Question: ENROL CASE ANALYSIS

Table of Contents
QUESTIONS ............................................................................................................................................. 2
Q1: WHAT WERE THE ESSENCE AND CAUSES OF THIS CORPORATE SCANDAL IN THE FINANCIAL
MARKETS? .......................................................................................................................................... 2
INTRODUCTION .............................................................................................................................. 2
HISTORY AND FORMATION OF AN ORGANIZATION ..................................................................... 3
IMPORTANCE. ................................................................................................................................. 3
CAUSES OF THIS CORPORATE SCANDAL ............................................................................................ 4
Q2. What were the essence and causes of this corporate scandal in the financial markets? ........ 8
Essence of the Enron Scandal ........................................................................................................ 8
Causes of the Enron Scandal .......................................................................................................... 8
Q3. Where did CG institutions /mechanisms including the corporate board) fail in their duties? 9
Q4. How did Sarbox (2002) Act try to amend the situation?.......................................................... 10
Q5. What are the home country CG standards /guidelines and how do they measure up to
current USA and OECD CG standards?............................................................................................. 12
Q6. How could these home standards be ameliorated to competitively attract more
international investment from abroad? .......................................................................................... 13
REFERENCE ............................................................................................................................................ 15
ENRON CASE ANALYSYSIS

QUESTIONS

Q1: WHAT WERE THE ESSENCE AND CAUSES OF THIS CORPORATE SCANDAL IN THE
FINANCIAL MARKETS?

INTRODUCTION

The financial markets are a financial system through which savings and investments are
conveyed, that allows risks to be transferred from one party to another, and that offers
participants with vehicles to store their wealth Antelo & Peon (2012). Financial Markets
include any place or system that provides buyers and sellers the means to trade financial
instruments, including bonds, equities, the various international currencies, and derivatives.
Financial markets facilitate the interaction between those who need capital with those who
have capital to invest. In addition to making, it possible to raise capital, financial markets
allow participants to transfer risk (generally through derivatives) and promote commerce
Gordon & Natarajan (2010). This is done through Primary or secondary markets. In the
primary markets, new bonds and stocks are issued for the first time. For example, when a
government wants to sell new bills and bonds, or when a company already trading at the
stock market wants to issue new shares, they must do it through primary markets. Most
issuance is distributed with the aid of an underwriter generally an investment bank or stock
brokers. In secondary market the securities are traded through the security exchange. The
Enron scandal provided an insight of rotten activities which are happening in the financial
institutions and public organizations listed on the stock exchange. To start with we will look
at the formation of the Enron company to its liquidation and all the activities that led to that
liquidation. The Enron scandal, which unfolded in the early 2000s was one of the most
infamous cases in corporate history that shook the business world and exposed the darker side
of corporate culture. Enron Corporation, once hailed as a model of innovation and success,
ultimately collapsed in 2001 due to a web of financial fraud, deceptive accounting practices,
and a culture of greed. This write-up explores the key events, factors, and consequences of
the Enron scandal as well as shedding light on its impact on the corporate world and
regulatory reforms.

HISTORY AND FORMATION OF AN ORGANIZATION

Enron Corporation, founded in 1985, began as an interstate through the merger of Houston
Natural Gas and Omaha-based InterNorth. Kenneth Lay, the former chief executive officer of
Houston Natural Gas, became CEO, and the next year won the post of chairman. It rapidly
grew to become a dominant player in the energy industry, specializing in natural gas and
electricity trading and providing a range of energy-related services. By the late 1990s, Enron's
stock price soared, and the company was hailed as a symbol of innovation and success,
regularly appearing on Fortune's list of America's most admired companies. Enron was
rebranded by Lay as an energy trader and supplier.

IMPORTANCE.

As shown in the above case it is important to study the history of how the company was
formed and the main objective such as core business of such a company. Mergers sometimes
may come with different intentions which may lead to market control as such mergers control
the market through taking advantage of large market share acquired.

The case showed how the organizations may be practising malpractices by applying in-
appropriate accounting policies like in Enron's case, the firm would construct an asset, like a
power plant, and then immediately record the predicted profit on its books, despite the fact
that the facility had not generated any revenue for the company. The company would move
the asset to an off-the-books corporation and conceal the loss if the power plant's revenue was
below the predicted level rather than taking the loss. Enron was able to write off
underperforming operations using this type of accounting without it having an adverse effect
on its bottom line.

The case brought out the insight of owners of the businesses may be hiding some suspicious
activities such as huge debts and losses by establishing so many subsidiaries and
establishments within the same entity. This is well understood when Lay then the chairman of
Enron, Fastow CEO and other Enron employees devised a plan to use off-balance-sheet
special purpose organizations (SPEs), also known as SPVs, to conceal the toxic assets and
mountains of debt that Enron possessed from creditors and investors. Instead of focusing on
operating results, these SPVs' main goal was to conceal accounting reality.

As an Auditor not to stay too long with the client and not to offer non- audit services. This
will make an auditor loose his independence in doing his duties and expressing his
independent advice and opinion. The Enron’s bankruptcy case is of particular interest to
accountants, because its long-time auditor, Arthur Andersen, was one of the Big 5 CPA firms.
In 2000, Andersen was paid $25 million in audit fees and $27 million for non-audit
consulting.

CAUSES OF THIS CORPORATE SCANDAL

Unveiling the Scandal

The unravelling of the Enron scandal began in October 2001 when the company announced
significant financial losses and a substantial reduction in shareholder equity. Investigations
revealed a web of fraudulent activities, complex accounting schemes, and the creation of off-
balance-sheet entities to hide debt and inflate profits. Enron's financial reports were found to
be misleading and deceptive, presenting a distorted picture of the company's true financial
health.

Lack or Weak Regulatory and Accounting framework

If the industry where the business is operating is not well regulated, such directors and
business owners will capitalise on this space to manipulate the market. This is well explained
in the Enron where deregulation of the energy markets at that time allowed corporations to
speculate on future prices and Enron was ready to capitalize. Skilling joined Enron at a
fortunate time where Enron thrived in the era's weak regulatory environment. Enron's
downfall can be traced to its elaborate and deceptive accounting practices. The company used
off-balance-sheet entities such as Special Purpose Entities (SPEs) to hide debt and artificially
inflate profits. By moving liabilities and losses off its financial statements, Enron created an
illusion of financial stability and growth. These complex accounting manoeuvres were
facilitated by the complicity of accounting firm Arthur Andersen, which failed in its duty to
provide objective auditing services, regulatory bodies such as the Securities and Exchange
Commission (SEC) failed to adequately monitor Enron's activities and relied heavily on self-
reporting.

Lack of well-established oversight board

Within the organization to help in making important decisions such as making senior
appointments and key investments such as forming a new company. Thus, one person makes
the decisions himself as when he feels fit. An example for Enron, Lay created Enron Finance
Corp. and appointed Jeffrey Skilling, whose work as a McKinsey & Co. consultant had
impressed Lay to head the new corporation. Enron's fraudulent activities were facilitated by
a lack of transparency and inadequate oversight. The company's financial reports were
convoluted and difficult to decipher, making it challenging for investors and regulators to
identify the underlying problems.

Lack of experienced personnel to head the organization.

Where the senior personnel lack experience to run the organization and handle the large
corporations’ affairs as in the case Skilling was then was one of the youngest partners at
McKinsey & Co. consultant meaning he was not experienced enough in the field of
business. The scandal implicated several high-ranking Enron executives most notably CEO
Jeffrey Skilling and Chairman Kenneth Lay. Skilling implemented the company's aggressive
and risky business strategies while Lay fostered a culture of excessive risk-taking and
rewarded short-term financial gains. Chief Financial Officer Andrew Fastow played a
central role in orchestrating the deceptive accounting practices through special purpose
entities, notably the notorious off-balance-sheet entity known as "Enron Special Purpose
Entity (SPE)."

Lack of separation between the office of the chairman and the CEO
At one-point Lay was the CEO and Chairman of Enron against the corporate governance
practise requirement of having this office held by different independent people. The CEO
dealing with the day to day operations of the organization and chairman offering the
leadership role in the oversight role in the company.

Lack of independence of external Auditor.

External auditor is a watchdog in any organization. Situations such as staying with the clients
for a long time causes familiarity threats thus compromising the auditors’ independence.
Offering other non-auditing services to the client also makes the auditor unable to offer an
independent advice and opinion. For the case of Enron Enron’s bankruptcy is of particular
interest to accountants because its long time auditor, Arthur Andersen, was one of
the Big 5 CPA firms In 2000, Andersen was paid $25 million in audit fees and $27 million
for non-audit consulting.

Whistle blower Exposes the Truth

In 2001, Sherron Watkins, a former Enron vice president, sent an anonymous memo to CEO
Kenneth Lay, warning him about accounting irregularities and the potential for a massive
financial collapse. Her memo highlighted the questionable practices and urged Enron to come
clean. Although her concerns were largely ignored internally, her actions eventually led to the
unraveling of Enron's fraudulent activities.

The Collapse and Aftermath

As Enron's financial situation deteriorated, the company's stock value plummeted, and
investors lost billions of dollars. In December 2001, Enron filed for bankruptcy, making it the
largest bankruptcy in U.S. history at the time. The fallout from the scandal was far-reaching,
resulting in the dissolution of Arthur Andersen and the implementation of stricter accounting
and corporate governance regulations. The case also highlighted the need for increased
accountability and ethical standards within corporate culture.

Legal Proceedings and Accountability

Several key figures in the Enron scandal, including CEO Jeffrey Skilling and CFO Andrew
Fastow, faced criminal charges for their involvement in the fraudulent activities. Skilling was
convicted on multiple counts of conspiracy, fraud, and insider trading and received a prison
sentence of 24 years. Fastow cooperated with authorities and received a reduced sentence of
six years. The case served as a stark reminder that corporate executives could be held
accountable for their actions.

Consequences and Impact

The Enron scandal had far-reaching consequences for multiple stakeholders. Thousands of
employees lost their jobs and retirement savings as Enron filed for bankruptcy in December
2001. Shareholders suffered massive financial losses, and investors lost faith in corporate
governance and financial reporting practices. The scandal also triggered a broader crisis of
confidence in the accounting profession and led to the demise of Arthur Andersen, Enron's
accounting firm.

Regulatory Reforms

In response to the Enron scandal, the U.S. Congress enacted the Sarbanes-Oxley Act (SOX) in
2002, which aimed to strengthen corporate governance, enhance financial disclosures, and
increase penalties for fraudulent activities. The act introduced stringent regulations on
accounting practices, audit committees, and the independence of auditors, in an effort to restore
investor trust and transparency in the corporate sector.

Legacy and Lessons Learned

The Enron scandal exposed glaring weaknesses in corporate governance, financial oversight,
and regulatory frameworks. It highlighted the dangers of unchecked greed, inadequate
oversight, and a culture that prioritizes short-term financial gains over long-term sustainability.
The event served as a wake-up call for corporations, regulators, and the public, prompting a
revaluation of business practices, ethical standards, and the need for robust regulatory
measures.

Conclusion
The Enron scandal stands as a cautionary tale of corporate greed, unethical behavior, and the
catastrophic consequences of deceptive accounting practices. It exposed significant flaws in
corporate governance, accounting oversight, and regulatory systems. The scandal prompted
significant reforms in financial reporting and corporate governance to restore public trust in the
business world. The Enron case remains a stark reminder of the importance of transparency,
ethical conduct, and robust oversight to prevent similar corporate disasters in the future.

Q2. What were the essence and causes of this corporate scandal in the financial
markets?

Essence of the Enron Scandal

Accounting Manipulation: Enron engaged in aggressive accounting practices and

manipulated its financial statements to portray a much healthier financial position than it
actually had. The company used complex and deceptive accounting methods, including off-
balance-sheet transactions, special purpose entities (SPEs), and mark-to-market accounting, to
inflate its earnings and hide its debt.

Off-Balance-Sheet Entities: Enron created numerous off-balance-sheet entities, such as

partnerships and special purpose entities, to keep its debts and losses hidden from investors and
regulators. These entities were used to shift debt and losses off Enron's financial statements,
giving the appearance of a financially strong and profitable company.

Insider Trading and Conflicts of Interest: Enron executives, including CEO Jeffrey Skilling
and CFO Andrew Fastow, engaged in insider trading by selling their shares while misleading
investors about the true financial situation of the company. Additionally, conflicts of interest
arose as executives were involved in both managing the company and profiting from their
personal investments in Enron-related entities.

Lack of Corporate Governance and Oversight: Enron's board of directors failed to exercise
proper oversight and allowed the questionable accounting practices to continue unchecked. The
board, which included prominent figures from various industries, did not fulfill its fiduciary
duties and failed to ask critical questions or challenge management decisions.

Causes of the Enron Scandal

Corporate Culture: Enron fostered a culture that prioritized short-term financial gains and
excessive risk-taking. The company rewarded employees based on their ability to meet
aggressive financial targets, which incentivized unethical behavior and encouraged employees
to engage in fraudulent activities to maintain the appearance of success.

Regulatory and Oversight Failures: Regulatory bodies, such as the Securities and Exchange
Commission (SEC) and the auditing firm Arthur Andersen, failed to detect and prevent the
accounting fraud at Enron. There were inadequate checks and balances in the financial system,
allowing Enron to exploit loopholes and manipulate financial reporting without sufficient
scrutiny.

Complex Financial Instruments and Lack of Transparency: Enron's use of complex

financial instruments, such as derivatives and structured finance, made it difficult for investors
and regulators to fully understand the company's financial health and the risks involved. Enron
took advantage of these complexities to obfuscate its true financial condition.

Ethical Lapses and Lack of Integrity: Enron's top executives, including Skilling and
Fastow, prioritized personal gain over ethical business practices. They disregarded their
fiduciary duty to shareholders and deceived investors, employees, and the public by
presenting false and misleading financial information

Q3. Where did CG institutions /mechanisms including the corporate board) fail in their
duties?

Board of Directors: Enron's board of directors failed to exercise proper oversight and fulfill
their fiduciary duties to shareholders. They did not adequately challenge or question the
management's decisions, especially regarding the complex off-balance-sheet entities and
accounting practices. The board consisted of influential individuals from various industries
who had personal and professional relationships with Enron executives, which compromised
their independence and objectivity.

Audit Committee: The audit committee of Enron's board, responsible for overseeing the
company's financial reporting and external audits, also failed in its duties. The committee did
not exercise sufficient scepticism or ask probing questions regarding the financial practices and
disclosures. They relied heavily on Enron's auditors, Arthur Andersen, who were later found
to be complicit in the accounting fraud.

External Auditors: Arthur Andersen, Enron's external auditing firm, failed in its duty to
provide an independent and objective assessment of the company's financial statements. They
did not adequately scrutinize the accounting practices, especially the off-balance-sheet entities
and mark-to-market accounting. Instead of challenging Enron's management, Andersen
actively participated in the accounting manipulations, destroying documents and obstructing
the investigation.

Regulatory Bodies: Regulatory institutions, particularly the Securities and Exchange

Commission (SEC), also failed to detect and prevent the fraudulent activities at Enron. The
SEC did not effectively oversee and regulate Enron's financial reporting, allowing the company
to exploit accounting loopholes and engage in deceptive practices. The regulatory framework
at the time had gaps that Enron was able to exploit.

Credit Rating Agencies: Credit rating agencies, such as Moody's and Standard & Poor's, failed
to accurately assess and reflect the risks associated with Enron's financial instruments and off-
balance-sheet entities. They assigned high credit ratings to Enron's debt instruments, providing
investors with a false sense of security and contributing to the market's confidence in the
company.

Q4. How did Sarbox (2002) Act try to amend the situation?

The Sarbanes-Oxley Act of 2002, often referred to as Sarbox or SOX, was enacted in response
to the Enron scandal and other corporate accounting scandals of the early 2000s. The act aimed
to address the shortcomings in corporate governance, financial reporting, and regulatory
oversight that were exposed by the Enron scandal. Here are some key provisions of the
Sarbanes-Oxley Act and how they attempted to amend the situation:

Enhanced Financial Reporting and Disclosure Requirements: Sarbox introduced stricter

requirements for financial reporting and disclosure by public companies. It mandated the
certification of financial statements by CEOs and CFOs, making them personally accountable
for the accuracy and completeness of the financial information. It also required companies to
establish and maintain internal controls and procedures for financial reporting to ensure
reliability and accuracy.

Strengthened Corporate Governance: The act introduced several provisions to strengthen

corporate governance practices. It required that audit committees be composed of independent
directors and granted them increased authority and responsibilities, such as overseeing the work
of auditors and addressing potential conflicts of interest. Sarbox also increased the
accountability of corporate boards by requiring them to establish codes of ethics and disclose
any waivers granted to executive officers.

Independence of External Auditors: Sarbox aimed to enhance the independence and

objectivity of external auditors. It established the Public Company Accounting Oversight
Board (PCAOB) to oversee the auditing profession and set auditing standards. The PCAOB
was given the authority to inspect audit firms and enforce compliance with auditing standards,
reducing the potential for conflicts of interest between auditors and their clients.

Whistle blower Protection: Sarbox provided protection for whistle blowers who report
corporate fraud or misconduct. It prohibited retaliation against employees who come forward
with information about potential violations of securities laws or fraudulent activities. Whistle
blowers were granted protections such as confidentiality, anonymity, and safeguards against
employment discrimination.

Increased Penalties and Enforcement: The act imposed stricter penalties for violations of
securities laws, including higher fines and longer prison sentences for corporate fraud. It
increased the powers of the SEC to enforce compliance and investigate potential violations.
Sarbox also made it a crime to alter, destroy, or falsify documents with the intent to obstruct
an investigation.

Auditor Rotation and Conflicts of Interest: Sarbox placed restrictions on the relationship
between auditors and their clients. It limited the types of non-audit services that auditors can
provide to their audit clients, reducing potential conflicts of interest. The act also mandated the
rotation of audit partners every five years to enhance independence and prevent long-standing
relationships that could compromise objectivity.
Q5. What are the home country CG standards /guidelines and how do they measure up
to current USA and OECD CG standards?

Kenya has made efforts to develop and improve its corporate governance standards and
practices in recent years. The Kenyan Code of Governance for State Corporations as anchored
in “Mwongozo” which is derived from OECD CG standards. The country has a regulatory
framework and guidelines in place to promote good governance and enhance transparency,
though it may not be directly comparable to the standards set by the United States and the
Organisation for Economic Co-operation and Development (OECD). Nevertheless, it is
valuable to examine the Kenyan corporate governance standards and their alignment with
international best practices, taking into account the lessons learned from the Enron scandal.

Kenyan Corporate Governance Standards and Guidelines:

Companies Act and Capital Markets Authority (CMA) Regulations: The Companies Act
provides the legal framework for corporate governance in Kenya. It includes provisions related
to the composition and duties of boards, financial reporting requirements, and shareholder
rights. The Capital Markets Authority (CMA) Regulations, particularly the Code of Corporate
Governance Practices for Issuers of Securities to the Public, provides additional guidelines for
listed companies and sets standards for corporate governance practices.

Corporate Governance Code: The Institute of Certified Public Accountants of Kenya

(ICPAK) developed the Corporate Governance Code, which provides principles and
recommendations for good governance practices in Kenya. The code emphasizes the roles and
responsibilities of boards, the importance of transparency and accountability, and the protection
of shareholder rights.

Alignment with US and OECD Standards: While Kenyan corporate governance standards
have evolved, they may not be fully aligned with the comprehensive standards established by
the United States and the OECD. Here are a few areas where the Kenyan standards may differ:

Disclosure and Transparency: The US and OECD standards emphasize the disclosure of
accurate and timely information to stakeholders. While Kenya has made efforts to enhance
transparency, further improvements may be needed to meet the level of disclosure expected by
the US and OECD standards. Transparency and disclosure is a key aspect of corporate
leadership and management which creates and sustains confidence of investors, stakeholders
and the wider society and provides opportunities for continuous improvement of business
structures and processes. These shall be contained in the State Corporations quarterly and
annual reports to be filled with the State

Board Independence and Composition: The US and OECD standards place a strong
emphasis on independent directors and their role in providing effective oversight. Kenya has
made progress in recognizing the importance of independent directors, but the proportion and
criteria for independence may differ from the US and OECD standards.

Shareholder Rights and Engagement: The US and OECD standards emphasize shareholder
rights and engagement, including the protection of minority shareholders and mechanisms for
their participation in corporate decision-making. While Kenya recognizes the importance of
shareholder rights, the extent and effectiveness of shareholder protection and engagement
mechanisms may vary.

Audit and External Oversight: The US and OECD standards emphasize the role of external
auditors and independent audit committees in ensuring the reliability of financial reporting.
While Kenya has regulatory requirements for audits and audit committees, further
strengthening of these areas may be necessary to align with international best practices.

Q6. How could these home standards be ameliorated to competitively attract more
international investment from abroad?

To competitively attract more international investment from abroad, Kenya can focus on
strengthening its corporate governance standards. Here are some measures that could help
improve the corporate governance landscape in Kenya:

Enhanced Transparency and Disclosure: Implement and enforce stricter regulations for
transparent and timely disclosure of financial information. This includes ensuring that
companies provide comprehensive and accurate financial reports, disclose related-party
transactions, and adhere to international accounting standards. Robust disclosure practices
build investor confidence and improve transparency.

Strengthening Board Independence: Promote greater independence on boards of directors

by encouraging a higher proportion of independent directors. Independent directors bring
diverse perspectives, expertise, and accountability to corporate decision-making. Clear criteria
and standards for independence should be established, along with mechanisms to prevent
conflicts of interest.

Shareholder Rights and Engagement: Strengthen shareholder rights protection and

encourage active shareholder engagement. This can be achieved by providing mechanisms for
shareholders to voice their concerns, exercise voting rights, and participate in important
corporate decisions. Clear guidelines for annual general meetings and shareholder
communication can enhance shareholder participation.

Audit Quality and Oversight: Enhance the quality of audits through strict regulation and
oversight of auditing firms. Implement rigorous requirements for audit committee
independence, rotation of audit firms, and regular inspection of audit practices. Promoting
adherence to international auditing standards can increase investor confidence in financial
statements.

Regulatory Enforcement: Strengthen regulatory bodies such as the Capital Markets Authority
(CMA) and ensure effective enforcement of corporate governance regulations. This includes
conducting regular inspections and investigations, imposing penalties for non-compliance, and
fostering a culture of accountability within the regulatory framework.

Education and Capacity Building: Promote awareness and understanding of corporate

governance principles and practices among company directors, executives, and professionals
through training programs and workshops. This can enhance their knowledge of best practices
and enable them to implement effective governance measures.

Whistle blower Protection: Establish robust mechanisms for whistle blower protection to
encourage individuals to report corporate misconduct without fear of retaliation. Protecting
whistle blowers helps uncover fraudulent activities and promotes a culture of accountability
and transparency.

Collaboration and Engagement: Encourage collaboration between regulators, industry

associations, and market participants to continuously review and update corporate governance
standards. Regular dialogue and engagement with stakeholders, including investors, can help
identify areas for improvement and address emerging challenges.
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