Enron Case Analysis

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What are the three most important improvements in the governance structure that could result from Enron from SOX? The Enron collapse has been on the failure of the corporate governance structure: that boards of directors did not do their jobs; that auditors did not do their jobs; that regulators did not do their jobs. Hence the improvements below could result from Enron from SOX. 1)_ Changes in the Audit Process.

The most detailed regulatory change is the new accounting regulatory system that federalizes most accounting supervision. The Public Company Accounting Oversight Board will have broad powers to set standards for accounting firms and to investigate and bring disciplinary proceedings against such firms. The legislation also regulates directly how the accounting function is performed. It limits contemporaneous consulting services performed by firms auditing public companies, and it requires registered public accounting firms to rotate their lead and review partners. This regulation of the auditing function also dips into corporate governance in that it requires auditors to report directly to the audit committee of the board, not to company management, and provides for the audit committee to be directly responsible for the appointment, compensation, and oversight of the work of the auditors. The Act requires directors who are audit committee members to be independent.

2)_ Changes in Internal Corporate Governance Structure.
Sarbox includes several explicit intrusions into state corporate law’s structure of corporate governance. In addition to the requirement that the audit committee of the board be independent, as discussed above, the Act also prohibits personal loans to executives; requires the company’s chief executive officer (CEO) and chief financial officer (CFO) to reimburse the issuer for bonuses and related compensation or profits in stock sales if the company is required to restate its earnings; and requires elaborate rules requiring company counsel to report evidence of material violations of securities law or breaches of fiduciary duty. The Act also imposes a prohibition on insider trades during a blackout period when the beneficiaries of a company’s pension fund cannot trade, striking at practices that occurred in the Enron context.

3)_ Additional Disclosure. The Act provides for additional disclosure, long the mainstay of federal law in this area. For example, the SEC is commanded to issue rules for disclosure relating to off-balance sheet transactions and pro-forma figures, and Section 16 disclosures are enhanced. Some disclosures are simply disguised substance. One provision requires the company to disclose “whether or not, and if not, the reason therefor, such issuer has adopted a code of ethics for senior financial officers.” Similarly, another provision requires an issuer to disclose “whether or not, and if not, the reasons therefor, the audit committee is comprised of at least 1 member who is a financial expert.” Both are likely to have much the same impact in changing corporate governance as if a state corporation code or a stock exchange listing requirement was changed to require such a governance structure.

1. What is wrong with Enron’s bank financing transactions they knew were without economic substance? “Asset light” strategy—monetizing or syndicating assets beyond Enron itself. The substance of the Enron strategy was a financial or paper hedge, not an economic one. It was a paper hedge designed to achieve favorable financial statement results, not a substantive hedge that was intended actually to transfer Enron’s risk of loss to an unrelated [third] party.” Enron’s investments in the bubble economy of the 1990s had produced substantial gains that its managers sought to protect against subsequent fluctuations in the market. Enron sought to protect itself against the volatility of various investments that it held, and it engaged in various transactions with counter parties (the...
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