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Case Study: Corporate Culture to Dissolve Unethical Issues Conflicts of Interests on Subprime Mortgages and at Goldman Sachs and Enron Dr. Etienne February 1, 2014 April M Rosier

Running head: CASE STUDY 1 Case and Background

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The Enron scandal was a fiscal, economical, and corporate scandal that was revealed in the later part of 2001 (DesJardins, 2014, Wilmarth, 2009). After a series of findings involving unbalanced accounting procedures which could be turned in as fraud; involving Enron and its accounting firm Arthur Andersen. Enron stood at the edge of falling into the most prevalent bankruptcy in history by November 2001. Enron filed for bankruptcy in December 2001. As the scandal was shown, Enron shares dropped from over $90.00 to cents on the dollar. As Enron had been known as a blue chip stock, this incident came as a surprise to all and was a complete disaster in the monetary world system. Enron's downfall happened soon after it was revealed that the majority of its profits and revenues were the result of deals with special purpose entities (limited partnerships which it controlled) (DesJardins, 2014, Wilmarth, 2009). The consequence was that many of Enron's debts and the losses were not reported in its financial accounts. Some of the information here was gathered from the public domain of Enron.com. Enron's non transparent financial statements did not clearly depict its operations and finances with shareholders and analysts. In addition, its complex business model and unethical practices required that the company use accounting limitations to misrepresent earnings and modify the balance sheet to portray a favorable depiction of its performance (Philips, 2009). Andrew Fastow, and other executives indirect actions of ignoring the problems later led to the bankruptcy of the company, and the majority of them were perpetuated by knowing their indiscretions (Shiller, 2008). Consequences of the Crisis According to the text on ethics and case study provided the people harmed most were the homeowners and the shareholders of banks that carried the mortgages (DesJardins, 2014). The

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mortgage brokers and real estate people were paid and they probably were ultimately the only ones who benefited. Homeowners were paying large amounts of money to mortgage holders and could not keep up with the payments, so they lost their homes after investing a lot of money into them. Banks that could not get the payments from homeowners cut earnings and the shareholders lost dividends among other things. Banks also failed, so bankers and employees lost out (Shiller, 2008). DeJardins (2014) states as Fastow gained power through his dual roles, the employees and investors were harmed because of his shenanigans. His purchases of stocks to hide the poorly performing shares did not help investors or employees who ultimately lost their retirement and investors who lost all their money. Because of his position he could hide evidence before and after audits, allowing him to hide the evidence from those who were dependent on the company for income (DesJardins, 2014). The conflict of interest is even more apparent when one realizes he was person entrusted to do financial diligence and abused that position for his own gain. Accounting rules must be stricter and have more checks and balances (Shiller, 2008). People should not be able to hold dual roles where conflicts of interest are apparent. Shareholders should be better protected by laws, allowing them to receive regular quarterly statements. Investments should be cleared by shareholders if over a specific amount. People, who hold positions of power, should also be accountable for transparency. High risk markets are just that, high risk, but when the risk is internal, it is unacceptable. A more transparent accounting and more emphasis on lending with reasonable consideration is more important than putting people and money at risk when they cannot afford it.

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Banks should have a better policy and not be part of a lending group without proper consideration of financial backgrounds (DesJardins, 2014). Additionally, banks should be subject to transparency to stakeholders where lending is occurring. A bank that wishes to work with higher risk loans should state it and make it part of any prospectus for individuals wanting to invest or just bank with the company. Ethics Issues The following is an ethical assessment based off of the case from the DesJardins text and the information on ethics from the text (DesJardins, 2014). The takes three top ethical dilemmas of the organization and explains them. The first matter of ethics breach is the absence of the board of directors independence and their break of fiduciary responsibility. The Board of Directors has the lawful and ethical obligation of observing the companys management on behalf of the shareholders. The members should remain independent and should always examine the companys operations with great care. In Enrons case, the Board of Directors was comprised of members who were excessively close to the senior management to perform objectively. They were much less likely to be unbiased and to question the companys business model. The board members ignored many warning signs of trouble and did barely the minimum to fulfill their fiduciary burdens. They relied solely on the information provided by a few members of senior management and failed to notice the severe breakdown of communication channels among key stakeholders such as the auditors and internal employees other than the CEOs and CFO. The senior management was also guilty of tolerance and encouragement of risky and reckless business practices, benefiting personally from fictitious accounting numbers and not acting in the companys best interests. Former CEOs Kenneth Lay and Jeffery Skilling and CFO Andrew Fastow were the key people in the whole Enron debacle. They built a culture that

Running head: CASE STUDY 1 rewarded irresponsible risk-taking behavior. They purposefully ignored warnings about

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problematic accounting practices and hid information from the public as well as the Board of Directors. Finally, accounting firm Arthur Andersen and several major banks were guilty of conflicts of interest and knowingly assisting Enrons fraudulent practices. The accounting gimmicks that Enron used are extremely complicated and they could not have been achieved without the involvement of the auditor and major banks. As Enrons external auditor, Arthur Andersen was supposed to ensure the quality of Enrons finance reports but it failed to fulfill this duty. The reason that the auditing team remained silent was the conflict of interest between its auditors and the consultant role. Enron was, at that time, also AA's major consulting/ business advisory client. AA collected an enormous amount of consulting fees from Enron every year and they would not want to risk losing this revenue stream. Personal Assessment After the Enron scandal, the public was outraged and blamed everyone who was related, including all Enron and Arthur Andersen employees. Since then nobody would want to be associated with these two companies. Top officials should be held responsible. In Enron, the dominant office culture was to be aggressive and earn as much money as possible. Top performers were saluted while bottom strugglers were asked to leave. Eventually some employees began to make risky decisions that were not in the companys best interest in hope of staying ahead of others and ultimately most employees followed. Similarly, it would be unfair to blame the whole Arthur Andersen team. In best understanding of the given information auditors are in general very ethical professionals. The Enron audit team was no different and the reason they failed to fulfill their duty must be because

Running head: CASE STUDY 1 of pressure from AAs top management, who cared only for income from the consulting

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business. Due to the conflicts of interest mentioned above, it is not difficult to imagine AAs consulting division recommending that the auditing team comply with what Enron suggested. The top management was at fault for putting the auditors in such a difficult situation. Conclusion Promoting an ethical mindset among company leaders remains the key to avoiding another Enron scandal (DesJardins, 2014). Also, regulators should create an environment in which all employees would be comfortable becoming a whistleblower. Society and the media should depict whistleblowers as heroes and reward them with reputation so that employees would not be afraid to step up and reveal unethical practices to the public. Former Goldman executive Greg Smith was not as lucky when he questioned the culture of Goldman Sachs. He was not granted the respect of calling out ethical problems within the company although he was trying to reach out and help. After Enron fell, regulators scrambled to enact new legislation to restore the integrity of the business world. The result was the 2002 Sarbanes-Oxley act, which established new standards for external auditor independence and mandated that senior executives take individual responsibility for the accuracy of financial reports (Zhang, 2007). Although shareholders are now better protected with the new regulations in place, Enron is unlikely to be the last company that tries to take advantage of legal loopholes. Human greed and the illusion of too smart to be caught will always lure managers to find new ways to commit business crime. It is essential for the business community to promote business ethics and encourage whistleblowing behavior in order to prevent another major business scandal.

Running head: CASE STUDY 1 References

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DesJardins, J.R. (2014). An introduction to business ethics (5th ed.). New York: McGraw-Hill. Wilmarth, A. E. (2009). The dark side of universal banking: Financial conglomerates and the origins of the subprime financial crisis. Connecticut Law Review, 41(4). Phillips, K. (2009). Bad money: Reckless finance, failed politics, and the global crisis of American capitalism. Penguin. com. Shiller, R. J. (2008). The subprime solution: How today's global financial crisis happened, and what to do about it. Princeton University Press. Dowd, K. (2009). Moral hazard and the financial crisis. Cato J., 29, 141. Zhang, I. X. (2007). Economic consequences of the SarbanesOxley Act of 2002. Journal of Accounting and Economics, 44(1), 74-115.