Negligence Risk Management… ENRON & Arthur Andersen

When we talk about the importance of Risk Management, one of the most famous cases in history in the sector of accounting and auditing, that must not ignore, is what happened with the well-known Enron Corporation and the prestigious Firm Arthur Andersen LLP, and their tragic ends in 2002. What I describe below is not the failure of a project, is the collapse of two companies that made a negligent risk management process, which transformed against them, creating a situation never seen before in the industry.

For this we have to take a trip back in time to the beginning of this century, mention the actors present in this story, and remember what were the factors that have led so precipitous drop, professionals of this segment will never forget the business, which in turn led to a risk management framework much more rigorous.

The Protagonists

Arthur Andersen – The Firm

The firm Arthur Andersen was one of the five largest firms that provide accounting services, audit and tax issues on the early years of this century, they had operations around the world, and was headquartered in Chicago, USA.  In the opinion who write this post who had experience in the aforementioned sector, this company from outside enjoys a fantastic prestige among its stakeholders. The Firm’s philosophy is based on high standards of Quality and Risk Management where every step is done with strong care and also attached to a scheme of work used globally, this basically means that all actions are performed had a previous scheme for execution.

ENRON Corporation – The Company

The fastest growing energy company in the 90s in the United States, a fantastic example of fast-growing in the US, the key to its exponential growth process is the birth of the company, a merge of Houston Natural Gas and InterNorth in 1985, both companies were located in Houston Texas. The operations of the company were significant and with high levels of profitability, enabling it to quickly enter a golden circle among the largest U.S. energy companies, so they decide to enter the world of the stock market which eventually their shares reaches record figures of US. $90.56, if we take into account the companies for that specific time, but what would follow would be one of the biggest collapses of American Energy Company to remember the date.

How did we get here?

For those not familiar with the world of large audit and accounting firms, it is essential to understand the functioning of these entities, I would initially indicate that the information described below is based on previous experiences I have had as a professional in this business sector, also some of these details may not be accurate considering the limitations of time where we were and the time in which these events occurred.

Arthur Andersen was a professional services company where basically the primary service is provides assistance to companies in the audit development processes as independent reviewers, in order to express an opinion on the financial statements of the company. This can be seen like a rigorous examination, of the accounts of Financial Statements of the organization and its subsidiaries in accordance with accounting regulations present to date, specifically those known U.S. GAAP – United States – General Accepted Accounting Principles, these standards form the backbone of management risk of companies engaged in this business.

The revisions of the financial statements of Enron at the beginning of the business relationship does not show anything wrong, in fact, its shows that the company obtained significant gains year after year without irregularities, they were a rocket at that time, and this was transformed into a steady improvement in the price of the shares in the US Stock Exchange.  The result was that within no more than 10 years the company had grown around the world, the results were so strong that every day more people invest money in the shares of the company; of course they had the support of prestigious firm, a perfect business marriage. 

During 2001, the price of Enron shares began to decline significantly, for instance at the end loss its entire value, which in turn began to hear rumors of the legality of the financial statements of the company.  Meanwhile the Security Exchange Commission (SEC) regulator of U.S. public companies began to establish a special interest in this company, and through rigorous reviews, found widespread irregularities in the financial statements of the company, these had “not been seen” by the Firm, however after a while they saw how some of the top partners of the defunct Firm breached their own review protocol of the financial statements, also violated its internal ethics codes, the key element of the risk management of these businesses.

The Consequences

Once the fraud was found it, the irreversible consequences hits both entities with strong force, ENRON had to adhere to Chapter 7 of the law of the U.S. Federal Reserve, that means the company declare into Bankruptcy, and seeks the protection of the American Government. They shows fake numbers of its operations in the financial statements, taking advantage of their results in their times more buoyant, achieving high profits of the investment products that were sell to American citizens through the sale of shares.

Arthur Andersen immediately had a devastating effect.  Without precedent they loss the prestige achieved it by 90 years of operations around the world. In fact some of the most important partners of the firm were prosecuted and sentenced to prison for committing a federal crime (complicity scam). The company was forced to close its doors and thousands of people lost their jobs, some in other countries to date was unknown dimension of the events unfolding in the United States.

The Takeaways

Both companies plummeted, affecting thousands of American investors and employees, why? The answer is in the corporate risk management, they just forgot it!

The desire to grow by ENRON and become a world class company, lead them to take actions that were clearly against their principles as a company.

For the case of Arthur Andersen things became much worse, they underestimate the violation of the rules they did,  the regulatory processes, and all this years of hard work were send it to hell. The loss all their prestige gained by all those many years of work.

This story is a world reference when we talk about risk management, some of you will know it, for others it will be a new story, In my opinion is worth telling when we talk about Risk Management.

Thanks for reading…

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