Enron's Scandal Details - Case Study Example

The Enron case Enron Corporation was based in Houston, Texas and was an American energy-trading and utilities company. At the height of the scandal, the company was the seventh largest corporation by revenue in the United States. Enron employed about 20,000 staff making it one of the largest in the industry it operated. However all these were before its bankruptcy on December 2, 2001. Enron shares traded at $85 initially and after the fraud was discovered it plummeted to $0.30 in the sell-off immediately the fraud was exposed (Armour and McCahery, 38). The fraud exposed the corporation and it was realized that their reported financial condition was sustained considerably by an institutionalized, methodological, systematic and crafted planned accounting fraud, which was to be known as the Enron scandal. The corporation did this through a complicated arrangement of special purpose entities they referred to as the Raptors. The Raptors were expected to cover their expenses if the stocks in their start-up businesses collapsed. Most surprising is the fact that the corporation took spent 16 years to grow from about $9 billion assets to $60 billion, but only spent about a month to go bankrupt. The Company collapsed so fast and so entirely. In fact it made history as the largest bankruptcy and accounting scandal in American. The absence of truthfulness by management about the company led to their downfall. The overriding benefits and public trust ended immediately. For years the management lied about the financial reporting thus worsening the economic ability. They made employees loos job and lack of investors trust was evident. The senior management team believed Enron had to be perfect in everything it did and that they had to safeguard their reputations and their compensation as the most successful management in the US. Three most common forms of accounting frauds above where witness that led to the downfall of the company. The corporation followed these illegal accounting practices in financing which subsequently ensure the company be valued more attractively and appealing to the investors by the by Wall Street analysts and rating agencies. Most notably was the fact that Enron as a company used various related parties in increment of equity and crafted its financial arrangements using various loopholes in laws. All these was surprisingly was conducted trying to not consolidate into its reports and accounts by at will not fulfilling certain ethical conditions. Mark to market This was a principle and a plan that proposed by both Andrew Fastow and Jeffrey Skilling. In their view they did so for three motives: To accelerate the stock price, cover the existing loss and attract more investment. However it was not practical to gain in a long-term operation in this manner making the principle illegal and clearly immoral. However, it was stated that the then US Security and Exchange Commission permitted them to use “mark to market” accounting technique. Ideally, Enron was subject to external governance sources including market pressures, monitored by government regulators, and oversight by private entities including equity analysts, auditors and credit rating bodies and it is shocking how this particular accounting malpractice occurred. Mark to market method Enron applied required that immediately a long-term agreement was put to pen, the amount of which the company’s theoretical asset would sell in the future market was reported on the financial statement at that time. All these were done with a goal of appeasing the investors to develop a consistent profiting goal. Likewise, Enron company traders were forced to forecast high cash flows in the future and low rates of discount on the long-term contract with the company. In the same technique, the deviation between the obtained net present value and the initial paid value was viewed as the profit of the company. For a fact, the net present value that Enron reported might have not occurred during the future years of the long-term contract. It can be concluded that the projection of the long-term earnings was overly inflated and optimistic Special Purpose Entity Enron applied SPEs in various aspects of its operations. The practices were clearly evident from the early 1990s through late 2001. It is also said that these practices included: First, sales to Special Purpose Entity of "financial assets" in other words these were equity interest or debt owned by the company, synthetic lease dealings, which concerned the sale to an Special Purpose Entity of an their asset and lease in return the asset. For incase, a case to support this is such as the company’s headquarters building in Houston. Secondly, sales to merchant "hedging" Special Purpose Entity of the company’s stock and trade contracts to receive company stock. Finally, transfers of other assets to bodies that had limited outside equity. In real sense, there may be no generally accepted definition of Special Purpose Entity to uniquely separate them from other known legal entities, However the employees of the Financial Accounting Standards Board (FASB) has used the notion of entities whose operations and authority are significantly limited by their contractual arrangement or charter. A Special Purpose Entity may take any legal form, like a corporation, trust or partnership. At the margin, it could be challenging to conclude whether a particular entity is a Special Purpose Entity or not. Accounting principles permits any company to exclude a Special Purpose Entity from its financial statements if an independent entity has control of it, and if this party owns at least 3% of the Special Purpose Entity. Special Purpose Entity diagram of Enron ompany 1. Enron’s equity used as collateral Outside lenders 5. SPE repays 2. 97% invest. Enron 6. Assets SPE special yield payment and 7. SPE repays cost 4. 3% equity inv. Outside investors Prepays The method of prepaid swaps was used by the company to disguise the nature of transactions between the Enron and major banks. In the technique, counter-party is offered a fixed sum in advance in exchange for a stream of future payments in other words, the receipts and payments being related to the oil price and made partly by an offshore conduit SPE. The cash flows of this method mimic those of a loan, however as long as the swap meets set conditions, the transaction was be accounted for as a hedge. Thus, prepays can boost operating cash flows, while at the same time keeping debt down. There are two ethical theories that can help understand the unethical decisions the company made and they are deontology and utilitarianism. Deontological or duty-based ethics focuses on what individuals or entities do, not with the outcome of their actions. Under this form of ethics doctrine, one cant justify an action or activity by showing that it results has in good consequences. A deontological ethics would have encouraged full disclosure in Enron case. In referring to the case of Enron, giving correct details about its financial situation in, say, previous years, would have hurt Enron by depressing stock value; it is also evident that company investors could have opted to take a financial “hit or sell off stocks or.” Likewise, not saying anything would keep investing in the stock, thus raise the stock holdings of employees. A utilitarian ethics presumably favors not saying the truth and hoping that events turn around. This was the case for Enron that turned to hurt them. Without question, the company was never socially responsible when it lied to the shareholders about its income and failed to disclose that its equity value was lower than its balance sheets indicated. Likewise, the Enron used its “partnerships” with the several firms it created to hide its debts and its losses. The company executives kept millions in stock-market gains and assumed accounting irregularities. Even though, they clearly knew that company workers who had stock in the organization would suffer. Without a doubt, the company betrayed its employees and its shareholders in overall. The company went against its stated commitment to integrity, and it eschewed communication for greed. From Corporation’s Angle Normally, the acts of a corporations managers are attributed to the corporation so long as the managers act within their power. However, the shareholders of the company didnt know and realized this concern from the superficial high stock price. Thus, the entire company was not of responsibility for this fraud. But the management can largely be blamed for the fault. They reluctantly refused to put in place the required mechanisms to stop various malpractices that were occurring at the company for those years. In relation to this the company failed to instill the culture that was needed for the ethical prosperity for their company. To them, they adopted various strategies and principles that contravened the way normal and legal business is carried out. All these corporate failures were made to increase investor confidence at the expense of the company. The board of directors can also be faulted for lack of concern or paying little attention to the company’s operations. While the board of director’s mandate is to oversee corporate management with the goal of protecting the interest of the shareholders, on various occasions, the company’s board waived conflict of interest rules. These rules permitted CFO Andrew Fastow to create a vibrant private partnership to do business with Enron. As a conclusion, the Enron Corporation’s case was the biggest in a series of scandals, and a lot to do with ethical issues can be learned from the case. The damage to reputations of corporations was evident, and the case helped expose various accounting malpractices that occur to some companies that are unknown to the public. The Enron company scandal moved the balance of authority away from their boards directly to the investors. Matters of conflict of interest were evident from the company and seen as an important factor for consideration, and that largely contributed to the scandal. However, the scandal could have been avoided but the management worsened the situation by the introduction of various accounting principles that were focused on instilling confidence on the investor’s at the expense of long-term success of the company. Enron was not being responsible; the corporation hurt many individuals even though it undoubtedly though that safeguarding secret would serve shareholders the greater good as they would reorganize things without greater harm. In the end, though, the company destroyed its credibility. All these were because they declined to follow their code of ethics. Work cited Armour, J. and McCahery, J.A. – After Enron, Hart Publishing, 2006 Read More