Raditya Pratama (16)

Auditing 3
Enron Case
1. Introduction
Although Enron went bankrupt and disappeared ten years ago, the impacts it has made on the
ethical standards never faded. It took Enron 16 years to go from about ten billion dollar
assets to more than sixty-five billion dollar assets, and took twenty-four days to go
bankrupt. (McLean & Elkind, 2004)
Enron, which once ranked as the seventh-largest company on the Fortune 500 and ranked as
the sixth-largest energy company in the world, on December 2, 2001, filed for bankruptcy
protection in the biggest case of bankruptcy in the United States up to that point (Jennings,
2009, p. 285). By November 2001, the companys stock, which once peaked at $90 US, was
down to less than $1 US. It was a disaster for the thousands of employees and investors
(Skilling v. United States, 2010). Employees lost their jobs and pensions, and investors lost
billions of dollars.
The Enron scandal is one that left a deep and ugly scar on the face of modern business. In
this article, the facts of Enrons case were reviewed and the major ethical issues involved in
Enrons scandal were analyzed. The rest of the paper is organized as follows. The second
part is a brief summary of what has happened in Enron. The third part described the role of
Arthur Andersen (AA) in the Enron scandal. In the following parts the culture of Enron, the
important people involved in this case, and also the major ethical issues about this scandal
were analyzed. At last, the conclusion part discussed what we should do to avoid another
Enron.
2.

Statements of Facts

2.1 A Brief History of Enron

Since found in 1985 as an interstate pipeline company, Enron had been a power supplier to
utilities. Its business began through the merger of Houston Natural Gas and Omaha-based
InterNorth. In the following 20 years, Ernon grew quickly and became the largest energy
trader in the world. By the end of the twenty century, Enron had many honorable titles, such
as one of the worlds leading electricity, natural gas, and communications companies, the
world most admired corporations, and so on. (Skilling v. United States, 2010)

In the following years, with the increase of competition, Enron decided to use diversification
and international investment to keep its market position. Actually, these activities brought
Enron an unexpected large amount of losses rather than profits. In 1999, after a foray into
fiber optics and the broadband market, which was a wrong decision again, Enron suffered too
many substantial losses and began bleeding quickly. However, Enron had never declared any
information about its losses until October 2001. Instead, in these years, Enron achieved a
phenomenal bottom-line through overstating revenues and hiding liabilities. For example, the
revenue numbers for 1998, 1999, and 2000, were $40 billion, $60 billion, and $101 billion
respectively. Besides manipulated the financial statements, Enron never mentioned the risks
which it should disclose to its investors. On the contrary, the executives of Enron disclosed a
great earnings forecast through the media and encouraged investors to purchase Enrons
stocks. They also suggested their employees invest their pensions in Enrons stock or stock
options. Arthur Andersen, the audit company for Enron, helped Enron hide these frauds for
five years. Every time when analysts or Enrons employees expressed their doubts about
Enrons financial condition, Enron would try to keep them quiet and fired them later.
Meanwhile, top executive embezzled. The executives also drove up the stock price and put a
large amount of money into their own pockets through trading stocks. (Skilling v. United
States, 2010)
Because of those frauds, from 1998 to 2001, the stock price peaked at $90 US. By
December 2000, Enrons shares [were] selling for $85 each, its employees [had] their 401(k)s
heavily invested in Enron Stock, and the company [had] a matching program in which it
contribute additionally shares of stock to savings and retirement plans when employees chose
to fund them with Enron stock (Jennings, 2009, P.356). Therefore, both investors and
employees suffered heavily from this disaster when Enron collapsed.
Problems began erupting in 2001. Jeffrey Skilling, the CEO, departed in August of 2001.
Then in October 2001, Enron reported a loss of $618 million. Following that, Chief financial
officer Andrew Fastow was replaced, and the Securities and Exchange Commission (SEC)
began investigating the company. After about one month, in late November, the SEC found
off-the-books entities and overstated revenues, and then the companys stock was down to
less than $1 US. Finally, on December 2, 2001, Enron filed for bankruptcy protection.
Investors lost billions of dollars.
All the people involved in this shocking fraud went on trial, including the executives of
Enron, Arthur Andersen and some other persons or companies who were involved in the
fraud. In January 2004, Andrew Fastow , the CFO of Enron, agreed to a plea bargain and a
10-year sentence. In February, Jeffrey Skilling, the CEO of Enron, was sentenced to 24.4

years (Skilling v. United State, 2010). Besides that, the court punished Arthur Andersen by
stopping their auditing work. Following that punishment, Arthur Andersen also went
bankrupt and disappeared.
2.2. The Role of Arthur Andersen in Enron Scandal
Arthur Andersen (AA) had served as Enrons outside auditor since 1985. Two years after the
collapse of Enron, Arthur Andersen went from an international firm of 36,000 employees to
nonexistence. In AAs 16 years relationship with Enron, besides external auditing, AA also
provided Enron internal auditing and consulting services. From 1997 to 2001, Enron
overstated its profits by $568 million, 20 percent of Enrons earnings for those four years.
Andersen auditors helped Enron hide this earnings manipulation. On June 15, 2002,
Andersen was convicted of obstruction of justice for shredding documents related to its audit
of Enron. (Arthur Andersen v. United State, 2005)
Arthur Andersen contributed to the Enron scandal in four aspects. Firstly, facing the false
financial condition, AA never disclosed it. Enron was one of AAs major clients. In order to
avoid the loss of this big client, AA helped Enron cheat on its financial statements. This
action is not only unethical, but also illegal. To avoid losing this big client, AA determined to
violate the standards. From the ethical aspect, AA should have stopped this fraud early.
Instead, AA chose to act illegally to earn profits.
Secondly, AA provided Enron external auditing, internal auditing and consulting services at
the same time, violating accounting and auditing standards because there are conflicts of
interests among these services. There was a fluid atmosphere of transfers back and forth
between those working for AA doing Enron consulting or audit work and those working for
Enron who went with Andersen (Jennings, 2009, p. 354). This conflict of responsibilities of
AA didnt follow auditing standards and were illegal.
In addition to the conflict of responsibilities, the violation of independency also existed
because there were close relationships and interest conflicts between AAs employees and
Enrons executives. David Duncan, the audit partner who was in charge of the Enron
account, was a close personal friend of Enrons chief accounting officer. Meanwhile, there
were many high level executives of Enron from AA. For example, in 2000, seven AA
auditors joined Enron (Jennings, 2009, p.355). Additionally, many AA employees had
permanent offices at Enron and kept close relationships with the employees in Enron. All of
these affected the independence of auditors from AA.

Fourthly, AA destroyed many papers and documents of Enron after Enrons scandal was
disclosed. Without those papers and documents, SEC encountered many difficulties when
they investigated the fraud of Enron. Nancy Temple, AAs in-house counsel, advised the
destruction of documents (Jennings, 2009, p.358). This action is both unethical and illegal.
2.3 The Important People in the Enron Scandal
In the case of Enron, some persons performed ethically and the others did not. For example,
John Olson, Margaret Ceconi, and Clayton Verdon, three employees in Enron, chose the right
things to do and performed ethically. However, there are also many other people who just
kept silent or even did the things which are obviously unethical or even illegal, such as the
executives in Enron, Ken Lay, Jeffrey Skilling and Andrew Fastow, as well as the auditors
from Arthur Andersen, David Duncan . In the following paragraph, I will talk about the
persons involved in this case.
Kenneth Lay is the founder, chairman and CEO of Enron. All the facts of the fall of Enron
show that Lay is a person who is dishonest and lacks integrity. Under his leadership, Enron
was involved in fraud, causing investors to lose billions of dollars. In 2001, although known
the risky financial condition of Enron, Lay still announced to employees and investors that
the future growth of the company has never been more certain and urged them to invest in
Enron stock further. Meanwhile, in the August of 2001, he sold a substantial amount of his
own shares of stock (Jennings, 2009, p.293). His announcement increased the price of
Enrons stock further and accelerated the bankruptcy of Enron. At last, Lay destroyed the
companies he built.
The second person we need to mention in Enrons case is Jeffrey Skilling. He was the
president COO, and also served as CEO from Feb. to Aug. 2001. Mr. Skilling said in his
testimony, We are on the side of angels ( Jennings, 2009, p.295). But obviously, they were
not. In August 14, 2001, he left the company without disclosing any financial problems of
Enron. He just said that he wanted to spend more time with his family. However, he sold
500,000 shares on September 17, 2011(Jennings, 2009, p. 293). Before his departure, he also
did many things which seem unethical. For example, Bethany McClean, a Fortune reporter,
asked Skilling some questions about profit margin. And Jeffrey Skilling refused to answer
that question although at that time he knew about the financial condition of Enron. He never
disclosed the problems to the public. Additionally, before the Congress, he denied any
knowledge of the financial manipulations until the bankruptcy of Enron. He waived Enrons
Code of Ethic and led Enron to a death.

The third person who played an important role in Enron is the CFO, Andrew Fastow. He was
directly responsible for Enrons disaster. He was the person who manipulated the financial
numbers for Enron. He said, Within the culture of corruption that Enron had, that valued
financial reporting rather than economic value, I believe I was being a hero. I thought I was a
hero for Enron. At the time, I thought I was helping myself and helping Enron to make its
numbers (Jennings, 2009, p.293). He was a principal in many of the off-the-book entities
and earned a lot of money from these entities. In the whole case, he is dishonest.
The fourth person I want to mention is David Duncan, the audit partner who was in charge of
the Enron account. The story and ethical issues about him have been introduced in the
previous part. Facing business dilemmas, he chose profit and violated the auditing standards
and contributed to the cheat of Enron.
The last person is an ethical model. She is Sherron Watkins, the vice president for corporate
development at Enron. She brought the financial situation of Enron to public light by
preparing a memo which disclosed the financial situation of Enron. Although she known she
would lose her Enron job, she continued preparing the reports and just looked for a new job.
In the dilemmas, she was one of the few people who chose to disclose the truth even if put
herself in the risk of losing her job.
3. Ethical Dilemmas
3.1 Factors contributed to unethical behaviors
Enrons culture contributed much to the ethic scandal. Enron was a harsh and condescending
company, who emphasized competition and financial goals. For example, it had a rating
system which required that 20 percent of all the employees had to be rated as below
requirements every year and then were encouraged to leave Enron (Jennings, 2009, p. 288).
Although Enron hoped this rating system could have encouraged employees to work hard,
actually, the system brought more harm to Enron than benefits.
Firstly, Enrons competitive environments and rigorous performance evaluation standards
caused a culture of deception. Since employees were nervous about losing their jobs, they
only focused on how to make their performances look good. They ignored the ethical
standards, and only focused on the achievement of their financial goal. After a few
employees began cheating on their works, the only way to beat these persons was to cheat
more. Gradually, no persons felt shame about cheating because they had no other choices
and all their co-workers surrounding them were cheating. This caused a culture of deception.
Employees were measured on their abilities to cheat. In such an environment, the people
who never cheated were regarded as odd. For example, Margaret Ceconi, an employee with

Enron Energy Service, once wrote a memo about the truth of accounting issues of Enron; she
was later counseled on employee morale (Jennings, 2009, p.290).
Secondly, this competitive environment contributed to the covering of the errors and cheating
because employees tended to be uncooperative and seldom communicated with each other.
The employees were unwilling to ask questions because asking questions was regarded as
humiliating. Besides that, they were also less willing to share resources and information
because they competed with each other. So in Enron, no persons asking questions as well as
no one want to answer questions. Because of this working environment, few employees at
Enron actually understood their jobs. As a result, they just tried to hide errors and made their
work look good. Additionally, they ignored the errors and cheatings of others. They never
mentioned their doubts about others works. Because they thought if others were not
actually wrong, the person who mentioned questions would be laugh at. So employees at
Enron were quiet.
Additionally, the culture of Enron emphasized too much on the financial goals. The person
who can achieve the budget numbers would be the hero of the company. Both executives and
most of employees focused on making profits for themselves through making good financial
numbers instead of a real increase of the companys economic value. Enron also was
concerned less about the needs, values, desires and also the well-being of the employees.
From the ethical aspect, employers should respond to their employees and keep the goal of
benefiting them. In such a company, ethical standards were just window dressing. No one
followed them. For example, the conflict of interest policy was waived to let the officers of
Enron served as officers in off-the-book entities.
Fourthly, Enron tried to keep its employees and outside parties quiet. Employees were
discouraged from expressing doubts about the financial condition of the company as well as
decisions made by the executives. In these years when it committed fraud in its financial
statement, Enron hurt both people inside and outside of Enron, who doubted Enrons
financial conditions. For example, John Olson, an analyst with a Houston company, lost his
job because Olson advised his client not to invest in Enron since he had questions about how
Enron was making money. Another example was that Clayton Verdon, a former employee of
Enron, was fired in November 2001 for posting his comments about overstating profits in
an employee chat room (Jennings, 2009, p. 291). Therefore, employees in Enron were
pressured to work blindly, keep silent, protect their own short-term interests, and try to
achieve their goals even if it was an obvious cheat.

This evil culture contributed to Enrons scandal. At Enron, both executives and most of
employees behaved unethically when they encountered conflicts of interests. They were
greedy and self-interested.

4. Implication of the Case

As for the impact of this case are as follows:
1. The US government published the Sarbanes-Oxley Act (SOX) to protect investors by
improving the accuracy and reliability of disclosure by the public company. In addition, also
formed PCAOB (Public Company Accounting Oversight Board) who is in charge:

Register public accounting firm that audit public companies

Establish or adopting auditing standards, quality control, ethics, independence and other

standards related to audit public companies.

Investigate the firm and its employees, conduct disciplinary hearings, and impose

sanctions if necessary.
Carry out other obligations required to raise professional standards in KAP
Improving adherence to SOX, PCAOB regulations, professional standards, capital
market regulations relating to audit public companies.

2. The changes specified in the Sarbanes-Oxley Act

To ensure the independence of the auditor, the KAP prohibited from providing non-audit
services to the audited company. Here are some non-audit services that are prohibited:
a. Bookkeeping and other related services.
b. Design and implementation of financial information systems.
c. Appraisal and valuation services
d. Opinion fairness
e. The functions relating to management services
f. Brokers, dealers, and investment advisers

Requires the approval of the audit committee prior to the audit firm. Each company has
an audit committee because the definition is expanded, ie if no, then the entire board of
directors into the audit committee. Prohibit the Firm provides audit services if the audit
partner has provided audit services for five years in a row to the client.

KAP should immediately make a report to the audit committee showing the significant
accounting policies used, alternative treatments appropriate accounting standards and
have been discussed with management of the company, his election by the management

and auditors preferences.

KAP prohibited from providing audit services if the CEO, CFO, chief accounting officer,
controller client had previously worked in the KAP and the audit client the previous year.

3. SOX prohibits the destruction or manipulation of documents that may hinder the
investigation by the government to companies that declare bankruptcy. Moreover, now the
CEO and CFO must make a statement that the financial statements that they report is in
accordance with SEC rules and all information reported is fair and no material errors. In
addition, it becomes more and more criminal sanctions for those who commit these
violations.
4. International Federation of Accountants (IFAC), at the end of 2001 to revise the code of
ethics for accountants who work in order to become whitstleblower as follows "professionals
are required not only to be professional in the rules of professional rules of the profession
alone but also in stating the truth during the community will be harmed, or there are measures
companies are not in accordance with applicable law ".
5. AICPA and The Big Five KAP Reform in America support initiatives that prohibit the Firm
to offer internal audit services and other consulting services to the audit client company KAP
concerned.
6. John Whitehead and Ira Millstein, chairman of the SEC with the Blue Ribbon Committee,
issued a recommendation on the need for Congress prepare the Act that require companies go
public to implement and report on adherence to corporate governance guidelines.
7. Securities Exchange Commission (SEC) and the New York Stock Exchange (NYSE),
calling that internal auditors must sharpen role in the examination of obedience, manage
risks, and develop business operations, and each company is required to have an internal
audit function (James: 2003 ).