Business & Professional Ethics
for Directors, Executives &
Accountants, 8e
Leonard J. Brooks and Paul Dunn
Cengage Learning, Boston, MA, 2018
Chapter 2 – Ethics & Governance Scandals
Chapter Questions and Case Solutions
Chapter Questions………………………………………………………….2
Case Solutions……………………………………………………………….9
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Chapter Questions
1. Do you think that the events recorded in this chapter are isolated instances of business malfeasance,
or are they systemic through the business world?
The events chronicled in this chapter range over an eighty-year period from 1929 to 2010.
During that time there were horrendous business failures, frauds and debacles that cost
2. The events recorded in this chapter have given rise to legislative reforms concerning how business
executives, directors, and accountants are to behave. There is a recurring pattern of questionable
action followed by more stringent legislation, regulation, and enforcement. Is this a case of too little
legislation being engaged too late to prevent additional business fiascos?
No amount of legislation can ever prevent crimes from occurring. One key to preventing
additional business fiascos from occurring is to create a business environment in which the focus
3. Is there anything else that can be done to curtail this sort of egregious business behavior other than
legislation?
Yes, boards and directors and executives can be educated to understand that unethical behavior
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4. Many cases of financial malfeasance involve misrepresentation to mislead boards of directors
and/or investors. Identify the instances of misrepresentation in the Enron, Arthur Andersen, and
WorldCom cases discussed in this chapter. Who was to benefit, and who was being misled?
Additional information on each case is included in Chapter 9 of the sixth edition of the text, which is
Enron
Misrepresentation
Result
Who Benefited
Premature recognition of revenue
using ‘prepays’
Overstatement of
revenue
Syndication of special purpose
entities (SPEs)
Understatement of
expenses
These frauds resulted in net income and
stock to increase, which benefited senior
management that had lucrative stock
Investors, regulators, employees and the general public were all mislead and harmed by this
fraud.
Arthur Andersen
Misrepresentation
Result
Who Benefited
Culture focused on revenue
production primarily through
non-audit services
Compromise on audit
quality
In the short-run, all the partners who
shared in the profits derived from
providing lucrative non-audit services to
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WorldCom
Misrepresentation
Result
Who Benefited
Capitalized expenses
Overstatement of net
income
No oversight of the CEO
Ebbers, Sullivan, and all the other
WorldCom executives and board members
fraud.
5. Use the Jennings “Seven Signs” framework to analyze the Enron and WorldCom cases in this
chapter.
Jennings ‘Sign’
Enron
Pressure to meet goals,
especially financial ones
Senior executives had
lucrative stock options
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6. Rank the three worst villains in the film Wall Street: Money Never Sleeps (2010). Explain your
ranking.
• Alan Loeb and Stephen Schiff, who wrote the screenplay, for simplifying a complex issue and
attempting to make money by being the first to present a fictionalized account of the
7. In each case discussed at some length in this chapter – Enron, Arthur Andersen, WorldCom, and
Bernie Madoff – the problems were known to whistleblowers. Should those whistleblowers each
have made more effort to be heard? How?
Whistleblowers in these cases did not use all of the following steps:
• Begin by talking to an immediate superior or relevant company official. At Enron and
WorldCom this would probably have been someone in the accounting or internal audit
8. The lack of corporate accountability, and an increased awareness of inequities and other
questionable practices by corporations, led to the Occupy Movement. Identify and comment upon
additional recent instances which have led to concerns over the legitimacy of corporate activities.
• Manipulation of LIBOR rates – see discussion in Chapter 2
• Over-leveraging of investment houses during the subprime lending scandal – see discussion
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9. It seems likely that the top executives of the major banks involved in the manipulation of the LIBOR
rate were aware of the manipulations, and of the massive profits and losses caused by those
manipulations. Why did they think that such manipulations could continue to be undetected,
and/or unpunished?
At least some senior bank officials were probably aware of the manipulative practices because
they had gone on so long. Also, the problem appears to have been generally known to insiders,
10. The new anti-bribery prosecution regime involves serious charges and penalties for bribery in
foreign countries during past times when many people were bribing in the normal course of
international business, and penalties were not levied. Is it unreasonable to levy extremely high fines
at the beginning of the new regime, and/or not to limit the period over which bribery can trigger
those fines? Why and why not?
Reasons supporting high fines at the start:
• Sends a strong message to leave no doubt of the risks of bribery
Reasons against high fines at the start:
• Unfair to levy high fines on unsuspecting companies
Conclusion – High fines are probably reasonable
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11. At GM and Takata, whose improper actions finally came to light, a whistleblower raised objections
to the actions before or very early in the production process. Why were their concerns ignored and
risks taken? In VW’s case, why didn’t a whistleblower come forward? What aspects of governance
were lacking in each company?
At GM and Takata the whistleblower’s concerns were not taken very seriously. Neither company
had a whistleblowing program that brought complaints to the senior officers and directors of
the company. The culture in both companies was also not encouraging to whistleblowers. In
GM, the dominant pressure was to keep costs low, so changes that would increase costs were
ignored. The potential harm, cost and reputational loss involved was simply not taken into
12. The CEOs of Valeant Pharmaceuticals and Turing Pharmaceuticals took the view that they could jack
up the price of their drugs by huge percentages because they could, and they failed to consider
seriously enough whether they should. Whose fault was this? In a well-functioning corporate
governance system, what measures should be in place to control such actions?
The CEOs of Valeant and Turing had, for some time, gotten away with the strategy of buying
fully developed drugs for which alternatives didn’t exist and jacking up their prices to sky-high
levels, and this would have continued except for the public outcry and political scrutiny that
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13. What are the reactions and outcomes that can be attributed to the leaked Panama Papers?
The Panama Papers release shocked the public and regulators, and galvanized both into action.
The public outcry against leaders and others who were evading taxation in the countries they
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Case Solutions
1. Enron’s Questionable Transactions (Chapter 2, pages 108-112)
What this case has to offer
The Enron Debacle is the icon for massive fraud allowed by failure of the company’s governance system
and the conflicted interests of its executives, auditors and lawyers. It precipitated the loss of credibility
Teaching suggestions
I use the PowerPoint slides on my website for instructors. First, I set up the topic of governance;
second, I use “Enron Affair” to review the important elements of the case; and finally I use “Enron
Debrief” to debrief, and review the rest of the material in Chapter 2 and models used in the course.
Depending on the audience (non-accounting or accounting), I review less or more of the details of the
fraudulent transactions. My PowerPoint provides a basic set. The key is to reveal enough that all
audiences understand:
• Basic governance structure and roles of the Board, executives, professional accountants and
lawyers, as well company policy (particularly on conflicts of interest) and compliance
systems.
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• The role of an ethical or unethical corporate culture in preventing or abetting fraud.
• Why whistle-blowing is important.
Discussion of Ethical Issues
The following questions are presented in the text for discussion of the significant issues raised in the
Enron case:
1. Which segment of its operations got Enron into difficulties?
2. How were profits made in that segment of operations (i.e. what was the business model)?
3. Did Enron’s directors understand how profits were being made in this segment? Why not?
Apparently they did not. They should have queried how almost 50% (See PPT 16 for the
4. Enron’s directors realized that Enron’s conflict of interests policy would be violated by Fastow’s
proposed SPE management and operating arrangements because they proposed alternative
oversight measures. What was wrong with their alternatives?
The Board’s alternative controls were left to Fastow to institute, oversee and presumably report
5. Ken Lay was the Chair of the Board and the CEO for much of the time. How did this probably
contribute to the lack of proper governance?
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“Kenny Boy” did not serve as a useful foil or overseer of his own CEO actions, as a good
independent Chair of the Board should. The inherent conflict of interests in being CEO and Chair
6. What aspects of the Enron governance system failed to work properly, and why?
7. Why didn’t more whistleblowers come forward, and why didn’t some make a significant difference?
How could whistleblowers have been encouraged?
See PPT 37. If you were contemplating coming forward, and you knew that Enron’s culture was
unethical (see examples) and the bosses knew it, would you come forward? – Not likely,
8. What should the internal auditors have done that might have assisted the directors?
They should have been alert for flaws in Enron’s conflict of interest policies, and any lack of
9. What conflict of interests situations can you identify in:
• SPE activities
• Arthur Andersen’s activities
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10. How much time should a director of Enron have been spending on Enron matters each month? How
many large company boards should a director serve on?
This depends on the complexity of the company’s operations, the competence and trust placed
11. How would you characterize Enron’s corporate culture? How did it contribute to the disaster?
Enron’s corporate culture was unethical (see PPTs 17 and onward). It was fraught with conflicts
of interest, unethical and also illegal and acts, poor examples were set by directors and
Subsequent Events
May 25, 2006
From Sunseri, Gina, and Rottman, Sylvie (May 25, 2006). “Enron Verdict: Ken Lay Guilty on All Counts,
Skilling on 19 Counts.” ABC News,
“Lay, 64, was convicted on all six counts against him, including conspiracy to commit
securities and wire fraud. He faces a maximum of 45 years in prison. Lay also faces 120
years in prison in a separate case.
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“Skilling, 52, was convicted on 19 counts of conspiracy and fraud. Combined with his
conviction on one count of insider trading, he faces a maximum of 185 years in prison.
Skilling was acquitted of nine other charges relating to insider trading.
Useful Articles, Links and Videos
C-Span (October 25, 2010). “Q&A with Bethany Mclean, author of All the Devils are Here and Smartest
Gibney, Alex (2006) Film “Enron: The Smartest Guys in the Room” [film preview, video footage and
Rose, Charlie (January 21, 2002). “A Conversation about Enron’s Declaration of Bankruptcy”[ including a
series of one-on-one discussions and panels with for journalists, the then SEC chairman, political
Time [Enron scandal webpage containing many links to stories] at
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2. Arthur Andersen’s Troubles (Chapter 2, pages 112-120)
What this case has to offer
Arthur Andersen (AA) will forever be a key part of the Enron SOX chain that accelerated changes in the
accountability and governance paradigm for corporations and the accounting profession. In fact, AA’s
Teaching suggestions
I use the PowerPoints in my Author’s Course download for Session 2 (PPTs 23-36) to discuss the case.
The key issues are:
• What happened and who did it?
Discussion of ethical issues
The following questions reveal the key points of the case:
1. What did Arthur Andersen contribute to the Enron disaster?
AA failed to protect the interest of current and future shareholders, and stakeholders that relied
2. What Arthur Andersen decisions were faulty?
Business & Professional Ethics for Directors, Executives & Accountants, 8e
3. What was the prime motivation behind the decisions of Arthur Andersen’s audit partners on the
Enron, WorldCom, Waste Management, and Sunbeam audits – the public interest or something
else? Cite examples that reveal this motivation.
It was revenue generation and retention. They served their self-interest rather than the public
4. Why should an auditor make decisions in the public interest rather than in the interest of
management or current shareholders?
An auditor is the agent of the shareholders, and is elected annually at the Annual general
5. Why didn’t the Arthur Andersen partners responsible for quality control stop the flawed decisions of
the audit partners?
6. Should all of Arthur Andersen have suffered for the actions or inactions of fewer than 100 people?
Which of Arthur Andersen’s personnel should have been prosecuted?
I don’t think so, because it seems unfair to the many innocent partners, staff and audit client
stakeholders that lost value because of the resulting discontinuity. I further do not believe that
7. Under what circumstances should audit firms shred or destroy audit working papers?
Given the developments in the AA Case, audit working papers should not be destroyed before
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8. Answer the “Lingering Questions” in the case (p. 119 in the text).
See the answer to Question 6 above. I do not think that the Big 4 firms could be shrunk to the
Big 3 in the future because it would not be seen to be in the public interest. I think that other
Subsequent events
July 15, 2003:
From Feeley, Jef (July 15, 2003). “Andersen Worldwide settles Enron Suits.” Financial Post, FP9:
“The network of foreign accounting firms once linked to Arthur Andersen LLP will pay
US$40-million to resolves lawsuits stemming from Enron Corp.’s collapse…
May 31, 2005:
The Supreme Court of the United States unanimously reversed AA’s conviction due to serious
flaws in the jury instructions.
As of 2008, there were over 100 civil lawsuits pending against AA.
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Useful Articles, Links and Videos
C-Span and Washington Journal (January 21, 2002). “Arthur Andersen and Enron .”
C-Span and Department of Justice Briefing Room (Mar. 14, 2002). “Arthur Andersen Indictments [video]”
firm Arthur Andersen with obstruction of justice.”
“Mr. Castellano discussed proposals to regulate the accounting industry as a result of the Enron
bankruptcy and the failures at Arthur Andersen…”
Oppel, Richard and Eichenwald, Kurt (January 16, 2002). “Enron’s Collapse: The Overview; Arthur
Andersen Fires an Executive for Enron Orders.” The New York Times,
http://select.nytimes.com/gst/abstract.html?res=F50A1EF9385C0C758DDDA80894DA404482
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3. WorldCom: The Final Catalyst (Chapter 2, pages 120-127)
What this case has to offer
When WorldCom announced massive overstatements of profit in June 2002, it completely shattered the
trust in corporate accountability and governance that President Bush and others had been trying to
Teaching suggestions
I review the events after Enron and up to SOX, and I indicate how it galvanized the development of SOX.
I then deal with the questions listed below.
Discussion of ethical issues
The following questions were presented for discussion of the significant issues raised in the case:
1. Describe the mechanisms that WorldCom’s management used to transfer profit from other time
periods to inflate the current period.
2. Why did Arthur Andersen go along with each of these mechanisms?
AA may not have known about the manipulations, or at least some of them. Cynthia Cooper,
Vice-president for Internal Audit was apparently the first to identify the irregularities. According
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3. How should WorldCom’s board of directors have prevented the manipulations that management
used?
An ethical corporate culture should have been developed that would have encouraged the
personnel who were ordered to manipulate to whistle blow. If scrutiny and analysis by internal
4. Bernie Ebbers was not an accountant, so he needed the cooperation of accountants to make his
manipulations work. Why did WorldCom’s accountants go along?
Because they thought they could get away with it for a while and that when profits returned
5. Why would a board of directors approve giving its Chair and CEO loans of over $408 million?
The Board did not recognize the risk that Ebbers would misuse the funds borrowed. To some
6. How can a Board ensure that whistleblowers will come forward to tell them about questionable
activities?
A protected whistleblower mechanism is vital, and its use must be encouraged by top
Useful Articles, Links and Videos
WorldCom Fraud Info Center [Website no longer active in 2017.]
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Faber, David (September 9, 2003). “The Rise and Fraud of WorldCom: Former CEO Ebbers talks in CNBC’s
The CNBC news show, “The Big Lie: Inside the Rise and Fraud of WorldCom,” January 2005
This 55 minute CNBC news documentary exposes the extent of the WorldCom fraud. Viewers
will gain insight into the actions, decisions, and deception of several key participants, including
the then-chairmen of AT&T and Sprint as well as the WorldCom capacity planner who
constructed the growth model.
“WorldCom Chief Guilty [video]” (March 16, 2005). CBS News,