Free «Enron Legal Issues» Essay
Enron was once the nation’s seventh largest company crumbled into bankruptcy in December 2001 after years of accounting tricks could no longer hide billions in debt or make failing ventures appears profitable (Weiss, 2008). Weiss says that “the collapse wiped out thousands of jobs more than $60 billion in pension plans” (p. 31). Enron may be gone but it should not be forgotten particularly by young generation of corporate leaders and accounting, finance and management who may find out working in similar circumstances with leaders with questionable motives and criminal intent (Weiss, 2008). It is important for corporate leaders to notice that they are fully exposed to not only legal behavior and what that means from standpoint of leading organizations and people.
It was noted that the company sought political protection although the Bush administration distanced itself from such corporate scandals and introduced revised laws on pensions and disclosure of financial information (Needle, 2010). Legal implications were that with the collapse of the share price, many investors lost considerable amounts. These investors included many employees who had been encouraged to back their own company, particularly in view of its remarkable rise. Needle (2010) continues to say that many of the employees were prevented from selling their shares before the collapse of the company but some senior employees sold their shares before the collapse attracting accusations of insider trading.
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Enron’s legal issue falls within failure to disclose material information which is actionable. Sterling (2002) noted that section 18(a) of the securities Exchange Act grants an express private right of action to investors who have been injured by reliance upon material misstatements or omissions of fact in reports which have been filed with the SEC. Sterling continues to say that the “insider Trading Sanction Act of 1984 codified throughout 15 U.S.C. sections 78et seq imposes fines of up to three times the profit gained or loss avoided upon anyone who trades stock while in the possession of material nonpublic information and therefore it was alleged that some Enron’s former executives and directors engaged in such trades” (p. 106).
Sterling (2002) says that “failure of Enron Corporation has presented major legal issues as an economic failure in which excessive corporate risks and speculation, deceptive bookkeeping, insider profiteering and conflicts’ of interest and possible collusion of supposedly independent outside auditors were all part of the troubled mix” (p. 63). He further says that at another level the legal implications of failure of Enron Corporation has been as a failure of Government regulation and one which exposed loopholes and gaps in such things as Government oversight and regulation of derivative trading required public reporting and record keeping by publicly traded corporation, regulations on the independence of public auditors, and rules for the protection of corporate sponsored or assisted employee pension plans (Sterling, 2002).
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Another legal implication is based on the fact that its creditors believed some banks assisted Enron in questionable deals and many were being pursued through the courts. For example Needle (2010) says that “JP Morgan Chase and Citigroup between them agreed to pay US$255 million to settle charges helping the company to commit fraud” (p. 317). The money was to be paid back in the pension fund although the two banks are still liable to private lawsuits brought against them by investors. This also implies that most of world’s big banks were keen to gain from Enron’s success.
Needle (2010) found out that legal issues lied Arthur Andersen which was one of the big five global accounting firms. Andersen was both a consultant to Enron with a contract worth $50 million a year and also acted as Enron’s auditors. The legal issue highlighted a debate within the accounting profession and governments that of the independence of auditors (Needle, 2010). The main argument was that firms which acted as both consultants and auditors are likely to be compromised in their auditing duties by their close association with companies especially where high fees are involved as with Enron.
The Houston office of Andersen admitted to destroying documents relating to the Enron case (Needle, 2010). Staff members were disciplined and the partner responsible was dismissed. More importantly Needle (2010) says that “in June 2002 Andersen was found guilty in a Houston court of obstructing justice a verdict which meant that Andersen was not allowed to audit public companies in the USA and it announced that it would practice by end of 2002” (p. 318). Arthur Andersen still faces legal action brought by investors and if these accusations go against them they would then be liable for the whole amount wiped off the Enron stock value. This implies that it would run to billions of dollars and would at the same time bankrupt Andersen. Needle (2010) indicated that “they are accused of not doing their job by spotting discrepancies in the accounts and alerting investors” (p. 318).
The Enron affair also brought down one of the oldest and largest firms of accountants. There are those who believe that Arthur Andersen deserved all that legal treatment and even more (Needle, 2010). It is also seen as a backlash of a USA government wishing to send out a strong message about corporate fraud. This there showed the legal implications surrounding corporate organizations within the country. Golann & American Bar Association (2009) says that the legal timing is not everything because for Enron/Andersen the mediation effort was both too late and too early when the company collapsed. In legal matters Enron /Andersen is an example of a situation in which legal and economic obstacles created a settlement barrier based on sequence or timing problems.
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Weiss (2008) says that Enron had been described as a culture of arrogance that led people to believe that they could handle increasing greater risk without encountering any danger. In his research Weiss says that Enron’s unspoken message was make the numbers, if you steal, if you cheat, just do not get caught a culture which did little to promote the values of respect and integrity.
In order to enable fraud Weiss (2008) says that each Enron division and business unit was kept separate from the others and as a result very few people in the organization had a big picture perspective of the company operations. It was not it was illegal that the company did not put emphasis on decentralization because there were insufficient controls. Illegally there was a distracted chairman, hands off chairman, a compliant board of directors and impotent staff of accountants, auditors and lawyers who helped to commit the fraud (Weiss, 2008).
According to Weiss (2008) the investigative reporters Mclean and Elkind one of the most sordid aspects of the Enron scandal was the complicity of so many highly regarded wall street firms in enabling Enron’s fraud as well as being partners to it. Among these firms included J.P. Morgan, Citigroup and Merrill Lynch. Weiss (2008) indicated that “legal issues rise from the point that the company used prepays which were basically loans that Enron booked as operating cash flow” (p. 30).
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Enron thus secured new prepays to pay off existing ones and to support rapidly expanding investments in new business. Besides this major legal issue was for example one of the related party transaction created by Andrew Fastow known as LJM2. Weiss (2008) says that he used tactic whereby it would take an asset off Enron’s hands usually a poor performance asset at the end of a quarter and then sell it back to the company at a profit once the quarter was over and earnings had been booked.
United States, Senate & Committee on Governmental Affairs (n d) says that whenever a company conducts transactions among its own affiliates there are inherent legal issues about the fairness and motivations of such transactions. Among the Enron’s dubious practices the company on various occasions appeared to have improperly used transactions with its affiliates to further its own financial ends. In this context United States, Senate & Committee on Governmental Affairs (n d) says that “FERC however either had no rules or inadequate rules to address these practices or had no effective means of monitoring whether the company was complying with them” (p. 26).
One of the concern was that where one affiliate in a transaction has captive customers, a one sided deal between affiliates could saddle those customers with additional financial burdens. United States, Senate & Committee on Governmental Affairs (n d) continues to say that “it appeared the company engaged illegally in a number of inappropriate affiliate transactions. The notable of these illegal affiliate transactions were loans that two of Enron’s natural gas pipeline subsidiaries obtained for their parent company” (p. 27).
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Besides publishing that it had acquired enormous loans evidence suggesting that Enron had engaged in a more extensive practice of exploiting the cash generating powers of its pipeline subsidiaries. Another legal issue investigated by FERC involved allegations of possible market abuses in the summer and fall of 2000. United States, Senate & Committee on Governmental Affairs (n d) says that the staff concluded that power sellers had the potential to manipulate the power market, but the commission concluded that there was no evidence to indicate Enron was involved in market abuse. Further investigations by FERC uncovered evidence suggesting that some of the types of abuses that had been alleged to take place occurred.
Niskanen (2005) says that it was a significant legal breach of decorum indicating an unusual, problematic, possibly guilty sensitivity in Enron top management to tough but fair questions about the company’s financial reporting practices. He continues to say that from a public policy perspective one of the most vexing challenges was to understand the role of the lawyers in the Enron collapse and to identify what if any changes needed to be made in federal or state policies affecting the type of behavior demonstrated by lawyers in Enron (Niskanen, 2005).
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There was a need to conduct legal investigation to prove three elements in aiding and abetting a securities law violation at Enron. Niskanen (2005) says that the first legal element at Enron was aiding and abetting that an independent, illegal act existed to which the aider and abettor could be attached. He thus says that this independent illegal act or primary violation at Enron could be a misrepresentation, omission, scheme to defraud, or fraudulent course of business (Niskanen, 2005). The second element according to Niskanen (2005) was of aider and abettor liability was either actual knowledge of the primary violation on the part of the aider and abettor or recklessness.
In this case the law is ambiguous with regard to the level of knowledge needed to prove aiding and abetting liability (Niskanen, 2005). At Enron it was proved that there was significant assistance to the representations of others or to the fraud conducted by the top management. Niskanen (2005) says that “some banks and individuals illegally assisted primary violators in many ways which include repeating their misrepresentations, aiding in the preparation of misstatements, acting as conduits to distribute securities, executing transactions and financing transactions” (p. 175).
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Legally it is expected that corporate fiduciaries communicate publicly or directly with stake holders, honestly, candidly, and completely in all material respects. This did not happen in Enron because the standard of disclosure did not arise to more general fiduciary duties of good faith and loyalty. Niskanen (2005) says that as a result “ the examiner concluded in his Second Interim Report that the financial statements and disclosure of Enron did not present a fair, full and complete picture of Enron’s financial condition” (p. 176).
In addition, Niskanen (2005) noted that the number of true sales opinions in Enron did not appear to a mistake but appeared to s conscious part of a conspiracy to commit securities fraud. As a result it presents a legal matter if the observer did not conclude or suspect that there fraud and patterns of illegal behavior within the company transactions. Niskanen (2005) thus says that “in its FAS 140 Transactions, Enron monetized a variety of otherwise illiquid assets from its balance sheet while at the same time retaining control over them with a view towards better timing the final sale of those assets” (p. 185).
The other legal issue was that in the Second Interim Report the examiner concluded that these transactions were improperly used by Enron to record income from gain on sale of assets and erroneously reported the cash proceeds from these transactions as cash flow from operating activities (Niskanen, 2005). Niskanen further says “it was also indicated that Enron failed to disclose adequately its obligations under the Total Return swaps that were entered into as part of these FAS 140 transactions and to reflect the indebtedness incurred” (p. 185). The implication is that the attorneys who wrote the Enron true sales opinions appeared to lack the ability to know the difference between renting an asset to an SPE or selling it to the SPE thus they continued to provide true sale opinions which the bankers and accountants heavily relied on.
More over it was a legal issue for Enron to avoid FASB No.5, which would have required the bank loans to be booked as cash flows from financing activities rather than cash flows from operations (Niskanen, 2005). Niskanen thus says when the transactions were netted they legally and financially operated exactly as bank loans from JP Morgan, Citicorp, CIBC and Chase (2005).
According to Sterling (2002) Enron was subject to the major disclosure requirements of the federal securities laws. The reason why the company faced legal implications was because the prevailing philosophy of these laws is that reporting companies must disclose all material information to make investment decisions. Sterling (2002) further says that the securities Act of 1933 makes it illegal to offer or sell securities to the public unless the securities have been registered with the SEC (Securities and Exchange Commission). Research shows that certain transactions and securities were exempted from the registration process. Sterling (2002) says that it does not appear as though Enron Corporation would have been able generally to utilize these exemptions from registration.
The collapse of Enron is viewed to involve the illegal or improper influence of moneyed corporate business interests over both elected and appointed officials in the Federal Government. The legal issue here is to note that the connections often involve allegations of improper influence purchased by soft money campaign contributions from Enron, the receipt of political contributions by political figures in return for favorable government treatment. The conduct of top management towards the collapse of the company presents irregularities which were subject to legal implications.