Name: Vibhu Singh Group # 10

Enron Ethics Case Study

The purpose of this paper is to give an analysis of the Enron Corporations fall and the ethical issues surrounding it. The effects of this scandal and the magnitude of the response to the company from everyone involved were enormous. Many suggestions and answers were developed in wake of the bankruptcy. A discussion will be made concerning what was the problem that took place with corporation and what impact did the problem or scandal have with the stakeholders. This paper will also review the outcome of the situation and if the punishment was fair for those involved. Finally, the role ethics played in how Enron conducted business. Ethics in business is not a new concept. The idea of business ethics has been around for centuries; however, at the beginning of the new millennium, with the Enron Corporation being at the top of the we have seen an accelerated maturation of ethics industry (Carroll & Buchholtz,2009, p. 233). The Enron corporation scandal has had an effect on how businesses operate, showtheir corporate responsibility, maintain and implement rules of ethics, involvement of the government to institute new legislation and regulations of business activities, and a rise in the education of business ethics. Although Enron was not the only corporation to be involved in a scandal in the 1990s and 2000s other big organizations were as well. Many of the charges against companies included sexual harassment, and racial discrimination, involving organizations like Home Depot, Mitsubishi, Coca-Cola, and Texaco (Carroll and Buchholtz, 2009, p. 234). Enron was the most well-known and largest company to be involved in any these scandals. The Enron Corporation was founded and was the worlds leading electricity, natural gas, communications and pulp and paper companies before it went bankrupt (Li, 2010). The corporation was based out of Houston, Texas. Before the company went bankrupt, they had billions of dollars in annual revenue. From 1995 to 2000, Enrons annual revenue rose from $9billion to over $100 billion (Li, 2010). It was at the end of 2001 when Enron reported that the corporation was financially sound and in good shape. Shortly afterwards the companys stock fell to $1 per share causing shareholders to lose $11 billion (Li, 2010).Ultimately the scandal was revealed in October of 2001 and it led to the Houston base company bankruptcy. The companys demise was the largest in American history and fell at an accelerated speed. According to Giroux (2008) Enron scandal is the worst to have ever happened in the US business industry. As Li (2010) states Enrons bankruptcy was a result of accounting fraud which was substantially institutionalized and creatively crafted within the management. As Giroux (2008)put it, the list of scandals within Enron is endless: the executive earned gigantic packages as form of incentives; the management focused on converting all the strategies into success to maintain their heavy compensations-through accounting manipulation; a greed financial officer with underground agreements to enrich himself; a collaborative law and auditing firms in Elkins and Arthur Andersen respectively; corrupt investment bankers- they structured all the financial deals in favor of Enron; deceptive financial analysts who would rate Enron high for attraction of investment, regardless of the reality of the economy; and a strong political system behind the company. The introduction of US deregulation policy in gas exposed gas producers to trade risks and banks became reluctant to provide loans for gas production. In 1989, Enron formed the Bank of Gas in order to, as Giroux (2008) argue, stabilize the gas market. In this strategy, Enron would contract gas producers to supply gas at specified future prices, then they would loan them money which was paid through gas; rather than cash. Meanwhile, Enron would contract to supply gas to traders at a future set price. The result was a relative stability; Enron as the only profiting. Enron made huge gains in this strategy. Mark-to-market technique of accounting introduced by Skilling (Giroux, 2008) revealed Enron successful in escaping losses which were associated with volatile prices of gas and inaccurate predictions. In this way, Enron valued long-term trading contracts at market value instead of the traditional historical cost. Mark-to-market is an accounting technique applied where developed markets for financial instruments exist and where there are obvious closing prices (Giroux, 2008). Essentially the profit is determined from the actual contracts. While it is clear that the market for gas was not obvious, Giroux (2008) notes that Enron went on to use it; Enron recorded big gains before even any gas sales were made. Enron also used SPEs and structured financing to conceal their debts off the book and camouflage their existing debts. The officers manipulated the financial analysts to rate the company as the strong buy. With the SPEs and structured financing, Enron was successful to hide losses even when it ventured into other markets which were in reality recording losses. This attracted huge public investment. Enron influential capability in the political class earned it loans of billions of dollars and other benefits for several international projects from the Federal government. In fact as Giroux(2008)

Name: Vibhu Singh Group # 10

notes, Lay, CEO, financed some powerful politicians and was involved in some key government appointments especially in the energy sector. As a result of these fraudulent strategies the company was able to record high annual revenue rise until 2000 (when it recorded $100 billion dollars). However, in 2001 Enron reported big losses. This attracted scrutiny from SEC and rating agencies for bonds. The valuation by these bodies discovered problems with the corporation. Meanwhile due to publicity in the scandals of Enron, banks became unwilling to offer loans to Enron. As a result the company declared bankruptcy by the end of 2001. According to Li (2010) the stock price of Enron dropped in mid- 2000 from $90 to less than $1 at the end of 2001 per share. The shareholders lost nearly $74 (US billion dollars) of which more than $30 billion US dollars was attributed to financial fraud. On its closure, Enron fired 4500employees without compensation of their dues (Giroux, 2008). Some major shareholders suffered financial losses such as Janus Fund who held 11 million Enron shares by the month of October 2001. As Shelley, Janus spokesman, notes (cited in Strauss, 2006) most of these shares were sold on loss. This subsequently resulted into loss of 26.1% and Janus trailed by 14% or so points in S&P 500. Other shareholders who experienced huge losses include JAGIX who owned about 3.2million Enron shares, JAMRX who owned 3.9 shares and Alliance capital who by mid- 2001owned over $40 million shares (Strauss, 2006).Patrick and Scherer (2003) stated that Enrons scandal had moral impact on both the primary and secondary stakeholders. Enrons top management involvement in shareholder deception for short-term financial gains destroyed both their professional and social standing(Patrick & Scherer, 2003). Officials such as Lay and Skilling were indicted in 2004 and sentenced to jail after conviction (Giroux, 2008). Several others including Lea and Kopper still face charges of financial frauds. The government was also harmed. Since Enron was reputed to serve the public, the government had offered a charter which in reality benefited the wealthy elite of the corporation and stakeholders (Patrick & Scherer, 2003). The scandal also caused harm to secondary stakeholders. Enron made other corporations to lose professional credibility to their clients. By agreeing to involve in questionable practices of accounting, as Toffler, (2003) notes, Arthur Anderson lost the credibility of his consulting firm. The shareholders and employees lost the most out of this scandal. In total shareholders and investors lost $64.2 billion in 2001 because of the companys bankruptcy (Neuman, 2005). Had the executives of Enron decided to be more socially responsible or invest ethically, the employees and other shareholders would have utilized their assets better. The company could have been truthful in allowing shareholders to know the financial situation. Social investing is a comprehensive approach that involves shareholder activism and community investing (Carroll and Buchholtz, 2009).Social investing is not a new concept, it began in the early 1900s when religious organizations refused to purchase sin stocks in alcohol companies, tobacco, and gambling establishments (Carroll and Buchholtz, 2009). Throughout time the trend of social investing has changed. By the 2000s, social investing or ethical investing has become a part of mainstream (Carroll and Buchholtz, 2009). The fact that Enron had its accounting firm, Arthur Anderson created off-book-partnerships to hide wealth, did not afford shareholders and employees to invest honestly (Neuman, 2005). Allowing investing from the public to put their money into make believe companies, was irresponsible and illegal. The Securities Exchange Commission immediately went into action and investigated the actions of the Enron executives. These types of actions from Enron are why it is necessary for economic regulation. The Security Exchange Commission is the regulatory body that handles such issues like insider trading and unacceptable accounting practices. The Security Exchange Commission is a stakeholder in the process because the regulatory body was not only for Enron, but the entire industry. Vinson and Elkins legal firm was another corporation whose reputation was tarnished by collaborating with Enron in condoning, against the legal mandate, frauds in employees and investors. Generally Enrons scandal created global fear in Americans corporate investment (Patrick & Scherer, 2003). The immediate outcome of the Enrons scandal was the declaration of bankruptcy of the corporation and immense losses on shareholders (Li, 2010 & Patrick & Scherer, 2003). The scandal elicited public discussion on the ethical behavior in the financial management of public corporations. Cox et al (2009) argues that there is a need for emphasize on ethical studies in business training. This, as Cox et al (2009) notes, will increase the awareness of the student unethical issues in their future careers. Many studies have been done about the scandal in an attempt to understand extend of financial immorality practiced by Lay and his accomplices. Many books have been written about Enron and the scandal: Power Failure which attempted to study the cause of collapse of the corporation (Giroux, 2008), Smartest Guys and others. After the scandal was revealed, Justice Department indicted over 30 Enron executives with Fastow charged with 78 cases of defrauding Enron and was jailed for 10 years (Giroux, 2008).This scandal brought a comprehension to the Federal government that a lot was happening in financial management. According to Giroux (2008) there are lots of unethical practices in financial corporation management. These include, as Giroux (2008) notes, corrupt law firms, ruthless and greedy executives, accommodating auditors, easily manipulated

Name: Vibhu Singh Group # 10

financial analysts and political influence. In order to counter reoccurrence of such scandals in the market, Sarbanes Oxley Act was constructed; the Act requires the corporation to hire independent CPAs as auditors (Scarpati,2003).According to Neuman (2005), the Enron scandal changed the public posturing of managers .In his study, Neuman (2005) established that the Managers are now aware that financial fraud can result into adverse impacts on their social standing, financial losses to the stakeholders and even can tarnish the entire capitalist giant image of the United States corporate. Managers, as Neuman(2005) asserts, have embraced the provisions of the Sarbanes Oxley Act. As a result the demand of CPAs has increased in the recent past with most CPAs unwilling to accept those auditing positions offered by most corporations. (Scarpati,2003).Prior to the Enron scandal, the government systematically rejected a series of safeguards that would have alleviated the damage caused by from the collapse or prevented it all together (New Republic, 2002).The government could have prevented the employees from losing their life savings in 1997when they could have changed the way companies required employees to invest huge portions of their 401(k) money into the companies. A 10% maximum was proposed as a total investment but it by congress. As Patrick and Scherer (2000 & 2003) conclude; managers cannot ignore integrity and morality for stability of the corporation, Enrons failure was as a result of moral ethics in the management. As Giroux (2008) states that the financial frauds in Enron resulted into its downfall. Therefore business ethics should be a subject of emphasize in both graduate and undergraduate business schools (Cox et al, 2009) & Patrick & Quinn, 2001). The Sarbanes Oxley Act of (Scarpati, 2003&2002) should therefore be unanimously embraced by the entire corporate world. This paper addressed issues surrounding the impact of the Enron Corporation and their demise into bankruptcy. Many ethical issues were addressed to determine what exactly happened and what lead the organizations leaders to make the decisions that were made. Shareholders and employees were affected by the business decisions made by the company; however, several other entities were impacted by the corporation. The Sarbanes-Oxley Act of 2002 was the response of the federal government to the public outcry for greater protection following this financial scandal of 2001 (Carroll and Buchholtz, 2009, p. 135). On July 30, 2002, the Accounting Reform and Investor Protection Act were signed into law. Better known as the Sarbanes-Oxley Act amended the securities laws to provide better protection for investors in public companies by improving the financial reporting of companies (Carroll & Buchholtz, 2009, p. 135).This law was an attempt to modify the corporate governance of public companies. The government afforded to investors of having access to important financial information regarding the company and their activities. Access was given to the balance sheets and other things that were prohibited. An analysis was given to the response of the federal government and the role they played as regulators of the industry. The government could have taken pervasive actions long before the Enron scandal. The lack of aggression in addressing issues surrounding new measures to protect investors could have lowered the impact or prevented the situation from ever occurring. This paper considered the federal government as a major stakeholder in this scandal.