LITERATURE REVIEW : ENRON CASE

INTRODUCTION:
Enron is a classic case of individual and collective greed born in an atmosphere of
financial
boom, market insurgence and corporate arrogance (Thomas 2002). The share price of
Enron
in just over one year fell from US$90.75 in mid-2000 to less than $1 by November
2001
(New York Times 2007). In December 2001 US SEC (Securities and Exchange Commission)
started an investigation and later in the month Enron filed for bankruptcy
according to
chapter 11 of the USA bankruptcy code with assets of over $63.4 billion, Enron
became
USA’s largest corporate bankruptcy until that time and with that the closure of
Arthur
Andersen an external auditor of Enron and one of the five biggest accounting and
audit firm
in the world (Benston 2016). Therefore, Enron’s case was not only the largest
bankruptcy
scandal in America during that time but also seen as the biggest audit failure in
the history
(Bratton 2002). Enron came into existence in 1985 by Kenneth Lay by the result of
merger
between Houston Natural Gas and Inter North. Few years later, after Jeffery
Skilling was
hired, he brought in Executives that would later on hide billions of Dollars in
Debt from
failed deals and projects by misrepresenting Financial Reports, using of loopholes
in
accounting and manipulating the SPEs (Special Purpose Entities). CFO of Enron
Andrew
Fastow with other executives were able to deceive Enron’s Audit Committee and board
of
directors on unusual and high risk accounting practices but also convinced Andersen
to
overlook the issues” (Lavelle 2002). There are many factors behind the corporate
debacle but
weak corporate governance and passive role of Independent directors are the two
major
factors that led to the corporate failure of Enron.
Major factor(s) led to the corporate governance failure at Enron
Dual role of Chairman and CEO: The best practise is to have separate roles of CEO
and
Chairman. The CEO leads the management whereas the Chairman is considered as the
head
of the board. If the same person has the responsibility of both roles and deem to
be too
powerful then his/her ability to oversight board as Chairman gets diluted (Gopinath
2002). In
the case of Enron Kenneth Lay was a Chairman and later took over as CEO after
resignation
of Skilling and pretended ignorance about the accounting misrepresentation at the
organization (Gopinath 2002). Kenneth Lay abused his powers by providing misleading
information to public about company’s financial health and defrauded in excess of
$90
million in 2001 (Thomsen & J. Clark 2004).

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Audit Committee: According to the Institute of Internal Auditors (IIA) the audit
committee
must be able to oversee internal controls, financial reporting, risk management,
ethics,
compliance, management, internal auditors, and the external auditors. One of the
most
important features of Audit committee is to ensure and monitor the code of conduct
have
been developed and reviewed and updated on regular basis plus ensuring compliance
with
laws and regulations (IIA 2013). Robert Jadicke a former accounting professor and
Dean of
Stanford University Business School were appointed as a chairman of Audit committee
since
1985 which turned out to be non-functional. Even though the chairman was a very
literate
person but he instead backed the motion to suspend the ‘Code of Ethics” of the
company in
order to allow certain employee to set up special partnerships which became the
cause of
conflict of interest whereas Audit committee was supposed to oversee the compliance
of such
“Codes” (Lavelle 2002). The audit committee comprised of four persons besides
Robert
Jadicke and three of them resided outside of USA which made it inactive as the
members of
Audit committee are supposed to meet frequently more than any other committees in a
corporation (Lavelle 2002).
Auditor Independence: Smith and Walter scrutinized the Auditors Independence.
According
to SEC report Anderson was paid $25m for Auditing plus $27m for providing non
Auditing
services (Martin 2016). In addition to that many employees from Anderson started
working at
important positions in Enron. It was evident form the scenario when Sherron Watkins
the
whistle blower approached Anderson revealing potential problems but the matters
were
dragged under the carpet as Auditors failed to escalate the issues to the board and
Audit
Committee (Smith & Walter 2006)
Other Facts
According to Businessweek, gatekeepers such as security analysts, company’s
experts, banks
and other players in financial markets failed to capture the true picture at that
time. Besides,
one of the many lapses observed in the corporate governance was about directors
having no
time to review and take well informed decisions and one such example was Mr Enron
Raymond Troubh who was holding directorships of 11 different companies (Gopinath
2002)
The independent directors of Enron did not play their roles rightly; had they
played,
the failure could have been avoided

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A board of Senate panel scrutinizing the Enron Corporation has deduced in a report
that the
organization's board could have ended a considerable lot of the risky accounting,
concealing
of liabilities or debts and conflict of interest that prompted Enron's collapse
(Richard 2016).
High Risk Accounting: The Enron Board purposely permitted company to practise high
risk
Accounting (Mark to market Accounting). The primary feature of independent
directors is the
composition of board as range of competencies plus experiences are required to
understand
and build the business and then use that expertise to be able to challenge
management
decisions constructively (Dembinski 2006). In case of Enron the board should have
appointed
more knowledgeable chairperson for Finance and Audit committee the two most
important
positions. According to (Lavelle 2002) their expertise may have been out of date
because of
the changes Enron went through in the 1990s. Audit committee could have proposed
for
consulting services from one accounting company and other as external auditors to
avoid
conflict of interest (Dembinski 2006).
Lack of independence: At Enron, the Board failed to maintain the independence of
the
company's auditor, permitting Andersen to provide internal audit and consultancy
services
while performing duties as Enron's external auditor. Furthermore, the independence
of the
Enron Board of Directors was negotiated by financial stakes between the corporation
and few
Board members (Dembinski 2006). Independence of Board individuals implies that
there
ought to be no financial association between the individuals and the organization
apart from
their Board remuneration. As in the case of Enron, The directors receiving
consultancy fees
from the same company, directorship at the charity organizations primarily funded
by the
company or establishment that get gifts from the organization and those directors
who are in
charge of other companies which are also in business with the same company holding
positions of Independent directors; such relationships primarily become the cause
of lack of
independence plus the directors may never want to challenge management so they
don’t lose
the side advantage and that will presumably make them part of the management team
and
will have difficulties in exercising independent judgement (Dembinski 2006).
Undisclosed off-the-books activity: The Enron Board of Directors purposely
permitted
Enron to perform billions of dollars in off-the-books activities to make its
financial matters
appear better than they really were and failed to warrant adequate public
disclosure of
material off-the-books liabilities that added to Enron's meltdown. (Watkins 2016).
Off the
book liabilities can be legitimate and used for a specific purpose but when there
is an
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incomplete transfer of risk to the other entity or being used to finance operations
or
expansion, then it is always important to disclose off the books liabilities in
footnotes of
financial statements plus the disclosures of all material liabilities must be
reviewed and
discussed by the board. If the transactions have to be taken into considerations,
then the risk
committee should be there to manage it properly following board’s guidelines and
must be
audited by external auditors who would express an opinion to the board (Dembinski
2006).
Inappropriate Conflicts of Interest: The Enron Board of Directors approved an
unusual
course of action permitting Enron's Chief Financial Officer Fastow, to set up and
operate the
LJM private equity funds which benefited at Enron's expense by performing business
transactions on behalf of the company. The Board of directors completely failed to
protect
Enron from unfair business deals and provided insufficient oversight of
transactions related to
LJM (law 2016). Senior executives should be required to declare and authorized to
accept
income from other activities for instance if a board member is also a director in
another
company (law 2016). The Board must guarantee that the senior management is in
pursuit of
the objectives of the organization and the goals are aligned, and perform duties in
the best
interest of the company (law 2016). In case of a complex scenario an external view
point
could be considered but further decisions must not be made unless the position is
clear on the
current opinion. A board will surely be put under a lot of pressure from the
management in
case of urgent matters but board should be competent enough to not take a step
where a
conflict of interest scenario has been created on purpose. These types of actions
may not be
seen as popular but independent directors must remain steadfast and diligent as
part of trust
conferred on them by shareholders (Dembinski 2006)
Conclusion:
The independent directors have a bigger role to play after the debacle such as
Enron as they
have been entrusted by shareholders and have a duty to intervene and speak up and
also make
sure the best practices are implemented and followed, they need to ensure that
their views are
heard during meetings. Most importantly independent directors always have the
option to
resign if their views are not taken into consideration and a company is taking
risky decisions
and following doubtful practices. Resignations of Independent directors are always
scrutinised by shareholders as they represent the later party plus it makes room
for doubts in
the mind about the level of governance being exercised.
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