Enron the Answer to the First Question

Enron

The answer to the first question is that the executives at Enron committed accounting fraud. The company had grown rapidly to become one of the largest firms in the United States, theoretically building a business in energy trading. Even before the scandal broke, the company did not produce accurate financial statements, if it produced them at all. The company used a number of unorthodox techniques to create its financial statements, essentially distorting the statements so that they did not accurately reflect the company's business.

The three basic things that Enron did were to create special purpose entities to hide the company's debt; recording transactions improperly to make the company's revenues appear larger than they were; and adopted unusual techniques for accounting such as the use of mark-to-market accounting for non-financial projects. These different techniques made the company's revenue look larger than they were, and made Enron's debt look smaller. This allowed it to continue to borrow, thereby defrauding the company's creditors.

The company's attitude towards ethics was demonstrated in its response to criticisms about its lack of transparency. The company claimed it did not want anybody to know how it made its money. In addition to contradicting SEC policy on the matter, this statement shows a clear intent to mislead investors and regulators alike. The CEO used a term that cannot be printed here to describe an analyst who questioned why Enron did not have a balance sheet.

One of the more notable failures at Enron was with its external auditor, Arthur Andersen. That firm overlooked all of Enron's shady accounting practices because it had a lucrative consulting business with the firm. This eventually led to the downfall of Arthur Andersen when Enron finally collapsed, as clearly it had not performed its role as auditor professionally.

The second question is a good one. There are a number of explanations for why Enron happened. Certainly, the regulatory environment was favorable. Not only where the business media largely enamored with Enron because of its apparent performance, but the regulatory community was as well. The SEC approved its use of mark-to-market accounting for energy derivatives, but just as important was the fact that the SEC failed to hold Enron accountable for not producing a balance sheet and for the questionable nature of its other financial statements. This helped to facilitate a culture that already existed within Enron.

The Enron corporate culture was essentially one of arrogance and a total lack of ethics. The company had profited from the California energy crisis, and was unrepentant about that. It has been asserted that over the years Enron generally developed lower and lower ethical standards. This came from the top of the company, but eventually it flowed through the entire organization. The company's ethical standards eventually became so low that many in the organization were either actively perpetrating fraud or took an amoral approach the issue, failing to even consider if their behavior met any sort of ethical standard.

A few things were done in the wake of the Enron scandal. Sarbanes-Oxley was passed, with two key provisions that related specifically to Enron. The first was the separation of auditing duties from consulting duties, so that accounting firms cannot do both for the same client. This eliminates a key conflict of interest that enabled Enron. The second is that the CEO and CFO of public corporations are legally liable for the accuracy of financial statements. The result of this is that they can be tried and imprisoned if they allow inaccurate statements such as those at Enron to be published. This gives the SEC and Department of Justice addition tools with which to fight the types of fraud perpetrated at Enron. In addition, the company was broken up and Arthur Andersen taken to court. The executives at Enron were prosecuted and many received considerable prison sentences, which should act as a deterrent to the commission of such behavior in the future.