Question

Exhibit 2-1: Enron, WorldCom, and Shifts in Business Regulation (p. 19 in the text)

Google either of these two companies to learn the story of the financial scandals that resulted in the loss of millions of dollars and the imprisonment of corporate officers. Do you think that the CEOS and other corporate officers were justly held criminally responsible? Do you believe that business can regulate itself to act ethically or is government oversight a necessity to protect the public from financial wrongdoing? Investors? Elaborate and explain.

For one of your posts, do a little exploring online and discuss another white-collar crime story in the news. Include one source, properly cited in APA format.

Answer 1

Part a) The Enron Scandal

Overview:

Enron was formed in 1985 following a merger between Houston Natural Gas Company and Omaha-based InterNorth Incorporated. Following the merger, Kenneth Lay, who had been the chief executive officer (CEO) of Houston Natural Gas, became Enron's CEO and chairman.

In 1990, Lay created the Enron Finance Corporation and appointed Jeffrey Skilling to head the new corporation.

One of Skilling's early contributions was to transition Enron's accounting from a traditional historical cost accounting method to mark-to-market (MTM) accounting method, for which the company received official SEC approval in 1992. MTM is a measure of the fair value of accounts that can change over time, such as assets and liabilities. Mark-to-market aims to provide a realistic appraisal of an institution's or company's current financial situation, and it is a legitimate and widely used practice. However, in some cases, the method can be manipulated, since MTM is not based on "actual" cost but on "fair value," which is harder to pin down. This accounting method by Mr. Skilling allowed Enron to hide it's actual debts and losses and appear profitable even though it incurred a loss. This amounts to a financial crime. Mr. Skilling was later appointed as CEO of the company.

By the fall of 2000, Enron was starting to crumble , CEO Jeffrey Skilling hid the financial losses of the trading business and other operations of the company using mark-to-market accounting.

In Enron's case, the company would build an asset, such as a power plant, and immediately claim the projected profit on its books, even though the company had not made one dime from the asset. If the revenue from the power plant was less than the projected amount, instead of taking the loss, the company would then transfer the asset to an off-the-books corporation where the loss would go unreported. This type of accounting enabled Enron to write off unprofitable activities without hurting its bottom line.

Andrew Fastow, who was promoted to chief financial officer in 1998, developed a deliberate plan to show that the company was in sound financial shape despite the fact that many of its subsidiaries were losing money.

Fastow and others at Enron orchestrated a scheme to use off-balance-sheet special purpose vehicles (SPVs), also known as special purposes entities (SPEs), to hide its mountains of debt and toxic assets from investors and creditors. The primary aim of these SPVs was to hide accounting realities rather than operating results.

All these fraudulent practices led to Enron being projected as a financially sound and well managed corporation. The stock price of Enron hit a high of $90.75. However, as the actual financial situation and losses of the company began to surface around the fall of 2000, the stock prices began to reduce.When Enron finally filed for bankruptcy in December 2, 2001 , the stock value was a mere $0.26. This led the shareholders of the company to suffer $ 74 billion financial loss.

In light of the above events, it could be seen that the fraudulent practices of Enron were deliberate and led to a loss of $ 74 billion to it's shareholders.

Therefore the government was right in convicting CEOs and other corporate officers and holding them criminally responsible. Shareholders of any company are part of a nation's economy and loss to shareholders translates to loss for national economy. Therefore, it is a government's duty to safegaurd the interests of shareholders.

Part b, the worldcom scandal

The worldcom scandal happened on almost exactly similar lines to the Enron scandal. As an example, To hide its falling profitability, WorldCom inflated net income and cash flow by recording expenses as investments, reporting a profit of $1.4 billion—instead of a net loss—in Q1 2002. .

Worldcom CEO, Bernie Ebbers had built the company into one of America’s leading long-distance phone companies by acquiring other telecom companies. At the peak of the dotcom bubble, its market capitalization had grown to $175 billion.

The impact of Worldcom scandal on shareholders was even bigger than that of Enron. The shareholders lost $180 billion. Around 20,000 people lost their jobs.

Again, the fraudulent accounting practices of Worldcom after the dotcom bubble burst in 2000, were deliberate and the government was right in convicting it's CEO and other financial officers.

Some cons of the convictions in the Enron and Worldcom are:

1) Only the CEO and financial officers of the company were convicted while some others who were involved in the scandal were not punished. As an example, Enron's accounting firm Arthur Andersen LLP and partner David B. Duncan, who oversaw Enron's accounts were never brought to justice though they were a part of the fraud. Arthur Andersen LLP was convicted for obstructing justice in June 2002 but the judgement was later overturned.

2) The magnitude of punishment given to the CEOs seems disproportionate to their crimes. Mr. Skilling was sentenced to 24 years in prison while Mr. Ebbers was sentenced to 25 years in prison. The punishment seems too harsh.

Part c Should there be government regulation of business

Enron's collapse and the financial havoc it wreaked on its shareholders and employees led to new regulations and legislation to promote the accuracy of financial reporting for publicly held companies. In July 2002, President George W. Bush signed into law the Sarbanes-Oxley Act. The Act heightened the consequences for destroying, altering, or fabricating financial statements, and for trying to defraud shareholders.

The theory that business can regulate itself to act ethically is only partially true. If the higher officials involved in business decide to commit fraud deliberately, this theory crumbles. Other examples of unethical practices by businesses involve setting up shell companies in tax havens to save on coporate tax and setting up shell companies to hide the money made unethically (the so called 'black money). In these, cases we cannot expect the businesses concerned to regulate themselves to act ethically.

Therefore government control to a certain extent is necessary. The objectives of government control should be :

1) To safegaurd the interest of shareholders, creditors and other stake holders against a deliberate fraud.

2) To ensure that businesses follow ethical business practices and not involve in unethical practices like undercutting competition, hostile takeovers, etc.

The cons of too much government control are:

1) A significant amount of the company's resources (both human and financial) would be spent on liaisoning and dealing with the regulatory authorities. This would lead to inefficiency.

2) If the government officials are given too much power to control the business, they will interfere with functioning of the company in fraudulent ways, leading to loss of efficiency and financial losses. Note that when the government control was too strict in socialist countries (eg. India) and communist countries (eg. China), the growth rate of the countries was miniscule and the economies were in shambles. Therefore, government control above a certain extent is definitely counterproductive. The businesses should be given a chance of regulating themselves under government oversight.

Part d Other white collar crime crime story

("White Collar Crime", 2016) gives detailed information about the financial crime by Mr. Madoff.

Bernie Madoff, a former non-executive chairman of the NASDAQ stock market, began his own Wall Street investment securities firm in 1960. He employed his brother, his brother’s daughter, and two of his brother’s sons at the firm, where he worked as Chairman until December 2008, when he was arrested for committing a white collar crime known as a Ponzi scheme.

While Madoff started the business with his personal earnings as a lifeguard and sprinkler installer, his father-in-law also loaned him money. About 10 years later, Madoff began attracting major investors and, through the years, even convinced a number of wealthy celebrities to invest in his firm.

Madoff would acquire money from these investors by promising them huge returns. However, when he received the money, he would deposit it into a personal account. If an investor asked for some of the money, Madoff would take it from his fake business capital, which was composed of other people’s investment money, and give them a small amount, stringing them along for bigger returns. By the 2000s, Madoff was unable to repay any of the investors, as the money cycle began running out. This sparked an investigation.

In December 2008, Madoff’s own sons reported to federal authorities that their father had admitted to them that his asset management company was a massive Ponzi scheme. The next day Madoff was arrested and charged with securities fraud. At trial, in March, 2009, Madoff pled guilty to 11 federal charges involving white collar crimes. These felony charges included securities fraud, perjury, and money laundering.

According to the criminal complaint, investigators could document that Madoff had defrauded his clients to the tune of around $65 million, making his scam the largest Ponzi scheme ever recorded. The Securities Investor Protection Corporation (“SIPC”) put investors’ actual losses at closer to $18 billion.

Madoff claimed that he was the only one responsible for the fraudulent acts, and refused to name any family members or anyone else associated with the con. He was sentenced to 150 years in federal prison. Later that year, however, a number of Madoff’s key personnel, including David G. Friehling, Accountant and Auditor, and Frank DiPascali, Finance Chief, later pled guilty to more than a dozen felony charges.

Friehling, who was facing more than 100 years in prison, cooperated extensively with authorities for a shortened sentence, naming five former employees, each of which was convicted and sentenced to prison. For his help, Friehling’s sentence was reduced to 1 year of home detention, and 1 year probation. DiPascali also cooperated, testifying at the trials of the five additional employees. While he originally faced 125 years in prison, he died of cancer before being sentenced.

This extreme example of white collar crime shocked the public, increasing awareness of how people in key positions can bilk others of huge amounts of money. Even small consumers were spurred to take extra care in trusting their financial wellbeing to another, whether a small time advisor, or huge corporations.

Ref. March 25,2016 , "White Collar Crime", https://legaldictionary.net/white-collar-crime/