Business Law: ENRON SCANDAL
Introduction
The scandal that is Enron stands out among other corporate scandals such as WorldComm, Global Crossing. At Enron, the situation is illustrated of how the free enterprise system in the United States of America and the unregulated trust vested on auditors can be abused by a group of selfish and individualistic capitalists determined to make good of a bad situation. The case also illustratively points out the effects of corporate pressure from the shareholders on the management and the weaknesses of the stewardship concept of management of shareholders wealth. Enron puts a clear case of the need to have strong ethical appeals even in the face of pressure to perform during tough economic times. This paper is of the contention that the case of Enron reflects the heavy responsibility conferred upon business stakeholders. It shows that the overall responsibility in the business community is not limited to the managers at the executive leadership, but is equally shared and incurred in the same proportion by management, external and independent auditors, the regulators and the citizenry. More importantly, Enron shows that ultimately the overall consequence as to the costs of economic losses would always be borne by the citizenry who invest in these corporate companies.
The case at Enron was discovered late when the collapse was already completely in the fold. However, it should be appreciated that early symptoms had already shown and these should have gotten the stakeholders suspicious of the going concern and the financial position of the firm. For starters, the pressure on Enron to perform should have been reason enough to raise the eyebrows of a suspicious mind. It is on record that despite the tough economic times prevalent in the economy during the years leading to the scandal, Enron continued to meet the shareholder pressure and post positive performance. As it would be noted later, the pressure from the shareholders on the management would occasion the creative accounting and fraudulent manipulations that would led to the eventual scandal that saw the bankruptcy of Enron. Another symptom could be seen in the management behavior leading to the discovery of the scandal. The executive continued to issue reassuring messages sending emails to the employees assuring them of better times despite the worries and contrary signs that the firm was making losses. It should be appreciated that the executives were busy offloading their shares in the market while constraining and encouraging the employees to hold onto their stocks. Any person with this insider knowledge would probably conclude that tough times were coming and that Enron indeed needed to be re-examined.
Lastly, the nature and manner of relationship that Enron enjoyed with its external auditors should have sent early signs home that not all was well. Both Enron and Arthur Anderson were reputable firms in business with the latter being among the four top world’s auditing firms and the former being a leading firm in the energy industry in California. Despite the troubles within the gas industry, the competitive nature of businesses and the economic turmoil of the times, Enron posted profits and their statements were qualified with positive reports by Arthur Anderson. The employees who knew about the creative accounting and at least perused the audited accounting statements would be able to notice the stalk differences and at least seek an inquiry from the management who were charged with the accounts. Therefore, from the onset keen personnel and industry analysts would be able to see the signs of the trouble that was to later fall. It is in this vein that one of the Vice Presidents Sherron Watkins noticed the irregularities, the disparities and connected the same to the fraudulent accounting. It was her keen approach and love for detail that would earn her the title of Enron’s whistle blower.
The Accounting and Ethical Mal-Practises
The root problem that resulted to the Enron Scandal can be seen in two main forms, that is, the accounting and the ethical mal-practises. It is evident from the transactions that the main stakeholders had either omitted or committed acts that would facilitate transactions of defrauding Enron and duping the interested parties. It is this paper’s contention that the overall responsibility hence the blame squarely lies with the following stakeholders: the management and by extension the audit committee, the auditors, the Securities and Exchanges Commission and the employees in-charge of accounting. It is noteworthy that the irresponsibility arose either from omissions or commissions and assume an ethical or accounting character. Therefore, in the long run, the case sits within the province of accounting and ethical mal-practises.
The accounting mal-practises were acts of commission committed by the accounting staff in collusion with the executive management. In the interest of the management and in a knee jack reaction to the pressure to perform positively, Enron accounting pursued the path of creative and fraudulent accounting that reflected the following outcomes. One, the accounts would effectively reduce the tax burden of Enron. This was made possible by employing laws within the tax regime and positioning a situation suggestive of a lower tax liability. Secondly, the accounts inflated Enron’s income and net profits. The inflation was intended to facilitate a market reaction that would enable valuation of the stocks to be high at the stock exchange thereby earning the company a good reputation and market positioning. In addition, inflated profits served managerial desires in positioning and relaying a favourable financial situation of the firm. Another element of accounting fraud lay in the inflation of the accounting stock price and credit rating. Of course, this was facilitated by the original false entries that had posted false and fabricated profits. The net effect was that the stock price and the credit rating at the stock exchange suggested a different position as compared to what was actually the real position. It should be appreciated that creative accounting and generally accounting is a step by step procedure that utilizes the initial posted and entered entries in the computation of the final outcome.
Another element of accounting fraud was in relation to the related party transactions. It has been recorded that the company failed to record off balance sheet subsidiary transactions. In fact the accounting system was manipulated so that the off balance sheet subsidiaries absorbed any losses that Enron had incurred during the year. This way, Enron in its capacity did not post any losses. The net effect is that the consumers of these published financial accounts were not given the right, accurate and honest state of affairs. This consequently meant their decisions were largely flawed given that they had relied on false information in arriving at the decisions. Finally, the accounting was created so as to represent a false impression of the status of the company to the public. These reflections were intended to win the trust and admiration of the public and to make it appear like the company was profitable. This was meticulously designed so as to position the company fairly in the eyes of the public ending up hoodwinking the public.
All these accounting fraud and creative accounting practises though committed directly by the accounting staff, had the sanction and support of the executive management and the external auditors. It is this aspect that arises ethical concerns. One wonders what ethical principles the management and the external auditors subscribed to. This section shall briefly discuss the role of the management and the external auditors in relation to the ethical context of the case. It should be noted that management owe a stewardship responsibility to the shareholders. To this extent, the management need to display good faith, material and full disclosure and subscription to elements of integrity and truth. This requires that management exercise due care and diligence while managing the resources of the company. In entertaining creative accounting practises and equally allowing for false accounting to be used in the financial statements preparation and publications, the management chose convenience over truth. The management overwhelmingly failed to excise and show due care and diligence. They ignited, facilitated and encouraged the false accounting practises and regrettably failed to live by the principles of honesty and integrity. These shortcomings should be seen in light of the ethical context. Ideally, the management is expected to be constituted of personnel of high integrity, who poses and demonstrate a high degree of honesty and truth. Other than just entertain creative and fraudulent accounting, the management took no care in the management reports that it issued for the public’s consumption. The reports to the public duly prepared and signed by the management cast the financial position of the company in a favourable light despite the management’s knowledge of the contrary position. It is indicative to note that this was an outright betrayal of the material disclosures and the good faith requirements.
It has been observed by scholars that what the management did was to exploit the free enterprise systems in the United States of America and the easily manipulated legal regime in relation to accounting and ethical requirements. In this light, the American regime in relation to accounting standards and procedures has claimed its fair blame for the occurrence of the scandal. However, even as the management was entertaining fraud and creative accounting and blatantly choosing greed over principle, the question put forth is what did the ordinary checks and balances system do? This question points to the direction of the Securities and Exchanges Commission and the auditors.
This paper contends that these two groups were equally to blame for their failure either deliberately or accidentally to note and identify this fraud. This section shall briefly examine the role of the two parties in the commission of the scandal. The biggest party to be blamed other than Enron itself, is the auditor, Arthur Anderson. In fact, it illustrative to note that the two companies went down together like Siamese twins. Enron would not have committed the fraud to that extent without the collusion of its auditors. The worst case scenario would have been one year of fraud after which an audit of the company would have revealed all the mal-practises. Enron management in the realisation of the essential role the auditors were to play in facilitating the fraud, enlisted the services of Arthur Anderson. The auditors were a strategic choice. For one, this audit company was big and made it in the list of the big four. This would earn the public’s trust as the public would rely on audited accounts by a member of the big four. Enron colluded with Arthur Anderson to audit the false accounting statements and give qualified positive reports. This easily displaced the need for thorough scrutiny. It should be noted that as an auditor, it was the role of Arthur Anderson not only to give a report on the true and fair position of the firm, but to consider the risks and material errors and fraud. However, Anderson failed to act diligently and with due care. It also failed the ethical test of integrity and honesty. In the long run, it facilitated the process of hoodwinking the public. Another group that failed the professional test was the Securities and Exchanges Commission. With the arsenal it had and the regular filing by companies, one would expect that the SEC was able to detect and or at least investigate Enron. This never happened. Questions have been put forth after Enron on the effectiveness of the SEC.
Alternatives
The case of Enron illustrates situations of fraud and incompetence by stakeholders in the business community. Interventions proposed have taken a legal, ethical and economic character. First, the legal infrastructure has since been improved to curb accounting fraud. In America this necessitated the development of the Public Accounting Oversight Board with the role of regulating the accounting practises in public organizations. In addition, the Sarbanes Oxley Act, 2002, was drafted and adopted into law. The scope and duties of the auditor in auditing has been expanded and the auditor has a more expanded scope and responsibilities. These alternatives are in connect to the legal and ethical requirements impressed upon stakeholders with particular emphasis on the management, the auditors and the regulators. One expects that with the alternatives already implemented and standards continuing to develop, such cases would be a thing of the past.
References
Correia, C., Flynn, D. K., Uliana, E., & Wormald, M. (2012). Financial Management. New York: Juta and Company Ltd.
Craig, P. (2012). The Role of Auditors During the Recent Financial Crisis and the Future of Auditing. Accounting and Auditing Journal.
Cunningham, G. M., & Harris, J. E. (2006). Enron and Arthur Anderson: The case of the crooked E and the fallen A. Global Perspectives on Accounting Education, 27-48.
Oxford University Press. (2009). The ongoing financial crisis: Where were the auditors? Oxford University Press Journal, 2(1), 12-15.
The Association of Chartered Certified Accountants. (2011). Audit under fire: a review of the post-financial crisis inquiries. The Association of Chartered Certified Accountants, 2(1), 1-20.
