It all went down in late 2001, when Enron- one of the largest and most wealthy corporations in the world- fell to scandal. Along with the fall was one of the Big 4 accounting firms, Arthur Andersen. On December 2, 2001, Enron’s $63.5Billion in assets became the largest corporate bankruptcy in US history at the time.
That was nearly twenty years ago.
What have we learned?
Lesson #1: Cheaters get caught
That’s right, you can’t run from the law. No matter now big or small you are, how big or small your CPA firm is, or how smart you think you are…. you can’t cheat the system. Enron hid debt from failed deals by using accounting loopholes and special purpose entities. They got away with it for about a decade, then it started with Wall Street Journal and Fortune Magazine articles about the company’s performance- because it didn’t make sense. Does this count as “if you see something, say something”? You’ll get caught for being shady, no matter how big you are or how powerful your friends are.
Lesson #2: Hire an auditor who isn’t your CPA
Arthur Andersen was both the accounting firm providing advice, and the auditor. They received $27M in consulting fees, and $25M in audit fees. Translated, Arthur Andersen is going to go easy on their audits because they don’t want to lose consulting fees.
If you have a CPA who files your taxes, even if you’re a super small business and not publicly traded, hire another resource to look through the books.
Why is this smart?
- If you are audited, then you can show another resource double checked the work of the primary service provider. It’s “piece of mind”.
- You’ll get questions from the auditor that the CPA or bookkeeper didn’t think about, or mistakes that were made.
- Because it makes your stakeholders/investors happy knowing their assets are safe.
- It’s far cheaper to hire an auditor than it is to pay penalties from the IRS and lawsuits from your investors.
Lesson #3: If you’re on the board of directors for a company, you might be BS-ed by ownership, but you’re still going to be held accountable.
Enron used shady derivatives and hedged its own risks by forming special entities to hide its losses. They had to do this because the energy market was volatile, and no one knows what the market would look like in the future. Therefore, when investments were made, such as in a spin off company named Whitewing, the transactions were counted as sales instead of loans. This inflated the balance sheet, obviously misrepresenting revenues to the board and investors.
The board had no idea this was happening- just heard the successes of these ventures, and signed off on the transactions. Then, they paid for it.
If someone asks you to be on a board of the directors for a small or mid-sized company, a non-profit, or a publicly traded company, understand what your duties are. Yes, often it’s just a figure head position, and you have no decision making power. However, if asked to be on a board, make sure the company understands that you will give advice and ask questions if something doesn’t smell right. You will be held responsible, even if you don’t know something smelly is happening, and it’s still your reputation.
It’s been nearly 20 years since this happened, and we still remember how this scandal re-shaped the accounting, compliance, and corporate governance rules that we know today. There are still some really shady things that happen, but I promise you’ll go to jail if you don’t play by the rules. Jail is no fun… but you can avoid it.
CEO, Sharp Specialty Resources