, though Facebook claims that (at least for the present) it anonymizes this tracking data after a period of 90 days.

Online photos on Facebook pages have also been a bone of contention. When users post a photo on their Facebook page, they can tag it with the names of the individuals in that photo. They can also establish links to the profiles of those individuals, assuming that they too have a Facebook page. Those who come to realize that they have been tagged can serve the link to their profile but can't do anything about the actual photo.

It remains to be seen whether Facebook can successfully fend off regulators in Europe and the United States and live up to the expectations of its investors, who expect the company to be able to exploit the commercial value of the information it collects. To this end, Zuckerberg has repeatedly sought to diminish privacy expectations and encourage Facebook users to share their information in the spirit of openness and greater connectivity.

Questions:

What is the problem that is described in the case?

What are the known facts (from the case or references provided)?

Who are the key people (stakeholders) involved?

What is the timeline of events?

What are the alternative courses of action that can be implemented to solve the problem?

Which of Facebook's past or present privacy policies do you find to be the most troubling? Which ones are not a 'big deal' in your estimation?

Should social media sites like Facebook be subject to more regulations to ensure the preservation of privacy rights?

How much do you think companies like Facebook really know about their users? How much of that knowledge can be a potential revenue source? What is the economic value of such user data?

Sam Ellis is worried. As president and CEO of Forward Software,Inc., Sam

introduced a new spreadsheet product, Cinco, to market lastyear. Forward Software has

been developing and marketing high-quality software packages formore than five years,

but those products were mostly computer software languageinterpreters, similar to

Pascal, FORTRAN, and C. These products received excellentcritical reviews, and

because of Forward’s aggressive pricing and marketing, thecompany quickly captured a

major share of the software market. Buoyed by its wideacceptance, last year Forward

Software decides to enter the applications area for the IBM andcompatible audience,

leading off with Cinco and following up with a word processingapplication, Fast.

The spreadsheet market is dominated by Focus Software, whoseproduct – Focus

A-B-C has an 80% market share. Focus A-B-C was released in 1981,shortly after IBM

personal computer (PC) was introduced, and the two products hadan immediate

symbolic effect. The spreadsheet was a major advance over whatwas available at the

time, but required the extra 16-bit processing power that theIBM PC offered. IBM, on

the other hand, needed an application that would make its PC a“must buy.” Sales of

Focus A-B-C and the IBM PC took off as a result of theirnear-simultaneous release.

At the time of its release, Focus A-B-C was a superb product,but it did have

flaws. For example, because the software was copy-protected, itcould be installed on a

hard disk, but the original floppy disk has to be inserted eachtime before the software

could run. Many users found this step an annoyance. Anotherproblem with A-B-C was

printing graphs. In order to print a graph, users had to exitthe software and load a new

program, called Printgraf, which would then print the graph.Finally, the product had a

list price of $495, and the best discount price available wasapproximately $300.

However, Focus A-B-C had a unique menu system that was intuitiveand easy to

use. Pressing the slash key (/) displayed the menu system at thetop of the spreadsheet.

The menu allowed the user to make choices and provides aone-line explanation of each

menu option. Compared to the cryptic commands or keystrokesusers had to enter in

other products, the Focus A-B-C menu system was a model ofsimplicity and clarity.

Millions of users became accustomed to the menu system andhailed its use.

Another advantage of Focus A-B-C was its ability to let userswrite their own

macros. Literally a program, a macro allowed a user to automatespreadsheet tasks and

then run them with a keystroke or two.

In 1985, a small company named Discount Software introduced itsown

spreadsheet to the market. Called VIP Scheduler, the productlooked and worked exactly

the same as Focus A-B-C. Pressing the slash key displayed theidentical menu as found in

Focus A-B-C. VIP Scheduler was designed to look and work exactlyas Focus A-B-C so

that users would not have to learn a new system and could startproductive work

immediately. VIP Scheduler also offered two advantages overFocus A-B-C: its list price

was $99, and the software was not copy-protected. Sales for VIPScheduler were strong,

but many consumers, perhaps feeling safer with the Focus name,did not buy the product,

even though critical reviews were positive. VIP Scheduler didfind a receptive market in

academia.

When Forward released its first spreadsheet product, Cinco, itwas hailed by

critics as a better all-around product than Focus A-B-C. It hadbetter graphics, allowed

users to print graphs from within Cinco, and was 100% compatiblewith Focus A-B-C,

but the menu and options were arranged more intuitively. Forusers who did not to invest

time to learn a new menu system, Cinco could emulate the FocusA-B-C menu system.

Both menus were activated by pressing the slash key, and theusers could specify easily

which menu system they wanted. All macros written for FocusA-B-C ran perfectly on

Cinco, provided that the Focus A-B-C menu system was being used.Because of

favorable reviews and aggressive marketing by Forward, Cincoquickly gained market

share. In a move that surprised the industry, Focus recentlysued Discount Software,

publisher of VIP Scheduler, for copyright infringement. Focusclaimed that its menu

system was an original work, and that VIP Scheduler, byincorporating that menu system

in its product, had violated copyright laws. Focus claimed thatthe look and feel of its

menu system could not be used in another product withoutpermission. Sam is certain

that Focus initiated this lawsuit because Cinco has made suchdramatic progress in

gaining a share of the spreadsheet market. Sam is also sure thatFocus’s target is not

really VIP Scheduler, because it has such a small market share,but Cinco.

After discussions with Forward’s attorneys, Sam thinks that ifhe makes a quiet

overture to Focus to settle out of court, Focus would beamenable to such proposal. This

overture, if settled, would stave off potential negativepublicity when Focus wins its suit

against Discount Software and then follows up with a lawsuitagainst Forward. Based on

projections of Cinco’s sales, Forward’s attorneys think thatFocus could ask for $5, $8, or

as much as $12 million in damages. Sam believes that theprobabilities of Focus agreeing

to $5, $8, and $12 million are 0.5, 0.3, and 0.2, respectively.Also the settling process

would cost Forward $1 million of the attorneys’ fee.

Sam knows that settling now means an immediate loss of income,in the amount

of one of the three estimates given, plus an admission of defeatand guilt for Forward.

On the other hand, Sam could wait for the outcome of the Focusversus Discount

Software suit. Forward’s attorneys believe that Focus has a 40%chance of winning its

lawsuit against Discount Software. With a win, Focus would haveits legal precedent to

sue Forward. It is by no means certain that Focus wouldinstitute a lawsuit against

Forward because Forward is a much larger company than DiscountSoftware and could

afford a vigorous legal defense. Also the case against Forwardis not a clear-cut because

Cinco has its own menu system as the primary mode of operationand offers the Focus A-

B-C menu system for those who want to use it. VIP Schedulerprovides only the Focus

A-B-C menu system. However, Forward’ attorneys believe there isa 90% chance that

Focus would initiate a lawsuit against Forward if Focus wins itssuit against Discount

Software. They also believe that Focus would not initiate anylawsuit if Focus loses its

suit against Discount.

Sam believes that even if Focus sues Forward, he would still tryto settle the case

out of court at that time or decide to go to trial. An attemptto settle out of court at that

time would be more expensive for Forward because Focus wouldfeel secure that it would

win its case against Forward, having already won its lawsuitagainst Discount Software.

Thus Forward’s attorneys think that Focus would settle for noless than $8 million,

possibly asking for $11 million or even $15 million. Therespective probabilities that

Focus would settle for these amounts ($8, $11, and $15 million)are estimated to be 0.3,

0.4, and 0.3. Also, Forward would have to pay its attorneysroughly $1.2 million to go

through the settling process.

However, if Focus sues Forward and Forward decides to go totrial instead of

initiating settlement proceedings, Forward could lose the case.Forward’s attorneys

estimate there is an 80% chance that Forward would lose thetrial, resulting in a judgment

of $8 million, $16 million, or $18 million against Forward, withprobabilities of 0.1, 0.3,

and 0.6, respectively. The attorneys also estimate that theirfees for a trial could run

around $2.5 million.

What is Sam’s optimal decision strategy and what is the expectedcost of that

strategy. What considerations would you like to bring to Sam’sattention?

An outside law firm has recently offered Forward Software for$0.7 million

dollars to conduct a detailed research on the likelihood thatDiscount Software will win

the lawsuit filed by Focus.

This law firm has a reputation in correctly predicting

outcomes of many copyright lawsuits similar to the one Sam mayrun into. In fact, the

prediction accuracy of this law firm in the past is about90%

2

2

The outcomes of 90% of the lawsuits were correctly predicted bythe law firm; i.e., P(Law firm predicts

Focus wins | Focus actually wins) = .90 and P(Law firm predictsFocus loses | Focus actually loses) = .90.

. Do you think Sam should

hire this law firm to do a similar study for Forward Software?In other words, is $0.7

million a good price for such a study, and if not, what shouldbe Forward’s counter offer?

Explain.

Case 14-6 Making Connections Social Konnections Inc. (SKI or the “Company”) is a global Internet company that runs Social Konnections, a large social media networking Web site. SKI has experienced steep growth since its launch in 2005, and the Company went public in 2010. SKI currently has over 500 million active users who visit the site to connect with others, express themselves, and play games. Last year, substantially all of SKI’s revenue came from advertisers who market their products and services to SKI’s active users through advertisements placed on the Web site or its various mobile platforms. The Company’s remaining immaterial revenue was received from fees associated with the sale of virtual goods and services by third-party application developers using SKI’s various platforms. In Q1 of the current fiscal year, SKI acquired Corporate Collaborations (CC), an entity that manages private and public social media networks for corporations. CC’s customers are primarily national and global companies whose employees connect over its platform. In addition to hosting private social media networks for corporations, CC provides services to develop the networks it manages. CC’s revenues are earned through the performance of multiyear revenue contracts with its customers. In the current year, CC is expected to produce approximately 20 percent of SKI’s consolidated revenue. SKI’s investors are focused on the growth prospects of the Company’s legacy open social media platform operations and its new corporate revenue unit. The Company’s MD&A disclosures include (1) various user and revenue metrics to help financial statement users assess its traditional operations and (2) backlog information to help users assess CC’s operations. Audit Because of SKI’s continued growth, the audit committee has requested that the Company choose a new audit firm with experience in auditing public technology companies. A new firm was selected and has performed each of the interim reviews in the current year. Kristine Drew, a senior auditor, is the in-charge accountant on the SKI audit. In addition to her supervisory and administrative responsibilities, Ms. Drew is responsible for auditing revenue. Ms. Drew has read the Company’s disclosed accounting policies and is interviewing the revenue controller, Bill Cook, and various sales personnel to develop in- depth process flow documentation that will serve as the basis for the team’s risk assessment. SKI creates advertising space on its Web site and mobile applications and sells the space to advertisers either directly or through advertising agencies. According to Mr. Cook, the amount an advertiser pays is dependent on the number of views the ad receives or on the number of user clicks (depending on the type of advertisement defined in the underlying contract) and the revenue is recorded in the period in which the views or clicks are made. Ms. Drew has learned that simple advertising can be purchased directly from SKI through SKI’s advertising Web site at standard rates, with the advertisements and terms input directly into the Company’s ad delivery platform. However, most advertising revenue is generated directly through the advertising sales team, which has the ability to help advertisers develop more sophisticated advertising campaigns. Management has established minimum pricing and volume thresholds for these advertisements; however, the sales staff is given significant latitude in securing contracts with customers. Extra commissions are paid to sales individuals who sign longer-term contracts that meet minimum revenue targets. Once a contract is signed, the ad development department creates the ad content and obtains the customer’s approval. The approved ad and the contract are electronically sent to the ad scheduling department, and the advertisement is uploaded into the Company’s ad delivery platform. The ad delivery platform is a robust system and is designed to capture all the nuances associated with the contract. For example, an advertiser may wish to have its ads displayed only to users whose IP addresses are from a specific geographic location, or the contract may be structured to provide the advertiser with variable pricing or incentives (such as a set of free advertisements) once a certain level has been paid for. In summary, the delivery platform captures all the relevant pricing information associated with the contract to allow for real-time revenue recognition according to the terms of the contract. After the contract is entered into the system, a summary of the contract setup is provided to the sales manager that worked with the customer. The sales manager then reviews the contract setup for accuracy. The Company’s ad delivery platform automatically tracks the advertising activity each day and reports the activity to its customers, who are then billed weekly for the aggregate ad activity. As part of its new corporate services program from the acquisition of CC, the Company earns revenues by providing corporate social network development and hosting services. For new customers, a contract will typically require an up-front fee to SKI for the development of the customer’s specific social media network; the contract will also include a separate multiyear hosting agreement. The customized social media networks only operate on the Company’s hosting platform, and customers do not have the option to take possession of the software used to run the networks. Revenues for the up-front fee associated with the development are recognized as the development is completed and the system is available to the customer. Hosting revenues are automatically recognized by the system based on the invoicing cycle outlined within the customer’s contract. According to Mr. Cook, this invoicing cycle is fairly uniform throughout the hosting period; therefore, from a materiality perspective, the Company will disclose that hosting fees are recognized ratably throughout the hosting contract period. , Ms. Drew was told that the corporate sales director had established a goal of increasing the length of the average hosting contract. Before SKI acquired CC, most of the multiyear hosting agreements were for three-year terms. In Q4, the corporate sales director implemented a strategy shift that would increase the contracted hosting period to five years. To accomplish this goal, the sales team was able to offer its customers three months of free service, to be added at the end of any new five-year agreement signed. In addition, the sales director offered an additional commission for converting existing contracts to five-year agreements. To accelerate the implementation of this plan, the sales commission is doubled if the contract modification occurs before the end of the fiscal year. Ms. Drew’s Concern Ms. Drew is concerned about several things she has learned regarding the appropriateness of management’s revenue recognition policies. Question: 1) Identify the potential revenue recognition issues related to each of the Company’s sources of revenue. 2)On the basis of the information Ms. Drew has learned, what fraud risk factors should she consider discussing with her team at the next fraud brainstorming meeting? 3)What potential audit procedures could the team consider to evaluate management’s revenue recognition policies and determine whether those policies are appropriately applied?