Enron Fraud Scandal: A Massive Failure in Corporate Governance

This report discusses the Enron fraud scandal, highlighting the company's fraudulent practices and the impact on various stakeholders. It also explores the concept of corporate governance and the enactment of the Sarbanes Oxley Act to prevent future accounting scandals.

Business Law and
Ethics - Project 2 -
Individual Report: 50%

Table of Contents
INTRODUCTION ..........................................................................................................................3
TASK 1............................................................................................................................................3
Enron Fraud Scandal...................................................................................................................3
Corporate governance.................................................................................................................7
Sarbanes Oxley Act, 2002...........................................................................................................8
CONCLUSION ..............................................................................................................................8
REFERENCES................................................................................................................................9

INTRODUCTION
Accounting frauds is an intentional manipulation of the accounts statement so that the
financial health of any company is created falsely. The companies manipulate the accounts in
order to mislead the investors and shareholders so that the actual position of the organisation is
not foreseen. Enron Corporation has been a massive failure in terms of accounting standards. The
company began to rise and shine in the early years of its corporation but was simultaneously
hiding the huge debts in order to show sound financial position of the firm (Ali, 2020). The
concept of corporate governance got its relevance after the massive scandal of Enron
Corporation where the company failed to follow the concept of corporate governance. In order to
prevent further scandals, the government of USA took an initiative to enact a law on
transparency of accounting system so that the interest of shareholders are protected. This report
shall cover the notorious fraud scandal of Enron Corporation.
TASK 1
Enron Fraud Scandal
Overview of company
Enron corporation was established from the merger of two companies InterNorth and
Houston Natural Gas. The firm took ten years to build its empire of $60 billion. It was headed by
Kenneth Lay, the CEO and chairman of the organisation. The company had around 29000
employees before it went to bankruptcy. Enron was a public company dealing in energy,
pipeline, telecommunication, paper and electricity. The company earned the revenue of around
$101 billion in 2000 before the scandal was highlighted.
The Rise of the enterprise
During the establishment of Enron Corporation, the natural gas pipeline was deregulated
and the company lost its rights on pipelines. The CEO of the enterprise Kenneth Lay hired
Jeffrey Skilling so that a business strategy can be developed in order to grow. The company
acquired huge debts as a result of the deregulation. In 1989, Jeffrey Skilling came up with an
innovative strategy to deal in natural gas commodities by becoming an intermediary between the
supplier and the customers so that there can be solution for Enron's debts (Kulkarni, 2017). The
idea to build a network between consumers and suppliers resulted in energy derivatives which
helped to overcome the debts of the firm.

By getting so much impressed from Jeffrey, Kenneth Lay established a new division of
Enron corporation, that is , Enron Finance Corporation which dominated the natural gas contract
market under the leadership of Skilling and company was able to generate huge profits by
predicting future prices with much accuracy.
The best is yet to come now when Jeffrey Skilling started hiring top MBA candidates to
change the culture of the workplace so that it can become more competitive. He started rewards
systems to motivate the workforce. One of the key personnel hired by Jeffrey was Andrew
Fastow who soon became the Chief Financial Officer in 7 years. He advised to engage the
corporation with different partnerships so that they can successfully hide the debts of the
company and show imaginary profits (Puebla and Peterson, 2020). Fastow oversaw the
investments of the company and Jeffrey took responsibility of overseeing trading operations.
During 1990s, the corporation engaged itself in online trading where they were ready to
create any market for anybody who were willing to trade. The derivative contracts were made for
many commodities like coal, electricity, steel and paper. A new division was started, namely
EnronOnline to facilitate the trading in high speed by building the broadband network of
telecommunication.
The fall of Enron
When the company has risen in its boom years, there came an end to this when the
competition increased in energy trading business. The profits of the company began to shrank
and the investors and shareholders started pressuring the company to show the financial position
of the firm. It was the phase when the company started engaging itself in dubious accounting
system where a technique called ' mark to market' accounting was used to hide the debts of the
corporation. This accounting allowed the organisation to reflect imaginary profits and write the
unrealised future gains. Further the corporation engaged itself in Special Purpose Entities where
the trouble assets can be transferred to these SPEs which are the limited partnerships created
with some outside parties. Other companies use this practice to distribute their assets but Enron
misused this practice in order to show the losses less severe and illusionary profits were
highlighted. From here the downfall of Enron began.
During these practices, Arthur Andersen became auditor and consultant for Enron
Corporation and Andrew Fastow was entrusted to run these Special Purpose Entities (Seijts,
2017). The fall did not just stopped here, the situation went more severe when the CEO of the

company Kenneth Lay resigned from the office of CEO but retained as the member of Board of
Director. Jeffrey Skilling became the successor for CEO office. After few months, Jeffrey
Skilling also resigned by citing personal reasons as its cause for resignation. This made the
number of analysts question about the financial health of the company and they began to dig the
financial statements of the corporation which were publicly available.
The whistle blower for the scandal was the new Vice President, Sherron Watkins who
warned Kenneth Lay regarding the misrepresentation in financial statement and he assured her to
view the matter. Later on Kenneth asked Arthur Andersen to assist the matter. But nothing went
and later on during the bankruptcy of the corporation, Sherron disclosed the misleading
accounting practices to the investigation agency.
The internal investigation was initiated by signing a memorandum by the Vice President
and simultaneously the Securities and Exchange Commission began the formal investigation to
look into the transactions between Enron Corporation and partnership firms.
Investigation by Securities and Exchange Commission
During the investigation, the stock prices of the corporation began to see a drop and
gradually they dropped from $90 dollar to less than $1 dollar. Kenneth Lay and Jeffrey Skilling
resigned from their office and Andrew Fastow was being fired during the early investigation.
The company announced its loss of 618 million dollars and revealed that it had hide the
losses from 1997 and overstated the profits in order to show its sound financial position
(Sorensen and Miller, 2017). The rival company, Dynegy stated that it has backed out from the
deal of merging with Enron.
As the consequences from this investigation, Enron filed for bankruptcy and the criminal
investigation was initiated as confirmed by the Justice department.
Criminal investigation
When the justice department confirmed regarding the criminal investigation, the
following judgement was passed and the key players were punished by the court. Kenneth Lay
was charged with conspiracy and fraud and before passing of the sentence, he died of heart
attack. Jeffrey Skilling was charged for fraud, insider trading and conspiracy for which he was
sentenced for 24 years but was subject to reduced punished when he agreed to become the
informant against the Enron executives. Andrew Fastow was charged with money laundering,
conspiracy, fraud and insider trading to which he was sentenced to 10 years of imprisonment.

The Arthur Andersen LLP lost majority of its client and as a result it was dissolved. In
addition to this, many shareholders filed civil suits against Enron Corporation and Arthur
Andersen LLP.
What went wrong in the scandal ?
There were many issues which resulted the highlighting of this scandal, some of them are
discussed below-
 The auditor of Enron Corporation violated the principles of GAAP by permitting the
company to play games.
 The regulations of Public Accountant Practices was also violated by Arthur Andersen
because he was the internal and external auditor of the corporation.
 The assets which were showing loss of money were sold to different partnerships created
by SPEs and sale of asset were listed as earnings of the company.
 The company showed its major income as pension plan for the employees so that it is
able to contribute to deferred tax payment. As a result they enjoyed not paying tax to the
government.
 The relationship between different banking groups with the corporation contributed to the
scandal.
 The derivative activities took place in deregulated market which shows little or no
information regarding the profits of the company. This resulted in downfall for the Enron
Corporation.
Impact of the scandal
There are many people who are affected from the scandal which includes employees,
shareholders, competitors, government and customers (Zengin, 2019). The impact on these are
discussed below-On Employees
 The employees lost their jobs and retirement savings due to bankruptcy and scandal of
Enron.
 The workers of lower level were unable to sell their shares due to 401k restriction and
lost their lifetime savings. The employees also lost their pension funds.
On shareholders

 By filing the law suits, the shareholders got limited returns but lost huge money in stock
price.
 The shareholders suffered major loss after the bankruptcy as the company's stock price
went to 90 dollar before bankruptcy and fell to less than 1 dollar after it declared
bankruptcy. During settlement, only $7.2 billion were received as approved by the federal court and
the Enron holdings of many eligible shareholders became worthless.
On competitor The rival company, Dynegy backed out of merger deal from the Enron Corporation when
it was declared that there were financial irregularities in the company.
On customers
 After the bankruptcy of Enron, many customers of natural gas deposit lost their supply
source. There was power shortage and high cost for trading in natural gas as a result of which this
burden shifted on to the customers now.
On government
 This accounting fraud prompted government to amend the accountability law and pass a
new law which brings transparency to accounting system so that interest of shareholders
are protected.
 This scandal led to huge economic losses for the country.
Corporate governance
This concept refers to the combination of laws, rules and processes by which the
businesses are controlled, regulated and operated. The main purpose of the corporate governance
is to provide a prudent and effective management so that success can be delivered by the
company (Na and Younies, 2020). This concept got its relevance after the massive Enron scandal
where there was lack of corporate governance in the functioning of the business. The four main
pillars to this are management, internal and external auditors and the board of directors.
A good corporate governance ensures transparency, participation, effectiveness,
efficiency, rule of law, responsibility and accountability in the working of the organisation. The
fall of Enron resulted in questioning the effectiveness of the corporate governance practices. This

scandal shocked the countries around the world and now they are examining their corporate
governance in more detail.
Sarbanes Oxley Act, 2002
The business financial practices has got its comprehensive reform from the enactment of
Sarbanes Oxley Act, 2002. This Act applies to public companies and some of its provisions may
apply to the private companies as well. This law was passed to prevent further accounting
scandals from happening by setting new standards for corporate management and public
accounting firm.
The ongoing and extensive crimes and misdeeds by the executives of Enron Corporation
has urged the legislatures to enact a law which is capable of bringing transparency in accounts
and audits so that the interest of the shareholders and investors are protected (Hurson, 2016.). To
bring accuracy and reliability in disclosing the financial statements and prohibit the financial
disasters from happening, Sarbane Oxley Act, 2002 was passed.
CONCLUSION
From the above report, it is concluded that Enron Corporation has been a massive failure
and resulted in financial loss to the economy. This company has been engaged in misleading and
fraudulent practices from a long time which resulted in the bankruptcy of the corporation and
large number of employees have lost their jobs. The scandal has impacted many people like
shareholders, customers, government, customers and employees which has suffered financial as
well as economic losses. Further it is concluded that the concept of corporate governance has got
its relevance after this notorious scandal and a law was also enacted immediately after this to
protect the interest of the shareholders.

REFERENCES
Books and Journals
Ali, C.B., 2020. Agency Theory and Fraud. In Corporate Fraud Exposed. Emerald Publishing
Limited.
Hurson, D.J., 2016. Sarbanes-Oxley, Dodd-Frank, Retaliation, and Reward: Representing Clients
in the Age of the Whistle blower. ABAJ Lab. & Emp. L.. 32. p.381.
Kulkarni, A.D., 2017. Emphasizing Sustainable and Balanced Growth through Integrated
Reporting. IBMRD's Journal of Management & Research. 6(2). pp.1-7.
Na, T. and Younies, H., 2020. Corporate governance: on the crossroads of meta-regulation and
social responsibility. Journal of Financial Crime.
Puebla, I.G. and Peterson, M., 2020. The Important Roles for Transparency and Standards in
Marketplace Agreements. Marketing as a Social Science: Festschrift für
Universitätsprofessor Dr. Dr. hc Helge Löbler. p.187.
Seijts, G., 2017. Enron Explained (Reading). Leadership in Practice: Theory and Cases in
Leadership Character.
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.
Zengin, S., 2019. Corporate Scandals and Systemic Risk. In Handbook of Research on Global
Issues in Financial Communication and Investment Decision Making (pp. 316-338). IGI
Global.