The Fall of Enron Corporation

Knapp Case 1.

Q1 The fall of Enron Corporation left many debating who was the most responsible for arguably one of the largest corporate scandals of the 21st century. While the management of Enron is responsible for the financial statements, auditors by profession are held to a higher ethical standard. We believe both the auditors of Arthur Andersen and the management of Enron Corporation are most responsible for this crisis.

The PCAOB explains the distinction between the responsibilities of an auditor and management. Management is responsible for “adopting sound accounting policies… and report(ing) transactions consistent with management's assertions embodied in the financial statements.” (AU Section 110.03) In other words, they are expected to provide statements conveying the true financial position of the company. Andrew Fastow, Jeffrey Skilling, and Kenneth Lay abused the establishment of special purpose entities (SPEs) and failed their duties to create truthful financial statements. Clouded by the pressure to retain high stock prices, they performed illegal transactions and produced fraudulent financial statements.

However, the auditors of Arthur Andersen face the same, if not higher level of accountability. Auditors must give an opinion on the financial statements given by management (AU Section 110.03). At the time of Enron, the audit firm was able to provide a variety of services related to internal auditing and design of accounting systems. Due to the nature and compensation Andersen received for these services, they lacked true objectivity and failed to report their opinion of Enron in a fair manner. Auditors are public servants meaning outsiders heavily rely on their expertise in order to make investment-related decisions. Enron is an iconic example of the devastating consequences when auditors fail to uphold professional integrity.

Many debated who was responsible for the crisis of Enron. We believe the two most responsible parties were the auditors of Arthur Andersen and the management of Enron Corporation.

Q2 As a result of the Enron Corporation scandal, regulatory authorities immediately began to reform accounting and financial reporting policies. Congress passed the Sarbanes-Oxley Act (SOX), in 2002, to outline services auditors can give to their clients while maintaining independence. Nine types of services exist that audit firms are now prohibited from providing to clients considered as public companies. Regulators consider these consulting services to be a threat to independence and compromise the integrity of the financial statements.

SOX Section 201 titled, “Services Outside the Scope of Practice of Auditors,”