Corporate Compliance, Collapse of Enron and WorldCom - Article Example

CORPORATE COMPLIANCE INTRODUCTION Corporate compliance is an issue that is gaining attention in the business world today. This has happened due to the high profile collapse of Enron and WorldCom recently. Thus compliance and compliance standards debate has started in both the business and political arena. In this essay, we will first try to look at the history of the political efforts that have tried to encourage corporate compliance. Thereafter both the success and problems caused by the government's efforts to enforce corporate compliance will be looked at from an international perspective. And finally this essay will illustrate that despite all the criticism, both established and new laws enforcing corporate compliance have contributed significantly to the prevention of many bad business practices as well as the creation of many good corporate citizens nowadays. Moreover, we will take a close look at how and why Enron failed and how non compliance led to the disaster. The accounting and financial scandals that rocked the year 2001 and 2002 has had far-reaching consequences for the companies and issues of corporate compliance. The governments have introduced new laws and regulations such as the Sarbanes-Oxley Act 2002 to ensure stricter compliance. And new codes of conduct have been developed and corporate boards have tried to restructure themselves to include more independent members to avoid Enron like situations. It has been seen that the Sarbanes-Oxley Act and the related policies by the Securities and Exchange Commission and new rules and regulations introduced by the major stock exchanges, have resulted in more ethical behavior and effective corporate compliance from private companies. As per these regulations, the companies and their senior executives and board members can now be held personally accountable in the case of the financial reporting irregularities and other areas relating to ethics and corporate compliance. And the companies that follow the code of ethical policies and corporate compliance are getting a distinct advantage in the marketplace. BACKGROUND All industries have faced the issues of non compliance by corporate companies since long. The governments and regulating bodies have come up with new rules and regulations to prevent these issues from time to time. The False Claims Act of 1986, the U.S. Federal Sentencing Guidelines for Organizations of 1991, the, the historic decision given by the Delaware Chancery Court in 1996 regarding Caremark International, Inc., and the Sarbanes-Oxley Act of 2002 all have contributed to the issues of compliance and ethical behavior of private companies. All these have in some or the other way tried to protect the shareholders and other stakeholders from incurring losses due to misconduct and malpractices of companies. But all this has not still deterred companies from resorting to wrong practices. Actually, till recently, the rules or the laws have been quite lenient in dealing with the cases of wrong practices by the private companies and the low fines have contributed to the relative nonchalance shown by the defaulting companies as they treat them as a cost of doing business. (Harvard Law Review, 1783). But in 1991, the guidelines required companies to not only implement the ethical policies and prevent corporate crimes but also to self evaluate and self enforce them. But the critics have argued that these guidelines do not provide adequate guidance for companies who are interested in compliance. They further add that in cases where companies have tries to implement policies of ethical behavior and still some particular employee has been acting unethically, company should not be blamed for it. Otherwise the companies will become very strict and normal employee behavior will also come under unnecessary scrutiny. As per the Harvard law review of 1996, about two-thirds of the organizations included compliance in their employee evaluations, but only about 40% used audits as the tool for preventing and detecting violations. PROBLEMS TO COMPLIANCE The current rules and policies have a flexibility that allows corporations to tailor their programs to meet their specific needs. But the requirements for these are quite vague and thus the companies usually find it difficult to structure their programs for effective compliance. As per the given literature these companies thus are trying to match many sources of information in designing their compliance programs. For example the 1996 guidelines and the government programs that track them or the government institutions used to monitor them, the Department of Justice environmental policy and directives and industry-sponsored best-practices forums. But such practices are proving to be quite expensive for the private companies. Specially, the government-imposed programs requiring that corporations hire external monitors or auditors are very costly from company’s point of view. Moreover since the external auditors are unaware of internal mechanisms of the company, they are unable to take informed decisions. And if indeed, some irregularities have taken place, the outside auditors will not be given that information easily nor will they be able to detect cover-ups. Thus it is not advisable to force companies to use costlier and less effective monitoring systems. It has also been found that the current system though advocating self evaluation and reporting is hardly conducive or encouraging companies to follow it Since self checks and reporting place greater emphasis on preventing violations , it should be promoted by the government agencies. And if the companies are given better guidance in developing effective compliance programs and an assurance from the government that self-evaluation efforts will not be turned against them then this would probably provide more motivation to companies to focus on prevention of corporate crimes. MOTIVATION TO COMPLY As Winter and May (675) say that companies need to be provided with some kind of motivation or reason to comply with rules and regulations. This could be in form of incentives or as fear of being caught and being liable to fines or other forms of punishment. And in some cases it could be social pressure or a question of being regarded as a responsible brand in the eyes of the customer. They further argue that only intention is not good enough and the companies should have the ability to comply as well. Thus based on the literature so far, they go on to provide three types of motivations for compliance --- Calculated, Normative and Social. In the calculated motivation – the private companies generally calculate the costs and benefits of compliance and if the benefits are higher – there is more likelihood of compliance by them. In the normative motivation – the companies are more likely to comply in cases where they agree with the compliance issue and usually feel it is there duty to comply. While in the case of social motivation – the companies feel a need to be approved by the society in general or in fact may actually feel very strongly about an issue. They feel a social responsibility and are ready to comply ENCOURAGING COMPLIANCE But as stated earlier – the motivation in itself is not enough – the companies should have the ability to comply and for this awareness of the rules and regulations is a must along with the financial ability. And another factor that should be taken into consideration is the ability to monitor and audit compliance in a real time manner. David Weil (618) in his article “If OSHA is so bad, why is compliance so good?” talks about OSHA (Occupational Safety and Health Act) of 1970 and its effect on compliance by the industry. He shows that even though the OSHA is not able to do as many inspections as the number of companies and also imposes low fines for violations, it still manages to act as a deterrent to companies because of the fear of getting caught or a fear of being under investigation. Thus even other studies have shown that the mere presence of such acts and rules act as a reminder to companies to work clean, and thus high handed approaches and very strict rules are not needed. Most of the companies are interested in compliance but either are not aware of the rules or the rules are too complex or are too costly for them to implement. Thus what is required is a combination of higher fines and good guidance and clear and simple rules for companies to follow. Actually the need of the hour is to show the companies how better compliance is going to benefit them in the long run. Efforts should be made to educate them regarding the higher benefits they will have on compliance. Actually, it has been seen that many violations of compliance across a wide spectrum of industries occur due to insufficient staff training or ignorance towards the rules and regulations. Similarly the ethical training is mostly absent from the corporate training manuals. Most companies do have a code of ethics written down but it is not properly communicated or enforced down the line. Even Enron had a perfectly good code of ethics but no one was responsible for enforcing it. And it is not the question of doing it right – the corporate compliance also provides tangible benefits to the companies as well. In one of the surveys from the Economist Intelligence Unit it has been shown that more business executives and corporate investors are now giving importance to corporate responsibility in their decision-making. (AMEINFO, 2005) In the article --- Corporate responsibility and corporate governance – they refer to the two studies that prove that corporate responsibility and ethical behavior has a positive impact on financial results of the companies. The research by Marc Orlitzky (University of Sydney ) and Schmidt and Rynes (University of Iowa) -- "Corporate Social and Financial Performance," used data of 52 studies over 30 years and showed that there is a strong association between corporate social performance and financial performance. A similar study in 2004, (UK environment agency) also researched about 60 previous studies over the last six years and found that 51 of them (85%) showed a positive correlation between environmental management and financial performance. Thus both of them proved that if companies follow proper environmental practices they will see benefits in their overall financial performance. This is because develop new competencies by thinking out of the box to meet environmental challenges and are able to build reputations and attract best talent to work for them. PATHS TO COMPLIANCE -- INTERNATIONAL PERSPECTIVE In his article – “ Paths to Compliance “ , Jonas Tallberg (609) discusses about the most effective means of achieving compliance. He provides two main approaches – enforcement and management as the means of getting companies to comply. He actually advocates the use of a combination strategy that combines both the enforcement and management approaches towards achieving international cooperation and compliance. This is similar to what we discussed earlier in our paper that a combination of disciplinary rules and a friendly guidance is necessary to achieve the required effect. The enforcement approach is based on the cost and benefits analysis and is usually accompanied by monitoring and sanctions. Monitoring helps to instill the fear of being caught and possible exposure which will not be in the interests of the company. And the possible sanctions that will be slapped for violations raise the costs of non compliance thus making it a less beneficial strategy for the companies. But this is good when the companies are willfully indulging in malpractices or irregularities. In case of companies where some employees have unintentionally violated the policies due to ignorance – this causes an undue harassment and resentment. In such cases the management approach works better. Moreover, from international perspective as well, sanctions and monitoring are childish terms and countries cannot be compelled to act in a certain way because of the fear of sanctions. In short, it simply does not work. Many live examples are already in our memory where international sanctions have not been successful. Thus on international scene – the management approach with its better understanding of the issues works better. Because in this approach – it is assumed that non-compliance occurs due to inability to comply or ignorance of the rules. Thus a value based or a problem-solving strategy of rule interpretation and guidance and exploring alternative and cost effective methods to comply is more suitable. But there may be cases where companies or countries may try to use this rule ambiguities for their non compliance – thus for such cases a combination of enforcement and management approaches should be used. CASE OF ENRON Enron was a Fortune 500 company with revenues of $100.8 billion in 2000. It was a provider of energy and energy-related products and services. In 2001, the company announced irregularities in its financial statements for the last four years and subsequently filed for bankruptcy. (Harvard Law review, 2124) The investigations revealed that among other problems, the most critical was the failure of Enron's officers to comply with Enron's Code of Conduct of Business affair. Thus it showed that a mere presence of compliance programs is not enough unless there are specific monitoring controls in place. And in this case not only the small employees of the company were involved but also the higher officers such as the vice president. Actually, the investigation agency found that the there had been quite a few related party transactions between Enron and fake companies created and managed by Enron Executive Vice President and Chief Financial Officer Andrew S. Fastow and by other Enron employee.(Powers report) and these people thus made lots of money, at Enron's expense. Moreover, they also managed to get the waiver of the Board on the company's conflict-of-interest policies three times in twelve months. Even later the public filings also failed to convey the exact nature of transactions between Enron and those companies. CONCLUSION Thus to conclude, we can say that corporate compliance has become a big issue today and the need of the hour is an approach which provides necessary guidance to the companies with regards to rules interpretations and ambiguities and is able to monitor the compliance issues effectively. One of the biggest factors for compliance issues in companies revolve around their culture. The companies should promote a culture of ethical behavior and inform and train their employees on the ethical codes and policies from time to time. The board of directors must now be more visibly involved in overseeing ethics and corporate compliance. Even the newer regulations require the board to be more active in the compliance reporting process. Thus a very critical component of an effective ethics and compliance program is the ability to monitor and audit compliance in a timely manner. Thus it is important to seek new and innovative technological solutions to help identify potential unethical behaviors before the cost becomes too great. REFERENCES: Corporate responsibility and corporate governance, 2005 Retrieved from: http://www.ameinfo.com/55905.html Harvard Law Review, 2003, The Good, the Bad, and Their Corporate Codes of Ethics: Enron, Sarbanes-Oxley, and the Problems with Legislating Good Behavior, 116, 7, 2123-2141. Harvard Law Review, 1996, Growing the Carrot: Encouraging Effective Corporate Compliance 109, 7. 1783-1800. POWERS REPORT, note 39, 3-4. Tallberg, Jonas, 2002, Paths to Compliance: Enforcement, Management, and the European Union International Organization, 56, 3. 609-643. Weil, David, 1996, If OSHA is So Bad, Why is Compliance So Good? The RAND Journal of Economics, 27, 3. 618-640. Winter, S. and Peter J. May , 2001, Motivation for Compliance with Environmental Regulations Journal of Policy Analysis and Management , 20, 4. 675-698 APPENDIX 1. Enron Must-Knows Num. of Enron employees: 21,000 Enron stock high and low: $90/60¢ Num. of seated U.S. Senators who took Enron campaign contributions: 71 $ amount of Enron political contributions 1990-2002: $5.9 mill. Enron's off-the-books liability (est.): $690 mill. Est. Enron loss to employee 401Ks: $1.2 bill. Sources: NPR, THE NEW YORK TIMES, THE ECONOMIST, FORBES, and the Center for Responsive Politics 2. Key Events in ENRON September 2000. Enron chairman Kenneth Lay tells employees in an online conference call that Enron stock was a bargain. At this time, he was quietly selling Enron stock worth over $16m. October 2001. Enron eliminates $1.2bn of shareholder equity. Enron stock falls from $90 per share to practically nothing. October 31, 2001. The Securities and Exchange Commission (SEC) announce a formal investigation into the finances of Enron. November 21, 2001. Shareholder lawsuit filed by Amalgamated Bank and the AFL-CIO. January 15th, 2002. It is revealed that Enron’s auditor, Andersen, had shredded and deleted documents relating to Enron after receiving subpoenas from regulators. January 22nd, 2002. It is alleged that Enron itself had also shredded and deleted documents http://www.users.globalnet.co.uk/~rxv/orgmgt/caseenron.htm 3. Vertical scale is logarithmic EDF Case Study: Enron EDF credit measures range from a low of 0.02% to a high of 20% in one basis-point increments. A basis point = 1/100 of a percentage point. EDF credit measures are actual probabilities, not credit scores. A company with a current EDF credit measure of 2% has a 2%probability of defaulting within the next twelve months. That is, out of 100 companies with a 2% EDF credit measure, we would expect, on average, that 2 would default over the next twelve months. Also, a company with a 2% EDF credit measure is 10 times more likely to default than a firm with a 0.20% EDF credit measure. Read More