Enron Accounting Scandal - Case Study Example

Enron Accounting scandal Introduction Every organization and its managers have a man to maximize the investor’s returns as they comply with laid regulations, avoiding conflicts of interest, and increasing organization’s capital. Achievement of such laid measures necessitates application of ethical principles in order to avoid future legal problems. Unethical management practices saw the downfall of Enron Company. The Enron accounting scandal has been the most widespread in the United States following the bankruptcy of the loan and savings banks in the 1980s. The Enron scandal portrays some of the unethical qualities and illegal businesses that led to the establishment of Sarbanes-Oxley Act 2002. The politicians of Capitol Hill investigating the case blamed the managers, directors, and auditors for the bankruptcy. The work seeks to expound the lessons learnt from Enron’s accounting scandal, with a close look at the scandal summation, and the basic breakdowns that transpired at the corporate governance level. Enron Accounting Scandal Summary Enron Corporation’s business included natural gas, energy, and electric utilities in Houston Texas. With more than 21000 employees, this company had revenue of over $100 billion in the year 2000 making it America’s most innovative company for six years consecutively, and being the seventh largest company in America. Dave (np) found out that that Skilling and Lay who were the (Chief Finance Officer) CFO and (Chief Executive Officer) CEO respectively played a big role in this scandal through their conspiracy to inflate profit, and committing security frauds. They both used the off-the-records collaboration as they lied to the investors about the company’s financial status. These executives equally traded out their personal shares in secret. This means that these top officials continued violating SPE laws, and accounting laws, while breaking all rules in order to satisfy themselves (Dave, np). Enron Scandal and Business Ethics The scandal that hit Enron Corporation went down as the most shocking in the history of the US as its magnitude was incredible. Ethics were severely violated, and even though the culpable individuals were legally charged, the violations can never be forgotten. The first ethical issues present in the case included lack of transparency in order to swindle the public of their money. It was reported that when the company’s executives engaged in what is popularly known as the insider trading. The reason for this act, which is considered illegal, was to cover up the real statistics of the company. This was considered not only unethical as it sought to portray false information, but also illegal since the company was public-traded. Secondly, the firm conspired to ensure that its employees never succeeded in selling their shares, yet the management could sell theirs. In the end, the employees’ shares were irrelevant unlike the management’s whose shares went on to be sold just before being declared bankrupt. Ethical literacy calls for forecasting the issues before they culminate into legal cases as they could pose reputational and operation risks. In the case of Enron, one of its contacted audit firms, Arthur Andersen, engaged in destroying some of the records. While the issue of destroying might not always be illegal, in this case, it posed legal challenges since the motive was to destroy the seemingly incriminating evidence. Besides these issues, Enron Corporation’s management violated ethics that require firms to value both clients and shareholders. It was noted that the company misled its board on approving deals whose risks were pretty high. As a result, the board’s approval saw the company’s shares skyrocket to a price of over $90 and this attracted many buyers. Sadly, this was just a ploy to ensure a majority of people bought the shares. A few months later, the same shares sold at less than $1. Clearly, in this scenario, the ethics were violated since sinister motives are evident, and a careless attitude towards the shareholders and interests exhibited. It is expected that every business strictly adheres to the regulations that guarantee its short-term and long-term success, but this lacked at Enron. The management, on several occasions, hid the exact figures of debt, which had accumulated from failed deals. This is another case of ethics violation by the management because business managers ought to observe the rules and regulations that help in the success of a business. Because of these debts, the company’s recovery proved to be impossible, yet this direction could have been avoided. Apart from destroying and fabricating the records, the company’s executives engaged in the altering of documents in order to mask losses. Customer’s confidence is normally dependent on a company’s ability to provide truthful and accurate information about its dealings. By engaging in these activities, the management was crossing the line, and this had dire consequences. Many of the problems that resulted in the closure of Enron could be traced to lack of one vital ethical requirement of integrity. Any leader, whether in a business or any other organisation, is expected to remain above board in terms of integrity. Integrity entails remaining professional whether when alone or with others. It is evident here that the Enron management were poor concerning integrity. Compromise of values can be seen throughout the scandal especially on the side of the accounting firms. While there were reports that the company’s auditor, Arthur Andersen was compelled to ignore the accounting issues, it is evident that the auditor was compromised. In as far as, ethics are concerned; individuals ought to remain unperturbed by any threats that might be issued in the course of their duties. Instead of compromising, it is imperative to adhere to the known values. Each of the other executives disregarded the values that such individuals are expected to demonstrate, and this was not only detrimental to the company, it marked the end of the same. Ethics are not concerned alone with the observation of the company rules; all legal matters ought to be considered before any action is taken. Enron Corporation’s management knew all too well that money laundering was against the US laws. Surprisingly, this knowledge and the likely outcomes did not deter the management from engaging in these habits. In fact, one of the reasons the top management was sued and subsequently jailed was due to this laundering activity. Though it is a legal issue the management broke, it started when the executives failed to embrace the ethics standards, which require company managers to understand the laws governing the country and follow them to avoid composing the business. Intimidation of staff cannot be overlooked as an additional ethical issue that the Enron management violated. This act is evidenced by the instructions given to Arthur Andersen to ignore all the records that showed the company’s illegal acts. In addition, the management had the auditor shred the documents, which ensured that the regulatory authority never got the information critical to the ensuring legal case. Subsequently, Arthur Andersen was charged with the obstruction of justice for this role. The management could therefore, be accused of intimidating Arthur while the latter’s unethical behaviour of cooperating with the management could only be described as both illegal and compromising. Disrespect and deception to the employees was a grievous mistake that the management at this corporation made. As noted earlier, the employees were compelled not to sell their shares when the prices were high, and as the shares plummeted below $1, the value meant that the employees’ savings had been almost lost. In any business, employees are crucial stakeholders for without them none of the operations would be done effectively. Sadly, this is not the view Enron management held, and the innocent hardworking employees were victimised. The many years they spent saving their money were wasted, and this clearly shows a total disregard of ethics on the management’s part. Selfishness was evident in all the dealings the company undertook especially concerning the concealing of the information about the sales. Besides engaging in the unethical behaviour of hiding crucial information about deals and debts the company had engaged in, the management conspired to indirectly rob the investors. It, indeed, is an unethical issue to commit resources in a bid deceive and swindle investors whose money made the company stand. In all these dealings, it is the employees, investors and the public that has to suffer. Even though this paper has highlighted the ethical issues evident in the case, it is likely that the management were involved in much more of these. Overall, this case confirms the importance of observing ethical standards at all times irrespective of what it is convenient. Lessons Learnt from the Scandal The Enron case offers many lessons especially to the finance and audit employees in all organization. The following chapter analysis some of the lessons learnt mainly by auditors considering that the department totally failed in its profession in this particular case. The Effects of Poor Governance This case concludes how poor governance can negatively affect an organization. Enron’s case gives an impression of deteriorating corporate financial reports globally, and the qualities of organization auditing and company profits. It is a good presentation of how poor governance can lead to bankruptcy. There is growing evidence that Enron is a common case of poor management with misleading reports for the stakeholders and other interested parties. The case portrays shoddy auditing, and probably an outright fraud. Proper capital market involves accurate company accounts, which comes through proper auditing. However, Anderson, the company that audited Enron since 1985 represented a failure to the whole profession. In fact, this auditing firm seems to have been guilty of shredding any incriminating papers ahead of the investigation. According to DeFond & Francis (15), Enron’s audit failures involved some business relationships bedevilled by conflicts of interest and vicious incentives. A study by Grusd & Morris (22) posits that hypothetically, the shareholders autonomously assign the auditors to whom they report. Nevertheless, practically the company bosses select the auditors to whom they end up becoming beholden. The audit clients tend to buy consultation services from these firms, and sometimes hired for senior positions in these firms. The impact of Lack of Transparency in an Organisation A company should ensure transparency especially in the finance department. Enron had heavy debts, and the top officials hid the information from the investors and the analysts. A study by Holtzman, Venuti & Fonfeder (23) reveals that this company’s credit rating drastically fell and the lenders started demanding for money. Enron’s accountant Anderson equally contributed to the scandal since he served as an accountant and an auditor. Together with the CEO, Anderson Enron participated in many deals, with these two putting financial greed above everything else. They covered all financial debts and losses, which never reflected in the financial statements. Consequences of Poor management It is important for the finance department to consider the consequences of their actions because they may end up hurting many people. The people who got hurt in this scandal included the stakeholders like the employees, business partners, stockholders and customers. Both institutional and individual investors lost millions of dollars, which they had invested in this corporation. In the year 2000, Enron’s stock price hit USD $90, and by the time of collapsing, it was below a dollar. The employees equally suffered considering this scandal left around 5600 people jobless and without any retirement benefits according to research. Unfortunately, Lay kept advising the employees to retain their stocks when they were falling as he sold his shares. Consequently, it is conclusive that poor governance has a negative effect on the organization, and its stakeholders. Effects of an Organisation’s Loss of Objectivities Every department in each organization has a responsibility in relation to the organisation’s objectives. Research shows that the major lesson in regards to internet boom is that it is often difficult for analysts to understand and evaluate any new upcoming businesses. It is also clear that executives like Skilling were not ready to foster open enquiry especially after having sworn in during a conference call from an analyst who had pointed out on the balance sheet. The Enron Corporation debacle was an illustrative problem that has become all evident in last few years in the Wall Street’s loss of objectivity. It is clear that most investment banks seem to make more profits in mergers or underwriting compared to profits made from broker fees. The analysts from such firms seem to make more conflicts especially in loyalties. More often, they find themselves in positions whereby they have to worry whether the CEO finds a report offensive or whether it is helpful to the investor. As a result, loss of objectivity by managers can lead to bankruptcy as in Enron case. Importance of Truthfulness in an Organisation The case of Enron presented the impacts of untruthfulness and what its effects on an organization. Research shows the management in this company failed to practice truthfulness. According to Kirk Hanson who was an executive director for Markulla Centre for Applied Ethics, failure for truthfulness caused the unhealthy situation for Enron Company. Skilling and Lay who were the CFO and CEO respectively played a big role in this scandal through their conspiracy to inflate profit, and committing security frauds because they believed everything had to be perfect. The executives attempted shielding their names and the reward of being the paramount executives at the time with a responsibility to uphold total disclosure and good faith. However, these executives refused to advice the stakeholders on the falling share per capita and while they encourage them to continue buying shares, they sold theirs. After all, these employees would take a long time to understand on the falling shares maybe days or weeks, as it is usually the case. Only the inquiry of this corporation explained to the stakeholders on what ensued to the business. The executives did their sell-offs to the company to repay monies owed to the company by these executives. Unfortunately, a disclosure in this type of operation allows 45 days after a company’s fiscal year and this allowed the delays. Effects of Conflict of Interest Interest plays a vital role in a company’s success, and Enron portrayed the negative effects of special and selfish interests by the company’s executives. Among the causes of the Enron Corporation’s collapse included conflicts of interest and lack of independent oversight by these executives board. In addition, many people feel that the compensation policies for Enron Corporation created a myopic focus on the stock price and the earnings growth. Moreover, recent regulatory changes seem to focus on enhancing the internal accounting and control systems, while starting with Enron’s Board. It is clear that there was a conflict of interest with Arthur Anderson acting as both the auditor and a consultant for Enron Corporation. One major step that Enron Corporation undertook was to salvage its business through spinning off most of its assets. Having filed for the Chapter 11 bankruptcy, this helps it to reorganize its finances while remaining protected from the investors. Kenneth Lay who is a former executive and chairperson resigned with Stephen Cooper coming in as the new interim Chief Executive. UBS Warburg tied up with the Enron’s major business, which included the energy-trading arm. How Over Smartness can negatively affect an Organisation This case clearly shows that a finance manager can be too smart to outplay the auditors. The financial officer can use clever and accounting financial devices to confuse the analysts and other interested party like the investors. If the company reported the losses early enough then maybe Enron would have survived since the market would have digested the information. However, many companies learnt a big lesson from this scandal. These irregularities often happen in different companies especially when there is collaboration among senior members of staff or executives. The executives used the off-the-records collaboration as they lied to the investors about the company’s financial status. However, a new act came up after the scandal that safeguarded companies from similar mess. This scandal brought about the formation of Corporate and Auditing Accountability, Responsibility, and Transparency Act of 2000 also known as Sarbanes-Oxley Act 2000 The main idea of setting up this new act was to set more new and enhanced standards for every United States public organizations boards, management and accounting companies. According to Lordan (47), it is clear that many people have been victims of such frauds and with this new act, most auditing especially from external forces identified the problems upfront. This law’s main intention was to ensure that the top management individually certified their financial data. Lordan (47) argues that the act also minimized any collaboration between the auditing firms and the companies at hand. They also ensured that any penalties on misconduct were severe enough, while it ensured independence of external auditors whose duties included reviewing all financial statements. With very strict penalties or jail-terms, these executives would withhold any intentions of fraud. Ethically, Corporate acts normally originates from the actions and choices made by human individuals therefore they must be seen as the primary bearers of the moral duties and responsibilities. Lay, the chairman of Enron, and Skilling, the CEO allowed Fastow, the CFO to build private cooperate institution in secret, while transferring property illegally. Fastow, who was the Chief Finance Officer at the time, violated his professional ethics, taking the crime of misconduct. While Skilling who was the superior Chief Executive Officer, and the Chairman of the board, Lay, ordered the conspiratorial employees to conduct an act they knew was wrong, the employees equally had a moral responsibility for the action. A study by Lorinc (20) found out that the utilitarian ethical concepts allow actions that will make the people happy. This theory also emphasises that it is not always about the results, but rather it is about people’s contentment, which was not the case here. The most radical change would be taking the auditing responsibilities away from the private firms, and giving the government the lock, stock and barrel. However, the government might not evade some of the errors and conflicts similar to private auditors, but it would run the quality risks. On the other hand, maybe the duty of choosing the auditors should move away from the company executives to government agencies like Securities Exchange Commissions whether from their list or the company’s list of recommended auditors. On the other hand, accounting firms should not provide consulting services to their audit clients because this creates a leeway for corruption. In addition, there should be a rotation of the auditors after a given period to ensure that the auditors and the clients are not too committed to each other. The government should find a way of banning the hiring of senior auditors in the company from these external firms Lorinc (20). A healthy corporate culture is vital in every organization and Enron Company failed to practice or maintain a healthy culture. It is clear that the board became over optimistic about the executives of the Enron Company who believed on the best of whatever they did. It was clear that there was a lot of cover-up especially on realized losses, and other company failures. These executives continued ensuring the stakeholders that all was well. There should be a more complete system to supervise any operators and executives in order to understand any company’s operating system since this would have stopped Enron from collapsing. The fall of this company heavily affected America’s economy meaning the government should equally intervene through placing tougher regulation. Skilling and Fatsaw use a “Mark to Market” plan to pump the stock price, while covering the losses hence attracting more customers, which was not only immoral, but also illegal. Nevertheless, research shows that the United States Security and Exchange Commission played a big role by allowing them to apply the mark to market accounting method. People should be willing to apply some business ethics as a thesis point. The manager’s allegiance to the corporation includes improving the employer’s significance. Conclusion This scandal presents regular errors that occur in organizations causing bankruptcy. Collaboration between the external auditors and the employees could lead to disastrous scandals similar to Enron’s case. This fraudulent act by senior executives saw a sudden fall of a great gas companies. However, this may have taught several professionals especially in the audit departments many lessons considering the negative effects on the company. The executive officers, and Anderson auditing firm collaborated in hiding of the company’s financial statements until the time when the company collapsed in 2001. However, this saw the creation of Corporate and Auditing Accountability, Responsibility, and Transparency Act of 2000 also known as Sarbanes-Oxley Act 2000. It set more new and enhanced standards for every United States public organizations boards, management and accounting companies and this was a major lesson learnt by many corporations, and especially in the auditing departments. As a result, it is import to ensure that the external auditors have no close links to their clients to avoid such collusions. References Dave, Melendi. "Questions Raised About Accounting Standards After Enron Scandal." San Gabriel Valley Tribune (West Covina, CA) (n.d.): Newspaper Source. Web. 18 Apr. 2015 DeFond, Mark L., and Jere R. Francis. "Audit Research After Sarbanes-Oxley." Auditing: A Journal Of Practice & Theory 24.(2005): 5-30. Business Source Premier. Web. 18 Apr. 2015. Grusd, Neville, and Thomas W. Morris. "The Enron Affair From A Lenders View." CPA Journal 72.12 (2002): 8. Business Source Premier. Web. 18 Apr. 2015. Holtzman, Mark P., Elizabeth Venuti, and Robert Fonfeder. "Enron And The Raptors." CPA Journal 73.4 (2003): 24. Business Source Premier. Web. 18 Apr. 2015. Lordan, Edward J. "The Enron Endrun -- PR Lessons From An Accounting Debacle." Public Relations Quarterly 47.3 (2002): 22. Business Source Premier. Web. 18 Apr. 2015. Lorinc, John. "After ENRON." CA Magazine 135.10 (2002): 20. Business Source Premier. Web. 18 Apr. 2015. Index: Figure 1: cash flow ratio, 1st three quarters in 1999, 1st three quarters in 2000, 1st two quarters in 2001. Figure 2: Largest bankruptcy filings (source: Bankruptcydata.com) Figure 3: Fraud summary Read More