Enron scandal

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ENRON'S SCANDAL

Introduction: after 2002, Enron's scandal was discovered, after that many studies, reports, cases and others were issued to try to know what are the factors leading to this fraud?. This report aims to identify the related factors in this situation, and to give some recommendations to prevent it from happening again.

How did the Scandal (fraud) occur?

ENRON was one of the largest energy corporation across the world, it found a lot of Special Purpose Entities (SPEs) to serve its terrible target. It hadn't owned any stock in these SPEs, just control over by agreements and let the BOD from its men, then, it forced the SPEs to make loans for itself. ENRON recorded these loans as Revenues. Here, the role of Arthur Anderson (AA) was considered. AA served Enron with Attestation services and Consulting services at the same time, and that was a real violation in the Independency Standard. So, AA was participated in this fraud. In 2001, they discover this scandal, and the investors lost their money. AA was liquidated; the interested parties (CEOs, lawyers, Banks) were punished.

Problem Statement:

The Fraud made by ENRON, what went wrong? Who is accountable?

The purpose of the report:

This report aims to identify, discover, surround and put the finger on all parties that had a direct and indirect relationship with Enron, which helped to make this fraud. These factors are mentioned in the following questions:

>> What is Enron? Who is affected?

>> What is the role of the auditor "Arthur Anderson"?

>> How the Enron's consolidated companies (Special Purpose Entities) exploited and employed to make this fraud.

>> What is the role of the banks?

>> How the accounting environment indirectly helped, allowed and permitted to do this situation.

>> How the Securities and Exchange Commission "SEC" and the accounting environment developed and improved to prevent such case again.

>> How this case helped to discover the real facts and circumstances of other corporations.

The relevance of the report:

The report puts a spotlight on how the ordinary person should reasonably, safely invest his savings after studying all factors and risks that might affect his life savings. On the other hand, this report gives the accountants a vision to look at the corporation from all possible sides and faces, by the way, it could support a good criteria for the auditors to deal with their clients.

LITERATURE REVIEW

There are many studies published overall the world to identify, explain, interpret, analyze, discover facts and putting solutions for the dilemma of Enron ( An American energy, commodities, and services company based in Housten, Texas ) that made a big fraud in the world of accounting at 2002. Three of these studies discussed as follow:

[1] The rise and fall of Enron, by William Thomas. April 2002, published in Journal of Accountancy.

This report was written to show the story of Enron and the factors related to this situation that helped Enron's management to achieve their plans. Thomas begins with the rise of Enron and what helped Enron to do this crime then he showed the way of the fraud that tricked the shareholders including the role of the auditor of Enron "Arthur Anderson", after that he mentioned how the American Institute of Certified Public Accountants "AICPA" deals with this problem and what the Securities and Exchange Commission "SEC" stated to prevent this case again. This article issued in the Journal of Accountancy that's specialized in accounting and auditing, so it's not written to public because it mentioned this problem according to standards of accounting and auditing out of the mind of non-accountants.

[2] Enron and Arthur Anderson: the case of the crooked A and the fallen E, by Cunningham and Harries, March 2006, Book: Global Perspectives on Accounting Education.

This report shows the brother relationship between Enron and its auditor Arthur Anderson, that is so strong as you want to talk and report the case of Enron you must consider the factor and the role of Arthur Anderson equally, the writers discussed the story of Enron and how it attracted people to buy its stocks from the all global world, and how Arthur Anderson helped Enron to achieve their fraud. They considered the role of the U.S government and other legal parties and how they treated with this case. Then they discussed the problem in U.S. perspective and how the Financial Accounting Standard Board "FASB" and Generally Accepted Accounting Principles "GAAP" improved and developed to prevent such problem.

[3] Enron: Who's Accountable? by Daniel Kadlec, January 2002.

This report aims to identify and discover the responsible parties of the fraud events and how the accounting theories and standards helped the management of Enron to make this fraud, and the role of the auditor "Arthur Anderson" that played a game with Enron to say to the shareholders: "Game Over". He mentioned the role of the lawyers and attorneys to achieve what the management wants and covered the illegal methods made by Enron and Arthur Anderson.

Theoretical Framework:

1) Variables of the study:

1- Enron's Fraud: (D.V)

Enron is an American corporation based in Houston and Texas that provides energy-trading and utilities. Enron's executives employed accounting practices that falsely inflated the company's revenues, which at the height of the scandal, made the firm become the seventh largest corporation in the US.

2- Enron's Board of Directors (BOD): (I.V)

One of the role of BOD is to select and remunerate the executives. 15 members with more than 15 years of experience in the board of Enron and many of them are members at board in other companies, failed to safeguard Enron's shareholders by allowing executive to make inappropriate transactions, extensive undisclosed off-the books activities and excessive executive compensations.

3- CEOs and other key employees: (I.V)

• Kenneth Lay was Enron's Chief Executive Officer (CEO) since 1985. Lay gave up his position in early 2001 to Jeffrey Skilling, but was re-elected in August 2001 when

Skilling resigned. Under pressures from creditors, Lay resigned in January 2002. Skilling reported that he left due to personal reasons after more than ten years with Enron. Lay and Skilling allegedly played major roles in the bankruptcy, but did not

have a direct impact on the financial reporting and auditing issues.

• Andrew Fastow was Enron’s Chief Financial Officer (CFO) until October 2001, when Lay fired him. Fastow had the reputation of being a money wizard who constructed the complex financial vehicles that drove Enron’s growth. Since 1993, Fastow created SPEs that permitted accounting deceptions. Fastow plead guilty in a plea-bargaining arrangement with his wife, who was also implicated.

• David Delainey was the CEO of the retail and wholesale energy divisions. He plead

guilty to insider trading, for knowingly participating in manipulating reported financial performance.

• Ben Gilsan, Jr. was treasurer of Enron until he was fired in October 2001, for benefiting personally from one of Enron’s complex SPE investments. He was a former accountant with Andersen and played a key role in accounting-related deceptions. He plead guilty to one count of conspiracy related to financial reporting deception.

• Michael Kopper was Fastow’s assistant who was actively and aggressively involved in creating and managing SPEs, and in the accounting deception, along with Ben Gilsan. He plead guilty to a lesser charge and has been cooperating with the government to investigate and prosecute others.

• Richard Causey was the chief accountant working under Fastow. He plead guilty to

crimes related to unfair financial reporting in a plea-bargaining arrangement in exchange for his information in the prosecution of Lay and Skilling.

• Sherron Watkins previously had a senior position at Enron that was eliminated in a

downsizing activity. She was later re-hired and played a major role as the so-called

“whistle blower” who started the downfall. She had worked several years as an accountant for Arthur Andersen and then moved to Enron where she worked for Andrew Fastow for eight years.

• David Duncan, a partner in the Houston office of Andersen, headed the Enron audit

and allegedly orchestrated a document shredding campaign. Arthur Andersen terminated Duncan’s partnership shortly after events became known publicly.

• Joseph Bernardino, managing partner and CEO of Andersen, tried to defend its audit of Enron rather than admitting failures and accepting the consequences.

• Carl Bass, head of the Professional Standards Group at the Houston office of Andersen. Bass advised against the auditors’ accepting certain misleading accounting

practices of Enron, but Joseph Bernardino overruled him because of complaints by

Duncan.

All of these employees made a management collusion to make this scandal.

4- Special Purpose Entities (SPEs): (I.V)

An entity that is created by another company to engage in a limited specific type of business activity, such as owing or leasing real estate. Enron created these entities and owned from 0-20% of them, but Enron required that all of BOD of these entities selected by Enron.

4- Arthur Anderson (AA): (I.V)

Enron's external auditor was Arthur Anderson, which also provided the firm with extensive internal auditing and consulting services. The consulting fees were $27m on accounted for more than 50% of $52m earned by Arthur Anderson for work on Enron. All of that affected the independency of Arthur Anderson when auditing Enron.

5- Enron's Banks: (I.V)

They were deeply involved in the manipulation of its reported and earnings and the balance sheet. The role played by the banks is: the banks had actual knowledge of the wrongful conduct in transactions, and the banks gave substantial assistance to certain of Enron's officers by participating in the structuring abd closing of these inappropriate transactions.

6- Securities and Exchange Commission (SEC): (I.V)

The agency of the US Government with the primary responsibility for regulation of securities markets.The SEC is responsible for for reviewing firms' financial statements and review companies' annual report at least once every three years. However, the annual return of less than 50% of public companies had been reviewed in the previous 3 years at the time of Enron's bankruptcy (at 2002) and no review of Enron's returns had taken place after that of 1997, despite the warning signs.

7- Generally Accepted Accounting Principles (GAAP): (I.V)

Guidelines for the presentation of financial statements in the US. GAAP allowed and permitted corporations that invests in other companies by less than 50% to not include Balance Sheet and Income Statement of these affiliated companies in the corporatin's books directly. Corporation only record a pro-rata amounts, and that helped Enron to hide the truth about money borrowed from these companies by the name of Enron or other affiliated companies.

2) Theoretical Framework Model:

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3) Theoretical Explanation for relationships between variables:

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The BOD selects and remunerates CEOs and other executives and officers. These employees create the SPEs that played a large role in hiding the truth of revenues of Enron which is that, revenues, in fact, are borrowings and debts from these SPEs.

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""2-

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As previously said, AA was Enron's internal and external auditor at the same time, and its consultant. All of that affect and influence the independency of this auditor according to Enron. This interpret the brother relationship between Enron and AA while making the fraud.

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""3-

The banks of Enron helped and gave it the assistance to make the inappropriate transactions.

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""""4-

SEC should review the annual reports and the financial statements of public companies at least once every 3 years, However, the annual return of less than 50% of public companies had been reviewed in the previous 3 years at the time of Enron's bankruptcy (at 2002) and no review of Enron's returns had taken place after that of 1997, despite the warning signs. All of that helped Enron to make fake financial statements, and that tricked the investors of Enron.

""""""

""""5-

GAAP allowed and permitted corporations that invests in other companies by less than 50% to not include Balance Sheet and Income Statement of these affiliated companies in the corporation's books directly. Corporation only record a pro-rata amounts, and that helped Enron to hide the truth about money borrowed from these companies by the name of Enron or other affiliated companies.

Data:

This is more a case study. So, I can't apply the practical side (primary data, questionnaires, population of study, and the sample) upon this study. However, I will apply the theoretical side to deal with this case, by studying and analyzing the previous studies written about this scandal.

After reviewing, studying, and analyzing plenty of studies (secondary data) talked about ENRON and how they made the fraud, I concluded that:

The BOD selects and remunerates CEOs and other executives and officers. These employees create the SPEs that played a large role in hiding the truth of revenues of Enron which is that, revenues, in fact, are borrowings and debts from these SPEs.

As previously said, AA was Enron's internal and external auditor at the same time, and its consultant. All of that affect and influence the independency of this auditor according to Enron. This interpret the brother relationship between Enron and AA while making the fraud.

The banks of Enron helped and gave it the assistance to make the inappropriate transactions.

GAAP allowed and permitted corporations that invests in other companies by less than 50% to not include Balance Sheet and Income Statement of these affiliated companies in the corporation's books directly. Corporation only record a pro-rata amounts, and that helped Enron to hide the truth about money borrowed from these companies by the name of Enron or other affiliated companies.

SEC should review the annual reports and the financial statements of public companies at least once every 3 years, However, the annual return of less than 50% of public companies had been reviewed in the previous 3 years at the time of Enron's bankruptcy (at 2002) and no review of Enron's returns had taken place after that of 1997, despite the warning signs. All of that helped Enron to make fake financial statements, and that tricked the investors of Enron.

Recommendations

So, if we want to prevent this scandal from happening again such as Worldcom and other corporations, we should know how to invest our savings away from these multi risks, by analyzing corporations' financial statements and going beyond the numbers to keep ourselves aware by everything happens in the corporation and around it.

In addition, the government and the responsible parties should adjust, improve, and put new laws, regulations and restrictions on how can the corporation invest and build other companies, and they should make more control on the auditor of the corporation.

CONCLUSION:

After this scandal, many rules and interpretations were issued to prevent this from happening again, in accordance of government and the accounting standards all over the world. These standards centralized about that, a company can control over another firm without owning any stock, and making punishment on the audit firms if they violated the standards.

References:

- Bethany Mclean, September 2004. The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron.

- Brian Cruver, 2002. Anatomy of Greed: The Unshredded Truth from an Enron Insider.

- Cunningham and Harris, March 2006. Enron and Arthur Anderson: the case of the crooked E and the fallen A, [article], from book: Global Perspective on Accounting Education.

- Daniel Kadlec, January 2002. Enron: Who's Accountable, [article].

- Kurt Eichenwald, march 2005. Conspiracy of Fools: A True Story.

- Mimi Swartz, march 2003. Power Failure: The Inside Story of the Collapse of Enron.

- Richard Munson, 2005. From Edison to Enron: The Business of Power and What It Means for the Future of Electricity.

- William Thomas, April 2002. The Rise and Fall of Enron, [article] published in Journal of Accountancy.

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