Salomon Litigation, Essay Example

Salomon Litigation and its effect on Recent Corporate Fraud Cases

Introduction

In recent years, there have numerous cases of fraud and breach of business ethics within the corporate world. Each of these cases have their own distinct factors that make it unique in terms of the application of company law. However, one of the most common areas of company law that is faces criticism and is perceived as a weakness within company law is the aspect of limited liability of a company. A company is considered as an entity on its own, with the rights, power and abilities to enter into contractual agreements with other entities and/or individuals (Smith). The business can make contractual agreements with individuals to perform certain tasks for the company at given levels. These individual, employees, can in-turn make contractual agreements with other entities on behalf of the company without incurring any financial liability in the execution of their tasks and responsibilities. When businesses are perceived as lawful entities, liability is limited to the assets of the entity in question. As such, employees, such as CEOs, CFOs and MDs, are not liable to any losses that the business entity will incur, and in the case of insolvency, personal assets belonging to these employees cannot be used to recover the value of amounts lost. This opens a huge door and opportunity for employees of business entities to commit fraud with little liability. This paper will critically look at the cases of Enron, Arthur Anderson, and WorldCom, and how Salomon litigation has affected company law and the case of Enron. It will take a critical look at the case of Salomon vs. Salomon & Co.

The Salomon code has brought an enormous change in the company law which has left many with unanswered question in regard to its applicability. While trying to dig out on how it found its way by becoming incorporated into the corporate group constitution there is very interesting finding which cannot be exhaustively discussed in this paper. However, following are some of the details.

Companies came to enjoy the personality of separation which they take pleasure nowadays subsequent to a resolution by the House of Lords on a case by Aron Salomon. Any person reading the decision will not fail to notice the unmistakable conviction in the midst of the associate of the House of Lords that they were correct. The speeches do not submit to any previous case law or yet to some up to date thoughts or findings.

Background Information

As a leather business man, Aron Salomon started to concentrate in production of leather boots on large scale. He worked hard and the business became a success as the only administrator. It was when his sons shown interest in his business that he found it necessary to have it become a Limited Liability Company registering it under the name Salomon & Co. Ltd.

It was a requirement that seven people were to be listed as shareholders of such a company which prompted Salomon to have his wife, four sons and a daughter making the number complete with him included. Salomon was the managing director; two among his sons were registered as directors. Of the 20,007 shares, Mr. Salomon owned 20,001 and remaining six shares were distributed among the six shareholders each being apportioned one share. As he later sold the company and debentures given to him he continued to have the highest shareholding. Selling his company at 39,000 he gained whereby 10,000 became a debt to him therefore he maintained his position as the principle shareholder and creditor.

While under insolvency, the liquidator raised the argument that the debentures which were used as security for the debt by Mr. Salomon were not valid basing his facts on fraud. Judge Vaughan Williams acknowledged this disagreement. In his ruling the judge found Mr. Salomon guilty arguing that he as the principle was liable for debts to the unsecured creditors and that his intention to create the company was purely for the purposes of transferring his business to it, it left no doubt that the company was his agent. Salomon & Co, Ltd creditors have to blame themselves for their loss. It seemed they had a lot of trust with the company since they had worked together with Mr. Salomon for a period of time.

Corporate Veil

The guiding principle of the company law will always be the truthfulness of the separate traits of the company: the corporate veil will simply be raised in the most excessive of state of affairs. The law has not distinctively stated clearly the officially permitted rights of shareholder and their dealings with the panel of directors.

As much as there was prove about corporations being separate lawful units, Salomon’s case gifted the company with the entire necessary characteristic with which to become the motivating force of capitalism. Even as the case progressed, however, it was a terrible verdict. Salomon’s case has made it possible for individuals to swindle and dodge officially authorized commitments due to the broadened benefits of absorption to small private ventures. On the other hand this commentary will argue that the general balance is optimistic

Sited Salomon principle benefits

Efficiency is sighted to flow from this principle. If we refer to previously organized businesses, one will notice that contracts created by way of partnership were very complicated. Each partner was to be involved in all the contracts detailing all the secreted rights and responsibility of each and every partner. When it would be noted that a company was of distinct nature, which is to mean that the company was like an individual, contracts were to be done in the name of the company as an independent entity which simplified the contracting complications.

The benefit of companies contracting as legal persons is that only single documentation is required which are verified by those who have been given authority to transact business in the companies involved. Any of these transactions are processed within the company’s articles of association or by the guidance’s upon which the board members have agreed upon. It is therefore noted that corporate personalities as legal persons simplifies business transaction for multifaceted commercial organizations.

To the persons in the company’s created within the circumstances as that of Aron Salomon, their personal properties will be protected when companies fail to perform as expected. Changing a business to a limited company, draws a line between your personal property and those which are owned by the company and which can and will be attached in case of business failure.

Sited problems with Salomon principle

Salomon principle has a central ethic problem. The security principle of personal properties when a company fails to perform does not benefit the third parties. This is because only the company’s assets become available when the company goes into bankruptcy. Those in position of managing such companies do their work with less accountability and negligence is rampant since they have nothing personal to lose. As for the other shareholders who do not play active roles in the running of such companies, they exercise very little responsibility or none. This is because they have limited personal liability as stipulated by the company law. It is becoming clear and factual that the entire financial system is populated by enterprises in whose shareholding and administration put up very slight express individual accountability or failure when such companies do not get good returns. The principles of such a wealth are questionable if nobody is ready to stand the threat of undefined, personal loss.

To this day Salomon’s case is still referenced in the law courts but not without censure.

Arthur Anderson

Arthur Anderson was one of the most prestigious accounting firms in Chicago. However, it fell in a cloud of shame and scandal. It was involved with the cover-up of information on Enron, and at the same time obstructing the federal investigation into the company. The company began valuing heavy fees replacing the good honest bookkeeping that the firm was built on. It broke ethical rules by firing accountants who were not willing to adopt the firm’s new philosophy. Standards were compromised so as to make more profit.

Enron

Enron is one of the largest electricity production and distribution companies that has faced huge bookkeeping irregularities that destroyed the company’s reputation and led to huge losses incurred by the shareholders, and eventual fall of the firm. The firm was embroiled in in a series of unscrupulous accounting techniques during the 90s. in December 2001, Enron eventually filed for insolvency  (Thomas).

The manipulated financial records were eventually audited and the stock prices of Enron took a blow from the discoveries. In reality, the value of Enron’s shares was not desirable in the market. Management omitted crucial information pertaining to the risks associated with the business, attracting new financiers that provided much needed capital to the business. With every passing financial year, management had to further inflate and manipulate financial records and statement to keep up appearances of a high-profit generating venture. As capital rapidly flowed into the business, management failed to employ checks and balances to curb the ever growing capital balances and stock price in a legal manner (Gudinkunst). During this state, management of the company failed to exercise their responsibilities. It was thought the Audit Committee of the Board should have been more cautious of the auditors and their work. As the prices and incomes of stocks were always rising, there was no requirement to scrutinize the internal accounting methods of Enron or the opinion letters of the accounting company.

Enron failed due to corrupt practices by the administration team and all other players failing to perform. Failures are expected in any business, but by laying healthier organizational practices, risks can be reduced. The correct moral code of conduct ought to be followed, and businesses should concentrate on making the employees responsive of the several ethical policies.

WorldCom

In 2002, WorldCom, a big telecommunications company, now known as MCI Inc. was embroiled in a huge scandal. The firm’s assets were found to have been inflated by over $11 billion. This led to the company laying off up to 30,000 workers. Furthermore, investor lost $180 billion. The main player in this scandal was the then CEO Bernie Barnes. He managed to underreport line costs by debiting instead of crediting. He also over quoted the revenues by having numerous counterfeit entries.

Tyco

That same year, Tyco, a Swiss blue-chip security systems company, had $150 million stolen by the CEO and CFO. This had been achieved by inflating the company’s income by up to $500 million. The two executives executed fraudulent stock sales and unapproved loans from which they siphoned funds. They channelled the money put of the company under the disguise of benefits and executive bonuses.

The Waste Management

The Waste Management was a Houston-based company. Its stock was publicly traded. However, it was found that the company had been reporting fake earnings that amounted to $1.7 billion. This scandal involved the Dean Buntrock, the founder/CEO/Chairman. He was assisted by Arthur Andersen, their contracted auditors.

Effect of Salomon Litigation on Arthur Anderson, Enron and WorldCom

Arthur Anderson, Enron and WorldCom were all involved in fraudulent activities where senior level management was found to be embezzling company funds. They performed unscrupulous entries in their financial reporting, inflating the company’s value by a huge margin. Even though these cases were realized and brought to the limelight, all culprits walked away owing to the fact that an employees of a business entity is not liable to incur any losses realized by the company. The security principle of personal properties when all these companies failed to perform did not benefit the third parties. Those in position of managing such companies do their work with less accountability and negligence is rampant since they have nothing personal to lose. The principles of such a wealth are questionable if nobody is ready to stand the threat of undefined, personal loss. Each stakeholder has to be involved in all the contracts detailing all the secreted rights and responsibility of each and every stakeholder, inclusive of high-level management.

Ethics and ethical standards are vital in the decision making process, financial planning and accounting process for every business where accounting standard is followed. The foundation for success is that business and accounting principles should be followed. Unscrupulous conduct is not a key to realize pinnacles in business  (Thomas). The greatest ethical conduct in the area of decision making and accounting is that all the businesses must follow the International Accounting Standards

Conclusion

Salomon proceedings judges could have an option that the company was a nonentity for the behavior of plaintiff and not in any way an individual person. In this case the observation of companies as simply a manifestation of a scheme whereby actual human beings carry on with their dealings has a derivation in the company law. The joint stock company was disapproved of as being an unseen trader who was not known by anyone and could not be traced.

The law had no provisions to the acknowledgment of dependence where it was argued that the six were a trust. Irrespective of what their rights were, the statue failed to make them shareholders to any intentions and purposes with their relevant constitutional rights and responsibilities. The singled out relations approved were that the shareholders had the right to enjoy all the benefits and rights which belong to the corporate body.

The Legislature indicated that one share was enough to make up a shareholder whether they may be having independent benefits or interest. Years after this case, there have been facts of a variety of outstanding circumstances which have been described both by elected representatives and the courts. In some countries like Ireland and English and other parts of the world, courts can lawfully pay no attention to a company’s separate lawful qualities such as where offense or scheme has been committed.

Lord McNaughton commented that with such an incidence he anticipated that many would come out openly to criticize the law which allowed a vacuum of hanging charge. Nevertheless a floating charge is moreover well-situated a structure of defense which cannot be carelessly wiped out. As he reflected along this issue he wished to persuade his learned friend to the same thinking line sitting that the regular suppliers owed by the trading corporation were supposed to have a special claim on the assets in insolvency in value of sum unpaid which accumulated within a definite limited time before closing. But at that moment that was different.

It is common knowledge that on a situation of winding-up debenture-holders normally step sweeping off everything which turn out to be a great scandal. All these accounting ethics breaches underline the importance and roles of the FASB and PCAOB. The PCAOB was created to regulate public accounting firm, ensuring the set rules and regulations are adhered to. The FASB exists to improve financial accounting and reporting. It upholds the best interest of the public and ensures accounting standards are adhered to.

Works Cited

Fox, Loren. Enron: The Rise and Fall. Hoboken: Wiley, 2003. Print.

Gudinkunst, A. Enron-A study of failures, who, how, and why? 2002. Internet Source. 9 April 2014. <Enron-A study of failures, who, how, and why?>.

Robbins, Stephen P and Timothy A Judge. Organizational Behavior. Boston: Pearson, 2013. Print. 8 November 2012. <https://ecampus.phoenix.edu/classroom/ic/classroom.aspx>.

Smith, Douglas. Company Law. Oxford: Butterworth-Heinemann, 1999. Print.

Thomas, William C. “The Rise and Fall of Enron.” Journal of Accountancy – New York 193.4 (2002): 41-52. Print.