Enron Scandal: Corporate Governance and Sarbanes Oxley Act, 2002

This report discusses the Enron scandal, one of the most infamous accounting scandals in history. It explores the unethical practices of Enron, the role of corporate governance in preventing such scandals, and the enactment of the Sarbanes Oxley Act, 2002 to protect investors and ensure transparency in financial reporting.

Business law and
ethics

Table of Contents
INTRODUCTION ..........................................................................................................................3
TASK 1............................................................................................................................................3
Enron scandal. ............................................................................................................................3
Corporate governance.................................................................................................................6
Sarbanes Oxley Act, 2002...........................................................................................................6
CONCLUSION ...............................................................................................................................7
REFERENCES................................................................................................................................8

INTRODUCTION
Ethical corporate governance means the policies and processes that company places to
deal with any issue that concern the conduct and administration of day to day operations of the
business. The company's main objective is to earn profit and it must ensure that it shall not
possess any unethical behaviour to achieve its goal (Brandt, 2018). This report is based on Enron
fraud scandal, committed in 2001 which became the most famed accounting scandal till date
now. After the scandal, there came a need to enact a law known as Sarbanes- Oxley Act,2002
which aimed to protect the investors through proper disclosure of accounts in a reliable and
accurate manner.
TASK 1
Enron scandal.
The Enron scandal is a series of events that has resulted in bankruptcy of US energy,
commodities and services dealt by Enron Corporation with a de facto dissolution of one of the
largest companies of auditing and accounting namely,Arthur Anderson LLP. The scandal took
place in 2001 which has more than $60 billion assets. This gave an alarm to the US legislatures
to improve the accounting standards for the companies.
History of Enron Corporation
Enron Corporation was founded by Kenneth Lay in 1985 with the merger of two
companies dealing in natural gas transmission, namely InterNorth INC and Houston Natural Gas
Corporation which were renamed as Enron. Kenneth Lay acquired huge debts and started
looking at different strategies to earn high profits. In 1990, Jeffrey Skilling was appointed and
was assigned a project for which an executive staff was developed by him who were successful
in hiding the million dollars debt of Enron by using accounting loopholes and poor financial
reporting (Kalinowski, 2018). From 1996-2001, Enron corporation was named as 'America's
Most Innovative Company” for its business model.
Timeline of scandal
During the establishment of Enron, the natural gas and electricity was under the state
monopoly but it started trading online when the government announced deregulation of energy
market as it was free from government of USA scrutiny. Then subsequently Enron launched the
first online trading website with a name EnronOnline in 1999. The company even invested in

many trading ventures which converted into contracts and were sold to investors. Subsequently,
the prices of stock went high for Enron and it became the most innovative company in America.
With business rising at heights, the Enron was suffering from huge debts but the
executives were able to hide it through accounting frauds and setting partnerships which resulted
in generating imaginative revenues and the losses were hidden. Creative accounting was adopted
which would in-fluctuate the assets and profits of the company (Na and Younies, 2020). The
company even successfully brought new investors who were ready to make money by showing
fraud earnings.
Another reason for downfall was the company made artificial crisis of energy in
California which increased their chances of manipulating the power supplies and thereby charged
excessive prices for the same.
Key players in scandal
Jeffrey Skilling, the CEO of the Enron Corporation developed successfully the financial
instruments which could fraud the accounting system of the company and hide the real position
thereby showing profits earned by the company.
Andrew Fastow, Chief Financial Office was liable to make $30 million secretly by
managing partnerships to cover the losses of the company. When Enron made loss of $60
million, Fastow was responsible for engineering off balance sheet of partnerships.
David Duncan, the Chief Auditor was liable for shredding the documents of Enron to
hide them from SEC (Securities and Exchange Commission).
Political implications in scandal
The CEO of Enron, Kenneth Lay was close to Bush family and he even provided millions
of dollars to Bush for its campaign of 2000 election. The executives of Enron met Vice President
to discuss the administration's energy plan of Bush.
How it came into limelight
In 2001, Kenneth Lay announced for the retirement and named Jeffrey Skilling as the
President and CEO but retained as Chairman of Enron. After few months, Jeffrey Skilling also
resigned unexpectedly and cited personal reason behind his resignation and also sold large
amount of his shares. Subsequently, the stock prices dropped and this prompted the Wall Street
to question the financial health of the company. Kenneth Lay also sold his shares when the prices
dropped. The price went from $83 dollar to less than dollar.

The whistler blower behind the scandal was Sherron Watkins, the Vice President alerted
Kenneth Lay regarding the irregularities in accounting system in financial report. She was
assigned a task to find assets for selling off but it became a difficult task so a memo was
prepared which stated various problems in Enron's accounting system but it was never
considered. So in August 2001, she alerted Kenneth regarding irregularities and in February,
2002. she revealed various facts from Enron Partnerships and resigned from the post of Vice
President. But the revelation was done after Enron was filed for bankruptcy.
In 2001 October, the US Securities and Exchange Commission opened the formal
investigation on the partnerships of Enron which was headed by Jeffrey Skilling. The SEC even
formed a special committee to examine all financial transactions of Enron Corporation. The
company itself revealed that it was hiding losses due to deals in partnerships. Enron even
admitted that it has overstated the profits by $600 million.
Then in 2001 November, the investigation of Securities and Exchange Commission
extended to Arthur Anderson for its audit frauds and in December 2001, the Enron Corporation
filed for Bankruptcy. In January 2002, the justice Department began criminal investigation
against Enron.
What was held
During investigation, it was found that Arthur Anderson tried to hide tons of documents.
Kenneth tries to sought help from 2 cabinet ministers from The White House and then he
resigned from the post of Chairman and CEO. The head of the trading unit of Enron, Cliff Baxter
was even found dead in January 2002 at gunshot.
It was held that Arthur Andersen was convicted on 78 counts for 6 years imprisonment
and 2 years of probation. Kenneth Lay was convicted for 11 counts but died due to heart attack
in 2006 after he was found guilty the same year. Jeffrey Skilling was charged with 36 counts and
was sentenced but later agreed to become an informant for reduced sentence (Petra and Spieler,
2020).
Reasons for scandal
 There was lack of transparency in financial system which resulted in deceptive reporting
practice. The internal management easily showed imaginative earnings of the company
and no investor or shareholder was able to find it out which gave rise to deceptive
financial system.

 Another reason is 'mark to market' accounting which helped company to list their profits
as the projections rather than on their actual number.
 There was even lack of review process due to which the company was able to hide its
actual financial situation and showed profits. The corporation was easily showing energy
crisis which turned the situation in favour of company and it raised the prices due to
which it was able to generate more revenue.
 The lack of laws to protect the interest of investors and even the independent auditing
mechanism was missing which resulted in giving rise to this scandal.
Corporate governance
The concept of corporate governance refers to the rules, practices and policies that tells
how the top level management shall manage and oversee the business operations. It favours
principle of security, accountability and transparency. It is a system which direct and control the
companies. It helps in balancing the interest of the shareholders, senior management and other
stakeholders.
The corporate governance helps in balancing the relationship between internal and
external stakeholders. The concept was mainly highlighted during the Enron scandal when
problems arose in implementing this concept (Sorensen and Miller, 2017). The board of
director's moral character was lacking which resulted in their willingness to engage in fraudulent
activities and unethical management.
Sarbanes Oxley Act, 2002
This law is also called the 'Public Company Accounting Reform and Investor Protection
Act' and 'Corporate and Auditing Accountability, Responsibility and Transparency Act' designed
for the public company management, boards and public accounting firms. Its some provisions
can be applied to private companies as well. Due to rise in scandals like Enron, there was a need
to enact a law which could protect the shareholders and investors from being struck in big
scandals. This Act states the responsibilities for Top management like board of directors for
fraudulent activities and imposes penalty for misconducts (Nunziata, 2017). It states the
regulations for Securities and Exchange Commission which are to be complied by them.
The main reason for its enactment was the misdeeds and crimes committed by the
officers of Enron. The misrepresentation in financial position which resulted in heavy losses
suffered by the shareholders forced the enforcement of Sarbanes Oxley Act, 2002 so that there

can be provisions for independent audits, fair and true disclosure of financial health of the
company and even to protect the interests of the investors.
CONCLUSION
It is concluded from the above report that Enron corporation used deceptive practices and
showed imaginative earnings to attract the investments in the company. It used dubious
accounting system to reduce its tax and hide huge debts to show that the company is performing
well in the market to misrepresent its shareholders. After the investigation being initiated by
SEC, the investors faced heavy losses which even resulted in bankruptcy of the Enron
Corporation. After the scandal there was a need to enact a law which would protect the interest
of investors and bring the independent audits and transparency in accounting system, so Sarbanes
Oxley Act, 2002 was enacted.

REFERENCES
Books and Journals
Brandt, B., 2018. Sarbanes-Oxley: An Effective Solution?.
Kalinowski, C., 2018. Topical Analysis of the Enron Emails Using Graph Theory.
Na, T. and Younies, H., 2020. Corporate governance: on the crossroads of meta-regulation and
social responsibility. Journal of Financial Crime.
Nunziata, G., 2017. Accounting scandals: the dark side of success for top companies: an
extended perspective, with a specific focus on recent events.
Petra, S. and Spieler, A.C., 2020. Accounting Scandals: Enron, Worldcom, and Global Crossing.
In Corporate Fraud Exposed. Emerald Publishing Limited.
Sorensen, D.P. and Miller, S.E., 2017. Financial accounting scandals and the reform of corporate
governance in the United States and in Italy. Corporate Governance: The International
Journal of Business in Society.