Enron Case Study

Introduction

On December 2, 2001 Enron Corporation filed for Chapter 11 bankruptcy. The nature of Enron’s business is primarily the trading and delivering of energy, natural gas and other physical commodities. The establishment of a deregulated energy market allowed Enron to grow from an ordinary pipeline company into one of the largest electronic traders acting as the middleman for utility companies worldwide. Prior to December 2nd, Enron was one of the most admired companies with a market capitalization of $80 billion. Enron was seen as a pioneer for creating marketplaces for deregulated commodities. However, the world would quickly realize that Enron was not as financially sound as it appeared to be. Enron’s stock value dropped from a high of $90 in August 2000 to a low of $0.26 per share just prior to bankruptcy. On November 28, 2001 the company’s bonds were downgraded to “junk” status. Over 4,000 Enron employees lost their jobs after the bankrupt declaration as well as losing a huge portion, if not all, of their retirement funds that were invested in Enron stock. The bankruptcy filing with over $13 billion in direct liabilities does not even cover liabilities not included in Enron’s financial statements and their list of creditors includes names such as J.P Morgan Chase, Citigroup and the Bank of New York, just to name a few.

The question remains: “What can be done to prevent a future Enron?” In my opinion, there are no specific methods that can completely eliminate the threat of a future Enron. The main reason in my opinion is because of GAAP. GAAP does not have a “definitive list of practices and that are generally accepted” (1). There is too much diversity in accounting principles that still remains. The better question is: “What can be done to reduce the threat of a future Enron?” The answer lies in the Sarbanes-Oxley Act.

Sarbanes-Oxley Act

The Sarbanes-Oxley Act came into force in July 2002 and introduced major changes to the regulation of corporate governance and financial practice. It established the Public Company Accounting Oversight Board to oversee the auditors of public companies to ensure fair and independent audit reports. The Sarbanes-Oxley Act is arranged into eleven 'titles'. As far as compliance is concerned, the most important sections within these eleven titles are usually considered to be provisions on auditors, audit committees, Officers and Directors, strengthen disclosure requirements, and tougher criminal penalties.

Sarbanes-Oxley imposes new auditor independence standards in response to concerns that Andersen's audits of Enron may have been compromised by the fact that the accounting firm was earning more from Enron for consulting services than for auditing. The SEC regulations also require both the lead and concurring audit partners for any client company to rotate off of that client's audit after five years, with a five-year time-out before they can return to audit that company. Other audit partners are subject to a seven-year limit with a two-year time-out. Smaller audit firms with five or fewer public audit clients and ten or fewer partners are not subject to the rotation requirements, but any work that would otherwise be barred by the rotation rules must be reviewed by the oversight board every three years. Once again, though, Congress and the SEC stopped short of more drastic measures, such as a proposal for mandatory rotation of entire auditing firms, rather than merely partners in such firms.

The audit committee of the board of directors at any public company gains new power and responsibilities, and there are more safeguards to ensure that audit committee members are not controlled by top management. Audit committees now must pre-approve numerous audit and non-audit services, although in many instances they may do so by putting in place policies and procedures to be followed rather than actually reviewing each decision. Auditors must communicate to the audit committee all "critical accounting policies" and any discussions of "material accounting alternatives" that may affect how results are reported.

CEOs and CFOs of public companies are required to personally certify the accuracy of various financial reports, with significant criminal penalties for false certifications (up to 10 years in prison for "knowing" violations; up to 20 years if "willful"). While the penalties sound significant, the government's difficulty in enforcing this provision will likely come in proving that a corporate officer's inaccurate certification was done at least "knowingly," as opposed to negligently or even recklessly.

In addition, if a public company makes a "required" accounting restatement due to "misconduct," that company's