Enron Scandal: Fraud, Ethics, and Securities Regulation

Introduction

Enron was one of the biggest business collapses in history, and one of the most egregious incidents during a period in the early 2000s when investor faith in the securities system was shaken by a series of scandals. The scandals varied in their composition, but behind each of them was greed — the drive by senior management teams to defraud securities regulators and investors for personal gain. This paper examines the Enron fraud in particular. It was probably the worst of the era, given the bald-faced contempt that Enron management showed toward securities regulators, and the largest in scale, as Enron had been one of the stars of the stock market during its rise and crashed to near worthlessness almost instantly.

Key Players

As with most cases of stock market fraud, the key players were the senior executives. At Enron, they were Kenneth Lay, Jeffrey Skilling, Andrew Fastow, and the accounting firm Arthur Andersen. Kenneth Lay was the CEO until 2001 and remained on the Board afterward. Skilling replaced Lay as CEO. Fastow served as Chief Financial Officer. Arthur Andersen was Enron's external auditor, and in that role its responsibility was to ensure that the financial statements produced by Enron accurately reflected the company's financial condition (Investopedia, 2017).

Securities Regulation and Fiduciary Duty

In the United States, the Securities and Exchange Commission is tasked with securities regulation. As part of this role, it verifies the financial statements of publicly traded companies to ensure that those statements were prepared according to generally accepted accounting principles and subjected to external audit by a qualified accounting firm. Firms that do not meet these criteria are subject to investigation and, if found guilty, punishments ranging from fines to de-listing. De-listing is considered a severe sanction, as it would all but eliminate a company's equity value — even the possibility of de-listing would likely destroy a company's market capitalization (SEC, 2017).

One of the central tenets governing public companies is that the Board of Directors hires senior executives and guides strategy. The Board hires the CEO, who is then responsible for appointing other executives, setting corporate strategy, and overseeing other initiatives. The senior management team has a fiduciary duty, granted by the Board, to act in the best interests of shareholders. This duty often lies at the core of ethical dilemmas in business and has become the subject of considerable debate.

The two sides of the fiduciary duty debate are broadly the shareholder approach and the stakeholder approach. The shareholder approach was articulated most famously by Milton Friedman, who argued that the social responsibility of business is to increase its profits, which are then dispersed to shareholders who may do with their earnings as they please. Underlying the argument is the idea that business serves as a vehicle for financial investment — that is, the creation of wealth. Friedman was careful to specify that business must operate within the bounds of the law: "to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom" (Friedman, 1970). Thus, the shareholder argument requires not only that businesses comply with the law in pursuit of profits, but that they respect ethical custom as well. The stakeholder argument, by contrast, holds that businesses affect a wide range of parties beyond shareholders — including workers, local communities, and the environment — and that these interests should be factored into corporate decision-making.

The concept of fiduciary duty is critical in the Enron case because the senior executives had a clear duty to increase shareholder wealth. While their actions succeeded in the short term, Enron's collapse ultimately resulted in shareholders losing their entire investments. Enron's executives therefore failed comprehensively to uphold their fiduciary duty.

References

Friedman, M. (1970). The social responsibility of business is to increase its profits. New York Times Magazine. Retrieved December 13, 2017 from

Investopedia (2017). Enron scandal: The fall of a Wall Street darling. Investopedia. Retrieved December 14, 2017 from https://www.investopedia.com/updates/enron-scandal-summary/

McConnell, T. (2014). Moral dilemmas. Stanford Encyclopedia of Philosophy. Retrieved December 13, 2017 from https://plato.stanford.edu/entries/moral-dilemmas/

SEC (2017). The laws that govern the securities industry. Securities Exchange Commission. Retrieved December 13, 2017 from https://www.sec.gov/answers/about-lawsshtml.html

Stinson, T. (no date). Arthur Andersen and Enron: Positive influence on the accounting industry. McKendree.edu. Retrieved December 13, 2017 from https://www.mckendree.edu/academics/scholars/issue4/stinson.htm

Thomas, C. (2002). The rise and fall of Enron. Journal of Accountancy. Retrieved December 13, 2017 from https://www.journalofaccountancy.com/issues/2002/apr/theriseandfallofenron.html