Ethics

“A man's ethical behavior should be based effectually on sympathy, education, and social ties…"

-Albert Einstein

Ethics are the principles and standards that guide our behavior toward other people. They are based on morals and entrenched in our culture, religion, and background. Ethics play a prominent role in business, as well. Billionaire Kerry Stokes explains, “Ethics or simple honesty is the building blocks upon which our whole society is based, and business is a part of our society, and it's integral to the practice of being able to conduct business that you have a set of honest standards.” While ethics can be defined as doing the right thing, the distinction between right and wrong is often blurred. The law outlines what is legal but sometimes conflicts with what is ethical. For example, it may not be illegal to run personal errands on company time, but it is certainly not ethical. Because acting ethically and acting legally do not necessarily always align, it can be difficult to decide what the appropriate decision in a certain situation may be. When these choices are not perfectly clear, it is important to give the situation much though and even discuss it with a colleague. Some companies even offer an ombudsman, an individual who gives advice on work-related ethical issues. Regardless of how one comes to make a decision, it is essential to act ethically.

Enron: A Lesson in Ethics, or Lack Thereof

Enron originated from a company known as the Northern Natural Gas Company. After purchasing Houston Natural Gas in 1985, the name changed to "Enron.” Kenneth Lay took the helm as CEO shortly after. The initial function of the company was to channel gas and electricity across the nation, and manage the operation of pipelines and major power plants. Enron had an advantage in this industry because it owned a large chain of untapped gas lines utilized by interacting with many other gas businesses. These lines were the only part of Enron that made significant profit, and made it possible for the organization to dominate the industry. Soon after, in 1998, Enron expanded their control to include the water division. This led to the formation of the Azurix Corporation. However, this creation proved unsuccessful and eventually dissolved in 2001. Although this initiative proved to be a failure, the company began to prosper, largely due to their marketing power and innovative abilities.

Despite what was going on behind the scenes, Enron was a renowned and well known company. They were named as one of Fortune's "100 Best Companies to Work for in America" as well as earning the title of “America’s Most Innovative Company” for six consecutive years. However, everyone was oblivious to Enron’s fast growing financial debt, even its own employees. From an outsider's perspective, the company offices even seemed affluent. Many respected the company and it was even referred to for its amazing benefits and efficacious management. However, the secret scandal was soon to be brought to light by a utilities analyst named Daniel Scotto. After he found out what was happening within the corporation he wrote a document called, "All Stressed Up and No Place to Go." This report suggested to the general public that they should refrain from buying Enron securities.

Soon after this information was discovered, it became known to the public that almost all of Enron's reported profits and net worth were amplified to astronomically enlarged numbers. In some cases, portions of the reported earnings were actually nonexistent, a practice the company started as far back as 1987. Enron Oil Corporation was constantly climbing to higher levels of debt while the stock price was soaring to record highs. Some people questioned Enron’s unexplainable profit increases, and the company repeatedly claimed that they didn’t have the records to provide to the public that truly depicted their economic growth. CEO Jeffrey Skilling felt that he had gotten in over his head, and resigned from the company in August 2001.

The large amounts of debt were able to be covered up by the creation of offshore bank accounts that were not reported in any of the company’s financial earnings statements. The scandal was also concealed with vast and intricate methods of hiding financial transactions in order to make them virtually impossible to be detected. Some employees, such as Louis Borget, even took millions of dollars of corporate funds and transferred them into their own personal accounts. Another major way the company found to deceive the public and economy was by the Hypothetical Future Value (HFV) system. This was the market-to-market accounting that Jeff Skilling introduced to the company. Here the company could claim any amount of income that they wanted based off of future accounts.

These systems were implemented to take any unprofitable records off of Enron's statements. This gave the appearance that the company was earning billions of dollars in profit but in all actuality, they were losing colossal amounts of money. The only people who actually knew about the deceptive operations that were occurring were the executive officers. At the end of each financial period, the executives would have to hide more and more debt, which led to the black hole of bankruptcy and resulted in one of the biggest corporate scandals in history.

In late 2001, Enron filed for bankruptcy and didn’t emerge from it until November 2004. This was one of the largest bankruptcy cases in American History. Enron’s bad name has become linked to dishonesty and fraud. In September 2006, they sold their remaining business to Prisma Energy International, figuring their name couldn’t be cleared.

Jeffery Skilling, former CEO, was sentenced to 24 years in jail in late 2006. He was convicted of 19 different charges and still pled not guilty. Kenneth Lay, chairman and CEO, was convicted of 10 charges and faced 20-30 years in jail. However, he died of heart attack resulting from coronary artery disease while vacationing in Colorado about three months before he was scheduled to be sentenced. Andrew Fastow was sentenced to 6 years in jail and 2 additional years of community service. Fastow helped the prosecution by testifying against other Enron employees and had his jail sentence reduced

Auditing & Ethics: Arthur Andersen's Debacle

Ethics is the core of all auditing.

How Arthur Andersen fell apart…

October 12, 2001:
4 days before Enron disclosed a $618 million loss for the third quarter (this being their first public disclosure of financial problems) – workers at Andersen received a memo to destroy all audit material, except for the most basic “work papers.” RED FLAG?

November 8, 2001:
The first Security and Exchange Commission subpoenas were issued on this date. Supervisors kept reminding employees their destruction responsibilities in the weeks leading up to this date.

At the time, there was no rule for how long accounting firms must hold on to papers, but its standard was to hold many of them for several years.

"Anyone who destroyed records out of stupidity should be fired," said committee chairman Billy Tauzin, a Louisiana Republican. "Anyone who destroyed records to try to circumvent our investigation should be prosecuted."

Ethics definitely comes into play here. There comes a time (especially in auditing) when you have to take a good look around you and decide if what you are doing is right. The statement above is true, but how do you choose who was just blindly following the pack and who knew what they were doing?

In 2002, Anderson was convicted of witness tampering for shredding documents related to its audit of Enron. The firm agreed to surrender its license and its right to practice.

In 2006, The Supreme Court unanimously overturned Andersen’s conviction due to flaws in the jury instructions. According to the court’s view the instructions allowed the jury to convict Anderson without having proof that the firm KNEW it broke the law. Also, there was no proof that there was a link of any official proceeding that prohibited the destruction of documents. This is where the Sarbanes-Oxley Act comes into play.

The Sarbanes-Oxley Act (Also known as SOX) is the direct result from the Enron and Anderson scandal.

There is now an established law that requires you to hold onto documentation for a secure amount of time.

Sec. 802(a)(1) "Any accountant who conducts an audit of an issuer of securities to which section 10A(a) of the Securities Exchange Act of 1934 (15 U.S.C 78j-1(a)) applies, shall maintain all audit or review workpapers for a period of 5 years from the end of the fiscal period in which the audit or review was concluded."

Another law is directly related to the destruction of documents.

Sec. 802(a) "Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both."

Aftermath:
So Andersen is no longer convicted…does it all go back to normal?

No. Reputation is key in auditing. Although they may have been deemed innocent, they in no way APPEARED innocent, which is just as important.

The firm had lost nearly all its clients when it was indicted, and they couldn’t climb out of that hole. They still have a few employees left but the majority of their work is dealing with numerous lawsuits.

Conclusion

Ethics are the building block of our society and thus should be the building block of our corporations. Henry Kravis states, “If you build that foundation, both the moral and the ethical foundation, as well as the business foundation…then the building won't crumble.” It is essential not to let greed cloud judgment. The colossal missteps taken by Enron and Arthur Andersen shall serve as a lesson for those that consider straying from the path of morality.