CORPORATE FRAUD
On October 16, 2001, Enron, the seventh largest corporation in the U.S., announced a $638 million loss in third-quarter earnings. On November 8, 2001, the company publicly admitted to having overstated earnings for four years by $586 million and to having created limited partnerships to hide $3 billion in debt. As investors lost confidence in the company, Enron stock,
which had been worth as much as $90 per share
in 2000, plummeted to less than $1 per share.
Thousands of Enron employees lost their jobs
and retirement savings, which had been invested
in corporate stock through a 401(k) retirement
plan. Banks and lenders lost millions of dollars
in loans made to Enron based on the fraudulent
earnings reports.
Enron Corporation started as a pipeline
company in Houston, Texas, that delivered gas at
market price. Over the next 15 years, Enron
expanded into an energy power broker that
traded electricity and other commodities, such
as water and broadband INTERNET services.
Enron became one of the nation’s most success-
ful companies, employing 21,000 people in
more than 40 countries. The senior executives at
Enron attributed their success to their corporate
strategy,which was to be light in assets but heavy
in innovation.
The innovative business practices of over-
stating profits and concealing debt increased the
company’s stock value, thus allowing the com-
pany to borrow more money and to expand. It
also led to some top executives selling their stock
and making over one billion dollars. Those for-
mer executives were later indicted for FRAUD,
MONEY LAUNDERING, and conspiracy, and they
also face dozens of civil lawsuits filed by PEN-
SION funds and former employees. The com-
pany’s accounting firm, Arthur Andersen,
admitted to having shredded Enron documents
after it had learned that the SECURITIES AND
EXCHANGE COMMISSION (SEC) was conducting
an investigation of the corporation. The
accounting firm was convicted of OBSTRUCTION
OF JUSTICE, lost hundreds of clients and
employees, and went out of business.
After the Enron scandal became public
knowledge, many wondered how such an over-
statement could have escaped notice. What the
public soon would learn was that Enron was
only one among many such stories.
In March 2002, the world learned that
WorldCom, the second largest long-distance
phone company in the U.S., had overstated prof-
its by listing $3.8 billion in normal operating
expenses (which were basically routine mainte-
nance costs) as capital expenses. This move
allowed them to spread the expenses out over
several years, thereby making profits look much
larger and artificially inflating the company’s
value in order to meet Wall Street’s expected
earnings.WorldCom stock, which was valued as
high as $60 per share in 1999, dropped to 20
cents per share in response to the news. Seven-
teen thousand WorldCom employees lost their
jobs. The JUSTICE DEPARTMENT has secured
indictments against the former Chief Financial
Officer, Richard Breeden, for bank fraud, SECU-
RITIES fraud, conspiracy and false statements in
SEC filings. Four other former WorldCom exec-
utives have pled guilty to securities fraud and
agreed to cooperate with the prosecution. The
SEC has filed a civil suit against the company. As
of 2003, the SEC has uncovered over $9 billion
in bogus accounting. In July 2002, WorldCom
filed the world’s largest BANKRUPTCY.
After Enron’s and WorldCom’s fraudulent
accounting practices became public knowledge,
news of more corporate accounting scandals
came flooding in. In February 2002, Global
Crossing was caught inflating revenue and
shredding documents that contained account-
ing information. In April 2002, Adelphia Com-
munications made headlines amidst the
discovery that $3.1 billion worth of secret loans
had been made to the company’s founding fam-
ily—some of whom were later arrested—and
earnings were overstated. In May 2002, Tyco
International, Ltd. accused three former senior
executives of having fraudulently taken out
loans from the company without permission
and without paying them back. The men also
allegedly issued bonuses to themselves and other
employees without approval from the com-
pany’s board of directors. The SEC has since
charged the three for fraud and theft and is investigating whether the company had knowledge of this conduct. In July 2002, it was
revealed that AOL Time Warner had inflated
sales figures. Amid further investigations, the
company admitted to having possibly overstated
revenue by $49 million. Other companies in the
spotlight for corporate accounting scandal allegations
include Bristol-Myers Squibb, Kmart,
Qwest Communications International, and
Xerox. In addition to corporate scandal, television
personality and home decorating maven
Martha Stewart was indicted for allegedly selling
3,928 shares of stock in ImClone Systems, thus
making about $227,824, based on an insider
trading tip that she had received from the company’s
founder, Samuel Waksal.
Many fraudulent accounting practices came
about over the past decade when energy,
telecommunication, and other industries were
expanding rapidly, and competition was especially
fierce. The STOCK MARKET indices were
reaching all-time records, and investors were
looking for short-term earnings targets. Many
corporate executives did whatever was necessary
to meet the quarterly expectations of the analysts
on Wall Street, thereby increasing the price of
their stock. This often allowed their companies to
borrow more money to grow and compete. Since
most top executives also enjoyed stock options
that rose in value with their companies’ stock
prices, they had the added incentive of making
significant profits by selling their stocks at the
higher prices. This resulted in a considerable
transfer of money from individual shareholders
to corporate managers. However, the individual
investors were still making profits and therefore
not paying attention to conflicts of interest and fraudulent practices, thus allowing the executives
to go almost unchecked in their actions.
Since the collapse of Enron and WorldCom,
some corrective actions have been taken. The
New York Stock Exchange has made improvements
in its accounting, auditing, and corporate
governance rules for corporations that want to
list their stock on the exchange. Congress
approved the SARBANES-OXLEY ACT, Pub. L. No.
107-204, 116 Stat. 745, which created the Public
Accounting Oversight Board to monitor public
accountants, made changes in auditing rules,
and authorized an increase in criminal penalties
for more WHITE-COLLAR CRIMES. The declining
economy and bear market has also changed the
attitude of corporate managers who had to
downsize and apply more caution in making
new investments and deciding executive salaries
and bonuses. Most importantly, corporate
employees and individual investors are paying
more attention to the actions of the executives
who control their investments.
FURTHER READINGS
Arnold, James. “WorldCom’s Star Falls to Earth.” July 22,
2002.Available online at news.bbc.co.uk/l/hi/business/
2066885.stm (accessed Novmber 20, 2003).
“Cato Handbook for Congress, 108 Congress, Chapter 22:
Enron,WorldCom and Other Disasters.”Available online
at www.cato.org/pubs/handbook/hb108/hb108-22
.pdf (accessed November 20, 2003).
“Enron Scandal At-a-Glance.” Available online at news.bbc
.co.uk/l/hi/business/1780075.stm (accessed November
20, 2003).
Patsuris, Penelope. “The Corporate Scandal Sheet.” August
26, 2002. Available online at www.forbes.com/2002/
07/25/accountingtracker_print.html (accessed November
20, 2003).
Enron: An Investigation into Corporate Fraud
The collapse of Enron Corporation in
2001 led to massive investigations
involving allegations of a range of criminal
activities perpetrated by some of the
company’s top executives. In January
2002, the U.S. JUSTICE DEPARTMENT
announced that it had formed an Enron
Task Force consisting of a team of federal
prosecutors and under the supervision of
the department, agents of the FEDERAL
BUREAU OF INVESTIGATION,
and agents of the criminal
division of the INTERNAL
REVENUE SERVICE. The scandal
developed into a case study
of corporate fraud, poor management
decisions, and faulty
accounting practices.
Enron had built itself into the seventh
largest company in the United
States, with annual revenues of $100 billion.
In December 2000, the company’s
stock sold for as much as $84.87 per
share. However, stock prices fell throughout
much of 2001. In October, the company
announced that it had overstated its
revenues, claiming losses of $638 million
during the third quarter of 2001 alone.
Stock prices then plunged, hurting
investors and employees with retirement
plans that were tied into company stock.
By the beginning of December, Enron’s
stock prices had fallen to below $1 per
share. Enron filed for Chapter 11 BANKRUPTCY
protection on December 2,
2001. To date, the event constituted the
largest bankruptcy in U.S. history.
Much of the early investigation into
the Enron fiasco focused on
the company’s financial reporting
practices. Though the
company followed generally
accepted accounting principles
(GAAP), these practices gave
the false impression that the
company was more profitable
and more secure than it really was. The
company reported revenues that were
actually funds flowing through transitional
transactions with related companies.
Moreover, the company hid its losses
and debts in partnerships that did not
appear on Enron’s financial statements.
The first criminal charges were filed
against Enron’s accounting firm, Arthur
Andersen, L.L.P. The Justice Department
brought charges that the accounting firm
had destroyed thousands of documents,
including computer files, related to its
dealings with Enron. Anderson was also
convicted for doctoring a memo and
misstating a news release related to
Enron. The company was found guilty of
OBSTRUCTION OF JUSTICE in June
2002—an appeal is still pending as of
September 2003. It was placed on PROBATION
for five years and required to
pay a fine of $500,000. Analysts questioned
whether the accounting firm
would survive after the conviction. In
addition to its role as accountant, Arthur
Andersen had served as a consultant to
Enron for a number of years, thus raising
conflicts of interest questions.
Because the Justice Department had
not moved forward with criminal indictments
against Enron officials, several
critics charged that the federal government
under President GEORGE W. BUSH
was protecting top Enron executives. Several
of these executives were questioned
by the Senate Commerce Committee in
February 2002, but no charges were filed.
Several of Enron’s senior executives reportedly had personal interests in certain
risky transactions. These executives
even sold Enron stock while at the same
time convincing employees to hold their
stock. The board of directors of the company
also allegedly failed to provide significant
oversight regarding the auditing
and reporting by the company.
The first major criminal charges
involving an Enron executive were
brought against Michael Kopper, who
had served as an aide to chief financial
officer Andrew Fastow. Kopper pleaded
guilty to charges of MONEY LAUNDERING
and conspiracy to commit FRAUD in
August 2002. Kopper implicated Fastow,
claiming that Fastow had conducted
transactions on behalf of Enron for the
benefit of third-party partnerships
owned by Fastow.
The Justice Department then focused
its attention on Fastow, who allegedly
had $12.8 million in funds and was constructing
a $2.6 million house. The government
alleged that Fastow and Kopper
had accumulated $22 million from illegal
Enron deals. In November 2002, the Justice
Department indicted Fastow on 78
counts, including fraud, money laundering,
and obstruction of justice. The criminal
indictment did not include former
CEO Kenneth Lay, former CEO Jeffrey
Skilling, or any other top executives. The
Justice Department also announced that
it could file a superseding indictment
with additional charges. This superseding
indictment might name additional
defendants as well.
Fastow appeared before the SECURITIES
AND EXCHANGE COMMISSION in
December 2002 but invoked his FIFTH
AMENDMENT PRIVILEGE AGAINST
SELF-INCRIMINATION. In several trade
publications in the late 1990s, Fastow had
discussed his accounting practices at
Enron, including methods for keeping
funds off of Enron’s books. According to
several commentators, Fastow could represent
a “fall guy” for the Enron fiasco, as
it was probable that other executives and
members of the board were aware of
these reporting practices.
Others involved in Enron transactions
were also brought up on criminal
charges. In July 2002, three British
bankers were charged with wire fraud for
their dealings with Enron. The Justice
Department subsequently focused its
attention on Enron Broadband Services,
an INTERNET division of the company.
The Houston Chronicle reported in April
2003 that executives of that branch were
likely to be indicted for insider trading,
fraud, and money laundering.
As of the end of April 2003, twelve
charges had been filed relating to the
Enron fiasco, though only seven were
filed against company insiders.
FURTHER READINGS
Ackman, Dan. 2002. “Andrew Fastow, Fall
Guy.” Forbes (October 3). Available online
at
Baird, Douglas G., and Robert K. Rasmussen.
2002. “Four (or Five) Easy Lessons from
Enron.”Vanderbilt Law Review 55 (November):
1787–812.
Flood,Mary, and Tom Fowler. 2003. “Five Men
Could Be Charged.” Houston Chronicle
(April 26).
Fox, Loren. 2003. Enron: The Rise and Fall.
Hoboken, N.J.:Wiley.
“Key Enron Figure Strikes a Deal.” 2002. CBS
News.com (August 21). Available online
at
(accessed July 11, 2003).
Salem, Christina R.. 2003. “The New Mandate
of the Corporate Lawyer After the Fall of
Enron and the Enactment of the Sarbanes-
Oxley Act.” Fordham Journal of
Corporate & Financial Law 8 (summer):
765–87.
Swartz, Mimi, with Sherron Watkins. 2003.
Power Failure: The Inside Story of the Collapse
of Enron. New York: Doubleday.
CROSS-REFERENCES
Accounting; Bankruptcy; Embezzlement;
Fraud.
