Ethics Matrix: Sarbanes Oxley Act and Enron Scandal

Regulatory Requirements Enron’s Scandal Factors
Members of the Boards of Directors
  • it is prohibited to extend loans to subsidiary companies (Neblett, 2003);
  • auditing financial statements should be performed by the audit committee under a company’s board of directors (or by the board of directors itself);
  • audit committee members of the board of directors should not be dependent of management.
  • falsification of financial statements;
  • the first target company named Cactus Funds issued two types of promissory notes: class A with a fixed interest and class B with a floating interest. The second subsidiary company received a loan from a consortium of banks and bought Cactus Funds (Ghosh, 2002);
  • market-to-market accounting and structured finance were two components of Enron’s falsification;
  • Enron activity was de facto conditioned merely indirectly since losses of investors turned out in the company’s shares;
  • In order to conduct falsification, CEOs should have violated the provision on the conflict of interests of Enron’s code of ethics, while the board of directors allowed it (Petrick & Scherer, 2003).
External Auditors
  • an audit committee has the right to involve independent experts to ensure its activities;
  • auditing companies are prohibited to provide consulting services to a client simultaneously with audit services for financial statements (with rare exceptions) (Neblett, 2003);
  • conclusion on the effectiveness of the internal control system became the standard part of the audit report;
  • a mandatory internal rotation of auditors at least every five years (in other words, no partner of an audit firm has the right to work with one client on audit issues for more than five years consecutively).
  • Enron created three thousand legal entities, including 800 offshore companies. The most famous of these offshore companies are those named after the heroes of the Star Wars (Li, 2010);
  • American regulations regarding accounting were arranged so that Enron should not have consolidated offshore companies’ accounts into its own until co-investors were present. In order to make the number of external co-investors smaller, Fastow, one of Enron’s directors, or his wife acted as external auditors (Ghosh, 2002);
  • Arthur Andersen, an audit company, working with Enron, was incompetent or deliberately ignored the fact that financial data of the latter was not appropriate as it did not want to lose the lucrative stream of consulting orders and other work provided by Enron (Peavler, 2017).
Enron’s Managers
  • managers are required to create an effective internal control system that will ensure that investors are provided with correct financial statements;
  • a company’s loans to its top managers and any business relations between the company and its managers are prohibited (a manager cannot be the owner of a business connected with business relations with the company, in which this top manager is working);
  • manipulations of managers with reporting and misleading investors to the true state of affairs in the company became criminal offense with significant terms of imprisonment.
  • managers systematically overestimated the results of the company’s activities so that their shares would worth more, and options could be sold at a higher price;
  • Enron’s employees at different levels were convicted of price collusion in California (Ghosh, 2002);
  • some top managers were also accused of having loans directly from the company as well as their extensions.

Table 1. Direct correlations regulatory requirements from the Sarbanes-Oxley Act and factors associated with Enron scandal.

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Preventing Incidents Similar to that of Enron

Enron’s financial falsification that involved the board of directors, managers, and external auditors is a lesson for the entire business community. After the scandal with Enron, business schools began to discuss ethics as an integral part of any company. The more transparent a firm, the better the market understands what happens with it. In this regard, the focus on corporate culture, the code of ethics, some non-material incentives, and reputation seem to be missing in the Sarbanes-Oxley Act. Accordingly, the tools of society that measure and record the above elements are essential and may include business journalists, analysts, rating agencies, etc. (Markham, 2015). The regulation regarding corporate culture would be a valuable advantage to enhance the given act.

There have been several changes with auditors since audit and consulting were divided, and auditors’ rotation was introduced. Suggesting that auditors target control at the level of the entire organization, especially in large accounts, serious processes and procedures where violations can lead to significant losses should be the object of the mentioned act. The advantage of the internal audit before any other services of a company is its independence ensured by the structure of subordination and specific relationships with management as well as a unique knowledge base and experience accumulated during the years of audit (Markham, 2015). The above advantages would allow internal auditors and employees of a company to act solely in its interests and, at the same time, remain formally and actually independent in assessments and recommendations. By viewing a company as a single organism and conducting work on risk assessment, specification of weaknesses and strengths, and the preparation of relevant recommendations, internal audit seems to ensure continuous effectiveness.


Ghosh, A. (2002). Enron Corporation: From boom to bust-a case study. International Academy for Case Studies: Proceedings, 9(2), 1-6.

Li, Y. (2010). The case analysis of the scandal of Enron. International Journal of Business and Management, 5(10), 37-41.

Markham, J. W. (2015). A financial history of modern US corporate scandals: From Enron to reform. New York, NY: Routledge.

Neblett, A. C. (2003). Overview of Sarbanes-Oxley Compliance. Commercial Lending Review, 18(6), 42.

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Peavler, R. (2017). The Enron scandal that prompted the Sarbanes-Oxley Act. Web.

Petrick, J. A., & Scherer, R. F. (2003). The Enron scandal and the neglect of management integrity capacity. American Journal of Business, 18(1), 37-50.

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