The Enron Scandal - Essay Example

Sometimes there are events that occur in the business world that astonish and shock the entire community. Back in the 1990s Nike Corporation was one of the villains whose reputation was hurt due to a sweetshop scandal. This event was shocking, but understandable how it could occur because it involved external stakeholders. At the turn of the 21st the Enron Corporation filed in 2001 at the time the biggest corporate scandal in the United States history. The reason for the bankruptcy was associated with cooking up the numbers. The complete collapse and demise of the company occurred due to fraudulent behavior by the executive management staff of the company and its accountants. The purpose of this paper is to describe the events associated with the Enron scandal. Enron Corporation was founded in 1985 by Kenneth Lay. The company became the largest energy company in the United States in the late 1990s. Enron was name the most innovative company in the world by Fortune Magazine from 1995-2000. The common stock of the company skyrocketed in the 1990s to reach a peak of $90 in the summer of 2000. Enron became the world’s largest energy company holding over 25% of energy contracts in the world. Enron was an admired company and all its stakeholders believed in the firm. The employees of the company were conned into investing their entire pension funds in Enron stocks. Nobody was complaining when all the pension money was going into Enron stocks because the ship seemed too mighty to ever fall. When the Enron scandal was revealed the ship sank faster than the Titanic as investors lost overnight over $13 billion in equity valuation. The stock became a worthless penny stock. The Enron scandal was so alarming due to the fact that the firm was a public company whose financial statements were audited every year by an external auditing firm. The accounting firm responsible for the audits of Enron Corporation was Arthur Anderson. Arthur Anderson was receiving over $1 million in weekly revenues from Enron. Arthur Anderson colluded with Enron to hide the truth about the fraud Enron was perpetrating to its shareholders and other stakeholder groups. The company was the 7th largest company in the United States prior to its collapse. A lot of people lost their jobs as well as their entire life savings. In its peek Enron employed over 21,000 people. The shareholders of the firm were another group was severely negatively impacted by the behavior of a small group of con men that were in charge of Enron. Due to the fact that the company went bankrupt the lenders also took a huge blow with losses worth billions of dollars. The Enron scandal was masterminded by a small group of Enron executives that had all the power and opportunity to pull off the scam. Three of the major players in the con game were Chairman Kenneth Kay, Jeff Skilling, CEO, and CFO Andrew Fastow. Arthur Anderson was also deeply involved in the scam. Arthur Anderson destroyed thousands of pages of financial documents prior to the federal government raided their offices. The employees at Arthur Anderson committed obstruction of justice when they destroyed all those documents. In the year 2000 the cash flow position reported by the company in its balance sheet was $3 billion. In reality the company had a $153 million dollar cash flow deficit. It was beyond absurd and dumb what the executives were doing since eventually it was inevitable that they were going to get caught. That same year the company reported profits of over $1 billion when in reality the company did not make any money whatsoever. There were several strategies that the company used to create the scam. It seems as if criminals are always able to find loopholes in systems to take advantage of short term opportunities. The first accounting trick that the company used was called market to market accounting. The Securities and Exchange Commission (SEC) approved the use of market to market accounting by Enron. It was impossible for the SEC to visualize that Enron would use market to market accounting as a tool to pull off one of the biggest accounting scams in business history. The use of market to market accounting allows companies to estimate future earnings which can be reflected in the current earnings of the financial statements. A basic accounting concept that must be used for market to market accounting to work is conservatism. The principle of conservatism anticipates lower gains and higher losses when making estimates (Wisegeek). Instead of following the principle of conservatism Enron did the exact opposite. It inflated gains on energy contracts, while at the same time minimizing losses in its estimates. The use of market to market accounting was directly responsible for the $1 billion in fake profits that the company reported in the year 2000. The fraud would have been prevented in the auditors of Arthur Anderson would have spoken up and revealed the fraudulent behavior of the company. It is also hard to believe that the Securities and Exchange Commission was not able to catch the fraud sooner. In the aftermath of the scandal new rules came into play that increase the investigative and power of the SEC and the authorities when dealing with cases of financial fraud. Enron Corporation used two major tools to make its financial statements look good. The market to market accounting was used to inflate the income statement, while off-balance sheet transactions were manufactured in order to hide the debt of the company. The CFO of the company created a network of special purpose entities all of which had ownership of less than 49% by Enron. The loophole in the accounting rules was that if the ownership of the parent company is below 50% the debt does not have to be reported. Enron created over 3,000 special purpose entities to create confusion and hide most of the firm’s debt in shelf companies. The end result of the special purpose entities was to understate liabilities. The Enron scandal was an impressive scam that was extremely hard to detect due to the size of the company and the lack of control mechanisms to prevent these types of events from occurring. All the governing bodies of accounting and finance including the Securities and Exchange Commission were completely fooled by Enron and its gang of white collar criminals. The Enron scandal was finally revealed due to the involvement of a whistleblower. “A whistleblower can be defined as a person who reveals any wrongdoings or malpractices that are taking place within an organization” (Bainbridge). The valiant Enron employee who came forward and told the authorities about the wrongdoing in Enron financials was Sherryl Wadkins (Gold). The information she provide gave the SEC and the justice department reasonable doubt to launch a full investigation into the financials of Enron. The executives at Enron committed many crimes including using insider information to defraud the market. The executives sold hundreds of million of dollars in stock fully knowing the stock was going to go down. Insider information is a serious crime because it distorts the market and lets a trader illegally take advantage of information that is not accessible by anyone. This act showed a lot of disrespect to the thousands of workers that lost their lifetime pension due to a fraud committed by a small group of managers that completely disregarded common decency. The corporate culture of Enron was full of deceit and unethical behavior. The fraud started at the top, but on many instances the energy traders acted unethically in their dealings with the California energy grid. Deregulation in California allowed Enron to make million in profits by at times cutting off the energy of people intentionally in order to raise the prices. The Enron scandal came along with a wave of other financial scandals including Tyco, Adelphia, and WorldCom. Due to the severity and size of the Enron scandal and other cases that occurred during the same timeline the United States government stepped in and created a new regulation to bring social justice to all stakeholder groups. Senator Paul Sarbanes and Representative Michael Oxley created the Sarbanes Oxley Act of 2002 commonly referred to as SOX (Sox-online). SOX raised the investor confidence in the financial market by creating auditor independence, accountability, better internal controls, and criminal penalties for accountants and executive managers that commit fraud. The CEO of the firm is now personally responsible for the financial statements of the company he or she is in charge of. SOX established a maximum penalty of 25 years for violators of the Sarbanes Oxley Act. The Enron scandal marked a dark episode in United States business history. The greed of a few managers hurt the lives of dozens of thousands of people. The use of market to market accounting and off-balance sheet transaction were two of the instruments that the Enron crew used to deceit the government and the general public. The corrupt executive managers were brought to justice. One of the few good things that came in the aftermath of the scandal was the governmental intervention that led to the creation of the Sarbanes Oxley Act. Work Cited Page Bainbridge, R. 8 January 2007. “Whistleblower Definition.” 1 December 2011. Gold, D. 10 November 2011. “Enron Whistleblower Sherron Watkins Joins America Whistleblower Tour at Brandeis University.” 1 December 2011. Sox-online.com. 2006. “Sarbanes-Oxley Essential Information.” 1 December 2011. < http://www.sox-online.com/basics.html> Wisegeek.com. 2011. “What is Convervatism?” 1 December 2011. Read More