The "Enron scandal" was one of the biggest corporate collapses in the financial world resulting in an estimated loss of $US74 Billion. As a result of this spectacular but tragic collapse, the Sarbanes Oxley Act was enacted which touches on many topics of this course such as Audit & Governance, Ethics and Internal controls. Provide an analysis of how these topics (or other topics) apply to the Enron case.

 

Sarbanes-Oxley Act was implemented in the year 2002 by U.S. Congress with the aim to safeguard the interest of the investors from all the fraudulent practices performed by public corporations in financial reporting. The major objectives of SOX Act are :

i. Continuous check on the financial reporting of publicly held corporations

ii. Check on the internal controls of publicly held corporations

iii. Examining of the audit procedures for the publicly held corporations as performed by external auditors

Step-by-step explanation

Sarbanes-Oxley Act was implemented in the year 2002 by U.S. Congress with the aim to safeguard the interest of the investors from all the fraudulent practices performed by public corporations in financial reporting. SOX Act came into existence after identification of various financial scandals reported in early 2000 involving mostly large publicly traded corporations. The major objectives of SOX Act are :

i. Continuous check on the financial reporting of publicly held corporations

ii. Check on the internal controls of publicly held corporations

iii. Examining of the audit procedures for the publicly held corporations as performed by external auditors

Major highlights of Enron's financial scandal are :

a. Enron was incorporated with the merger of two companies i.e. Houston Natural Gas Company and Inter North Incorporated in the year 1985.

b. In 1990, U.S. Congress deregulated the energy market that helped all companies trading in energy market to bid for higher prices and Enron also took advantage of the financial market. This was a golden period for Enron, in which the corporation had seen massive growth in its operation that made Enron world's leading oil and gas trader.

c. There was a change in the financial reporting method of the company by Jeffrey Skilling. He changed the historical cost accounting method to mark-to-mark accounting method (MTM accounting), this new method helped the corporation to easily manipulate its accounts resulted in misstated financial position. The company was able to do so for a longer period of time by being unnoticed by the investors and financial legislation of the country.

d. In the mid of 2000 year, there was a boom of dot-com bubble that created the very famous fall of Wall Street market. During that period many large public and private corporations failed and were closed down and, at that particular time Enron decided to enter into high speed telecom networks. With aim of extreme growth in distress market, the company heavily invested the new project and because of depression in the economy, Enron wasn't able to earn any return out of the new heavily invested project. The failure of new project resulted in the fall of company's overall share price and being operating in the most volatile market, Jeffrey Skilling decided to hide the financial losses of the corporation by using the MTM accounting approach. This helped the company to show profitability situation even during the depression period, which started getting noticed in the eyes of investors and law.

e. After the resignation of Jeffrey Skilling from the corporation in August 2001, Enron started reporting massive losses and in order to overcome the situation of loss, the company decided to enter into an agreement with SPVs to raise funds. SVPs helped the company to hide massive debts and losses by reporting them in off-balance sheet items but, there was a conflict of interest between Enron and SVP that resulted in decline in both company's share price.

f. Another major player in the failure of Enron was its accounting and auditing firm "Arthur Andersen LLP". Arthur LLP approved the financial reports of Enron, that were prepared using poor accounting practices. Such situation finally dragged the attention of SEC to investigate the financial reports of Enron and hence, with the interference of SEC, Enron declared its bankruptcy in the year 2001.

The financial scandal of Enron Corporation is stated as one of the biggest financial scandal in the history of U.S. financial market and because of this scandal, the economy of U.S. got to know that there was a need to established effective compliance system for governing the large publicly held corporations. With reporting of many financial scandals such as Enron during the period of 2000 to 2002, there was a sudden movement in the financial market that shook the investor's trust in making investment in such large public corporations. In order to establish better system in the financial reporting for publicly held companies and to lower down the fraudulent acts in the financial reporting, U.S. Congress came up with Sarbanes-Oxley Act in 2002.

Major steps that could be seen in the implementation of SOX are as follows :

a. SOX with in depth understanding identified many loopholes in the accounting practices that are being used by public corporations and provided guidelines for not using them.

b. SOX strengthen the overall corporate governance rules that needs to be adhered by the public corporations that helped to improve the governance and internal controls.

c. Provided many rules and regulations related to accountability and proper disclosures for the financial reporting. These regulations were particularly oriented towards the disclosure execution by the higher authority of corporation such as corporate executives, internal and external auditors i.e. public accountants.

d. Increased the mechanism of corporate transparency by complete disclosure of facts presented in front of the investors and other external users of reports. This will ensure to establish a strong trust of investors towards the publicly held corporations by ensuring continuous monitoring of compliances.

e. Establishment of PCAOB especially for the monitoring of audit performed by external auditors for the public companies.

The major effects that could be seen after implementation of SOX Act are :

a. There has been a very strong compliance towards the corporate governance in the audit committee of public companies.

b. There has been significant rise in the importance of adopting accurate financial reporting standards as prescribed by the independent bodies in order to reduce compliance check on the financial reporting practices by SEC.

c. There has been significant decline in reporting of financial scandals by large public companies as there are established rules and practices provided by PCAOB for the external auditors to have complete check on the audit and internal control of the corporation.