The Enron scandal is one of the best examples of how corporations can violate their ethical and moral obligations in an effort to remain competitive in the present global economy. This paper provides an analysis of the happenings at Enron and how the company was eventually caught. It tries to explore the level of unethical practices that were perpetuated, whether some of the practices were unethical or others were ethical. The paper also presents the population that was most affected by the scandal as well as who were eventually convicted of the crimes perpetuated by the company. It also presents the efforts that the government is undertaking to ensure that such a scandal does not happen again. The example presented is Sarbanes Oxley and how much it costs the businesses to comply and implement it.
Introduction and background information
Enron traces its roots to a Houston Pipeline company started in 1985 after Internorth and Houston Natural Gas merged. The company experienced massive growth during the Reagan years after the American energy policy underwent wholesale deregulation. The company continued on its upward growth during the Clinton Era. This growth saw the company expand from the pipeline company it had started as to become the renowned energy broker trading in electricity as well as other energy related commodities. Its strategic plan comprised of supplying electricity for resale. This involved locking the fixed prices on the supply contracts it got and then hedging these contracts in the market. By 2000, the company had become the largest company trading in energy across the globe with a total earning of 101 billion dollars realized from its tremendous growth. Its growth strategy at the time was pegged at15 percent every year. The company's move to venture its energy business to online trading was impressive: it created the impression that Wall Street had been specifically started to deal in energy. The company at the time held 1,800 contracts on the online market enabling it to control the entire energy market in the United States. This saw the company's stock trade at 85 dollars per share by year end 2000. Further still, the company had its workers invest in the company's stock with a variety of programs meant to tie the employees' savings and retirement plans with the company's stock (Sterling 2002).
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The company however began diversifying its activities to other areas as the competition in the area of energy trading began to increase. This is seen as one of the disastrous moves made by the company as it saw its earnings diminish. For example, the company's venture into the waster business failed instantaneously, its power plants in Brazil and India largely unprofitable as well as its venture into the broadband sector being an instant burst. This massive diversification by the company is seen as the reason why the company began bleeding; compromising the impressive earnings it had previously enjoyed (Sterling 2002).
Going into the 21st century Enron was largely a giant middleman, with it being referred to as a traditional exchange hybrid. At this level, the company was acting as the middleman between buyers and sellers by entering into contracts with both parties. This allowed it to make a profit on the margins between the buying price and the selling price. This game was being played at a very massive scale with the company playing its cards close to the chest. Apparently, the company was so good at this game that most of the sides that were into contract with Enron did not know what role they were playing in the complex contracts. As it diversified, Enron began to find that making money was not as easy as it were before. In an effort to remedy this, it resulted to using a legion of its employees who it tasked with fashioning what one might call a masking façade. This was in an effort to portray endless profits at the company. In effect this was meant to ensure that Enron remained a healthy and profitable company in the eyes of the investors and the public (Tesfatsion 2010).
Enron was responsible for providing minimal disclosures with regard to its numerous off-the-balance sheet liabilities. This was a strategy designed to fool the investors into put their money into the company without fully realizing the risk they were exposing themselves to since it ensured that the company's financial statements presented a healthy and profitable picture. Just to point to the magnitude of this charade, the company had over 3000 off-the books entities, partnerships, limited liability companies also referred to as Special Purpose Entities (SPEs) and limited partnerships. These entities were designed in a manner that enabled them to absorb Enron's spin off debts and obligations. This enabled the company not to disclose the said debts in its financial statements. The FASB under article 125 held this activity as being legal. Under the FASB, a company does not need to disclose any debt and/or obligations held in an off-the-books entity as long as it does not own over 49 percent of the controlling interest in the said entity. Enron did it part and ensured that it did not hold a controlling interest in any of the entities, after all they had been started for the very reason of taking advantage of this law. This is seen as a failure by the government and regulations bodies to determine just how dangerous and easily manipulated a lax law can be in business (Bauer 2009).
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In effect, these off-the-books entities formed a complex networks. Further still, some of the entities were run by officers of Enron. This acted as a mutually beneficial agreement with the principals benefiting from the commission they earned form purchase of assets that were held by Enron while Enron ensured that debt and obligations were kept of its books and thus maintaining a healthy looking bottom line. Most of the entities had Andrew Fastow, Chief Financial Officer at Enron, as well as his wife who also a senior executive at thee company acting as their principal. The money they earned was so much that some of it was paid to accounts belonging to their two young children. These partnerships effectively enable Enron to be able to transfer from its books assets as well as the associated debt to the off-the-book entity. In this partnership, the outside entity would funds as little as three percent of the venture with Enron providing the initial money to the said investor in most of the situations. To expedite the matter, Enron would further guarantee a bank loan for the entity in order to facilitate for the purchase of the asset by the entities. Most of the times, the banks acquired Enron's stock so as to secure the loan, especially where the asset being purchased was not deemed as sufficient to cover the loan were the entity to fail in clearing it. An accumulated effect of this practices placed the amounts of debts held by Enron in this SPE's by the time it was collapsing as 38 billion dollars even though its balance sheet only indicated a mere 13 billion dollars (Sterling 2002).
The company's off-the-books loans as well as debt management efforts were further complicated by the fact that most of these entities were based in the Cayman Islands. The total corporations in the Cayman were 881 with 700 of these being initially formed in the islands. This practice enabled the company to not only keep most of the debt it had accumulated in its businesses but also to enjoy numerous tax benefits as it was granted tax-free operation in the Caymans. In retrospect, this also allowed the company to also pay very little by way of the federal income taxes between 1997 and its collapse (Petrick & Scherer 2003).
The scandal for the most part included also those companies that Enron had entered into a partnership to provide essential services such as financial services, accounts services (auditing) and legal service. Author Anderson, LLP acted as the company's external auditor and was also a certified public accounts. The accounting practices at Enron were more than questionable. One might claim that Enron pressurize the audit firm into endorsing its financial report as it comprised one of its biggest client. However, moral obligation of any certified public accounts firm lies with the public by ensuring that all financial reporting in above board. Author and Anderson failed in this task (Sterling 2002).
The external legal services at Enron were provided by Vinson and Elkins. The company is guilty of having failed to provide the clients with timely as well as accurate legal services. In so doing, the company's actions delegitimized the stakeholders' role in corporate governance. The financial suppliers such as CitiGroup, J.P. Morgan and Merill Lynch all acted to boost the credit worthiness of Enron. However, even when one of Merill Lynch employees, Olson, pointed at this as being irregular, he was fired. In so doing, it cannot exonerate itself by claiming ignorance in the role it played in the management fraud that took place at Enron. This perpetuated the crony capitalism that only acted to erode the credibility of these firms. Anderson and Enron were also reported as having shredded numerous documents that contained auditing information on the financial state of Enron. The executive of Arthur Anderson, David Duncan was implicated of this action and as a result was fired for having orchestrated the shredding, however, he would later refuse to testify to congress. The document shredded was reported to be up to early January of 2002 (Petrick & Scherer 2003).
In addition to this, the company also practiced mark-market accounting approach. This allowed the company to include profits that were expected to be earned in future to its financial records and earnings. This had the effect of substantial earnings being included into financial records which had no way of being ascertained. In effect, this contributed to the company appearing as being healthier than it actually was. This accounting approach had been approved by the FASB as an accepted standard for the energy trading sector and as such Enron did in fact act within its legal right by choosing to adopt the method. According to the FASB this method provides an insight in the true value of a company comparing the contracts that is holds to the market prices as well as to the fluctuations in prices of the commodity being traded. However, this method remains purely speculative as the future earnings attached to the contracts are subject to market changes. The numbers that are placed on the earnings are as such based purely on assumptions regarding various market factors (Sterling 2002).
How Enron was caught
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Many of the inconsistencies presented by this method of accounting have resulted in complaints from many analysts especially regarding the inclusion of non-cash earnings. These same analysts were also at the forefront of expressing their concerns as the non cash earnings reported in the financial statements at Enron since they were constantly way above the actual revenue that the company was making. Further concerns were also raised regarding the discrepancies that existed between the company's cash flows and margins and the records of earning. The differences are termed as having been phenomenal. The questions raised with this respect was how the company was able to make so much money with the operating margins which were noted as being too low to generate the amounts of revenue indicated. However, this did not deter the investors as the company was constantly meeting its targets and thus its popularity at Wall Street. The skeptics were however right to linger on the issues of the numerous transactions the company reported as having carried out off-the-balance sheet. Many of the people who had rightfully asked some of these questions such as Mr. Chanos and Bethany McClean a Fortune Reporter were often readily dismissed, with claims that their concerns were ungrounded (Sterling 2002).
Olson of Merrill Lynch was once quoted as saying that whenever one questioned how Enron was making so much money, the answer was usually the same "Enron is part of a new economy, u just do not "get it". This is a particularly unethical way of responding to inquiries by ones investors as they need to be confident of how the company conducts its business so as to ensure its sustainability and secure their money. Olson reportedly advised his clients not to invest in the Enron Stock and rightfully so. The logic behind his decision was simple; there is no wisdom in investing in something you have no understanding of. His actions which are ethical in my eyes resulted in him getting fired from Merrill Lynch, denying any link of the firing with the Enron case even though Enron was one of the company's biggest clients. Again another unethical act associated with Enron. Merrill Lynch would also come to be associated with another deal engineered by Andrew Fastow of Enron known as the "wanna buy" a barge deal. In this deal, Merrill Lynch temporarily bought the Barge from Enron which allowed it to inflate its earnings to meet the targeted numbers goals. This in effect means that Merrill Lynch actively participated in the earnings management that was being carried out at Enron (Petrick & Scherer 2003).
The fall of Enron
In August 2000, the price of the Enron stock was at its highest, 90 dollars. Enron's executive who already knew about the state of the company started to offload their stock. However, they continued to encourage their employees, general public and other investors to buy into the stock. The executive claimed that the price of the stock would reach as high as 130 dollars to 140 dollars range. As the executives continued to sell their shares, the price started dropping. Kenneth Lay continued to assure the public to continue buying the stock as it would rebound. As the stock dropped, the more people bought it in anticipation of making some money. This was a big mistake. On October 16, 2001, Enron announced that restatements to the company's statements between the years 1997 and 2000 had been necessary to correct various accounting violations. These restatements reduced the earnings by 23%, 613 million dollars while increasing the liabilities by 628 million dollars and reducing equity by 1.2 billions at the end of 2000. The company claimed that these losses were as a result of investment losses as well as other costs such as the 180 million dollars used to restructure the troubled broadband sector. On November 28, 2001, the news about the million of dollars that Enron had hidden went public which resulted in the stock price falling below one dollar. This led to the bankruptcy of the corporations as well as the dissolution of Arthur Anderson which had been responsible for auditing the company. This scandal presented the biggest audit failure as well as the largest bankruptcy reorganization in the history of America at the time. At the same time Dynergy Inc. pulled out of the proposed acquisition. This saw Enron's credit fall to junk status making it worthless. The company had very small amounts of money it could not run its own operations let alone service it astronomical fines. This resulted in over 11 billion dollars losses to the shareholders of the company's stock with its employees being a majority since they had been forced to buy into the company stock. This initiated the investigation by the Securities and Exchange Commission. Enron's operations in Europe filed for bankruptcy by the end of November in 2001 seeking chapter 11 protection within two days of this (Petrick & Scherer 2003).
Ethics issues regarding Enron Activities
A lot of ethical issues are presented in the manner in which Enron conducted its business. The act of damping stock at a high price by the top management once they realized that the company was going down constitutes an abuse of power. They went further to commit unethical business practices by encouraging the shareholders and employees to increase the portfolio of Enron stock they held promising it would rise while it was apparent it would not. The losses accrued by the shareholders as a result of this were immense. The company also failed the public by not disclosing its actual financial position while failing in it fiduciary duty in that it failed to increase the investors wealth as well as failing to practice sound business practices. The work culture at Enron points to the reward of employees who delivered in financial results no matter what the cost. There was no moral ceiling within the management resulting in a moral cesspool as well as character erosion with such vices as arrogance, dishonesty, cowardice, greed, indifference as well as hypocrisy manifesting itself amongst the top management. Enron's activities infected other stakeholders including the board of directors as well as essential external service providers. All this activities point to the business practices at Enron being unethical (Tesfatsion 2010).
Parties affected by the Enron dealings
The Enron scandal had a debilitating impact on very many cycles of the American business as well as way of life. Its collapse affected populations from all walks of life. Perhaps the greatest losers in this debacle were the company's employees and the individual investors who held the Enron shares at the time the company collapsed. By false fully presenting information about the company that was far from the entire truth, the company ensured that the company remained to be seen as profitable and healthy. This only led to more investors buying on the cash because of the stability it represented. It was not only outside investors but also the internal investors as we have seen that the employees' savings and retirement packages were tied into the company's stock. The most unethical thing that happened was the sale of stock by the top executives when they realized that the company was about to collapse. They therefore managed to damp the worthless stock on to the market for a high fee. Investors were only glad to increase their portfolio with a well performing stock; little did they know that this was going to result in a financial disaster. Once the company collapsed, the top executives were left with their millions intact with the poor investor holding to millions of worthless stock and no way for the employees to secure their future with non existing retirement and savings plans. The shareholders were reported to have lost 74 billion dollars in the four year period before the company went bankrupt with between 40 billion dollars and 45 billion dollars in losses being attributed to fraud. Because of its massive debts, the employees and shareholders only received a severance from the company. The company also attempted to clear some of its debts by selling assets which included logo signs, photographs, art and its pipelines. A suit filed by more than 20,000 former employees of Enron passed. They were awarded 3,100 dollars each. The following year investors in the company also received 4.2 billion dollars. Again, in 2008, shareholders were awarded 7.2 billion dollars in compensation (Petrick & Scherer 2003).
The government was also compromised by this scandal as the Enron had been able to use its influence on lobbying and campaigns to push for deregulation by the government. This acted only to ensure limited liability for the company as well as minimal to almost non-existent requirements on reporting which only resulted in the stakeholders ending up as victims. The government included. The powerful private interests of the company were as such able to prevail above the interests of the public which the government is sworn to protect. In effect the public is now more skeptical about the ability the government has at protecting it from business abuse of power. Credibility of the regulatory standards that were in force at the time of the scandal came into question which acted to pressure the government to reviewed various legislature and laws governing reporting as well as acceptable business practices (Petrick & Scherer 2003).
Through its immensely strong hold on the energy trading sector as well as its unscrupulous business practices which enabled it to lock out most of the competition from the sector, Enron managed to elevate itself to the position of a monopoly. This enabled it to dictate the pricing of energy resources around the country. The main losers of these actions were the consumers, who were forced to dig deeper into their pockets so as to afford the inflated commodity prices. This effect was mainly felt in the west coast and its alternative markets as a result of unfair deprivations of those markets due to the price gouging (Petrick & Scherer 2003).
Fastow and Lea, his wife, both pleaded guilty to the charges that were brought against them. The initial charges for Fastow were 98 counts of fraud, insider trading money laundering, and conspiracy among other. Fastow was however sentenced for ten years in prison with no parole on two charges of conspiracy as a pleas bargain for offering to testify against, Skilling, Lay and Causey. His wife had six felony counts leveled against her but was only sentences for one year fro a single misdemeanor charge fro helping Fastow to hide income from the federal government. For their role in the Enron Scandal, Skilling and Lay went on trial in January 2006.in total they were charge with 53 counts on a 65-page indictment which comprised of numerous financial crimes: bank fraud, securities fraud, money laundering, wire fraud, releasing false statements to the auditors and banks, conspiracy and insider trading. The verdict for the case of Skilling and Lay returned in May 2006. Of the 28 counts of wire fraud and security fraud, Skilling was convicted on 19 and acquitted on the other nine which included the insider trading charges. He was sentences to prison for 24 years and 4 months. On his Part, Lay pleaded that he was innocent and had only been misled by other in the company claiming that Fastow was responsible for the Enron's collapse. Lay faced a total of 45 years in prison for six counts of wire and securities fraud. However, he died before he could be sentenced on July 6 2006. The Security Exchange Commission was also seeking 90 million dollars from him in addition to the civil fines. His wife who sold half a million shares an hour or so before the company announced its collapse however was not charged with any Enron-related event (Bauer 2009).
Other players who were tried included: Kopper who was one of the first executive from Enron to plead guilty; Rick Causey, Chief Accountant Officer, who was charged with six felony counts for concealing the financial state of Enron. He pleaded not guilty but later pleaded guilty after which he was sentenced to prison for seven years. In total, sixteen people pleaded to having been guilty of the crimes committed by Enron with another five who included four former employees of Merrill Lynch being found guilty. Eight former executives at Enron testified in the cases with the Fastow and Kenneth Rice, chief of high-speed internet Unit as Enron being key witness. Rice's testimony helped to convict Lay and Skilling. He was sentenced to 27 months in prison (Bauer 2009).
In addition to Enron, Arthur Anderson was also found guilty as it had shredded numerous documents, deleted e-mails as well as other files that contained financial information from the audits it had conducted on Enron. Although this case was later reversed, the company had already lost most of its clients as well as having been barred from public company auditing. The firm was eventually closed with 85,000 of people losing their jobs. Greenwich NatWest was also affected with three of its employees, David Bermingham, Gary Mulgrew and Giles Darby, all Britons, all sentenced to 37 months in prison.
The Senate Committee overseeing Banking, Urban Affairs, and Housing as well as the House Committee on Financial Services held numerous hearings between 2001 December and 2002 April regarding Enron's collapse as well as the associated investor protection and investor issues. These hearings and the Enron Scandals are what led to the passage of the Sarbanes-Oxley Act. In essence this act presents a mirror image of what Enron was. The corporate governance failures that occurred at Enron were matched point for point and provided for in the Act's principle provisions. Sarbanes Oxley is a federal law that was passed in the United States in 2002. The aim of this law was to protect the public against any major corporate accounting scandal as witness at Enron that could result in the loss of billions of dollars of investors' money if the worth of the share value in the stock market was to drop. The official name of this law is the Public Company Accounting Reform and Investor Protection Act of 2002. The bill was sponsored by Senator Paul Sarbanes as well as Representative Michael G. Oxley. That is where it derives its name from. The two also helped in the bills preparation (Bauer 2009).
Sarbanes Oxley mainly established legislation for all public company boards as well as public accounting firms in America that is wide-ranging. Some of the highlights include the establishment of the Public Company Accounting Oversight Board which is a government/public agency. The law also requires that all public companies should evaluate as well as disclose opening their financial reporting. It also creates the need for the Chief Financial Officer as well as the Chief Executive Officer to certify financial reports for public companies. It provides for the independence of the auditor. Companies listed on stock exchanges are required to have in place audit committees that are totally independent so as to offer oversight over the company and its auditor. It also provides for companies to provide additional financial disclosures in a more transparent and comprehensive manner. It prohibits the company from offering loans to its executive employees. In addition, the criminal penalties for violation of securities fraud laws were added with civil penalties increased as well (Bauer 2009).
The implementation of the Sarbox law involved various enhancements which means that both small and large public companies in the country have to make extensive changes in the way they report the business's earnings, how auditing is conducted as well as improve the transparency of financial decisions made. Sarbox implementation has proved to be a daunting task. This is true for both large and small companies, with some of the small public companies actually opting to go private instead so as to avoid the costs of implementation. These extensive changes to the structures of financial reporting although costly to the company, ultimately holds benefits for the investors. In addition, the company is more likely to increase the faith of the investors in the company when it implements the law. This is also likely to add value to the company (Bauer 2009).
The need for legislation in large corporations is apparent to most executives as well as investors. The cost of implementation has been a big thorn with this respect. The biggest cost is usually derived from the information systems update so as to comply with the standards and minimum requirements under Sarbanes Oxley on reporting and financial control. On average large corporate entities report an initial cost of compliance as 4.36 million dollars. This statistics are derived from the Financial Executives International Survey conducted on 217 companies that have annual average revenue of over 5 billion dollars. The costs of implementation in the first year are expected to be the highest with this cost (time and money) becoming increasingly less as the company becomes more adept at implementing Sarbanes Oxley (Bauer 2009).
The scandal at Enron revealed just how vulnerable investors, shareholders as well as the public is vulnerable to exploitation if and where there are no appropriate standards and regulations governing corporate business practices. Enron revealed that even when corporations have good intentions the act of corporate governance to ensure transparency and ethical business practices is better left to an independent oversight body to bridge the gap between the company's interests and that of the public. Enron several mistakes in the way it diversified in an effort to leverage its revenue. However it major mistake is the manner it choose to handle the debt it accumulated from the losses it was incurring in its diversification efforts. An independent oversight body would have prevented against this. The case also forced the government to take note and implement some measures to ensure such a thing does not occur again. One of the measures is the passing of the Sarbanes Osley Act that is meant to regulate all companies operating in the private domain.