Case 9 Enron Questionable Accounting Leads to Collapse

Case 9 – Enron: Questionable Accounting Leads to Collapse

1. How did the corporate culture of Enron contribute to its bankruptcy?

The corporate culture of Enron was aggressive and arrogant. The company rewarded high performance and if an employee did not reach a certain achievement mark they were essential thrown out of the company. The executives of the company believed in high risk transactions and that any situation could be turned into a profit, in turn employees of the company also believed this philosophy. Since the employees were put under such scrutiny to turn a profit and perform well, many individuals were willing to cross ethical lines in order to keep their jobs by cutting corners and falsifying transaction to increase earnings. The company also did not hold a high level of concern for their shareholders. Most of the decisions made in the board room were made on account of how the executives could turn more profit into their own pockets.

2. Did Enron’s bankers, auditors, and attorney’s contribute to Enron’s demise? Is so, how?

Enron’s bankers, auditors, and attorneys did play a major role in Enron’s demise. Many major banks were guilty of helping Enron manipulate financial records so it looked better to investors. There were also three British bankers who were charged on wire-fraud related to a deal at Enron. They used secret investments to take $7.3 million in income that belonged to their employees. Several attorneys were also involved in the scandal. They approved transactions as legal without question and also helped structure special-purpose partnerships in a way that seemed honest. Enron in fact could not have finalized several of the transactions without the opinions from such attorneys. Arthur Andersen was Enron’s auditor and was responsible for ensuring the accuracy of Enron’s financial statements and internal bookkeeping. Many investors expected the company’s financial records to be accurate due to sound bookkeeping but this was not the case.

3. What role did the company’s chief financial officer play in crating the problems that led to Enron’s financial problems?

Andrew Fastow was the CFO of Enron at the time that the company hit the spotlight. He was indicted on 98 accounts for his efforts to help inflate company profits. The charges were fraud, money laundering, conspiracy and one count of obstruction of justice. Federal officials attempted to recover all the money Fastow earned illegally and seized $37 million. Fastow was said to be the brain behind the partnerships used to conceal some $1 billion in Enron debt and that this debt led directly to Enron’s bankruptcy. He was also said to have defrauded Enron and its shareholders through off-balance sheet partnerships, making Enron appear more profitable than it actually was. They also alleged that Fastow made about $30 million by using these partnerships to get kickbacks disguised as gifts from family members, and taking income himself that should have gone to other entities.

Internet Component

Article 1: Enron, Ethics, and Today’s Corporate Values

Forbes

Ken Silverstein May 14, 2013

http://www.forbes.com/sites/kensilverstein/2013/05/14/enron-ethics-and-todays-corporate-values/

Enron’s scandal taught the business world the importance of firm corporate values. It was the biggest business bankruptcy of its time in 2001 due to misplaced morals. These lack of principles eventually killed the company and brought to light many moral failings. Even though it may seem if character is meant to be applied on an individual basis, it is just as important in organizations as it is in people. As a result of Enron’s shortcomings and other scandals that have been exposed over the past decade new laws have been enacted to try and prevent future incidents. Enron became an overnight sensation to be the seventh largest publicly held corporation in its prime. Now 16 former Enron employees and executives have been sentenced to prison after the exposure. Enron showed the business world the importance of crating a corporate code of ethics. Competition to earn profit can sometimes promote temptation but it is a companies responsibility to balance pleasing shareholders while also practicing sound business ethics. According to Richard Rudden, managing partner at Target Rock Advisors in New York City, “Ethics and integrity are the core of sustainable long term success. Without them, no strategy can work and, as Enron has demonstrated, enterprises will fail. That’s despite having some of the ‘smartest’ guys in the room.” Most individuals are raised with a sense of ethics from their family, but these can get lost in translation if a company is not careful. Enron’s downfall was not all negative though, it did bring a heightened awareness to board members and investors that has encouraged companies to become more sure that their company does illustrate a sound corporate culture.

Article 2: MANAGEMENT CONTROLS: THE ORGANIZATIONAL FRAUD TRIANGLE OF LEADERSHIP, CULTURE AND CONTROL IN ENRON

Ivy Business Journal

Clinton Free, Mitchell Stein, and Norman Macintosh July/August 2007

http://iveybusinessjournal.com/topics/the-organization/management-controls-the-organizational-fraud-triangle-of-leadership-culture-and-control-in-enron#.VLxi4VpH1hA

The change of leadership within the company walls began the final downfall of Enron when Jeff Skilling became the company’s CEO. Before this change Enron was known to have highly effective control system, but this all soon changed into a powerful risk taking culture with blurred ethical lines. According to the article leadership and corporate control play into the ultimate success and effectiveness of a management control system. Enron now poses as the poster company of vital lessons learned about good management controls in larger, complex organizations. Enron was born a small company and became an over night top Fortune 500 company. The executives within the company created an aggressive corporate culture and even went as far as to offer bonuses for met cash-flow and profit goals and clear out employees who failed to meet such expectations. After Enron’s downfall due to finical reporting issues several solution have been implemented within many companies in the business world to help keep this kind of scandal from happening again. As mentioned in the article, fraud can easily take place within a company due weak leadership, management controls, and corporate culture. Enron displayed weakness in all three of these areas at the time they filed bankruptcy. Executives within the company were risk-takers with no regard to anyone or anything other than an incredible bottom line at the end of the month. These executives were also willing to cross moral and ethical lines which in turn dwindled down to the company employees who would also cross these lines in order to keep their jobs and look successful to upper management. A Risk Assessment Control group was set in place within the company and their duties were to approve all deals and risk that were being taken by the company. These were also the same individuals who believed that any situation could be turned into a profit with little regard to risk. Essentially Enron brought to light several internal issues with a company’s corporate culture that need to be strictly monitored so that the ethical long-term success can be held with integrity, not only for the stockholders, but also employees and executives who represent the company on the inside.

Article 3: 10 Things We Didn’t Learn From Enron Scandal

ABC News

Sussanna Kim December 1, 2011

http://abcnews.go.com/Business/10-things-learn-enron-scandal-10-years/story?id=15048641

Ten years after the collapse of Enron from massive fraud much has changed about how corporate business is done due to the huge scandal. On the other side though some of the same characteristics of Enron’s corporate culture that brought them to their downfall still remain in the business world. According to Lawrence Weiss, professor of international accounting at Tufts University’s Fletcher School of Law and Diplomacy said, “We did learn some lessons and people were more careful, but greed creeps back in again.” For example, Enron was the biggest corporation to file bankruptcy of its time, but since then other companies have been added to the scandal list such as AIG and Worldcom. Some of these problems that still seem to reoccur over time include, 1. Conflicts of interest still occur. These kinds of problems will continue to occur until new Dodd-Frank provisions are created to prohibit them. 2. If it’s too good to be true, it probably is. After years of operation the cash flows did not match the profits which should have raised warning signs. Also it was difficult to understand were the money was coming from, but somehow the company was exceeding profit goals on paper month after month. 3. Regulators and the regulated continue their dance. This issue is a bit more complicated. Many believe regulators are good because they make unethical accounting more difficult, but it also puts a higher burden other companies that do follow the rules. 4. Transparency is vital. Companies need to be able to disclose the risks they are taking clearly and regulators need to start making this a vital part of disclosure. 5. More capital is better. Enron’s risks were high and one of their shortcoming was spending exceedingly more than they had to initial capital. The more capital a company has the lower the risk. 6. Excessive leverage is as dangerous as bad debt. Many companies still use side doors to hide debt and fail to disclose these liabilities to the public. 7. Corporate leadership makes all the difference in the world..for good and for bad. The leadership style behind Enron’s executives included rewarding high risk and profit at whatever the cost. In the short-run this seemed like an acceptable tactic, but in the long run proved harmful to the company and all those attached. 8. Preferred stockholders get preferred treatment. When Enron collapsed many employees and other stockholder’s received little to nothing after all the assets were cashed in while many top executive preferred shareholders received millions in dividends. 9. Still building fragile financial structures. Companies that are built on risky deals do not have a strong foundation and can collapse easily, as Enron more than proved to the business world. 10. Important names make mistakes too. Many well known banks that Enron associated with were also part of the fraudulent activities that took place inside the company.