Enron Corporation, once the 7th largest company in US and a global leader of electricity and natural gas industries, filed for bankruptcy protection in late 2001. It was revealed that the company had been hiding investment losses and created fictitious revenue through several complicated accounting gimmicks. Besides Enron’s senior management who created the whole fiasco, many people believed that several other parties, such as the Board of Directors and the external auditors should also share the blame. The public began to question the integrity of US corporations, especially surrounding the fiduciary duties of Boards of Directors, conflicts of interest between the role of auditor and the advisory unit, as well as moral standards of business management.
At that time it was the largest bankruptcy in history. The empire that Enron built over several decades was destroyed within mere weeks when the scandals were made public. This eventually led to the disintegration of the Arthur Andersen and the enactment of the famous Sarbanes-Oxley Act that aimed at enhancing reporting and internal governance standard of public companies.
The first issue is the lack of independence of the board of directors and their breach of fiduciary duty. The Board of Directors has the legal and ethical duty of monitoring the company’s management on behalf of the shareholders. The members should remain independent and should always examine the company’s operations with great care. In Enron’s case, the Board of Directors was comprised of members who were too close to the senior management to act objectively. Many of them also served on the board for over 20 years. They were much less likely to be unbiased and to question the company’s business model. In addition, the board members received twice the national average compensation and had little incentive to complain about current operations. Despite receiving a huge compensation, the board members ignored many red flags and did barely the minimum to fulfill their fiduciary duties. They relied solely on the information provided by a few members of senior management and failed to notice the severe breakdown of communication channels among key stakeholders such as the auditors and internal employees other than the CEOs and CFO.
The senior management was also guilty of tolerance and encouragement of risky and reckless business practices, benefiting personally from fictitious accounting numbers and not acting in the company’s best interests. Former CEOs Kenneth Lay and Jeffery Skilling and CFO Andrew Fastow were the key people in the whole Enron debacle. They built a culture that rewarded irresponsible risk-taking behaviour. They purposefully ignored warnings about problematic accounting practices and hid information from the public as well as the Board of Directors. Most importantly, to the anger of the public, each of them received millions of dollars from all of the questionable transactions that eventually destroyed billions of dollars in company value.
Finally, accounting firm Arthur Andersen and several major banks were guilty of conflicts of interest and knowingly assisting Enron’s fraudulent practices. The accounting gimmicks that Enron used are extremely complicated and they could not have been achieved without the involvement of the auditor and major banks. As Enron’s external auditor, Arthur Andersen was supposed to ensure the quality of Enron’s finance reports but it failed to fulfill this duty. The reason that the auditing team remained silent was the conflict of interest between its auditors and the consultant role. Enron was, at that time, also AA’s major consulting/ business advisory client. AA collected an enormous amount of consulting fees from Enron every year and they would not want to risk losing this revenue stream. Similarly, banks such as Merrill Lynch and Citigroup generated huge profits from the Enron account every year and had every incentive to cooperate with the Enron management.
After the Enron scandal, the public was outraged and blamed everyone who was related, including all Enron and Arthur Andersen employees. Since then nobody would want to be associated with these two companies. In my opinion, only the top officials should be held responsible. In class students were asked if they would refuse to be corrupted under similar circumstances and most of us agreed that it would be a difficult decision to make. It is a tough decision not only because of the huge amount of money involved, but also because of peer pressure. In Enron, the dominant office culture was to be aggressive and earn as much money as possible.
Top performers were saluted while bottom strugglers were asked to leave. Eventually some employees began to make risky decisions that were not in the company’s best interest in hope of staying ahead of others and ultimately most employees followed. When most employees are involved in some sort of unethical behaviour, refusing to be corrupted would only result in one of two consequences: either you resigned or became the bottom 15% and were fired. If you were not one of the top officials, your job was on the line and it was not a simple choice of whether you wanted to be ethical or not. This is very common in many companies, where only the employees that generate the most profit have the say on company direction and ethical standard. Not every one of them will turn into Enron but it should be a concern for top management.
Similarly, I believe it would be unfair to blame the whole Arthur Andersen team. To my understanding auditors are in general very ethical professionals. I do not believe the Enron audit team was any different and the reason they failed to fulfill their duty must be because of pressure from AA’s top management, who cared only for income from the consulting business. Due to the conflicts of interest mentioned above, it is not difficult to imagine AA’s consulting division “recommending” that the auditing team comply with what Enron suggested. The top management was at fault for putting the auditors in such a difficult situation.
Promoting an ethical mindset among company leaders remains the key to avoiding another Enron scandal. Also, regulators should create an environment in which all employees would be comfortable becoming a whistleblower. Society and the media should depict whistleblowers as heroes and reward them with reputation so that employees would not be afraid to step up and reveal unethical practices to the public. In 2012 former Olympus CEO Michael Woodford became a media hero after he revealed the company’s fraudulent accounting practices to the public. This would certainly give other future whistleblowers encouragement, knowing that such behaviour will be well-received in the media. On the other hand, former Goldman executive Greg Smith was not as lucky when he questioned the culture of Goldman Sachs. Many critics said that bad-mouthing a former employer is wrong and that Mr. Smith will have problems looking for a new job. I have no idea whether Mr. Smith was telling the truth but I do not think he should be punished in any way for raising his concerns. Nobody will be willing to step up if Goldman Sachs is truly corrupted one day.
After Enron and WorldCom fell, regulators scrambled to enact new legislation to restore the integrity of the business world. The result was the 2002 Sarbanes-Oxley act, which established new standards for external auditor independence and mandated that senior executives take individual responsibility for the accuracy of financial reports. Although shareholders are now better protected with the new regulations in place, Enron is unlikely to be the last company that tries to take advantage of legal loopholes. Human greed and the illusion of “too smart to be caught” will always lure managers to find new ways to commit business crime. It is essential for the business community to promote business ethics and encourage whistleblowing behavior in order to prevent another major business scandal.