Enron hid most of its debts by establishing several LLPs, with some of them being secretly ran by Andrew Fastow, CFO at Enron. By counting only the gains and losses of the companies, but not having to report the LLPs on its financial sheet, Enron's financial position seemed very good. Consolidating the statements would have defeated the purpose of Fastow because the goal was to dump debt, not to report it.
This would have made Enron look less profitable. There was no need to consolidate the two statements to count the LLP loses as well as the gains because Enron executives made sure that an outside company had a three percent control of the LLPs. This was the minimum investment required to stop the reporting on the financial sheets of Enron.
The company wanted to reduce its debt to keep its investor ratings. The company could have issued more stocks, but this would have diluted earnings per share and reduced the stock's value. As mentioned earlier, most of the executive compensation was tied to stock options, so issuing more stock would have taken money out of the CEO's and top executives' pockets.
To protect this money, unethical behavior spiraled out of control. The company bankrolled some of the companies with stocks, and engaged in ludicrous business activity such as ridicules guarantees to the LLPs acting at arm lengths. This and other information gave rise to suspicions of the dealings going on at Enron and started a federal investigation. Unfortunately, around this time all Enron pension plan members were prevented from moving any of their 401(k) assets between Oct. 29 and Nov. 13, supposedly to allow for a transition to a new outside plan administrator (Glassman, 2002). "Enron's great local Houston rival, the much smaller Dynergy Inc., announced a bid to acquire Enron but withdrew it on November 28, having done some due diligence. Moody's, the rating agency, downgraded Enron's debt to 'Junk' (Ca) on November 29, with the inevitable result of forcing Enron to seek protection from its creditors a few days later." (Hamilton, 2004) This is important because everything that the company did unethically to flourish and keep a good rating turned out to be for not. The company ended up with a useless junk yard rating. Again, this underscores the point that being unethical does not pay in the end.
D. The End
Essentially, Enron created more and more LLPs to cover the debt that was mounting (Wilson, 2003). When they could not hide the debt any further, Enron began resting Income and restructuring the LLPs. This cost the company stock to go down to almost nothing. The company eventually had to file for bankruptcy. Congress and the federal government began investigations, Arthur Anderson the auditor for Enron, who should of have accounted for the shaky practices of Enron, was also responsible because they either turn a blind eye or was in on the scandal. Arthur Anderson further complicated matters by shredding audited paper work of Enron's. Many questions still remain and the extent of Enron's deceit still has not been discovered.
One thing that the Enron case showed that Internal controls at the company was non-existence. The company was ripe for financial fraud. Therefore, I would implement the following controls in the company.
III. Procedures Needed in a Company to Protect Against Unethical Behavior
A. Internal Control Procedures
The goals of internal control are to safeguard the assets a business uses in operations, encourage adherence to company policy, promote operational efficiency, and ensure accurate and reliable accounting records.
Theses goals are standard for most companies in order to limit fraud and theft. With a good control system, the chances of apprehending deception in the company are much greater. Goals alone are insufficient; companies must also put in place internal and external controls. These controls are:
Competent, Reliable, and Ethical Personnel - Enron did not have ethical personnel. It had people who wanted to outsmart everyone and get rich quick.
Assignment of Responsibility - the major responsibilities at Enron were divided among a few people. This allowed the employees to cover their tracks while they were stealing money from stock holders
Proper Authorization - Enron had a board of directors and the main players in the company received authorization from the board. However, they deceived the board in many instances
Separations of Duties - Enron did not separate duties well. For example, Mr. Fastow ran the LLPs and worked for Enron. This was possible, because he was working for Enron and handling the LLPs by himself with little or no oversight.
B. Components of Internal Control
1. Organizational Environment - Ken Lay and Jeff Skilling set an environment for making money as fast as they could. The company was energetic, and it was accepted to cut corners, and to be innovative with the financial plan. This type of tone and mentality from the top lead to Enron's demise.
2. Risk Assessment - the Board of Directors of Enron failed miserably to properly monitor Enron's business practices. They did not do adequate risk assessment before they approved LLP deals.
3. Implementations of Procedures to Prevent Fraud - Fraud was rampant at Enron. In order to prevent it, there should have been more division of responsibility, and a second outside auditor to audit the books
4. Information and Communication - it is not clear if Enron had a strong it team, but a stronger it team would have allowed the Board of Directors to place more oversight on Enron.
5. Monitoring - a company the size of Enron requires multiple auditors. Its relationship with Anderson as exclusive auditor presented the opportunity for fraud.
After reading all of the factors and importance of ethics, let's place one thing in cement. All the actions taken at Enron were to keep the stock price strong. In order to manipulate the stock prices, this company's leaders uprooted and disregarded the foundation of GAAP. This means that the top executives of the company were not acting in an ethical manner. and, as the executives would later learn, they were acting in a criminal manner.
The tragedy of this story is the investors and employees who were left virtually penniless.
Akhigbe, a, Madura, J., and Martin, a.D.(2005, July 1). Accounting contagion: the case of Enron. Journal of Economics and Finance 29.2: 187-202. http://www.allbusiness.com/finance/3502611-1.html
Glassman, J.K. (2002, January 18) Diversify, diversify, diversify. Wall Street Journal [New York, N.Y.] Eastern edition: A10. http://www.opinionjournal.com/editorial/feature.html?id=95001750
Hamilton, S. (2004, June 4). Enron unravelled. European Business Forum. 66-71. http://www.accessmylibrary.com/coms2/summary_0286-3847472_ITM
Supanvanij, J. (2005). Does the composition of CEO compensation influence the firm's advertising budgeting? Journal of American Academy of Business, Cambridge 117-123.
Wilson, a. And Campbell, W. (2003, January-March) Enron exposed: Why it took so long. Business and Economic Review. 6-10. http://mooreschool.sc.edu/moore/research/Publications/BandE/bande49/49n2/enron.html