ENRON WHAT CAUSED THE ETHICAL COLLAPSE
CASE 1
ENRON: WHAT CAUSED THE ETHICAL COLLAPSE?
CASE SUMMARY
Kenneth Lay, former chairman and chief executive officer (CEO) of Enron Corp., claimed to be a
moral and ethical leader and exhorted Enron’s officers and employees to be highly ethical in their
decisions and actions. In addition, the Enron Code of Ethics specified that “An employee shall not
conduct himself or herself in a manner which directly or indirectly would be detrimental to the
best interests of the Company or in a manner which would bring to the employee financial gain
separately derived as a direct consequence of his or her employment with the Company.” Enron’s
ethics code was based on the values of respect, integrity, communication, and excellence. Given
this code of conduct and Ken Lay’s professed commitment to business ethics, one wonders how
Enron could have collapsed so dramatically? The answer to this question seems to be rooted in a
combination of the failure of top leadership, a corporate culture that supported unethical behavior,
and the complicity of the investment banking community.
The failure of Enron’s top leadership was evident in the activities of Andrew Fastow, Jeff
Skilling, and Ken Lay, all of whom faced multiple counts of criminal activity with respect to their
decisions and actions at Enron. Included among these criminal charges were money laundering,
wire fraud, securities fraud, conspiracy, making false statements on financial reports, and insider
trading. Some of the activities that led to these criminal charges were: (a) concealing how
extensively Enron was involved in trading in order to support a high market valuation of Enron’s
stock; (b) setting up and operating related party transactions, called LJM partnerships, to do
business with Enron; (c) exempting Fastow from the company’s ethics code regarding the private
partnerships he set up; and (d) covering up the nature and extent of Enron’s problems through
deceptive accounting practices and deliberate misinformation.
Enron has been described as having a culture of arrogance that led people to believe that they
could handle increasingly greater risk without encountering any danger. “Enron’s unspoken
message was, ‘Make the numbers, make the numbers, make the numbers if you steal, if you
cheat, just don’t get caught. If you do, beg for a second chance, and you’ll get one.’ ” Enron’s
culture of arrogance can be characterized by an emphasis on decentralization with inadequate
financial and operational controls, a very rigorous and threatening employee performance
evaluation process, and a compensation plan that encouraged people to inflate the value of
contracts and to use non-standard accounting practices.
“One of the most sordid aspects of the Enron scandal is the complicity of so many highly
regarded Wall Street firms” in enabling Enron’s fraud as well as in being partners to it. This
complicity occurred primarily through the use of prepays and related party transactions. Prepays
occurred when Enron booked loans as operating cash flow, and regularly secured new prepays to
pay off existing ones as well as to support rapidly expanding investments in new businesses.
Related party transactions were used by Andrew Fastow to sell an underperforming asset to the
investment bankers, usually at the end of a quarter, and then and then to have the bankers sell it
back to the company at a profit once the quarter was over and the “earnings” had been booked.”
Such transactions were basically smoke and mirrors, reflecting a relationship between the
partnerships and the banks wherein “Enron could practically pluck earnings out of thin air.”
A follow-up of Enron’s major officers speaks to the cover-up and false testimony they paid to
their ethics code and announced values. A grand jury indicted Lay on July 7, 2004 on 11 counts
of securities fraud and related charges. He was found guilty of 10 counts against him on May 25,
2006. A judge dismissed the last count since each count carried a 5 to 10 year maximum prison
sentence. Had he not died of a heart attack on July 5, 2006, he could have served between 20 to
30 years in prison. Skilling is still serving a 24-plus year prison sentence, after he was convicted
on 19 counts-- “one count of conspiracy to commit securities fraud and wire fraud, 12 counts of
securities fraud, five counts of making false statements to accountants, and one count of insider
trading.” Recently, it was questionable whether or not he would be temporarily released after his
son’s suicide attempt. Fastow was sentenced on conspiracy to commit securities fraud and
sentenced from 10 to 6 years after he testified against Ken Lay, Jeff Skilling, and others. His
release date is scheduled on December 2011.
Enron, the company’s, aftermath also stands witness to the corruption of its officers,
“Enron Creditors Recovery Corp. is a shell of the former Enron Corp. (once the
world's #1 energy trader) and is shelling out the remaining assets of the bankrupt
Enron to creditors. Once the largest buyer and seller of natural gas and electricity in
the US, Enron also traded numerous other commodities. Following its collapse
Enron was forced to sell all of its North American power utility and gas pipeline
assets, as well as its global interests in utilities and power plants. Between 2004 and
the end of 2010 Enron Creditors Recovery Corp. paid out more than $21.6 billion to
Enron's creditors, including $40 million in November, 2010.”
QUESTIONS FOR DISCUSSION
1.
What led to the eventual collapse of Enron under Lay and Skilling?
Answer:
There are a host of reasons that led to Enron’s collapse. Taken together, answers to all the
questions stated here address this particular question more completely. To summarize,
Enron’s collapse was caused by: (1) A corrupt leadership at the top, (2) Violation of laws
that were not enforced by the company’s CEO, Chair and members of its Board of
Directors, and auditors (Arthur Andersen), (3) Lack of regulation Enron had one of the
best ethics code in the industry. The collapse of the company clearly illustrates that
written ethics and compliance codes alone do not work. Corrupt leaders at the top (and
middle) of organizations is a recipe for disaster. Probably no code or law can prevent the
willful intent with the available means for criminally minded and greedy CEOs (Lay and
Skilling), CFOs (Fastow) and other top level officers (individually and as coalitions)
from defrauding and stealing from their organizations. Secondly, as the Sarbanes Oxley
Act and the Revised Federal Sentencing Guidelines show, effective communication,
monitoring, and auditing of the organization’s legal and ethical compliance standards and
procedures must be enforced. Kenneth Lay paid lip service to ethics. He said he fully
understood the legal, moral, and ethical implications of leading organizations and people.
In an introductory statement to the revised Enron Code of Ethics issued in July 2000, Lay
emphasized that Enron’s officers and employees should conduct the company’s business
affairs “in accordance with all applicable laws and in a moral and honest manner.”
Enron’s ethics code was based on the values of respect, integrity, communication, and
excellence. The code specified that “An employee shall not conduct himself or herself in
a manner which directly or indirectly would be detrimental to the best interests of the
Company or in a manner which would bring to the employee financial gain separately
derived as a direct consequence of his or her employment with the Company.” So much
for ethics codes with leaders who do not ‘walk the talk.’ Answers to the following
questions add to the response given here.
Lay and skilling also created a corrupt elite coalition among themselves, Fastow, and
several of the traders in the company. The now classic film , “Enron: The Smartest Guys
in the Room” reveals the inside workings of this courrupt subculture that became the
dominant engine that drove the company into bankruptcy—without the lower level
employees ever knowing. Do values count? Yes, in Enron’s case, the dominant
coalition’s values were greed, flamboyance, waste, and win-at-any-cost.
2.
How did the top leadership at Enron undermine the foundational values of the Enron
Code of Ethics?
Answer:
Key players among the top leadership were Andrew Fastow, Jeff Skilling, and Ken Lay.
Each of these individuals contributed to undermining Enron’s foundational values; their
activities raise crucial questions about how closely they adhered to the values of respect,
integrity, communication, and excellence.
Skilling, for example, did not take the obligation to communicate very seriously when he
accused an investigative reporter of unethical behavior because she asked him to clarify
Enron’s “nearly incomprehensible financial statements” and he refused to do so. A
subsequent effort to have three key executives meet with the reporter to answer her
questions “completely and accurately” turned out to be more deception than clarification.
The decentralized nature of Enron also created communications barriers and prevented
all but a few people in the organization from seeing the “big picture.” The
communication value was also undermined when Fastow tried to conceal how
extensively Enron was involved in trading in order to maintain the high market valuation
that was essential to keeping Enron from collapsing. Lay’s assertion that he lacked any
knowledge of what was happening is another action that brings into question the
commitment of Enron’s leadership to the communication value.
Enron’s commitment to excellence was perverted through the “rank and yank”
performance appraisal system and the compensation system that enriched executives,
encouraged people to inflate the value of contracts, and promoted use of non-standard
accounting practices. Both the performance appraisal system and the compensation
system were creations of Enron’s top leadership.
Collectively, all of the preceding decisions and actions did little to support the values of
integrity and respect. In addition, Fastow’s exemption by the board and top management
from the company’s ethics code undermined the values of respect and integrity.
3.
In retrospect: given Kenneth Lay’s and Jeff Skilling’s operating beliefs and the Enron
Code of Ethics, what expectations regarding ethical decision and actions should Enron’s
employees reasonably have had?
Answer:
The employees were kept ‘in the dark’ on the misguided and corrupt strategic and
operational dealings of Lay, Skilling, and Fastow. Sherron Watkins (the whistle blower
who helped reveal Enron’s illegal activities) warned Lay several times but to no avail. In
an August 2001 interview it was noted that, “Sherron Watkins, an Enron vice president,
had sent an anonymous memo to Lay that read, ‘I am incredibly nervous that we will
implode in a wave of accounting scandals.’Of course, that's exactly what happened. After
the company's demise, the investigating U.S. Congress discovered Watkins' memos to
Lay and other top executives. (After sending the memos, she had met with Lay with no
results)” (Carozza, 2007).
With regard to lower level employees, what could they have reasonably expected
regarding Enron’s code about ethical decisions and actions? In hindsight, Enron was
continually winning Fortune Magazine’s best-in-class awards, Arthur Andersen (Enron’s
auditors) saw no problems year after year with Enron’s accounting procedures, the SEC
(Security Exchange Council)—Enron’s regulator—had no problem with Enron’s business
practice, so why would lower level employees question the company that was adding to
their wealth before the crash? Watkins stated in 2001, “Enron was primarily a financial
trading house. A financial trading house lives on its investment grade rating and its
reputation. Any hint of trouble and business disappears like water through a sieve. When
I met with Ken Lay, I was both optimistic and naive. I not only expected that a thorough
investigation would occur but I also expected Enron to establish a crisis management
team to address the financial peril Enron would face when the accounting was exposed,
which in my opinion was sure to happen. In the long run, companies rarely get away with
‘cooking the books.’ But no other top executives came forward to back me up and Ken
Lay gravitated toward good news and didn't quite accept what I was saying. (Carozza,
2007).
4.
How did Enron’s corporate culture promote unethical decisions and actions?
Answer:
The succinct and unequivocal answer to this question is that Enron’s corporate culture did
little to promote the values of respect and integrity that were articulated in the Enron
Code of Ethics. These values were undermined through the company’s emphasis on
decentralization, its employee performance appraisals, and its compensation program. By
keeping each Enron division and business unit separate from the others, very few people
had a holistic perspective of the company’s operations. This decentralization, in
conjunction with insufficient operational and financial controls as well as “a distracted,
hands-off chairman, a compliant board of directors and an impotent staff of accountants,
auditors and lawyers, contributed to a corporate culture that enabled the occurrence of
unethical decisions and actions. The extremely rigorous and threatening performance
evaluation process utilized peer evaluations wherein employees frequently ranked their
peers lower in order to enhance their own positions in the company. Enron’s
compensation plan “seemed oriented toward enriching executives rather than generating
profits for shareholders,” and encouraged people to inflate the value of contracts and to
use non-standard accounting practices. The performance appraisal system and the
compensation systems helped define and reinforce a culture that was rife with the
potential for unethical decisions and actions. In short, Enron’s culture encouraged and
reinforced unethical decisions and actions. As revealed by whistleblower Sherron
Watkins, “Enron’s unspoken message was, ‘Make the numbers, make the numbers, make
the numbers if you steal, if you cheat, just don’t get caught. If you do, beg for a
second chance, and you’ll get one.’ ”
5.
How did the investment banking community contribute to the ethical collapse of Enron?
Answer:
Investment banks were not found legally liable in actively contributing to the Enron
scandal. “In what may have been the final blow to plaintiffs’ attempt to hold several
investment banks liable for their involvement in the Enron scandal, the United States
District Court for the Southern District of Texas granted summary judgment in favor of
the investment banks after several years of litigation. In re Enron Corp. Sec., Derivative
& “ERISA” Litig., No. H-01-3624, 2009 WL 565512 (S.D. Tex. Mar. 5, 2009),” (David
O'Neal (2009). “No Liability under Stoneridge for Investment Banks That Did Business
with Enron.” Securities Litigation Blog, http://securities.litigation.alston.com/blog.aspx?
entry=2004 May 5, 2009, accessed March, 2011). However, the debate continues with
regard to whether or not J.P. Morgan and Citibank, in particular, violated their ethical
responsibilities to shareholders and the public in continuing to loan Enron funds while the
company lied and defrauded all who were involved during the scandal. An Economist
article described the role of these banks this way, “Might J.P. Morgan and Citi have let
their lending standards slip in order to win investment-banking business from Enron,
allowing the company to become over-leveraged? Did being both a creditor of Enron and
an adviser create acute conflicts of interest as the company approached bankruptcy? As
creditors, the banks may have had an interest in preserving whatever value Enron had left
to maximise their chance of being repaid. As advisers, they may have had reason to
promote riskier strategies in a bid to keep Enron alive and stop its shareholders being
wiped out. An article in the Economist stated the issue this way, “Both banks vehemently
deny lowering lending standards to win investment-banking business. J.P. Morgan had
lent to Enron for many years. The banks also deny that they took advantage of their
advisory role by getting Enron to pay off unsecured loans to the company with money
raised during a secured refinancing late last year.”( “Commercial banks after
Enron,Conflicts, conflicts everywhere” (2002). The Economist.
http://www.economist.com/node/954024 Accessed March, 2011.)
It could also be argued that the investment banks were one of several “watchdogs” who
failed to regulate Enron during its scandalous period. Where were Enron’s public
auditors, board of directors, federal government watchdogs—e.g. the SEC (Security &
Exchange Commission)? Unfortunately, the lessons from Enron have been repeated as
witnessed by the latest subprime lending crises that also involved investment banks in
even more risky practices than Enron.
6. and 7. If the Sarbanes-Oxley law had been in effect, do you believe the Enron debacle would
have occurred? Explain. 7. Could another Enron occur now? Why or why not? Explain.
Unfortunately, it seems that the answer to these two questions is “Yes.” As stated in the
response to the previous question, the subprime lending crisis that continues to negatively
affect the national and global economies recently occurred and involved many more
financial institutions and companies, including banks. The problem appears to be
multifaceted: (1) the deregulation of the financial industry, including banks and a lack of
federal laws, some of which have been repealed, to regulate this industry; (2) a lack of
enforcement of laws like Sarbanes-Oxley; (3) a lack of ethical leadership of CEOs and
boards of directors to safeguard their corporations from scandals such as Enron and the
subprime lending crisis; and (4) Congress members receiving large campaign
contributions from companies and industry lobbies to “water down” and even repeal
regulations and laws that would prevent such scandals as Enron and the subprime lending
crisis. For example, corporations and their lobbies help passed The Reform Act of 1995,
which was called the ‘Securities Rip-off Act.’ This Act offered substantial loopholes and
decreased the power of the Securities & Exchange Commission to act as a watchdog over
brokerage and financial firms (Moore, Hank, 2011. “The Big Picture of Business –
Business Lessons to be Learned from the Enron Scandal.”
http://www.strategydriven.com/2011/03/11/the-big-picture-of-business-business-lessonsto-be-learned-from-the-enron-scandal/ Accessed March, 2011).
Sources: Carozza, D. (2007). Interview with Sherron Watkins, Constant Warning. Fraud Magazine.
http://www.fraud-magazine.com/article.aspx?id=583 Accessed April, 2011.
Mulligan, T. and Bustillo, M. (July 6, 2006). "Death Puts Lay Conviction in Doubt". Los Angeles Times.
http://www.latimes.com/news/printedition/front/la-fi-lay6jul06,1,4669506.story?coll=la-headlinesfrontpage; CNNMoney.com. Corporate convicts: Where are they now? Andrew Fastow. (2009, June 25).
http://money.cnn.com/galleries/2008/fortune/0805/gallery.convicts.fortune/4.html; Yahoo! Finance (2011,
March 8). Enron Creditors Recovery Corp. Company Profile. http://biz.yahoo.com/ic/10/10521.html,
March 8.
Rufca, S. (2010, Mar.1). Update: Supreme Court hears former Enron CEO Skilling's arguments.
http://culturemap.com/newsdetail/03-01-10-supreme-court-hears-enron-exec-arguments/. Kristen, C.
(2004, Jul. 7). "Lay surrenders to authorities". CNN Money.
http://money.cnn.com/2004/07/08/news/newsmakers/lay/.
Pasha, S. and J. Seid (2006, May 25). "Lay and Skilling's day of reckoning". CNN Money.
http://money.cnn.com/2006/05/25/news/newsmakers/enron_verdict/index.htm; Wikipedia. Kenneth Lay.
http://en.wikipedia.org/wiki/Kenneth_Lay.
ENRON: WHAT CAUSED THE ETHICAL COLLAPSE?
CASE SUMMARY
Kenneth Lay, former chairman and chief executive officer (CEO) of Enron Corp., claimed to be a
moral and ethical leader and exhorted Enron’s officers and employees to be highly ethical in their
decisions and actions. In addition, the Enron Code of Ethics specified that “An employee shall not
conduct himself or herself in a manner which directly or indirectly would be detrimental to the
best interests of the Company or in a manner which would bring to the employee financial gain
separately derived as a direct consequence of his or her employment with the Company.” Enron’s
ethics code was based on the values of respect, integrity, communication, and excellence. Given
this code of conduct and Ken Lay’s professed commitment to business ethics, one wonders how
Enron could have collapsed so dramatically? The answer to this question seems to be rooted in a
combination of the failure of top leadership, a corporate culture that supported unethical behavior,
and the complicity of the investment banking community.
The failure of Enron’s top leadership was evident in the activities of Andrew Fastow, Jeff
Skilling, and Ken Lay, all of whom faced multiple counts of criminal activity with respect to their
decisions and actions at Enron. Included among these criminal charges were money laundering,
wire fraud, securities fraud, conspiracy, making false statements on financial reports, and insider
trading. Some of the activities that led to these criminal charges were: (a) concealing how
extensively Enron was involved in trading in order to support a high market valuation of Enron’s
stock; (b) setting up and operating related party transactions, called LJM partnerships, to do
business with Enron; (c) exempting Fastow from the company’s ethics code regarding the private
partnerships he set up; and (d) covering up the nature and extent of Enron’s problems through
deceptive accounting practices and deliberate misinformation.
Enron has been described as having a culture of arrogance that led people to believe that they
could handle increasingly greater risk without encountering any danger. “Enron’s unspoken
message was, ‘Make the numbers, make the numbers, make the numbers if you steal, if you
cheat, just don’t get caught. If you do, beg for a second chance, and you’ll get one.’ ” Enron’s
culture of arrogance can be characterized by an emphasis on decentralization with inadequate
financial and operational controls, a very rigorous and threatening employee performance
evaluation process, and a compensation plan that encouraged people to inflate the value of
contracts and to use non-standard accounting practices.
“One of the most sordid aspects of the Enron scandal is the complicity of so many highly
regarded Wall Street firms” in enabling Enron’s fraud as well as in being partners to it. This
complicity occurred primarily through the use of prepays and related party transactions. Prepays
occurred when Enron booked loans as operating cash flow, and regularly secured new prepays to
pay off existing ones as well as to support rapidly expanding investments in new businesses.
Related party transactions were used by Andrew Fastow to sell an underperforming asset to the
investment bankers, usually at the end of a quarter, and then and then to have the bankers sell it
back to the company at a profit once the quarter was over and the “earnings” had been booked.”
Such transactions were basically smoke and mirrors, reflecting a relationship between the
partnerships and the banks wherein “Enron could practically pluck earnings out of thin air.”
A follow-up of Enron’s major officers speaks to the cover-up and false testimony they paid to
their ethics code and announced values. A grand jury indicted Lay on July 7, 2004 on 11 counts
of securities fraud and related charges. He was found guilty of 10 counts against him on May 25,
2006. A judge dismissed the last count since each count carried a 5 to 10 year maximum prison
sentence. Had he not died of a heart attack on July 5, 2006, he could have served between 20 to
30 years in prison. Skilling is still serving a 24-plus year prison sentence, after he was convicted
on 19 counts-- “one count of conspiracy to commit securities fraud and wire fraud, 12 counts of
securities fraud, five counts of making false statements to accountants, and one count of insider
trading.” Recently, it was questionable whether or not he would be temporarily released after his
son’s suicide attempt. Fastow was sentenced on conspiracy to commit securities fraud and
sentenced from 10 to 6 years after he testified against Ken Lay, Jeff Skilling, and others. His
release date is scheduled on December 2011.
Enron, the company’s, aftermath also stands witness to the corruption of its officers,
“Enron Creditors Recovery Corp. is a shell of the former Enron Corp. (once the
world's #1 energy trader) and is shelling out the remaining assets of the bankrupt
Enron to creditors. Once the largest buyer and seller of natural gas and electricity in
the US, Enron also traded numerous other commodities. Following its collapse
Enron was forced to sell all of its North American power utility and gas pipeline
assets, as well as its global interests in utilities and power plants. Between 2004 and
the end of 2010 Enron Creditors Recovery Corp. paid out more than $21.6 billion to
Enron's creditors, including $40 million in November, 2010.”
QUESTIONS FOR DISCUSSION
1.
What led to the eventual collapse of Enron under Lay and Skilling?
Answer:
There are a host of reasons that led to Enron’s collapse. Taken together, answers to all the
questions stated here address this particular question more completely. To summarize,
Enron’s collapse was caused by: (1) A corrupt leadership at the top, (2) Violation of laws
that were not enforced by the company’s CEO, Chair and members of its Board of
Directors, and auditors (Arthur Andersen), (3) Lack of regulation Enron had one of the
best ethics code in the industry. The collapse of the company clearly illustrates that
written ethics and compliance codes alone do not work. Corrupt leaders at the top (and
middle) of organizations is a recipe for disaster. Probably no code or law can prevent the
willful intent with the available means for criminally minded and greedy CEOs (Lay and
Skilling), CFOs (Fastow) and other top level officers (individually and as coalitions)
from defrauding and stealing from their organizations. Secondly, as the Sarbanes Oxley
Act and the Revised Federal Sentencing Guidelines show, effective communication,
monitoring, and auditing of the organization’s legal and ethical compliance standards and
procedures must be enforced. Kenneth Lay paid lip service to ethics. He said he fully
understood the legal, moral, and ethical implications of leading organizations and people.
In an introductory statement to the revised Enron Code of Ethics issued in July 2000, Lay
emphasized that Enron’s officers and employees should conduct the company’s business
affairs “in accordance with all applicable laws and in a moral and honest manner.”
Enron’s ethics code was based on the values of respect, integrity, communication, and
excellence. The code specified that “An employee shall not conduct himself or herself in
a manner which directly or indirectly would be detrimental to the best interests of the
Company or in a manner which would bring to the employee financial gain separately
derived as a direct consequence of his or her employment with the Company.” So much
for ethics codes with leaders who do not ‘walk the talk.’ Answers to the following
questions add to the response given here.
Lay and skilling also created a corrupt elite coalition among themselves, Fastow, and
several of the traders in the company. The now classic film , “Enron: The Smartest Guys
in the Room” reveals the inside workings of this courrupt subculture that became the
dominant engine that drove the company into bankruptcy—without the lower level
employees ever knowing. Do values count? Yes, in Enron’s case, the dominant
coalition’s values were greed, flamboyance, waste, and win-at-any-cost.
2.
How did the top leadership at Enron undermine the foundational values of the Enron
Code of Ethics?
Answer:
Key players among the top leadership were Andrew Fastow, Jeff Skilling, and Ken Lay.
Each of these individuals contributed to undermining Enron’s foundational values; their
activities raise crucial questions about how closely they adhered to the values of respect,
integrity, communication, and excellence.
Skilling, for example, did not take the obligation to communicate very seriously when he
accused an investigative reporter of unethical behavior because she asked him to clarify
Enron’s “nearly incomprehensible financial statements” and he refused to do so. A
subsequent effort to have three key executives meet with the reporter to answer her
questions “completely and accurately” turned out to be more deception than clarification.
The decentralized nature of Enron also created communications barriers and prevented
all but a few people in the organization from seeing the “big picture.” The
communication value was also undermined when Fastow tried to conceal how
extensively Enron was involved in trading in order to maintain the high market valuation
that was essential to keeping Enron from collapsing. Lay’s assertion that he lacked any
knowledge of what was happening is another action that brings into question the
commitment of Enron’s leadership to the communication value.
Enron’s commitment to excellence was perverted through the “rank and yank”
performance appraisal system and the compensation system that enriched executives,
encouraged people to inflate the value of contracts, and promoted use of non-standard
accounting practices. Both the performance appraisal system and the compensation
system were creations of Enron’s top leadership.
Collectively, all of the preceding decisions and actions did little to support the values of
integrity and respect. In addition, Fastow’s exemption by the board and top management
from the company’s ethics code undermined the values of respect and integrity.
3.
In retrospect: given Kenneth Lay’s and Jeff Skilling’s operating beliefs and the Enron
Code of Ethics, what expectations regarding ethical decision and actions should Enron’s
employees reasonably have had?
Answer:
The employees were kept ‘in the dark’ on the misguided and corrupt strategic and
operational dealings of Lay, Skilling, and Fastow. Sherron Watkins (the whistle blower
who helped reveal Enron’s illegal activities) warned Lay several times but to no avail. In
an August 2001 interview it was noted that, “Sherron Watkins, an Enron vice president,
had sent an anonymous memo to Lay that read, ‘I am incredibly nervous that we will
implode in a wave of accounting scandals.’Of course, that's exactly what happened. After
the company's demise, the investigating U.S. Congress discovered Watkins' memos to
Lay and other top executives. (After sending the memos, she had met with Lay with no
results)” (Carozza, 2007).
With regard to lower level employees, what could they have reasonably expected
regarding Enron’s code about ethical decisions and actions? In hindsight, Enron was
continually winning Fortune Magazine’s best-in-class awards, Arthur Andersen (Enron’s
auditors) saw no problems year after year with Enron’s accounting procedures, the SEC
(Security Exchange Council)—Enron’s regulator—had no problem with Enron’s business
practice, so why would lower level employees question the company that was adding to
their wealth before the crash? Watkins stated in 2001, “Enron was primarily a financial
trading house. A financial trading house lives on its investment grade rating and its
reputation. Any hint of trouble and business disappears like water through a sieve. When
I met with Ken Lay, I was both optimistic and naive. I not only expected that a thorough
investigation would occur but I also expected Enron to establish a crisis management
team to address the financial peril Enron would face when the accounting was exposed,
which in my opinion was sure to happen. In the long run, companies rarely get away with
‘cooking the books.’ But no other top executives came forward to back me up and Ken
Lay gravitated toward good news and didn't quite accept what I was saying. (Carozza,
2007).
4.
How did Enron’s corporate culture promote unethical decisions and actions?
Answer:
The succinct and unequivocal answer to this question is that Enron’s corporate culture did
little to promote the values of respect and integrity that were articulated in the Enron
Code of Ethics. These values were undermined through the company’s emphasis on
decentralization, its employee performance appraisals, and its compensation program. By
keeping each Enron division and business unit separate from the others, very few people
had a holistic perspective of the company’s operations. This decentralization, in
conjunction with insufficient operational and financial controls as well as “a distracted,
hands-off chairman, a compliant board of directors and an impotent staff of accountants,
auditors and lawyers, contributed to a corporate culture that enabled the occurrence of
unethical decisions and actions. The extremely rigorous and threatening performance
evaluation process utilized peer evaluations wherein employees frequently ranked their
peers lower in order to enhance their own positions in the company. Enron’s
compensation plan “seemed oriented toward enriching executives rather than generating
profits for shareholders,” and encouraged people to inflate the value of contracts and to
use non-standard accounting practices. The performance appraisal system and the
compensation systems helped define and reinforce a culture that was rife with the
potential for unethical decisions and actions. In short, Enron’s culture encouraged and
reinforced unethical decisions and actions. As revealed by whistleblower Sherron
Watkins, “Enron’s unspoken message was, ‘Make the numbers, make the numbers, make
the numbers if you steal, if you cheat, just don’t get caught. If you do, beg for a
second chance, and you’ll get one.’ ”
5.
How did the investment banking community contribute to the ethical collapse of Enron?
Answer:
Investment banks were not found legally liable in actively contributing to the Enron
scandal. “In what may have been the final blow to plaintiffs’ attempt to hold several
investment banks liable for their involvement in the Enron scandal, the United States
District Court for the Southern District of Texas granted summary judgment in favor of
the investment banks after several years of litigation. In re Enron Corp. Sec., Derivative
& “ERISA” Litig., No. H-01-3624, 2009 WL 565512 (S.D. Tex. Mar. 5, 2009),” (David
O'Neal (2009). “No Liability under Stoneridge for Investment Banks That Did Business
with Enron.” Securities Litigation Blog, http://securities.litigation.alston.com/blog.aspx?
entry=2004 May 5, 2009, accessed March, 2011). However, the debate continues with
regard to whether or not J.P. Morgan and Citibank, in particular, violated their ethical
responsibilities to shareholders and the public in continuing to loan Enron funds while the
company lied and defrauded all who were involved during the scandal. An Economist
article described the role of these banks this way, “Might J.P. Morgan and Citi have let
their lending standards slip in order to win investment-banking business from Enron,
allowing the company to become over-leveraged? Did being both a creditor of Enron and
an adviser create acute conflicts of interest as the company approached bankruptcy? As
creditors, the banks may have had an interest in preserving whatever value Enron had left
to maximise their chance of being repaid. As advisers, they may have had reason to
promote riskier strategies in a bid to keep Enron alive and stop its shareholders being
wiped out. An article in the Economist stated the issue this way, “Both banks vehemently
deny lowering lending standards to win investment-banking business. J.P. Morgan had
lent to Enron for many years. The banks also deny that they took advantage of their
advisory role by getting Enron to pay off unsecured loans to the company with money
raised during a secured refinancing late last year.”( “Commercial banks after
Enron,Conflicts, conflicts everywhere” (2002). The Economist.
http://www.economist.com/node/954024 Accessed March, 2011.)
It could also be argued that the investment banks were one of several “watchdogs” who
failed to regulate Enron during its scandalous period. Where were Enron’s public
auditors, board of directors, federal government watchdogs—e.g. the SEC (Security &
Exchange Commission)? Unfortunately, the lessons from Enron have been repeated as
witnessed by the latest subprime lending crises that also involved investment banks in
even more risky practices than Enron.
6. and 7. If the Sarbanes-Oxley law had been in effect, do you believe the Enron debacle would
have occurred? Explain. 7. Could another Enron occur now? Why or why not? Explain.
Unfortunately, it seems that the answer to these two questions is “Yes.” As stated in the
response to the previous question, the subprime lending crisis that continues to negatively
affect the national and global economies recently occurred and involved many more
financial institutions and companies, including banks. The problem appears to be
multifaceted: (1) the deregulation of the financial industry, including banks and a lack of
federal laws, some of which have been repealed, to regulate this industry; (2) a lack of
enforcement of laws like Sarbanes-Oxley; (3) a lack of ethical leadership of CEOs and
boards of directors to safeguard their corporations from scandals such as Enron and the
subprime lending crisis; and (4) Congress members receiving large campaign
contributions from companies and industry lobbies to “water down” and even repeal
regulations and laws that would prevent such scandals as Enron and the subprime lending
crisis. For example, corporations and their lobbies help passed The Reform Act of 1995,
which was called the ‘Securities Rip-off Act.’ This Act offered substantial loopholes and
decreased the power of the Securities & Exchange Commission to act as a watchdog over
brokerage and financial firms (Moore, Hank, 2011. “The Big Picture of Business –
Business Lessons to be Learned from the Enron Scandal.”
http://www.strategydriven.com/2011/03/11/the-big-picture-of-business-business-lessonsto-be-learned-from-the-enron-scandal/ Accessed March, 2011).
Sources: Carozza, D. (2007). Interview with Sherron Watkins, Constant Warning. Fraud Magazine.
http://www.fraud-magazine.com/article.aspx?id=583 Accessed April, 2011.
Mulligan, T. and Bustillo, M. (July 6, 2006). "Death Puts Lay Conviction in Doubt". Los Angeles Times.
http://www.latimes.com/news/printedition/front/la-fi-lay6jul06,1,4669506.story?coll=la-headlinesfrontpage; CNNMoney.com. Corporate convicts: Where are they now? Andrew Fastow. (2009, June 25).
http://money.cnn.com/galleries/2008/fortune/0805/gallery.convicts.fortune/4.html; Yahoo! Finance (2011,
March 8). Enron Creditors Recovery Corp. Company Profile. http://biz.yahoo.com/ic/10/10521.html,
March 8.
Rufca, S. (2010, Mar.1). Update: Supreme Court hears former Enron CEO Skilling's arguments.
http://culturemap.com/newsdetail/03-01-10-supreme-court-hears-enron-exec-arguments/. Kristen, C.
(2004, Jul. 7). "Lay surrenders to authorities". CNN Money.
http://money.cnn.com/2004/07/08/news/newsmakers/lay/.
Pasha, S. and J. Seid (2006, May 25). "Lay and Skilling's day of reckoning". CNN Money.
http://money.cnn.com/2006/05/25/news/newsmakers/enron_verdict/index.htm; Wikipedia. Kenneth Lay.
http://en.wikipedia.org/wiki/Kenneth_Lay.