The Unethical Business of Enron and How It Affected the Employees and Investors, Research Paper Example

Introduction

Enron was originally formed in 1932 as a Northern Natural Gas Company in Omaha, Nebraska. Later on, in 1979, Enron became the leading subordinate of the holding company InterNorth. Consequently, the headquarters of the company were moved to Houston, as a result of the merger. Enron began an active rebranding of its business, thus indulged in distribution of natural gas and electricity throughout the territory of the United States. Enron became famous for constructing and operating pipelines and power plants, thus dealing with specific rules and regulations in this sphere all over the world. As a result, Enron owned a huge natural gas pipelines network, including such companies as Northern Natural Gas, Florida Gas Transmission, Transwestern Pipeline Company, and Canada’s Northern border pipeline. Eventually, Enron became an economic power house with more than 22,000 employees and considerable financial strength.

The Scandal and Its Effects

The Enron Scandal

 The Enron scandal was a corporate scandal revealed in October 2001 and which involved both Enron Corporation and their auditors Arthur Andersen which was an auditing, accounting and consultancy firm. By the time of its collapse, Arthur Andersen was among the list of the top five biggest audit firms in the world. The price of Enron’s stock had taken a nosedive from a previous high of  $90 for each share in 2000  to a rather dismal $0.12 by January 2002. According to Elkid and Mclean in their book Smartest Guys in the Room, the scandal grew gradually from habits values and actions which spiralled out of control after many years went and eventually culminated in bankruptcy. The fraudulent actions were perpetrated through direct knowledge as well as indirect actions by the management of the corporation. The major factor that destroyed the market confidence in Enron’s share and eventually occasioned their downfall was the misuse of the off balance sheet financing and their efforts to correct the misreporting of the previous periods (Konzelman & Deakin 2003 ).

To meet the market expectations Enron misrepresented its financial statements to the extent that they cast an image of a successful and well off company. This misrepresentation failed to recognize the fact that Enron was highly indebted to the loaning institutions through the structured finance plans. The other factor that led to this financial failure was the rather astronomical paychecks that made their chief executives so highly paid that the executives of the opposition looked pale in comparison. This was also heightened by the fact the companies executives were being granted hefty share options. The decline in investor confidence is what condemned Enrons shares to the sudden decline. The sudden decline in the share prices made the business operation unsustainable which eventually pushed them to file for bankruptcy in December 2001 leading to what has become the most famous business scandal as well as the biggest liquidation case so far. It was noted that Enron’s senior executives motive of keeping the company looking profitable was driven by the fact that they had huge stock options out of which they stood to benefit if the stock price was high (Konzelman & Deakin 2003 ).

The Role of Enron Corps Auditors: Arthur Andersen in the Enron Scandal

Enron’s Auditors Arthur Anderson has been accused of not only being complacent in their review of the financial figures presented by their clients but of being party to the collapse. First Arthur Andersen’s Risk management standards in as far as client engagement is concerned were brought into question. The key question that was being asked of how Arthur Andersen had sought to address the issue of self review. This is where an audit firm subjects its own decisions to a review during audit (BPP Media). This was especially in appreciation of the fact that the auditors used to rake in colossal amounts of money in consultancy fees besides the audit fees. Also of importance to note is the fact that the auditors failed to point out the credit risk that Enron was running due to the financing arrangements as well as that they moved to shred all the evidence they had when the scandal was eventually unearthed led to the downfall of the audit firm. They were accused by Enron’s board of malpractice leading to their eventual closure.

The Effects of the Scandal on the Investors and Employees

The most notable effect on Enron investors was the colossal amounts of money that they lost through the price decline of the shares, as the share prices plummeted without a warning, the investors lost huge sums of money in the scandal. Eventually, the share prices started dropping after chief executive office disposed them on the market. However, company investors predicted share prices to rise again, but it appears they were wrong and the company file for bankruptcy in the end.

The other effects included the investors failing to trust analysts as well as stock brokers. This is because Enron’s well orchestrated scam had managed to dupe all and sundry into believing that they were a profitable. Most of the analysts rated Enron’s as a strong buy up to the time of bankruptcy ( USA today.com). This led to the Investors being stingier with their cash and it has eventually resulted in a less vibrant stock market.

Enron employees suffered as well from loss of employment in a very drastic way. It is to be noted that Enron employed up to 22,000 employees by the time of its collapse. Worse still was the fact that the highly exploitative pension scheme ran by Enron had the employees investing their pension savings in the employers stock. This meant that with the collapse of the employer, not only did the employees lose their jobs, but they also lost their long term savings that they had set aside for a rainy day (Krugman 2001). This was quite a blow to the employees as they always sought to do their best in investment as social security turned out to be their social insecurity.

Legal Perspective of the Scandal and Case Law

According to business Law Fraud is defined as deprivation by deceit, false representation of facts made by its falsity or carelessly whether true or false. (BPP 2009) The free dictionary on the other hand defines fraud as dishonesty calculated for advantage; this implies that any company that conceals information from creditors is carrying out fraudulent trading (The free Dictionary). This implies that the manner in which Enron carried business through special investment plans that were never recognised as creditors amounted to fraudulent trading.

In looking at this case there are other cases that involved fraudulent trading that comes to the fore. In the case of Halls V David and another 1987, the accused sought relief from the liability in light of the section 727 of the company’s act 1985 which allowed reprieve from liability if the accused was found to have acted honestly and in the best interest of the company. This was after the directors were accused of misrepresenting the balance sheets of the company. The ruling stated that the Companies act was not intended to exempt the director from liability under section 214. This implies that Enron directors could not seek relief from liability since they were not protected by the law in this respect.  Similarly in the case of R v Bailey 2005 the judge in his ruling made pronouncements to the effect that directors are to be held personally responsible for public pronouncements. This is in an effort to ensure that the integrity of the market is preserved as well as the investments of the public are protected. Finally in the case of R v Kemp 1988, it was ruled that fraudulent trading is not limited to carrying out business with an aim to defraud creditors only but also carrying out business for any purpose of fraud. These cases serve to clearly show that not only were Enron directors liable to their creditors but also to the investors and business partners who lost money in the scam.

In the wake of the Enron scandal and the other major financial failures such as Tyco and Worldcom, investor confidence was taken to the core. This necessitated the enactment of the Sarbanes-Oxley Act 2002 which gave guidelines on the practice of accountancy and to protect the investors as well as restore public confidence in the accounting and financial reporting practices.  This act clearly defined the responsibilities and liabilities of both the management and the auditors. It also defined the mandatory requirements for financial reporting purposes. The Sarbanes-Oxley as part of the United States Federal law sought to gave a clear indication of the extent to which fraudulent behaviour will be fought.

Conclusion

Going into the future, the audit environment has been seriously regulated. This is in the form of strict risk management standards being imposed upon the practitioners. There are seriously restrictions on the kind of work that an auditor can do for their audit clients; this implies that the threat of self review is highly reduced by this restriction. Similarly the combined code of corporate governance defines clearly the specific responsibilities of the directors as well as the various stakeholders of the corporation. The combined code of corporate governance was revised to give a regulatory framework within which all public corporations are to be governed. The Public Company Accounting Oversight Board (PCAOB) is charged with the responsibility of regulating the auditors of public companies to ensure that the accounts they give are true and fair representation of the companies in question. This has ensured that the investors and the general public as well as the employees are not given erroneous information concerning the financial situation of the companies. The Enron scandal was not only a moment that led to major changes in the corporate governance code but also a eye opener to the investors and other big audit companies on the risks they are exposed to in their normal course of business.

References.

BPP Learning Media (2009). Corporate and Business Law.  London: BPP Publications.

Deakin, Simon; Suzanne J. Konzelmann (2003). “Learning from Enron” ESRC Centre for Business Research University of Cambridge (Working Paper No 274) Retrieved on 05 August 2009. From: http://www.cbr.cam.ac.uk/pdf/wp274.pdf.

McLean, Bethany; Peter Elkind. (2004). The Smartest Guys in the Room. New York. Penguin Group

Paul Krugman (2001). Enron workers losses and a cautionary tale for others. New York Times. 5 Dec 2005

The free dictionary. Fraud. Retrieved 13 August 2009.  Available a href=”http://legal-dictionary.thefreedictionary.com/Fraud”>Fraud</a

USA Today. Ten Lessons from the Enron Scandal. Retrieved 12 August 2009 Available: http://www.usatoday.com/money/energy/enron/2002-02-19-lessons.htm.