Corporate Scandals and the Sarbanes-Oxley Act of 2002

Early on, in the twenty-first century, several corporate accounting scandals led to the loss of billions of dollars worth for investors. Which also caused several bankruptcies for several corporations such as Enron, WorldCom, and Adelphia (Auerbach, 2010, pp. 1). Therefore, the United States Congress reformed corporation’s accounting practices that would hold executives accountable for accuracy of their company’s financial statements. This is the Sarbanes-Oxley Act of 2002, also known as the SOX Act or SarbOX Act.

In the later part of 1990s, there was an epidemic of accounting scandals which arose with the disclosure of financials transgressions by trusted corporate executives. The misdeeds involved misusing or misdirecting funds, understating expenses, overstating the value of corporate assets or underreporting the existence of liabilities, and overstating of revenues.

The Sarbanes-Oxley Act of 2002 – its official name being “Public Company Accounting Reform and Investor Protection Act of 2002” – is

In October 2001, Enron announced it was reducing after-tax net income by approximately $500 million & shareholders’ equity by $1.2 billion. It also announced that it was restating net income for the years’ 1997-2001. In November 2001, Enron recognized in a federal filing that it overstated earnings by nearly $600 million since 1997. Within a month, they declared bankruptcy. It was discovered that many financial reporting issues were poorly disclosed or not disclosed at all. There were major

Another corporate accounting scandal that occurred in the United States before the Sarbanes-Oxley Act came into effect was the WorldCom scandal in 2002. Seventeen thousand employees were fired and $3.8 billion dollars in profit were removed from their accounting books after an internal audit discovered improper expense accounting in 2001 and 2002. This improper accounting inflated the cash flow so the company would not report a net loss, only a net gain (Hancock, 2002).

There were several large scandals in the beginning years of the 2000’s. The public had a lack of trust within the capital markets and investors who had invested their capital would soon find out that they had lost a substantial amount, as share prices decreased. Senator Paul Sarbanes and Representative Michael Oxley both came together and were part of creating legislation which would deter future scandals such as Enron, WorldCom, Tyco amongst other frauds that led the public lose trust in the markets- to never happen again. Sarbanes-Oxley Act of 2002 is comprised of 11 sections, and one of them is the creation of the (PCAOB) Public Company Accounting Oversight Board, PCAOB definition “The PCAOB is a nonprofit

In recent year we have seen numerous companies fail as a result of these bad and/or fraudulent practices. In 1998 the publicly traded Waste Management Company falsely reported 1.7 billion in earnings. They got caught when the new CEO and management team went through the books.

This event was unprecedented. The seventh largest company in the United States disintegrated from an annually profitable company in business for over sixteen years to a company claiming to be bankrupt over a period of a few months (O’Leary). Ultimately, fraudulent accounting and misstatements of revenues and debt obligations orchestrated by the CEO, CFO, and other senior managers were to blame. These revelations roiled stakeholder trust in public companies' financial reporting, accounting methodology, and overall transparency. In addition to Enron’s admissions, their accountant and auditor, Arthur Andersen LLP, was determined to have conspired to assist in the inflation of stated profits mainly by not disclosing Enron's money-losing partnerships in the financial statements (PBS). Arthur Andersen eventually surrendered the practices’ CPA licenses in the United States after being found guilty of criminal charges relating to the firm's handling of auditing for Enron

Nonetheless, Enron declared bankruptcy a year later. Prior to its collapse, it was revealed that Enron inflated profits and concealed debt (Hoyle et al., 2013). Most importantly, its chairman and chief executive officer (CEO) at the time (i.e., Kenneth Lay) received over one hundred-fifty million dollars in compensation during the same year Enron declared bankruptcy (Hoyle et al., 2013).

The Enron scandal was one of the most notorious bankruptcies of all time. Many people know about the energy titan’s downfall but less realize that it was also one of the biggest auditing blunders in American corporate history, leading to the dissolution of the Arthur Andersen LLP, which at the time was one of the five largest auditing and accountancy partnerships in the world. The most intriguing aspect of this case is that Andersen was eventually cleared by the United States Supreme Court, yet the company still failed to live on due to its tarnished reputation stemming from its unethical behaviors. The pressure to generate revenue for clients while simultaneously auditing their books became too large a burden for the firm and they eventually resorted to unethical means to achieve their objectives. The demise of the Andersen accounting firm shows the true importance of practicing good ethics and maintaining a good reputation amongst peers; the vitality of the business could depend on sustaining a clean image in the ever-changing business world.

One of the “Big Five” accounting firms, Arthur Andersen, provided top-notch auditing, consulting, and tax service to several clients. Deemed as one of the leaders in the industry, Arthur Andersen services attracted major corporations and individual clients. Slowly, however, Arthur Andersen began to run their services with a greater focus on the clients’ management and performance and less on accounting standards and the investors’ well being. In June 2002, everything changed. Arthur Andersen became the first major accounting firm to be criminally convicted after being in “position as one of the leading professional services firm in the world, with over 85,000 staff in 84 countries and revenues in excess of $9 Billion” (Smith and Quirk 1). The company and its management began to act unethically and irresponsibly with several clients that they had been providing both auditing services and consulting services, a lethal combination. Ultimately, Andersen’s role in the scandals involving large corporations such as Enron, Waste Management, WorldCom, and Sunbeam led to not only these companies’ downfalls, but the

The first article researched was The Anatomy of Corporate Fraud: A comparative Analysis of High Profile American and European Corporate Scandals. The abstract discusses the analysis conducted on the three major American accounting scandals; Enron, WorldCom, and HealthSouth, and compares to the three major European accounting scandals; Parmalat, Royal Ahold, and Vivendi Universal. Bahram Soltani (2014), also discusses within the abstract the different areas reviewed regarding why the accounting scandals occurred; ethical climate, tone at the top, bubble economy and market control, fraudulent financial reporting, accountability, control, auditing, governance, and management compensation (p. 251).

Enron was America’s seventh largest corporation. Enron rose to dramatic heights only to face a tremendous collapse. Enron was ‘America’s most innovative Company’ and it shocked the world by the biggest bankruptcy of that time. Enron was formed in 1985 following a merger between Houston Natural Gas Company and InterNorth Inc. of Omaha (Investopedia, 2016). Enron’s collapse affected lives of thousands of employees. When Enron was at lifetime high, it’s share prices were at $ 90.75, but that fell to a low of $ 0.67 in January 2002 following its bankruptcy (BBC News, 2002). It is really a wonder how such a powerful and innovative business disintegrated overnight and managed to dupe the regulators with the help of fake books of records and off the books transactions for such a long period of time. Enron presented the picture that it was a great Company with remarkable revenue however that was actually not the case, a huge part of Enron’s profit was fabricated. This was facilitated by masterfully designed accounting and morally questionable acts. Concealing losses contributed to a huge problem and by late 2001, the company was declared insolvent. There were countless factors which affected Enron’s journey to the top and its abrupt fall. In this case study, we will analyze the related party transactions that the company entered into which were questionable, evaluate the accounting firm’s logic and the errors and proposed rules to avoid any such fraud in future.

The Enron case is well known for being the largest corporate bankruptcy in American history. Thousands of people world-wide lost billions of dollars, lost life savings, and lost their jobs. Due to the vast corruption, greed and the blatant disregard for integrity from the very top of Enron leadership, world markets crumbled and investor confidence in corporate America was severely damaged (Chandra, 2003.)

But what were already considered accounting practices on the edge of acceptable standards were eventually revealed to be outright fraudulent. The disgrace drove so much business away from and created such liability for accounting firm Arthur Anderson that it was itself forced out of business. By this time, though, the true value of the company had been revealed and the stock price collapsed, leaving employees with worthless options and pension packages. Of course, executives that understood the real picture sold their shares in advance of the collapsed and waltzed away with billions.