The corporate

governance lessons
of Enron
Gerald Vinten
Gerald Vinten is Head of Business, European Business School, London, UK and Member of Council, Chartered Institute of
Public Finance and Accountancy.

Keywords Corporate governance, Boards of directors, Fraud, constant over time, and could easily be accorded book
Accounting, Audit length treatment. History would certainly indicate that Enron
Abstract The failure of the Enron Corporation in late 2001, will not be the final example of its kind. From the more
apart from signalling the largest corporate bankruptcy in the modest smaller building societies scandals in the UK (Vinten
USA, has also thrown up a myriad of questions about the and Greening, 2001) and examinations in England and
effectiveness of contemporary accounting, auditing and Wales under the Charity Acts (Vinten, 1997), one moves to
corporate governance practices. There are strong historical global giants such as BCCI (Vinten, 1991, 1992), Maxwell
antecedents for distrust of the corporation, latterly represented (Vinten, 1992, 1993), Barings, and Marconi. Long-term
in extreme form by the anti-capitalists. The causes of the Enron capital management (LTCM), although small in terms of the
failure and the immediate response in the USA are outlined. This
eÂlite who founded it, the 100 investors and under 200
is followed by the response in the UK among the accountancy
bodies, and the results of a comprehensive survey to assess the
employees, nevertheless created a trillion dollar hole in the
impact of Enron. This then leads to a comprehensive series of international banking system (Lowenstein, 2001). Even
lessons to be learnt in the form of recommendations under the religious organisations are not exempt with the largest ever
headings of serving the public interest, accounting and financial US consumer mail fraud being perpetrated in the late 1980s
reporting, auditing, corporate governance, and education. by a radio evangelist. Jim Bakker cheated 150,000 members
of his ``flock’’ out of $158 million (Tidwell, 1993). Lessons are
Corporations cannot commit treason, nor be outlawed, nor
supposedly learnt from each example, often following
excommunicate, for they have no souls (Sir Edward Coke (1552- expensive official enquiries, and they then become part of
1634) Case of Sutton’s Hospital, 1612). the archival history of corporate disaster and failure. Indeed
We have much to fear from great corporated, moneyed institutions. this monotonous and repetitive litany seems to have become
We are today more in danger from organised money than ever we an industry in itself. The anti-capitalists will certainly find this
were from slavery (Henry Ward Beecher (1813-1887) Proverbs from
latest sad episode further grist to their mill.
Plymouth Pulpit, 1887).
The intense media interest in Enron suddenly erupted and
Corporation, noun. An ingenious device for obtaining individual profit
without individual responsibility (Ambrose Bierce (1842-1914) The has continued unabated since. Matters in which their normal
Devil’s Dictionary, 1911). interest is minimal, such as accounting standards and
There is the veil of corporate personality which protects the individual procedures, and the role of auditors, became the talk of the
from any personal liability at all. That is the fundamental principle of
our company law (Lord Denning, House of Lords, 15 January 1985).

Introduction

T
hese quotations from across the centuries all witness
to the perils inherent in the body corporate after and The current issue and full text archive of this
before the landmark event of the South Sea Bubble. journal is available at
The theme of corporations lacking soul and conscience is http://www.emeraldinsight.com/1472-0701.htm

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town. The outcome has been scrutiny of the accounting and announced on October 16, 2001 a $544 million after tax
auditing profession, and a severe dent in the public’s charge against earnings. There was additionally reduction of
confidence in the capital markets. The total picture is still not shareholders’ equity of $1.2 billion.
fully assembled, with a myriad of investigations ongoing Less than a month later came the gigantic revisions to
through several agencies. In the USA there has been far from financial statements from 1997 to 2001 because of
full co-operation from some of the implicated parties, and accounting errors relating to transactions with a different
several have invoked the Fifth Amendment. Even the 212 Fastow partnership, LJM Cayman, L.P. (``LJM1’’) and an
page Powers Report of February 1, 2002, had limited scope, additional related party entity, Chewco Investments, L.P.
and only gained a partial view. This was a Special Chewco was managed by an Enron Global Finance
Investigative Committee of the board of directors of Enron. employee, Kopper, who reported to Fastow. It was also now
Here is a summary of the facts that are emerging, the revealed for the first time that Fastow received more than $30
investigations that are in train, and the steps being taken in million from LJM1 and LJM2. The Powers Committee
the USA to develop solutions that can help restore the subsequently discovered Kopper has received at least $30
public’s faith in the financial reporting system. million, two others $1 million each, and two others
$000,000s. In almost all the transactions there was extensive
The current situation in the USA advice and participation from Andersen. This is particularly
On December 2, less than a month after it admitted apparent from the separate billing, in addition to the normal
accounting errors that inflated earnings by almost $600 audit fee of up to $58 million, of $5.7 million for advice
million since 1994, the Houston-based energy trading concerning the LJM and Chewco transaction. David Duncan,
company, Enron Corporation, filed for bankruptcy protection. the Andersen partner responsible for Enron, was described
With $62.8 billion in assets, it became the largest bankruptcy as a ``client pleaser’’ by the Andersen lawyer at the federal
case in US history, dwarfing Texaco’s filing in 1987 when it trial in May 2002. Andersen’s Professional Standards Group
had $35.9 billion in assets. The day Enron filed for had been raising various substantive issues about the
bankruptcy its stock closed at 72 cents, down from more accounting treatment, but obviously not effectively, and the
than $75 less than a year earlier. Many employees lost their client view tended to prevail after a skirmish with the issues.
life savings and tens of thousands of investors lost billions. Symptomatic was Enron’s successful lobbying to have Carl
Bass removed from the audit. He was unhappy with many
aspects of Enron, and was a member of the Professional
``The Houston-based energy trading Standards Group (Wall Street Journal, 2002). Ironically the
then CEO, Jeff Skilling, had given an interview in February
company, Enron Corporation, filed for 2001 in which he had stated:
Our business is not a black box. It’s very simple to model. People
bankruptcy protection . . . with $62.8 who raise questions are people who have not gone through it in
detail. We have explicit answers, but people want to throw rocks at us
billion in assets, it became the largest (McLean, 2001).

At least half a dozen Congressional Committees, the

bankruptcy case in US history’’ Securities and Exchange Commission (SEC), the US Justice
Department, and an investigative panel appointed by
According to the Powers’ Report, many of the most Andersen LLP are trying to assess responsibility. Several
significant transactions were designed to achieve favourable parties may have contributed ± Enron top management and
financial statement results rather than achieve bona fide audit committee, their outside law firm, the auditors at Arthur
economic objectives or facilitate the transfer of risk. Other Andersen, investment advisors, and the environment which
transactions were implemented improperly to offset losses. encouraged the company’s highly questionable practices.
They permitted Enron to conceal from the market huge The challenge for investigators is to sort out the criminal
losses resulting from merchant investments by creating the activity (such as the shredding of subpoenaed documents at
illusion that they were hedged ± that is, that a third party was both Enron and Andersen, possible insider trading, and
contractually obliged to pay the amount of any losses. In the knowingly falsifying financial documents), from the flaws in
result, the third party turned out to be simply an entity in the system that allowed Enron to hide debt and losses.
which only Enron had a substantial economic stake. Various The US General Accounting Office has also played an
investment partnerships had been created and managed by invaluable role, and has issued a series of timely and
Andrew S. Fastow, Enron’s former executive vice president insightful reports. One of the most bizarre episodes has been
and chief financial officer, and by other Enron employees the unprecedented need to litigate the vice president, Dick
who worked with Fastow. In connection with LJM2 Co- Cheney, in his capacity as chair of the National Energy Policy
Investment, L.P. (``LJM2’’), created by Fastow, Enron had Development Group. Only limited information was sought,

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but the vice president has seen fit to challenge the GAO’s assistance to help them address the ramifications of the
fundamental statutory authority to assist the Congress in Enron collapse with their clients, employers and
connection with its constitutional, legislative and oversight colleagues. The AICPA has also announced its support
authorities. The NEPG was financed with appropriated funds for more extensive changes in its self-regulatory
and staffed mainly by the government department and structure.
agency staff allocated to it. It is plain that the upshot of the & The AICPA strongly believes that additional reforms
vice president’s stand is that in the future any administration need to be enacted to deter accounting abuses and
desiring to avoid scrutiny would simply assign such activities avoid an Enron-type disaster in the future. These include
to the vice president or a body under the White House’s providing a new and improved financial reporting model
immediate control. It would seem that the whole American suitable for companies of the Information Age for which
Revolution was fought in vain, and the tea at Boston earning assets are not accurately valued by traditional
needlessly dumped into the ocean, rather than the eager measures.
cups of the Bostonian middle classes. The AICPA and state Certified Public Accountant societies
As a direct result of the Enron collapse, major changes are working hard on both the national and local levels, with
are in store in the regulatory environment. Among the steps members of Congress, the SEC, and other parties, to fulfil
that have already been taken are: the profession’s commitment to the public interest, and
& The Securities and Exchange Commission (SEC) has regain the public confidence in the nation’s CPAs
announced plans to create new organisations outside
the structure of the American Institute of Certified Public The situation in the UK
Accountant (AICPA) to oversee auditors of publicly held The UK has been the home to a fulsome series of corporate
companies. A disciplinary board would be created to governance reports, which have been replicated throughout
accelerate the investigation of alleged audit failures and the globe (Vinten, 2001a). The Treasury Committee launched
provide more transparency, and the current program of an inquiry into the financial regulation of public limited
firm-on-firm triennial peer reviews for auditors of publicly companies in early 2002. The formal terms of reference were:
traded companies would be replaced by an annual To examine, in the light of the Enron collapse, the arrangements for
quality monitoring process for the largest firms, financial regulation of public limited companies in the United
administered by a new organisation. This new body Kingdom.
would have expanded authority to monitor compliance Commenting on the Committee’s decision, Mr John McFall,
with SEC practice standards and to refer instances of MP, chairman of the Treasury Committee said:
non-compliance to the disciplinary board. Both new The impact of the collapse of Enron in the United States has been felt
entities would have a majority of public members and in many other places, including the United Kingdom. As an American
operate outside the profession’s existing self-regulatory company, Enron is subject to regulation by the relevant United States
authorities. Accounting and auditing practice there differs from that in
structure.
the United Kingdom. Nonetheless, some of the concerns that have
& In response to these proposals by the chairman of the been raised, such as how best to ensure the independence and
SEC, the members of the Public Oversight Board (POB) objectivity of auditors, clearly have a resonance in this jurisdiction.
announced their intention to terminate the Board’s The question has also been asked ± could a large and unpredicted
existence no later than March 31, 2002. Currently, the corporate failure happen in the United Kingdom? At the recent World
Economic Forum, Sir Howard Davies, chairman of the Financial
POB oversees the peer review, quality control inquiry,
Services Authority, said that the honest answer to this question is
and other activities of the SECPS and the standard ``yes’’. We have therefore decided to examine the arrangements for
setting efforts of the Auditing Standards Board. financial regulation of public limited companies, with a view to
& Reversing a longstanding position, the AICPA making recommendations as to how the regulatory regime might be
announced it will not oppose limits on providing certain strengthened, thus reducing the risks.

non-audit services to public company audit clients. There is the benefit of a number of the submissions having
& The AICPA and the 1,200 firms that are members of the been published on various Web sites. These all set out their
AICPA’s SEC Practice Section are implementing wares as if it is the prelude to some kind of shortlist or
improved audit standards for detecting fraud, as well as competitive tendering! The Institute of Chartered
new measures for deterring fraud such as expanded Accountants of England and Wales presents a
internal control procedures for management, boards, comprehensive but succinct report examining :
and audit committees. & financial reporting and the development and
& The AICPA has participated in interviews with every top enforcement of accounting standards;
national newspaper and dozens of local ones, and has & corporate governance, audit committees, non-executive
appeared on almost every national cable, broadcast directors, and internal control and the management of
and radio business program. It has provided State risk, including the role of internal audit;
Societies and individual AICPA members with & audit, its value, inspection and sanctions.

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The Association of Chartered Certified Accountants (ACCA) executives who mislead auditors. There are, however, two
argues for: areas of consensus. First, on the auditor-client relationship,
& a global set of principles-based financial reporting 63 per cent of business respondents, 62 per cent of student
standards and a global code of corporate governance; and part-qualified accountants and 54 per cent of
& solutions based on principles agreed and co-ordinated accountancy practitioners think that the Enron scandal
at global level; proves auditors are too involved in their clients. The second
& the objectives of financial reporting practice to be area of agreement concerns the Big Five global accounting
expanded to recognise the growing level of concern firms, which until recently counted Andersen as a member,
arising from the globalisation of business; that dominate the audit market. The second most effective
& the participants in capital markets ± both major preventive measure, supported by 37 per cent of all
corporations and institutional investors ± should respondents, was a ``clampdown on the Big Five cartel’’.
resource an externally administered levy which confers
no influence at the regulatory level; Key findings
& auditor independence should be revisited towards more Why did Enron fail and could it happen again?
transparency; Half of respondents think another Enron is inevitable and that
& regimes for monitoring practice in auditing, financial the UK is not immune. One in four auditors believes Enron
reporting and corporate governance should be was a business failure; only 8 per cent of accountants in
reviewed. business agrees. UK accountants, both in business and
The Chartered Institute of Public Finance and Accountancy practice, think auditors are too close to their clients.
has a significant number of members operating in or
involved with public limited companies. In commending the
UK public sector audit model worthy of further consideration,
``UK accountants, both in business and
it reports under the four headings of:
(1) Auditor independence ± most public sector bodies do
practice, think auditors are too close to
not appoint their own auditor.
(2) Audit quality and regulation ± ``low balling’’ is avoided,
their clients’’
and there are stringent quality reviews, generally
incorporating independence rather than peer review. How can Enron-style business collapses be prevented?
(3) Provision of non-audit services ± permission is required, Criminal penalties for executives who mislead auditors is
but it is more likely that experience gained from the audit seen as the most effective deterrent, but support split along
of one public sector organisation will benefit another, territorial lines: 88 per cent of auditors want it; 34 per cent of
rather than being within the one organisation. business respondents disagree. Of business respondents,
(4) Stakeholder reporting ± with the wider scope, greater 36 per cent want to ban firms from providing non-audit
disclosures are made. services to audit clients; 26 per cent of auditors disagree. A
total of 35 per cent of auditors strongly support audit firm
The UK accounting Web survey rotation. There was widespread support for separation of
This can justly claim to be one of the first meaningful inquiries internal and external audit functions. A significant minority
into the views of auditors, and the profession as a whole, was sceptical about accountancy’s self-regulation structure:
since the collapse of Enron. It reported in May 2002. UK 25 per cent felt the Accountancy Foundation could not
auditors admit that Enron could happen here. UK prevent another Enron; a similar proportion felt an externally
accountants believe that another Enron is inevitable, and that funded body would be a better solution.
the British system of professional regulation is not equipped
to prevent a similar business disaster in this country. The Lasting damage to accountancy’s reputation
accountancy profession itself has suffered visible damage as A total of 92 per cent of accountancy students expressed
a result of the US scandal and will feel the impact in the years discontent with the status quo. One in three accountancy
ahead: a third of all accountancy students believe Enron has students believes Enron has irreparably damaged the public
irreparably damaged the public perception of the profession. perception of the profession; one in seven accountancy
As a result, many predict that promising graduates will now trainees predicts promising graduates will now turn away
turn away from accountancy as a career. from accountancy as a career. A quarter of the respondents
The study, based on 294 responses, found that the identified themselves as auditors. Just over a third of them
profession was split over post-Enron measures: respondents strongly support audit firm rotation even though many
in business favour a total ban on accountancy firms leading professional bodies maintain that this restriction
providing audit and non-audit services; auditors would prefer could damage the effectiveness of audit. A complete ban on
to see the introduction of criminal penalties for business firms providing audit and non-audit services to the same

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client was seen as the most effective safeguard of audit direct contribution scheme invested in its own stock
independence, gaining 38 per cent support from business (compare Proctor and Gamble 92 per cnet, Anheuser-
respondents and 27 per cent of accountants in practice. Busch 83 per cent, Abbott Laboratories 82 per cent,
Rank and file accountants hold more radical views than their Pfizer 82 per cent, McDonald’s 74 per cent).
professional representatives and many are willing to make & Regulation needs to be disconnected from the
personal sacrifices in order to protect the long-term integrity accounting and auditing profession.
of their professional qualifications. The survey provides
Accounting and financial reporting
strong evidence that accountants doubt whether the & Principles-based ``substance over form’’ should become
profession’s own reform proposals will prevent another
the norm. However the proper role for a rules-based
Enron.
approach needs to be debated and determined.
& The USA as a major player needs to move more in line
The lessons ± recommendations
with the rest of the world, with an expedited convergence
The attempt here is to formulate a comprehensive set of
taking place.
issues that spring out of the Enron affair as it is currently
& Three levels of rigour of reporting need to be established
understood, rather than to enunciate everything that might
as opposed to the present two: large, high risk and/or
be said in a guide to good boardroom practice.
materiality entities; intermediate companies; small
Serving the public interest businesses.
& State National Audit Offices across the world should & With the complexities involved, as in derivatives and
follow the US example of investigating matters of public special purpose entities, the near incomprehensibility of
interest, and issuing reports. This means moving accounts to many of the stakeholders, and accountancy
beyond the narrow focus of the public sector. Such itself trying to keep up with the realities of e-commerce
extension has occurred already in the explicit rather than and the knowledge environment, steps need to be taken
implicit involvement in value-for-money studies in many to ensure adequate communication to users. Issues
jurisdictions. With the move of former state industries which impact on risk and value need to be made explicit.
into the private sector, state audit has sometimes been & Our more inclusive reporting model presupposes more
retained. Thus the UK Competition Commission qualitative data, including that on which board and
continues to ``audit’’ the former nationalised industries to company performance can be judged.
ensure they are operating in the public interest.
Auditing
& Legislation should specify clear and strict rights of
& ``True and fair’’ or ``fairly present’’ should mean not just
access to relevant agencies for such information as they
conformity with accounting principles, but convey
reasonably deem necessary, to avoid the need for them
adequately the overall situation.
to initiate legal action on a case-by-case basis. The
& Auditors should adopt a stakeholder orientation in
model of the UK Audit Commission should be adopted
addition to the current shareholder one.
whereby it can act in an independent but quasi-judicial & All the ramifications of audit independence need to be
fashion to decide any challenges to such powers. This
assessed and reported on, as does the detail of how the
will avoid delaying tactics, and minimise cost.
external audit has been carried out and the conclusions
& Criminal penalties, large fines and strict liability will apply
drawn. The onus should be on the auditor to indicate
to all those implicated in the shredding or concealment
how she/he has upheld independence in terms of the
of documentation.
& Jurisdictions, the vast majority, which have not legislated threats to it commonly encountered. A threats and risks
based model should be adopted.
to protect valid acts of whistleblowing should do so
& The rotation issue needs to be addressed in a balanced
forthwith (Vinten, 1994).
fashion, with half-way solutions, such as partial rotation
& A more inclusive stakeholder model (Vinten, 2001b)
of staff, explored. Joint auditing may also be considered
should be adopted, rather than the current minimalist
(in Canada large banks require two auditing firms).
model.
& The role of internal auditing should be highlighted,
& The UK model of the chartered secretary should be
possibly made mandatory at law, and its own
extended world-wide where not currently present.
& The law pertaining to fraud needs to be consolidated independence guaranteed, with protected external
reporting in the public interest for matters of concern.
and rationalised (Vinten, 1990).
& Pensions and employee savings plans require more Corporate governance
participant education and safeguards. This is particularly & Board members should be properly inducted, trained
the case where employees are locked into schemes in and developed.
which material amounts are invested in the employing & The pros and cons of different types of corporate
company or a limited range. Enron had 41 per cent of its governance need to be explored and best practice

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 disseminated. Thus the UK system has a balanced amelioration strategies are similarly multi-dimensional. There
mixture of types of director, whereas in the US system are unlikely to be simple solutions, but the present
the ``independents’’ predominate. The UK fragmentation of approaches needs to be avoided.
``independents’’ may therefore be closer to the action. Globalisation implies that there need to be global principles
& There needs to be more company sponsored practical (rather than standards) covering corporate governance (the
research on governance, rather than the black box it
1999 OECD ones providing a model), accounting, auditing
often is at present.
and independence. It is to be hoped that the measures
& National research agendas need to be formulated, with
adopted may minimise the risk of anything as large as Enron
central collection and dissemination of results.
& Although the Turnbull Report report emphasised risk, happening in the future, and that due confidence in the
one needs to put risk in perspective. It is not simply a capital markets will return.
``policing’’ matter, but equally weighing up the risk of References
missing opportunities. Risk is endemic in business and Lowenstein, R. (2001), When Genius Failed, Fourth Estate, London.
presents opportunity as well as the possibility of sub- McLean, B. (2001), ``Why Enron went bust’’, Fortune, 24 December,
optimal performance or even disaster. pp. 52-8.
& Business ethics is a crucial ingredient, and Tidwell, G. (1993), Anatomy of a Fraud. Inside the Finances of the PTL
consideration should be given to appointing a chief
Ministries, John Wiley, Chichester and New York, NY.
ethics officer, an ombudsman, or the Registrar function
Vinten, G. (1990), ``Ethics, law and computer hacking’’, Managerial
as in the John Lewis partnership.
Auditing Journal, Vol. 5 No. 4, pp. 5-11.
& Equally crucial is what has been known as the ``tone at
Vinten, G, (1991), ``The BCCI debacle marks watershed case in British
the top’’. A board subcommittee should consider this, or
and international bank regulation’’, International Banking
the audit committee with widened remit take this issue
Regulator, Vol. 3 No. 29, 9 August, p. 8.
on board.
& Institutional investors and organised shareholder/ Vinten, G. (1992), ``Internal audit after Maxwell and BCCI: public
stakeholder groups should be permitted a voice in the responsibility versus loyalty to the organisation’’, Managerial
boardroom. Auditing Journal, Vol. 7 No. 4, pp. 3-5.
& A diversity of non-executive directors, outside the ``old Vinten, G. (1993), ``The Maxwell interview’’, Managerial Auditing Journal,
boys’’ network, and with true independence should be Vol. 8 No. 7, pp. 22-4.
recruited. Vinten, G. (Ed.) (1994), Whistleblowing ± Subversion or Corporate
Citizenship?, Editor and contributor, Sage, London.
Education
Vinten, G. (1997), ``Corporate governance in the charity’’, Corporate
& Schools should include corporate governance as part of
Governance. An International Review, Vol. 5 No. 1, pp. 24-8.
their citizenship education.
& Higher education should teach elements of business Vinten, G. (2001a), ``Corporate governance and the sons of Cadbury’’,

ethics and corporate governance as part of all courses. Corporate Governance, Vol. 1 No. 4, pp. 4-8.
& Business courses should place more emphasis upon Vinten, G. (2001b), ``Shareholder versus stakeholder ± is there a
risk and fraud, rather than pretending that fraud never governance dilemma?’’, Corporate Governance. An International
takes place. Review, Vol. 9 No. 1, pp. 36-47.
Vinten, G. and Greening, M. (2001), ``Internal control and fraud in the
Conclusion smaller building society’’, Journal of Financial Crime, Vol. 8 No. 3,
The issues raised are multi-faceted, and the public and pp. 201-6.
business interest will only be protected if solutions and Wall Street Journal (2002), 16 May.

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