Enron Scandal

Managing Finance and Financial Decisions

 Enron Scandal

1.0: Nature of Enron Corporation Fraudulence Practices

Enron Corporation as a product of business combination exercise was established in 1985 as
the first natural gas pipeline network across the country with attention being focused on
unregulated energy trading markets. By 2001, though looked successful, the energy assets
value appeared to have commanded more income than the real ownership of tangible assets
with $139 billion revenue base. The business was making fortune especially in its core energy
operations but recorded massive downturn in its broadband trading capacity given its huge
capital outlay been financed with huge debts instruments (McLean and Peter, 2003). The
corporations international business expansion mainly in public utilities in UK, India etc was
stifled with domestic politics restricting quick urge in price envisaged by the firm. Contrary
to wide spread believe, the Corporations energy trading businesses were generating less
extensive and profitable than what the organisation presented in its financial statements
(McLean and Peter, 2003). The bubble burst when there was no enough cash flow to enable it
coping with major losses in internet and international investments.

The Enron fraud appeared to be complex and confusing to the shareholders and analysts, as
the problem was rooted to the application granted by the federal regulators allowing Enron to
adapt an accounting technique called mark-to-market which was known to be in used with the
stock broking and trading firms. The technique permitted the price of a security to be
recorded on daily basis so as to determine profits or losses. According to Niskanen, (2007)
the system allowed the Corporation to record the estimated earnings from long term energy
contracts as current income which might to be realised in a foreseeable future. It became
tedious to determine trends of Enron cash inflows, revenue figures were inflated by doctoring
the projections for future earnings. This complex business model together with the unethical
practices enabled the firm to use accounting limitations to misrepresent earnings and modify
the comprehensive statement of financial position to suggest a favourable result (Niskanen,
2007).

Usually, organisation makes decision that proved bad or ill-timed projects. The technique
employed by the Enron Corporation to respond to its financial irregularities constituted the
major financial scandal of the business. Niskanen, (2007) posits that the regulation requires
that business entities should disclose its true state of financial positions to public investors

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Enron falsified its own financial records. Business losses and almost-scrappy assets were
assigned to unconsolidated partnerships and special purpose entities. Put differently, the
corporations public financial statements appeared that losses occurred to the Raptor entities
but not Enron, in which case Raptor entities were obviously independent companies that have
already consented to absorb Enrons losses. In real facts, it was an accounting contrivances
established and absolutely controlled by Enrons management. Apart from this, Enron seems
to have concealed bank loans as energy derivatives trade to hide the level of its indebtedness
(McLean and Peter, 2003).

The nature of Enron fraudulence practice was a misrepresentation where the firm consistently
misrepresenting earnings in its reports and continuing to attract revenue provided by the
prospective investors which did not have privy knowledge of the true financial position of
Enron financial statement. The top management executives of the company misappropriated
and embezzled funds generated from investments but presenting fraudulent earnings to the
investors. This encouraged proliferated of more capital inflow in form of investments from
current stockholders and as well fascinated new investors wanting to benefits from obvious
financial gains enjoyed by the Enron Corporation (Salter, 2008). Enron executives devised a
means to obscure its debts and established off-balance-sheet vehicles, complex financing
structures, and behave so terribly that only few individual could comprehend the situation

After correcting observed abnormality in the firms accounting records, more than 80% of its
profits reported since 2000 disappeared, and hence Enron immediately collapsed. In view of
Chary, (2004) the collapse of a large corporation that led to losses in job, shareholders wealth
and market confidence, signifies that there were severe flaws in the U.S. system of securities
regulation, that based on the full and accurate disclosure of all financial information which
investors require to make an informed investment decisions. The transactions conducted by
the Enron lacked transparency where corporate insiders pursue their selfish interest at the
expenses of committed workforce and stockholders who suffered diminish in their wealth and
income. All the issues observed in this complex scenario led to the bankruptcy of the Enron
and most of the atrocity was committed with direct or indirect knowledge of the firms
executives

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The corporations auditor, Arthur Andersen LLP, was having Enron as its second biggest
client. The auditors had the job as the Enrons external as well as its internal audits during the
years under reviewed simultaneously. Andersens workforce was perpetually kept on
permanent assignment at Enrons offices. Several Enrons internal accountants, directors and
controllers have served in Andersen in an executive capacity. These relationships together the
auditors extensive concurrent consulting practice, the Congress members and the press are
raising questions about the Andersens audit independence and the credibility of the audit
process for the Corporation.

According to the federal securities law as observed in Chary, (2004), it is required of the
publicly traded corporations statement of accounts to be certified by an independent auditor.
The Arthur Andersen was the auditor of the Enron; the firm turned a blind eye to inadequacy
of accounting practices, but was practically implicated in fashioning complex financial
structures and transactions which assisted deceit. The certification by an auditor shows that
the considered financial statements have been prepared in line with generally accepted
accounting principles (GAAP). Giving the Enrons case, it became obvious that not only that
whether GAAP were breached, and the present current accounting standards allow
organisations to play numbers games, with the investor exposure to unnecessary uncertainty
by financial reports that lack clarity and consistency. Apart from the SEC statutory
regulations that set standard for companies that transact securities with the general public, the
Financial Accounting Standards Board (FASB) set the accounting standards for large entities
and the non-governmental organisations (Healy, and Krishna, 2003). Though these standards
setting process was considered clumsy and too vulnerable to business.

It was observed from the evidence that Andersens Auditors failed to fulfil their professional
responsibilities in relation to its Enrons financial reports audits, as we as its obligation to call
the attention of Enron's Board or the Audit and Compliance Committee and express its
worries concern the corporations internal contracts over the related-party transactions
(Healy, and Krishna, 2003).

2.0: Changes to US Accounting Regulations after Enrons Scandals

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Dharan and William, (2008) described that to respond to the accounting and auditing
challenges threw up by Enron and some other large organisations fraudulent practices, the
Congress made a law referred to as the Sarbanes-Oxley Act of 2002. The purpose of enacting
Sarbanes-Oxley Act, was aimed at enhancing corporate responsibility, improving disclosures
in financial reports and fight corporate and accounting fraud. This is a piece of legislation
widen the consequences for destroying, fabricating or altering organisation vital records in
federal investigation or an attempt to defraud shareholders (Dharan and William, (2008). It
attempted to increase the accountability of auditing companies in remaining objective and
independent of their clients.

This Act contains some the most extensive changes to the securities laws since the 1930s.
The Sarbanes-Oxley Act (2002) stipulates that:
A new oversight board should be created to control the independent auditors of
publicly traded organisations which are deemed to be operating under the supervision
of the Securities and Exchange Commission
Increases the standards of auditor independence by restricting auditors from offering
specific consulting services to their audit clients while the pre-approval would be
needed by the clients directors board for any other non-audit services.
The top management and audit committees are required to take more direct
responsibility regarding the financial statements accuracy. The board audit committee
must majority of independent auditors that not affiliated in any ways with the
management with sole duties of hiring, overseeing, firing and provide compensation
for the corporation external auditors. At least one director who is a financial expert be
appointed into audit committee
Certain transactions like stock sales by company insiders, unconsolidated subsidiaries
transactions, and other major activities which may need real-time disclosure must
need specific disclosure requirements.
Requires the SEC to make guidelines to prevent conflicts of interest which may
influence stock analysts objective views
It requires the SEC to review organisation financial statements from time to time
Creates and with severe penalties the variety of punishment with offenses that relate
with the securities fraudulent practices such as misleading an auditor, mail and wire
fraud, and records destruction.

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The post Enrons scandal encourages individual accountants and their related associations to
place emphasis on the renewed traditional professional themes like accountability, integrity,
objectivity and independence so as to boost the public trust and confidence on the profession
and dedicated to prevent any future corporate failures occasioned by poor accounting or
auditing practices (Wells, 2004).

However, Sarbanes-Oxley Act of 2002 as a major legislation brought quite number of

changes to the accounting profession regulations. Among such changes is the creation of
Public Company Accounting Oversight Board (PCAOB) which is a private sector and non-
profit-making entity with purpose of overseeing the auditors of public companies. PCAOB
was established and empowered to protect the public interest by setting and enforcing
auditing standards in areas like ethics, independence, quality control as well as any area that
deemed to protect public interest. According to Wells, (2004), the Act provided that the three
out of the five board members of PCAOB must not be Certified Public Accountants (CPAs)
but all must be knowledgeable in financial matters.

The US Sarbanes-Oxley Act (2002) also creates new rules for audit committee independence
by expressing the independence of its member in a clear term, which must not have received
any fee other than for service on the board from the issuer and not as well being affiliated
with individual in the organisation (Salter, 2008).

Other changes brought to accounting regulation aftermath Enrons scene includes

specification that certain non-audit services in US such as recordkeeping or other services
that relate directly with auditing exercise on clients accounting financial records, designing
and implementing financial information systems and internal audits are expressly forbidden.
Salter, (2008) thus explained that this Act stipulates a five-year audit partner alternation on
public organisation engagements.

The law likewise empowered the New York Stock Exchange (NYSE) to regulate
organisations practice and hence, issued Guiding Principles for Audit Committee Best
Practices where it was recommended that for all publicly-traded organisations, all its audit

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committee members must have sufficient financial experience and knowledge upon which
they can engage both the internal and external auditors

3.0: Likelihood Prevention of Enrons Scandal Should Earlier Implementation of

Greater Regulations

Aftermath of Enrons case spate the serious enhancement of existing financial reporting
standards in a way that financial deals were more transparent and better understood by the
investors. In 2003, Financial Accounting Standards Board (FASB) dealt with matter relating
to variable interest entities called Special Purpose Entities. It has been implemented that the
US business organisation with a controlling financial stake in Special Purpose Entities must
comprise both the assets, liabilities and operational performances of such entity in its
consolidated financial statements (Toffler and Jennifer, 2004). If this measure has been
implemented, isolating consolidated financial records that hidden details of Enrons debts and
losses could have been made exposed to the stakeholders generally.

Toffler and Jennifer, (2004) described the reporting standard issued by the International
Accounting Standards Board (IASB) requiring stock options to be expensed while FASB in
2004 proposed a new rule that requires organisations to expense employee stock options.
Earlier greater execution of rule could have prevented Enron from stating the employees
retirement plan as its own current assets.

Giving the announcement by the US Securities and Exchange Commission (SEC) in 2003,
that firms issuing periodical (annual and or quarterly) financial statement filed with the SEC
must have to disclose all material off-balance sheet deals that were expected to impact
currently or in foreseeable future, on the organisations financial position (Swartz and
Sherron, 2004). Earlier implementation of this rule might have required Enrons executives to
disclose and invariably expose their shady deals.

Because under S. 302 of Sarbanes-Oxley Act, the chief executive officer and chief financial
officer of an organisation must certify that the financial statements and disclosures therein are
materially accurate, and provide an examination of the existing internal controls effectiveness
as the law prescribes severe US criminal sanctions for wilful fraudulent activities.

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4.0: Appropriateness of Penalties on Individual Culprits

Rosen (2003) listed the several individuals that were summarily involved in the fiasco.
Andrew Fastow, an ex-finance executive and main witness in the scandal trial, found guilty
and bagged 10 years sentence, his wife Lea got 1 year jail term for conspiracy in assisting her
suitor to avoid income due to the authority. Jeffrey Skilling was convicted and jailed for 24
years for his role in the scandalous activities. Ken Lay in 2006 was pronounced guilty of
conspiracy, fraud, over trading and initiated several financial schemes and deals that resulted
into huge losses and this earned him 24 years imprisonment.
Michael Kopper, ex-Enron executive received 37 months jail term for his role (wire fraud and
money laundry). Michael Koenig, another ex-executive spent 18 months in prison for role
played to doctor and falsifies account reports to the investors. Precisely, sixteen people were
found guilty for Enrons financial scandals and 5 others, including 5 ex Merrill Lynch
colleagues. Kenneth Rice was another former Enrons chief in charge of high-speed Internet
unit but also received a 27 months sentence for part he played in the process (Dharan and
William, 2008).

Giving the penalties meted out to the players in the Enrons scandalous activities, it appeared
that the justice was seen to be served adequately and aimed at serving as deterrent for the
future occurrence, but in my opinion the penalties were not sufficient. Giving the value of
capital lost suffered by the investors and amount of Pension Plan contributions from the
employees and the lost scream of monthly income, it would have been better for the authority
to move further against the culprits in recovery of the looted public fund. Their personal
estates, business empires and any other viable stake in other enterprises should have been
confisticated and the proceeds generated from its auction be distributed to the employees and
the shareholder who have suffered immense financial lost. This, in my opinion could have
served justice extensively in a way that provide deterrent to others.

Conclusion
The Enron Corporation incidence was the biggest among the several scandals committed by
large organisations which have damaged the companys goodwill. Consequently, the US
Congress enacted a law which made organisations top executives to be criminally liable for

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manipulating their account records. The case in the Enron scandal has shifted the balance of
power away from the corporation boards toward the investing stakeholders in the business.
The Sarbanes-Oxley Act (2002) was effective in curbing the top corporation executive
excesses due to the fact that after the scandal they are more meticulous about the spinning off
of accounts records which might be inaccurate and inconsistence with attendance of criminal
liability associated with the crime

References:

Chary, (2004), The Ethics in Accounting, Global Cases and Experiences, accessed
online on 13/01/16
Dharan, G. and William, R. (2008), Red flags in Enrons reporting of revenues and
key finacila measures, accessed online on 12/12/2015.
Healy, P. and Krishna, G. (2003), The fall of Enron, A Journal of Economic
Perspectives, online resources accessed on 13/01/2016
McLean, Bethany and Peter, Elkind (2003), The Smartest Guys in the Room, New
York, a video production viewed on 12/12/2016

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Niskanen, William A. (2007), After Enron: Lessons for Public Policy, retrieved online
on 11/12/2015.
Rosen, Robert (2003), Risk Management and Corporate Governance: The Case of
Enron, accessed online from Law Review of the Connecticut websites on 12/01/16.
Salter, M. (2008), Innovation Corrupted: The Origins and Legacy of Enron's Collapse
accessed online 03/01/2016.
Swartz, M. and Sherron, W. (2004), Power Failure: The Inside Story of the Collapse
of Enron.
Toffler, B. and Jennifer R. (2004), Ambition, Greed and the Fall of Arthur Andersen,
retrieved online on 16/01/2015.
Wells, J. T., (2004), Corporate Fraud Handbook. Prevention and Detection, New
Jersey, retrieved online from the Association of Certified Fraud Examinations
website.

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