Impact of the Enron Scandal on Accounting Standards

Abstract

Every company and its manager must maximize shareholder profits while also adhering to the regulations, avoiding principal-agent conflict of interests, as well as increasing the credibility of their companies. In practice ethically, it’s not just about giving out a huge amount of money to charity, but being aware of and taking action on ethical issues that could arise before they turn into legal problems are more crucial aspects worth managing. Enron fell apart as a result of unprofessional management practices, such as the denial of tax payments and accounting fraud. It is believed that the Enron incident is possibly the largest corporate failure that has occurred in the United States since the failure of several banks that were savings and loans during the 1980s. This crisis demonstrates the need for a thorough examination of the ethical aspects of the corporate culture in general and business organizations within the United States. Businesses must embed integrity and ethics into their corporate culture and also into their definitions of success. Business practices that were illegal and unethical at Enron caused the formation of the Sarbanes — Oxley Act of 2002. The report will analyze and expose untruthful and illegal activities impacting stakeholders and lessons learned from the Enron case.

The Enron Scandal and Ethical Issues

Enron Corporation is an energy trading natural gas, energy trading, and electric utilities firm based in Houston, Texas that had approximately 21,000 employees at the time of mid-2001, when it was declared into bankruptcy. The revenue is earned in 2000 was over $100 billion. It was rated as “America’s most innovative corporations” for the past six years” by Fortune. Enron was a business that was able to make a profit through the provision of fuel to utility companies and other businesses at a fair market price. Enron was classified as the 7th largest corporation of the United States and had supremacy in trading communications power, weather, and securities (Corporate Narc and 2nd).

On the surface, Enron looks like a great corporate citizen and has every aspect of CSR (CSR) as well as business ethics instruments available in the community (Sims and Brinkmann 2003). But, the scandal that erupted at Enron is the biggest ever corporate scandal and has become the symbol of well-planned and institutionalized corporate fraud. The Enron scandal is a result of the use of illegal and unethical practices.

As per Carroll Buchholtz and Buchholtz (2008) The CFO Jeffrey Skilling and the CEO Ken Lay played major roles in the Enron scandal. Both were guilty of fraud with securities and conspired to boost profits. The debts disguised by Enron, Lay and Skilling employed off-the-books partnerships after they admitted that “they lie to employees and investors about the company’s dire financial condition while also selling shares of their own company” (Carroll and Buchholtz 2008, page. 254). The top management of Enron has broken several accounting laws, SPE laws and has manipulated accounting rules in order to satisfy their own demands of making money in the short-term, but not considering the long-term implications for shareholders, investors, and employees, as well as the business itself. The close connections which were established between senior executives, as well as directorships, became overly confident, believing they had no limit and leading them to behave in a non-moral way. Enron let Andrew Fastow, the Chief Financial Officer, oversee the two SPEs (special purposes entities) which were in fact associated with Enron and also gave him the chance to abuse his position.

Enron also put certain of its debt in the balance sheets in its SPVs and hid it from investors and analysts. The extent of its debt load was discovered, the company’s credit rating plummeted and creditors demanded urgent repayment that was hundreds of million dollars of debt (Sims and Brinkmann 2003). It is a sign that Enron’s management decision-makers saw the shuffle of debt more in terms of timing, rather than an ethical decision. They maintained that the business was financially stable and that most of the problems they had uncovered actually weren’t that grave even though they knew the truth and made financial decisions to safeguard their personal gain.

The discussion on the Enron scandal could be complete without a discussion about the involvement of the accountants at Enron as well as the firm Arthur Andersen. Arthur Andersen was one of several causes of the Enron collapse, when they caused conflicts of interests between the two roles that they played by Enron as auditors, and also as a consultant. Andrew Fastow, the Chief Financial Officer of Enron was a major force in negotiating deals in which he was interested in both sides of the transaction. Through his involvement in these agreements, he placed his financial lust over the accountability of his job as the head of the company. Based on Paul as well as Palepu (2003) In 2000 Arthur Andersen earned $25 million in audit fees and $27 million in consultation fees. This amount represented about 27 percent of the audit costs of clients who were public clients for Arthur Andersen’s Houston office. The audit methods used by the auditors were questioned for having been conducted solely for the annual fee or due to their lack of experience when it came to reviewing Enron’s revenue recognition procedures, derivatives, special entities, and other accounting methods. Due to the relationship Enron was able to establish in common with Arthur Andersen, it was simply too easy for Enron as well as the firm that was accounting for it to collaborate to cover financial deficits and debt. Andersen was also accountable for certain bookkeeping tasks for Enron’s internal accounting Some of Andersen’s employees ultimately departed to join Enron. The outcome is that a lot of the losses Enron suffered were not reported within its accounts. In November of 2001 Enron revised its financial statement for the preceding five years in order to record $586 million of losses (Corporate Narc and 3rd).

Following a string of scandals that involved sloppy accounting practices that bordered on fraud, involving Enron along with its company’s accountant Arthur Andersen, it stood close to undergoing the biggest bankruptcy in its history at the beginning of November 2001. Because Enron was regarded as a blue-chip stock it was a rare and catastrophic event in the world of finance. Enron’s fall came about following the revelation that the bulk of its earnings and revenue came as a result of agreements with special purposes entities (Corporate Narc and as well as nd).

The executives of Enron did not acknowledge, but later dismissed serious issues regarding their business operations and were more focused on their personal financial benefits over those of the company. The company’s stock price started to fall when the issues were made public the company was in the process of transitioning from one investment plan to another.

Impacts on Stakeholders

Every business is bound by a moral obligation to help its customers regardless of whether they’re customers, business partners, or stockholders. The bankruptcy of Enron has hurt a number of stakeholders, including banks, stockholders, and former employees customers as well as communities, suppliers as well as communities, and the United States.

Impacts on Employees

The first and the most significant thing that the Enron scandal caused was the situation at work. Carroll and Buchholtz (2008) stated they believed that “when Enron went bankrupt and after that when the Arthur Andersen accounting firm went out of business in 2002, employees were dislocated and severely adversely” (p. 47). The financial crisis of Enron caused thousands of employees to lose their jobs, left thousands of employees working for the failed businessman, and “left 5600 employees unemployed and facing retirement without nest eggs to save” (Carroll and Buchholtz, 2008, page. 254). A lot of employees had their entire pensions invested in Enron shares. Kenneth Lay advised employees to keep their Enron shares when the company was in the midst of a collapse and sold its own. Even though employees were not able to sell their shares, Lay and other executives were selling off a lot of parts of the stock. The savings and lives of a lot of employees were destroyed. They were also denied the option of diversifying their portfolios for retirement and had to stand in awe as their retirement savings dwindled while top management swung into their profitable stock options.

Impacts on Investors and Stockholders

Due to the Enron scandal, individuals and institutional investors suffered huge losses due to misinformation about the company’s financial performance because of accounting practices that were suspect as well as all shareholders lost the money they invested in the company after it was declared bankrupt. Shareholders lost more than $11 billion in the event that Enron’s share price, which was at the high of US$90 per share at the mid-2000 point dropped to below $1 at the close in November (Answers.com in 2010). Investors who suffered cannot be made completely new again following the tragic events at Enron.

Impacts on the United States and Communities

Political parties, like those of the Bush administration, took donations from Enron and were putting themselves in situations where they had to return the money to Enron or make them available to charity. Enron also impacted its impact on the United States in several important ways. If there is anything positive to be stated concerning this Enron scandal, it’s that it raised the consciousness of how important integrity is in Accounting and in business generally and led to the creation of new security measures to ensure that this kind of thing does never happen again, or at the very least not in the full magnitude of Enron harm.

Enron deliberately and shrewdly created the fake California electricity crisis that occurred between 1999 and 2000. Between 30 and fifty percent of California’s energy business was shut by Enron for a large portion of the time. up to 76 % at one time and Enron drove the cost of electricity up to nine-fold (Corporate Narc, 2nd).

Impacts on Other Stakeholders

It is also important to note that the Enron scandal also caused harm to other parties. For instance, Enron’s top managers pressured Arthur Andersen to certify maximum-risk accounting practices that were questionable in order to preserve their consulting business. in submitting to the demands, Arthur Andersen won huge contracts in the short term but eventually lost their credibility as a professional and their client base. Certain investment banks, like Citigroup, J.P. Morgan as well as Merrill Lynch made over $200 million in fees through deals that aid Enron and other energy companies to increase cash flow and conceal debt. In addition, by not exercising their own sufficient due diligence they increased the damage done to the other participants. Citigroup along with JP Morgan Chase in particular was seen to have a significant amount to lose due to the collapse of Enron.

Punishment

A large number of disgruntled employees, as well as investors and others, were eager to learn what punishments will be handed to those who concealed the truth about Enron’s financial situation and so effectively for the past several years. Three individuals who participated in the numerous frauds committed at the hands of Enron comprised the ex CEO and president of Enron, Jeffrey Skilling; the former chief financial officer who was responsible for LJM, Andrew Fastow; chairman, founder, and CEO Kenneth Lay. In 2002, at first Enron’s former chief finance chief, Andrew Fastow, and three other former and present Enron executives exercised the Fifth Amendment right not to be a witness at a congressional hearing. Fastow was accused of fraudulent wire transactions, securities money laundering, fraud by mail, and conspiracy. It was alleged that Fastow and his associates came up with a scheme to fraudulently defraud Enron and the shareholders of its company (Cbsnews.com 2006). Fastow along with his spouse Lea Fastow and nine other former executives were charged with 31 additional charges as well as 98 counts of fraud. They were also charged with numerous fraud in the form of insider trading, fraud, and other charges (Associated Press 2006). Andrew Fastow pleaded guilty to two charges of conspiracy. The plea was for 10 years in prison and help in pursuing ex-top Enron executive Kenneth Lay and Jeffrey Skilling. Lea Fastow pleaded guilty to making false tax returns. In the month of March 2006, Fastow was already guilty of tax fraud and could face up to 10 years in jail for two charges of conspiracy.

Lay and Skilling were convicted of their roles within The Enron scandal that occurred in the month of January of 2006 in Houston. Skilling was accused of 31 charges ranging from fraud to lying auditors, for allegedly lying about the financial condition of Enron. Lay was convicted of seven charges of conspiracy and fraud for allegedly instigating the scheme. Following six hours of deliberations on May 25, 2006, the jury reached a verdict at the Houston trial of former Enron chiefs Kenneth Lay and Jeffrey Skilling. Skilling was found guilty of 19 of the 28 charges of wire and securities fraud and cleared of the remaining nine counts, which included the charges of insider trading making him the top former executive with the demise of Enron. The sentence was 24 years, four months of prison time for his involvement as a part of one the most significant corporation scandals to occur in U.S. history (Cbsnews.com, 2006). Lay was found guilty of all six charges against him, which included the conspiracy to commit securities fraud and wire fraud, and was sentenced to as long as 45 years in prison. But, prior to sentencing being set, Lay died on July 5, 2006, due to an attack of the heart (Answers.com in 2010).

Lessons learned from the Enron Case

In the present economic environment world, the Enron scandal has been a moral lesson. The Enron scandal will teach executives as well as members of the American general public some of the essential ethical lessons. The primary lesson is that organizations and individuals or businesses should only earn money through the provision of products or services that are of real value in today’s economy. Additionally, executives who earn excessively may think they’re above the rules and could be enticed by the opportunity to take ethical shortcuts in order to keep their wealth and privileges. All companies must demonstrate that they have removed all off-book accounts that can alter the public’s perception regarding the health and financial condition of their organization and should also pledge the company will never violate the firm’s code of conduct or at the very least, report to the public if they do. To stop a similar scandal to Enron There must be oversight of executives and managers when they make their own business judgments regarding what is best in the interest of an organization.

Kirk Hanson (2002), executive director of the Markkula Center for Applied Ethics said that the Enron scandal “demonstrates the need for major changes in the accounting system and governance of corporate entities across the United States, as well as a closer look at the ethical standards of the business culture broadly and business corporations across the United States”. Because of the accounting frauds that took place during the Enron scandal, a number of accounting firms must reorganize their employees to remain loyal to ethical guidelines set by the SEC. In order to avoid a similar scandal to that of Enron, it is necessary to provide supervision of executives and managers who make their own judgments regarding what is best in the interests of an organization. However, when accounting firms are shifting to cut off both the services of auditing and consulting for their consulting business and consulting businesses, the SEC is likely to establish additional disclosure rules. Rules and regulations from the government have to be revised for the current economic climate, but not loosened and removed.

Conclusion

Examining the Enron scandal from a retrospective view of history, the majority of the issues faced by Enron resulted from the morally questionable and unprofessional actions taken by its board in an attempt to make personal gains. The Enron scandal has impacted the lives of every person in America and perhaps even more crucially, it forced all of us to examine ourselves and see the consequences of greedy and reckless behavior as well as the breaking of laws on an arbitrary basis. The majority of people and companies were being punished in the right way and lessons on their importance.

Translate »
Need Help? Chat with us