Ethical issues in the Enron scandal

Enron & Ethics

Enron Ethical Lessons

The collapse of Enron in 2001 was an incredibly negative event in the business world of the U.S., and it sent shock waves through corporate hallways everywhere. It also sent laid-off employees scurrying for comfort and it sent many stakeholders into the poorhouse as 401K investments melted away like butter in a blast furnace.

And even though there have been numerous corporate meltdowns since then, especially in the past year due to the recession and bank failures, the Enron case stands out as one of the darkest moments in the economic history of the United States. And the one simple word with complex meanings is at the root of Enron's stunning collapse: ethics.

Indeed, the appalling ethical breaches that occurred at Enron before and leading up to its demise are the subjects of countless lectures in universities, books, scholarly articles, and no doubt the lessons of Enron are shared in many HR training sessions as well.

What happened? Basically there were many causes for the Enron collapse, according to Kirk Hanson, executive director of the Markkula Center for Applied Ethics. Santa Clara University sponsored an interview between Hanson and Japanese journalist Atsushi Nakayama (with Nikkei, a major Japanese newspaper). Hanson said for one thing, the conflict of interest between the dual roles place by auditor Arthur Anderson led to a deceitful corporate accounting. For another, members of the Enron board of directors did not pay close attention to what was happening with the "off-books financial entities with which Enron did business" (Hanson, 2002). A third reason that led to the collapse of Enron was the "lack of truthfulness" on the part of management as to the financial health of the company.

But all those reasons notwithstanding, Hanson hits the nail on the head when he explains that "...the culture of Enron was the primary cause of the collapse" (Hanson, 2002).

Introduction

The Congressional Research Service of the United States Congress published a report for members of Congress looking in to the Enron failure (Jickling, 2002) in February 2002, which offered "An Overview of Financial Issues" relative to the Enron collapse. Enron began in 1985 from a merger of Houston Natural Gas and Internorth; soon Enron was the "first nationwide gas pipeline network" in the U.S., Jickling writes. In time, Enron's focus moved away from the regulated transportation of natural gas around the country to "unregulated energy trading markets" (Jickling, CRS 1). The Enron philosophy was working on the notion that there was more money to be earned "buying and selling financial contracts linked to the value of energy assets (and to other economic variables) than in actual ownership of physical assets" (Jickling, CRS-1).

To all intents and purposes, and to most observers from the financial world and Wall Street, the Enron transformation from ownership of energy assets to buying and selling contracts was an "outstanding success," Jickling continues. In fact Enron reported annual revenues that were impressive; in the early 1990s Enron was reporting annual earnings of $10 billion, but by 2000 Enron reported annual earnings of $101 billion.

The "unraveling" of Enron began in August 2001, Jickling explains, when the CEO, Jeffrey Skilling, suddenly quit his post for "undisclosed reasons"; and shortly thereafter, on October 16, 2001, Enron reported its first quarterly loss in four years (Jickling, CRS-1). Things began to spiral downward for Enron; on November 8, 2001, the company announced in a filing with the SEC that it was "restating its earnings since 1997 - reducing them by $586 million" (Jickling, CRS-2). On November 28, the "coup-de-grace" came down on Enron as their bond rating was downgraded to "below-investment-grade, or junk bond status" (Jickling, CRS-2). Shortly thereafter, on December 2, 2001, the giant and successful energy company filed for Chapter 11 bankruptcy.

Discussion

There are numerous legal strategies and myriad financial angles to employ when approaching reasons for this disaster that Enron dragged its employees, its stakeholders, its customers, the public and its retirees through. For this paper, the ethical aspect will be explored, examined, and analyzed by scholars and journalists. The Public Broadcasting Service (PBS) put the Enron scam into fairly simple language (www.pbs.org) onJanuary 30, 2002. Explaining how a giant company that was worth "billions of dollars" and had reported earning $100 million in 2000 fell so far so fast, the PBS reports that Enron's company officials "...used secret investments and tricky math to make Enron appear stronger than it was" (Bauman, 2002). By doing that the stock prices went "up and up," Bauman writes. Meantime unscrupulous insiders - "who knew the real picture" - went ahead and sold their stock when the price was very high and as a result of this skullduggery those insiders "made millions of dollars" (Bauman, 2002).

Among the saddest aspects of Enron's collapse is that thousands of honest investors who trusted the company to deliver honest reports were left "holding worthless stock," Bauman explains. Many of those investors "lost their life savings," Bauman continues. The PBS report mentions that then President George W. Bush had received substantial political donations from Enron, but so did many other politicians, in Texas and elsewhere. But aside from all the losses and personal financial disasters surrounding this matter, the root of the scandal is ethics.

On the subject of ethics, one of the most poignant ironies of the entire affair is the "Code of Ethics" that Enron published in July 2000; the Foreword was written by Chairman and CEO Kenneth L. Lay, who asserted that since Enron "...enjoys a reputation for fairness and honesty," and that it is "respected," it is up to all Enron employees to "...keep that reputation high." Employees were required to sign a "Certificate of Compliance" as a statement of agreement to "comply with the policies stated herein..." (Lay, p. 3). The entire 64 pages of the Enron's "Code of Ethics" is available online from the Web site that originally published it and specializes in investigative work, www.thesmokinggun.com.

Although it is far too voluminous to review in great detail, for this research paper on ethical issues a few select phrases and statements from Enron's "Code of Ethics" will serve a worthy purpose. It is interesting to note that "Enron's Vision and Values" go well beyond just good corporate behavior, and indeed was built, according to Lay, on "human rights principles" (Lay, p. 4). Under "Values" the Enron ethical rules include a Biblical-themed section; employees were expected to "treat others" as "we like to be treated ourselves" - which means Enron does not tolerate "ruthlessness, callousness and arrogance" (Lay p. 4). Of course in the aftermath of the Enron disaster the corporate leadership treated employees, retirees and stockholders with a ruthless, callous and arrogant disregard for their rights.

The "Integrity" section of the Code of Ethics urges employees to work with customers and potential customers "...openly, honestly and sincerely" (Lay, p. 4). In the "Excellence" section on page 4 Kenneth Lay (the late Kenneth Lay) insists that Enron will be satisfied "...with nothing less than the very best in everything we do. We will continue to raise the bar for everyone."

Later in the "Code of Ethics" Lay asserts that Enron was "...dedicated to conducting business according to all applicable local and international laws and regulations, including, but not limited to, the U.S. Foreign Corrupt Practices Act, and with the highest professional and ethical standards" (Lay, p. 5). One has to wonder if, when writing this or approving the writing that someone else did, Lay felt a twinge of guilt, or if perhaps his conscience clicked in for just a moment, given that the company had for years been tweaking the books and lying to its stakeholders - not to mention setting up phony companies to hide millions of dollars that he and other cohorts could later abscond with.

The "Code of Ethics" actually reads like a book titled "Ethics Enron Offered but Did Not Follow"; on page 8, for example, Lay outlines the "consequences" for those who would give consideration to insider trading. "...Insider trading violations can be staggering," Lay writes, and goes on to outline those consequences. One, persons caught doing insider trading face "...a civil penalty of up to three times the profit gained or loss avoided"; two, there is a "criminal fine...of up to $1 million"; and three, persons convicted of insider trading face "A jail term of up to ten years" (Lay, p. 8). He went on (p. 9) to explain that a company that is guilty of insider trading could be fined - "a criminal penalty" - up to $2.5 million (which would have been small potatoes compared with the money Enron executives stole away with, or attempted to steal).

Meanwhile, if so much attention was paid to the legal ramifications of insider trading, then a fair question to ask is, why did Lay and other top Enron executives participate in this illegal activity? Part of the answer certainly has to be that those executives didn't follow their own ethical guidelines. From all facts and appearances, those Enron executives gave lip service to ethics, then went on their own way, making as much profit as they could while the company teetered on collapse.

One final example from Enron's "Code of Ethics" is titled "Twenty-Twenty Hindsight" which carries its own irony without delving into its points. Lay writes on page 10 that if any employees' security activities or transactions "become the subject of scrutiny," those transactions will be viewed "after-the-fact with the benefit of hindsight" (Lay, p. 10). And so, the section continues, "...before engaging in any transaction you should carefully consider how regulators and other might view your transaction in hindsight" (Lay, p. 10).

Looking Deeper into Ethical Standards and Conduct

Craig Edward Johnson is the author of the book Meeting the Ethical Challenges of Leadership: Casting Light on Shadow (Johnson, 2008). Anyone even remotely familiar with the Enron mess knows that there were some shadowy activities within the executive ranks at Enron. But Johnson makes a case that everyone has a "shadow side." On page 4 of his book Johnson notes that psychotherapist Carl Jung was the first social scientist to identify the side of the human personality called the "shadow side." Jung was alluding to and studying the subconscious in this context, and looking into both positive element ("creative," and "the desire for achievement") in the subconscious and the negative, or dark element ("greed, fear, and hatred") (Johnson, p. 4). Other psychologists equate the shadow with "destruction," Johnson writes, but most psychologists agree on this point: "If we want to manage or master the dark forces inside us, we must first acknowledge that they exist" (Johnson, p. 4).

Johnson goes to great lengths to examine the shadow side of executives and leaders in a number of instances, including Jim Jones (People's Temple) who led a mass suicide in Ghana a few years ago. But the focus on Enron is particularly effective in terms of a reader attempting to understand what went wrong in the minds of those who committed the illegal and contemptible actions that led to Enron's downslide and eventual demise. The more power we have, Johnson goes on, "...the more likely others are to comply with our wishes" (Johnson, p. 7). The author discusses the "five power bases" in an attempt to explain how power can become corrupted.

Coercive power" is a system based on "penalties or punishments" like salary reductions, suspensions of students in high school or college, "physical force" or "embargoes against national enemies" (Johnson, p. 7). "Reward power" comes in the form of praise, cooperation, trust, "bonuses, health insurance" or grades, while "legitimate power" comes with the position, not the person (examples include judges, cops, parents and supervisors) (Johnson, p. 7). "Expert power" is based on the knowledge of the individual, the skill level, certification and education of the person, Johnson continues on page 7. And the fifth kind of power is "referent (role model) power," which rests "on the admiration one person has for another" (Johnson, p. 7). Johnson explains that leaders most often draw on more than one power source, and in the case of Enron one can certainly deduce that "coercive power" and "reward power" played significant roles.

Meantime, Johnson (p. 29) asserts that Enron's executives "cast shadows" in several ways, in terms of ethics. Those executives certainly exhibited an "abuse of power," and the story of their abuse of ethics can be capsulated through the activities of Jeffrey Skilling (Lay's replacement who didn't stay long). Skilling "wielded power ruthlessly," Johnson explains. Skilling frequently intimidated subordinates while Lay simply "demoted" underlings who disagreed with him. Another shadow cast by Enron leaders vis-a-vis ethics was through "excess privilege"; the executives simply spent wildly with money that truthfully did not belong to them. Lay told a friend, "I don't want to be rich; I want to be world-class rich" (Johnson, p. 29). Even as the 401K accounts of their employees were being "wiped out" Lay and his colleagues were unloading their shares and profiting by multiple millions of dollars.

A third "shadow" that was cast by Enron executives was "mismanaged information" - which Johnson (p. 29) says is a process that deceived the public and the board members. They set up partnerships "off-the-books" which is an illegal way to manage corporate books. A fourth shadow mentioned by Johnson was "Inconsistent Treatment of Internal and External Constituencies"; this breach of the company's own code of ethics amounted to Lay and his executive colleagues giving five hundred Enron officials "retention bonuses" of over $55 million while lower-level employees were being laid off with tiny little severance paychecks (Johnson, p. 29). The fifth breach of ethics from Johnson's perspective was "Misplaced and Broken Loyalties" which occurred because Lay and his cohorts placed loyalty within themselves and were thoroughly disloyal to stockholders, business partners, local communities, ratepayers and even foreign governments.

Author Johnson, who is professor of leadership studies (Ph.D) at the University of Denver and director of the Doctor of Management program at George Fox University, also lists "irresponsibility" as one of the shadows cast by Enron's top people. The last shadow needs no further enumeration. The Enron executives who led their company down the path to darkness and scandal had ethical lapses, for sure, but they also had "warped minds," Johnson asserts on page 37 of his book. He plucks "warped minds" from a survey of corporate psychologists - found in USA Today - a survey that concluded "insatiable desires of out-of-control CEOs have less to do with money and more to do with the following: "poor self-image" (they try to make up for feelings of "inadequacy" by constructing "monuments to themselves"); "The 'I Deserve it' Myth" (executives believe sometimes they deserve all the credit); "Unchecked Fantasies" (they can live out their fantasy by spending and exerting power with unchecked enthusiasm); "Society's Blessing" (as long as they produce results, some executives believe the public allows they to do whatever they want to do); "Competitiveness Gone Awry" (out of control egos strive to out-do their competition in a fanatical way); "Lonesome Soldier Syndrome" (expensive things take the place of friends; high-powered executives find it hard to make friends because they fear the "friend" just wants to be close to power); "Boredom" (at the top of their games, many executives invent "new challenges" that end up being illegal); and "Power Corrupts" (some CEOs "lose the sense of what is rightfully theirs and what isn't...treating others like peasants and claiming all that they see" (Johnson, p 37).

The accounting scandals at Enron and ethical attitudes in general are the subject of an article in Social Science Quarterly (Conroy, et al., 2006) titled "Changing Ethical Attitudes: The Case of the Enron and ImClone Scandals." In other words, how did the Enron disaster affect the way Americans feel about ethics? The authors note at the outset of the piece that while "ethical attitudes do appear to change over time," previous research has not been able to exactly identify the "stimulus for such change" (Conroy, p. 396). When there are legal consequences associated with a corporate scandal, and it becomes a major media event night after night on television and in the newspapers, society also suffers, as society did with the Enron collapse, Conroy explains. As to the American public's response - in ethical terms - to Enron's messy aftermath, the degree to which the public rejected the corruption was "...driven by the realization that such actions cause significant harm to innocents" (Conroy, p. 397).

The article presents surveys of public attitudes tapped into during and following the Enron scandal. The Pew Research Center tested public opinion, according to Conroy, in December 2001, and asked Americans if they had been following news of the Enron collapse "very closely" or "fairly closely." The response was that 34% in December 2001 admitted to listening "very closely" or "fairly closely" but by January 2002 that percentage went up to 43%; in February, 2002, the news media was swarming all over the Enron story and as a result 61% of those polled admitted to following the scandal.