Enron Fraud Scandal

The Enron scandal is a series of actions that resulted in the bankruptcy of Enron Corporation, energy, and Commodity Corporation, incorporated in the United States in general terms. The Enron scandal was considered among the largest bankruptcy filing cases in American history. It engendered debates on the need to formulate practices to ascertain sustainable results in the financial and accounting world, including universal accounting standards. Accordingly, this paper will discuss the Enron fraud scandal concerning ethical corporate governance and the Sabine Oxley Act of 2002.

Overview of the company

Enron Corporation was established by Kenneth Lay in 1985, and it included a union of two corporations, InterNorth and Houston Natural Gas (Connell, 2017). The company lost its rights to trade in natural gas after deregulating the natural gas industry in the 1990s. However, Jeffrey Skilling mainly transformed the company. Initially, Enron Corporation traded mainly with derivative contracts; this meant it acted as a midway between the consumers and natural gas producers. This form of trading permitted producers and manufacturers to manage risks of energy price variations by fixing selling prices through Enron’s free negotiated contracts. The company started generating substantial profits under the leadership of Skilling. Besides, he slowly changed the company’s culture to focus mainly on aggressive trading. His hires were top MBA graduates with adequate management skills. Last but not least, he transformed the working environment into a more competitive environment that angered closing several profitable trades within the shortest period possible.

Enron scandal

The end of the boom years resulted in a fall in the competitiveness and profitability of Enron Corporation. The company's Stakeholders pressure the executives to engage in accounting malpractices. A procedure referred to as "mark-to-market accounting" was used to hide the company's flaws (Bondarenko, 2020). The technique allowed the accountants to write future gains on the current profit statements, hence creating higher profitability. Moreover, the troubled operations were transferred to SPEs (special purpose entities) that are corporations signed with external organizations.  Even though SPE was an avenue for despising assets, Enron misused the practice by using SPE to dump only bad assets. The practice allowed the company to realize fewer losses in the income statements.

In 2001, suspicious analysts began digging into the company's public statements. Following a memo from Enron's Vice president, an internal investigation was initiated. Soon, the Security and Exchange Commission also took up the matter to analyze transactions between Enron and Fastow (Bondarenko, 2020). The company filed a Chapter 11 bankruptcy protection in December. Most of the executives were accused of several charges and were later imprisoned. Besides, other shareholders filed several lawsuits against Enron. The scandal led to debates on the efficiency of the company's corporate governance. Also, legislation on the effectiveness of publicly traded companies' financial reporting was established.  Most importantly, the Sarbanes-Oxley Act (2002) described harsh penalties for manipulating financial records. The act also outlawed audition firms form conduction simultaneous consulting business with a similar company.

Corporate governance in relation to the scandal

Corporate governance is the core of sustainable business operations. Corporate governance mainly involves business directing rather than control. It has become the center and lead of academic research as it plays an essential role in the general health of a business and the entire economic system (Dibra, 2016). Faults may occur in a company's corporate governance, hindering business performance. For example, the series of corporate frauds in the 1990s was mainly attributed to a deficient system of corporate governance (Dibra, 2016).  Therefore, it is significant in protecting shareholders' rights, maintaining investors' confidence in the company, and attracting more investment to increase the capital base.

Furthermore, corporate governance has become a reference point in the current global business environment in debates regarding effective management. The well-documented collapse of Enron has led to international scrutiny of the operations of organizations. Besides, it presents the most critical role that corporate governance plays in preventing a company's failure. 

One of the main objectives of a corporation is to maximize shareholders' wealth. In this consideration, the board of directors is charged with the obligation of overseeing corporate management. They are in a better position to protect the interests of shareholders. However, changes were affected in 1999 when the board of directors waived the rules concerning conflict of interest, allowing Andrew Fastow to create a partnership with the company (Dibra, 2016).  The partnership appeared to have hidden liabilities that would significantly affect the organization's reported profits.

Consequently, the collapse of the Enron Corporation raised concerns about better mechanisms for reinforcing the director's ability to question business dealings through the corporate managers.  Several corporate governance issues have emerged due to scandals experienced by the company. Unregulated decision-making power possessed by chief executive officers is a looming problem that characterized Enron's management.

Besides, other ethical issues were latter unveiled after the downfall of the company. For instance, the document issued by the Federal Energy Regulatory Commission stated clearly that Enron Energy utilized strategies that manipulated the market. In general, the corporate governance used in the organization was weak in all aspects. The board was composed of several individuals who lacked moral character.  Their credibility was questionable. The directors were willing to engage in fraudulent activities to the detriment of enhancing shareholders' values.

Furthermore, the inefficiency of management was the root cause of the company's corporate governance failure. Different books have been written in an attempt to explain what transpired In the Enron fraud scandal. Discussions regarding the company's collapse have been prioritized in most debates about corporate governance (Dibra, 2016). This has been occasioned due to weaknesses in the overall administration, including the board of directors. The fall of the Enron Corporation will likely reinforce the ethical corporate environment in different countries. Besides, continuous development of corporate governance codes of practices and systematic reviews of the checks and balances in corporate governance are desired to avoid future Enron scandal cases. These mechanisms can detect and correct unethical practices before their impacts are recognized in the company. The intangible nature of fraud renders it complicated. Moreover, there is a dilemma surrounding what is good or bad in human behavior.

Development of the Sarbanes-Oxley Act of 2002 after the Scandal

Besides negatively impacting employees' lives, the Enron scandal changed the accounting and financial world's aspect and how publicly certified accounting firms present reporting. The increasing corporate frauds between the 1990s and the 2000s gave birth to the Act (Connell, 2017). The Enron scandal is one of the frauds that led to developing the Sarbanes-Oxley Act of 2002 to reduce company fraud occurrences. It aimed to protect investors and their properties by closing gaps in accounting practices and tightening corporate governance. The Act also authorized the creation of a public accounting oversight body to enhance surveillance of corporate behavior, especially those dealing with accounting (Peavler, 2017). Two sections in the Act deal with the regulation of scrutiny and financial reporting. The first addressed the issues related to senior management's corporate responsibility and their ability to certify the validity of the company's financial statement.  The executive officer must certify that the officer, pending their signature, has read, reviewed, and understood that the report does not have any false statement or omit to state a material fact to make the statement made amid circumstances that such statements were made, not deceptive; this report represents the corporate (SEC: Sarbanes Oxley Act of 2002, 2002). It also stipulates that the signing officers must maintain and implement the internal controls based on critical evaluation. The other section deals with the necessity of internal controls. In this case, a company should have strong internal controls that they should report on often. The report should contain the capability of the administration to uphold a firm core control, the adequate procedure for financial reporting as well as structure.

The two sections were fundamental in preventing company fraud in diverse ways. The public accounting oversight board was created to oversee the auditing of publicly listed companies. The companies' financial statements were to be free and fair to represent the investor's interests and the interests of the general public. Also, the oversight board was to oversee the auditing of dealers and brokers to promote investors' interest. Another noteworthy point is that the oversight body was mandated to ensure that an auditing company could not do any other consulting business with the client. This enhanced the independence of the firms, therefore improving the nature of their reports. An independent auditor was allowed to review and report on the firm internal control mechanisms, hence preventing fraudulent activities. Establishing the department of internal auditing guarantees an increase in compliance with the company's operations. The act also protected whistleblowers. In the Enron case, some stakeholders were probably interested in reporting the fraudulent activities that led to enormous losses. If, for example, the employees and other managers had the security of not being ostracized or fired, the company would still be in operation. According to the act, employers should not reprimand, blacklist, or fire employees who report fraudulent activities and testify against the offenders (Peavler, 2017).  The measure reinforced other oversight mechanisms that the act provided.

The corporate world transformed its accountability after the establishment of the act. The company's financial statement was marred with irregularities, nor does it have checks and balances encouraging transparency. Besides, investors are accessible to more accurate and additional information that can inform their investment decisions. However, because of the stringent requirements, there is some backlash regarding the execution of the act. The main provision of the act is the responsibility bestowed on auditors to oversee the accuracy of the financial statements.  Independence is required between the auditors and the corporation being audited; this is the most significant element of producing accurate reports. Therefore, the auditors are highly restricted regarding the compliance of this provision. An independent auditor is barred from providing any other consultation services or non-auditing work to the clients. The auditor cannot conduct bookkeeping or services related to accounting for the client (Bumgardner, 2010). Another crucial regulation that enhances the auditor's independence is the requirement that the lead auditors be replaced every five years so that the opportunity to commit fraud is reduced considerably. The audit committee acquired much more power after the implementation of the act. The committee forms part of the firm's board of directors and is responsible for the supervision of financial disclosures and reports. All publicly listed corporations must have a qualified auditing committee to maintain their powers to be listed in their stock exchange. The committee members should be independent directors from outside the organization and at least one qualified financial expert. The committee is mandated to pre-approve or approve various auditing and non-auditing services. However, in most instances, they should develop strategies and practices to guide auditing rather than just reviewing the decisions. Therefore, auditors must establish constant communication with the audit committee regarding substantial accounting strategies and the materiality of accounting substitutes that may impact financial reporting (Bumgardner, 2010). The company's Chief executive officers (CEOs) have an enormous responsibility to the company and the investors. The requirements that they should certify financial report creates a punishment for those who defy the provision.

Conclusion

The Enron scandal informed the accounting and financial world in several aspects.  Experts deliberated on the obligation of corporate governance to enhance the accuracy of financial reports.  The corporate governance structure should be adequate to support the going concern purposes of the business. In this case, accountability should start at the top management of the company. There is a need to develop policies to protect shareholders from fraudulent activities. For instance, the Sarbanes-Oxley Act of 2002 is a regulation that ensured the prevention of more fraudulent activities after the Enron scandal. The act created an accounting oversight board, an independent auditor, and an audit committee to ensure that the financial reports represented an accurate and fair monetary position opinion. Also, it protected whistleblowers from unjust firing because of reporting fraudulent activities in the organization. Checks and balances on cooperate governance and the creation of the Sarbanes-Oxley Act of 2002 were a major addition to the accounting and financial sectors in preventing fraud.

References

Bumgardner, L., 2010.  Reforming Corporate America - How Does the Sarbanes-Oxley Act Impact American Business? Graziadio Business Review. Graziadio

School of Business and Management. Pepperdine University, 29 Oct. 2017. [Online] Available at: gbr.pepperdine.edu/2010/08/reforming-corporate-America. 

Bondarenko. P., 2020. Enron scandal. United States history. [Online] Available at: https://www.britannica.com/event/Enron-scandal [Accessed 9/3/2020].

Connell, M. 2017. The fall of Enron and the Creation of the Sarbanes-Oxley Act of 2002.

Dibra, R. 2016. Corporate governance failure: The case of Enron and Parmalat. European Scientific Journal, 12(16).

Hosseini, S. B., 2016. The lesson from the Enron case-moral and managerial responsibilities. Journal of Current Research, 8(08), pp. 37451-37460.

Peavler, R., 2017. Enron, the Sarbanes-Oxley Act and Corporate Fraud. [Online] Available at: www.thebalance.com/sarbanes-oxley-act-and-the-enron-scandal-393497.

SEC., 2002. Sarbanes Oxley Act of 2002. [Online] Available at: www.sec.gov/about/laws/soa2002.pdf.