Term Paper on "Enron Sham and Shame"

Term Paper 11 pages (3249 words) Sources: 9 Style: APA

[EXCERPT] . . . .

Enron

SHAM and SHAME

The Impact of the Enron Scandal

The Story of Enron

Enron began as an intestate pipeline company from a merger of Houston Natural Gas and InterNorth of Omaha (Canadian Broadcasting Company 2006). The former chief executive officer of Houston Natural Gas, Kenneth Lay, became the merger's CEO and later its chairman of the board. From a regulated natural gas company, it ventured into new fields and eventually became one of the world's biggest energy businesses. In 1999,. Enron opened its broadband services and Enron Online, its website for trading commodities. Ninety percent of its overall income came from businesses conducted through the website. Business was swift. The following year, its annual revenue was $100 billion. It became the seventh-biggest company in the Fortune 500 list and the world's sixth largest energy company (Canadian Broadcasting Company).

The downfall was as swift as the growth. In only a year after its steep climb, CEO Jeffrey Skilling, announced he was leaving his post after occupying it for only six months (Canadian Broadcasting Corporation 2006). Ken Lay took over. In October 2001, the company reported a $618 million loss in its first quarter in four years. Then chief financial officer Andrew Fastow was replaced. The string of events prompted the U.S. Securities and Exchange Commission to investigate the partnerships led by Fastow. The investigation eventually led to the discovery of a complex network of partnerships intended to hide company debt. In late November, 2001, company stock cost less than $1. It was clear that investors had lost billions of dollars on the company. Enron filed for bankruptcy on December 2 that year and became the most notorious bankruptcy case in America. More than half a million employees lost their jobs. Ken Lay resigned as chairman and CEO. In January 2004, Fastow pleaded guilty to conspiracy to commit wire fraud and conspiracy to commit securities fraud. He agreed to plea bargain and to cooperate with prosecutors. That February, Skilling pleaded not guilty to 40 charges. The charges included wire fraud, securities fraud, conspiracy, insider trading and false statement in financial reports. In July, Lay was accused of fraud and making misleading statements but pleased not guilty to 11 of the charges. Prosecutors charged that Lay and Skilling used "accounting tricks, fiction, trickery, misleading statements, half-truths, omissions and outright lies" to commit the crimes. On May 25, the jury found Lay guilty of all counts and Skilling, of 19 (Canadian Broadcasting Corporation).

According to its annual report to investors, Enron's aim was to create value and opportunity by combining financial resources, access to physical commodities, and market knowledge in order to create innovative solutions to challenging industrial problems (Weinrich 2002). The business leaped when it changed focus from brokering domestic energy to water, international brokerage of energy and broadband transmission of communications. In order to maintain the looks of profitability and stock price, the company had to resort to sham operations. These activities were intended to keep debt and risk from getting reflected in financial statements and to create a palatable but false income. Its November 8, 2001 Form 8-K filing revealed the company's failure to consolidate three special-purpose entities or SPEs. This was to achieve off-balance sheet of assets and liabilities to prevent them from appearing on transferor's financial statements. Enron had around 500 of these SPEs and thousands of dubious partnerships. Enron's executives were said to have large personal interests in them and received large gains from them (Weinrich).

When informed about violating generally accepted accounting principles or GAAP, Enron announced it would restate financial statements for the previous 4 and a half years (Weinrich 2002). The restatement would eliminate around $1.2 billion stockholders' equity and approximately $569 million of the previously reported income. In reaction, rating agencies reduced Enron's long-term debts below investment grade. Dynegy cancelled its agreement with Enron. On December 2, 2001, Enron filed for bankruptcy protection. Congressman John Dingell of the House Energy and Commerce Committee said that Enron pulled all the way from the seventh rank at Fortune 400 to a penny stock in three weeks. For years, he said Enron lied about its true financial shape (Weinrich).

Enron employed accounting gimmicks to raise its P/E ratio to more than 50 in 2001 (Weinrich 2006). These included allowing it to establish SPEs and to shift liabilities; remove large amounts of debts between Enron and these SPEs; omitting many of these fraudulent transactions from financial statements as related-party transactions; paying millions of dollars as audit and consulting fees to auditors and, thus, affecting their independence; and hiding these transactions for the benefit of insiders rather than stockholders and creditors (Weinrich).

Impact

Widespread Call for an Ethics and Compliance Audit System

The Enron scandal caught and gripped global attention. In response, massive efforts to recapture public trust and confidence were expended by install truly strict regulatory and corporate policies (Verschoor 2004). The U.S. Sarbanes-Oxley Act of 2002 and the U.S. Sentencing Guidelines, which called for an effective corporate ethics program, were among these efforts. International entities, such as the World Bank and the Organization for Economic Cooperation and Development or OECD recommended governance principles, which included ethics in management and ethical relationships with employees. The International Standards for the Professional Practice of Internal Auditing required internal auditors to perform a wide range of audits and examinations. These included the effectiveness of an organization's internal controls, its code of conduct system and compliance to confidential reporting of ethical and legal violations, if any. They also emphasized the importance of integrity and ethical values to internal auditors. An ethics and compliance system audit would seek out "behavior vs. standards gap" from top management downward. It would determine if and how far behaviors, which demonstrated the organization's core values, were communicated and modeled in all levels. Depending on the corporate structure, assessment could be done using internal auditing setup; ethical features; ethics and compliance programs; information from interviews, surveys and focus groups; and personnel practices (Verschoor).

Effect on Healthcare

Radical changes of accounting and auditing standards, disclosure requirements, auditor independence, and the cost and complexity of healthcare audits, could very likely rattle the relationship between independent auditors and their clients (Clarke 2002). The basic need is for all financial managers to provide stakeholders with useful, timely and accurate financial and operation information. The Health Finance Managers Association suggested certain considerations in meeting this need. A full disclosure by providers to stakeholders of this information was required on a regular basis to insure and retain better understanding and trust. The information must be consistent over time and useful according to the purpose of the data. Providers and users must cooperate and consider the costs of preparing reports. And they should respect the confidentiality of individual patient data and competitive management data at all times (Clarke).

Securities Regulation

Massive changes in the accounting profession also developed in response to the Enron scandal (Carroll 2002). These centered mostly on the composition and role of audit committees, auditor independence, and a new regulatory system to oversee the accounting profession. The New York Stock Exchange Corporate Accountability and Listing Standards Committee recommended the increase of accountability, integrity and transparency of listed companies. The most recent study recommended granting audit committees the sole authority to hire, retain or fire an independent auditor. It also required audit committees to direct the independent auditor in preparing annual reports. These annual reports would describe the auditor's internal quality control procedures, materials raised during peer review or governmental investigations. They would also assess auditor independence and all the relationships between him and the company (Carroll).

Auditors of public companies now confront new restrictions on their consulting functions and other arrangements with audit clients (Carroll 2002). Legislative, regulatory and judicial proceedings would clarify the degree and form of restrictions. But they generally encourage State regulatory boards and professional groups to limit the role of attorney CPAs. Conflicts that could arise if an auditor acted as consults to a public company would be different if he provided multiple, non-audit services to private businesses and in an economical and ethical way (Carroll).Recent studies pointed to questionable methodology used by auditors in evaluating a company's internal controls. Another study also inquired into the reasons for independent auditors' issuing unqualified audit opinions to companies, which later declared bankruptcy. These queries prompted for reforms beyond the structure of the accounting profession. They demanded tightening the system itself and offered the accounting profession a chance to correct its wrongs, which could account for the torrent of scandals within the profession (Carroll).

Lawyers' Ethics

Lawyers were among those implicated in the Enron fiasco and other consequent fiascoes (Lawry 2003). Enron's outside lawyers were named as defendants to a lawsuit in Texas, which sought to recover investor losses. The Sarbanes-Oxley Act legislation was partly aimed at lawyers. And as a result of this Act, two new sets of rules were drafted by the Securities and Exchange Commission to raise lawyers' standards in order to protect the public from corporate… READ MORE

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