Essentials of the Dodd-Frank Act Research Paper
Enron collapsed very quickly in November 2001, and its failure should have been a warning to serious dysfunctions in the entire corporate and financial system, but this did not happen. Its executives admitted that they had falsified its records going back for at least five years, although in reality they had been doing so since the 1980s. When the company filed Chapter 11 bankruptcy it laid off over 20,000 workers and at least $24 billion in pension assets, stocks and mutual funds also vanished (McLean and Elkind 2003). In addition, the Arthur Anderson accounting firm that had been complicit in covering up the fraud and embezzlement at Enron for many years, also went out of business. This catastrophe also demonstrated that Wall Street banks, stock analysts and ratings agencies had either been deceived or allowed themselves to be deceived by Enron when they continually painted a positive picture of the company and its future prospects. Later in the decade, the exact same problem would occur with the banks and investment firms that were marking ‘assets’ of dubious values like subprime mortgages. They also collapsed and ended up receiving trillions in dollars in bailouts from the Congress and the Federal Reserve, which was also yet another indication that Wall Street and corporate America had basically bought the government and both political parties. Enron had certainly done so with donations to politicians of both parties, and was especially close to both George Bush’s, who helped the company obtain the deregulation it desired and billions in government subsidies.
The Criminality of Enron’s Leadership
In Criminology Today, Gene Stephens, predicted that the Internet would make white-collar crimes like those of Enron far more common since the company found it easier to conceal bogus transactions, clients and traders using the new technologies. Advancements in copying technology, instantaneous financial transactions and rampant corruption in the U.S. all facilitated the white-collar crime epidemic (Schmalleger, 2008, p. 508). As Joseph F. Coates asserted “the crimes that have the widest negative effects- in the advanced nations will be increasingly economic and computer based,” including electronic theft and fraud, manipulation and disruption of records, and tampering with security systems (Schmalleger, p. 504). Enron was a house of cards that should have collapsed years before, except that the accountants and analysts who concealed the fraud, and in fact were ordered to do so by their superiors. Its profits were all smoke and mirrors, but Wall Street promoted the company as if it had invented a new business model. None of the analysts and accountants went to prison, unlike Ken Lay, Jeff Skilling and Andrew Fasto, and they all denied any wrongdoing. Cliff Baxter, another executive who had been very close to Skilling, committed suicide after the scandal became public, although his manic depression could also have been a factor. Arthur Anderson had been lying about Enron’s false accounting since 1987, when it already knew that the company was making fictional trades, setting up offshore accounts under the names of persons who did not exist and engaging in dishonest financial reporting (McLean and Elkind 2003). All of these are felonies under federal law, but at Enron they continued for years until the company finally crumbled like the pyramid scheme that it really was.
Ken Lay imagined that his close connections with the Bush family would ensure that Enron never sank, evidently not realizing that the Bushes were quite cunning and ruthless about avoiding all such awkward situations. Bush Senior had always avoided any major questions about his role at the Central Intelligence Agency, for example, or his connections with the oil industry, the Gulf State monarchs, the Iran-Contra scandal or the covert wars in Central America when he was Reagan’s vice president. Lay was a Baptist minister’s son, from a much lower social standing than the Bushes, and had eagerly worked for deregulation of the energy markets during the Reagan years with the goal of becoming rich and powerful (McLean and Elkind 2003). Although the aristocratic Bushes eagerly accepted his donations, they distanced themselves immediately as soon as Enron collapsed. They also denied doing the company any favors, either in Austin or Washington, and the media never seemed to pursue this angle very seriously. As the company sank, Lay and other executives cashed in over $1 billion in stocks and stock options while pretending that Enron was one of the most profitable companies in the world. To cover their fraud and corruption, they attempted to shred all the company records, which is also a crime under federal law (Enron 2005)
Jeff Skilling had been influenced by a book called The Selfish Gene, which was a defense of the Social Darwinism that had made a comeback in the 1980s and 1990s. He was a believer in the survival of the fittest and insisted that human beings were only motivated by money, which was a common view in an America governed by Ronald Reagan and the Bush family (McLean and Elkind 2003). All Enron employees had to accept this aggressive, competitive worldview or they did not remain long at the company. Skilling was also highly insecure, a former nerd who rebranded himself as a corporate executive and global adventurer and frequently proclaimed “I am Enron” (Enron 2005). Even with billions of dollars appearing and disappearing or simply going unaccounted for, Enron could make money in the great bull market of the 1980s and 1990s as long as it kept up an image of tremendous profitability and innovation, and no one checked the books too closely. Ken Lay promised that Enron’s stock prices would double every year, and all the executives engaged in ‘pump and dump’, by which the artificially inflated the value of the stick then sold it off for their personal profit. None of the company’s profits had ever been real, yet the stock values always went up, while Lay and Skilling were “fixated on the stock price” (Enron 2005). Through skilled manipulation, intimidation and bribery, they presented an image of being the ‘smartest guys in the room’.
That image was based completely on lies since all the alleged profits were bogus and the massive losses were concealed by accounting tricks. Enron had huge energy projects all over the world that were actually losing money, although none of these losses were ever reported. It had lost over a billion dollars on a massive power plant in India, for example, for which the Indians had been unable to pay. It bought Portland General in Oregon in order to gain access to the newly deregulated energy market in California, and then lied about the high earnings received from this acquisition (McLean and Elkind 2003). Wall Street analysts generally believed the press releases put out by Lay and Skilling and rarely looked beneath the surface. Enron was also extremely hostile and vindictive towards the few skeptical analysts and arranged to have them fired if they did not praise the company sufficiently. For the most part, though, “never was heard a discouraging word” when it came to Enron, up to the day it went out of business (Enron 2005).
Up until the Dot.com bubble burst in 2000-01, Enron had been treated not only as a star performer but almost like a religious cult that was all-knowing, all-powerful and infallible. In 200, the company’s stock had gone up by 90% and the company announced new strategies for bandwidth trading and even betting on the weather through options. As usual, its executives concealed the fact that it had lost money on these schemes by using accounting tricks like mark-to-market to conjure up ‘profits’ that never existed (McLean and Elkind 2003). By that time, it had concealed at least $30 billion dollars in debt in bogus companies with names like Jedi. LJM, and Raptor. As soon as a few financial analysts and journalists started asking some real questions, however, Enron simply collapsed.
Energy Policy, Lobbying and Corruption
In 2000-08, the energy and natural resource sector spent $304 million on federal elections, 72% of which went to Republican candidates. Of this $141 million came from the oil and gas industry, and overall these industries were the fifth largest contributors to elections, with finance, insurance and real estate (FIRE) always in first place. More importantly, energy and natural resource companies spent $2 billion on lobbying during the same period, and had allies in control of the Energy Task Force chaired by former Halliburton CEO Dick Cheney, as well as the key House and Senate Committees. In George W, Bush, they also had a Texas president whose family had been closely connected to the oil and gas industry for decades, and had himself been head of an independent oil company (Gevi and McNabb, 2009, p. 93). Under these highly favorable circumstances in 2005, the real question is not whether the energy industries were in control of the entire process, since they obviously were at every level, but that Democrats and environmental groups were able to obtain some tax breaks and subsidies for conservation, renewable energy, hybrid vehicles and energy-efficient appliances. Since the bill passed with bipartisan support in both houses of Congress, and was overwhelmingly favorable to the oil, coal and nuclear industries, the Democrats and their allies were only able to obtain some concessions for they allies and interest groups (Sherman, 2009, p. 36).
Under a Republican administration and Congress, any type of energy policy bill is going to be overwhelmingly favorable to the oil, gas, nuclear and goal industries, which direct most of the campaign donations and lobbying efforts to that party. This is simply a matter of public record and not in dispute, although Democrats Senators from oil and coal states like Jay Rockefeller of West Virginia and Mary Landrieu of Louisiana will also fall in line behind the traditional energy industries. No Democratic administration has ever been able to eliminate the subsidies and tax breaks that regularly flow to this sector, or shift the focus of energy policy to greener alternative fuels and renewable energy. In 2009-11, the Obama administration attempted to do so and failed because enough Democrats joined with Republicans to block any such change in policy. At present, the U.S. still imports 58% of its oil and obtains most of its domestic electricity from coal-fired power plants, and the Energy Policy Act of 2005 showed exactly how effective the lobbying efforts by traditional energy companies could be in Congress (Sherman, pp. 37-38). Nothing in the bill was directed at improving the fuel efficiency of automobiles, for example, which would be the single best method known today for reducing oil consumption, while it subsidized offshore drilling and the construction of new coal and nuclear plants. In contrast to the giant oil, coal and nuclear industries, alternative energy companies spent only $3.8 million in federal campaign contributions in 2000-08, or just 1.5% of the total for the entire energy and national resource sector (Gevi and McNabb, p. 93). Given the realities about how Congress really functions, that relatively small amount of money buys them very little influence, and this is reflected in every energy bill that has ever passed.
Widespread Failures in Ethics and Corporate Social Responsibility
Enron has hardly been unique over the last decade, but rather seems to be one of many examples of massive corporate fraud, corruption and lack of social responsibility to employees, consumers, shareholders and the general public. BP presided over the worst oil spill in history, for example, while Tokyo Electric Power Corporation was responsible for one of the worst nuclear disasters in history, both of which also involved considerable deception of the public about the scale of the catastrophes. Fraud and corruption on Wall Street and the mortgage industry resulted in the worst financial meltdown in history, and WorldCom under the leadership of Bernie Ebbers collapsed in one of the worst corporate frauds in history. Over the last decade, public confidence in corporate leadership and the economic system in general has been badly shaken, and with good reason.
In contrast to all these blatant and obvious failures in social responsibility, Corporate Responsibility Magazine listed the Gap as one its 100 best corporate citizens in 2010, with a rank of ninth overall and the best in the retail category. This is based on factors like human rights, philanthropy, environment, employee relations and governance. Gap has been praised by the International Labor Rights Fund, Workers United, the Natural Resources Defense Council and Ethical Trading Initiatives for its ethical social, labor and environmental policies (Gap Social Responsibility Report 11). It sought to build links with unions and environmental organizations, governments, employees, unions and community investment funds. Gap developed new policies of social and environmental awareness designed to “appeal to its young and progressive clientele,” or at least the type of customers it hoped to attract. Perhaps this helped improve its sales in a very difficult economic climate, which rose by 12% in 2010 (Malhortra 2010). In India, Gap received the Personal Advancements, Career Enhancement (PACE) award for improving the promotion and educational opportunities for women in the textile and garment industries. Gap also received the award for World’s Most Ethical Company in the retail sector, and since 2008 (Malhortra 2010).
Gap has always tried to attract a young clientele and the use of child labor and slave labor in industry was highly damaging to its corporate image and brand names, so it responded with new policies of corporate social responsibility that examined its entire supply chain to eliminate the worst abuses. Gap does cancel contracts with manufacturers in the developing world that do not meet the standards of its Code of Conduct and now claims that it no longer employs child or sweatshop labor. This is still common in the developing world, with children as young as five being employed for very low pay to help prevent their families from starving. In 2008 there were over 260 million child laborers in the world, with at least half employed in dangerous conditions (Gap Social Responsibility Report: 34). Gap has a “zero tolerance” policy for child labor, and refused to work with the government of Uzbekistan when it organized children to harvest cotton (Gap Social Responsibility Report: 37). 60% of children in India worked and did not receive adequate educations, and in 2007, the Observer in the UK reported that children as young as ten had been sold into slavery in Indian textile and garment factories that made products for Gap. Gap cancelled contracts with 136 factories in 2006 because of violations of it Code of Conduct, including 42 in China and 31 in India. As of 2010, 22% of Gap’s products were manufactured in China, but the company stated that it had no contracts with sweatshops since 2004 (Malhortra 2010).
Public Demands for Reform and Regulation: Sarbanes-Oxley and Dodd-Frank
In light of Enron’s example and the more recent fraud and corruption among the large banks and investment houses, the main recommendation would be that the provisions of Sarbanes-Oxley and Dodd-Frank be enforced vigorously around the world. Companies that continually lie to public and investors and cover up their true financial condition should be driven out if business and their CEOs and CFOs should face criminal and civil prosecution. With Sarbanes-Oxley, few people really “thought that the tightening of the rules was a bad thing,” although there were frequent complaints about the costs of compliance (Holt 2008). These stricter controls over accounting and auditing practices caused many corporations to delist from U.S. exchanges, yet foreign countries have also been passing their own versions of SOX since 2002 and regulations are certainly going to become even stricter and better enforced because of the recent financial meltdowns in Europe and the United States. In the future, laws and regulations like SOX and Dodd-Frank are going to be the international norm. SOX was correct in forcing CEOs and CFOs to sign all financial reports are certify them as true to the best of their knowledge, even though they may not be familiar with every detail of the transactions of large corporations. On principle, making the boards and the leading executives civilly and criminal liable for all false reporting should act as a deterrent to ethical and legal violations in the future, as long as the law is enforced.
Later in the decade, the exact same problems would occur again with the large Wall Street banks and investment firms that were marking ‘assets’ of dubious values like subprime mortgages. They also collapsed and ended up receiving trillions in dollars in bailouts from the Congress and the Federal Reserve, which was also yet another indication that Wall Street and corporate America had basically bought the government and both political parties. Enron had certainly done so with donations to politicians of both parties, and was especially close to both George Bush’s, who helped the company obtain the deregulation it desired and billions in government subsidies. In the Internet age, white-collar crimes like those of Enron are becoming far more common since the companies find it easier to conceal bogus transactions, clients and traders using the new technologies. This was the type of white-collar crime that the Sarbanes-Oxley Act (SOX) of 2002 was designed to eliminate, while the Dodd-Frank Act was intended to prevent similar financial meltdowns from occurring again. Advancements in copying technology, instantaneous financial transactions and rampant corruption in the U.S. all facilitated the white-collar crime epidemic, and although banks are corporations frequently complain about the new regulations, they are here to stay and will be expanded to the global level in the future. This certainly should happen, although once again whether the news laws and regulations are going to be enforced from the outside or end up being internalized as part of corporate culture is another matter. A great deal of recent evidence indicates that this is simply not occurring in many large organizations, since ethics policies exist only on paper or as a public relations exercise rather than in actual day-to-day practice.
SOX did not prevent the much larger financial collapse of 2008-09, although rampant corruption like the Enron case was indeed a warning sign that all was not well in corporate America or with the legal and regulatory enforcement mechanisms that were already in place. Dodd-Frank created a Financial Stability Oversight Council of all state and federal regulators to better coordinate oversight and enforcement, as well as an Office of Financial Research to collect information on all bank holding companies (Anand 2011). In addition, the new law established a Bureau of Consumer Financial Protection as part of the Federal Reserve, even though Republicans and the financial industry have always opposed this and refused to even allow an agency head to be appointed. This seems like a particularly foolish and shortsighted policy that is bound to increase public suspicion and hostility toward the banks. Moreover, because of all the new rules and regulations “relentless cost management and ongoing productivity gains will be required to offset lost revenues” (Wilson 2011). Although the new prudential rules will take several years to write, they are going to become the global norm for at least a generation, as will the new balances between capital and liquidity. One of the main goals of Dodd-Frank was to restrict liquidity, especially the bogus and fraudulent type found in the bundled subprime mortgages. Although this might cause the economy to contract in the future, it will be more likely to prevent the type of corruption that caused the disasters of the last decade. One of the key problems in all of these cases has been the lack of transparency in reporting and transactions, which is why regulations and standards are going to become much stricter in the future. Boards and senior management will have to adjust to this new reality and ensure that corporations conduct genuine internal reviews and do more than merely pay lip service to ethical standards.
That massive fraud at Enron had continued for so many years without any real auditing, regulation and public scrutiny should have served as an object lesson that something had gone seriously wrong with corporate America. Lay and Skilling eventually went to prison and Congress passed the more stringent Sarbanes-Oxley Act in order to prevent such fraud in the future, but in the end this was not sufficient to prevent the larger collapse that occurred on Wall Street in 2008-09. In that case, the entire global financial system came close to the type of crash that the world had not seen since 1929, and ultimately the fiasco cost the United States trillions of dollars. Enron is a testament to the deregulated, out-of-control capitalism that had been brought back to life in the United States by the Reagan administration. None of this was new in American history, and such massive fraud, corruption and speculative bubbles had all occurred in the past, but evidently every generation needs to learn the same lessons again and again. New regulations like Sarbanes-Oxley and Dodd-Frank have been put in place to prevent a repetition of these scandals, despite considerable resistance from the business community over the costs of implementing the new rules. Such changes were essential in order to restore some semblance of public trust and confidence in corporate capitalism after a decade of scandals. Very few large companies seemed to be living up to even basic standards of ethics and social responsibility, although Gap was an exception. In many ways, though, the criminality of Enron’s leadership has become a symbol of a scandalous era in American history that has a great deal in common with the Gilded Age.
Anand, S. (2011). Essentials of the Dodd-Frank Act. NY: John Wiley.
Enron — The Smartest Guys in the Room (2005). Starring John Beard and Jim Chanos. Directed by Alex Gibney.
Gap Inc. 2007/2008 Social Responsibility Report.
Gevi, L.R. And D.E. McNabb (2001). Energy Policy in the U.S.: Politics, Challenge, and Prospects for Change.
Griffin, J.M. (2009). A Smart Energy Policy: An Economist’s Rx for Balancing Cheap, Clean, and Secure Energy. Yale University Press.
The Importance of Corporate Social Responsibility (2005). The Economist Intelligence Unit.
Holt, M.F. (2008). The Sarbanes-Oxley Act: Costs, Benefits and Business Impacts. CIMA Publishing.
Malhotra, H.B. (2010). “Gap’s Social Responsibility Driving Retail Growth.” The Epoch Times, May 3, 2010.
McLean, B. And P. Elkend. (2003). The Smartest Guys in the Room. Portfolio Hardcover.
Schmalleger, F. (2008). Criminology Today: An Integrative Introduction. Pearson Education, Inc.
Sherman, J. (2009). Oil and Energy Alternatives. ABDO Publishing.
Wilson, G.P. (2011). Managing the New Regulatory Reality: Doing Business under the Dodd-Frank Act. NY: John Wiley.
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