Introduction: This paper examines the ethical and governance concerns associated with the Enron scandal in 2001. These concerns include the hiding of documents connected to their sudden profit growth and the close ties between Kenneth Lay and George Bush. The investigation received support in uncovering the events of the Enron scandal.
Enron Scandal Overview: In just 15 years, Enron transformed from an obscure company into the seventh largest in America, employing more than 21,000 employees across 40 nations.
Enron’s fraudulent activities, such as lying about profits and hiding debts, led to accusations of shady dealings. Michael Kopper, an insider, revealed the company’s murky finances and ultimately pleaded guilty. According to the Los Angeles Times, Kopper was sentenced to 37 months in 2006, despite agreeing to a maximum term of 15 years in his plea. As the investigation unfolded, Enron attempted to salvage its business by divesting various assets. The company faced numerous legal actions.
S firms that utilized aggressive accounting tactics to hide debts or one-time charges from public scrutiny were affected. President George W. Bush had enacted legislation to combat corporate fraud, including a review of pension regulations in the United States. Enron: The Real Scandal reveals the close connection between Enron’s chairman/CEO, Kenneth Lay, and George Bush, as well as other Republicans from Texas. Lay and other executives at Enron made pleas to government officials for assistance. There were also allegations that members of Congress were accepting campaign donations from Enron.
Three quarters of the Senate received cash from Enron, which is a fact. The auditor of Enron has confessed to making a “judgment error” when dealing with the debt of one of Enron’s off-balance sheet entities. Due to Enron’s circumstances, the Securities and Exchange Commission (SEC) believes that systemic reforms are essential in three areas: regulation of auditors, elimination of conflicts of interest in accounting firms, and improvement of America’s accounting standards, which were previously considered the most rigorous globally under GAAP standards.
Additionally, Enron paid Andersen, the company’s firm, $25 million as payment. However, Andersen earned even more money through consulting and other services. Currently, accounting firms are taking steps to limit or cease providing consulting services to audit clients. They argue that doing so eliminates any potential conflicts of interest. It is also suggested that if Enron had adhered to British standards, they would not have been able to artificially inflate their profits to such a significant extent. The book “Enron: The Rise and Fall of Enron” reveals that individual and collective greed driven by market euphoria and corporate arrogance were the primary factors behind Enron’s downfall.
Following Kenneth Lay’s retirement announcement in February 2001, Jeffrey Skilling assumed the role of Enron’s president and CEO. In the company’s annual conference with analysts that same month, Skilling expressed optimism regarding the stock’s worth, projecting an increase from $80 to $126 per share. Nonetheless, the stock price consistently decreased over time. Merely six months into his tenure as CEO, Skilling stepped down on August 14, citing “personal reasons”.
Enron instructed its auditors to destroy all audit material, except for basic “work paper”. If Enron had not destroyed all emails, electronic files, and paper files, investigators from the FBI, congressional probers, and workers suing for retirement savings would have had strong evidence. Enron’s actions were illegal as they were destroying documents before being subpoenaed.
Then, in addition to their involvement in the Presidential campaign of George W. Bush, Enron also made significant contributions to U. S Attorney General John Ashcraft’s unsuccessful 2000 Senate re-election bid in Missouri. The company gave $57,499 in campaign funds. Additionally, Enron provided $158,000 in campaign contributions to Texas attorney general John Comyn. The collapse of Enron has had a tremendous impact on the financial world and has prompted concerns about corporate governance. Arthur Andersen disregarded the disappearance of money, contributing to the scandalous situation.
Despite the presence of off the books, unregulated private partnerships that could incur debt, conceal losses, and generate inflated revenues, executives at Enron successfully maintained the satisfaction of bond rating agencies. Andrew Fastow, who was involved in both sides of every transaction, manipulating Enron’s financial statements for his own benefit and that of other service executives, faced the highest level of blame. The use of creative accounting at Enron can be described as a euphemism for accounting practices that technically adhere to the established rules but clearly deviate from their intended purpose.
Enron employed the strategy of extending market-to-market accounting for a short period of time, typically two or three years, resulting in an artificial boost to their earnings and increased profits. This approach was adopted in order to present continuous growth to the public. The implementation of creative accounting practices made Enron appear highly robust on paper. However, as the saying goes, appearance can be deceiving. Enron utilized special purpose entities as a means to conceal risky investment activities and financial losses. The company claimed to adhere to Generally Accepted Accounting Principles (GAAP), thereby evading the need for creative accounting. I am reminded of Sherron Watkins’ statement that “Accounting doesn’t get that creative”.
I have to wonder where she obtained her CPA. She should be aware that accounting indeed becomes innovative, not because Enron or any other company is attempting to deceive anyone. They adopt such practices because it is mandated by the federal government (the SEC requires public companies to follow GAAP). The same federal government that allegedly failed to adequately safeguard investors compelled Enron to utilize a specific form of accounting. “- (Elision, 2011) Enron established offshore entities, which is a conventional method in accounting and tax planning.
Offshore entities offer a higher level of privacy, which is why Enron’s auditors, investors, and potential whistleblowers were unaware of the company’s activities (“Creative Accounting,” 2011). Many businesses establish offshore entities to reduce their tax liabilities, either through legal means (tax avoidance) or illegal means (tax evasion). From 1996 to 2001, Enron showed several warning signs of possible fraud, including significant increases in its financial statements. In just four years and nine months, Enron’s revenues soared from $13.3 billion to $138 billion, propelling them to the sixth spot on the Fortune Global 500 (Dharan, 2008). Enron encouraged its employees to buy stock and promote it to their acquaintances. Senator Levin presented a list of red flags that should have alerted Enron’s board to potential troubles. These included a 60% surge in cash sales during the manipulative years despite declining cash margins and earnings. Additionally, Enron experienced receivables deviation double that of comparable firms’ average. Notably, Enron saw a significant decline in employee count – six times greater than the average firm.
Enron demonstrated the limitations of consolidation standards in 2001 by utilizing Variable Interest Entities (VIEs), legally separate “shadow entities,” which they did not consolidate. It is crucial to identify variable interest equity because if the company is the primary beneficiary of the variable, it should consolidate these entities. Enron’s failure to consolidate their entities led to a lack of understanding regarding their debt and resulted in an overstatement of income by recognizing transactions with the special purpose entity.
In the wake of Enron, a new accounting guideline has been introduced to provide special purpose entities with guidance on consolidation principles, according to Stephen Spector. A special purpose entity, created by an asset sponsor, is utilized by companies to carry out specific purposes, activities, or transactions. These entities help companies access capital and manage risk. Some examples of transactions involving special purpose entities include lease arrangements, financing arrangements with third-party financial institutions for asset or business acquisitions, and project development activities.
The Enron scandal required a third-party investor to have a minimum of three percent investment in a special purpose entity (SPE) to legally represent an equity ownership interest under U.S. GAAP. Corporate governance holds a corporation’s management accountable to its owners. The collapse of Enron led to the development of a new corporate governance model, but its significance can only be understood by considering the changing expectations of stakeholders.
After examining the Enron responses from the main spokesmen on corporate governance, it becomes clear why the Sarbanes-Oxley Act was inevitable. Both organizations formed special committees or task forces to reevaluate and strengthen their stance on best practices in corporate governance shortly after Enron declared bankruptcy. The BRT was the first to take action, releasing its revised “guiding principles of corporate governance” in May 2002. The BRT’s position on corporate governance principles is notable for three reasons.
According to the BRT, the United States is believed to have the best corporate governance and financial reporting systems in the world (Alton B. Harris, 2003). Earning management at Enron can be considered a form of creative accounting, which refers to accounting practices that may conform to standard accounting rules. It is a strategic approach used by company management to align actual earnings figures with projected goals. Earning management falls under the same category as creative accounting, as it involves misrepresenting financial statements through excessive manipulation of earnings. This practice is enforced by U.
The Securities and Exchange Commission emphasizes the significance of earning management in today’s society by highlighting its potential impact on American capital markets. If earning management continues to increase, it could compromise the transparency and reliability of financial statements that investors heavily rely on, thus undermining their confidence (Rowland 2002). Certain managers view earning management as a necessary practice due to the capital markets’ lack of forgiveness towards companies that fail to meet earnings estimates. To ensure stockholders’ satisfaction, these managers feel compelled to employ strategies that enhance the appearance of their financial performance (Lo 2008).
Enron’s entire scheme was foolish because they were aware of the eventual consequences. It is uncommon for a large company like Enron, ranked in the Fortune Global 500, to experience such a significant increase in profit and revenue within just one year. They began laying off employees without any clear reason. Despite their efforts to destroy evidence, the public still became aware of their actions. Eventually, some individuals served jail time while others were recently released from prison (Alton B. Harris et al., 2003; Creative accounting, 2011; Dharan, 2008).The text includes indicators of misconduct at Enron, such as the reporting of revenue. It also cites various sources, including a paper on SSRN with the abstract ID 1172222, Elision’s work titled “Creative accounting at Enron” in The Enron Blog edited by an individual, and Kadlec’s work titled “Enron: Who’s accountable?” published on January 13th, 2002.
The Time Magazine article on Enron can be found at http://www.time.com/time/magazine/article/0,9171,1001636,00.html. The Institute of Internal Auditors provides insights on Enron’s red flags in their CAE Bulletin at http://www.theiia.org/CAE-bulletin/index.cfm?iid=195. C.W. Thomas wrote an article titled “The Rise and Fall of Enron,” which is published in the Journal of Accountancy and accessible at http://www.journalofaccountancy.com/Issues/2002/Apr/TheRiseAndFallOfEnron.htm. The Economist delves into the real scandal of Enron in their article located at http://www.economist.com/node/940091. For a concise overview of the Enron scandal, refer to the BBC News-Business report published on August 22, 2002.
