TheReasonsbehindaCorporate

Collapse:ACaseStudyofEnron
Abstract
The 21st century has already experienced main reforms in the major corporate structures. The
Surbanes Oxley Act 2002 in USA and the Higgs and Smith reports (2003) in UK have
brought paramount reforms in the two major corporate systems. These reforms were made
following the major corporate collapses like Enron, WorldCom, Adelphia, Global Crossing,
K. Mart and Parmalat. Among these corporate collapses Enron is deemed to be the greatest
tragedy in corporate history. This article examines the reasons behind a corporate collapse
and point out the possible discrepancies. The example of the fallout of Enron is taken to
explain a corporate collapse.

Name:

Muhammad Asif Khan

LLM (University of Liverpool)
Member Khyber Pakhtunkhwa Bar Council

Address: Village & P.O. Tarujabba, Tehsil PAbbi & Distt. Nowshera
Email:
ursasifkhan@yahoo.co.uk
Cellphone Number:
00-92-3139109416

Electronic copy available at: http://ssrn.com/abstract=1923277

INTRODUCTION:
The 21st century has already experienced main reforms in the major corporate structures. The
Surbanes Oxley Act 20021 in USA and the Higgs and Smith reports (2003) in UK have
brought paramount reforms in the two major corporate systems. These reforms were made
following the major corporate collapses like Enron, WorldCom, Adelphia, Global Crossing,
K. Mart and Parmalat. Among these corporate collapses Enron is deemed to be the greatest
tragedy in corporate history.2 Some call it a Titanic miscalculation,3 and some compare it
with the frenzied corporation of Charles Ponzi.4 By 31st December 2000, Enrons stock was
priced at $83.13 and its market capitalisation exceeded $60 billion dollars. It was also rated
as the most pioneering large company in Fortunes Most Admired Companies survey. A year
later on 2nd December 2001, Enron filed for bankruptcy. The investors lost about $80
Billion.5 Thousands of Enron employees lost not only their jobs but a significant part of their
retirement savings; Enrons shareholders saw the value of their investments tumble; and
hundreds of businesses around the world were affected, Enron creditors turned into the
bankruptcy court likely to receive only pennies on the dollars owed to them. This sudden
demise of Enron opened speculative debates on the future of corporate structure. The fall of
Enron has been related to different discrepancies in its corporate structure.

Enron was created in 1985 by Kenneth Lay, through the merger of two natural gas pipeline
companies. Starting with gas pipelines it extended its work and got involved in natural gas
trading. Deregulation of the energy market in 1980s followed by the deregulation of
electricity market in 1992 was taken as granted by Enron. This deregulation allowed energy
providers to expand their approach and become more competitive. Enron diversified with
these changes, it became a market maker in electric power, coal, steel, paper and pulp, water,
and broadband fiber optic cable capacity. Its domestic trading and international business grew
dramatically through the 1990s. This diversified trading model of Enron was envisioned by
Jeff Skilling in 1988,6 he served Enron as President and Chief Operating Officer (COO), and
eventually became the CEO of the company for 6 months, before he resigned in August 2001

SeeSarbanesOxleyAct(2002),Pub.L.No.107204,116Stat.745(2002).
R.Powell,TheEnronTrialDrama:ANewCaseforStakeholderTheory,38(2006)UniversityofToledoLaw
Review,atp.1087.
3
SeeN.B.Rapoport,Enron,Titanic,andthePerfectStorm,71(2002)FordhamLawReview,pp.13731397.
4
SeeD.G.BairdandR.K.Rasmussen,EasyLessonsfromEnron,55(2002)VanderbiltLawReview,pp.102130.
5
J.Webberetal.,ArthurAnderson:HowBadWillItGet?,(December24,2001)BussinessWeek,atp.30.
6
JeffSkillingjoinedEnronin1990fromMcKinsey,butheenvisagedthediversifiedversionofEnronin1988,in
aMckinseyengagementatEnron.ItwasJeffSkillingwhopushedthepipelinecompanyintoanenergybank.
2

Electronic copy available at: http://ssrn.com/abstract=1923277

(about 4 months before Enron filed for bankruptcy). Enron was a market maker and a
creator of new types of products, Jeff Skilling once said, We are a company that makes
markets. We create the market, and once its created, we make the market.7 The Accounting
approach of Enron before diversification was simple; the company listed actual cost of
supplying the gas and actual revenues received from selling it. Then it adopted the mark-tomarket accounting.8 This proved challenging and tricky as it is based on assumptions of
future profit making, especially when the market conditions are specified through predictions.
The other controversial practise of Enron was the use of Special Purpose Entities (SPEs).
Special Purpose Entities are shell firms created by a sponsor, but funded by independent
equity investors and debt financing. For example, Enron used SPEs to fund the acquisition of
gas reserves from producers. In return, the investors in the SPE received the stream of
revenues from the sale of the reserves. Enron used many SPEs till 2001, including Chewco
(a company owned and operated by an Enron employee called Michael Kopper), Raptor, and
in 1999 the LJM partnerships in which Andrew Fastow9 was the manager and an investor. In
these partnerships key Enron employees like Fastow profited handsomely. These SPEs were
also used in off balance sheet financing, depicting a false picture of companys economic
status. Another name to mention in the story of Enron is its audit firm Arthur Anderson. It
was Arthur Anderson who knew all the financial mishaps closely, more than anyone else.

The fall of Enron has raised many questions regarding corporate governance. Thus we will
discuss the Enron failure in light of the role of different corporate governance players. We
will analyse the role of directors, the shareholders and stakeholders, and the gatekeepers in
Enrons demise. Keeping the Enrons example in front we will discuss the importance of the
role of these players in corporate governance. We will also examine whether this collapse
could have been avoided, and how can future collapses be avoided. Following the Enron
scandal the key players also got capital sentences as a criminal liability. We will also discuss
the importance and need of criminal liability in corporate governance.

S.DeakinandS.J.Konzelmann,LearningfromEnron,12(2004)CorporateGovernance,atp.135.
A technique whereby the entire profit to be derived from the spread between the long and short run
contractsistakenintoearningsupfront,atthetimewhenthecontractissigned.
9
AndrewFastowremainedEnron'sExecutiveVicePresidentandChiefFinancialOfficer(CFO).
8

THEBOARDOFDIRECTORS:
A companys board is its heart and as a heart it needs to be healthy, fit and carefully nurtured
for the company to run effectively.10 In USA the boards are usually large. The CEO and the
chairman is the same person in most companies. In 2001, Enrons Board of Directors had 15
members, several of whom had 20 years or more experience on the Board of Enron or its
predecessor companies. Customarily, they had five regular meetings per year, each of which
began with a dinner followed by two full days of meetings thereafter.11 Many of Enrons
Directors served on the boards of other companies as well. It was organised into five
committees; Executive committee, Finance committee, Audit Committee, Compensation
committee, and Nominating committee. Kenneth Lay was performing two responsibilities as
CEO and chairman, followed by Skilling as the president and COO of the company. A
Boards duties include reviewing the companys overall business strategy; selecting and
compensating the companys senior executives; evaluating the companys outside auditor;
overseeing the companys financial statements; and monitoring overall company
performance. In short the boards duty is to safeguard the interests of the companys
shareholders.12 The directors also hold a fiduciary duty towards the shareholders to safeguard
the investment they had made in the company. Enrons board members were compensated
with cash, restricted stock, phantom stock units, and stock options.13 The total cash and
equity compensation of Enron Board members in 2000 was valued by Enron at about
$350,000 or more than twice the national average for Board compensation at a U.S. publicly
traded corporation.14

The Enron Directors seemed to indicate that they were as surprised as anyone by the
companys collapse. But there were more than a dozen incidents over three years that should
have raised Board concerns about the activities of the company.15 The board had known
about the different SPEs including LJM and Chewco, it was briefed about their purpose and

10

J.SolomanandA.Soloman,CorporateGovernanceandAccountability(WILEY,2004),atp.65.
TheRoleoftheBoardofDirectorsinEnronsCollapse,AReportPreparedbythePermanentSubcommittee
onInvestigationsoftheCommitteeonGovernmentalAffairsUnitedStatessenat,.atp.9.
12
StatementonCorporateGovernance,TheBusinessRoundtable(September,1997)atpara.3.
13
Supranote11,atp.11.
14
See Director Compensation; Purposes, Principles, and Best Practices, Report of the Blue Ribbon
CommissionoftheNationalAssociationofCorporateDirectors(2001),atp.5.
15
SeeSupranote11,atp.12.
11

nature.16 Much of what was wrong at Enron was not concealed from its Board of Directors.
High risk accounting practices, extensive undisclosed off-the-books transactions,
inappropriate conflict of interest transactions, and excessive compensation plans were known
to and authorized by the Board.17 The most serious of the conflicts related to the involvement
of Enron corporate officers in setting up and running some of the sham SPEs with which the
company dealt. Michael Kopper, a senior employee in the finance section of the company,
ran the Chewco SPE through a series of limited partnerships and companies which he
controlled. Fastow ran the LJM SPEs and was prominently involved in several of the entities
used as part of the Raptor transactions, as were a number of more junior Enron employees in
accounting and finance positions. Fastows involvement in the LJM deals was not only
disclosed to the board, at a meeting which took place in 1999, but the board approved of his
participation, following a recommendation to this effect from the then CEO and Chairman,
Ken Lay.18 The directors though disagreed with these allegations and contested that things
were concealed from them, for instance Mr. Winokur, former head of the Finance Committee
stated that We cannot, I submit, be criticized for failing to address or remedy problems that
have been concealed from us.19 So if the directors knew about all the doubtful transactions
going on at Enron, then they had a duty to be more vigilant and active in questioning all these
mishaps. If, for instance, the directors were unaware of the correct situation then they were
irresponsible and had a lack of interest in their job. Moreover Fastow received $30 million in
return for his part in the deals with LJM. It was only in October 2001, when the deals were
falling apart, that the board asked and learned about the extent of Fastows remuneration.
Following this, it decided to suspend him from his employment with Enron. It is far from
clear that Fastow committed any legal wrong in not notifying the board, since the sums in
question were not received in his capacity as Enrons CFO. It is, however, difficult to explain
why the board made no earlier inquiry on the matter.20 They should have done more in
safeguarding the shareholders interests, by failing to do so they had breached their duty. Thus
the directors shared a responsibility in the collapse of the company. This shows lack of
independence of the directors, most of the work was carried through by the Skilling and Lay.
So the involvement of the directors in the key matters of the company has to be made
practicable by giving more collective powers rather than an individual approach.

16

SeeSupranote11,atp.15.
SeeSupranote11,atp.16.
18
Supranote7,atp.138.
19
Ibid.
20
Ibid.
17

As in most other US companies, Enrons management was heavily compensated using stock
options. Heavy use of stock option awards linked to short-term stock price may explain the
focus of Enrons management on creating expectations of rapid growth, and its efforts to puff
up reported earnings to meet Wall Streets expectations. In its 2001 proxy statement, Enron
noted that within 60 days of the proxy date (February 15), the following stock options awards
would become excisable, 5,285,542 shares for Ken Lay, 824,038 shares for Jeff Skilling, and
12,611,385 shares for all officers and directors combined. On December 31, 2000 Enron had
96 million shares outstanding under stock option plans, almost 13 percent of common shares
outstanding. According to Enrons proxy statement, these awards were likely to be exercised
within three years, and there was no mention of any restrictions on subsequent sale of stock
acquired. After the deregulatory reforms in 90s, the Security and Exchange Commission
(SEC) changed the rules under section 16(b) of the Securities Exchange Act of 1934, to
permit officers and directors to exercise stock options and sell the underlying shares without
holding the shares for previously required six months period.21 Now under these rules if the
executives increase the stock price through premature revenue recognition (as it was done
through mark-to-market accounting in the case of Enron) or other techniques, they could sell
their stocks in short term, leaving the shareholders to bear the cost of the stock decline, later
when the stock price could not be maintained.22 Hence the personal gain of the key players in
the company gains importance with such rules and the shareholders interest is kept aside.

The absence of a remuneration committee kept the directors remunerations unchecked, and
transparency in this regard was missing. The Board members were involved in getting stock
and cash compensation and extra amount for consultancy. For instance Enron paid Lord John
Wakeham, a chartered accountant, $72,000 per year for consulting services in accounting.23
Board member John Urquhart and his Connecticut based consulting firm received $493,914
in 2000.24 Board member Charls Walker, a tax lobbyist, received $70,000, paid to firms he
controlled.25 A company on whose board director Herbert Winokur also served, the National
Tank Company, sold $1,035,000, $643,793, $535,682 and $370,294 of equipment to Enron in

21

J.C.Coffeejr.,WhatCausedEnron?:ACapsuleSocialandEconomicHistoryofthe90s(2003)ColumbiaLaw
School,WorkingPaperNo.214,atp.37.
22
Ibid,

23
Supranote11,atp.51.
24
Ibid.
25
Ibid.atp.52.

the years 1997-2000.26 The directors clearly played double role for extra gains. The role of a
director should only be limited to his job, if any director want to get involve in some other
way, then he should cease to be a director. High board compensation thereby prevented the
board from seeing early signs that the underlying reality was crumbling. The role of nonexecutive directors was also contentious. They were controversial because they received
payments as consultants, some received money in form of gifts to their universities and
hospitals.27 The Sarbanes Oxley act and the Higgs report have thus stressed upon more
independence for non-executive directors. The role of the non-executive directors can only be
improved by more involvement; a non-executive director may be well qualified but if he/she
doesnt have the requisite knowledge about the company they are least functional. Moreover
a formation of a remuneration committee consisting of outside directors will bring
transparency and fairness within the remuneration system.

SHAREHOLDERSANDSTAKEHOLDERS:
Shareholders expect a return on their investment to compensate them for bearing risk. The
riches on which the large edifices of the companies stand belong to the shareholders. The
stakeholders on the other hand are involved in running the business. The role of these players
has been of silent spectators in running a company when everything seems to go in the right
direction, albeit its an illusion. The shareholders and stakeholders in some cases should be
involved in the company matters; in some technical cases their involvement may not be
possible. For instance the appointment of the key players within the company should be done
by the approval of the shareholders. Ken Lay as the CEO in case of Enron was involved in
making key appointments. Thus shareholders must shoulder some of the blame. Management
was often forced to live up to unreasonable expectations. If expectations are not met through
actual results, they can be achieved through forged results. This keeps everyone happy for a
while, but in the long run its a failed game.

In some cases approval of the shareholders is not practicable. Thus in context of a listed
company such as Enron, approval by the board will almost certainly suffice. With a dispersed
shareholder base it is impracticable to require shareholder approval in such a case, and
corporate law generally does not insist upon it. Fastows involvement was, however,

26
27

Ibid,atp.5152.
Supranote7,atp.139.

disclosed to shareholders in Enrons annual report for 2000, after the transactions were
undertaken but well before the companys difficulties began.28 When everything is going well
on papers the investors tend to reduce their reliance on gatekeeping services based on their
false belief that extraordinary returns will persist.29 In case of Enron, many investors were
likely misled by such overvalued earnings, but they should have been more vigilant;30
particularly when about 60 percent of the stock owners were institutional investors. So, when
everything is going on smoothly then the investors are least bothered, thus the role of these
investors along with other stakeholders should be more than just a silent observer. For
instance the shareholders should have noticed the high remuneration of managers and
directors. So investors can only intervene when they observe something unusual or alarming
within the company. For instance the passengers in a ship have least knowledge about the
technicalities of running a ship; it is the captain and his crew who have the requisite
expertise. The passengers though have paid to be on board, but still cant do much if the ship
hits an iceberg.

GATEKEEPERS:
Gatekeepers are reputational intermediaries who provide verification and certification
services to investors.31 After the fall of Enron the question was raised that, what the
gatekeepers were doing during all these mishaps. The US accounting rules enabled
companies to set up corporate vehicles, or the SPEs, to manage assets off balance sheet. To
improve its financial statements Enron indulged in fraudulent transactions with fake affiliates.
The debt on its balance sheet was shifted to the fake affiliates balance sheet. Enrons
gatekeepers i.e. its investment banks, attorneys and accountants were allegedly involved in
these fraudulent transactions.32 The SPEs were those fraudulent entities used for this
purpose. Enrons financial statements were overvalued by the help of these SPEs. Enrons
fall was probably unavoidable once the fraudulent SPE transactions began to unravel in the
autumn of 2001. Chewco was the first SPE to be wound up and the LJM and Raptor
transactions then followed. In each case Arthur Andersen having initially approved the deals,

28

Ibid,atp.138.
Supranote21,atp.34.
30
Ibid.
31
Ibid,atp.13.
32
SeeG.J.Aguirre,TheEnronDecision:ClosingtheFraudFreeZoneonErrantGatekeepers,28(2003)Journal
ofCorporateLaw,atp.453.
29

now told the company that they were incompatible with accounting principles.33 Instead of
checking these sham transactions and briefing the company directors about the dangers
related to it, the auditors neglected these acts to create a wrong impression in the market. The
revelations of these sham entities, and its effect on the Enrons balance sheet created a fuss
and the credit rating agencies downgraded Enrons long term debt.34 This later resulted in
Enrons bankruptcy. This was more than just a simple flaw in treasury management.35 The
auditors were never asked to explain the situation and they did that just at the eleventh hour.
The auditors were also involved in the mark-to-market accounting practises which were
allowed under the SEC policies at that time; which proved as putting matches in the hands of
a child.36 Thus it was the abuse of the mark-to-market practise which let Enron down.

Enrons auditors also showed lack of independence in their work. Andersen received fees not
just for auditing, but also for consultancy services; and it engaged in regular exchanges of
employees with Enron. In 2000, Arthur Andersen earned $25 million in audit fees and $27
million in consulting fees. It also earned substantial fees, tens of millions of dollars, from
organising the SPE transactions which were to prove most costly to the company. Enrons
legal advisers, Vinson and Elkins, were also directly involved in arranging these transactions.
The Enron and other corporate scandals owed much to the decline in the professional
standards of the legal and accounting gatekeepers during the 1990s.37 Thus the double role
played by the Auditors i.e. the auditing and consultancy, should be separated. This practice
was allowed within the US system at that time.

Unlike other companies Enrons audit committee had more expertise. It consisted of 6
members chaired by Dr. Robert Jaedicke of Stanford University, an accounting professor and
former dean of Stanford Business School. The committee held short meetings with a large
agenda to cover.38 SO, inspite of having a better audit committee also failed to play a role that
an audit committee should play. The reason can easily be guessed by the fact of short
meetings that it held. The question here arises that with such experienced members in the

33

Supranote7,atp.138.
Ibid.
35
J.Plender,GoingofftheRails,inGlobalCapitalandtheCrisisofLegitimacy(Wiley,2003),atp.175.
36
B.Stewart&S.Stewart,TheRealReasonsEnronFailed18(2006)JournalofAppliedCorporateFinance,at
p.116.
34

37

See J.C. Coffee jr., Understanding Enron:Its about the Gatekeepers,Stupid (2002) Columbia Law School,
WorkingPaperno.207.
38
P.M.HealyandK.G.Palepu,TheFallofEnron17(2003)JournalofEconomicsPerspectives,atp.17.

committee, why did the committee failed to point out the deceptive activities on time. So the
role of the audit committee should be enhanced to get more transparency and reliability. This
can be achieved by a more responsible and independent committee with more frequent and
meaningful meetings, giving ample time to discuss key audit issues. The committee should
make sure that the investors have the adequate information about the companys economic
reality.39 In the case of Enron, for example, it might well have led to more transparent
disclosure with regard to the special purpose entities. The audit committees should be vigilant
enough to bring transparency in the work of a corporation.

Any annual review of the managers by the accountants or lawyers was not done in case of
Enron. This was not a corporate governance practise before but this is now becoming a
common practise.40 If the Enron transactions, especially the SPEs related transactions were
reviewed at an early stage, many mishaps could have been deterred, including the $45 million
dollars accrued by Fastow out of LJM transactions. Furthermore it is the duty of the
gatekeepers to point out the unfavourable practises and warn of its consequences. The
lawyers need to say The law lets you do it, but dont....its a rotten thing to do.41 So any
mischievous act if detected by the lawyers, even if the act seems to be profitable should be
pointed out. In other words lawyers need to behave as true counsellors to their clients, rather
than as hired guns who are just following orders.42

The role of the credit rating agencies was also very contentious in the case of Enron. Senator
Joseph Lieberman, whose Senate committee held the first hearings on Enron said, The
credit-rating agencies were dismally lax in their coverage of Enron. They didnt ask probing
questions and generally accepted at face value whatever Enrons officials chose to tell them.
And while they claim to rely primarily on public filings with the SEC, analysts from Standard
and Poors not only did not read Enrons proxy statement, they didnt even know what
information it might contain.43 So the credit rating agencies also relied on the information
given by the company. The agencies seem to be least interested as well when everything is
going on well. The responsibility of the credit rating agencies is to show a clear picture of the

39

Ibidatp.29.
D.M.Branson,EnronWhenAllSystemsFail:CreativeDestructionorRoadmaptoCorporateGovernance
Reform?48(2003)VillanovaLawReview,atp.1018.
41
Supranote3,atp.1387.
42
Ibid,atp.1391.
43
Senate Committee on Governmental Affairs, press release, Financial Oversight of Enron: The SEC and
PrivateSectorWatchdogs(October8,2002).
40

progress of a company, thereby it has to rely on more than what it gets from the company
itself.

CRIMINALLIABILITY:
The personal liability of the corporate managers and directors has increased in the last
decade.44 The criminal liability in this regard was non-existent or negligible. Light sentences
were awarded to the managers convicted of securities fraud.45 As mentioned earlier the start
of 21st century brought major corporate reforms with it; one of the major consequences of the
big corporate collapses is the increased criminal liability for corporate frauds. Major
sentences were awarded to the managers and directors in case of WorldCom, Tyco and
Enron, alongwith other corporate collapses. With such large amount of capital involved in the
companies, the criminal liability for any fraud or misappropriation of money seems to be a
necessity.
In case of Enron, Lay was found guilty of all six counts against him and Skilling guilty of
nineteen of the twenty-eight counts against him.46 Skilling was found not guilty of nine of the
ten insider trading charges and guilty for all of the eighteen remaining charges, including
conspiracy, securities fraud, and false statements. Though Skilling faced up to a 185-year jail
sentence, he ultimately received a twenty-four year prison sentence on October 23, 2006.47
Lay was also found guilty on four counts related to bank fraud in a parallel bench trial, but he
died of cardiac failure before sentencing on July 5, 2006.48 After the announcement of the
verdict, a number of jury members made public statements indicating that they struggled to
understand the complexity of Enron's missteps, but that the degree of harm to employees and
the community influenced their decision to convict.49 Fastow pled guilty to two counts of
wire and securities fraud, and agreed to serve a ten-year prison sentence. He became an
informant and cooperated with federal authorities. Despite entering into a plea agreement to
serve 10 years in prison, Fastow was sentenced to six years, followed by two years of

44

J.R.Kroger,EnronFraudandSecuritiesReform:AnEnronProsecutorsPerspective,76(2005)Universityof
ColumbiaLawReview,atp.110111.
45
Id.
46
See Mary Flood, ExEnron Bosses Closer to Prison, Houston Chronicle, May 26, 2006, available at
<http://www.chron.com/disp/story.mpl/special/enron/3898754.html>(lastvisitedon2ndMay,2011).
47
Tom Fowler, Skilling Gets 24 Years in Prison for Enron Fraud, Houston Chronicle, Oct. 23, 2006,
<http://w.chron.com/disp/story.mpl/special/enron/4279719.html>(lastvisitedon2ndMay,2011).
48
See Kurt Eichenwald, An Enron Chapter Closes: The Overview; Enron Founder, Awaiting Prison, Dies in
Colorado,N.Y.Times,July6,2006,atAl.
49
SeeSupranote2,atp.1090.

probation.50 His wife, Lea Fastow, a former Enron assistant treasurer, pleaded guilty to a
misdemeanour tax charge and was sentenced to one year, and an additional year of
supervised release.51 Thus the major actors in the Enron story were destined for a sad ending.
The judges acclaimed that they could not understand the complexity of the situation. This
may lead us to a conclusion that we may need special juries for corporate crimes who could
understand the corporate dealings. This may lead us to fair trials not dependent on the
statements of a person who entered into a plea bargain.

CONCLUSION:
The fall of Enron was an unavoidable collapse. Corporations depend upon risk taking; the
stake of managers and directors is also involved in the companies. Thus risk taking should be
calculated in order to safeguard the interests of shareholders and stakeholders to the best
possibility. The Enron management indulged into activities in order to increase the company
business, thereby risk taking was involved. Once involved in the questionable activities it was
practically impossible to come out of the cumbersome situation; especially at the cost of
companys credibility. The only choice left was to take further risk and be on the edge in
order to withhold the image of the company. While hoping for the best things went further
wrong, especially when fraudulent conduct of some individuals like Fastow took over
companys interest. The only thing that could have saved Enron was good governance, but
the then governance codes or rules left a window open for bad governance. For instance the
allowance of the use of mark-to-market transactions by the SEC albeit it was misused by
Enron depicts a governance failure, internally and externally.

To avoid another collapse like Enron all the corporate players will have to play their role
effectively. The heart of the company (the directors) was unhealthy and unfit, thus the blood
in the Enrons veins could not run effectively. The board needs to be independent and active;
if the board had checked the company transactions in detail then they should have noticed the
sham transactions made through the SPEs. Moreover had they been independent they would
have posed harsh questions in this regards. The absence of appropriate committees also led
Enron down. For instance remuneration committee would have been a check upon amount
received by the managers and directors. The combination of the role of CEO and chairman is

50

SeeEdwardIwata,FastowsFastTracktoInfamy,USATODAY,available
<http://www.usatoday.com/money/industries/energy/20020915enronfastow_x.htm>
51
SeeLeaFastowEntersPrison,CNNMoney.com,available
<http://money.cnn.com/2004/07/12/news/newsmakers/lea_fastow/>.

also a contentious practise. The Shareholders role needs to be more active rather than being a
silent spectator. They can play a policing role in taking more interest in the company affairs
(especially in considering the remunerations), rather than moaning about their fate after the
company is vandalised. The Gatekeepers proved fatal for Enrons creditors, thus the rotation
of accounting partners rather than relying on the services of one can be effective.
Independence of auditors by separating the consultancy and auditing role is also
indispensable. Furthermore the role of the audit committee is important to inject transparency
into the corporate finances. Any sham transactions can be identified early provided that the
audit committee is independent and vigilant. The lawyers can play a gatekeeping role by
blocking the way of any mischievous acts going on within the company. This can be achieved
by giving them more independence rather than keeping them for advice which is seldom
operated. The role of credit rating agencies is important as a gatekeeper, they need to rely on
more realistic sources rather than the reports given by the companies. Finally the criminal
liability for corporate fraud will decrease risk taking within the corporate business. The
management rely on risk taking but with enhanced criminal liability they will always be
afraid of a risk failure. Thus the criminal liability needs to be restricted to the fraud detection
i.e. criminal convictions shall be made where fraud is detected. For instance Fastow was
liable for his earnings from the fraudulent LJM transactions. Concluding Enrons demise I
would say it was character of the leadership which let Enron down and lack of accountability
allowed dishonest conduct.

What the literature teaches us is that the ethical behaviour is taught from the top down.... It
is the managements commitment to ethical standards that sets the tone.52

52

M.C. Daly, Panel Discussion on Enron: What Went Wrong? 8 (2002) Fordham Journal of Corporate and
FinancialLaw.

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R.Powell, The Enron Trial Drama: A New Case for Stakeholder Theory, 38 (2006)
University of Toledo Law Review.
N.B. Rapoport, Enron, Titanic, and the Perfect Storm, 71 (2002) Fordham Law Review, pp.
13731397.
See D.G. Baird and R.K. Rasmussen, Easy Lessons from Enron, 55 (2002) Vanderbilt Law
Review, pp. 102-130.
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