Compare/discuss the Enron, Worldcom and Madoff scandal. What need to be done by the Government and also your suggestion as to how to avoid the above scandal
Enron is an energy company based in Houston,Texas that deals with the energy trade on an international and domestic basis. It was formed in 1985 when Houstan Natural Gas merged with InterNorth. Originally Enron was an operator of interstate gas pipeline, by 1989 Enron diversified into trading energy-related commodities. The company had been spectacularly successful at persuading investors that it had found a way of making huge amounts of money out of the reliable but dull business of supplying energy. In few years, Enron becomes the largest merchant of energy in the United States and the United Kingdom. In addition to energy, Enron is already buying and selling cellulose, pulp, paper, fertilizer, plastics, metals and bandwidth. By the year 1999 Enron grew so big, that it became involved in about a quarter of all energy deals in the world.
The success of Enron was phenomenal as how did it manage to fool the regulator and Wall Street community for so long with fake off-the books corporation. Enron grew wealthy due to largely to marketing, promoting power and its high stock price.
Enron??™s reported revenue was based on its exploitation of a loophole in accounting rules that allowed it to book revenue from huge energy-derivative contracts at their gross value, not their net value by adopting mark to market accounting. In this case, Enron would build an asset such as power plant and immediately claimed that the projected profit on its books even though it hadn??™t made any money yet from it. If the revenue from the plant was less than the projected amount, instead of taking the loss , the company would transfer these assets to an off-the-books corporation, where the loss would go un reported.
Part of the reason the company was able to pull of this manipulation for so long is that CEO, Jeffrey Skilling, also competed with the top Wall Street firms for best business school graduate and would shower them with luxuries and corporate benefit. One of Skilling??™s top recruits was Andrew Fastow who joined as Chief Financial Officer. The mark-to market practice has led to schemes that were designed to hide losses and make the company appear to be more profitable than it really was. In order to cope with the mounting losses, Andrew Fastow came up with a devious plan by creating special purpose entities (SPE) in order to hide any assets that were losing money or business ventures that going gone under. This would keep the failed assets off of the company??™s book. In return, the company would issue the investors of the SPE shares of Enron??™s common stock to compensate them for the losses. This eventually failed as SEC started investigation on his involvement in this business partnership.
Enron also was consider the as a strategic company which tightly linked to US government. It was extremely active in the domestic politics of the US, in the political finance of the country??™s two major parties, act as a player in foreign market and fearless participant in the international energy politics. The closeness linked Enron??™s executive with US politicians enable them to manipulate and disguise their financial losses. This scandal also caused the dissolution of the Arthur Andersen accounting firm where it was found that several of the executive was recruited from this major accounting firm. Arthur Andersen was found guilty due to obstruction of justice for destroying key documents of its audit client, Enron.
The collapse of Enron, as famously known a company was considered ???too big too fail??™, who depended on outside credit sources to finance its daily operations. In turn its credit-worthiness depended on its performance as reflected in Enron??™s share price. When the price of Enron??™s shares collapsed, so its??™ credit rating. Without ready infusion of cash, Enron became unable to meets it earlier credit obligation. This depressed Enron??™s stock even deeper, which in turn let the further decline in already low share prices. Being unable to pay its??™ creditors, with no forthcoming offers of merger from its competitors and no foreseeable rescue attempted by the government, Enron was forces into bankruptcy.
Worldcom was formed by the acquisition of MCI Communication which let by the CEO Bernie Ebbers. It was a company that was dealing with long distance telephone and internet communication server provider technologies. Worldcom was became success through the execution of an aggressive acquisition startergy and eventually evolved into the second largest long distance telephone company in the United States and one of the largest companies handling worldwide internet data traffic. Worldcom crushed in 2002 after it was discovered that it had improperly booked US$3.8 billion in expenses. There are three major issues in the fall of Worldcom which are the corporate strategy of growth through acquisition, the use of loans to senior executives and failed of corporate governance.
Worldcom strived as player in telecommunication industry through the completion of 65 acquisitions. As a result of these acquisitions, they gain access to various networks that ultimately boost the share price and made Worldcom share more desirable. As the shares value went up, it was easier for Worldcom to use the shares as the vehicle to continue to purchase additional companies. Between 1991 and 1997, Worldcom spend USD$60 billion in the acquisition of many companies and accumulated USD$41 billion in debt.
The abuses in accounting the financial matter of Worldcom also contributed to this bankruptcy. The infamous discovery among them was the admission of improperly accounting for operating expenses as capital expenses in violation of generally accepted accounting practices (GAAP). Worldcom has entered into a number of long-term lease agreement where according to the term of agreements, the company was obliged to pay a fixed amount to the carriers, regardless of how much of leased capacity was actually utilized by Worldcom. As per the prevailing accounting principles should have been treated as ???operating expenses??™ in the income statement of the company.
The management of company also generously provided corporate loans and guarantees of USD$400 million to Bernie Ebbers in order for him to finance other business which he use his existing holdings as collacteral. He became very wealthy from the rising price of his holdings in Worldcom common share. In 2000, the telecommunications industry entered a downturn and the Worldcom??™s aggressive growth strategy suffered setback when it was forced by US Justice Department to withdraw proposed merger with Sprint in mid 2000. As the Worldcom shares price plunged further, his way of navigating this operation ultimately faced him in difficult dilemma, because his personnel assets were insufficient to meet the margin call to recover.
Poor management also contributed this downfall, as the challenge of integrating new and old organizations into a single smoothly functioning business have resulted in numerous organizational problem. The company was not up to the task of merging them. Dozens of conflicting computer systems remained, local systems were repetitive and failed to work together properly and billing systems were not coordinated.
Madoff investment scandal is a Ponzi scheme that brought Bernard Madoff to 150 years sentence in prison. He managed to disguise his fraudulent activities since 1990s. All of his investors to the alleged profitable investment have been manipulated by his successful character over the years. He was former NASDAQ chairman and founder the Wall Street firm Bernard L. Madoff Investment Securities LLC in 1960. The Madoff family also gained unusual access to Washington??™s lawmakers and regulators through the industry??™s top trade group. The Madoff family has long-outstanding, high-level ties to the Securities Industry and Financial Market Association (SIFMA), the primary securities industry organization.
All this special qualities of Madoff have gain trust from his best friends, new comers to his investment and event the Jewish community. His strategy of investment method was ???too complicated for outsiders to understand??™ have left the investors only rely on his expertise in trading. He was secretive about the firm??™s business and kept his financial statements closely guarded.
Even though, whistle blower, Harry Markopolos has raised an allegation of the Madoff??™s fraudulent practices. The SEC claimed it had conducted inquiries into Madoff but did not find any violations or major issues of concern.
All these scandals have resulted in huge financial disaster and were affected global financial market. Not long ago, these companies and their executives were worth hundreds of billion dollars. Today they were no longer exist and their important players have served prison sentences due to various fraudulent practices.
Our government has taken these lessons in order to safeguard our financial market and to restore investor confidence and faith in financial sector that was notorious for fraudulent activities, easy credit and hazardous investment.
Under the Ministry of Finance, various regulations have been introduced and upgrade the existing regulations in order to protect the capital market as well as to investor and public interest. Apart from the Companies Act1965, the act has been amended in 2007 which emphasis on the director??™s duties and new duty to auditors. The act also has incorporate Whistle Blowing Act, whereby to protect whistleblower if he to report wrong doings pertaining to non compliance with the securities laws, Bursa Listing rules and those irregularities that have material financial impact on the public listed company and its subsidiaries. This new regulations are important aspect in regards of safety of the whistleblower and also public to take part in preventing such scandals or fraud from happening again. Others regulations such as Capital Market and Service Act 2007 and Malaysia Code of Corporate Governance, plays major roles in protecting our capital market by increased the penalties for financial manipulation and codified the principles and best practices of good governance described optimal corporate governance structures and internal process. The government has revised the code in 2007 by putting in place the criteria for qualification of directors and strengthening the audit committee as well as internal audit function of the public limited companies. All and all the board of directors will be responsible for ensuring the adherence to the scope of internal audit functions. This will give great pressure to the board in order to run the company smoothly and in orderly manner.
The scandal that mentions above particularly Enron and Worldcom, the role of auditors that regards as the goalkeeper for the financial statement comes no surprise that their appointed auditor, Arthur Andersen that endorsed many of the accounting irregularities that contribute to both companies demise. As a result of these alarming scenarios, Malaysia Securities Commissions has established Audit Oversight Board whereby their tasked is to assists SC in overseeing the auditors of public interest entities and to protect the interests of investors by promoting confidence in the quality and reliability of audited financial statements of public interest entities. Now auditors will be checked by auditors board whether during their auditing activities will inspect and monitor the extent of their compliance with recognized auditing and ethical practices.
Lessons that can be learned from this corporate scandals, shows us what a company and its leadership are capable of when they are obsessed with making profit at any cost. As a result of Enron scandal, the creation of Sarbanes-Oxley Act of 2002, this tightened disclosure and increased penalties for the culprits. Accounting regulators have raised its level of ethical conduct in promoting, issuing or developing accounting standard in order to avoid easy financial manipulation. Board of directors now are becoming more independent, monitoring the audit company and quickly replacing bad managers.
The collapses of these companies were unfortunate incident and it is important to now and why it happened so that we can understand how to avoid these situations in the future. Looking back, both companies had incurred tremendous financial loss as a result of arrogance, greed and foolishness from the top management all the way down. Many of the companies??™ losses started the collapse that could have been avoided if someone had had the nerve and the will to put a stop to it.