THE ROLE OF FINANCIAL BODIES ON ENRON CASE

Author: Iloka Benneth Chiemelie
Published: 30th March 2017

1.      Introduction

The case of Enron is the most cite case in terms of describing regulatory dissatisfaction in the USA. The case received such hype that even the Senate conducted an investigation in relation to the company’s transactions during the Bush’s administration. Following the investigation, the SEC and congress made findings that show how blown out the crisis was (Browning, 2002). The Enron scandal also had ripple effects in the industry as other corporations were forced into the crisis. This scandal also had effects on the company’s former auditor, Arthur Anderson LLP, losing customers and forcing itself into regulatory restricting as other corporations started pulling out in order to avoid being the next financial victim, but some still ended up as victims.

The whole issue happened in such an unravelling speed that it gathered huge interests both home and abroad. The issues started in 2001 when Skilling took over the position of Enron’s CEO, as the company’s stocks began failing and never recovered throughout the year. In March, a number of financial analysts started to express their concern about the company’s inflated stock price with Fortune magazine having the major say by nothing business activities in the company that were too good to be true (Browning, 2002; Clifford, 2002). This was followed by the CEO resigning just six months into the position, leading many more people to concur with existing views that the company is in big financial danger, and their stocks started to plunge further into the red zone.

Within the shortest possible time, the situation worsened and in October, Enron made the announcement that of its third quarter earning 2001. Analysts was this as an opportunity to conduct detailed review of the company’s SPVs and findings indicate that (both to the knowledge of Enron and its auditing firm) that some SPVs were not qualified to be listed as independent entities; as the company posted  report of $533 million after tax while reducing shareholders equity down to $1.2 billion. This forced the company to cite the major cause of this problem to be its transactions with LJM2, with a major part of the company’s share being shortened the same day (Francis, 2002).  On the 22^nd of the same month, SEC did request Enron to present information about its dealing in terms of LJM2 in order to allow them address recent communications that are contained in their balance sheet and this resulted to the company’s shares plunging further down same day. Fastow, the company’s supposed representative took a leave of absence on the 24^th of the same month, and this forced the federal government to set up a committee for special investigation on the case. By 8^th of November, Enron made the announcement that it will be making certain adjustments on its annual and quarterly balance sheet back from 1997’s annual report. In the same report, the company noted that the causes of such adjustments were its LJM1 and LJM2 SPVs.

Between October and November of the same year, the company revisited its Chewco transactions with the auditor and they both came to the conclusion that JEDI and Checo should have been added into Enron’s balance sheet (Grimm, 2002). If such was the case, the company would have witnessed a huge restatement on its income and debt, and this would have been avoided in a situation where the Chewco accounts meet the 3% rule that is necessary for independent consolidation as an SPV.

Just a matter of months following the issue issues, Enron went from being US’s largest and most influential company into a bankrupt brand that is under government investigation. The company’s stock experienced a 60% fall from January to august of 2011, and it also repeated the same volume of 60% fall in stock from early period of September down to early November (Hamel, 2002). As such, it is evidently clear that a number of lessons can be learned from the company’s sharp boom and sudden burst. Accounting professionals can also be linked to the situation and this is the overall objective of this research paper.

2.    Effects of accounting and auditing standards on corporate scandals

Probably the most baffling question when it comes to the case of Enron is how the company’s accountants and lawyers allows such scandalous activity to occur although it is mandated that the company consults them prior to making any publications about its financial statement. The significance of this question is raised when considering the fact that they were all consulted prior to any financial decisions made about the company’s balance sheet and SPVs. One of the factors that have been identified in numerous studies is that rules relating to auditing practice in the country are too rigid and does not provide necessary room for accounting professional to innovate around it. The second argument is the case of conflict of interest where the accountants play significant role in terms of covering up the company’s financial negativities in order to sustain investment (normally for based on the understanding that such will come with personal financial gains to them).

2.1.           Roles of accounting regulations on financial scandals

It is important to note that two other companies have also had similar scandalous issues within the same industry that Enron operates in the past. These issues occurred in 1930s and 1990s respectively. As a remedy to avoid future occurrence, the government did enact rules that can be adopted as the basis for restricting such incidence in the future. These rules were effective at that point in time, but new accounting approaches did weaken them.

Generally, explicit rules can be considered excellent when measuring them against the purpose they were created for in the earlier days. However, as time passed their effectiveness weakened in the regulatory cycle due to the financial industry finding new ways to dodge around these rules (Hubbard, 1994; Keller, 2002). These policies also attracted criticism as certain elements where deemed unfit for the risks they represent. For instance, rules allows for independent representation of SPVs so long as they external shareholders have at least 3% of the total shares. Under normal setting (such as in the case of sale and lease back), these rules can be effective because the associated risks were not much. However, under huge financial risks such as in the case of Enron, they tend to be less effective. In any case, the financial industry has taken full advantage of this weakness and it now seems more like a norm in the financial settings of the big corporations.

As such, Enron took advantage of this flaw by declaring its assets as well as making necessary disclosures that are aligned with the settings established by the terms. Thus, while the company was under-preforming, it was both legal and easy for its accounting professionals to cover up business flaws by adopting the disclosures contained in these regulations. The most significant aspect of this is that while the auditors might view their actions as being protective of the company’s present financial setting, they tend to neglect the fact that it could be pushing the company further into a bigger crisis (Labaton, 2002). This is also evidence in the case of Enron where it as noted that the company decided on readjusting its financial statements from 1997, which represents a long-year back in terms of manipulated data and misleading information being published on its annual report.

2.2.           Influence of accounting professional on financial scandals

In most cases (both in the issue of regulation discussed above), accounting professional have significant role to play when it comes to misrepresentation of financial data. The influence can be in the case of such firm being directly linked to the principal agent as indicated in the case of Enron where it was discovered that the major shareholders of Enron where also part of the management board for Anderson, the auditing firm. Thus, this strong link makes manipulation of data easier as transparency is hindered. Under normal setting, it is expected that Enron should have employed the service of an independent auditing firm (Marshall and Subu, 1994; Michael et al., 2002). That would have ushered in necessary transparency in the auditing process as they will be more likely to question the company on ambiguous and potentially misleading financial representation, and also notify the company in cases where such is expected to have direct impact on the country’s investment outcomes. The decision of Enron to adopt the service of Anderson (which it has been doing since 1983) made it impossible for these issues to have been identified. As a result of long-term partnership, Anderson was not made just the auditing and accounting firm, but was also made the consulting firm in terms of financial related issues. Eventually, this ushered in a new era of tight relationship, which would consider any decision of the company to either question Enron or reveal its financial mayhem a conflict of interest. In a bid to retain the existing relationship, Anderson also resorted to keeping their financial flaws a secret. There are indications that since its inception, Anderson recorded its highest financial performance ($25 million) in 2000 for accounting and auditing related services, with another $27 million in the same year for consulting services, which was used to invest on Enron’s SPVs (McKinnon and Greg, 2002). These are close indicate of financially influenced decisions to keep the company’s poor financial performance at bay from the sight of regulatory bodies and keep misleading the investors and general public at large.

Even in cases where the auditing firm is made to be independent of the principal agent, chances still arise that they scored be lured into such unethical behaviour in the accounting profession. In order to make way for their intended financial misconducts, these accounting professionals normally looks for loop holes in the accounting regulatory systems which is the case of Enron as their activities were purely based on taking chances of the existing loop holes in the regulations. It is worthy to note that this is never the intention of the regulatory bodies that make these laws, but it is increasingly becoming evident that these loop holes as unavoidable as accounting firms will always find a way of moving around. Thus, conclusion can be drawn in this case that accounting professionals play significant role when it comes to fraudulent financial activities across industries (McKinnon and Greg, 2002). This is because they represent the bridge between the company’s actual value and the value that the company presents to the public – making it easier for them to manipulate such values in order to gain desired financial reputation.

3.    Conclusion

Financial crisis does not seem to elude businesses as decades after decades, new crisis that change the business sphere does emerge. One could be forced to ask questions as to why the government allow such or if there are no rules that regulate the business process. The answer is not farfetched as a simple review will show that there are countless rules enacted to regulate the business process. However, the financial professionals who are supposed to be executing their professional business in line with these rules are actually the ones foiling them. They take their time to study these rules, identify loop holes and advantage of these loop roles to device a means for conducting fraudulent activities with the companies they work force. It is not surprising that corporations are always looking for new ways to bud tax, make more profit and expand their business process – thus, one should expect that these issues could plunge them into take advantage of the financial industry to reach their selfish interest.

In conclusion, it can be deduced from this study that accounting professionals have a role to play when it comes to financial scandals that behalf industries. This is because they are enacted by law to regulate the financial processes and analyse any information that companies intend to publish to the general public. Yes, they see flaws and intentionally cover them up for a number of reasons as indicated in this study. It can be to present higher values about the company and attract more investors in the process, or to gain higher financial performance in the form of compensation that the company pays them for such services. Whichever is the case, it is should be noted that such is an unethical accounting practice and should be avoided under all circumstances.

4.    References

Browning, E.S. (2002) “Burst Bubbles Often Expose Cooked Books and Trigger SEC Probes, Bankruptcy Filings.” Wall Street Journal.

Clifford, L. (2002) “What’s in a (Hip, New) Name?” Fortune 6 April 2001. Online. ProQuest. Duke University Libraries, Durham.  

Francis, J. (2002). Enron symposium: Financial Reporting, Legal and Governance Issues Associated with the Enron Situation. Durham: Duke University.

Grimm, D. (2002). “Reporting Value in the New Economy.” CMA Management July-August 2001. Online. ProQuest. Duke University Libraries, Durham.

Hamel, G. (2002). “Driving Grassroots Growth.” Fortune 4 September 2000. Online. ProQuest. Duke University Libraries, Durham.

Hubbard, R, G. (1994). Money, the Financial System, and the Economy. New York: AddisonWesley Publishing Company, Inc.,.

Keller, B. (2002). “Enron for Dummies.” New York Times 26 January 2002. Online. ProQuest. Duke University Libraries, Durham.

Labaton, S. (2002) “Audit changes are Facing Major Hurdles.” New York Times 24 January 2002. Online. ProQuest. Duke University Libraries, Durham.

Marshall, D, and Subu, V. (1994). “Bank Capital for Market Risk: A Study in Incentive-Compatible Regulation.” Chicago Fed Letter.

Michaels, A., Michael, P., and Peter, S. (2002). “SEC Gets Tough amid Enron Fallout.” Financial Times 19 January 2002. Online. ProQuest. Duke University Libraries, Durham.

McKinnon, J, and Greg, H. (2002). “How Treasury Lost Battle to Quash a Dubious Security.” Wall Street Journal 4.