Blog 8.

Does fraud come hand in hand with power?

The final contemporary finance issue that we were taught in the international finance and responsible finance management module was financial ethics. In this blog I am going to investigate this financial issue and relate what I have learnt to some real-life instances of such ethical issues such as fraud.

“Fraud encompasses an array of irregularities and illegal acts characterized by international deception. It can be perpetrated for the benefit of or to the detriment of the organization and by persons outside as well as inside the organisation” (O'Gara, 2004).

A typical organization loses about 5 percent of its revenue to fraud each year, according to a 2012 report by the Association of Certified Denver Business Journal Strategies: How to detect and prevent workplace fraud (Albrecht, 1982).

Research has shown that financial enticements within an organisation can tempt individuals to commit ethically questionable and fraudulent acts. There are many examples of fraudulent acts taking place in organisations, one of the most famous being the energy company Enron. “Management fraud in the United States has increased despite nearly three decades of sustained efforts to reform corporate governance, to use effective compensation systems to better align managers and shareholders’ interests, and to institutionalize codes of conduct that improve managers’ ethical performance” (R.L Rasheed, 2005).

A classic example of this may be Enron CFO Andrew Fastow’s use of Special Purpose Entities (SPE’s) to create off-balance sheet financing vehicles to hide Enron’s debt mountain from investors. When Enron Corporation went bankrupt in December 2001 and all the revelations had been discovered about the company’s insider deals and faulty accounting, it was the staff that felt the most impact. The employees who had been encouraged to place a majority of their retirement savings into Enron’s stock then went on to lose some $1.3 billion in 401 accounts (Kroger, 2005). Show in figure one at Enron's peak, its shares were worth $90.75; when the firm declared bankruptcy on December 2, 2001, they were trading at $0.26 (Segal, 2019). Many people to this day still wonder how one of Americas largest companies disintegrated within such a short period of time, this all boiled down to the skills of the leadership within the organisation to be able to fake accounting books. They were able to do this by using special purpose vehicles (SPVs), or special purposes entities (SPEs), to hide its huge amounts of debt and toxic assets from investors and creditors.

Skilling, 64, was convicted in 2006 of fraud and conspiracy in connection with the collapse of the energy company, where aggressive mark-to-market accounting inflated profits and off-balance sheet entities concealed debts. His original sentence of 24 years for 18 counts was cut to 14 years in 2013 in a deal with the US Department of Justice; he appears to have been released after serving less than 12 years on the basis of good behaviour. (Armstrong, 2018)
References

Figure 1 - (Begin To Invest , 2017).

CEO Jeffrey Skilling managed to hide the financial losses that Enron were facing by using an accounting method of mark to market. It has been stated that this method can work well when trading securities, in contrast, opponents claim that mark-to-market accounting leads to excessive and artificial volatility. As a consequence, the value of the balance sheets of financial institutions would be driven by short-term fluctuations of the market that do not reflect the value of the fundamentals and the value at maturity of assets and liabilities (Allen, 2008). For example, Enron would build an assets such as a factory and they would nearly immediately put the projected profits into their accounts, even if the company had not opened or started running the factory therefore making no profit. This led to the fact that Enron seemed more profitable than it was, leading to investors not worrying about their money being unsafe invested in this company.

There are two major factors influencing the level of fraud occurs within an organisation. These are the chance of being caught and the repercussions that will occur if caught for example time spent in incarceration. An individual must consider the two factors that come as an effect of being involved in fraud. The amount of power that an organisation has or in some cases the amount of money they can provide, determines how the individual who has been involved in fraud is prosecuted.

In conclusions I do believe that most companies are involved in some cases of fraud, whether they be large or small cases. However, in the case of Enron because the effects of fraud such as their accounts being manipulated had such a monumental disruption in the company, thus leading to them declaring bankruptcy. It has been stated that legal professional codes have been evolved in an attempt to protect organisation from being involved or effected by corporate fraud, however some believe that management fraud has become so sophisticated that people such as auditors are struggling to discover within organisations.

References- 

Albrecht, S. &. (1982). How to detect and prevent business fraud. . 1.

Allen, F. (2008). Mark-to-market accounting and liquidity pricing. Economic Consequences of Alternative Accounting Standards and Regulation, 358-378.

Armstrong, R. (2018, September 7). As Skilling leaves prison, Enron’s old businesses are thriving. Retrieved from Financial Times: https://www.ft.com/content/ed75c0c4-ad57-11e8-89a1-e5de165fa619

Begin To Invest . (2017, December 14). A Brief History of Enron – With Enron Stock Chart. Retrieved from Begin To Invest : https://www.begintoinvest.com/enron-stock-chart/

Kroger, J. R. (2005). Enron, Fraud, and Securities Reform: An Enron Prosecutor's Perspective. Colorado: University of Colorado.

O'Gara, J. (2004). Corporate Fraud: Case Studies in Detection and Prevention. Corporate Fraud, 1.

R.L Rasheed, S. Z. (2005). The antecedents and consequences of top management fraud. Journal Of Management, 804.

Segal, T. (2019, May 29). Enron Scandal: The Fall of a Wall Street Darling. Retrieved from investopedia: https://www.investopedia.com/updates/enron-scandal-s