Case Study: Accounting for Enron

Table of Content

Just the year before, Enron posted a 57% increase in sales between 1996 and 2000. And Enron shares hit a 52- week high of $84. 7 per share in the last week of 2000 (O’Leary, 2002). As the story unfolds, investors lost billions of dollars and thousands of people lost their jobs and their retirement savings (Arnold, 2013). Enron turns out to be one of the worst corruption scandals due to the deceit and fraud created by its top executives. To understand Enron’s demise is to disseminate the rationale for the collapse.

How could it happen?

Hence, this case study will focus on the company’s rise to fame and on the key players that fostered a Darwinian company culture which helped to enable its downfall, evaluate the inconsequential unethical business practices and its disastrous fallouts, discuss the impacts to industrial, social, governmental policy and the fundamental changes to how corporations conduct business today as a outcome and suggest additional safeguards to protect investors, society at large and to ensure integrity of the financial markets.

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Analysis To understand what happened with Enron is to start by understand the company’s beginnings and the key players’ roles in creating the corporate values. Enron Corporation was a merger between Houston Natural Gas Company and Interior Incorporated during 1985. Kenneth Lay, then-CEO Of Houston Natural Gas Company (HANG), engineered the merger and later became the Chairman and CEO of Enron Corporation (Free, Macintosh, and Stein, 2007). The following year, Lay brought on Richard Kinder to joined Enron’s executive team in 1986. Cinder’s job was making sure Enron worked, and he was good at it” (Bryce, 2002). Kinder focused on financial performance and earnings accountability from each business unit leaders. During his time as President from 1 990 to 1996, Enron’s revenue rose from $5. 3 billion to $13. 38 billion, while reported earnings increased from $202 million to $584 Bryce, 2002). With laser focus on the financial, he ran the company with a tightly gripped iron fist. He created a company culture where Enron business unit leaders were “expected to show up, ready for a grilling” (Bryce 2002).

Cinder’s leadership relentlessly pursued a results-oriented organization at all cost. He rewarded and promoted managers who survived his inspection. Hence, his leadership style drove intense cross-examination at all levels to defend each teams’ position and survival. As a consequence, the sever scrutiny engendered a lot of organizational learning and cross-functional immunization, as new ideas emerged, and innovative rethinking ensued (Ibises and Outlet, 2004). Lay and Kinder controlling leadership style fostered a cutthroat work environment.

However, Enron’s culture would undergo a more detrimental change under Jeff Killings reign as President and CEO from 1996-2002. Killing embodied a very different and high risk taking management style. Killing brought a corporate culture to Enron that was Dianna to the point of near absurdity. From Fox’s book on Enron (Fox, 2003), Killings survival of the fittest tactics were reflected in his policies for performance review. These performance review committees would rate their peers on a 1-5 scale and the bottom or so of employees would be systematically fired each year.

The stakes were high because all the rewards were linked to ranking decisions. Managers judged “superior”–the top 5% got bonuses 66% higher than those who got an “excellent” rating, the next 30%, and the bottom 10% were fired (Businesslike. Com, 2002). From an already cutthroat environment, Shilling’s survival-of-the-fittest mindset further fueled the employees to the point of Machiavellian. Backstabbing cunning, unscrupulous and individual-focused were the ways to behave and o be rewarded. “In the Enron culture, there was no significant counterbalance,” says Jon R. Switchback (Businesslike. Mom, 2002), a consultant and former McKinney colleague of Killing who has studied the company. “The lesson is you cannot rely solely on individual achievement to drive your performance over time. Companies with only that one path overemphasized it and run into trouble, switching over to vanity and greed. ” A ruthless culture was brewing at all levels of the organization, which set the stage for Enron’s unethical business dealings. Combine the cold-bloodiness of the company culture with Shilling’s lenses risk taking to drive growth; Enron was primed for an epic financial accounting deception.

By 2000, trading operations accounted for 99 percent of income, 88 percent of income before tax and 80 percent of identifiable assets, while reported revenue increased from $11 ,904 million in 1996 to nearly $100,000 million in 2000 – a tenfold increase (Epstein and Lee, 2009). Killing shifted Enron’s business model from a gas trading and pipeline company to become a Wall Street-like financial trading machine dealing with all sorts of commodities, derivatives, options and hedges. With the versification, Enron was betting on too many horses and too many risky horses.

To offset these losses, Enron’s SCOFF, Andrew Fast, created Special Purpose Entities (Specs) (Arnold, 2013). According to the CPA Journal (Anyways. Org 2014), SPECS are off-balance-sheet arrangements that served a legitimate business purpose: to isolate financial risk and provide less- expensive financing. In theory, because SPECS do not engage in business transactions other than the ones for which they are created, and their activities are backed by their sponsors; therefore, they are able to raise funds t lower interest rates than those available to their sponsors.

However, Fast used SPECS and off- balance-sheet partnerships to enter into transactions generally considered too risky or controversial for ordinary commercial entities. These SPECS and partnerships were not consolidated with Enron’s other activities on Enron’s financial statements; as a result, Enron’s significant losses and debts could be concealed from public disclosure (Marmoreal, 2004). Moreover, the idea of a venture entity managed by the SCOFF is a red flag for conflict of interest in itself, but Fast was allowed to continue.

Everyone looked the other way because they company was soaring. At the beginning of 2001 , Enron’s stock was trading at $80 per share. However, the domino effect from the SPECS was spiraling out of hand. Analysts and journalists questioned Enron’s stock prices biblically. By the summer, Enron executives were selling off their stocks by the truckload. Finally, in October 2001, Enron was forced to report a quarterly loss of $618 million (Arnold, 2013). And by December, their stocks were worthless. The greed for financial grog. /the at all cost resulted in 20,000 employees lost their jobs and in unrecoverable SSL . 2 billion lost of employees’ savings, retirement and pension funds (Paulsen, 2002). From ESP. conflict of interest to executive insider trading, the unethical misconduct of Enron ran deep within their company core and it impacted all, shareholders and employees alike. The greed and deceit went beyond Enron. No one blew the whistle, not the auditors, not the lawyers, not the government because they were all apart of it.

The deception also scaled to Arthur Anderson, the accounting firm that was responsible for auditing Enron’s financial. By definition, first and foremost, auditors are expansible to certify or to attest to the truth of financial statements for the purpose of the users of those statements and not to the client. Secondly, auditors are responsible for upholding the Aspic’s statements on auditing standards. Above all, they have accountability to assess and to maintain their auditors’ independence status according to the four basic principles of independence (Arnold, 2013).

Although subordinate auditors at Arthur Anderson had grave concerns about the SPECS, David Duncan, their head of auditors continued to attest to Enron’s financial statements. Moreover, by sass, Arthur Anderson was pioneering the integrated audit, which would mingle not only internal and external audits, but also a whole package of services ranging from tax strategy to advice on corporate-finance issues. Auditors were required to bring in two times their revenues in work outside their area of practice as a part of their performance review, which meant they were required to bring in non-auditing sales (Brown and Dugan, 2002).

Hence, Arthur Anderson was doing significant consulting business with Enron at a fee rate of around $1 00 million a year and it catapulted the firm into the accounting stratosphere as one of the top global giants. The independent check and balance auditing function was blurred with greediness. Conflict of interest was seamlessly rampant. Furthermore, in the mist of the Enron disaster, Arthur Anderson was caught shredding documents and was indicted for obstructing justice.

By August 2002, Arthur Anderson was out of business. The failure impacted the publics faith and trust in the accounting professional for decades to come. The Enron failure correspondingly extended to government officials and attorneys. Government regulators owe assurance to he general public and to the market that businesses do not create harm, deception or unfairness in their dealings with others, which means creation of industry standards and enforcement policies (Arnold, 2013).

For example, the Security and Exchange Commission (SEC) created rules and guidelines that are designed to promote the full and fair disclosure of information by businesses, and to clarify and enhance existing prohibitions against insider trading (Sec. Gob, 2014). The SEC occupied a unique position in this system as the public institution responsible for overseeing the financial markets, and, accordingly, has the most comprehensive mandate to act in the public interest and protect the interests Of investors (Gpo. Gob, 2002).

Additionally, the former head of the SEC, Arthur Levitate, realized that the conflict of interest ultimately occur when a company pays an accounting firm consulting fees that outweighs the auditing fees. Although during his tenure in 2000, he tried to propose a number of legislative reforms to separate accounting firms auditing business from their consulting business, he was unsuccessful due to corporate lobbied efforts (Arnold, 2013). Regardless, the SEC was unable to strain Arthur Andersen’s auditing and consulting conflict of interest until Enron filed for bankruptcy.

Only then did the SEC reacted to investigate Enron’s wrongdoings and only then did the United States Justice Department announced it had begun a criminal investigation into the accounting firm. In totality, the Enron collapse highlighted a catastrophic failure across the industry overseers to combat financial frauds. Not only were the investors’ faith and believe were lost in the corporate account system; it was lost on a grander scheme of distrust for the government and its ability to protect the public. Solutions In 2002, The U. S.

Congress passed the Serbians-Solely Act (SOX) as a direct response to the Enron scandal and to protect investors from the possibility of fraudulent accounting activities by corporations. It mandated strict reforms to improve financial disclosures from corporations and to prevent accounting fraud. According to the SEC (Sec. Gob, 2014), SOX mandated a number of reforms to enhance corporate responsibility, to enhance financial disclosures, to combat corporate and accounting fraud and to create the “Public Company Accounting Oversight Board,” also known as the PEPCO, to regulate the activities of the auditing profession.

Furthermore, the eleven sections of the bill cover responsibilities of a public corporation’s board of directors and add criminal penalties for certain misconduct (Wisped. Com, 2014). Since its inception, according to Cravings, a Harvard Business School Associate Profession (Hanna, 2014), “Despite high initial costs of the internal control mandate, evidence shows that it has proved beneficial. Markets have been able to use the information to assess companies more effectively, managers have improved internal processes, and the internal control testing has become more cost-effective over time.

Furthermore, his study suggested an opportunity to implement a better tool to measure the cost benefits of such legislation in the future since SOX was create without the forethought of how to measure its effectiveness quantitatively. Having such consideration in place early on will help to evolve and to modify future legislations’ success in implementation and long-term policy adoption. In addition to Serbians-Solely enactment to renew trust in publicly traded companies, key executives were held accountable in the criminal court of law.

Top executives such as Killing, Lay and Fast were brought to justice and mound guilty of fraud and insider trading. However, not enough Enron executives were held accountable. There were countless more executives who received excessive bonuses for the fraudulent accounting. For example, in 1 998, the top 200 highest-paid employees received $193 million from salaries, bonuses, and stock. Two years later, the figure jumped to $1. 4 billion (Wisped, 2014).

All of these 200 employees should likewise be held accountable and be tried in the court of law as criminals similar to Killing, Lay and Fast. By holding all the 200 top employees responsible, a strong usage will be sent to the American public: unethical, greedy, deceitful business practices will not be tolerated. With better measurement tools and methodology to gauge the effectiveness of legislation and a stronger criminal stance on individual accountability to exemplify and to set precedence, these two recommendations will help to limit the Enron tragedy from occurring again.

Justification Enron was an unfortunate iconic representation of corporate corruption on the grandest scale. However, overall the appropriate Steps were taken to bring justice, law and order back to the U. S. Uncial accounting institution. The Serbians-Solely Act provided the foundation for accounting reforms and financial statement transparency back to shareholders. For example, the PEPCO regulatory board was established to oversee the audit professionals.

Furthermore, a decade later, SOX is still intact and has been strengthen with the Dodd-Frank Wall Street Reform and Consumer Act due to the 2009 financial services industry abusive dealings. The new legislation “further promotes the financial stability of the United States by improving accountability and transparency in the financial system” (Wisped, 2014). As a consequence, new regulatory agencies have been created to protect consumers and to prevent abuse from financial services business practice.

Although some may criticize that more government regulation can stymie global competitiveness; nevertheless, as recent as December 2014, “the SEC handed out sanctions to eight small audit firms with fines totaling $140,000 for violating auditor independence rules because they prepared financial statements of brokerage firms whose financial statements the auditors were also auditing. At the same time, the PEPCO disciplined seven different small rims with fines of $2,500 each for the same offense, preparing financial statements or portions of statements for audit clients (Whitehorse, 2014). ” Compliance remains an issue.

Given the accounting deception from Enron and the recent Wall Street scam that contributed to the U. S. Economic recession, and continued compliance issues, perhaps not enough regulation has been put in place and more regulations and check-ins with overseers will help to curb the corporate greed. Additionally, ethical issues in finance are critical to hold at the individual level. If more personal accountability and attribution were instilled in the culture of publicly traded corporation, there would be less likelihood of mass corruption and less greed hidden behind company sales and revenue spreadsheets.

Not only prosecute the top ;o or three executives, but also prosecute all those who contributed towards the malady. Other employees at Enron who benefited from large bonuses and insider trading should also have been charged to set precedence. Internal corporate regulation should also be more stringent. Perhaps bi-annual compliance adherence and associated training will help to further curtail opportunities for deceit and missteps. Furthermore, consideration should be put into prosecuting those individuals who were aware and chose to do nothing.

They also contributed to the gross unjust by omission. As with capital punishment for repeat offenders, studies show that “the estimates of the deterrent effects are far greater, ranging from three to 32 murders deterred for each execution (Fagan, 2014). ” Hence, perhaps harsher punishments will ensure corporations will not be allowed to behave unethically again. Summary Enron Corporation was one of the largest bankruptcies in the U. S. History. It was the epitome Of greed, corruption and dishonesty in corporate scandals.

At the root of the cause was a volatile company culture of cutthroat, high-risk taking, and a Darwinian survival of the fittest mentality. Combined with a win at all cost compensation structure, arrogance and greed were brewing and it set the stage for immense unethical business practices at all levels of the organization. Moreover, the Enron fiasco emphasized the underlining failure of the safeguard system with auditors, attorneys and governments. Although regulations have been passed such as the Serbians-Solely Act, large corporations such as ones in financial institutions continue to behalf unethically.

If white color crimes were treated similar to blue color crimes, the deterrent statistics would comparably show decrease in activities. Hence, more government regulation is needed and similar to capital punishment for repeat offenders, more stringent punishment is needed to set precedent and to discourage greed and abuse by large corporations from occurring again.

Question 1: What responsibility did David Duncan owe to Arthur Andersen? To Enron’s management? Enron’s stockholders? To the accounting profession?

Explain. David Duncan, as head of auditors for Arthur Anderson, was responsible to certify and to attest to the truth Of financial statements and to adhere to the Aspic’s statements on auditing standards for everyone involved, from company management to stockholders. Specifically, according to the Cohen Report, which was also reiterated in the subsequent CPA statements of auditing, Duncan serving as an independent auditor has the responsibility first and foremost to ensure fairness to society as the intermediary between the financial statements and the users of those statements. Meaning, his responsibility is towards the user or stockholders in this case of those statements and not to the client.

For the companies he served as his clients, he should have the responsibility to evaluate the internal auditing control system and the safeguard mechanism that is in place to ensure it is adequate for fair assessment. He also has the responsibility to detect and report errors, irregularities, and or fraud that he encounters. Above all, he has accountability to assess and to maintain his auditors independence status according to the four basic principles of independence (Arnold, 2013). Abiding by all these guidelines and principles, Duncan can ultimately uphold the interest of the profession by avoiding any potential for inflict of interests.

Question 2: What are the ethical responsibilities of a corporate attorney, such as Nancy Temple, who works for an “aggressive” client wishing to push the envelop of legality?

Explain. According to the American Bar Association (ABA) Model Code of Professional Responsibility, specifically Canon 7 (Americana. Org, 2014), the dominant model of layering over the last 30 years asserts that the lawyer is ethically bound to pursue the client’s interests zealously within the bounds of the law.

Given Nanny’s professional affirmation to the Bar, she acted within the ethical noonday in her email to Duncan at Arthur Anderson in regards to document retention. Although the email was a key factor in the indictment of Arthur Anderson, it was subsequently overturned (Wisped, 2014). Hence, the courts later determined her email was also within the law. Regardless of the aggressiveness level of the client, all eyeliners are responsible to uphold the Bar and act within the law by which defines their professional behavior and accountability.

Question 3: Under what conditions should an employee such as Sharron Watkins blow the whistle to outside authorities? To whom did she owe loyalty?

Explain. An employee has a duty of confidentiality with regard to legitimately private matters with the organization for which one works. However, regardless of how strong the duty is, it is not unconditional and absolute (Arnold, 2013). And according to Principle of Positional Responsibility, it morally obliges people to report wrongdoing to those who might prevent the wrongdoing’s correction.

Sharron should have loyalty to Enron, but at the same time she was in a position to clearly know and understand the wrongdoing of Enron’s accounting practices. Therefore, she had responsibility to blow the whistle in this instance. Although she was considered a whistle blower because of her email to Kenneth Lay, Enron’s Board Chairman, she technically did not blow the whistler to outside authorities. “Far from whistle-blowing, Watkins’ actions actually provide cover for Lay and the Enron board,” according to Forbes. Com (Cancan, 2002).

She should have done more much earlier given all the consideration of her tenure and full awareness.

Question 4: To whom does the board of directors owe their primary responsibility? Can you think of any law or regulations that would help to ensure that boards meet their primary responsibilities?

Explain. By law, a corporation of any size must have a board of directors elected by its shareholders. The directors have a fiduciary duty to the shareholders, who are the corporation’s owners, and directors as well as corporate officers can be held liable for failing to meet their fiduciary duties to stockholders.

Investors and the public are particularly interested in the financial reports released by publicly traded companies, and boards of directors of these companies have a legal obligation to ensure that these reports are fair and accurate (Irreproachableness. Com, 2014). However, according to Green vs.. Freeman, the Supreme Court in NC “reaffirmed those directors’ duties generally are owed to the corporation itself rather than to the individual shareholders” (Appellate. Unctuous. Org, 2014), which could set precedence for other cases to question who the board of directors owe their responsibility to.

In addition to stipulations on auditing for CEO, Controller, SCOFF, Chief Accounting Officer or person in similar position, Congress enacted the Serbians-Solely Act of 2002 to also help the board meet their responsibilities. It mandates the members of corporate boards must avoid any financial, Emily, employee, or business relationships with the companies on whose boards they serve (Irreproachableness. Com, 2014). In other words, Serbians-Solely clearly emphasizes not only independence and avoidance of conflict of interest for auditors, but also for board members.

Question 5: What responsibilities do government regulators owe to business? To the market? To the general public?

Explain. Government regulators owe assurance to the general public and to the market that businesses do not create harm, deception or unfairness in their dealings with others, which means creation of industry standards and enforcement policies. For example, the SEC created rules and guidelines that are designed to promote the full and fair disclosure of information by businesses, and to clarify and enhance existing prohibitions against insider trading (Sec. Gob, 2014).

Given the debacle of the likes of Enron, the governments regulatory testators should restore corporate integrity and market confidence. At the same time, these regulators should avoid limiting economic growth.

Question 6: Are accounting and law professions or businesses? What is the difference?

Explain. Accounting and law are both professions and businesses. The key differences are law and accounting requires professional education and certification to practice. For example, accountants are required to pass the Certified Public Account (CPA) license to be certified in the accounting profession.

In most U. S. States, only Spas who are licensed are able to provide to the public attestation (including auditing) opinions on financial statements. Furthermore, in auditing engagements, Spas are required by professional standards and Federal and State laws to maintain independence from the entity for which they are conducting an audit and review engagement (Wisped, 2014). Hence, most individual Spas who work as consultants do not work as auditors. Similar for lawyers, they are required to pass the Bar given by the American Bar Association (ABA).

Abs’s most importantly stated activities are the setting of academic standards for law schools, and the formulation of model ethical codes related to the legal profession (Wisped, 2014). To own and operate a business, only a business license is needed. Depend on the form of business ownership, the license is a government issued permit dispensed by government agencies that allow individuals or companies to conduct business thin the government’s geographical jurisdiction (Wisped, 2014). It is the authorization to start a business; it does not detail ethical boundaries to conduct business.

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