Black Out Periods And The Sarbanes Oxley Act Accounting Essay

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Who Suckered Who (Executive Summary). The subsequent paper will discuss the Sarbanes-Oxley Act and how it specifically pertains to the Enron case and their organization. The former public traded company that was once valued at over 60 billion dollars and became one of the quickest and largest firms on Wall Street suffered an even quicker downfall by monopolizing the system and breaking laws. This paper will examine an act that was passed based almost solely on the illegal transactions that transpired during the Enron era. It highlights the importance of the Sarbanes Oxley Act, its importance in this case and defines what this act means for present and future companies. While Enron was certainly not the first company to manipulate funds or lack business ethics, their unique situation gave Congress the necessary fuel to enact this new law. This act, as well as the Enron case set new precedents legally and ethically and has changed the scope of Wall Street.

This essay also emphasizes black out days, an important aspect of the Enron case that provided evidence to their immoral business behavior in addition to more support of implementing the Sarbanes Oxley Act. Blackout days involve a period of time where an employee or stakeholder cannot obtain loans, distribute funds or transfer and/or diversify assets for more than three consecutive business days. During this period, these options are suspended, limited or restricted. If a company needs to access these options during this period, they must give notice written in plain English in a timely manner to the issuer of any employer securities. Even though blackout dates existed prior to Enron, the Sarbanes Oxley Act of 2002 revised the rules and new restrictions were "Enron-Driven."

The paper below will also discuss Enron's scandalous behavior and several of the many laws that were broken that created the Sarbanes Oxley Act as well as how other companies and stakeholders will benefit from the act. It will also explain that although many will say lack of ethics do not necessarily mean breaking laws, the revisions in the Sarbanes Oxley Act were set in place due to the immoral actions of Enron executives and their stakeholders. In fact, the Act suggests that its execution was due in part to fighting "legal" but immoral actions.

Finally, the paper will conclude with the penalties that a one would face should they violate any of the rules in the Sarbanes Oxley Act. It also draws attention to ways to protect oneself should they become aware of a person or company violating the Act. It stresses how Enron's downfall set new legal precedents and sets an example of what not do both legally and professionally.

Meet the Crooks (Situational Analysis)

At the time of its collapse, Enron made history as the largest and most infamous bankruptcy in American history. This was of course before the collapse of WorldCom and Leman Brothers, and its failure was directly responsible for the creation of the Sarbanes Oxley Act, GAAP (Generally Accepted Accounting Principles) and the establishment of the PCAOB (Public Corporation Accounting Oversight Board). Enron was so much at fault for the establishment of these regulations that the Sarbanes Oxley Act reads nearly identically as a prohibition to each now unlawful action taken by Enron's executives. Overnight, the collapse of Enron destroyed thousands of pensions, investments and retirement funds. The impact was so severe that stakeholders were still being compensated as late as December 2009. In 2001, key Executives of Enron, an extremely powerful and influential energy corporation and affiliated accounting and financial firms were found guilty of corporate fraud, obstruction of justice, falsification of documents, embezzlement and insider trading.

The edifice of Enron's demise began in 1992 when Jeff Skilling the President and COO of Enron convinced Federal regulators to let Enron use an accounting method called "mark to market" which allowed them to grossly inflate their accounting figures. With the assistance of accounting firm Arthur Anderson which now Accenture, Enron was able to tacitly conceal their losses by implementing a variety of unscrupulous accounting practices. Andy Fastow created 3000 special interest holding corporations, which he used to conceal Enron's losses, implemented distribution of corporate equity disguised as loans and employed complex anonymity practices which included failing to produce balance sheets with earning statements. An example includes the materializing of the California energy crisis, where Enron intentionally created the illusion of an energy shortage which they used to drive prices upward. Another example is when in 1999, Enron sold Merrill Lynch a $7 million stake in three energy-generating barges in Nigeria. Enron disguised the sale as a loan, yet reported it as a $12 million profit. As a result of such practices Enron's stock price grew steadily and by early August 2001 the price was over $90 per share. The SEC announced that they were going to investigate Enron and by August 15, 2001, the stock price had fallen down to $42 per share, $15 by the end of October and closed at $0.60 per share in late November before a bankruptcy filing on December 2, 2001.

Ken Lay, Enron's CFO continued to perpetuate the image of a profitable company to the public and Enron's shareholders even as the company already suffered $102 million in losses. Meanwhile, Lay had sold $90 million dollars worth of stock, former Enron executive Paula Rieker unloaded $1 million dollars worth and CEO Jeffery Skilling sold off 400,000 shares then announced his resignation.

A total of sixteen people pleaded guilty in the Enron case, this includes four former Merrill Lynch employees. Kenneth Lay was indicted on 11 counts of securities and wire fraud and found guilty of 10. He faced 45 years in prison, however on July 5, 2006 four months before his sentencing Lay died of a heart attack; he was facing over $90 million in fines to the SEC.

Over 20,000 former Enron employees won $85 million in a class actions suit against the company which amounted to approximately $3,100 each. This victory was paltry as it accounted for less than 5% of the over $2 billion in losses they incurred. However the following year they received another $4.2 billion and in September 2008, they received an additional $7.2-billion which was distributed among an additional 1.5 million former shareholders.

Andy Fastow pleaded guilty to all charges brought against him. Initially he was charged with 98 counts of fraud, insider trading, conspiracy and money laundering among other crimes. As a result of a plea bargain deal where he testified against Lay and Skilling, he was sentenced to ten years in prison with no parole.

As a result of shredding thousands of documents and deleting untold amounts of emails and other digital files, former accounting firm Arthur Andersen was found guilty of obstruction of justice. This ruling was later overturned by the U.S. Supreme Court, but the damage had already been done. Andersen lost most of its clients, became barred from offering auditing services. The firm closed its doors and 85,000 workers became instantly unemployed.

What Went Wrong (Analysis of relevant legal and ethical issues)

During the time of the Enron scandal, it was not considered insider trading or unlawful for CEOs or relevant management to dump their stock during blackout periods. A blackout period is identified as such when three consecutive business days go by during which 50% or more of the company employees are subject to frozen pension funds or they are or not able to obtain loans or distributions (SEC Adopts Rules). At this time, executives were not held liable if they opted to not stick through a recovery period for which the blackout periods are intended.  

 

The period of time that was detrimental to Enron employees which fueled the creation of new legislation was from October 29th of 2000 to October 23rd of 2001 when the employees of Enron were not allowed to sell their sinking stock from their 401(k) plans (Welytok, 29). However, during this time, Enron executives knew the stock price would continue to tumble due to their own fraudulent calculations of inflationary profit numbers and therefore took it as an opportunity to sell off their company stock while everyone else suffered the losses.  As previously stated, however unethical as this was it was not illegal. 

 

In 2002, the Sarbanes-Oxley Act was created. The law aims to avoid the loss of life savings by employees who invest in the company they work for, which was the case for Enron staff, where about 63% of the average employee had investments that were parked in the Enron Corporation (Welytok, 29). As part of its many provisions, the Act details specific rules regarding company "black-out" periods, when employees are not able to sell their shares of company stock. (Grill) More specifically, a blackout period can be defined as "the time during which a participant's ability to direct or diversify plan assets, obtain plan loans or receive distributions is temporarily suspended, limited or restricted for more than three consecutive business days" (Kautter).  

In Section 306, the Sarbanes-Oxley Act prohibits executives from selling stock during these blackout periods. During the Enron scandal, when employees were unable to sell their shares as the stock price plummeted, but senior executives were. This resulted in many employees' 401k's being wiped out. Furthermore, Section 306 always requires that companies give their employees 30-days notice prior to a blackout period, or face $100 per participant for every day of a blackout period (Grill). 

 

It is important to understand that these blackout periods are, in most cases, completely legal. They usually occur when there are administrative changes in the 401k department. The problem in the Enron case is that while the blackout period was normal in nature and length, it came at a very bad time, as the company was struggling and head executives were aware that things were only going to get worse. Legal action can be taken in these situation if it is deemed that Enron executives did not act with their employees' best interests in mind when issuing the blackout period (Marchiz). 

Class action suits followed on the behalf of Enron employees. These suits were filed against Enron officials, Enron's accountant Arthur Andersen, and Northern Trust, the 401k plan's administrator ("Enron 401(k) Litigation").

Retribution (Recommendations & Conclusions)

Future companies must learn from the mistakes made by Enron through the use of risk management precautions. Since the time of the Enron scandal, legislation has passed that give companies clearer guidelines to follow and incentives to act accordingly. Clearly, one of the most important steps companies must take is to ahdere to the Sarbanes-Oxley Act, Section 306, when figuring out how to handle blackout periods. Executives must refrain from trading during blackout periods, and must give proper warning to employees when these periods are approaching.

A great deal of the demise of Enron was attributed to many people turning a blind eye to obviously flawed financial records. A major issue addressed in the Sarbanes Oxley Act was preventing such conscious avoidance. CEO's and CFO must sign off on all financial statements and letters that are issued to the public.

There was also the issue of concealment, non disclosure, alteration and outright destruction of documents which is an obstruction of justice. Such actions are now penalized by fines and 10 to 20 years of prison time. No longer can a corporation's accounting firm provide any other services than accounting to said corporation, as to prevent a conflict of interest. Most importantly the corporate organization has been completely restructured restructured. The board of directors must consist of a majority of independent members. The board must hold meetings independent of those with the executives. The compensation, audit and nominating committees must consist entirely of independent directors. Lastly the auditors must report directly to the audit committee and not the officers and directors.

Beyond blackout periods, however, Sarbanes-Oxley also requires the Federal Sentencing Commission to detect ways for companies to improve ethical culture. Companies would be well-advised to follow these guidelines, such as:

- Instill a code of ethics

- Train employees in the code and in ethics, in general

- A means for employees to report misconduct (ex: hotline)

- Follow-up on reports of misconduct submitted by employees

- Action by the board on complaints

- Self-reporting and investigation on ethical and legal issues

- Sanctions and terminations for those who violate the law and company rules

- A high-ranking officer to be in charge of applying the code of ethics

(Jennings, 61)

Sources: 

"Enron 401(k) Litigation". JPMorgan Chase. 04/10/2010 <http://159.53.60.165/cm/cs?pagename=JPM_redesign/JPM_Content_C/Generic_Detail_Page_Template&cid=1159307685433&c=JPM_Content_C>. 

 

Grill, Bennet. "Sarbanes-Oxley for Entrepreneurs". Gaebler. 04/10/2010 <http://www.gaebler.com/The-Sarbanes-Oxley-Act-Title-III-Blackout-Periods.htm>. 

Honig, Stephen; Morris, Duane. Rights and Responsibilities of Public Employers, Executives and Lawyers After Sarbanes-Oxley. 

Kautter, David. "DOL issues Enron-driven "blackout" rules.". The Free Library. 04/10/2010 <http://www.thefreelibrary.com/DOL+issues+Enron-driven+%22blackout%22+rules-a096555837>. 

 

Machiz, Mark. "PRESERVING PENSIONS". PBS. 04/10/2010 <http://www.pbs.org/newshour/forum/march02/enron5.html>.

SEC Adopts Rules on Provisions of Sarbanes-Oxley Act: Washington, D.C., January 15, 2003.

Welytok, Jill. Sarbanes-Oxley for Dummies. Wiley Publishing, 2008.

Jennings, Marianne. BUSINESS: Its Legal, Ethical, and Global Environment. Mason, Ohio: Cengage Learning, 2008. 

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