1. Given the corporate ethical breaches in recent times, assess whether or not you believe that the current business and regulatory environment is more conducive to ethical behavior. Provide support for your answer.
Unethical conduct has been all-pervasive in all sorts of business for the last few decades. Many changes have taken shape in the business environment giving rise to immoral behavior and the inclination for corruption. Unethical accounting behavior is the consequence of the growing corruption that has engulfed the corporate world. After the unethical accounting scandals like the Enron, WorldCom, Peregrine Systems, Adelphia and Tyco International rocked the nation, the US government was forced to strengthen regulations and monitor business actions closely. In reaction to these corporate scandals which made investors lose billions of dollars, a federal law popularly known as Sarbanes–Oxley Act of 2002 or SOX was enacted for imposing regulations on accounting firms and publicly held companies to show better precision in accountability and financial documentation. But the passage of SOX has not been entirely successful in bringing an end to accounting scandals with many recent corporate frauds having come to the news, such as Madoff scandal, Satyam Fraud and Lehman Brothers scandal.
However, there is no denying the fact that in recent years most of the companies are showing concerns for developing strict ethical codes of conduct. Any business behavior starts at the top and then trickles down to the bottom layer of employees and therefore, in order to maintain ethical codes and conducts in the organization the top management should set the tone of ethical behavior. Fortunately more and more business corporations are realizing the importance of ethics. An international survey shows that compared to 41% in 1991, the percentage of board of directors setting ethical codes of conduct today has increased to 80%. Most of the companies have ethical officers entrusted with the responsibility of keeping tab on ethical violations in the organizations and providing trainings and guidance to employees to conform to ethics. Many companies encourage anonymous reporting of unethical behavior in the workplace and 35 states in the US have laws to protect the whistleblowing employees who report of unethical conduct of their employers.
2. Based on your research, describe the organization, the accounting ethical breach and the impact to the organization related to ethical breach.
Enron Corp. was established in 1985 following a deal which merged two natural gas pipelines companies - InterNorth based in Omaha and Houston Natural Gas based in Texas. Though started as a pipeline company, Enron entered into gas market and started selling gas. Kenneth Lay who was the CEO of the company initially sold gas energy at market prices but after the legislation related to deregulation on the sale of natural gas was approved by the US Congress Enron started selling energy at higher prices. In order to prevent increased regulation on the price volatility Enron and other energy companies started lobbying, forming a cartel. Enron further diversified its portfolio by entering into other business ventures such as fiber optics, water, telecommunications and newsprint.
Jeffery Skilling was hired few years later and he developed a team of executives who used the loopholes in accounting practices and poor financial reporting. This way the company was able to hide debt equivalent to billions of dollars from its failed projects. They also muscled the financial auditor Arthur Anderson to play along with its fraudulent accounting practices. Between 1991 and 2000 the company’s share price went up more than 350%. In 2001, the company’s shareholders filed a lawsuit to Securities and Exchange Commission and within a year the company share tanked to $1 from $90. Enron scandal was exposed. It was the biggest financial scandal in US history till that time. This was mainly made possible because of the complex financial practice Enron used to report its income statement and balance sheet. The GAAP requirements at that time were not very robust and transparent and Enron financial team took full advantage of that. Also as Enron hired its own auditors and paid them for auditing the firm’s assets and liabilities, so it was a conflict of interest. It was evident that the auditing firm would not write any adverse report on the company that was paying them. Also Enron was managing the pension fund for its employees and that helped Enron use that portion of the fund for other ulterior purpose and continue with the corruption for a longer time. Codes of ethics for any company are voluntary and generally the top management ensures that the best interests of the shareholders and employees are taken into account in any decision made by the company. Ethical practices are always structured at the top level but in Enron the whole top management level employees acted only for self-interests, completely ignoring the interest of the shareholders. The board of directors who are generally there to protect the rights of shareholders should have enforced ethical practices in the company. Enron’s executives did not act within their scope and acted far beyond their limits. They have exploited the power entrusted on them by the shareholders. Top management people even told Arthur Anderson to destroy all its accounting books few weeks before the bankruptcy was filed. It was an illegal act that completely violated the condition of maintaining transparency in accounting practice.
3.0 Determine how the organizational ethical issue was detected and how management failed to create an ethical environment.
The accounting scandal that was as big as Enron was definitely not a handiwork of few people. Rather it was a product of concerted efforts undertaken by many parties who consciously created an environment of continuous unethical practice across the entire organization. The CFO Fastow and Kopper along with the accounting team built the foundation of the scandal. Their intentions were centered on their own benefit rather than that of the company. The accounting team never found it important to consult Enron’s code of conduct for business affairs before taking any decision (Bratton, 2002). In Enron there was a cell for ethics and compliance. Also the Enron board was there to oversee the interest of the shareholders. Ethics department or the board was unable to enforce ethical practices and report of wrongdoing for the fear of retaliation from the organization. This resulted in prolonged malpractices inside the company for more than five years (1996-2001) before finally the company filed bankruptcy.
4. Analyze the accounts impacted and / or accounting guidelines violated and the resulting impact to the business operation.
The basic revenue of Enron used to come from providing service to maintain power plants, natural gas pipelines, processing facilities and storage. Although in such cases the revenue should have been stated as the service fees but Enron chose to show the full value of the trade as revenue. This helped inflate the revenue of the company and soon Enron became one of the largest companies of the world. Enron was the first non-financial company to have adopted mark-to-market accounting practices. By using this method future natural gas contracts are accounted for in the financial books at the net present value today. These long term contracts are generally complex in nature and it is not easy to estimate cash flow. Enron accelerated the income by stating future contracts in advance and then even if the project failed, which happened in its ventures in Brazil and UK, it started posting false numbers to keep its share value intact (Powers, 2002). This became a common accounting practice in Enron. When the first time this fraudulent practice started, the bankers associated with Enron showed the company how to manipulate the accounting books to hide the loss. Enron with the help of its bankers and auditors continued this fraudulent accounting practice for a sustainable period of time which inflated the stock price to very high levels. Ultimately when the scandal unfolded the shareholders and employees suffered enormously.
5. As a CFO, recommend which measures could have been taken to prevent this ethical breach and how each measure should be implemented in the future.
There are many things which could have been prevented only by creating a few ethical structures inside the organization. First of all, the ethical board that was in place in Enron was powerless. The board should have created the ethical department as an independent body. The Ethical department should have been only answerable to the board of directors and not to the company managers or executives. In this way ethical department could have functioned autonomously without the influence of the managers (Brown et al, 2009). Also in such cases chances of employees coming forward to report unethical behavior of others would have improved. Secondly, auditing and financial consulting practices should be separated. If this was the case for Enron, Arthur Anderson would have probably reported the wrongdoing much earlier. There are many other changes required in accounting practices apart from the ethical structure inside the organization. Transparent accounting practices, responsible management reporting and stringent law by the government will ensure less such incidents in future.
References
Nature and Significance of Marketing Ethics. Retrieved on 31st July 2013 from <http://www-rohan.sdsu.edu/~renglish/370/notes/chapt04/>
The Biggest Accounting Scandals Of All Time (2010). Huffington Post Business. Retrieved on 31st July 2013 from <http://www.huffingtonpost.com/2010/03/17/biggest-accounting-scanda_n_502181.html#s73820&title=Satyam__10>
Brown. J., Gilman, S., Navran, F. & Harned, P. (2009). Ten Things You Can Do to Avoid Being the Next Enron. Retrieved on 31st July 2013 from <http://www.ethics.org /resource/ten-things-you-can-do-avoid-being-next-enron>
Powers, Jr. W. (2002). Report of Investigation by the Special Investigative Committee of the Board of Directors of Enron Corp. Retrieved on 31st July 2013 from, <http://fl1.findlaw.com/news.findlaw.com/wp/docs/enron/specinv020102rpt1.pdf>
Bratton, William W (2002). Does Corporate Law Protect the Interests of Shareholders and Other Stakeholders: Enron and the Dark Side of Shareholder Value. Tulane Law Review, New Orleans: Tulane University Law School. Retrieved on 31st July 2013, from < http://papers.ssrn.com/sol3/papers.cfm?abstract_id=301475>
