Global Journal of Management and Business Research: D Accounting and Auditing Volume 14 Issue 4 Version 1.0 Year 2014 Type: Double Blind Peer Reviewed International Research Journal Publisher: Global Journals Inc. (USA) Online ISSN: 2249-4588 & Print ISSN: 0975-5853 The Financial Collapse of the Enron Corporation and Its Impact in the United States Capital Market By Prof. Edel Lemus, M.I.B.A Carlos Albizu University, U nited States Abstract- The purpose of this article is to review the collapse of the Enron Corporation and the collapse’s effect on the United States financial market. Enron Corporation, the seventh largest company in the United States, misguided its shareholders by reporting $74 billion profit of which $43 billion was detected as fraud. Moreover, according to the association of fraud examiners $2.9 trillion was lost because of employee fraud. For example, as presented by Kieso, Weygandt, and Warfield (2013), in a global survey study that was conducted in 2013, it was reported that 3,000 executives from 54 countries were involved in fraudulent financial reporting. Therefore, the world of accounting is dominated by the top four accounting firms known as (1). PricewaterhouseCoopers (PwC), (2). Deloitte & Touche (DT), (3). Ernst & Young (EY) and (4). KPMG which represent a combined income of $80 billion. Keywords: enron corporation, bankruptcy, securities and exchange commission (sec), generally accepted accounting principles (gaap), sarbanes-oxley act of 2002, section 404, corporate governance, auditing, and economic crime. GJMBR-D Classification : JEL Code: M49 TheFinancialCollapseoftheEnronCorporationand Its ImpactintheUnitedStatesCapitalMarket Strictly as per the compliance and regulations of: © 2014. Prof. Edel Lemus. This is a research/review paper, distributed under the terms of the Creative Commons Attribution- Noncommercial 3.0 Unported License http://creativecommons.org/licenses/by-nc/3.0/), permitting all non-commercial use, distribution, and reproduction in any medium, provided the original work is properly cited. The Financial Collapse of the Enron Corporation and Its Impact in the United States Capital Market Prof. Edel Lemus, M.I.B.A. Abstract- The purpose of this article is to review the collapse The United States Securities and Exchange of the Enron Corporation and the collapse’s effect on the Commission (SEC), after adopting the Sarbanes-Oxley United States financial market. Enron Corporation, the seventh Act of 2002, introduced 11 chapters or provisions by 2014 largest company in the United States, misguided its reshaping the accounting system and designing unique shareholders by reporting $74 billion profit of which $43 billion ear sets of rules and regulations. Section 404 under the Y was detected as fraud. Moreover, according to the association of fraud examiners $2.9 trillion was lost because of employee Sarbanes-Oxley Act of 2002 requires management and fraud. For example, as presented by Kieso, Weygandt, and independent auditors to report their findings with 41 Warfield (2013), in a global survey study that was conducted in accuracy and reliability in the unqualified opinion report. 2013, it was reported that 3,000 executives from 54 countries Since the implementation of the Sarbanes-Oxley Act of were involved in fraudulent financial reporting. Therefore, the 2002 information technology (IT) has provided high world of accounting is dominated by the top four accounting relevancy and compliance in the accounting industry. firms known as (1). PricewaterhouseCoopers (PwC), (2). Also, the types of services that are considered unlawful Deloitte & Touche (DT), (3). Ernst & Young (EY) and (4). KPMG are price fixing, inappropriate use of the tax law which represent a combined income of $80 billion. practices for money laundering off-shore, and violation Keywords: enron corporation, bankruptcy, securities of the laws and social norms in society. Consequently, and exchange commission (sec), generally accepted the prohibitions set by Sarbanes-Oxley (SOX) impacted accounting principles (gaap), sarbanes-oxley act of not only the auditors but also professional accountants. 2002, section 404, corporate governance, auditing, and economic crime. II. Literature Review ) I. Introduction a) The Historical Background of the Enron Scandal D In corporate American history the most famous ( his research paper will introduce seven parts in the corporation to use creative accounting was the Enron literature review as it relates to the collapse of Corporation. In 1985 the Enron Corporation was created Enron Corporation. The three major violations T by the acquisition and merger of two natural gas under Generally Accepted Accounting Principles (GAAP) companies. The Enron Corporation began to expand its that preceded the fall of the Enron Corporation were: (1). line of operations and services in different sectors and The off-balance sheet arrangements, (2). The role of as a result acquired utility plants in Brazil, India, the mark-to-market, and (3). The manipulation of United States, and most importantly the United Kingdom derivatives. In 1977 the United States Congress passed by taking advantage of the deregulated market in the the Foreign Corrupt Practices Act (FCPA) to prevent natural gas and electricity industry. For example, Enron major financial irregularities in the market such as Corporation, from a simple energy trading strategy, corporate bribery, violation of an accounting system, decided to shift financial directions to trade weather and so forth. By the mid-1980s, the United States derivatives. Then in 1999 the internet-based trading Government committed to examine all failures and fraud platform was introduced which gave the Enron in the financial market. However, in 2002 the United Corporation more leverage to trade internet in metals, States Congress passed the Sarbanes-Oxley Act of energy, and woods products. By 2000 the Enron 2002 to prevent accounting scandals such as Enron, Corporation was the seventh largest corporation by Arthur Ardersen, and Tyco. The purpose of the act was growth revenue in the gas and utility market in the to reestablish the financial trust and confidence of United States territory; however, by October, 2001 the investors among major publicly traded companies in the Global Journal of Management and Business Research Volume XIV Issue IV Version I Enron Corporation began to experience financial United States market (Warren, Reeve, & Duchac, 2014). difficulties which caught investors, who were unaware of Enron’s financial strategy manipulation, by surprise. Author: Assistant professor in the Business Department (School of Consequently, on December 2, 2001 the Enron Business) at Carlos Albizu University. Corporation decided to file bankruptcy. The e-mail: [email protected] unprecedented financial events of the Enron ©2014 Global Journals Inc. (US) The Financial Collapse of the Enron Corporation and Its Impact in the United States Capital Market Corporation provided proof that major organizations in 2000 and one-third was reported as a pretax profit in the gas and utility industry could fully manipulate a firm’s 1999. Therefore, one of the major causes of Enron’s fall financial statements (Madura, 2015). was the U.S. Securities and Exchange Commission (SEC) allowing Enron Corporation to use at best PART I- Enron’s Three Major Violations under Generally capacity the mark-to-market accounting method (Li, Accepted Accounting Principles (GAAP) 2010). b) Enron’s Off-Balance Sheet Method d) Enron’s Derivatives Manipulation The three major violations under Generally The third major violation of the Enron Accepted Accounting Principles (GAAP) that preceded Corporation under Generally Accepted Accounting the collapse of the Enron Corporation were: (1). The off- Principles (GAAP) was the manipulation of derivatives balance sheet arrangements, (2). The role of mark-to- which increased from $1.8 billion to $10.5 billion. The market, and (3). The manipulation of derivatives. The management team of Enron utilized specific financial creation of the off-balance sheet method (OBSEs) 2014 tactics to hide losses in the derivative section; served its specific purpose in Enron’s corporate furthermore, investment and commercial banks advised ear accounting scandal. In addition, the specific purpose of investors about the underwriting problem at Enron. For Y the Enron Corporation (as cited in e.g., Anson 1999; example, the three most important credit agencies Evans, 1996) was to increase financial flexibility, 422 known as Moody’s, Standard & Poor’s, and Fitch/IBC decrease the cost of borrowing from creditors, reduce failed to disclose the financial trouble at Enron because the tax portion, maximize profitability, and adequately Enron paid the three credit agencies substantial monies improve the financial health of the company as noted by by not properly advising the investors at Enron of such (Angbazo, 1997; James, 1989; Shevlin, 1987). existing financial problems. Another example, ESM Moreover, the legitimate financial purpose of Enron’s Government Securities created large receivable fraud by utilization of the off-balance sheet was to hide losses hiding $400 million in the balance sheet. Therefore, the and debt from auditors, investors, financial analysts, and law firms that represented Enron made a big profit from regulators. Furthermore, in November, 2001, the Enron derivatives contract (Albrecht, Albrecht, Dolan, & Corporation announced plans to consolidate the Malagueno, 2008). financial