A Hard Fall In December 2000, Enron claimed to have tripled its profits in two y

Question

A Hard Fall

In December 2000, Enron claimed to have tripled its profits in two years. Even as recently as this summer, Enron was still seen as an amazing success story. However, there were warning signals indicating the coming collapse as early as March 2001.

On March 5, 2001, Fortune magazine writer Bethany McLean published an article that questioned Enron's method of making money. In August 2001, Enron vice president Sherron Watkins sent an anonymous letter to the CEO of Enron, Kenneth Lay, describing accounting methods that she felt could lead Enron to "implode in a wave of accounting scandals."

Also in August, CEO Kenneth Lay sent e-mails to his employees saying that he expected Enron stock prices to go up. Meanwhile, he sold off his own stock in Enron.

The real collapse began when, on October 16th, Enron announced a loss of $638 million, partly due to the failure of its Internet investment.

On October 22nd, the Securities and Exchange Commission (SEC) announced that Enron was under investigation. On November 8th, Enron said that it has overstated earnings for the past four years by $586 million and that it owed over $6 billion in debt by next year.

With these announcements, Enron's stock price took a dive. This drop triggered certain agreements with investors that made it necessary for Enron to repay their money immediately. When Enron could not come up with the cash to repay its creditors, it declared for Chapter 11 bankruptcy.

Grading
1. Describe how Sarbanes-Oxley would have helped Enron (5 points)

Source: http://www.pbs.org/newshour/extra/features/jan-june02/enron_past.html

Explanation / Answer

The three major factor that led to collapse of Enron are Enron’s weak internal control, deceptive treatment of special purpose entities, and the conflicting interests that were present between them and their chief external auditor, Arthur Andersen.

Enron’s internal control system was the first factor leading to the company’s collapse. Arthur Andersen performed some of Enron’s internal audit work as well was the company’s external auditor at the time which is a clear breach in auditing policy, because of the extreme amount of differences between an internal and an external audit . Enron also turned over to Arthur Andersen some responsibility for its internal bookkeeping, blurring a fundamental division of responsibilities that companies employ to assure the honesty and completeness of their financial figures.

Enron’s board waived the company’s conflict of interest policy to allow its CFO to invest in the corporation’s special purpose entities, then failed to follow up to ensure the mandated compensating controls were being adhered to

Enron’s managers failed to identify the major risks facing their operating areas and develop control practices and procedures for employees to follow .

At Enron, the board of directors appears to have been either unwilling or unable to fulfill its responsibilities. Although it is possible that Enron's board members did not understand the necessity of strong internal controls, it is far more likely that they understood the need but did not possess the knowledge or skills to implement an effective control system .

Enron abused Off-Balance Sheet Entities, where Enron had massive amounts of debt on their books, but they were able to keep it off their balance sheet and from affecting their inflated share price.

Now, had the Sarbanes-Oxley Act been there before hand, then it would have ensured closing loopholes in the accounting practices, helped strengthen its corporate governance rules, increasing accountability and disclosure requirements as well for its corporate executives, and corporation's public accountants and as well would have had the requirements for corporate transparency in reporting to shareholders in place which would have resulted in identifying the issues earlier and fixing them, taking corrective measures and not led to bankruptcy, if the issues continued and if else, this would have not happened at the first place

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