I. The Company Overview
Enron was founded originally as a natural gas pipeline company in Houston, Texas in 1985 and quickly expanded into creating a market for itself - the energy trade. Their business included many long term risky investments that had no short term revenues, which lead the company to create special purpose entities (SPE’s) to spread the risk of these investments. Although this spread of risk was in itself not illegal, the way the SPE’s were created and ultimately managed was. To create these illegal SPE’s, Enron used the 3% rule (EITF 90-15), which states that 3% of subsidiary’s startup capital must come from an outside investor; Enron actually received this outside investment from managers in Enron or their wives.
Enron’s auditor has also been accused of conducting business in an unethical manner in its attempt to retain the loyalty of Enron executives. Current laws and SEC regulations allow firms like Arthur Andersen to provided consulting services to a company and then turn around and provide the audited report about the financial results of these consulting activities; therefore making an “independent audit” by Arthur Andersen independent in name only.
Our legal system allows companies like Enron to manage their own employee pension funds, producing a conflict of interest because the company has an incentive to use these funds in ways that benefit the company even when they negatively affect employees. Most companies also have codes of ethics that prohibit managers and executives from getting involved in another business. The managers and executives are faced with a conflict of interest because they have a duty to act in the best interest of the company and its shareholders.
Enron’s top level management violated several accounting laws, SPE laws, and bent the accounting rules to satisfy their own desires to profit in the short term, completely ignoring long term repercussions for investors, stockholders, employees and the business itself. When Enron corrected these problems in their financial statements, they restated with a loss of $609 million, Wall Street devalued their equity by $1.2 billion, and less than a month later filed for bankruptcy.
Most of the problems faced by Enron derive from the immoral and unethical actions taken on by the board of directors in their attempt to achieve personal profits. In order to prevent these unethical acts from re-occurring among other organizations, there needs to be an emphasis on the integrity of executives. Due to accounting frauds of organizations such as Enron, the SEC has begun to take significant steps in preventing loopholes within the accounting and financial disclosure system by enacting the Sarbanes-Oxley bill. Due to the accounting frauds that occurred in the Enron scandal, several accounting firms have begun reorganizing their employees towards remaining loyal to the ethical standards demanded by the SEC. In order for companies to prevent an Enron-like scandal, there needs to be supervision over managers and executives as they exercise their own business judgments about what is in the best interest for an organization.
II.1 Accounting Firm and Partners Involved
It was the job of Andersen Consulting, one of the nation’s top five recognized accounting firms, to ensure the accuracy and reliability of the financial statements of Enron so that creditors and investors could make good financial decisions. However, it is now Andersen that is under investigation for illegal and unethical accounting practices which places both companies, Andersen and Enron, in the spotlight in the largest account fraud cases at the time. Enron hired Andersen, the reputable accounting firm, , to conduct corporate financial audits. Enron was one of Andersen’s largest accounts, and also a major business partner to Enron as they sold...