Economic Scandals: The Enron Corp and Bernard Madoff

Introduction 

Even though the two mega economic scandals that rocked the United States economy took place in the early 1990s, they all involved concealment of the truth in one way or the other. For Enron Corporation, the largest supplier of natural gas, the executives misled both the board members and the firm contracted to audit its financials. The executives took advantage of loopholes, poor financial reporting, and special purpose entities to commit their fraudulent acts. After the approval of the legislation that liberalized the sale of natural gas by Congress, Enron sold energy at higher prices, thus, increasing its revenue significantly. The firm was able to design a trading website that made it possible for the company to manage better its trading business (Carberry, & Zajac, 2017). Furthermore, the company diversified in broadband services, gas pipelines, water factories, electricity factories, and pulp and paper factories located at various locations worldwide. Hence, the company’s financial statements became complicated and confusing to analysts and shareholders thus creating a loophole for fraud. 

On the other hand, Bernard Madoff led one of the largest Ponzi schemes in the history of the United States and misled the government and the public with false information. Madoff initiated his firm as a penny stock trader and through family and friends the company grew in leaps and bounds. These were the times when the firm used the National Quotation Bureau’s Pink Sheets to quote bids (Mandell, 2015). Through the integration of computer information technology, Madoff was not only able to compete effectively with firms that were members of the New York Stock Exchange but also assisted in the development of the National Association of Securities Dealers Automated Quotations (NASDAQ). Investigators were of the opinion that the fraud begun in the 70’s the fact that Madoff refutes claiming he started it in the ’90s. 

Reason for the Downfall of Enron Corporation 

The executives knew perfectly well that the growth rate of the 90s was not sustainable yet due to the constant rewards, they strived to avoid punishment from credit agencies. This self-inflicted pressure on the executives led to the team adopting shortcuts that drove the company to accrue massive debts without proper plans on how they were going to pay back the loans. Employees that were discouraged from questioning the operations of the firm and those who were sluggish or inquisitive were axed out (Carberry, & Zajac, 2017). The pressure created an environment where the executives sorted illegal deals and hid their devious acts through accounting fraud. 

Secondly, the organization did not rely on a consistent growth strategy but was dependent on the accountant’s take on the reported earnings. Thus the organization formulated a culture where personal and corporate wealth could be gained through inaccurate accounting and dubious and shoddy deals (Giannetti, & Wang, 2016). Furthermore, the accounting records were considered as a cover-up scheme for those projects that were not making enough profits. 

Madoff’s Alleged Strategy 

Madoff’s investment strategy comprised of taking options contracts on blue-chip stocks that he had purchased and then positioning them with the strike price. This strategy led to the improvement of the rate of return and also endorsed the ascending trend of the portfolio stock to the strike price. The profits from this simple strategy were provided modestly and steadily to clients who were considered exclusive or privileged. He went ahead and marketed the investment strategy as extremely complicated for outsiders to comprehend (Mandell, 2015). Thus successively managed to keep his company’s operations covertly and financial statements close to his chest. In his investment strategy, Madoff targeted Jews and because of that, avoided to direct contact with investors. 

Sarbanes-Oxley Act 

This federal Act of 2002 was instituted for comprehensive monitoring of public companies through auditing their financial principles. Congress designed the legislation to safeguard the public, employees, and shareholders against fraudulent financial methods and accounting blunders. Furthermore, SOX as the legislation is commonly referred to aims at improving the dependability of public companies’ mode of reporting their financial positions as well as reinstate investor assurance following the increase in corporate crime ( Stohr, 2014) . The law also was established to include not-for-profit organizations and private companies in the regulation of reporting financial positions. In order to make the legislation efficient, penalties were established within the law to be meted to those that were non-compliant with its conditions. 

Section 101 

The SOX was sponsored by Senator Paul Sarbanes and United States Representative Michael Oxley. The Securities and Exchange Commission (SEC) was mandated to oversee its application. From the eleven sections in the SOX, three sections are of critical importance for review in relation to concealment of evidence. These are section 101, 302, and 404. Section 101 of the Sarbanes-Oxley Act empowers the Public Company Accounting Oversight Board, which was created under the same Act, to register all accounting firms (Hail, Tahoun, & Wang, 2018). Furthermore, the Act allowed the Board to monitor all auditing firms and set standards that will govern the operation of the said firms. Above all, PCAOB was given the mandate to enforce the provisions of the SOX-related to accounting firms. 

Section 302 

Section 302 of the SOX stipulated new rules for publicly traded companies. In these rules, the CEO and CFO are obliged to endorse all financial statements from their companies. Penalties accompany those who will not comply ( Stohr, 2014) . This section prevents CEOs and CFOs from distancing themselves from the accounting departments when errors arise. Hence, they must review the financial documents and report if there is any misrepresentation that has come under their attention. As much as most companies cite reviewing of the internal controls as an expensive exercise, section 302, emphasizes that the CEO and CFO must evaluate the effectiveness of the internal auditing controls ( Stohr, 2014) . After the evaluation, they must submit a report to that effect. The aim of this evaluation is to prevent errors arising from within the organization be it by chance or intentional. 

Section 404 

Section 404 of the Act pertains to “Compliance with Internal Auditing Controls” and asserts that publicly traded companies must display to the public their guidelines for reporting financial positions and details relating to their internal controls. Other rules within the SOX require auditing firms that have publicly traded firms to instigate quality control measures. Moreover, the firm must have a second partner who will review the financial audits before approving them. More so, the leading partner together with his reviewing partner must rotate out after every five years. The rotation prevents any of the partners getting affectionate with the client (Hail, Tahoun, & Wang, 2018). The accounting firm must also audit the client’s internal control and issue a report on its effectiveness. The audit on the client’s internal controls provide an extra source of revenue to the accounting firm, but the SOX prevents these companies from offering non-audit services such as consultancy or valuation to their audit clients. 

Concealment of Evidence by Enron and Bernard Madoff 

For the information that was destroyed by the Securities and Exchange Commission, no evidence was retrieved. This act came as a surprise as most of the companies’ under investigation had their shreds of evidence destroyed by the same agency that was meant to investigate them. The evidence could not be retrieved from the shredded files since the SEC had denied carrying out such activity until later on when it was discovered that it was part of their culture to shred the files. So far, for the two corporate frauds, they were successful in concealing information, and nothing was retrieved. In Madoff’s case, they forged documents ahead, and in a situation where they were caught off-guard, they quickly printed the cooked data and to prevent the papers being discovered to being recently printed, they were put in a fridge and then tossed to make them look old ( Larson, 2013) . It is due to the successful concealment of financial information that the SOX was adopted. The legislation made it an offense to hide any evidence that could be damaging to a company. The law was once used on a fisherman caught fishing underlings, the act that the fisherman concealed through instructing his worker to throw back into the water and replace them with larger fish. The fisherman was jailed for thirty days. 

Admissions for the Crimes Committed 

Madoff Investment 

Bernard Madoff pleaded guilty to all eleven counts of his federal crimes and was convicted for 150 years in jail. Madoff did not implicate anybody from his company, Madoff Investment, even though among his staff included his brother, brother’s daughter, and his two sons ( Larson, 2013) . His brother Peter was arrested and sentenced to ten years while his son Mark Madoff committed suicide after the arrest of his father. Paul Konigsberg who practiced as an accountant in New York was also connected with the scandal and pleaded guilty to fraud charges and is facing up to 30 years in jail. Konigsberg, a close ally to Madoff, was associated with preparing tax returns for the Madoff Family Foundation (Mandell, 2015). Furthermore, Konigsberg’s accounting company, Konigsberg Wolf and Company, was enlisted as a reputable auditing firm and received a monthly $30,000 for funneling client checks for Madoff’s personal use and advice on the company’s operations. In total, 15 people have been jailed in connection with the Madoff Investment scandal with a majority of them taking a plea of guilty. 

Eron Corporation 

Unlike Madoff, Kenneth Lee Lay did not confess to his crimes and was tried and found guilty, but, died of heart attack before he was convicted. His Chief Operating Officer, Jeffry Skilling like his boss, did not confess to his crimes, but, was found guilty on 19 counts of wire fraud and securities fraud (Giannetti, & Wang, 2016). Skilling was sentenced to a prison term of twenty-four years with a fine of $180 million and an additional $630 million payable to the government. In total sixteen people confessed and took the plea of guilt for the various crimes associated with the company, five others were found guilty through trial. Arthur Andersen is another giant that Eron Corp dragged down to bankruptcy with. Arthur Andersen LLP was the auditing firm that was contracted by Eron Corporation (Carberry, & Zajac, 2017). The firm was found guilty of the federal crime and was asked to voluntarily submit its licenses to practice as Certified Public Accountants within the US. The Supreme Court reversed Arthur Andersen's sentence due to flaws in the instructions given to the jury by the trial judge. The company later disassociated the Accountancy practice from the outsourcing and consultancy practice and later after splitting from Andersen Worldwide renamed itself and resumed operations. 

Nature of Fraudulence 

For the case of Madoff Investment, the crime was perpetrated as a collaborative crime, but Madoff decided to take the full blame. It was a family run business with his brother, Peter Madoff acting as the company’s Senior Managing Director and Chief Compliance Officer hence, nothing could have escaped the top management ( Larson, 2013) . Moreover, the Rules and Compliance Officer and the company’s Attorney was Peter’s daughter, Shana Madoff. Madoff’s two sons were also part of the management; hence, they must have assisted Bernard in the clandestine operations of the company (Mandell, 2015). Alone, Bernard Madoff could not pull the massive scam since it would have been too involving and he would not have time to do anything else apart from running the firm. 

Eron Corporation’s scandal was run as co-conspirators where Kenneth Lay Lee and his COO, Jeffry Skilling conspired and kept it as a well-guarded secret sacking any inquisitive staff. The company was operated through threats and positive motivation to the staff who were working tirelessly to see the company grow (Carberry, & Zajac, 2017). Thus, the company operated by way of positive and negative motivation. The management style was adopted from top to down. 

Recovery of Information from Destroyed Documents 

No information could be retrieved from the destroyed evidence as these two firms were very clandestine in their operation ( Larson, 2013) . Madoff is believed to have started his scandal way back in the 70s, but there is no evidence to support these claims. Furthermore, the figures that were attached or believed to have been scammed are approximated amounts as there is no evidence to show any transactions. The only evidence present is the forged financial reports and the evidence of non – performing stocks that were recorded as losses. Similarly, very few arrests were made due to lack of circumstantial evidence to prosecute workers from the two firms. 

Conclusion 

Eron Corporation and Madoff Investment are not the only leading US companies that misled the public for selfish benefits; other companies include the Charles Ponzi that led to a loss of around USD$20 million, Worldcom with an estimated fraud cost of USD$100 billion, and Stratton Oakmont an estimated loss of USD$200 million. The perpetrators of the above schemes were sentenced to 5 years, 25 years, and 22 months imprisonment respectively. Other frauds include James Paul Lewis Jr.’s USD$311 million scandals that led to a 30 years’ imprisonment and restitution of USD$156 million, Bre-X Minerals that involved loss of USD$3 billion and many other scandals. Most of these investment companies failed due to increasing greed or whistleblowers action against the firms. The SOX was established to safeguard the public, employees, and shareholders. Some of the benefits of the legislation include a reduction in a number of investment scandals, improved financial practices, and increased investor confidence. 

References 

Carberry, E., & Zajac, E. (2017, January). How US Corporations Changed Executive Compensation after Enron: Substance and Symbol. In  Academy of Management Proceedings  (Vol. 2017, No. 1, p. 15134). Briarcliff Manor, NY 10510: Academy of Management. 

Giannetti, M., & Wang, T. Y. (2016). Corporate scandals and household stock market participation.  The Journal of Finance ,  71 (6), 2591-2636. 

Hail, L., Tahoun, A., & Wang, C. (2018). Corporate scandals and regulation.  Journal of Accounting Research ,  56 (2), 617-671. 

Larson, Erik , (2013). Ex-Madoff Employee Helped Conceal Fraud Prosecutor Says. Bloomberg 

Mandell, H. (2015). Imagine What the Gentiles Must Think: Editors of the US Jewish Press Reflect on Covering the Bernard Madoff Scandal. In  Journalism, Audiences and Diaspora  (pp. 17-33). Palgrave Macmillan, London. 

Stohr, Greg,(2014). Enron Meets Red Grouper as High Court Mulls Evidence Case. Bloomberg