The Fall of Enron-An Analysis of Ethical Issues

ENRON & ARTHUR ANDERSEN ETHICS ESSAY

The Fall of Enron

An Analysis of Ethical Issues

Xiaomeng Wang

    

 

 

 

 

 

 

 

 

 1.     Introduction

Although Enron went bankrupt and disappeared ten years ago, the impacts it has made on the ethical standards never faded.  It took Enron 16 years to go from about ten billion dollar assets to more than sixty-five billion dollar assets, and took twenty-four days to go bankrupt. (McLean & Elkind, 2004)

Enron, which once ranked as the seventh-largest company on the Fortune 500 and ranked as the sixth-largest energy company in the world, on December 2, 2001, filed for bankruptcy protection in the biggest case of bankruptcy in the United States up to that point (Jennings, 2009, p. 285).  By November 2001, the company’s stock, which once peaked at $90 US, was down to less than $1 US.  It was a disaster for the thousands of employees and investors (Skilling v. United States, 2010).  Employees lost their jobs and pensions, and investors lost billions of dollars.

The Enron scandal is one that left a deep and ugly scar on the face of modern business.  In this article, the facts of Enron’s case were reviewed and the major ethical issues involved in Enron’s scandal were analyzed.  The rest of the paper is organized as follows.  The second part is a brief summary of what has happened in Enron. The third part described the role of Arthur Andersen (AA) in the Enron scandal.  In the following parts the culture of Enron, the important people involved in this case, and also the major ethical issues about this scandal were analyzed.  At last, the conclusion part discussed what we should do to avoid another Enron.

 

  1. 2.     Statements of Facts

2.1.            A Brief History of Enron

Since found in 1985 as an interstate pipeline company, Enron had been a power supplier to utilities.  Its business began through the merger of Houston Natural Gas and Omaha-based InterNorth.  In the following 20 years, Ernon grew quickly and became the largest energy trader in the world.  By the end of the twenty century, Enron had many honorable titles, such as “one of the world’s leading electricity, natural gas, and communications companies”, “the world most admired corporations”, and so on.  (Skilling v. United States, 2010)

In the following years, with the increase of competition, Enron decided to use diversification and international investment to keep its market position.  Actually, these activities brought Enron an unexpected large amount of losses rather than profits.   In 1999, after a foray into fiber optics and the broadband market, which was a wrong decision again, Enron suffered too many substantial losses and began bleeding quickly.  However, Enron had never declared any information about its losses until October 2001.  Instead, in these years, Enron achieved a phenomenal bottom-line through overstating revenues and hiding liabilities. For example, the revenue numbers for 1998, 1999, and 2000, were $40 billion, $60 billion, and $101 billion respectively.  Besides manipulated the financial statements, Enron never mentioned the risks which it should disclose to its investors.  On the contrary, the executives of Enron disclosed a great earnings forecast through the media and encouraged investors to purchase Enron’s stocks.  They also suggested their employees invest their pensions in Enron’s stock or stock options.  Arthur Andersen, the audit company for Enron, helped Enron hide these frauds for five years.  Every time when analysts or Enron’s employees expressed their doubts about Enron’s financial condition, Enron would try to keep them quiet and fired them later. Meanwhile, top executive embezzled.  The executives also drove up the stock price and put a large amount of money into their own pockets through trading stocks. (Skilling v. United States, 2010)

Because of those frauds, from 1998 to 2001, the stock price peaked at $90 US.  “By December 2000, Enron’s shares [were] selling for $85 each, its employees [had] their 401(k)s heavily invested in Enron Stock, and the company [had] a matching program in which it contribute additionally shares of stock to savings and retirement plans when employees chose to fund them with Enron stock” (Jennings, 2009, P.356). Therefore, both investors and employees suffered heavily from this disaster when Enron collapsed.

Problems began erupting in 2001.  Jeffrey Skilling, the CEO, departed in August of 2001.  Then in October 2001, Enron reported a loss of $618 million.  Following that, Chief financial officer Andrew Fastow was replaced, and the Securities and Exchange Commission (SEC) began investigating the company.  After about one month, in late November, the SEC found off-the-books entities and overstated revenues, and then the company’s stock was down to less than $1 US.  Finally, on December 2, 2001, Enron filed for bankruptcy protection.  Investors lost billions of dollars.

All the people involved in this shocking fraud went on trial, including the executives of Enron, Arthur Andersen and some other persons or companies who were involved in the fraud.  In January 2004, Andrew Fastow , the CFO of Enron, agreed to a plea bargain and a 10-year sentence.  In February, Jeffrey Skilling, the CEO of Enron, was sentenced to 24.4 years (Skilling v. United State, 2010).  Besides that, the court punished Arthur Andersen by stopping their auditing work. Following that punishment, Arthur Andersen also went bankrupt and disappeared.

2.2.            The Role of Arthur Andersen in Enron Scandal

Arthur Andersen (AA) had served as Enron’s outside auditor since 1985.  Two years after the collapse of Enron, Arthur Andersen went from an international firm of 36,000 employees to nonexistence.  In AA’s 16 years relationship with Enron, besides external auditing, AA also provided Enron internal auditing and consulting services.  From 1997 to 2001, Enron overstated its profits by $568 million, 20 percent of Enron’s earnings for those four years.  Andersen auditors helped Enron hide this earnings manipulation.  On June 15, 2002, Andersen was convicted of obstruction of justice for shredding documents related to its audit of Enron. (Arthur Andersen v. United State, 2005)

Arthur Andersen contributed to the Enron scandal in four aspects.  Firstly, facing the false financial condition, AA never disclosed it.  Enron was one of AA’s major clients.  In order to avoid the loss of this big client, AA helped Enron cheat on its financial statements. This action is not only unethical, but also illegal.  To avoid losing this big client, AA determined to violate the standards.  From the ethical aspect, AA should have stopped this fraud early.  Instead, AA chose to act illegally to earn profits.

Secondly, AA provided Enron external auditing, internal auditing and consulting services at the same time, violating accounting and auditing standards because there are conflicts of interests among these services.  “There was a fluid atmosphere of transfers back and forth between those working for AA doing Enron consulting or audit work and those working for Enron who went with Andersen” (Jennings, 2009, p. 354). This conflict of responsibilities of AA didn’t follow auditing standards and were illegal.

In addition to the conflict of responsibilities, the violation of independency also existed because there were close relationships and interest conflicts between AA’s employees and Enron’s executives.  David Duncan, the audit partner who was in charge of the Enron account, was a close personal friend of Enron’s chief accounting officer. Meanwhile, there were many high level executives of Enron from AA.  For example, in 2000, seven AA auditors joined Enron (Jennings, 2009, p.355). Additionally, many AA employees had permanent offices at Enron and kept close relationships with the employees in Enron. All of these affected the independence of auditors from AA.

Fourthly, AA destroyed many papers and documents of Enron after Enron’s scandal was disclosed.  Without those papers and documents, SEC encountered many difficulties when they investigated the fraud of Enron.  Nancy Temple, AA’s in-house counsel, advised the destruction of documents (Jennings, 2009, p.358). This action is both unethical and illegal.

2.3.            The Important People in the Enron Scandal

In the case of Enron, some persons performed ethically and the others did not.  For example, John Olson, Margaret Ceconi, and Clayton Verdon, three employees in Enron, chose the right things to do and performed ethically.  However, there are also many other people who just kept silent or even did the things which are obviously unethical or even illegal, such as the executives in Enron, Ken Lay, Jeffrey Skilling and Andrew Fastow, as well as the auditors from Arthur Andersen, David Duncan . In the following paragraph, I will talk about the persons involved in this case.

Kenneth Lay is the founder, chairman and CEO of Enron. All the facts of the fall of Enron show that Lay is a person who is dishonest and lacks integrity. Under his leadership, Enron was involved in fraud, causing investors to lose billions of dollars.  In 2001, although known the risky financial condition of Enron, Lay still announced to employees and investors that the future growth of the company has never been more certain and urged them to invest in Enron stock further. Meanwhile, in the August of 2001, he sold a substantial amount of his own shares of stock (Jennings, 2009, p.293).  His announcement increased the price of Enron’s stock further and accelerated the bankruptcy of Enron.  At last,  Lay destroyed the companies he built.

The second person we need to mention in Enron’s case is Jeffrey Skilling. He was the president COO, and also served as CEO from Feb. to Aug. 2001. Mr. Skilling said in his testimony, “We are on the side of angels” ( Jennings, 2009, p.295). But obviously, they were not.  In August 14, 2001, he left the company without disclosing any financial problems of Enron.  He just said that he wanted to spend more time with his family. However, he sold 500,000 shares on September 17, 2011(Jennings, 2009, p. 293).  Before his departure, he also did many things which seem unethical. For example, Bethany McClean, a Fortune reporter, asked Skilling some questions about profit margin. And Jeffrey Skilling refused to answer that question although at that time he knew about the financial condition of Enron. He never disclosed the problems to the public.  Additionally, before the Congress, he denied any knowledge of the financial manipulations until the bankruptcy of Enron.  He waived Enron’s Code of Ethic and led Enron to a death.

The third person who played an important role in Enron is the CFO, Andrew Fastow.  He was directly responsible for Enron’s disaster.  He was the person who manipulated the financial  numbers for Enron.  He said, “Within the culture of corruption that Enron had, that valued financial reporting rather than economic value, I believe I was being a hero. I thought I was a hero for Enron. At the time, I thought I was helping myself and helping Enron to make its numbers” (Jennings, 2009, p.293).  He was a principal in many of the off-the-book entities and earned a lot of money from these entities.  In the whole case, he is dishonest.

The fourth person I want to mention is David Duncan, the audit partner who was in charge of the Enron account. The story and ethical issues about him have been introduced in the previous part.  Facing business dilemmas, he chose profit and violated the auditing standards and contributed to the cheat of Enron.

The last person is an ethical model. She is Sherron Watkins, the vice president for corporate development at Enron. She brought the financial situation of Enron to public light by preparing a memo which disclosed the financial situation of Enron.  Although she known she would lose her Enron job, she continued preparing the reports and just looked for a new job.  In the dilemmas, she was one of the few people who chose to disclose the truth even if put herself in the risk of losing her job.

3.     Ethical Dilemmas  

3.1.            Factors contributed to unethical behaviors

Enron’s culture contributed much to the ethic scandal.  Enron was a harsh and condescending company, who emphasized competition and financial goals.  For example, it had a rating system which required that 20 percent of all the employees had to be rated as below requirements every year and then were encouraged to leave Enron (Jennings, 2009, p. 288).  Although Enron hoped this rating system could have encouraged employees to work hard, actually, the system brought more harm to Enron than benefits.

Firstly, Enron’s competitive environments and rigorous performance evaluation standards caused a culture of deception.  Since employees were nervous about losing their jobs, they only focused on how to make their performances look good.  They ignored the ethical standards, and only focused on the achievement of their financial goal.  After a few employees began cheating on their works, the only way to beat these persons was to cheat more.   Gradually, no persons felt shame about cheating because they had no other choices and all their co-workers surrounding them were cheating.  This caused a culture of deception.  Employees were measured on their abilities to cheat.  In such an environment, the people who never cheated were regarded as odd.  For example, Margaret Ceconi, an employee with Enron Energy Service, once wrote a memo about the truth of accounting issues of Enron; she was later counseled on employee morale (Jennings, 2009, p.290).

Secondly, this competitive environment contributed to the covering of the errors and cheating because employees tended to be uncooperative and seldom communicated with each other.  The employees were unwilling to ask questions because asking questions was regarded as humiliating.  Besides that, they were also less willing to share resources and information because they competed with each other.  So in Enron, no persons asking questions as well as no one want to answer questions.  Because of this working environment, few employees at Enron actually understood their jobs.  As a result, they just tried to hide errors and made their work look good.  Additionally, they ignored the errors and cheatings of others.  They never mentioned their doubts about others’ works.   Because they thought if others were not actually wrong, the person who mentioned questions would be laugh at.  So employees at Enron were quiet.

Additionally, the culture of Enron emphasized too much on the financial goals.  The person who can achieve the budget numbers would be the hero of the company.  Both executives and most of employees focused on making profits for themselves through making good financial numbers instead of a real increase of the company’s economic value. Enron also was concerned less about the needs, values, desires and also the well-being of the employees.  From the ethical aspect, employers should respond to their employees and keep the goal of benefiting them.  In such a company, ethical standards were just window dressing. No one followed them.  For example, the conflict of interest policy was waived to let the officers of Enron served as officers in off-the-book entities.

Fourthly, Enron tried to keep its employees and outside parties quiet.  Employees were discouraged from expressing doubts about the financial condition of the company as well as decisions made by the executives.   In these years when it committed fraud in its financial statement, Enron hurt both people inside and outside of Enron, who doubted Enron’s financial conditions. For example, John Olson, an analyst with a Houston company, lost his job because Olson advised his client not to invest in Enron since he had questions about how Enron was making money.  Another example was that Clayton Verdon, a former employee of Enron, was fired in November 2001 for posting his comments about “overstating profits” in an employee chat room (Jennings, 2009, p. 291).  Therefore, employees in Enron were pressured to work blindly, keep silent, protect their own short-term interests, and try to achieve their goals even if it was an obvious cheat.

This evil culture contributed to Enron’s scandal.  At Enron, both executives and most of employees behaved unethically when they encountered conflicts of interests.  They were greedy and self-interested.

3.2.           What Should We Do?

If you were one of these persons, what would you do?  You have many questions about the condition of the company, and depending on your business intuition, you feel there must be some problems at Enron.  But if you ask questions or mention your opinions, you will be hurt right now, such as lose your job, or receive unfair reviews.

In the Utilitarian Theory, Philosophers Eremy Bentham and John Stuart Mill argued that “resolution of ethical dilemmas requires a balancing effort in which we minimize the harms that result from a decision even as we maximize the benefits” (Jennings, 2009, p. 6). In this theory, when we make decisions, we should consider the interest of all the parties who are affected by our decision and choose the actions which can maximize the benefits.  We can just do the most good that we can.  It is an ethical dilemma—protecting our own interest with a predicted harm to all the investors, or just protecting most of stakeholder’s interest and give up our own short-term interest.   According to the Utilitarian Theory, the answer is obvious.  The Categorical Imperative and Immanuel Kant theories stated a standard “you cannot use others in a way that gives you a one-side benefit” (Jennings, 2009, p.6).

Furthermore, we can apply the test mentioned in The One Minute Manager. Ask ourselves the following three questions: Is it legal? Is it balanced? How does it make me feel? If I were an employee of Enron, I would think about the answers for the three questions above.   Firstly, according to my business intuition or some threads, I feel the company may commit fraud.  It’s illegal to help the company hide fraud.  Secondly, if I disclose this information to public, I may lose my job. Otherwise, if I hide the information, more people will suffer, such as the investors and stockholders of Enron.  Thirdly, I need to disclose these to public and try best to stop the fraud of Enron although I may lose my job. Hiding the facts I know and letting others suffered from that facts, make me feel guilty.

 

  1. 4.     Conclusion

In the case of Enron, we saw the weakness of human beings. The executives of Enron are really smart guys, but they destroyed the fortune they built in 16 years and also hurt many investors.  The fundamental cause of this disaster is that they lack the idea of the business ethic.  Therefore, when the executives encounter dilemmas, they chose the wrong way. To avoid another Enron, I have three suggestions for companies in today’s business world.

Firstly, companies should think about their corporate culture carefully because companies’ culture will impact the decision of both the employees and employers when they face ethical dilemmas.   As discussed in the third part, Enron’s culture brought many bad results and contributed to its fraud and bankruptcy.  Enron had competitive environments and rigorous performance evaluation standards.  Besides that, Enron only focused on its financial goals.  If Enron gave more job securities to their employees, there might be less cheating on work.  Additionally, employers could not make so many decisions if they cared about the interests of their employees and other stakeholders.  Therefore, companies should build a healthy corporate culture.

Secondly, companies need to build a robust ethics infrastructure and follow it in the daily business.  Only having ethical codes is far from enough.  Enron had a well written code of ethics, but many unethical behaviors still happened.  So companies should write a code of ethic and communicate it to all the employees.  If you have an ethical code, you should try your best to follow it. Don’t make your code of ethics be window dressing.  Instead, companies should make ethical standards common sense in every person’s mind.

Thirdly, companies need to learn business ethics theories and models because they are the ethical basis in all the situations.  For example, in these theories and models, the impacts of your decisions and the interests of related parties are emphasized.  These ethics and models give out good ways of balancing the interests of all the related parties, so they can help you make the right decisions when you face ethical dilemmas.  Executives of business should have a good knowledge of business ethics.  Then when they encounter dilemmas, they can know what to do.

Therefore, to avoid another Enron, companies should consider whether they have a healthy business culture, whether they have a well-written code of ethics and also follow the code, and whether the employers and employees have enough knowledge about business ethics.

 

Reference:

 

McLean, B., & Elkind, P. (2004). Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (2th Ed.). Portfolio Trade

Marianne M. J. (2009). Business Ethic Case Study and Selected Readings (6th Ed.). Salt Lake City, UT, U.S.A.: South-Western Cengage Learning

Skilling v. United States, 561 U.S.__ (2010)

Arthur Andersen LLP v. United States, 544 U.S. 696 (2005)

 

 

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