Lecture Notes: Enron and the Sarbanes-Oxley Act

Enron Collapse

• Enron was the 7th largest company in the US.
• Collapsed due to accounting fraud.
• Management engaged in:
  • Cooking the books.
  • Concealing business problems.
  • Defrauding investors.
• Collapse resulted in:
  • Loss of $2 billion in retirement savings.
  • Tens of thousands of job losses.

Subsequent Accounting Scandals

• Followed by scandals at WorldCom and other companies.

Sarbanes-Oxley Act

• Enacted 20 years ago in July in response to the Enron scandal.
• Aim: Restore trust in the financial system.

Key Components of Sarbanes-Oxley

1. Auditing Quality Enhancements

   • Improved auditing standards.
   • Professional associations initially set auditing standards, creating conflicts.
   • Establishment of the Public Company Accounting Oversight Board (PCAOB).
     • Independently funded.
     • Under SEC oversight.
   • Financial Accounting Standards Board received independent secure funding.

2. Auditor Independence

   • Enron's auditors had consulting ties, creating conflicts.
   • Sarbanes-Oxley created barriers between auditing and consulting services.

3. Corporate Governance Improvements

   • Addressed misaligned incentives between executives, boards, auditors, accountants, and audit committees with investors.

Impact and Lessons

• Improved quality of public company audits over 20 years.
• Important lessons:
  • Maintain robust, independent standard-setting and enforcement bodies.
  • Separate auditing services from consulting services to avoid conflicts.
  • Ensure companies are accountable for their financial reporting.
• Enhanced trust benefits both investors and issuers.