Calamities resulting in the demise of the Enron Corporation are reflective of the desire for wealth. This desire itself is not problematic, however, the deceitful methods employed by Enron executives resulted in the rewarding of employees at a cost of defrauding investor and stakeholders are not only controversial but in other instances illegal. As a result. Legislation was passed to address the actions that ensued from ethical and fiduciary shortfalls. Laws enacted attempted to restrict the actions of management through the supervision of third-party review, clawback provisions, transparency in financial statement information to the public and whistleblower protections.
How did the corporate culture of Enron contribute to its bankruptcy?
The corporate culture at Enron prior to the circumstances of their financial manipulation was that of intense competition. A philosophy of producers was encouraged by rewarding the top producers and terminating the positions of those that were not producing to the levels set by management (Ferrell et al., 2017). Instead of focusing on the quality of business or personnel interactions, the “bottom-line” was reinforced, creating an environment that led to justifiable means profitability. The CEO Ken Lay was reported to espouse ethical virtues, however without implementation and example, they were never integrated.
Understanding Special Purpose Entities (SPEs)
To understand the reason for Enron’s collapse it is crucial to understand the role that Special Purpose Entities (SPEs) played. SPEs are an entity, similar to a trust that can be created. Typically, they are used as an entity applying for credit or used as an asset in evaluating credit of the parent company (Byrnes, 2002). Once an SPE is created, investors can invest in the SPE, thus enriching it with cash. Typically, an asset from the parent company is sold to the SPE, thus generating cash from the sale. In the case of Enron accounts receivables were used as the asset sold to the SPE. The SPE now having an asset of value, can market itself based on the value of that asset to future investors, thus raising more cash. The perceived value of the SPE and the asset(s) it contains carries the ratings of the parent company it was acquired from. The slight of hand maneuver is that the asset once it was sold to the SPE…was removed from the balance sheet of the parent company…which results in an improved credit rating, which of course enhances the SPE and the attractiveness to investors. It should be noted that this use of SPEs by Enron utilized a legal procedure of product creation. Enron entered the arena of uncertainty and manipulation by using their stock as collateral in guaranteeing the assets in these SPEs (Snow 2002). When Enron’s credit rating was subsequently lowered the collateralized SPEs imploded and investors lost.
As a result of the Enron collapse, laws governing SPEs have changed and assets can no longer be removed from balance sheets of parent companies, keeping them transparent to investors of the parent companies as well as their created SPEs (Cheney, 2003).
How did Enron’s bankers, auditors, and attorneys contribute to Enron’s demise?
The calamity of Enron’s misrepresentation to investors and stakeholders was enabled by several parties. Most obviously upper management was responsible as primary players in the drama, but other fiduciary charged entities such as Merrill Lynch, the Houston law firm of Vinson & Elkins and accounting behemoth of Arthur Anderson LLP were all instrumental via their interactions with Enron in its collapse.
The law firm of Vinson & Elkins was acknowledged as instrumental in the creation of the legal partnerships that became the center of attention. It was their expertise as lawyers who are fiduciarily responsible and were relied on to enable the creation of these partnerships correctly. It can be safely assumed that their role was that of an advisor providing their legal standing and expertise, otherwise they would have been charged and prosecuted with collusion and fraud. The firm eventually agreed to settle and pay $30 million without acknowledging any guilt in their association with Enron (Ferrell et al., 2017).
Merrill Lynch was a bank that was deeply involved with Enron Corporation. It was discovered that Enron engaged in selling phony assets to Merrill Lynch with the promise of buying these assets back at a guaranteed inflated price (Chaffin, 2002). When attention was brought up by employees as to the legality of these transactions, Enron threatened to ostracize Merrill Lynch in future stock issues, whereby Merrill Lynch succeeded to Enron’s threats. This enabling action of Merrill Lynch provided funds for a floundering income statement, by falsely inflating their income. As a result, four high ranking bankers were charged with helping Enron commit securities fraud (Chaffin, 2003).
Arthur Anderson LLP was the accounting firm employed by Enron. It was determined through the SEC’s investigation that the firm did “circumvent the intent of Generally Accepted Accounting Principles (GAAP), while attempting to produce a covering of technical compliance, all with the advice and support of its auditors” (Hartgraves, 2004). The firm dissolved in 2002, a proud, influential company disgraced.
The role the company’s Chief Financial Officer played in creating Enron’s financial problems.
Andrew Fastow was the Chief Financial Officer (CFO) of Enron Corporation. He was instrumental in the demise of Enron. He was charged with 98 counts that resulted in a 10-year jail sentence of which he served 6 years (Ferrell et al., 2017). Fastow, according to accounts was at the center of Enron’s financial machinations. As CFO, he would have been responsible for the creation of the SPEs, the legal review with Vinson & Elkins and the transactions with Merrill Lynch that resulted in the inflating of income for the purposes of financial statement fraud. His actions would most certainly not been done in a vacuum, without the knowledge of the CEO and the COO. Fastow has and still does maintain his innocence. This can be understood to some degree. Fastow has always argued that his actions were done with oversight and knowledge of his superiors. The creation and use of the SPEs could be construed as legitimate, as they were loosely regulated. The transactions with Merrill Lynch on the other hand cannot be attributed to vague rules, the intent of these transactions was to mislead investors in regard to the financial health of the company. It is here that his guilt in indisputable.
The responsibility of the position of CFO is to “weigh in on the strategic responsibilities and decisions involving the organization as well as serve as executives who can oversee sales transactions, regulatory reporting, compliance, tax functions, and other operational aspects of the business” (Khiyara, 2015). The position of the CFO is one of fiduciary oversight. It must be assumed that the responsibilities for the judgmental errors as well as illegal activities fall squarely in the shoulders of Andrew Fastow. As one can see from the resulting legislation of Dodd-Frank and Sarbanes-Oxley, the responsibility of the CEO, Chairman of the Board and the Board of Directors should have played a stronger part in the financial dealings of the company. With these new legislative laws, top executives are now required to sign-off on the financial statements as they are filed with the Securities Exchange Commission. Third-party auditors must review these financial statements for accuracy with opinions. Protections for whistleblowers were enacted with the hope that with these protections, more individuals will come forward in the future to share their knowledge.
It is likely that there were several issues within Enron that resulted in the unethical choices of its management. Pressures of profitability and the culture of performance would extend to the top management as well as mid-level producers. The admitted culture of “rank and yank” would weigh on the minds of all employees, no one would be immune (Ferrell, et al., 2017). Once compromises are entertained and engaged, subsequent comprises have a lower threshold and also become more justifiable for the means.
Byrnes, T. (2002, February 21). Special-purpose entities are often. https://people.stern.nyu.edu/adamodar/New_Home_Page/articles/specpurpentity.htm
Cheney, G. (2003). Post-Enron rules on SPEs could wallop wall street. Accounting Today, 17(14), 5.
Hartgraves, A. (2004). Andersen’s Role in Enron’s Failure. Die Betriebswirtschaft, 64(6), 753-771. http://ezproxy.liberty.edu/login?qurl=https%3A%2F%2Fwww.proquest.com%2Fdocview%2F208925427%3Faccountid%3D12085
JOSHUA CHAFFIN IN NEW YORK. (2002). Enron complaint cites ‘sham’ Merrill deal. Ft.Com, , 1.
JOSHUA CHAFFIN, I. W. (2003). Merrill Lynch bankers charged in Enron fraud. FT.Com, , 1. http://ezproxy.liberty.edu/login?qurl=https%3A%2F%2Fwww.proquest.com%2Fdocview%2F228717410%3Faccountid%3D12085
Khiyara, S. (2015). REVENUE MANAGEMENT AND THE WIDENING RESPONSIBILITY OF TODAY’S CFO. Corporate Finance Review, 20(1), 4-7. http://ezproxy.liberty.edu/login?qurl=https%3A%2F%2Fwww.proquest.com%2Fdocview%2F1700702682%3Faccountid%3D12085
Ferrell, O. C., Fraedrich, J., & Ferrell, L. (2017). Business ethics: Ethical decision making and cases (11th ed.). Boston, MA: Cengage Learning.
Snow, N. (2002). Enron’s SPEs, Andersen, the SEC and FASB. (trends & analysis). Oil & Gas Investor, 22(2), 64.