Executive Summary
Enron’s top corporate leaders discovered a way to bolster the company’s earnings by manipulating the firm’s financial data. As a result, they were able to create the illusion that the company was raking in a great deal of profit. Expenses were listed as earnings, and as a consequence investors poured money into the firm. Although the company’s corporate leaders devised a brilliant plan to deceive investors, the strategy had a slim chance of success without the participation of Arthur Andersen, one of the world’s best accounting firms. The conflict of interest was rooted in the fact that Arthur Anderson did not only serve as an auditor for Enron. Investigators revealed later on that the said accounting firm also served as a consultant for Enron. Contemporary business leaders must apply the principles found in the Sarbanes-Oxley Act of 2002 in order to prevent the repeat of the said scandal.
Enron’s tragic story must serve as a warning for unscrupulous business leaders thinking they can get away with crime. Enron’s debacle must serve as a cautionary tale for brilliant people who are thinking that white collar crimes, like accounting fraud, are difficult to detect. Compelled by extraordinary pressure to succeed and earn a great deal of money, Enron’s corporate leaders decided to bend certain accounting rules in order to create the illusion that the company was making a great deal of profit. In the end, the perpetrators of the said accounting fraud were found guilty of defrauding investors and the general public.
Introduction
A visit to Enron’s headquarters provided little clues that this multi-billion dollar company was once an obscure energy firm located in Houston, Texas. Enron’s humble origin was characterized by a simple business model based on selling natural gas. One can argue that greed was the precursor to Enron’s fall from grace, because at the start of its business life, the company was earning a handsome profit. Nevertheless, the hundreds of thousands of dollars in earnings were not enough for Enron’s top two executives, Ken Lay and Jeffrey Schilling. Both men came up with a brilliant idea to transform Enron’s business model into one that will require the company to undergo a major change in identity. Thus, Enron shifted from selling natural gas into a more complicated business model that transformed the organization into a trading firm.
Ken Lay founded Enron and the creation of a money-making company was a testament to his entrepreneurial skills (Walden and Thoms 474). His success in the energy sector enabled him to attract smart people to work for his business organization. Ken Lay realized that in order for his business to reach its full potential, he needed to hire a businessman like Jeff Skilling. His protégé was someone who was not afraid to offend people and perform tasks that were beneath Ken Lay’s standards (Fox 4).
Lay and Skilling’s partnership enabled them to develop a strategy that was based on the manipulation of financial data. In the said scheme, expenses were listed as assets (Fox 221). According to one report, “Enron often booked the full value of each trade as revenue, rather than just Enron’s slice of the transaction. So if Enron bought $100,000 worth of natural gas, then sold it an hour later for $101,000, Enron booked the full $101,000 as revenue rather than the $1,000 in gross profit it made on the deal” (Fox 221). The application of the said dubious scheme allowed Enron to make a false claim that the firm scored $100.8 billion in revenue in the year 2000 (Fox 221).
Accounting Fraud
Although Lay and Skilling’s strategy was effective in creating financial hocus pocus, the Securities and Exchange Commission established rules in order to detect this type of shenanigans. Therefore, without the help of accounting professionals this type of fraudulent schemes are rendered meaningless. In this regard Enron sought the assistance of Arthur Andersen. Investigators found out later that the said firm was able to evade detection because Ken Lay hired an accounting firm that was ready and able to help Enron cover its tracks. The company’s CEO made a smart move by hiring the services of Arthur Andersen, considered as one of the Big Five accounting firms in the country (Markham 118). It must be made clear that Arthur Andersen earned $52 million in fees from Enron in 2000 (Markham 118). However, a significant portion of the money paid to them came in the form of consulting fees (Markham 118). Thus, it was in the best interest of Arthur Andersen’s executives to keep the business of Enron. The said accounting firm knew about the manipulation of financial data, however, there was a conflict of interest, because the firm also served as a consultant for Enron (Bauer 4).
What Could Have Prevented the Scandal?
In the aftermath of the scandal, the Sarbanes-Oxley Act was signed into law in 2002 (Kranacher, Riley, and Wells 436). This law introduced stringent standards to mitigate the impact of accounting fraud. An overview of the said law revealed the need to increase the accountability of corporate leaders; increase financial disclosure; and to highlight the importance of an independent external auditor (Walden and Thoms 474). According to one report the Sarbanes-Oxley Act of 2002, “bolsters criminal and civil liability for securities fraud, founds a new oversight board for independent audit firms to be paid for by stockholders of public companies, and embraced restrictions on audit firms engaging in various non-audit services for their clients” (Niskanen 20). In the context of the Enron scandal, there was a way to prevent the company’s fall from grace if the services of independent audit firms were utilized, and if there was no conflict of interest between the auditors and corporate leaders of the company.
Conclusion
Enron’s corporate leaders engaged in dubious schemes to bolster the company’s image as a profitable business organization. However, the clever strategies that they created were useless because of the presence of auditors and accounting firms responsible for protecting the interest of the investors. Nonetheless, Enron was able to force the hand of Arthur Andersen’s executives, because this particular accounting firm did not only function as an auditor for the company. Investigators discovered later on that Arthur Andersen also served as a consultant for Enron. The legislation of the Sarbanes-Oxley Act created stringent standards to prevent unscrupulous businessmen from making auditors as their partners in crime. It is impossible to pull off the fraudulent scheme of Lay and Skilling without the participation of Arthur Andersen. The conflict of interest between auditors and corporate leaders was the root cause of the scandal. Business leaders must learn from this tale of greed and accounting fraud. The application of principles gleaned from the Sarbanes-Oxley Act of 2002 will help mitigate the impact of accounting scandals.
Works Cited
Bauer, Andrea. The Enron Scandal and the Sarbanes-Oxley Act. New York: Springer, 2009. Print.
Fox, Loren. Enron: The Rise and Fall. New Jersey: John Wiley & Sons, 2003. Print.
Kranacher, Mary-Jo, Richard Riley, and Joseph Wells. Forensic Accounting and Fraud Examination. Hoboken, NJ: Wiley & Sons, 2010. Print.
Markham, Jerry. A Financial History of Modern U.S. Corporate Scandals. New York: M.E. Sharpe, 2006. Print.
Niskanen, William. After Enron: Lessons for Public Policy. Lanham, MD: Rowman & Littlefield Publishers, 2007. Print.
Walden, Michael and Peg Thoms. Battleground. Westport, CT: Greenwood Publishing, 2007. Print.