Whistle-blower and subsequent investigation
Enron was a Texas-Based Energy Company; Arthur Andersen one of America’s preeminent Accounting Firms. Enron was a very successful corporation: employing over 20,000 people, claming 2000 revenues of slightly over $100, and named “America’s Most Innovative Company” by Forbes magazine for over 5 years running. However, because of an internal whistle-blower and subsequent investigation, the United States government found that the reported fiscal conditions of Enron (and validated by Andersen) was sustained by creative and planned accounting fraud. Both Enron and Andersen knew their numbers were reported incorrectly, showing profit where none existed, returns on investments that had never been made, improper tax burden reporting, and willful fraud when reporting financials to Wall Street and investors. By 2001, both companies filed for bankruptcy protection, Enron emerging with considerably less in terms of assets and employees, Andersen closing completely. The idea of the “Enron” scandal has become, in American popular culture, a symbol of corporate greed and dishonesty in accounting (Bryce, 2002).
Enron’s downfall, caused in part by the accounting treatment of a series of partnerships and ventures affiliated with the Houston energy trader, has thrown thousands of employees out of work and has cost the company’s pensioners and investors billions of dollars in stock value losses. Some of our political and economic leaders have tried to portray the Enron collapse as a problem limited to one company and certain individuals. Yet Enron’s bankruptcy — the largest in U.S. history — is symptomatic of deep structural flaws in our system, a system that needs a major overhaul rather than mere tinkering.
Enron’s inception took place in July 1985 when Houston Natural Gas merged with InterNorth, a natural gas company based in Omaha, NE. Kenneth Lay, formerly CEO of Houston Natural Gas, became the now-named Enron’s first Chairman and CEO in February 1986. This deal combined several pipeline systems, which established the first nationwide natural gas pipeline system. As early as 1987, Enron realizes that oil traders in New York have overextended the company’s accounts by almost $1 billion. In 1988, Enron seizes the opportunity to expand overseas in England due to the privatization of the power industry in that country. A major shift takes place, at this juncture, to pursue unregulated markets in addition to the regulated pipeline business. In 1989, Jeffrey Skilling joins the team of Enron executives. He initiates the Gas Bank program. Under this program, buyers of natural gas can lock in long-term supplies at pre-determined set prices. In December 1996, Skilling is elected president and Chief Operating Officer and continues his role as Chairman and CEO of Enron Capital & Trade Resources (McLean and Elkind, 2003).
Enron was a new-economy company, which was a market maker for energy trading. It ranked as the most innovative company in America four years in a row, as judged by envious corporate peers in the annual Fortune magazine poll. When Enron began, natural gas and electricity were produced, transmitted and sold by state-regulated monopolies, which were often quite inefficient. Enron used Wall Street magic to transform energy supplies into financial instruments that could be traded online like stocks and bonds. These contracts guaranteed customers a steady supply at a predictable price. By bringing the laws of supply and demand into the energy system it provided a new way of doing business for energy customers (Seeger, 2003).
Problems began with Enron’s idea that if it could trade energy — actually trade anything, anywhere, in the new virtual marketplace: television advertising time, insurance risk, high-speed data transmission, newsprint — anything that could have value once turned into an asset on the books. In each of these cases, the virtual commodity became a contract, called a derivative, and was sold on the investment market. Enron poured billions into these trading ventures; some failed, most succeeded, as long as the true nature of the mechanism was kept hidden from the public and regulators (Rapoport, 2009).
To keep its mystique alive and its stock price growing, Enron set up a web of partnerships where it could bury its losses, or generate imaginary revenues. One of the more audacious examples, pieced together by the Wall Street Journal, showed that Enron invested money in a joint venture with Blockbuster to rent movies online. The deal flopped eight months later, but in the meantime, Enron had secretly set up a partnership with a Canadian bank. The bank essentially lent Enron $115 million in exchange for Enron’s profits from the movie venture over its first 10 years. The Blockbuster deal never made a penny, but Enron counted the Canadian loan profit (Prentice, 2008).
Unfortunately, Enron’s success story is nothing but an elaborate scam. Simply put, profits were inflated and debts were concealed as special purpose entities, which didn’t show up on the balance sheet. Disclosures in Enron’s filings with the Securities and Exchange Commission revealed that three previously unconsolidated special purpose entities should have been consolidated in Enron’s financial statements based on the Generally Accepted Accounting Principles. (GAAP). Disclosure of the three SPE partnerships is what brought about the collapse of Enron. By creating these entities, Enron was able to capitalize on and draw capital from banks, insurance companies, pension funds, and individuals. Since much of the debt was off balance sheet, Enron was able to protect its credit rating. Unfortunately, however, at least three of Enron’s SPE’s did not meet the test of the GAAP to be accounted for as unconsolidated entities. Thus, the results had to be reconsolidate into Enron’s financial statements. Instead, these debts were off balance sheet transactions; therefore, the company’s true financial debt would not be realized until it was too late to recoup losses (Conroy and Emerson, 2006).
One of the major unethical practices took place when over half of the employees pension was tied up in the company’s own stock. This left the employee investors unable to sell their stock, which had plummeted in value once news of the company’s financial debt emerged. In addition to the hidden liabilities, company management, aware of the accounting discrepancies, sold their stock while stock price was elevated, most likely insider trading, unethical in and of itself. This reeks of insider trading, which is an ethical issue in and of itself.
Perhaps in an attempt to cover her own reputation, Sherron Watkins, Enron Vice President confronted Kenneth Lay in a lengthy letter outlining the numerous improprieties in which the company was engaged. She even went so far as to implicate Donald Duncan, Arthur Andersen’s Enron auditor, in the scheme. Jeffrey Skilling, President and COO, resigned in February 2001. Andrew Fastow, Enron’s CFO from May 1998 through October 2001, is credited with Enron’s “innovative” financial dealings. Fastow, beginning in 1997, began using off balance sheet SPE’s to increase capital and hide the mounting company debt (Kulik, 2005).
Enron, like numerous other companies, bought access. However, most of what Washington contributed to the glory of Enron it did in plain sight. Politicians demonized government regulation, and methodically dismantled the safeguards set up in previous downturns to protect both the market and smaller investors. They promoted the cult of stock-market speculation, even calling for Social Security funds to be fed to Wall Street. They cut taxes and all but stopped auditing tax return, allowing some to indicate that Enron’s $6 million in campaign donations probably paid a better return on investment than some of its speculations (Prentice).
In light of the above, why did the firm’s independent auditor, Arthur Anderson, not raise alarm at this shell game? The purpose of an auditor is to look, at the interest of the shareholders, independent from the board and management. By this definition Arthur Andersen clearly failed. They not only looked away from protecting the interest of shareholders they also helped Enron pull off their scam. The firm now faces hundreds of millions of dollars in civil damage claims, a criminal indictment for obstruction of justice, and its own downfall as an independent entity as clients, partners, employees and whole practices in Europe, Japan and elsewhere leave the firm. The criminal proceedings for obstruction of justice come from the shredding by Andersen officials of thousands of documents pertaining to Enron accounts, after these had been subpoenaed in several investigations. It seems, however, that the attempts to cover up a crime lead to costlier consequences than the original crime itself (Grey, 2003).
After the Securities and Exchange Commission launched its investigation, Andersen executives tried to blame their Houston office led by former partner David Duncan. The indictment also alleges that Andersen told executives and partners to destroy as many incriminating documents as possible. It is baffling that Anderson, a reputable firm with a pristine image, could ethical violate so many regulations, not only by omission, but also by actively setting up some of the dummy accounts and corporations (Swartz and Watkins, 2003).
The immensity and complexity of the Enron scandal was almost beyond explanation, and when charted shows an almost pandemic burst of chaos theory. Because of this complexity, the number of individuals only partially involved, and the tremendous amount of money generated at all levels, it was difficult to uncover just how complex the situation was:
Figure 1 — Relationship Map of Participants in Enron Scandal
(Source: University of Pennsylvania Course, “Networked Life,” Cited in: www.cis.upenn.edu/…/nwlife06.html)
One can not begin to trace the various lines and connections of the myriad of relationships, but the chart does fulfill the purpose of showing how much of a web this situation involved.
In the wake of the Enron scandal many questions have arisen centering on the strength of the U.S. Economy. Investors have questioned the accounting practices of many other firms; there has been significant fallout on the financial market; and considerable negative consequences in the market, the economy, the investment paradigm, and public confidence. All this contributed to a decline in the strength of the American economy, and certainly also had global repercussions.
The increased skepticism about accounting practices has forced many multi-national corporations all over the world to defend their financial statements. This loss of investor confidence has lead to significant changes in accounting standards and auditing practices. Corporate executives are now being required to be accountable to both their stakeholders and the government for actions taken on behalf of their organizations. Clearly, though, the “smartest guys in the room,” Enron’s management team, were brilliant — for awhile, yet their actions continue to have lasting effects upon the U.S. And global fiscal markets (Rapoport; McLean and Elkind).
Bryce, Robert, (2002), Pipe Dreams: Greed, Ego, and the Death of Enron,
Public Affair Press.
Conroy, S. And T. Emerson. (2006). “Changing Ethical Attitudes: The Case of the Enron and ImClone Scandals.” Social Science Quarterly.
Grey, C. (2003). “The Real World of Enron’s Auditors.” Organization.
Kulik, B. (2005). “Agency Theory, Reasoning, and Culture and Enron: In Search
Of a Solution.” Journal of Business Ethics. 59(4): 1573-697.
McLean, Bethany & Peter Elkind, (2003), Smartest Guys in the Room: The Amazing
Rise and Scandalous Fall of Enron, Portfolio Press.
Prentice, R. (2008). “Enron: A Brief Behavioral Autopsy.” American Business Law
Journal. 40(2): 417-44.
Rapoport, N., et.al. (2009). Enron and Other Corporate Fiascos: The Corporate
Scandal Reader, 2nd ed. Foundation Press.
Seeger, M.W. (2003). “Explaining Enron.” Management Communications Quarterly.
Swartz, Mimi and Sherron Watkins, (2003), Power Failure: The Inside Story of the Collapse of Enron, Doubleday.
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