Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 1:
Student Name__Seven Autrey_____________________________________
Student Name__Duc Nguyen_____________________________________
Telling the Enron Story
Name five ethical problems and the existing conditions that caused the Enron fiasco.
Explain each.
1. Fiduciary Failure – the board of directors failed to safeguard the companies from
many inappropriate practices.
2. High Risk Accounting – Enron allowed high risk accounting in that the
partnerships with Chewco and LJM1 and LJM2 did not conform with accounting
rules
3. Enron had extensive undisclosed off-the-books activity. There were billions of
dollars in off-the-book assets and liabilities.
4. Excessive Compensation – There was a cash drain caused by the 2000 annual
bonus and performance unit plan.
5. Lack of Independence – There were financial ties between Enron and board
members. Arthur Anderson provided internal auditing services as well as
consulting services.
1
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 1:
Student Name__Carol Cates_____________________________________
Student Name__Brenda Bohm____________________________________
Telling the Enron Story
Name five ethical problems and the existing conditions that caused the Enron fiasco.
Explain each.
1. At Enron, a lack of integrity was built into the foundation of the company from
the top to the bottom. The floor traders were heavily involved in the California
rolling blackouts and the management team was involved in numerous, non-
GAAP accounting practices. No internal controls existed to keep the members of
the various teams in check.
2. Auditors, attorneys, and investment bankers experienced conflicts of interest
between their professional duty to shareholders and their revenue generating
involvement with Enron management. For instance, all were involved in
structuring the illegal SPEs.
3. Lack of overall auditor independence. The focus at Arthur Andersen had shifted
from an ethics based focus to a strict focus on revenue generation. Ultimately,
AA was auditing transactions created by AA accountants.
4. Management reported the SPEs off-balance sheet, even though they were aware
that the 3% rule had been breached. Since the focus at Enron was to cash flow,
revenue, and increased stock value, decisions we not made with fairness and
transparency in mind.
5. The board failed in their fiduciary duties. It seems they were guilty of general
laziness. Also, the board was headed by Enron management – another conflict of
interests. Their basic duties included:
Obedience, loyalty, and due care
Applying the ―business judgment rule‖
Assuring the financial statements are presented fairly.
2
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 1: Norma Jacobs
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
Name five ethical problems and the existing conditions that caused the Enron fiasco.
Explain each.
Overview of Key Problems
• Governance failure at the Board level:
– Too much trust
– Incompetence - awareness and/or understanding of role , control &
reporting systems
– Lack of motivation, conflicts of interest
• Dishonest management, conflicts of interest
• Culture of deception, self-interest
• Manipulation of accounting and disclosure
• Poor standard setting
• Auditor deficiencies
• Regulatory short-sightedness
3
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 2:
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
Describe the activities engaged in by Enron to create misleading or financial reporting.
Enron’s Board of Directors failed to provide adequate oversight of the accounting
department. This allowed the accountants to misuse SPEs, form bogus partnerships,
mislead investors, and falsify accounting statements.
The Powers Report cited several examples of fraudulent activity. Among those were:
1. Employees enriching themselves without proper approval
2. Partnerships being established to help with favorable financial results
3. The use of SPEs to hide debt
Enron established SPEs using Enron stock as owner’s equity. SPEs require that at least
3% fo the total owner’s equity by provided by an owner independent of the company. As
Enron’s stock price fluctuated, the percent ownership of both parties changed. At times
the stock value forced the equity of the independent to fall below 3%; therefore requiring
Enron to consolidate the financial data for the SPE into the Enron financial statements.
Often times, this consolidation was not done.
Enron executives also conspired with Andersen auditors to establish the SPEs and issue
unqualified financial statements. Andersen’s lack of independence allowed Andersen
auditors to sign off on the questionable foundation of the SPEs. Andersen employees
also did not inform Enron’s audit committee of the conflicts of interest between Andrew
Fastow and Enron, nor did they advise the committee of the lack of internal controls.
4
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 2: Danielle Guerrero
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
Describe the activities engaged in by Enron to create misleading or financial reporting.
SPEs
Revenue recognition
Fair value that should have been recorded as market prices.
Energy trades-California Energy
Enron used non-consolidated SPEs to hide losses and debt. They misstated their funding
of SPEs as notes receivable instead of against stockholders equity, using SPEs to hide
debt that should have been on the balance sheet.
Enron also recorded revenue in the period they received it when it should have been
recognized over the period of the contract. For example, they recorded an up-front
payment, unearned revenue, from Chewco in the month they received it and not over the
12-month contract. They also recorded the discounts presented with sales contracts as
sales revenue, and they did not recognize the purchase contract as an off setting expense.
5
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 3:
Student Name: Kavita Chavda
Student Name: : Sripriya Venkatesan
Telling the Enron Story
Other parties have also been identified as culpable in the Enron fiasco. Name 5
additional parties that contributed to the Enron crisis and identify the major activity for
which they should have been held responsible.
1) Auditors (Arthur Andersen)-They provided services as external auditors, internal
auditors, consultants on accounting matters and advisors on tax matters. By providing all
these services it impaired their duty to work as independent auditors.
2) Enron’s Banks (JP Morgan Chase and Citigroup)-The banks knew about the unlawful
structure and accounting policies that Enron was involved in and they were the primary
sources of Enron ―prepay‖ funding.
The below mentioned parties allegedly provided highly questionable advice on twelve
large structured transactions that sheltered over $2 billion in tax. Enron’s management
not only used this advice to save tax but also used it to generate financial statement
earnings.
3) Several Accounting Firms
4) Investment Bankers
5) Law Firms
6) Enron’s outside attorneys, Vinson and Elkins were also involved with questionable
contracts of the SPEs that were being used to hedge accounts as they reviewed and
approved the SPEs.
7) The audit and compliance committee-The committee was responsible to review and
approve the creation of the SPEs and yet they carried out a limited scrutiny of the
transactions and approved them without a proper review.
6
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 4:
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
Identify five ways in which the Enron fiasco could have been prevented. Include in
your discussion any additional acts or responsibilities by parties other than Enron
management.
Corporate governance improvement
Internal control improvements
Independence issues
FASB & SEC rules
Accounting regulation
7
8
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 4:
Student Name_______Lois Watson______________________
Student Name______Ely Kosch________________________________
Telling the Enron Story
Identify five ways in which the Enron fiasco could have been prevented. Include in
your discussion any additional acts or responsibilities by parties other than Enron
management.
1. Arthur Andersen could have exercised more independence by dealing with the
conflicts of interest in an ethical and above-board way. Their control committee
person should have had veto rights over the audit committee person. Their lack of
self-governance and internal control jeopardized their independence, a critical
element in auditing.
2. A government agency could be established, funded by a tax assessed on public
company’s that would be responsible for auditing public companies.
Government’s role is already to watch out for the public good. Thus severing the
paradox of being paid by a company you should be skeptical of.
3. SEC could put a greater emphasis on and funding of enforcing the rules. This
would put more teeth into the rules that are already established; making it more of
a risk for companies to break the rules.
4. Putting a greater emphasis on the education of auditors that their role is to be
watchdogs for the public.
5. Having the board and audit committee take a more active role in guiding the
company. They should also have a questioning eye when looking over the
financial statements instead of just a stamp of approval with no real review.
9
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 4:
Student Name Toni Lusk
Student Name Paul Matthews
Telling the Enron Story
Identify five ways in which the Enron fiasco could have been prevented. Include in
your discussion any additional acts or responsibilities by parties other than Enron
management.
1. Outlaw SPE’s
2. More auditor independence
3. Correctly booking of stock transactions- do not use off balance sheet transactions
4. Create more ethical management environment
5. More oversight by board of directors and audit committee regarding Andy
Fastow’s role in SPE’s- he clearly had a conflict of interest
Arthur Andersen should have been more independent and they had the responsibility to
protect the public interest but clearly had their own and Enron’s management interests in
mind. Also the US GAAP, as structured and administered by the SEC, the FASB and the
AICPA, are substantially responsible for the fall of Enron. Enron and it’s outside counsel
and auditors felt comfortable in following the specified accounting requirements for
consolidation of SPE’s. The SEC had the responsibility and opportunity to change these
rules to reflect the known fact that corporations were using this vehicle (SPE) to keep
liabilities off their balance sheets, although the sponsoring corporations were liable for
the SPE’s obligation.
10
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 5: Melissa Hall
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
What is an SPE? Describe its fundamental characteristics. Identify 5 reasons for
creating special purpose entities:
SPE:
According to Wikipedia, a SPE is "a firm created by a company to fulfill narrow or
temporary objectives, primarily to isolate financial risk. A special purpose entity is
typically almost entirely owned by the parent company, but it is required that at least 3%
be owned by another investor." The special purpose entity can take the form of a trust,
partnership, joint venture, or corporation.
Fundamental characteristics:
A SPE is often thinly capitalized because the parent company is only required to
find investors to provide a minimum of 3% of the capital.
Use of professional directors, trustees or partners to perform the administrative
functions.
Absence of an apparent profit-making motive, such that the SPE is engineered to
pay out all profits in the form of interest or fees.
Have a specified life
Exist for financial engineering purposes
Five reasons to create a special purpose entity:
For off-balance sheet entities
To engage in tax-free exchanges
To transform certain financial assets, such as trade receivables, loans, or
mortgages, into liquid securities
11
For competitive reasons. For example, a parent company may be created a SPE to
own an asset, such as intellectual technology. This would be done to prevent
competitors from accessing the technology through pre-existing licensing deals.
To hold itself out to the public as a separate legal entity
12
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 5: Norma Jacobs
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
What is an SPE? Describe its fundamental characteristics. Identify 5 reasons for
creating special purpose entities:
A special purpose entity (SPE) is a firm (typically a limited partnership) created by a
company to fulfill narrow or temporary objectives, primarily to isolate financial risk. A
special purpose entity is typically almost entirely owned by the parent company, but it is
required that at least 3% be owned by another investor.
Reasons for creating special purpose entities are:
SPEs allowed Enron move unattractive debt and unproductive assets off-
balance sheet from the corporate balance sheet and onto that of a separate
newly created firm that was 97% owned by Enron and 3% percent owned
by outside investors of the newly created firm.
SPEs avoid involving the parent company in very risky projects. This
reason is weak though, as most special purpose entities have triggers that
commit the parent company to some obligations—these triggers are
usually meant to attract other investors to share the risks.
SPEs allow a company to operate in a barely legal manner. For example,
companies sometimes use special entities to employ workers without
paying them benefits. (This is the basis of certain litigations against Wal-
mart).
SPEs are useful to companies for competitive reasons, like sharing
technology or proprietary corporate information.
SPEs often function as a corporate tax shelter.
13
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 5: Michelle Lampkin
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
What is an SPE? Describe its fundamental characteristics. Identify 5 reasons for
creating special purpose entities:
A special purpose entity (SPE) is a subsidiary company created by a corporation. The
SPE is funded with equity investment. The majority of the equity investment comes from
the founding corporation and some must come from an independent third party.
Five reasons to create an SPE:
1. To insulate the company from bad debt
2. To start a new line of business separate from the current line of business
3. To enter into transactions that could not be arranged with independent entities
4. To hide debt or pass off losses (off balance sheet financing)
5. To inflate income through inappropriate transactions
14
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 6: Norma Jacobs
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
What was the nature of the misuse and abuse of the Enron SPEs that led to the
company’s downfall? Explain your answer.
Related-party transactions created opportunities for Enron management to own
greater than 97% of the limited partnerships called SPEs.
Off-balance-sheet financing and debt avoidance arrangements provided Enron
with the opportunity to raise needed capital for various purposes without showing
the related debt on the consolidated balance sheet.
Collaterization of SPE transactions through the use of Enron common stock
allowed the company to report unrealized gains on its own common stock.. thus
allowing Enron to do business with itself.
Enron propped up its own sagging earnings, thus allowing it to continue to
maintain a high credit rating, avoid debt-covenant violations, and continue to give
the appearance of positive cash flows… enough to continue its high-flying
ambition of becoming a New Economy energy mogul.
15
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 6:
Student Name: Jan Chomaitong and Scott Corbell
Telling the Enron Story
What was the nature of the misuse and abuse of the Enron SPEs that led to the
company’s downfall? Explain your answer.
1. Complex transactions yet insufficient disclosures. Various disclosures rgarding
Enron’s SPE’s transactions were approved by one or more of Enron’s outside auditors
(Andersen) and its inside and outside counsel. However, these transactions were
obtuse, did not communicate the essence of the transactions completely or clearly,
and failed to convey the substance of what was going on between Enron and the
partnerships.
2. The structuring and the accounting treatment of some SPEs such as the Raptor were
carefully crafted by Andersen, yet they had failed to provide objective accounting
judgment that should have prevented these transactions from going forward.
3. Conflict of interest. Former CEO Andrew Fastow realized $30 million in profits on
his investment on one of the SPEs that he oversaw. Several of his friends had also
profited from investments in the same SPEs.
4. Abusive use of the 3% rule. The 3% rule allowed a company to omit an SPE’s assets
and liabilities from its consolidated financial statements as long as parties
independent of the company provided minimum of 3% of the SPE’s capital. The 3%
threshold became both a technical minimum and a practical maximum. Enron was
able to divert huge amounts of their liabilities to off-balance sheet entities (the SPEs)
by arranging for external parties to provide exactly 3% of an SPE’s total capital.
5. Using the SPEs, Enron was essentially doing business with itself. In addition to using
the SPEs for financing activities, Enron would use SPEs to ―download‖
underperforming assets from its financial statement to the financial statements of
these related entities or it would report the unrealized gains on the increase in the
market value of its own common stock (also see #6).
6. Manipulation of reported figures. In addition to the use of SPEs to hide losses and
debt as previously mentioned, SPEs were also used in other ways to manipulate the
financial statements. For example;
- Certain revenue recognition practices by Enron such as those related to
forward contracts were not based on trustworthy numbers
- Enron recorded an increase in the value of its own stock through JEDI, one of
its SPEs, which is not permissible under the GAAP rule.
16
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 7: Norma Jacobs
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
The failed accounting practices of Enron were not limited to the abuse of limited partnerships
and off-balance-sheet financing. The company made extensive use of other accounting
gimmicks. For example, Enron also abused the controversial mark-to-market accounting method
for its long-term contracts involving various energy commodities. What is mark-to-market? How
was it abused by Enron?
According to Wikipedia.com
In economics, mark to market is the act of assigning a value to a position held in a
financial instrument based on the current market price for that instrument, or on a fair
valuation based on the current market prices of similar instruments.
Example, if an investor owns 100 shares of a particular stock purchased originally for
$40 per share, and that stock is currently trading at $60 per share, then the "mark to
market" value of the investor's shares is equal to (100 shares × $60), or $6000.
Enron employed market-to-market accounting, which enabled it to “count projected earnings
from long-term energy contracts… as current income. This accounting method had long been
accepted for securities companies. However, Skilling persuaded the SEC to approve its use by
Enron.
Enron also entered into limited liability partnerships in order to hedge in order to hedge the
company’s high-risk investments in start-up companies. (See discussion of Special Purpose
Entities).
17
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 7: Scott Booth & Melissa Hall
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
The failed accounting practices of Enron were not limited to the abuse of limited partnerships
and off-balance-sheet financing. The company made extensive use of other accounting
gimmicks. For example, Enron also abused the controversial mark-to-market accounting method
for its long-term contracts involving various energy commodities. What is mark-to-market? How
was it abused by Enron?
Mark-to-market accounting is the practice of adjusting forecasted earnings according to
the market outlook. Enron abused this type of accounting by raising their earnings
expectations when the market was up, but when the market was down, they would not
decrease their earnings outlook. This blatant misrepresentation created an inflated
earnings forecast and deceived investors.
18
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 8: Scott Booth and Melissa Hall
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
Some have called the failure of Enron “the perfect storm” in that all storm elements
occurred at the same time to cause it collapse. Describe major factors (incentives and
actions) related to the following stakeholders that contributed to “the perfect storm.”
1. Enron Executive Management- Incentives: Wanted to keep stock prices high, in
turn keeping bonuses flowing and earnings up. Actions: Created SPE’ and abused
of mark-to-market accounting
2. Arthur Anderson, LLP- Incentives: Keep Enron happy and large fees coming in.
Actions: Intertwined themselves with creating SPE’s and ignoring irregular
accounting practices.
3. Enron’s Board of Directors- Incentives: Hide abnormal accounting practices and
keep corporation afloat. Actions: Worked with Anderson in ignoring practices.
4. Enron’s Internal Audit Function- Incentives: Fear of losing job. Actions: Turned
their heads and ignored the things management told them to ignore.
5. Enron Bankers and Attorneys- Incentives: Keep steady flow of loans and interest
and keep SPE’s being formed. Actions: They ignored misstated financials and
non-consolidated financials.
19
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 9: Norma Jacobs
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
Describe how Enron’s governance and control structure was circumvented. (Brooks
Figure 2.2)
Governance failure at the Board level:
Too much trust of management
Incompetence – inadequate awareness and/or
understanding of role , control & reporting
systems
Lack of motivation, conflicts of interest
Dishonest management, conflicts of interest
Enron’s culture of deception
Manipulation of accounting and disclosure
Poor standard setting
Auditor deficiencies
Regulatory short-sightedness
20
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 9:
Student Name___Saiky Hasan_______________________________
Student Name___Karen Hoodman____________________________________
Telling the Enron Story
Describe how Enron’s governance and control structure was circumvented. (Brooks
Figure 2.2)
Anderson was not independent. They provided consulting service & internal audit
whilst serving as Enron’s outside auditor. In other words they audited their own
advice. This is not allowed under new Sarbanes-Oxley Act (SOX).
Anderson did not report concerns to an audit committee but they reported to the
board who were the almost the same individuals responsible for the fraud- Ken
Lay. CEO who is also Chairman of the Board will essentially be overseeing him
or herself, making for a situation that is hard to control.
Management members sat on the board. Under the new SOX laws sufficient
directors should be independent from management. Enron’s board of directors
was compromised by financial ties between the company and certain board
members.
The board was responsible for hiring/paying for the Audit and also consulting
services. Which means that upper management were ultimately in control.
The board had missing guidance on the company Code of Conduct. They
themselves didn’t follow it neither did their subordinates. Many Enron employee
knew of lack of integrity of SPE’s but few came forward.
The board members were in charge of whistle blowers and hence ones that blew
the whistle earlier blew it to the same individuals who were responsible for the
fraud. The whistle blower control structure wasn’t effective.
21
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting and Auditing, Post-Enron
Group 10: Student Name: Valerye Kay, Tanya Sullivent
Telling the Enron Story
Describe the impact of the Sarbanes-Oxley Act of 2002 on the corporate and
professional participants in the Enron fiasco described below.
1. Corporate executive management
Reduce conflict of interest between directors, auditors, and executives to exercise
loyalty, independent judgment, and objectivity in the best interest of the shareholders,
company, or public interest.
The CEO and CFO shall prepare a statement to accompany the audit report to certify
the "appropriateness of the financial statements and disclosures contained in the
periodic report, and that those financial statements and disclosures fairly present, in
all material respects, the operations and financial condition."
Requirement of code of ethics and compliance for senior financial officers.
Sanctions for wrongdoing including forfeiture of bonuses and profits.
2. Professional Accounting firms
Have access to and report to the board of directors.
Reduce conflict of interest between directors, auditors, and executives to exercise
loyalty, independent judgment, and objectivity in the best interest of the shareholders,
company, or public interest.
Auditors are prohibited from offering certain non-audit services to their audit partner.
This is to keep an audit firm from auditing their own work. The audit firm must have
permission by the client’s audit subcommittee to offer non-audit services.
The lead audit or coordinating partner and the reviewing partner must rotate off of
the audit every 5 years.
The accounting firm must report to the audit committee all critical accounting
policies and practices to be used and all alternative treatments of financial
information within GAAP that have been discussed with management and the
treatment preferred by the firm.
3. Board of Directors
Must be independent from management.
Possess financial competence.
Clarification of roles, responsibilities, and competencies of directors.
4. Internal audit functions
Instituting internal controls over financial statements.
Must establish procedures to receive and address complaints regarding accounting,
auditing and internal controls plus set up procedures for employees to submit
anonymous complaints.
Review and attest management’s assessment of company’s internal controls.
22
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 10: Norma Jacobs
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
Describe the impact of the Sarbanes-Oxley Act of 2002 on the corporate and
professional participants in the Enron fiasco described below.
Corporate executive management
Professional Accounting firms
Boards of Directors
Internal audit functions
Problems address by SOX:
Manipulation of financial reports to ―smooth‖ earnings
Enormous remuneration for top executives, particularly with stock options
Lack of effective governance by Boards of Directors, due to:
Lack of understanding
Failure to accept responsibility
Lack of competence
Lack of effective legal penalties for executive and director malfeasance
23
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 11: Jin, Mingqing
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
Following the collapse of Enron and Andersen, an investigative committee was
commissioned to identify what when wrong and why. Summarize the finding of the
Powers subcommittee.
After Investigation, the Power Report revealed following findings for Enron.
1. Employees enriched themselves by millions without apparent oversight and approvals
of the board.
---Andrew L. Fastow received more than $30 millions from LJM1 and LJM2.
---Michael Kopper received more than $10 million for little works for JEDI.
---Ben Glisan and K. Mordaunt each earned $1 million with a little investment.
2. Partnerships were created and used to form the favorable financial reports by SPE
treatment without 3 % and independence conditions, which does not comply with GAAP.
Most of those SPE transactions with Enron were in spending the interests of Enron’s
investors.
---Chewco was established in 1997 for the purpose of purchasing ― CalPERs‖.
---LJM1 was created in 1999 to hedge the possible lose of market value of Enron’s
investment in Rhythms and to purchase ―Brazilian‖ and ―Osprey‖.
---LJM2 was formed in 1999 for the similar purpose.
3. Other Transactions were improperly entered into hedge or offset almost $1 billion in
losses on Enron’s investments to inflate Enron’s profit approximately $ 1 billion between
the third quarter of 2000 and 2001. Those transactions engaged Enron in high risk
accounting practice.
4. Arthur Anderson was consulted and approved most of incorrect accounting treatments
for Chewco, LJM1, and LJM2. Anderson received overpayment for such services.
5. In 2001, Enron had to restate its manipulated earnings. Much of the need for
restatement due to the failure to satisfy two conditions required for Special Purpose
Entities (SPE). They are (1) An owner independent of the company make a substantive
equity investment at least 3 % of the SPE’s assets; and (2) the independent owner
exercise control the SPE. If those conditions had have been satisfied, Enron could have
recorded gains and losses on transactions with the SPE, and the assets and liabilities of
SPE would not have been included in Enron’s balance sheet. However, Enron treated
transactions with Chewco, LJM1, and LJM2 as SPE without satisfaction of two required
conditions.
24
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 12:
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
Following the collapse of Enron and Andersen, an investigative committee was
commissioned by Congress to identify the role of the Board of Directors in the Enron
collapse. What were the major findings of this Senate subcommittee?
25
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 13: Wan Zhang, Brad Molof, Danielle Guerrero
Telling the Enron Story
Describe the key elements of an ethical corporate culture.
1. Integrity
Integrity, as an ethical value, is the cornerstone of ethical corporate culture. Corporate needs
to operate with integrity. Integrity ensure corporate governance operate effectively.
Behaving with integrity, corporate will deliver fair, complete financial information to
stakeholders.
2. Accountability
The governance framework should provide honest and full accountability to shareholders and
other stakeholders. The corporate is responsible for the interest of public. Thus,
accountability is the prime responsibility of corporate directors to ensure and senior corporate
officers to deliver. A detailed instruction is needed to clarify the responsibilities and
obligations of directors, managements, audit committee and employees.
3. Independence
Independence is a critical element of ethical corporate culture. Conflict of interests should be
avoided or resolved by proper approaches making independent judgments being exercised.
Directors are required to be independent from management and audit committee members are
independent from directors and management.
4. Whistle-blowing
Corporate should set up a whistle-blowing system to allow employees or other stakeholders
to report wrongdoings, misconduct and fraud. Whistle-blowing creates an opportunity for all
levels of corporate to monitor the effectiveness of corporate governance. Corporate may
open an anonymous hotline or email for whistle-blower’s convenience.
5. Top management ethical
An effective ethical culture begins at the top. The top management is required to be familiar
with the operation of the compliance and ethics program. Also, since top management set up
an example for lower levels, management should conduct ethically.
6. Education and training
New recruits need to know the culture or code of conduct of the corporate by orientation.
Employees will be informed continuously with regard to the compliance and implementation
of the code of conduct. Also, through training, employees can be aware of new laws and
regulations.
(These elements were presented in class. For more information, please refer to page
147 in chapter 3.)
26
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 13: Norma Jacobs
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
Following the Enron failure a New Framework for Accountability and Governance
has been promoted by Congress and its regulatory bodies…one that emphasizes the
building of an “ethical corporate culture”. Describe the key elements of an ethical
corporate culture.
Strategic focus - comprehensive, directive
Assign responsibility
Identify and assess risks and opportunities
Code of conduct - values, guides
Governance & reporting - explicit part, time, energy
Measurement of performance
Ethics audits and targeted programs
Management of ethical risks & opportunities
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Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 14: Norma Jacobs
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
In 2002, the extensive period of self-regulation of the professional accounting
profession came to an end following the troubles of Arthur Anderson. Identify the
principal advantages and disadvantages of having the rule-making bodies in the
accounting profession controlled by the private sector rather than the federal
government.
1. Advantages:
a. The members of private sector rule-making bodies are probably more likely to be
practitioners and thus better acquainted with the key issues and problems facing
their profession at the practice level.
b. As a general rule, one might expect private sector rule-making bodies to be able
to respond to important issues more rapidly than governmental rule-making
bodies that are more likely to be slowed by bureaucratic "red tape."
c. Members of a given profession are probably more inclined to work closely with a
private sector rule-making body and less inclined to view the actions of that body
antagonistically since its members are representatives of the profession instead of
representatives of a government agency.
d. The operating costs of a private sector rule-making body are typically borne by
the relevant profession rather than by taxpayers.
Disadvantages:
a. A private rule-making body may be more susceptible to pressure from interest
groups within a profession than a public sector rule-making body.
b. The limited resources of a private rule-making body may not provide sufficient
funding for needed research projects to analyze the feasibility or reasonableness
of proposed standards.
c. A private rule-making body may focus too narrowly on the interests of its
profession rather than the broader interests of society.
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Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 15:
Student Name___Tanya Sullivent_____________________
Student Name____Valerye Kay________________________
Telling the Enron Story
What is an audit failure? Describe the major actions or events that caused the audit
failure of Arthur Andersen, LLP, in the case of Enron Corporation.
An audit failure is the ―inability‖ by the auditor to detect material misstatements or
omissions by management.
Events that caused the failure-
Andersen apparently approved as auditors and consultants the structure of many
SPE’s
Failed to recognize GAAP that prohibits the recording of shares issued as an
increase in shareholders’ equity unless they are issued for cash.
Andersen did not keep the audit committee informed of problems.
Did not adequately consider the advice of its quality control partner.
They did not find significant evidence, or did not act upon evidence found.
Lack of independence – poor judgment.
Did not want to upset management, particularly Fastow, Skilling, and
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Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 16:
Student Name Chris Henry________________________
Student Name ____________________________________
Telling the Enron Story
Large public accounting firms are among the parties most knowledgeable of
accounting rules and regulations. These accounting firms are often well positioned to
evaluate the soundness of proposed accounting rules. Should rule-making bodies
make use of the expertise of the insight of large international accounting firms when
considering proposed accounting standards? Why or why not?
We believe rule-making bodies should make use of the knowledge and expertise of large
public accounting firms when considering proposed accounting standards. In many
cases, the large public accounting firms have more understanding about what the benefits
and consequences will be to both the client and the accounting industry, as well as the
general investing public. Many times, an attorney, politician or educator is proposing
new accounting standards without realizing the impact it will have on the accounting
profession and clients to implement it.
However, while we believe those proposing new accounting standards should make use
of large public accounting firms expertise and knowledge, we believe all they should do
is consult and get their input and opinions. Their opinions and recommendations should
be used only as information in the gathering process for proposed accounting standards.
There would be a major conflict of interest if the large public firms were relied upon too
heavy or had final say in the proposed standards. Take the Sarbanes-Oxley Act of 2002
as an example. It would have been very unlikely that the authors of SOX would have
reached the same conclusion of how to deal with firm/client independence had they
consulted the large firms and allowed them any final say. The final result in SOX was
that firms could not perform certain (and in most cases, more lucrative) accounting
engagements for clients that they are engaged to issue independent audit reports on. This
regulation impacted the revenue opportunity for many large accounting firms and forced
them to re-focus their business plan and evaluate whether they wanted this client as an
audit client or not in the future.
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Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 16: Norma Jacobs
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
Large public accounting firms are among the parties most knowledgeable of
accounting rules and regulations. These accounting firms are often well positioned to
evaluate the soundness of proposed accounting rules. Should rule-making bodies
make use of the expertise of the insight of large international accounting firms when
considering proposed accounting standards? Why or why not?
2. Clearly, large accounting firms can be a tremendous resource for rule-making bodies
within the accounting profession. These firms encounter, on a daily basis, a wide range
of complex issues and problems at the practice level and, as a result, may have a better
understanding of these issues and problems than any other parties in the profession,
including members of rule-making bodies. These firms also devote large portions of their
operating budgets to educating and developing their employees. Consequently, the
individuals within these firms tend to be among the profession's best trained and most
productive members.
There are several ways that the profession's rule-making bodies could make effective
use of the resources of large accounting firms. One method would be to use these firms
to perform research projects focusing on the feasibility and reasonableness of proposed
accounting standards. If these studies were designed and their performance monitored by
rule-making bodies, their findings would be less subject to criticism stemming from
charges of bias on the part of large accounting firms. Another approach would be to
consider only retired professionals, including those of large firms, for appointment to
rule-making bodies. These individuals are less subject to being influenced by the
economic interests or lobbying efforts of their "clients"--since the clients are former
clients. Finally, one suggestion that many within the profession might find objectionable
is to not reveal the votes of individual members of a rule-making body on specific
standards being considered. This policy would limit the ability of clients and other
interest groups to ―punish‖ members of a rule-making body for their votes on proposed
standards.
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Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 17:
Student Name___Saiky Hasan____________________________________
Student Name___Karen Hoodman____________________________________
In the aftermath of the Enron crisis, some have argued that the term whistle-blower
should not apply to Sherron Watkins. What is a whistle-blower? Argue the case for or
against giving her whistle-blower status.
A whistle blower is an employee who has information as to organizational wrongdoing
and discloses the alleged organizational misconduct to the media or appropriate
governmental agency often after futile attempts to convince organizational authorities to
take action against the alleged abuse.
Corporate whistle blowers have traditional been treated as malcontents, trouble makers &
misfits.
Sherron Watkins is a whistle blower. She was a competent professional
accountant and she realized that the states were high and hence put her concerns
for her own self-interest aside and came forward.
She first sent anonymous letter – a signal of what she expected in treatment – to
Ken Lay regarding SPE’s strategy. He in turn consulted with lawyers but the
consultants that set up the SPEs were not going to change or admit mistake.
She eventually got prepared to testify before investigating committee
She testified to the senate subcommittee in Feb 14, 2002 about SPE’s issue and
complained about the aggressive accounting that was being practiced by Enron
and that Enron is likely to collapse and it did.
Time honored as its ―2002‖ Person of the year‖ three whistle blowers and Enron’s
Sherron Watkins was one of them. She tried to work within the organization to
expose wrongdoing. She acted out of commitment to the organization and not to
destroy the company or to cause negative consequences.
She was an ethical hero to have come forward and report despite Enron’s culture and
senior officers leading in wrongdoing. Men occupied in senior positions in Enron & who
had continuous interaction with the board members did not come forward e.g. Richard
Causey-CAO, Richard Buy-CRO, Ben Glisan-treasurer.
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Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 17:
Student Name___Melissa Hall____________________________________
Student Name___Scott Booth ____________________________________
In the aftermath of the Enron crisis, some have argued that the term whistle-blower
should not apply to Sherron Watkins. What is a whistle-blower? Argue the case for or
against giving her whistle-blower status.
A whistle-blower is an employee, or member of an organization who reports misconduct
to people or entities that have power to take corrective action. Generally, the misconduct
is a violation of law, rule, regulation, and/or direct threat to public interest.
Whistleblowers are most often employees of businesses, but are also commonly
employees of government agencies. We believe Sherron Watkins fits the whistleblower
role. When she learned of the wrongdoings she initially sent an anonymous letter due to
the fear of persecution from fellow employees and possible employment. Both of these
fears are issues faced by typical whistleblowers. She went against corporate belief and
stood for what she believed in. She blew the whistle and in the process was selected as
one of Time’s people of the year.
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Quiz 7
Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 18:
Student Name: Sripriya Venkatesan
Student Name: Kavita Chavda
Telling the Enron Story
Describe the emerging governance trends Post Enron.
Post Enron and other corporate debacles, the Sarbanes-Oxley Act of 2002 was passed.
SOX establishes a new framework for the following, in order to deal with the governance
credibility crisis and restore confidence in the current corporate capital market system.
Clarification of the roles, responsibilities and accountabilities of the board of
directors, its subcommittees, of the directors themselves and the auditors.
Reduction of the conflicts of interest influencing the directors, executives and
auditors, so that they establish loyalty, independent judgment and objectivity in
the interest of all stakeholders.
Ensure that directors are adequately informed of the company’s plans and
business strategies.
Ensure financial competence of directors.
Ensure accuracy, completeness, transparency and understandability of financial
reports (additional disclosures on transactions between principal stockholders and
management, corporations internal controls and assessment of their effectiveness)
Specific focus on whistle-blower systems and certification by CEO and CFO.
Directors’ responsibility for ensuring independence scrutiny of auditors.
Requirement for a code of ethics and compliance for senior financial officers.
Monitoring of exercise of any undue influence on the conduct of audit
Sanctions for wrongdoing (such as forfeiture of bonuses and profits, officer and
director bans from service and penalties.
Strengthen the role of audit committee, full independence of serving directors,
information flow and the ability of auditors to report on and engage the committee
in meaningful decision.
Reporting of Auditors to Audit committees.
Definition and emphasis on avoiding conflict of interest situations, as well as
codes of conduct for the CFO and others.
Establishment of PCAOB that will:
o Inspect, disciple and write rules governing audit firms
o Establish auditing standards, such as quality control and independence
standards
o Maintain a register of foreign SEC registrants.
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Question 18, continued:
Prohibition of auditors offering specific non-audit services to their clients without
permission from audit subcommittee.
o Some examples:
o Bookkeeping and other services
o Financial information system design and implementation
o Fairness opinions or contribution-in-kind reports
o Actuarial services
o Internal audit outsourcing services
o Management functions or human resources, etc.
Audit partner may not serve as the engagement partner or the concurring partner
for over five concurrent years.
Code of conduct for attorneys serving registrants.
Mandatory rotation of audit firms
Adoption of ―principle-based‖ accounting system
SEC responsible for introducing and implementing new regulations or changes for
compliance with SOX framework.
o E.g. Proposal for lawyers discovering any misconduct, must resort to ―up-
the-ladder‖ reporting of the violation or make a noisy exit as a last and
final option
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Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 19: Michelle DeFrance
Student Name_______________________________________
Student Name_______________________________________
Telling the Enron Story
In 2002, the extensive period of self-regulation of the professional accounting
profession came to an end with the advent of SOX and the Public Company
Accounting Oversight Board
Identify the principal advantages and disadvantages of having the rule-making bodies
in the accounting profession controlled by the federal government, rather than the
private sector.
Identify the principal advantages and disadvantages of having the rule-making bodies in
the accounting profession controlled by the federal government, rather than the private
sector.
Professional Accountants making the rules:
FASB and the AICPA have the experience and expertise in the industry to
understand the various aspects and complexities of accounting and financial
reporting.
The profession fully researches and understands the accounting situations before
making a decision on how certain transactions should be handled.
The profession is subject to influence by the industry; change is often handled
slowly because of this.
While the profession has been delegated the responsibility to create standards of
reporting, they can be superseded by law-making bodies.
Law-Making Bodies making the rules:
Law-making bodies can act quickly to react to an immediate crisis.
Law-making bodies are influenced by industry through lobbyists and
contributions.
Law-making bodies may act too quickly without full research and understanding
of accounting and financial reporting—may react to buzz-words or public outcry
inappropriately.
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Accounting 1370
Accounting Ethics Session 6
Governance, Accounting, and Auditing, Post-Enron
Group 20:
Student Name_Brenda Bohm______________________________________
Student Name__Carol Cates_____________________________________
Telling the Enron Story
Assume you were members of the Enron Board of Directors. Identify five essential
questions that should be asked of Enron management or its public accounting firm,
Arthur Andersen and company.
1. If other companies with on-line trading business experience large earnings
fluctuation one quarter to the next, how are we smoothing ours?
On-line energy trading business requires access to large lines of credit to ensure
settlement of trading positions at the end of each day. The nature of the business
causes large earning fluctuations from quarter to quarter, which makes it
challenging to maintain a low credit rating, and therefore to access low-cost
financing. This adds to operational cash drains. The Senate Subcommittee
reported that Enron ensured an investment-grade credit rating by emphasizing
increasing its cash flow, lowering its debt, and smoothing its earnings on its
financial statements to meet the criteria set by credit rating agencies.
2. Explain the SPE setup – diagramming the business process-flow from one
SPE to another?
The continuous creation of SPE which should have taken some of the economical
risk away from Enron with the 3% rule did not happen. Instead more and more
SPE were created to offset losses of one SPE to another, Enron using it own stock
in most cases, ultimately bearing the entire economic risk that eventually resulted
in Enron’s collapse.
3. Is there a conflict-of-interest with Enron’s employees owning and managing
SPE and partnerships?
Many of the Enron employees were involved in these transactions, but none were
approved to benefit as required by the Enron Code of Conduct, and the board
apparently did not know of their involvement, but the employees benefited greatly
due the SPE and partnerships created. Fastow was enriched by $30 million,
Kopper by at least $10 million and two other by al least hundreds of thousands of
dollars.
4. Are the SPE and partnerships at arm-length (3% rule) or are they related-
party transactions and how are we disclosing these transactions on our
financial statements?
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Question 20 cont.
5. Partnerships- Chewco, LJM1 and LJM2 – were established and used to enter into
transactions that could not be arranged with independent entities. Much of the
need for restatement of the financials arose because of the failure to satisfy two
conditions required for SPE to be independent from Enron: the 3% owner’s equity
and the independency of the owner exercising control of the SPE.
6. With large drains on operating cash, high executive compensation should
have been questioned along with excessively high stock-option plans in
particularly how the stock options were being disclosed on the financial
statements since the SEC does not require the reporting of stock-options
until they are exercised.
Enron’s BOD approved excessive compensation for company executives failing
to monitor the cumulative cash drain cause by Enron’s 2000 annual bonus and
performance unit plans, and failed to monitor excessively high stock options not
recorded on the financial statements when earmarked for the recipient. The
Senate Subcommittee testimony on the subject of Ken Lay’s overall
compensation of $141 million for 2001, the stock option portion of which was
approximately $130 million.
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