Enron Scandal - Research Paper Example

Enron Scandal The Enron scandal had deep repercussions for the American system in many ways. It led to the creation of legislation that ensured the presence of transparency and accountability in business organizations. Organizations now need to comply with laws with the presence of proper financial records and statements. Enron perpetrated fraudulent activities that were unprecedented in the history of the United States. It deliberately sought to create fake financial statements through the use of complicated strategies. Ghost companies were used with banks as intermediaries in order to acquire ghost loans. This created financial discrepancies in the form of loans. Profits were artificially generated in order to mention the cash flows that came in the form of such loans. Another technique used by the organization was to speculate on the energy sector. It calculated the market prices for the energy sector. The importance of ethics has also been demonstrated in the aftermath of the scandal. Corporate organizations need to have sound policies that demonstrate commitment, responsibility, and good governance. Such a culture helps employees to work for the prosperity of the organization. The collapse of Enron triggered shockwaves that took time to heal. The legislation in that time period allowed audit firms to provide diverse services which helped in the creation of fraudulent or misleading financial reports and statements. A major problem which occurred was the fact that Enron could recruit auditors that were inclined to make favorable statements in the organizational interest. Introduction Corporate scandals have a negative impact upon economic systems because they lead to drastic changes. The Enron scandal that erupted in 2001 shook the foundations of the American financial system. It had a catastrophic impact on the confidence of the market because the organization had been involved in fraudulent and malicious financial activities. The organization would become insolvent while its auditing partner, Arthur Anderson was also on the verge of bankruptcy. Enron was an organization that had been created in the mid 1980s. Jeffrey Skilling, Kenneth Lay, and Andrew Fastow were responsible for the scandal which involved the lack of proper financial reports and statements (Brewer & Hansen, 2002). Stock values were overstated in order to attract more cash flows. The Enron scandal had widespread repercussions on the entire financial system. The main executives received sentences while certain firms like Citigroup and Anderson Auditing had to pay heavy fines. The stakeholders were deeply affected as employees lost their life savings due to the transformation of stocks into junk following the collapse of the organization. The US government would pass the Sarbanes-Oxley Act which was designed to prevent such future scandals. This research paper will seek to analyze and assess the fraudulent activities perpetrated by the organization. It will analyze the final outcome of the case in an efficient manner. The paper concludes that the punishments were fair because they helped to create a set of new standards for the financial systems of business organizations. Finally the ethical concerns of the organization are elucidated in a proficient manner. Problem The Enron scandal shook the foundations of the US corporate world in many ways. It created new legislation that was designed to ensure compliance with accounting standards so that transparency and accountability could be achieved. Enron perpetrated fraudulent activities that were unprecedented in the history of the United States. It deliberately sought to create fake financial statements through the use of complicated strategies (Gillan & Martin, 2007). Ghost companies were used with banks as intermediaries in order to acquire ghost loans. This created financial discrepancies in the form of loans. Profits were artificially generated in order to mention the cash flows that came in the form of such loans. Another technique used by the organization was to speculate on the energy sector. It calculated the market prices for the energy sector (Gillan & Martin, 2007). The result was the assets of the organization were significantly increased due to its domination in the energy sector. Mark to market accounting was adopted as the system for the maintaining accounts of the organization. Theoretically this instrument argues that income should be calculated based upon the worth of future cash flows. Practically, this is a cumbersome task due to the vague and ambiguous nature of the system. Enron sought to use fake reports in order to satisfy the requirements of the investors (Gillan & Martin, 2007). Future profits need to be recognized in order to create a viable and stable financial system. Enron did not choose this path which led to significant losses for the organization. Corporate organizations usually have sophisticated systems that enable the management and investors to share information regarding the financial aspects of new projects. Such endeavors are carried with assistance from external auditors and internal governance agents. Enron had a board of directors that appeared to be appropriate according to legal standards (Nelson & Price, 2008). However this existed only on paper because the organization was able to use accounting and financial strategies to hide its financial performance while at the same time managing to lure new cash flows for projects. Another major flaw in the organization was that its performance management system was dysfunctional in many ways. Employees were encouraged to make short term deals in order to ensure their bonuses. Cash flows and profits were not thoroughly evaluated because employees needed to enhance their appraisals for the next year. Risk management was conducted in an inefficient and ineffective manner. The lack of proper procedures enabled the collapse of the organization. Derivatives and special purpose entities were used in an irresponsible and thoughtless manner (Nelson & Price, 2008). This led to the organization’s stock being overvalued according to the dynamics of the market. Enron was not able to conduct external audit in a transparent and appropriate manner. Anderson Auditing was forced by the organization to suspend the identification of charges that originated from special purpose entities. Enron’s credit risks were already manifesting in the financial markets. Anderson sought to protect its interests because Enron would frequently hire other firms to perform accounting jobs. Anderson was also accused of destroying crucial documents that provided evidence of the scandal. Impact on Stakeholders Scandals caused by corporate organizations usually lead to heavy losses on stakeholders. This has become a critical issue because stakeholders are unaware of the direct and indirect losses that are sustained from such operations. In addition, many stakeholders suffer indirect losses which can jeopardize their investment portfolios. The Enron scandal had a deleterious impact upon many employees who suffered from job losses and a large portion of their savings (Bryce, 2008). Many employees were prohibited from selling stock while senior executives were free from such restrictions. The stock value of the company continued to plunge which led to the loss of life savings for many employees. The workforce was deeply affected by the actions of the organization. Most of their future savings had been eliminated in junk stock. The audit firm Anderson was also placed in jeopardy for failing to identify the financial scandal in the company. Several thousand employees were terminated as the Justice department prosecuted the audit firm for eradicating evidence that was linked with Enron. Some 1750 partners belonging to the audit firm were threatened with the loss of life savings due to the indictment (Collins, 2006). The final outcome was that Anderson Accounting became a financially insolvent organization. It could not continue its operations due to the heavy fines that were incurred in the aftermath of the scandal. Other companies like Morgan-chase were the recipients of heavy fines that amounted to $135 million. Citigroup was forced to pay fines in the amount of $1.42 billion (Collins, 2006). Americans make considerable investments in index funds after retirement because it provides a steady source of income. Enron stock was present in over twenty five mutual funds because it was a participant in the Standard and Poors (S&P) 500 Index. However the index was negligent in its ability to study the situation in Enron. The organization was removed in a slow manner with the result that many investors lost money because the stock valued had already plunged to levels that were below the market value. Investment portfolios belonging to diverse sectors like healthcare and education had significant links with Enron (Bryce, 2008). Portfolio managers belonging to such sectors adopted a slow approach in diminishing their links with Enron as stock value continued to plunge at low levels. Politically, the repercussions were deep for the Bush administration that had been the recipient of funds from the organization. Enron’s actions have led to a deeper thinking about the impact of organizations on stakeholders. The stakeholders are the backbone of such organizations. The irresponsible actions of companies have a negative impact upon the stakeholders (Bryce, 2008). Outcome The Enron scandal shook the foundations of the US economic system as it entered the twenty first century. Previously Enron had been a model of the new economy in which corporate executives were able to apply creativity and innovation in order to increase profits. The company was hailed as an example of innovative firms with aggressive business executives. The Enron scandal led to the indictments of several individuals and organizations. Fastow and Lea were held culpable for their fraudulent activities inside the entire organization (Salter, 2008). Fastow managed to obtain a sentence of ten years in return for bearing witness against the other defendants. Fastow was the architect of Enron’s financial model that helped to increase its performance and profitability. The US legal system created a sixty five page report that mentioned a number of white collar crimes which Lay and Skilling had perpetrated. Skilling would receive a heavy punishment of twenty four years. Insider trading was the main crime in which Skilling had been involved. He was accused of other crimes like wire fraud and fake financial statements (Salter, 2008). Lay argued in the court proceedings that Fastow was the main culprit behind the scandal. This argument was rejected by the legal system and he was the recipient of the heaviest sentence among the group. A total of forty five years were to comprise the sentence of the individual. Lay would never serve time due to his death in the year 2006. He sold an estimated $90 million of company stock for fraudulent and malicious purposes (Salter, 2008). He made illicit profits from such measures that were the main cause of the scandal. Dan Boyle, James Brown, Daniel Bayly, and Robert Furst were individuals who received sentences for their part in the entire scandal. Several companies like Citigroup and Anderson Accounting received heavy fines for their role in the scandal. Sixteen people declared their role in the corporate scandal within the legal system. Furthermore, five people received sentences for their roles in the entire scandal (Salter, 2008). Punishments Fairness The punishments meted out to those involved in the scandal were fair due to several reasons. It led to the passing of the Sarbanes-Oxley Act of 2002. This Act provided a comprehensive set of guidelines for organizations in order to maintain accountability and transparency in their financial statements. A special Public Company Accounting Oversight Board was established so that audit and accounting standards could be complied by organizations (Cruver, 2003). In addition, it established the requirement that independent directors must be present in the board that manages any organization. The independent directors must be able to exercise their powers in the interest of shareholders (Fox, 2003). Public accounting firms were prohibited from offering any non-audit services to their clients. Audit committee members would be selected by using fair and transparent standards. Financial disclosure was made mandatory in cases of unconsolidated entities so that solvency could be attained in an efficient and effective manner. The punishments meted out to the defendants helped to provide several precedents (Fox, 2003). It established the rule that speculation can have a negative impact upon the performance of the economy. Goods and services need to be sold based upon their real significance in the financial market. In addition, a sound corporate strategy is the key to success for business organizations. The myth that corporate executives can be at the forefront of business profitability and innovation has been shattered due to the punishments. Any corporate executive who proclaims to have great knowledge of the market will now be met with greater skepticism from investors and the general public. A major reason for the fairness of the punishment was that Anderson Auditing was forced to pay heavy fines. This was essential because the organization had deliberately collaborated with Enron in ensuring that fraudulent activities would be perpetrated (Cruver, 2003). The result was that the organization almost went bankrupt as investors and clients lost confidence in its ability to perform auditing tasks in an efficient and effective manner. Fines imposed on Citibank, Morgan Chase, and Merrill Lynch were also a message to financial institutions that did not have proper accounting and financial reporting mechanisms. The fines incurred by Enron have also been used to pay off the money that is owed to employees and investors (Cruver, 2003). This is essential in order to create high levels of transparency and accountability. Overall the punishments sent the message that corporate scandals would not be tolerated in the United States. The set of government regulations have meant that corporate organizations need to invest considerable resources in ensuring that compliance can be achieved. Ethical Issues Business ethics are considered to be vital for the survival of organizations in the twenty first century. Such principles should be based upon corporate governance and responsibility (Swartz, 2004). The organization is entrusted with the responsibility of maintaining high standards of accountability and transparency. The Enron scandal demonstrates the importance of ethics in business transactions. The unscrupulous activities of Jeffrey Skilling, Andrew Fastow, Kenneth Lay and Arthur Anderson were responsible for the entire scandal. The ethical values were sidelined due to greed and profit by these individuals (Swartz, 2004). Skilling was indicted for the fraudulent manipulation of financial statements in order to cover the losses sustained by the organization. Fastow was responsible for the creation of ghost companies that were used to attract ghost loans from financial institutions. Kenneth Lay was responsible for overstating the stock value of Enron that caused extensive loss to employees, investors, and general public. Anderson was indicted for perpetrating fraudulent activity which included the destruction of several documents related to Enron’s financial system. Personal profit was the main motivation of these individuals. For this they were ready to perform any malicious act in order to achieve their goals. Enron’s corporate culture was characterized by the lack of effective ethical principles (Bethany & Elkind, 2003). Decisions were made through the creation of an elaborate corporate culture. This influenced individual members to mold their ethics according to the organizational culture of Enron. Many fraudulent activities were perpetrated by managers in the belief that their performance appraisals depended upon it (Brewer & Hansen, 2002). The board of directors began to have arrogant notions that the company was on the verge of innovation and profitability. The key corporate value was profit that needed to be pursued without any concern for ethics or moral principles. Whistle blowers were thus discouraged because of the corporate culture. Skilling used the policy of promoting employees who exhibited increased productivity and output. The pre-Enron scandal legislation was hopelessly inadequate to ensure proper transparency and accountability. This created serious problems for the entire financial system (Bethany & Elkind, 2003). The collapse of Enron triggered shockwaves that took time to heal. The legislation in that time period allowed audit firms to provide diverse services which helped in the creation of fraudulent or misleading financial reports and statements. A major problem which occurred was the fact that Enron could recruit auditors that were inclined to make favorable statements in the organizational interest. This was problematic because it created conflict of interests since audit firms could not produce reports that were against the interests of the organization (Bethany & Elkind, 2003). Enron did not have a set of corporate values and principles. The presence of such a system would have aided in the creation of a fair and transparent corporate culture. The lack of ethical values would ultimately lead to the collapse of the entire organization. Conclusion The Enron scandal shook the foundation of the US economy in the year 2001. It shattered the myth that corporate executives with innovation and profitability can create a new business model for the new century. In addition, it helped to create a set of government regulations that would lead to transparency and accountability for business organizations. The scandal occurred due to poor financial statements and reports. In addition, the malicious activities of the individuals were responsible for creating the mess. The corporate culture of Enron was based upon the pursuit of profit at all costs. This meant the absence of ethical or moral principles. Furthermore, the risk management and auditing process carried out in the organization was marked by several flaws and problems. The Enron scandal holds deep lessons for policy makers in the twenty first century. At the core level, organizations need to sell goods and products at their real value. Corporate executives need to adhere to a system of regulations in order to ensure efficiency and effectiveness. A corporate culture needs to be created which focuses on ethical responsibility and corporate governance. Such values can help in the prevention of future scandals because they would hold the company accountable for its actions. Furthermore the presence of independent directors can help organizations to achieve their goals and objectives. Such a course of action leads to superior outcomes where transparency and accountability can be achieved. References Gillan SL, & Martin JD. (2007). Corporate governance post-Enron: Effective reforms, or closing the stable door?. Journal of Corporate Finance, 13(5): 929-958. (December 2007) Nelson KK, Price RA, & Rountree BR. (2008). The market reaction to Arthur Andersen's role in the Enron scandal: Loss of reputation or confounding effects?. Journal of Accounting & Economics, 46(2-3): 279-293. Bryce, Robert (2008). Pipe Dreams: Greed, Ego, and the Death of Enron. PublicAffairs.   Collins, Denis (May 24, 2006). Behaving Badly: Ethical Lessons from Enron. Dog Ear Publishing, LLC.  Cruver, Brian (2003). Anatomy of Greed: Telling the Unshredded Truth from Inside Enron. Basic Books.   Fox, Loren (2003). Enron: The Rise and Fall. John Wiley & Sons.    Salter, Malcolm S. (2008). Innovation Corrupted: The Origins and Legacy of Enron's Collapse. Harvard University Press.   Swartz, Mary; Sherron Watkins (2004). Power Failure: The Inside Story of the Collapse of Enron. Broadway Business.  Bethany McLean, Peter Elkind (2003). Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron Portfolio Lynn Brewer, Matthew Scott Hansen (2002) House of Cards, Confessions of An Enron Executive Virtualbookworm.com Publishing Read More