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The Panic Of 2001 And Corporate Transparency Accountability And Trust A Case Solution
In the year 2001, many accounting scandals and frauds caught the public eye. These accounting and auditing scandals began by the collapse of Enron followed by the companies such as WorldCom, Xerox and Tyco leading to large scale unemployment and loss of valuable capital of these valuable companies. Enron at that time was listed at the 7th place among the Fortune 500 companies. The Act of Sarbanes Oxley signed into law in 2002 was the first accounting law passed by the US after SEC act in 1934 (Sarbanes-Oxley Act of 2002, 2002). The failure of Enron led to new laws passed by the subsequent accounting failures in the companies also led to serious outburst about the application of financial reporting, corporate governance, and internal controls. Accounting and audit companies, structure of corporate governance, and lack of regulations and lack of close monitoring were the a few of the root causes of the problem ("Minutes of the 12th Meeting of the International Auditing and Assurance Standards Board", 2004). More importantly, accounting and auditing firms’ regulations and their corporate practices came under the radar across the world, even in those areas which did not suffer serious scandals. However, the shift was most prominent in the United States of America, where the passing of Sarbanes-Oxley Act created new regulations for the audits of publicly listed companies, but there were changes and stringency in the other countries as well (Kaplan, 2019). Followed by the Enron and WorldCom downfall and crash and other accounting scandals in the public companies, the act of Sarbanes-Oxley Act of 2002 was passed by the Congress with the whole present house in the favor of passing the bill and then signed by the President George W. Bush on July 30, 2002 aimed at establishing and protecting shareholder value and market confidence by improving the quality of accounting and financial reporting.
Following questions are answered in this case study solution
Development of the content: Panic
Case Analysis for The Panic Of 2001 And Corporate Transparency Accountability And Trust A
2. Development of the content: Panic
Most of the world is very aware about the accounting scandal of Enron that took place due to the misstatements by the management. International Accounting and Auditing Standard Board was working on revising its various accounting and auditing standards when the Enron accounting scandal happened. The changes in these standards took into account the recent accounting crimes that took place (ACCA, for exams in 2010, 2009). They overstated 1998 profits by 113 million dollars in 1998, 1999 profits were high as well by $250 million and this figure was overstated by $132 million in the year 2000 which the company management did through off-balance sheet deals (Segal, 2020). Enron management used several accounting tactics to make its market picture more attractive. Such misstatements made up almost 96 percent of Enron are reported $ 979 million net income for 2000 (Batson, 2000). The Enron’s president and COO from 1996 to 2001 explained the internal controls of his company in the following words “Enron has one of the best control systems in the world with hundreds of lawyers and accountants aware of the financial risks associated with the firm”. When rating agencies and external experts asked about the company’s risk management abilities, he pointed to Enron’s RAC department ("At Enron, "The Environment Was Ripe for Abuse"", 2002). Skilling knew that market investors and observers wanted to have strong internal controls and management, so he made Risk Assessment and Control Department an element of company’s presentation to stock market analysts, shareholders and credit rating agencies. Skilling said in a financial journal, “Two things at Enron are not subject to negotiation: the firm’s policy to evaluate itself and the company wide risk management program.” (McLean & Elkind, 2013) In the year 2002, three former senior executive managers (Chief Executive Officer Dennis Kozlowski, Mark Swartz and the chief legal officer Mark Belnich) were sued by the Security and Exchange Commission. Kozlowski and Swartz issued hundreds of millions of dollars in secret low interest and interest free loans from Tyco which they used for personal expenditure. Later through Tyco, they forgave the debt they had issued to themselves and removed it from the books without disclosing it in the financial statements and to the shareholders as required by the law (SEC, 2002). Kozlowski and Swartz made various related party transactions and gave themselves luxuries through the company money- without disclosing to the shareholders about the debt transaction and company assets they used (US District Court, 2002). When SEC found out about it, they sued the PWC engagement partner for Tyco from 1997 to 2001 (Former Tyco Auditor Permanently Barred from Practicing before the Commission, 2003). The SEC ruled that Scalzo was equally involved in looting Tyco and received various information and facts about the lack of faithfulness of Tyco’s executive management, but he did not comply with the audit steps that he was required to implement during the audit. These facts were solid and material enough to blame Scalzo and to perform additional audit procedures, including further audits of various controls such as related party transactions, senior director’s benefits, salary of the senior management. However, he unfaithfully relucted to perform those audit procedures (SEC 2003a).
After Tyco, a $9 billion fraud was discovered at WorldCom. It was not late that Sarbanes Oxley Act was passed. This accounting misstatement led to the largest bankruptcy in the US history and resulted in the largest ever fine done by the SEC of $500 million (Larsen et al., 2003). The company recognized $9 billion worth of telephone line lease and other expenditures as capital investments in the assets. This will make room to recognize these figures as expenditure over the next 40 years. This fraud was aimed at manipulating 4 financial measures: operating income, operational cash flows, total assets and retained earnings. As a result, WorldCom’s stock price soared over time and those exercising low cost stock option became rich. The company’s CEO Bernard Ebbers made $35 million in June 1999, CEO Scott D. Sullivan made $1.8 million in August 2000, and audit partner Max Bobbitt got $18 million in 1999 (Romeo et al., 2002).
The famous merger of AOL and time warner on January 10, 2000 was another accounting scandal that came to light. Both companies issued a press release declaring merger to form the world’s 1st Internet-Age Media and Communications Company. It was the biggest merger to date and proved to be the most notorious one. Nearly $200 billion worth of market value was lost after the deal was announced. US Department of Justice started an interrogation regarding the company’s accounts, after which AOL Time warner probed an internal investigation to find out material transactions in revenues amounting to $49 million had been “inappropriately recognized.” The misstatements were small as compared to the total revenues made by the firm but they were material enough to hurt shareholder’s and investor’s confidence in the current management.
3. Strategic Alternative
The dot-com crash and the altogether accounting scandal’s disclosing leading to bankruptcies staggered the market to an economic crisis. Corporate governance failure, internal controls as directed by COSO, auditing failures on the part of audit firms such as Artur Andersen and PWC and their failures to implement independent and thorough audits, failure of security analysts, rating agencies and large banks. Investors put the blame on analysts and bankers for incomplete due diligence motives in investing, non-compliant stock market practices, growth in the number of companies listed on the stock exchange made it impossible to keep a close eye on the firms. The series of accounting scandals seemed linked to the recently occurred dot-com bubble. US society showed anger at the events and wanted federal government to intervene to save the US economy and corporate sector to protect the investor money. An article published on The Economist wrote:
The Enron scandal expresses doubts that America has about the US President who quoted: He is very close to the Big Businesses and the energy sector of the country and what he is concerned about is not ordinary. The visible sets of amendments post Enron’s collapse are campaign-finance laws governing the corporate governance and the audit profession ("Bush and Enron's collapse", 2002).
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