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Rachael Northrup, Katie Korus, Sthefanie Desouza, Monica Kempski MGMT203-02
Table of Contents 1.) Introduction In 1985 two companies called Houston Natural and Inter-North combined to make the company Enron. In 1986, Enron became a trading giant of natural gas and electricity. There are three major individuals that played significant role in the collapse of the company. Kenneth Lay, the Chief Executive officer, Jeffrey Skilling the Chief Financial Officer, and Arthur Anderson, a limited liability partner. The downfall of Enron directly led to the beginning of The Sarbanes-Oxley Act. 2.) Facts of Case - Monica Kempski - Enron¶s growth and success - Accounting fraud - Special purpose entity - Fake partnerships - Arthur Anderson - Prominent players - Michael Popper - Kenneth Lay and Jeffrey Skilling - Hearings - Convictions - Sentences - Arthur Anderson v. the United States 3.) Legislation ± Sthefanie Desouza - Criminal charges - Changes in law/accounting law 4.) Impact of the Case ± Katie Korus - How this affects accounting business process - In the USA - Worldwide 5.) Sarbanes-Oxley Act ± Rachael Northrup - Public Company Accounting Reform and Investor Protection Act - Enacted as a reaction to a number of major corporate and accounting scandals 6.) Conclusion -Even though Enron was a powerful company, the law did not permit them to commit fraudulent acts. In results of the companies actions, the way businesses do accounting has changed both in the US and worldwide. Everything is more closely monitored through The Sarbanes-Oxley Act.
Enron wasn¶t always the big global corporation we all know today. In 1985 two companies called Houston Natural and Inter-North combined to make the company called Enron. When the two companies merged they joined the longest pipeline ever to exist, it went on for thousands of miles. In 1986, Enron became a trading giant of natural gas and electricity. The downfall of Enron was due to a series of events, precipitated by the greed of its management. There are three major individuals that played a significant role in the collapse of the company. Kenneth Lay the Chief Executive Officer, Kenneth Skilling the Chief Financial Officer, and Arthur Anderson a limited liability partner were the main figures in the scandals that surrounded the company. The finances of the company when it was established and when it collapsed also warrant discussion (Company Overview 41). The Enron Corporation was created in 1985 when InterNorth bought Houston Natural Gas. At 38,000 miles long, it became the most extensive natural gas pipeline network in the United States. With this asset, the company served to trade natural gas and electricity. Enron continued to develop at an exponential rate from its trade, in which it bought natural gas and electricity from power companies. In turn, they sold it to customers nationally and internationally ("Junior Scholastic" 4). Then, profits changed for companies involved with electricity and natural gas. In the late 1980s, government policy moved to deregulation of the resources markets. This strategy actually created a rickety market in the economy. In the beginning, prices would fall causing supply to drop. Prices would rise again; yet, this increase was not enough to make a profit. However, Enron took advantage of this policy. The company adopted a new business strategy by moving away from long term contracts. Instead, Enron issued spot market contracts, which are basically thirty day supply contracts. With these new contracts, Enron became a ³market maker´ by
buying and selling ordinary quantities of gas. Finally after much familiarity with the short term contracts, the company was able to mature enough to return to long term contracts. With these long term contracts, Enron charged a premium over spot contract costs. This ultimately resulted in immense revenues, but amplified risks and made complicated deals with companies (Giroux). With their success, Enron kept expanding all over the world. In 2000, Enron was deemed the seventh largest United States corporation (³Enron Corporation´ 1). In August of this year, the company¶s stock price exceeded ninety dollars, achieving a market value of roughly seventy billion dollars. This amounted to 700% in returns for the decade (Giroux). By 2001, the company was so vast that it obtained more than forty-nine billion dollars in total assets (US Department of State). In reality, these numbers were not legitimate and were much less. Despite these high rankings and progress, the company also obtained a mass amount of debt. In response, Enron tried to conceal the debt from the public in order to make the company still look good to consumers. They achieved this by engaging in many fraudulent processes and acts that are against business ethics. Enron undertook an accounting process called ³Special Purpose Entities´ to alter their financial statements in their favor. This allowed the company to move assets and their liabilities to another disconnected partnership to keep the company¶s financial risks from their quarterly statements and books (Giroux). These partnerships were fake and were present solely on paper. Some partnerships were so outrageous that they even had humorous names such as ³Chewco,´ short for Chewbacca from Star Wars. Because of these false partnerships, their debt was not shown to consumers. Enron exaggerated their profits by 600 million dollars; therefore, they were seen as successful and attracted the consumer and investor¶s eye ("Junior Scholastic" 4).
Unfortunately for Enron, credit corporations relegated the company¶s debt to ³junk status,´ obliging it to pay off the debt with non-existent money in November of 2001 (Smith, and Emshwiller 1). Naturally, the company had to admit their debt and report their losses of a total of 638 million dollars ("FOXNews.com"). As a result, Enron filed for chapter 11 bankruptcy the following month. With this action, twenty thousand Enron employees became unemployed and lost their pensions ("Enron Corporation" 1). At this news, everyone in the public that was some way involved with Enron commanded investigation as to why the corporation was not exposed before. In January of 2002, the United States Justice Department and the Security and Exchange Commission reacted by launching a series of investigations to obtain evidence for trial (AICPA). Several answers were obtained with the examination of Enron¶s accounting firm, Arthur Andersen. Investigation evidence yielded that the firm was responsible for auditing the finances, as well as giving advice on how to keep the company¶s monetary losses hidden ("Junior Scholastic" 4). They did not report Enron to the SEC or restate their earnings as they ethically should. Apparently, Arthur Andersen had worked with the company since 1987, so they have been going along with Enron¶s excuse of their problems being ³immaterial´ (Giroux). Most importantly, Arthur Andersen was accused of destroying important documents to impede investigators in 2002. Hence, Arthur Anderson applied their best efforts to cover up Enron¶s debt. The government also investigated people involved with Enron through monetary regulation, sale of energy units, trading, and broadband units (³MSNBC.com´). In trails involving the Enron scandal, more than thirty people were charged with crimes because of personal greed ("Enron Corporation" 1). However, only the most prominent players received the
worst convictions. The people¶s motives were enormous compensation packages. Ultimately, managers engaged in anything, even if it was illegal to make the company look good allowing them to receive their bonuses. Thus, they manipulated they initiated and allowed the false accounting practices (Giroux). Michael Kopper was the first to come forward and was convicted of money laundering, creating false partnerships, and allowing false accounting practices while he absorbed money from the company. To lessen his sentence, he agreed to identify others responsible for corruption (³FOXNews.com´). Kopper identified manipulations in 1997 with Andrew Fastow, the finance executive of Enron. He created the first false partnership, and then was named finance chief ("FOXNews.com"). Kenneth Lay and Jeffrey Skilling were also identified as major conspirators in manipulating finances for personal gain. By exploitation of finances, former CEO and Chairman Kenneth Lay earned a base salary of 1.3 million, obtained a seven million dollar bonus, and had 782,000 stock options (Giroux). From 1999 to 2001 alone, Lay gained 220 million in compensation due to Enron¶s share purchases. Former CEO Skilling also benefited greatly from Enron¶s fraud. He received 150 million dollars. Also, he collected a sixty-six million dollar bonus from stock options ("MSNBC"). Skilling¶s hearing was not strong. He claimed that ³a classic run on the bank´ was the cause of Enron¶s demise. He asserted that he had no personal responsibility whatsoever. However, the judge became suspicious of this testimony because other key witnesses said otherwise. In addition, his defense certainly did not help him. He stated that the transactions he approved were very difficult to understand because he was not an accountant. However, he had a Harvard Business School MBA and was well qualified to realize the nature of the transactions. It
was also pointed out during his hearing that a chief executive¶s responsibility is to make sure that he could comprehend the transactions he passed (BBC News). Lay and Skilling were part of the same trial. During the trial, both executives claimed that they did nothing fraudulent, and said employees secretly pocketed the lost money. However, they were unable to sway the jury and convicted of conspiracy. Lay was found guilty for manufacturing false statements to banks, as well as bank fraud. He also was convicted of deceiving lenders to use seventy-five million in personal loans to take stock on the margin. Each count had a maximum of thirty years (Associated Press). Skilling faced twenty-eight charges involving conspiracy, fraud, and fooling investors of Enron¶s financial state (³MSNBC´). Overall, over twenty people were convicted and pleaded guilty to fraud and conspiracy ("Enron Corporation" 1). All conspirators mentioned above were found guilty in their trails and received prison sentences for their wrongdoings. Fastow received seventy-eight charges, causing him to serve ten years in prison ("FOXNews.com"). Skilling was sentenced to twenty-four years and four months (Smith and Emshwiller). Lay¶s charges amounted to a minimum of forty-five years from corporate trials and 120 for personal ("MSNBC"). However, Lay died in 2006 of heart failure ("Enron Corporation" 1). Following the unveiling of its scandals, Arthur Andersen was brought on trial in Arthur Andersen v. United States in 2005("FOXNews.com"). They were charged with disobeying the law that makes someone criminally responsible that intentionally applies force on someone to ³destroy, mutilate, or conceal an object with intent to impair an object¶s integrity or availability for use in an official proceeding.´ The jury found the company guilty; however, it went to the Supreme Court where they overturned it because the jury was improperly instructed. The jury was lead to believe that the defendant could be rendered guilty even if they honestly thought that
their actions were lawful. However, on the basis of fraud, one has to be aware of their wrongdoing before they can be charged as guilty (Perkins Coie). The Enron scandal and its outcomes compelled firms to change the way they do business, so they could no longer succumb to corruption from personal greed resulting in unfair accounting practices. Prosecutor Sean Berkowitz said it best when he stated, ³The jury sent an unmistakable message: You can¶t lie to shareholders. No matter how rich and powerful, you must play by the rules´ ("MSNBC"). The Enron scandal is a supermarket of corporate crime, fraud, and abuse«The first stage for making Enron the great engine for long-overdue structural reform is to document the wrongdoing´ (Nadar 18). The impact of the Enron scandal on businesses and individuals involved are far from over. Individuals are still afraid that another scandal like Enron could occur in the future. This scares workers and they need more protection when working in these kinds of companies now that this scandal has occurred. A reform bill to help companies and its workers has taken place since the scandal and has been impacting the way individuals in Congress vote for certain issues. One individual who was reluctant to sign the bill but eventually did was President George W. Bush. Accounting business processes both in the USA and worldwide, might never be the same after the Enron scandal, but precautions have been taking place to try and prevent another scandal like it in the future. The individuals who were affected the most by the Enron scandal were the workers it brought down with it. One source states, ³The most obvious Enron victims are its employees, who had much of their retirement money vested in Enron¶s now-worthless stock´ (New Republic 7). The workers suffered the most because they were told to stay invested in their stocks, when their managers were selling their own investments in the company. The workers were never
informed that there was inside knowledge corrupting them. ³Not only are executives in a far better position to know when to sell company stock than the workers, but the workers are sometimes prevented from selling their largest stakes in employer securities through lockdowns of their 401(k) plans, such as in the Enron context´ (Stabile 815). Therefore the workers never had a chance to get out of their stocks, when others had information telling them to sell their investments. This is wrong and completely unfair, which emphasizes that Congress needs to protect our workers even more than they are already doing for the future. These changes include, ³changes in accounting principles designed to introduce more rationality into the awarding of option compensation, and outright limits on the acquisition of employer securities by 401(k) plan participants´ (Stabile 831). One way that Congress has helped our workers is by passing a new reform bill. After a few long years of getting signatures together, the bill was finally passed. However, before it was passed President George W. Bush wasn¶t going to sign his name on the bill until he was sure of a few things. ³During 2001, the president specified that a reform bill would have to strengthen parties and preserve individual rights to expression in order to obtain his signature´ (McSweeney 509). Bush wasn¶t going to risk further political embarrassment after having close connections with the Enron case for a while, so he signed the bill. By George Bush signing the bill, he was safe from not being impeached. Therefore Bush agreed to reform, but was not active in supporting it. Republicans liked the new reform bill and most of the individuals who had signed the bill were in fact republican. The Democrats were really confusing about how they voted for this bill. Many democrats voted for the reform bill at first, but then realized that it wouldn¶t help them with raising hard money. They were below Republicans when there was a need for raising hard
money. Later they realized signing the bill didn¶t hurt them at all, so McSweeney states, ³Democratic support of reform appears to be a contradiction of electoral self-interest, which presents a challenge to conventional understandings of congressional behaviour´ (511). Therefore there was a lot of self-interest involved when signing the reform bill and Democrats were trying to hold to their previous commitments. A world wide impact from the Enron scandal was when it had a negative effect on the country Bolivia. ³The Bolivian government sold 50 percent of the equity in the state oil company to various multinational corporations (MNCs), including Enron and Shell´ (Hindery 3). This means that after the scandal, Bolivia lost 50% of their equity in oil to these companies. This was social and environmental impact to the country. Just like America, Bolivia set up reforms to try and boost their economy, as well as deepen their democracy. They are trying to heal their environmental factors through political acts. With individuals having political concern for their country, they believe that it will lead to them wanting to help their country environmentally as well. There is hope for Bolivia in the future to retain the oil costs that were lost in the scandal through political and environmental reassurance to their people, as well as the American people. Therefore the future for Bolivia is looking promising, not only for the country, but for its people as well. It is up to governments worldwide to protect our people and our workers. The reforms have helped to lessen the impacts that have happened from the scandal, but our acts are far from being over with when it comes to helping our countries. Our governments are in charge of keeping wrongdoings from occurring and this will cause our countries to stay strong. We have to stay strong and the impact on our accounting business processes will hopefully not affect them at all. Hopefully one day our companies will go back to being strong, the way they were before the
Enron scandal and our workers back to not being afraid of who they are working for. Once again our workers are the ones who suffered the most from the scandal and it is our government¶s job to make sure that never happens again. No one should have to live in fear and no one should have happen to them what happened to those workers. We are living in a powerful world, which some forget and this makes our world scary at times, but things are looking up for our future. In order to keep growing at this rate, Enron began to borrow money to invest in new projects. However, because this debt would make their earnings look less impressive, Enron began to create partnerships that would allow it to keep debt off of its books. One partnership created by Enron, Chewco Investments allowed Enron to keep $600 million in debt off of the books it showed to the government and to people who own Enron stock. When this debt did not show up in Enron's reports, it made Enron seem much more successful than it actually was. In December 2000, Enron claimed to have tripled its profits in two years. A lot of these deals went sour in the early months of 2001 and that¶s when the stock prices and debt rating imploded. Enron employed unscrupulous and deceptive accountants to cover up the growing losses the company was incurring. Enron began selling assets to independent partnerships. What that did was show positive income when in fact they were part of a risky buy back and certain stipulations that were written in contracts. In 2000-2001 Enron scammed California when they were having an electricity crisis by engaging in sham trading, where top executives from the company were buying and selling services to one another to show a power congestion that did not in fact exist. They made California pay charges so Enron could take care of the fabricated issue. When the truth behind this scandal was uncovered more than 30 people were arrested for the malpractice of Enron and 20 or more were arrested including the
Chairman, President, and Chief Financial Officer for fraud, conspiracy, and other related crimes (Thomas 41). In August 2001, Enron vice president Sharron Watkins sent an anonymous letter to the CEO of Enron, Kenneth Lay, describing accounting methods that she felt could lead Enron to accounting scandals. On October 22nd, the Securities and Exchange Commission (SEC) announced that Enron was under investigation. On November 8th, Enron said that it has overstated earnings for the past four years by $586 million and that it owed over $6 billion in debt by next year. With these announcements, Enron's stock price took a dive. This drop triggered certain agreements with investors that made it necessary for Enron to repay their money immediately. When Enron could not come up with the cash to repay its creditors, it declared for chapter 11 bankruptcy. The Enron Scandal deeply influenced the development of new regulations to improve the reliability of financial reporting, and increased public awareness about the importance of having accounting standards that show the financial reality of companies and the objectivity and independence of auditing firms. One consequence of these events was the passage of Sarbanes± Oxley Act in 2002, as a result of the first admissions of fraudulent behavior made by Enron. The act significantly raises criminal penalties for securities fraud, for destroying, altering or fabricating records in federal investigations or any scheme or attempt to defraud shareholders. The act expanded criminal penalties for destroying, altering, or fabricating records in federal investigations or for any attempt to defraud shareholders. ("SARBANES-OXLEY"). Here is a company that started out with the idea that they can do anything they wanted and not be held accountable for their actions. When Enron first started out in the mid eighties
they were practicing good business under Kenneth Lay. When Skilling came along he implemented business plans that would increase revenue. Lay had no qualms about this, despite the fact that the law had to be broken to incur these increases in income. The two conducted business in this fashion until they retired in 2001. Lay retired first then Skilling, after a few business contracts went sour and stock prices dropped. Even after the two retired they still fell under the scrutiny of the judicial system, except Lay died of natural causes before the courts indicted him. The company tried to regain their global standing but no one wanted to do business with them, their name was tarnished and everybody affiliated with them also received a bad reputation. In 2002 Enron and its new directors were making billion dollar purchases of other heating and electrical companies trying to rebuild the structure of the company. But this proved to be too little too late and the company promptly shut down (Thomas 41). The early years of Enron was an exceptional story of massive financial gains until the layers were peeled back and the truth about the company¶s underhanded dealings was revealed. The public saw a company that began as two independent entities, later to amalgamate themselves into a corporate giant that realized great success. That initial success would be squandered, as irresponsible and unethical management would precipitate illegal and unsavory business deals, leading to the company¶s decline. Here is an example of short-term yields taking precedence over long-term success, and shows how even a company as large and powerful as Enron can quickly crash if managed improperly, and greediness overtakes the managers (Company Overview 41). These events led directly to the creation of The Sarbanes-Oxley Act. The Sarbanes± Oxley Act of 2002, also known as the 'Public Company Accounting Reform and Investor Protection Act' and 'Corporate and Auditing Accountability and Responsibility Act' and
commonly called Sarbanes±Oxley, Sarbox or SOX, is a United States Federal Law enacted on July 30, 2002. It is named after sponsors U.S. Senator Paul Sarbanes and U.S. Representative Michael G. Oxley. The bill was enacted as a reaction to a number of major corporate and accounting scandals including those affecting Enron, WorldCom and other companies. These scandals, which cost investors billions of dollars when the share prices of affected companies collapsed, shook public confidence in the nation's securities markets. ("SARBANES-OXLEY"). After the Sarbanes Oxley act came into force, accounting system and financial statements disclosed by the companies made tremendous progress. This improvement has been possible due to thorough requirements stated in the Sarbanes Oxley act. Due to this upgrade it helps to protect investor confidence in the companies and the US legislature as well. Moreover, it also helps in establishing a public company accounting oversight board, auditor independence, and corporate responsibility and enhanced financial disclosures. ( Murray). The act created new standards for corporate accountability as well as new penalties for acts of wrongdoings. (SOX-online). The act also does audits to check up within the company to see if all financial data is accurate. A variety of complex factors created the conditions and culture in which a series of large corporate frauds occurred during the year of 2002. The highly-publicized frauds at Enron exposed significant problems with conflicts of interest and incentive compensation practices. Enron was in over their heads as soon they started deceiving their customers. A principal agent problem arises when management peruses their own goals, when doing so, lowers the profits for the company. The principal agent problem for Enron was the director¶s willingness to jeopardize their company¶s future by greed and self worth. They would keep doing business to benefit themselves while the actions they were doing it in was pretty close to be untraceable, until
everything turned into an investigation. Then the truth was there to be seen by everyone (Company Overview 41). Even though Enron was a powerful company, the law did not permit them to commit fraudulent acts. In results of the companies actions, the way businesses do accounting has changed both in the US and worldwide. Everything is more closely monitored through The Sarbanes-Oxley Act.
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