Enron scandal which took place in 2001 had become known all over the world for its unprecedented span. In accordance with BBC (2002) top management of the company was incriminated in concealment of the actual financial situation, namely: providing its stakeholders with irrelevant information about profits and debts of the company.
The current paper is to investigate causes and consequences of Enron scandal and discuss the Sarbanes Oxley Act of 2002 (SOX) points with respect to this case.
1. Brief Outline of Enron Crisis
Enron scandal had far-reaching financial and political implications which influenced economical and political life of the United States and the whole world.
BBC (2002) reported main figurants of the case: Kenneth Lay, former Chief Executive, Andrew Fastow, former Chief Financial Officer, Jeffrey Skilling, Chief Executive in 2001, Andersen’s auditor company Chief Executive, Joseph Berardino, Enron’s Chief Auditor at Andersen David Dunkan and Sherron Watkins, Enron former employee who recovered financial fraud.
Enron top management was accused in hiding internal price sensitive information. Andersen auditors were blamed to assistance in distortion of Enron reports. As a result, millions of Enron employees lost their pensions, many employees lost their jobs and funds invested in Enron stock (Cunningham and Harris, 2006).
Besides, Enron was provided with substantial tax privileges because of loss shown in its reports. In addition, the Company supposed to finance Jorge Bush election campaign thus it enjoyed certain privileges. Kenneth Lay was supposed to be in a friendly relationship with Jorge Bush (Cunningham and Harris, 2006).
Unethical and immoral behavior of Enron’s top management who satisfied their short term financial needs at the expense of thousands of people was evident. In addition, this scandal shook investors’ confidence in U.S. nation securities market (Cunningham and Harris, 2006).
Enron’s case had become the vivid example when violating moral and ethical code resulted in legal consequences.
2. Brief Outline of Sarbanes Oxley Act Points
SOX set new enhanced standards for all U.S. public company boards, public accounting firms and companies’ management which concerned internal control assessment, financial disclosure, auditor activity and corporate governance. The purpose of SOX was to eliminate accounting breaches which led to deception of Enron and other similar companies’ stakeholders and the Company bankruptcy.
Moreover, the reformers addressed the following issues: the role of political campaigns financing by business entities; limitation of the influence of energy companies' on national energy policy; conflicts of interest concerns between consultancy and auditing; tough regulation of trading of financial derivatives.
2.1 Establishment of Oversight Board
For the purposes of control the audit of public companies and protect the interests of stakeholders, the Public Company Accounting Oversight Board was established. In accordance with One Hundred Seventh Congress of the United States of America (2002), the main duties of the Board are as follows: registration of public accounting firms preparing audit reports; establishing and adopting audit and quality control; implementing ethics control and observance of other auditing standards; conducting inspections of public accounting firms; conducting investigations and disciplinary proceedings; improving quality of audit services and promoting high professional accounting standards; setting the Board budget and managing its operations.
2.2 Restrictions on Non-Audit Services
Under the terms of SOX of 2002, the company may use any non-audit services except for restrictions outlined in the section 201, point (g) 1-9, including actuarial services; investments advisers; brokers or dealers; banking investment services; bookkeeping related to financial statements of the audit client; designing and implementation of financial information systems; utilization of any appraisal and valuation services; human resources of management functions; outsourcing services of internal audit; legal and expert non-audit services or any services prohibited by the Board.
2.3 Rotation of Audit Partners
Sarbanes-Oxley Act amended Securities Exchange Act (SEA) of 1934 (section 10A) with the following audit partner rotation rules: the audit services are considered if a registered public accounting firm had been performing audit services for the issuer in each of the five previous fiscal years.
2.4 Auditor Reports to Audit Committees
The terms of auditor reports to audit committees are described in the section 204 of SOX of 2002 and amend the SEA of 1934 with the following: each public accounting firm performing audit for any issuer has to report the Audit Committee about alternative treatments of financial information within accounting principles that were generally accepted; critical accounting policies utilized; other material concerning written communication between audit firm and the issuer.
2.5 Conflicts of Interests
SOX (section 206) prohibits the employment of the issuer’s chief officers by the public accounting firms performing audit services for this issuer during the one-year period that preceded the date of the current audit.
2.6 CEO and CFO certification of annual and quarterly reports
Accordingly to SOX of 2002 certification of periodic financial reports described in the section 13(a) and 15(d) of SEA has to be accompanied by a written statement by the issuer’s CEO and CFO. Nonconformity or improper performance of this requirement (paragraph 1350) is punished by criminal substantial penalties up to $5,000,00 or imprisonment up to twenty years.
2.7 Internal control report and auditor attestation
The internal control reporting includes the following provisions: establishing an adequate internal control procedures and structure for financial reporting; evaluation of control procedures of the most recent issuer’s fiscal year.
Each registered private public accounting firm should pass mandatory certification in accordance with attestation standards issued or adopted by the Board.
Under the term of SOX (2002) the following services are considered unlawful: any violation described in the point (g) in section 201 listed above; preparation of issue of any audit report for the issuer by any person who is not a registered public accountant; performance of audit by the audit partner who performed audit for the issuer in each of the five previous fiscal years.
There were some restrictions implemented by SOX regarding auditors, namely: mandatory attestation of public audit firms; auditor reports to audit committee; rotation of audit partners; implementing strict control over conflicts of interests between public audit firms and issuers.
In order to avoid the situation that occurred to Enron, top management should keep up with ethical code and implement proper control over ethical issues, separate consultancy and audit functions, breed corporate culture, openly discuss any issues and regularly examine ethical climate in the organization (Gilman, Harned, Navran & Brown, 2009).
BBC. (2002, August 22). Enron scandal at-a-glance. Retrieved from http://news.bbc.co.uk/2/hi/business/1780075.stm
Cunningham, G. M. & Harris J. E. (2006). Enron and Arthur Andersen: the case of the crooked E and the fallen A. Global Perspectives on Accountinf Education, Volume 3.p.27- 48. Retrieved from http://gpae.bryant.edu/~gpae/Vol3/Enron%20and%20Aurhur%20Andersen.pdf
Gilman,S., Harned,P., Navran F.& Brown, J. (2009, May 29). Ten things to avoid being the next Enron. Retrieved from http://www.ethics.org/resource/ten-things-you-can-do-avoid-being-next-enron
One Hundred Seventh Congress of the United States of America.(2002, January 23). Sarbanes-Oxley Act of 2002. Retrieved from www.findlaw.com