Review of accounting ethics

Accounting Ethics: The Enron Scandal

A number of recent scandals in the past ten years have motivated regulators to change the legal landscape in regards to what constitutes ethical standards in accounting. With the Sarbanes-Oxley Act (SOX) in 2002, Congress created the Public Company Accounting Oversight Board (PCAOB), a non-profit entity that assumed responsibility for establishing auditing standards. It replaced the role previously filled by the Auditing Standards Board of the AICPA. The AICPA was deemed to be overly self-interested to regulate the conduct of auditors. One of the precipitating events that generated the political motivation to pass SOX was the Enron scandal. Specifically, "the plight of David Duncan, the lead audit partner at Arthur Andersen on the Enron account, underscores the consequences accountants may face under professional responsibility rules. Duncan pleaded guilty to obstruction of justice in connection with document shredding. The Texas State Board of Public Accountancy, in lieu of further disciplinary proceedings, revoked Duncan's license" (Romal & Hibschweiler 2004). Auditing has traditionally been a self-regulating profession, but after Enron, SOX put into place independent legal guidelines to prevent ethical breaches (Verschoor 2012).

The Enron scandal was a scandal of betrayal -- betrayal of the public trust, of ordinary employees, and shareholders. What is so extraordinary about the story of Enron is that it seemed like a historic American success story. "In just 15 years, Enron grew from nowhere to be America's seventh largest company, employing 21,000 staff in more than 40 countries" (Enron scandal at-a-glance, 2002, BBC). However, the reason for its stratospheric rise in profitability was that "Enron lied about its profits" and it concealed "debts so they didn't show up in the company's accounts" (Enron scandal at-a-glance, 2002, BBC). Enron created a series of shell corporations "designed to hide its liabilities and mislead investors" and even when it knew it was in financial trouble, it concealed its losses and encouraged employees and other investors to buy over $1.1 billion in stock (Enron scandal at-a-glance, 2002, BBC). Both investors and employees alike saw their life savings wiped out as a result of the fraud (Kadlec 2002).

Enron was able to pull the wool over the eyes of regulators for so long with the aid of the formerly well-respected accounting firm of Arthur Anderson. From an accounting perspective, what was so remarkable was the complicity of the stalwart firm in perpetuating the fraud. Anderson did not merely ignore accounting red flags -- it was instrumental in perpetrating the fraud itself. "Just four days before Enron disclosed a stunning $618 million loss for the third quarter -- its first public disclosure of its financial woes -- workers who audited the company's books for Arthur Andersen, the big accounting firm, received an extraordinary instruction from one of the company's lawyers….the Oct. 12 memo directed workers to destroy all audit material, except for the most basic 'work papers'" (Kadlec 2002). Arthur Anderson complied with these instructions despite the fact that there was mounting evidence that Enron's business practices would soon be under investigation.

It should be noted that at the time there was no specific law mandating that Anderson had to keep all documents intact, but most firms keep documents for at least several years and "any deliberate destruction of documents subject to subpoena is illegal" (Kadlec 2002). Anderson, in contrast, avoided keeping any documentation that was not specifically mandated by law. This indicated a pattern of suspicious behavior. Eventually, as a result of Arthur Anderson's massive shredding, the government was "denied thousands of e-mails and other electronic and paper files that could have helped illuminate the actions and motivations of Enron executives" (Kadlec 2002). Anderson's actions were not a one-time oversight: "supervisors at Arthur Andersen repeatedly reminded their employees of the document-destruction memo in the weeks leading up to the first Security and Exchange Commission subpoenas that were issued on Nov. 8" (Kadlec 2002). Loyalty to the client was clearly placed above loyalty to the overall public good and the standards of the profession. "Enron paid Andersen $25 million for its audit…and $27 million for 'consulting' and other services" which meant that Anderson had a substantial financial stake in retaining Enron as a client (Kadlec 2002). The Enron case illustrates the difficulty of self-policing within the industry. Today, providing additional services besides the audit itself is considered an ethical 'red flag' for an accounting firm (Verschoor 2012).

In retrospect, it is difficult to see how the Enron case could have had a happy ending, given that its business model was based upon fraud and deceiving investors. The best case scenario would have been for Anderson not to take the case at all. That is why effective pre-screening of clients is so important. "Practitioners must assess the ethical environment found within potential and existing clients and business partners" (Romal & Hibschweiler 2004). According to Sarbanes-Oxley Act, CFOs must sign a code of ethics. If no such requirement exists, the company must provide an explanation as to why. There seemed to be a clear conflict of interest in the firm taking the case at all. "Two of Enron's senior financial executives had previously worked for Andersen in Houston: Richard Causey, Enron's chief accounting officer, and Jeffrey McMahon, chief financial officer" (Kadlec 2002). The root of the scandal did not lie in the hands of certain employees uncertain of Anderson's expectations regarding corporate ethical standards: rather top personnel at the accounting company actively impressed upon employees that they were to do all they could to keep Enron solvent, versus doing a competent and rigorous audit.