Sarbanes-Oxley Act of 2002
Research Paper
Imagine over $60 billion of shareholder value, almost $2.1 billion in pension plans,
and initially 5,600 jobs – disappeared (Associated Press, 2006). One would have to
wonder how that is possible. These are the consequences the investors and employees of
Enron Corporation endured after the Enron scandal started to unravel. This paper will
focus on the infamous accounting scandal of Enron Corporation. It will also discuss how
the company was able to fool investors by producing misleading financial statements, why
they were not caught sooner, and new regulations enacted in response to the scandal.
Enron Corporation was a leading American energy company located in Houston, Texas.
The company was started in 1985 when Houston Natural Gas Omaha-based InterNorth
merged together (Thomas, Rise and Fall of Enron). Today, Enron Corporation is most
widely known for their 2001 accounting scandal, which led to the biggest audit failure and
largest bankruptcy in American history. After Mr. Jeffrey Skilling, Enrons President, was
hired, he began to build up a staff of top executives that were able to conceal billions of
dollars of debt the company had incurred from failed projects and deals. Therefore, even
when Enron was failing, they appeared to investors as profitable and growing. The staff
worked together and was able to cover their debt through the use of complex accounting
methods, special purpose entities (SPEs), various loopholes, and poor financial reporting
standards. Enron aggressively recognized revenue using the merchant model (Haldeman,
Fact/Fiction) which inflated trading revenue and helped create the notion that Enron was
experiencing high growth and remarkable business performance. They adopted
mark-to-marketing accounting which requires that once a long-term contract is signed,
income is estimated as the present value of net future cash flows (Haldeman, Fact/Fiction)
which also contributed to misleading numbers on Enrons financial statements. Enron also
used hundreds of special purpose entities, which are limited partnerships or companies
created to fulfill a temporary or specific purpose-to fund or manage risks associated with
specific assets, to hide its debt (Thomas, Rise and Fall of Enron). The company contained
a compensation and performance management system that focused on temporary earnings
to maximize bonuses, which only helped foster the reasons for the executives to conspire
and mislead everyone, including Enrons board of directors and audit committee of any
accounting issues and Enrons actual financial condition. Enron executives pulled every
complex tactic in the book.
Even though the Enron executives were able to mislead Enrons board of directors and
audit committee, they should have been stopped. Public companies are audited on a
yearly basis by external, independent auditors or CPA firms. During the external audit,
auditors are reviewing the companys financial statements to ensure that they are
consistently following Generally Accepted Accounting Principles (GAAP), which are a
dynamic set of both broad and specific guidelines that companies should follow when
measuring and reporting information in their financial statements (Federal Accounting
Standards Advisory Board). Businesses may deviate from GAAP however, they are
responsible for explaining why they have deviated and that their current non-GAAP
practice is ethical and appropriate for their situation. These audits take place to ensure
that the companys financial statements are as accurate and reliable as possible for investors
and the general public. While GAAP provides guidelines on how financial statements
should be presented, Generally Accepted Auditing Standards (GAAS) on the other hand
are standards for the audit cycle of a company such as which tests to perform and to what
extent (Business Definition). Arthur Andersen was the CPA firm responsible for auditing
Enrons financial statements. Under GAAS, they had a responsibility to investors and the
general public to ensure that Enrons financial statements were accurate and reliable as
there were many people who relied on Andersens professional opinion of Enrons financial
statements. One of the major items in GAAS states that auditors must remain independent
in both fact and appearance. However, Arthur Andersen was not only auditing Enron,
they were consulting for them as well. The consulting that Arthur Anderson was doing for
Enron brought in a lot of revenue therefore, they did not appear independent. Although
various auditors documented conflicts with the audit committee of Enron and several other
concerns, the leading partner on the audit, David B. Duncan, overturned the issues and
concerns. Due to the active role Arthur Anderson had in Enron Corporation, they
overlooked many accounting concerns and the fraud was undetected for a long period of
time.
However, the truth about Enron was eventually brought to light for the investors,
employees, and the general public. The accounting misstatements were discovered Enron
told investors they were going to restate their earnings for the past few years. Shortly
after Enron restated their earnings, the company declared bankruptcy. Also, Sherron
Watkins, an Enron Vice President, wrote an anonymous letter to Kenneth Lay who stepped
up as Enrons CEO after Skilling left due to “personal reasons”€. Sherron Watkins”€™
letter questioned Enrons accounting methods and also proposed that Skilling left due to
dishonest accounting and other illegal actions (Frey, Woman Who Saw Red). From there,
other people began to speak up and question how it was possible that Enron was
continuing to make money. Eventually, an investigation by the SEC was initiated to
review Enrons accounting procedures and their partnerships. Shortly after the
investigation, Enron officials admitted to overstating the company earnings for multiple
years. Today, Enron no longer exists and Arthur Anderson is no longer performing audits.
