Corporate Scandals Surrounding the Turn of 21st Century

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Corporate scandals surrounding the turn of 21st century,
creation of The Sarbanes and Oxley Act of 2002 and its effects on business environment.

The opening years of the twenty-first century were very challenging to the US economy. Not only the stock market reached one of the lowest levels since the crisis of 1930, but also several high profile corporate scandals shook the public trust. Insider trading, fraudulent financial reporting and other illegal practices caused investors to question reliability and integrity of the publically traded companies. Every week brought different news on misrepresentations at major American corporations and financial institutions. As soon as the report of accounting fraud at Enron reached public, media revealed similar scandals at WorldCom, Tyco and number of other publically traded companies. Improper revenue recognition, incorrectly recorded expenses, and other practices to manipulate financial statements along with briberies to auditors for covering the fraud caused the biggest concern. Investors could no longer rely on financial data presented by the management of those companies. Also auditors lost their reputation as they failed to perform an independent audit of the companies involved in the scandal. Arthur Andersen, the biggest Accounting firm at the time, is the best example of how lack of professional skepticism, ethics and integrity can literally destroy an accounting firm. In response to those issues, the congress took an action, and in 2002 Sarbanes and Oxley Act was passed. In July that year, the president George W. Bush signed the act and called it “the most far-reaching reform of American business practices since the time of Franklin Delano Roosevelt.” The reforms benefit the American economy in many ways, including restored investor confidence in the integrity of the capital markets, enhanced corporate disclosures, more regulated and strict accounting and auditing standards, increased emphasis on business ethics, and reduced incentives for corporate management to manipulate stock prices. Among all the corporate scandals of early 2000’s, Enron bankruptcy followed by the collapse of its auditing firm Arthur Andersen was named one of the largest scandals in business history. Enron’s origins dated back to 1985 when Houston Natural Gas merged with InterNorth. Around that time Kenneth Lay became the CEO of Enron, and shortly after he took the position of a chairman. By the early 1990’s Enron became one of the world’s largest pulp and paper, gas, electricity, and communication companies. It was also named one of America’s most innovative firms and best employers. Enron experienced very rapid growth and by the year 2000 its revenues reached $100 billion and its stock was valued at $90 per share. Enron became sixth largest energy company in the world and seventh largest company on the Fortune 500. It employed more than 21,000 people in over 40 countries. However, there were some serious problems behind what appeared to be a roaring success. The rapid financial growth of Enron was mostly financed through borrowing. Already in 1990’s the company was in debt and completely dependent on borrowing. In order to maintain the company’s high credit ranking, the CFO Andrew Fastow began searching for alternative ways to raise money. He decided to use Special Purpose Entities (SPE), which were technically independent limited liability companies, to enter into complex transactions and manipulate accounting records. In fact, SPE’s were fully controlled by Enron and used to finance company’s expansion. The biggest issue, however, was that those SPE investments were not included in Enron’s balance sheet. Enron owned most of subsidiary corporation or partnership, but as long as outsiders had voting control and owned at least 3% of equity capital, those SPE’s could be accounted for separately from Enron’s financial statements. The company’s credit ranking and stock price remained high, as the...
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