The company could have prevented the situation from occurring if it had put in place internal controls and procedures to protect it against fraud and inefficiencies. The company could have been operating to date had it structured its business operations around the major components of the internal control system, which include control procedures, monitoring of those controls, risk assessment, information systems, and control environment. Information systems would have enabled it to acquire accurate information essential for keeping track of its assets, as well as accurately measuring its profits and losses. Control procedures would have ensured that they work towards achieving the company’s goals.
The control environment, which had been seriously ignored by the CEO, Skilling, and the company’s directors, cost the company heavily. Control environment would have ensured that the company employees, including the executives maintain ethical conduct and the standard accounting principles. Enron’s monitoring system consisted of internal and external auditors who had allowed improper accounting practices which included inflating trading revenues, and the use of its special purpose entities to aid in hiding debts among other fraudulent accounting practices. It flawed its code of ethics. Besides, the company had also relied on an audit committee which was not effective as its members consisted of professionals who had modest finance and accounting backgrounds (Lublin, 2002).
The scope of the actions taken by Enron’s officer
It is quite obvious that the executives and other managers especially those charged with managing the financial activities and business operations of the company acted beyond their authority. They did not fully engage the generally accepted accounting principles, although this was mainly influenced by the accountability approach pursued by the company. First, they retained Arthur Andersen as the company’s external independent auditor but compromised the auditor’s performance by increasing the auditing and consulting fees paid to the audit firm, therefore creating a conflict of interest.
They, therefore, threatened the auditing firm with the termination of the contract if its auditors did not defer recognizing charges from the company’s special purpose entities so that it could hide its debts. Secondly, the company’s accountants capitalized on their accounting knowledge and the loopholes found in GAAP fraud the company. Thirdly, the company’s managers also adopted booking costs of the company’s canceled projects as its assets. This, they succeeded by making sure that there was no official letter stating that the project had been canceled. The managers deceived shareholders and analysts using non-transparent financial statements as proof of its tremendous increase in revenues and asset values (Bodurtha, 2003).
Such activities are classified as fraud. In 1998, Skilling had moved employees to the offices in the division the analysts were visiting to create an impression that the division had seriously expanded (Elkind & McLean, 2004). This was used to improve the company’s performance in the stock market. This act was done repeatedly.
Enron’s corporate culture
The company’s corporate culture changed significantly with the arrival of Jeffrey Skilling as its CEO in 1996. Enron’s board of directors and executives adopted a culture of deception (Free, 2007). As a result, Enron adopted nontransparent financial reporting aimed at deceiving shareholders and analysts about the true value and revenues of the company.
It began recognizing entire values of each of its trading deals as revenues; it adopted a mark-to-market accounting in its complex long-term contracts which allowed them to give investors misleading reports; it used special purpose entities which enabled it to overstate its equity while understating its liabilities; and finally, it adopted complex corporate governance as well as a network of intermediaries which enabled it to conceal its real performance. It succeeded in concealing its true performance through financing and accounting maneuvers which allowed it to hype its stock to very high levels. According to Berenson (2001), the board of directors had allowed these accounting practices and financial transactions.
Its corporate culture involved retaining and rewarding the company’s most valuable employees (Free, 2007). Employees, therefore, focused majorly on short-term earnings which enabled them to maximize bonuses. It was the company’s practice to reward deal-makers as well as executives with large cash bonuses. The management was always rewarded using stock options. As a result, the management applied improper accounting practices to meet Wall Street’s expectations. The company also allowed extravagant spending among its employees and executives and paid high salaries and bonuses to motivate them.
Alleged irregularities between Enron and sellers of securities
In Enron’s scandal, it was alleged that the Royal Bank of Canada, its 6 subsidiaries as well as its affiliates, had participated in helping Enron implement its manipulative and deceptive strategies, which included inflating Enron’s reported profits as well as financial conditions (Glater, 2001). It was also alleged that the banks had participated in a course of deceit on purchasers of the company and its related openly traded securities. This culminated in fraud. The banks had funded Enron’s fraudulent activities and had also helped the company execute its fraudulent transactions. They had participated in swap agreements with the company to conceal major off-balance sheet debt in the company’s financial transactions that required exposure of its off-balance-sheet debt.
Enron’s liability to the actions of its employees and agents
The company was liable for the actions of its employees since they represented the company. The board of directors which was charged with the management of the firm on behalf of the shareholders was fully aware of the fraudulent accounting practices and allowed them to continue to improve the company’s stock price.
Besides, the company had allowed its CEO, Skilling to modify the corporate culture and therefore change its financial reporting, rationalize and tolerate ethical slips. Fastow, the company’s Chief Financial Officer, was exempted from applying the company’s code of ethics to formulate and run two limited partnerships that were intended to save the company’s poorly performing stocks as well as stakes (Elkind & McLean, 2004).
These were formulated to deceive outside equity investors through its special purpose entities. Leaving the employees to be manipulated by the company’s CEO, Skilling, also meant that the company was liable for the actions of its employees. However, the company is not liable for the agents’ actions. According to Section 10(b) Liability of the Security Exchange Act of 1934, banks, as well as auditing firms, created or participated in the creation of misrepresentation about Enron, meaning that they had intentionally induced individuals and businesses to purchase the company’s stock and debt, and therefore they are liable for their actions (Gandhi, 2003). They failed to follow standard financial and accounting practices.
Berenson, A. (2001). A self-inflicted wound aggravates angst over Enron. The New York Times. Web.
Bodurtha, J. N. (2003). Unfair values: Enron’s shell game. Washington, D.C.: McDonough School of Business. Web.
Elkind, P., & McLean, B. (2004). The smartest guys in the room. New York: Portfolio Trade.
Free, C. M. (2007). Management controls: The organization trade triangle of leadership, culture and control in Enron. Ivey Business Journal, 71(6).
Gandhi, A. D. (2003). Enron court clarifies pleading standard for individual representatives of a professional accounting firm – Part I. Web.
Glater, J. D. (2001). A bankruptcy filing might be the best remaining choice. The New York Times. Web.
Lublin, J. S. (2002). Enron audit panel is scrutinized for its cozy ties with the firm. The Wall Street Journal. Web.