Corporate Corruption in America

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Corporate Corruption in America


The American economy saw record gains throughout the 10’s. Much of this phenomenon was due to great business; however, in light of recent scandals such as WorldCom, Tyco, and Adelphia, Americans have become increasingly skeptical of business, specifically, accounting practice. With the sudden collapse of Enron, one of the world’s largest energy companies, it is all too evident that business is not as clean and prosperous as Americans would like to believe. The problems arose in part because greedy executives at Enron and Arthur Anderson focused on the “letter of the law” rather than on whether or not their proposed accounting measures appeared ethical and fair. Obviously, the scope of this issue extends way beyond Enron, but understanding Enron’s downfall will shed some light upon this dark situation.


A brief history of the American economy is necessary. The Stock Market crashed in 1. Several years later, Congress’s Pecorra hearings uncovered a tremendous amount of scandal. Corporate insiders had been lining their pockets with money due to the virtually unregulated system. A backlash of legislation followed in the 10’s. The Securities Acts of 1 and 14 sought to regulate public companies and reform Wall Street. The Acts also separated commercial and investment banking, created the Securities and Exchange Commission, required accountants to be independent of their audit clients, mandated truthful disclosure by public companies, and prohibited insider trading.n1


Although it would take over twenty-five years to restore the Dow to its pre-crash level, these measures, along with others, restored accountability and confidence in the American economy. “Money came back out from underneath the mattresses as our emerging culture of honesty in financial markets produced the most efficient, deepest, and richest markets in the world. Our markets became the envy of the world. They were markets that created more wealth than all the rest of the securities markets in the world combined.” n


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All of this economic progress did not come free. Unfortunately, problems and scandal often go hand-in-hand with economic progress. During the 180’s and early 0’s, the economy had surged to record levels. Consequently, the number of class action suits against securities companies reached new heights as well. Many of these suits involved the recently deregulated and, as hindsight would show, quickly corrupted savings and loan industry. These suits resulted in billions of dollars of settlement and the ruin of several financial institutions.n


Naturally, the recoil troubled accounting firms, the corporate world, and investment banks. Their sentiments would not go unheard long though. In 14, armed with millions of campaign dollars from corporate lobbyists, the Republicans swept the first majorities in Congress in decades. The Republicans quickly sought to deregulate the federal security industry; specifically, they sought to curb securities class action suits and corporate accountability which had crippled them for years. The result was the Private Securities Litigation Reform Act of 15. This, along with several key decisions by the Supreme Court, completely undermined several decades of advancement in investor rights. “With regard to legal matters, the last five years of the 0th century were a nuclear waste dump for investors and a long-wished-for bonanza for corporate interests, Wall Street bankers, the accounting oligopoly, and their ‘white-shoe” law firms. As the century turned, investor rights and remedies in the United States had suffered their worst rollback in almost seventy years.” n4


The 15 Act was supposed to bring about greater capital formation, increased employment, and, generally, investors’ fortunes and the United States economy would improve. In fact, the opposite has happened. In recent years, the American public has seen a “massive upsurge in securities fraud.” n5 The scandals of WorldCom, Tyco, Adelphia, Enron, and a host of other companies have plagued our economy. Enron, however, remains the biggest and deepest of those scandals.


Before the demise of Enron, it was the seventh largest company on the Fortune 400. Enron reported nearly one billion dollars in net income for the year of 000. In just four years, they had claimed just under 600 million dollars in restated profit. n6 Their 000 annual report stated that its business is to create value and opportunity for your business by combining financial resources, access to physical commodities, and market knowledge to create innovative solutions to challenging industrial problems. n7 In 186, Kenneth Lay became the newly created firms top executive. He later became chairman of the board and hired Jeffrey Skilling as CEO. Under their leadership, Enron adopted an aggressive growth strategy. Andrew Fastow, Enrons CFO, helped create the complex financial structure for the new Enron. n8


Enron rapidly changed its business from a regulated natural gas company into one of the worlds largest energy traders. Enron was, in large part, an unregulated derivative-trading company. It generated funds by entering into extremely risky and expensive transactions. These trading operations relied mainly on very complicated financial transactions. n


Enron changed its business focus from primarily delivering and brokering energy domestically to focusing on three new key business areas water, international energy brokerage, and broadband communications. Although Enrons stock jumped as it entered these new markets, all three of these new endeavors went sour, causing Enrons stock to plummet. Enrons demise began when investors became aware of off-balance sheet partnerships that hid billions of dollars of liabilities. Many companies, like Enron, used special purpose entities (SPE) because as long as at least % of capital comes from outsiders, an SPE can be left off the consolidated financial statements of the parent company. n10 Enron used about 500 such SPEs and thousands of other questionable partnerships in order to structure transactions to achieve off-balance sheet treatment of assets and liabilities. n11 Enron executives often held large personal interests in these partnerships and made massive personal gains in such transactions. All this time it appeared as if the company was quite prosperous, when, in actuality, they were creating little or no real shareholder and creditor value, as was revealed when the questionable accounting and financial reporting decisions were publicly disclosed. In the end, there was nothing left but a 1 billion dollar debt and over $6 billion dollars in lost stock value. n1


Congressman John Dingell, ranking member of the House Energy and Commerce Committee, commented, “Enron went from the number seven company on the Fortune 400 to a penny stock in a stunning three weeks because it apparently lied for years in its financial statements. Where was the Securities and Exchange Commission? Where was the Financial Accounting Standards Board? Where was Enrons audit committee? Where were the accountants? Where were the lawyers? Where were the investment bankers? Where were the analysts? Where were the institutional investors? n1


How did this happen? Over the past several years, important changes in our financial markets occurred which contributed to the massive increase in financial fraud we have witnessed. The economic boom of the 180’s and 10’s created more than ,000 companies. n14 Many of these companies were smaller, high-tech, or biotech companies where the pressure to show earnings were strong. Many of these start-up companies showed little or no earnings initially. To counteract this, companies were pressured to show revenue increases, thereby creating apparent profit. Although many of these accounting principles were accepted under the Generally Accepted Accounting Principles, they created a false sense of security. This phenomenon, along with new executive compensation packages, which were based upon meeting predetermined earnings and/or stock-price targets, made for a deadly combination. The incentives and means were there to falsify reports. Many executives were made multi-millionaires relatively overnight. Unfortunately, in the aftermath of it all, we are left only with the gargantuan debts and losses.


The Private Securities Litigation Reform Act of 15 has come under much scrutiny obviously. The law made it so much more difficult to hold corporate executives, lawyers, bankers, and accountants liable for fraud. Ironically, the law encouraged unethical business. It bred what experts refer to as corporate arrogance. Even today, it is difficult to pin liability or blame on those involved. There certainly will be jail sentences for some involved in the Enron debacle, but, considering the extreme circumstances, the consequences should be far-reaching and severe. n15


What can we do to avoid another Enron disaster? Congressional hearings have revealed the many ways that Enrons management fooled the system. If corporate reporting is not made more credible, there is little hope of restoring public confidence in the markets. Congress has passed legislation, which, hopefully, will do just that. The Sarbanes-Oxley Act of 00 will change the processes for creating and adopting auditing, accounting, independence, ethics, and quality standards for CPAs that audit SEC registrants. In addition, the operation of the new Public Company Accounting Oversight Board (PCAOB) will encompass discipline and inspections. The Act also expands the scope of corporate crime by establishing several new areas of crime. The Act also outlines much greater sentencing outlines for corporate crimes. The Sarbanes-Oxley Act covers many items that will affect accounting principles and auditing standards for years into the future. n16


There is no question that investor confidence has taken a serious blow over the past several years. Strong financial markets depend on the confidence of its’ investors. Without it, we get what economists refer to as a money-under-the-mattress syndrome. Investors will not invest and the economy will remain stagnant. At this time, many Americans would prefer to earn little or no return on their investment than to lose their shirts. Right now, there is a fundamental problem with our financial markets. There is not enough individual accountability. Misconduct is often ignored or punished with a relative slap on the wrist. Perhaps, the indictments and convictions of wrongdoers will begin to restore investor confidence.


Hopefully, for Americans, the worst is behind us. The downfall of several large firms like Enron, WorldCom, and Tyco has sent a large warning to the American public about the state of American business. Political leaders, corporate executives, and accounting experts need to cooperate in the future so that we never again experience a situation like this. More businesses will fail, but with new measures in hand, the American public will not have to witness avoidable failure on such a magnificent scale.





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