Enron Scandal – The Evolution of Business Ethics

Aristotle said, “The end and purpose of the polis is the good life”. Adam Smith categorized the good life in terms of material goods and intellectual and moral excellence’s of character. Smith in his The Wealth of Nations commented, “All for ourselves, and nothing for other people, seems, in every age of the world, to have been the vile maxim of the masters of mankind.” Ethical misconduct has become a key concern in business today. Ethics is the main area of corporate governance, and management must take responsibility for their actions on global community scale. Ethics in business and shareholders desires for profitability are not always put on the same pedestal, and it is the responsibility of the executive management to ensure ethics surpass profitability. The 2008 financial crisis initiated critics to inquire about the ethics of the executives who were put in charge of large financial institutions around the world and financial regulatory bodies. Finance ethics is usually not looked into because issues in finance are often seen as matters of law rather than ethics. In the simplest way corporate ethics is a lawful matter. Laws such as protecting workers’ rights and suitable compensations must be top priority for management. Ethics becomes more difficult with the way things are done in particular practices, which makes it important to be aware of how certain steps may affect the community in a bad way. Managers are the key decision-makers, which is why they must be held responsible for the way the business is run and the affect it will have on shareholders, employees and the community in which it operates.

Business ethical customs reflect the customs of each historic period. As time passes customs evolve, causing accepted behaviours to become intolerable. Business ethics and the subsequent behaviour evolved as well. Business was involved in what drove slavery, colonialism, and the cold war. Before 1960, the United States went through several difficult phases of wondering what the concept of capitalism was. In the 1930’s came the New Deal, which blamed businesses for the country’s fiscal woes. Businesses were asked to work more thoroughly with the government to help increase family income. Through the 1950s, the New Deal advanced into the Fair Deal which was an ambitious set of proposals put forward by President Harry S Truman. This program made clear matters such as civil rights and environmental responsibility as ethical issues that needed to be addressed by businesses.

Up until the 1960s ethical issues associated to business were often discussed within the field of theology or philosophy. Moral issues that were related to business were now addressed in churches and mosques. Religious leaders started to speak out about fair wages, labour practices, and the morality of capitalism. During the 1960s, the American society turned to causes about social issues. Antibusiness attitude developed as people attacked the individuals in power that got benefits from the economic and political sides of society that they controlled. The 1960s saw the deterioration of inner cities and the beginning of ecological problems such as pollution and the disposal of toxic and nuclear wastes. This era also saw the rise of consumerism.

The word ‘business ethics’ came into common use in the early 1970s in the United States. It was developed as a course to study in the 1970s. The foundation that certain principles could be applied to business activities which were laid down by theologians and philosophers led to business lecturers start teaching and writing about corporate social responsibility (CSR) which can be defined as a form of corporate self-regulation integrated into a business model. Philosophers increased their participation, putting together ethical theory that will help to build the discipline of business ethics. Companies became more concerned with their public images and as social demands grew, many businesses realized that they had to address ethical issues more directly. Conferences where scheduled to discuss the responsibilities that businesses had socially and also ethical aspect of business. By the end of the 1970s, key ethical issues such as bribery, misleading advertising and price collusion had formed in the business. Business ethics became a common expression thanks to the media and it was no longer considered as an oxymoron. Limited efforts were made to explain the way the ethical decision-making process would work and also the things that would influence this process in organisations.

Firms started emphasizing their ethical standing in the late 1980s and early 1990s, probably trying to distance themselves from the business scandals of the day. Academics and practitioners started to acknowledge ‘business ethics’ as a field of study. In the 1980s, the Defence Industry Initiative on Business Ethics and Conduct (DII) which was developed to give a guide to organisations about support for ethical conduct. This era was the Reagan-Bush era where the belief of self-regulation was seen to be in the public’s interest.

In the 90s it was all about the institutionalization of business ethics. President Bill Clinton and his administration continued to show support for self-regulation and free trade. Unprecedented actions such as teenage smoking were dealt with by the government. Proposals included prohibition of cigarette advertising, and stopping sports events from using cigarette logos during advertisement. President Clinton chose Arthur Levitt to be the chairman of the Securities and Exchange Commission in 1993. Levitt who ineffectively pushed many reforms which could have prevented the accounting ethics scandals demonstrated by Enron and WorldCom.

The 2000s had a new focus on business ethics. This era brought in the many scandals that shook the business world to this day. Although business ethics was seen to have become more institutionalized in the 1990s, in the 2000s evidence came out that more than a few business executives and managers had not been compiling with the public’s desire for high ethical standards. For example, the former CEO of Tyco Dennis Kozlowski was indicted on thirty-eight counts of misappropriating $170 million of Tyco funds and netting $430 million from inappropriate sales of stock. Dennis Kozlowski pleaded not guilty to all the charges. He allegedly used the funds to purchase personal luxuries such as art for $14.725 million, also throw his wife a $2 million birthday party and also bought a $30 million apartment in New York City. He was found guilty and sentenced to serve eight years and four months to twenty-five years in prison for his role in the scandal.

Arthur Andersen, which was a holding company and formerly one of the “Big Five” accounting firm. In its role as Enron’s auditor, they were responsible for make sure that Enron’s financial statements and internal bookkeeping were accurate. The firm after been found guilty of criminal charges in the way the auditing of Enron was conducted gave up their licenses to practice in the US. The reputation of the accounting firm disappeared over night, also most of its clients left, and the firm went out of business, but it still exists in a small way today. The verdict was overruled by the Supreme Court of the United States. Most of the other accounting firms bought most of the practices of Arthur Andersen. Other companies such as Halliburton, WorldCom, Dynegy and Sunbeam where faced with charges about employing certain accounting practices and they were also audited by Arthur Andersen. One of the few revenue-generating assets that the Andersen firm still has is Q Centre, which is a conference and training facility outside of Chicago. Accenture which is a consultancy firm separated from the accountancy side of Arthur Andersen in 1987 and renamed themselves after splitting in 2000, still continues to operate and it is one of the largest multinational corporations in the world. These accounting scandals really confirmed to the public that falsifying financial reports and reaping questionable benefits had become part of the culture of many companies. Firms outside the United States such as Royal Ahold in the Netherlands and Parmalat in Italy, also were caught out in practicing accounting misconducts from a global perspective. Such scandals increased public and political demands for accountability and to also improve ethical standards in business.

The Enron Corporation was created in 1985 out a merger of two major gas pipeline companies. Through its subsidiaries the company provided products and services associated with natural gas, electricity, and communications for its wholesale and retail customers. It was based in Houston, Texas. It generated, transmitted and distributed electricity to the north-western United States and marketed other commodities such as natural gas globally. It was also involved in the growth, construction, and operation of plants, pipelines, and other energy-related projects all over the world. Throughout the 1990s, Chairman Kenneth Lay, chief executive officer (CEO) Jeffrey Skilling, and chief financial officer (CFO) Andrew Fastow transformed Enron from an old-style electricity and gas company into a $150 billion energy company and Wall Street favorite that traded power contracts in the investment markets. From 1998 to 2000, Enron’s revenues grew from about $31 billion to more than $100 billion, making it the seventh-largest company of the Fortune 500. The wholesale energy income represented about 93 percent of 2000 revenues for Enron, with another 4 percent coming from natural gas and electricity. The remaining 3 percent came from broadband services and exploration. The company’s worldwide internet trading platform Enron Online completed on average over five thousand transactions per day, buying and selling over eighteen hundred separate products online that brought in over $2.5 billion in business every day.

For the third quarter of 2001, Enron’s whole-sale business generated a potential $754 million of earnings (before interest and tax). This was an increase of 35 percent from the previous year. This represented over 80 percent of Enron’s worldwide sales. There was no reason to doubt that Enron was not financially stable in the third quarter of 2001 but it was later reported after a bankruptcy examiner examined their financial reports that there was a discrepancy in their net income and cash flow accounts. On October 22, 2001 Enron announces that the Securities and Exchange Commission (SEC) has launched a formal investigation into its related party’s transactions. Enron’s corporate culture was described by people using words such as arrogant or prideful. Enron only employed competent, creative and hardworking employees who were the best and brightest graduates and they were recruited from top universities. Enron employees had thus belief that competitors had no chance against it. There was an overwhelming confidence among Enron’s people that they could handle the increasing risk and pressure that came with the job.

The culture of Enron was about a focus on how much money could be made for the people at the top, at many levels, that shared in a stock option incentive program. Enron’s aggressive employee culture was motivated by the desire to improve their financial position. Skilling brought in a system where employees were appraised every six months and if the employees ranked in the bottom 20 percent they were let go. This system called the ‘rand-and-yank’ helped create a fierce environment in which employees didn’t only compete with rivals outside the company but also the rivals at the next desk to them. Problems in the trading operation were covered up and not told to management because of the fear of losing their jobs. Lay who was the chairman always maintained that he was concerned with ethics. In his indictment the business ethics issue was that he lied about the financial conditions of Enron, but he maintained that he openly dealt with all issues that were brought to his attention.

During 2001, when a series of revelations were revealed involving improper accounting procedures bordering on fraud committed throughout the 1990s involving Enron and its accounting company Arthur Andersen, Enron suffered the largest bankruptcy in history which has been surpassed by those of WorldCom during 2002 and Lehman Brothers during 2008. Off-balance-sheet financing called ‘special-purpose entities’ (SPEs) which were the write-offs and the losses not disclosed were the main thing that turned Enron into a disaster. Fastow the company’s then CFO said that Enron established the SPEs to help in the moving of assets and debt off its balance sheet so as to increase cash flow by showing that funds were flowing through its books when it sold assets, while in a meeting with Enron’s lawyers in August 2001. Critics believed they might constitute fraudulent financial reporting because they didn’t accurately represent the company’s true financial condition. Most of the SPEs at Enron were alleged to be entities in name only, and that Enron funded them with its own stock and maintained control over them. After the crash of Enron’s stock price, assets that were associated with the SPE system had to be written off.

This cost Enron over $1.2 billion in equity in late 2001. Enron filed for bankruptcy and faced twenty-two thousand claims totalling $400 billion. For some time it appeared that Dynegy might save the day by providing $1.5 billion in cash but when Standard & Poor downgraded Enron’s debt below investment grade on November 28, $4 billion in off-balance-sheet debt came due and Enron didn’t have the resources to pay. Dynegy terminated the deal.

Fastow and his wife, Lea, both pleaded guilty to charges against them. Fastow pleaded guilty to two charges of conspiracy and was sentenced to ten years with no parole in a plea bargain to testify against Lay and Skilling. Lea was indicted on six felony charges, but prosecutors later dismissed them in favor of a single misdemeanour tax charge. Lea was sentenced to one year for helping her husband hide income from the government.

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