ENRON ARTICLE

Enron, Andersen and the rise of accounting scandals

Although the Enron affair was a spectacular example of a major company brought low, it was by no means the largest in terms of the frauds and other misdemeanours that have come to light in corporate America since 2001. Its main claim to historical significance is that in the process a massive and previously highly regarded auditing and accounting multi-national—Andersen—was destroyed. In addition, fundamental questions have been raised about the relationship between the practice of auditing, the additional services that can be offered by auditors, and the control of accounting, auditing, and standard setting.

The practices that led to the investigation—and subsequent criminal charges—at both organizations arose largely because of the activities of Enron in creating so-called "Special Purpose Entities" (SPEs), the complicity of Andersen in their design, and their subsequent approval by Andersen, as Enron's auditors. The effect of these entities was to make Enron appear much less indebted than it really was. In the words of the authors of the Powers Report, a special investigative committee of the Enron board:

"The LJM1- and Chewco-related restatement (i.e, the restatement of Enron's accounts after "unwinding" the effects of the Special Purpose Entity partnerships created by Enron executives), like the earlier charge against earnings and reduction of shareholders' equity, was very large. It reduced Enron's reported net income by $28 million in 1997 (of $105 million total), by $133 million in 1998 (of $703 million total), by $248 million in 1999 (of $893 million total), and by $99 million in 2000 (of $979 million total). The restatement reduced reported shareholders' equity by $258 million in 1997, by $391 million in 1998, by $710 million in 1999, and by $754 million in 2000. It increased reported debt by $711 million in 1997, by $561 million in 1998, by $685 million in 1999, and by $628 million in 2000. Enron also revealed, for the first time, that it had learned that Fastow received more than $30 million from LJM1 and LJM2. These announcements destroyed market confidence and investor trust in Enron. Less than one month later, Enron filed for bankruptcy." (http://www.trinity.edu/rjensen/fraud.htm#Enron)

Apart from those Enron executives who profited from the SPEs directly, others reaped substantial (multi-million $U.S.) benefits because of the impact these arrangements has upon Enron's share price and therefore on the company's ability to issue share options rewards to its executives. For almost every employee not at the very top of the Enron organization the company's problems were compounded by the actions of the company's pension trustees, who reinvested massive amounts of the employees' pension contributions in Enron shares. When Enron eventually collapsed, the employees' pensions disappeared along with the company.

In both Andersen and Enron, tens of thousands of employees completely unconnected with the scandals lost their jobs and pensions. In addition, both Andersen and Enron are the target of hundreds of lawsuits. In the case of Andersen this could mean, if lawyers argue successfully for the organization's limited partnership status to be revoked, that every U.S. partner becomes liable to the full extent of his or her personal property. What is certain is that many partners at Andersen who had reinvested their life savings in the company on the assumption that it would never fail lost them all.

There are many Web sites that report on financial scandals. The best of these is probably:

http://www.trinity.edu/rjensen/fraud.htm

This huge site is run by Professor Bob Jensen of Trinity University in San Antonio, Texas. The site contains a more or less complete history of the Enron scandal, recorded via the day-to-day news reports of the period.
Professor Jensen's site on Special Purpose Entities is...

http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm

Note: not all links to other sites referred to in Professor Jensen's site are working.

The Economist http://www.economist.com/

The Economist is well-informed as regards the frauds and mis-statements, but most articles are available only for a fee.

As a result of Enron and other scandals, including Tyco, Global Crossing, and Worldcom, the U.S. government was forced to act, albeit with reluctance. (Enron in particular had given political donations to large numbers of members of Congress from both parties.) The Sarbanes-Oxley* Act passed by Congress in the summer of 2002 provided for the creation of an Accounting Oversight Board with wide-ranging powers; at the time of writing it is uncertain what the practical impact of these powers will be. In addition, boards were required to attest to the validity of their financial statements, the possible penalties for non-compliance being jail terms. The provisions of Sarbanes-Oxley also apply to the many Canadian companies that are quoted on U.S. stock exchanges.

The continuing aspects of the financial scandals of 2001 and onwards are:

1. The relationship between the provision of auditing and other services.
2. The issue of "regulatory capture," in other words, the ability of the regulated to soften or nullify the activities of the agencies that are responsible for the regulating process. In the case of U.S. accountants these agencies are the Securities and Exchange Commission (SEC), responsible for the regulations governing securities, the Financial Accounting Standards Board (FASB), responsible for setting standards, and the American Institute of Certified Public Accountants (AICPA), responsible for setting standards of professional conduct.
3. The impact of scandals on the reputation of accountancy as a profession and in particular on the ability of auditing to remain independent of much closer control by government. (Some commentators are of the opinion that auditing should be directly regulated by government.)

* http://financialservices.house.gov/media/pdf/H3763CR_HSE.PDF