Question

Topic: Financial scandal that took place prior to the Sarbanes-Oxley Act (SOX) of 2002

Question: What led to the scandal from a management ethics point of view, did management encourage the manipulation of financial data, did they just look the other way, did they cover it up, etc. Was there any corporate governance?

Answer 1

Corporate governance has been defined as a set of mechanisms of incentives and monitoring in order to assure a good management in behalf of company and its shareholders and others stakeholders. It should build an environment of trust, transparency and accountability for investments. Nevertheless, despite the improvement on business environment, some events periodically show that these principles are overlooked by important companies or even simulated.

The story of Enron Corporation depicts a company that reached dramatic heights only to face a dizzying fall. The fated company's collapse affected thousands of employees and shook Wall Street to its core. At Enron's peak, its shares were worth $90.75; when the firm declared bankruptcy on December 2, 2001, they were trading at $0.26. To this day, many wonder how such a powerful business, at the time one of the largest companies in the United States, disintegrated almost overnight. Also difficult to fathom is how its leadership managed to fool regulators for so long with fake holdings and off-the-books accounting.

KEY TAKEAWAYS

• Enron's leadership fooled regulators with fake holdings and off-the-books accounting practices.
• Enron used special purpose vehicles (SPVs), or special purposes entities (SPEs), to hide its mountains of debt and toxic assets from investors and creditors.
• The price of Enron's shares went from $90.75 at its peak to $0.26 at bankruptcy.
• The company paid its creditors more than $21.7 billion from 2004 to 2011.

After big corporate scandals like Enron, WorldCom, Tyco, Parmalat, the quality of financial statements and the role of auditors and accountants were broadly questioned and turned to be the central point in corporate governance issue for some couple of years. As a matter of fact, corporate scandals open wide weaknesses on internal and external controls over companies, which should be detected by good practices of governance. Effective corporate governance should reduce the likelihood of creative accounting and frauds.

Sarbanes-Oxley Act of 2002 approved by American Congress was a response to these scandals as a temptation to restore investor confidence by ensuring compliance. Effectively, it ended with a century of self-regulation of the accounting profession in the USA [2, 3]. Section 404 of this law requires extensive documentation, tests and assessments of companies’ internal-control procedures. Corporate Governance framework has shown to be ineffective to avoid or to preview financial misstatement. SOX was then supposed to allow detecting problems on financial reporting processes and procedures before scandals.

The SOX Act created the Public Company Accounting Oversight Board (PCAOB) with the mission to oversee the audits of public companies and related matters, even in foreign companies as they were listed on U.S. stock exchange market. It was given authority to inspect accounting firms work, conduct investigations and take disciplinary actions. After an initial constraint, European Commission (EC) rules started to incorporate part of Sarbanes-Oxley Act to remodel Corporate Governance standard within European Union. Self-regulation market approach was no longer efficient to assure corporate governance even in Europe.