This paper examines the Enron financial statement fraud scandal, tracing its origins from the company's founding in 1985 through its dramatic collapse and the dissolution of its auditing firm, Arthur Andersen. The paper identifies greed and lax oversight as the primary drivers of fraud, explains how executives used special purpose entities and falsified documents to hide massive debt, and analyzes the insider trading that accompanied the cover-up. It then assesses the wide-ranging consequences for investors, creditors, employees, and the perpetrators themselves, before concluding with a discussion of the Sarbanes-Oxley Act as the central regulatory reform that emerged from the scandal.
The Enron case made headlines when investors and employees realized that the company's accounting practices were not consistent with what the company was actually reporting to them. Eventually, those dishonest accounting practices led to the bankruptcy of the Enron Corporation and the dissolution of its accounting firm, Arthur Andersen (Foerstel, 2002). That accounting firm had been among the five largest in the world, but its auditing of Enron and the deceit in which it became involved proved to be its downfall. In order to understand clearly how this happened, it is necessary to describe the case, examine the factors that led to the fraud, identify what specific fraud actually occurred, and assess the effects on the various groups of individuals who were affected — both directly and indirectly — by Enron's demise. It was not just the employees or the investors who ended up damaged by the deceit.
Enron was formed in 1985 by Kenneth Lay. Several years later, Jeffrey Skilling was hired by the company and he developed a strong staff of high-powered, highly paid executives (Feinberg, 2002). Those executives focused on loopholes in accounting regulations and engaged in poor financial reporting. Special purpose entities were also created to hide billions of dollars in debt from failed projects and deals. Andrew Fastow, the Chief Financial Officer, along with several other executives, misled the Board of Directors and the audit committee regarding the high-risk accounting practices they were pursuing. They also pressured Arthur Andersen to ignore the issues the firm was observing (Feinberg, 2002). Arthur Andersen did not have to comply with those high-pressure tactics, but the firm chose to go along, in part because of the substantial financial perks that came with doing so.
Various factors contributed to the fraud at Enron, but the primary one was greed. When Jeffrey Skilling and Andrew Fastow realized they could manipulate the system and conceal deceptive practices from the Board of Directors and other oversight bodies, they took full advantage of that opportunity. They focused on hiding millions of dollars of debt and exploited every accounting loophole they could find to ensure that the Board and others who might have spotted the fraud did not notice it (Borger & Teather, 2002). When the fraud was finally discovered, it brought down both Enron and Arthur Andersen. Enron's stock became virtually worthless overnight, and the collapse of the accounting firm meant it could never fully recover — even after it was eventually cleared of the most serious charges. Too many clients had been lost by that time, and the trust was broken. Once trust in a company managing one's money is lost, it is very difficult to regain (Anderson, 1999), and the scandal received so much media coverage that the names Enron and Arthur Andersen became synonymous with corporate fraud.
Another factor that contributed to the fraud was how easy it was to perpetrate (Feinberg, 2002). No one caught on for a long period of time, and Arthur Andersen was complicit in the scheme. When the problem was finally discovered, there was significant speculation about whether Arthur Andersen had knowingly participated or had itself been deceived. Ultimately, it was determined that the accountants actively working with Enron were aware of what was taking place, but that others within the firm — and the firm as a whole — did not know. That finding led to the firm eventually being cleared of charges; however, the scale of the scandal was such that being cleared did not matter in practical terms. Arthur Andersen was still forced to close its doors due to the collapse of its client base. Because Enron's executives exercised such control over the company and were collectively complicit, it was relatively easy for them to falsify documents and misrepresent financial information.
The fraud consisted primarily of the falsification of documents and financial information to make it appear that the company was profitable when, in fact, it was deeply in debt and on the verge of collapse. On paper, the company looked strong — but Enron's CFO and other executives could translate that paper strength into real-world advantages by manipulating documents, enabling the company to secure credit lines and continue attracting investor capital. No one wants to invest in something that is clearly failing (Keller, 2002), and in order to keep attracting major investors, Enron needed to project the image of a company that did not need their money. It is far easier to attract investment from a company that appears financially healthy (Keller, 2002).
That was not the only form of fraud that occurred. Individuals within the company who realized they were about to be exposed began selling their Enron stock before the price collapsed. This constituted fraud because they used material, non-public insider information to make significant profits on their stock sales immediately before Enron's problems became public knowledge. Selling such large volumes of stock should have raised red flags, since there would be no obvious reason to liquidate those holdings if the company were still performing as well as it appeared.
The defrauding of employees and others who had placed their trust in Enron was a serious issue that was difficult to address on many levels. It was deeply frustrating and distressing for people who had devoted their careers to the company and suddenly found that they had nothing to show for their time, effort, and investment. Those who perpetrated the fraud did not escape legal consequences, but the legal outcomes did not restore what so many people had lost. Those who had been wronged were left with anger and difficult memories, with little else to show for their years at Enron.
"Financial losses and devastated retirement savings"
"Criminal penalties and Sarbanes-Oxley Act origins"
"Ongoing risks and cautious trust in corporate America"
Always verify citation format against your institution’s current style guide requirements.