Former Enron executive Andrew Fastow leaves a federal courtroom after his fraud indictment.
Accounting scandals are not a new phenomenon in America. However, the collapse of high-flying players like Enron brought renewed pressure for more rigorous standards. Congress responded in 2002 by passing the Sarbanes-Oxley Act, which made executives responsible for submitting false or misleading financial statements. Supporters of such legislation cite the need for transparency as their biggest priority -- since investors are less likely to flock to a company that does little to heed those rules.
Changing Corporate Culture
Without a strong ethical culture, financial services industry employees may cut corners more readily, the Center for Audit Quality stated in a December 2010 report. Professionals interviewed for the report stressed senior management's commitment to creating such a culture as the best line of defense against fraud. Managers must also clearly communicate ethical expectations and live by them, the report states. The center also recommended setting up readily accessible whistleblowing programs because most fraud is detected through tips.
Consequences for Employees
White-collar convictions also have implications for finance professionals like Walter Pavlo, who served a 41-month prison term for diverting $6 million from MCI's poorly performing clients into an offshore account. For Pavlo, the consequences included an order to pay restitution over a 27-year period, ABC News reported in March 2006. While in prison, Pavlo's wife divorced him, and the nature of his offense made employers leery of hiring him. Ironically, this led to Pavlo's present career as a white-collar crime lecturer.
Consequences for Governance
No scandal better illustrates the breakdown of traditional corporate governance than the 2001 demise of Enron, which left $1.2 billion in write-offs, University of Washington business professor Gary L. Sundem says. Employees and investors had no idea what was coming, because Enron's auditors, Arthur Andersen, stressed revenue above its reputation, Sundem contended in a speech for the 2003 CGA Accounting Research Centre's conference. By linking performance to profits, firms like Andersen made public service a lesser priority.
Consequences for Markets
The surge in financial reporting fraud has exerted a major negative ripple effect throughout the U.S. economy, the center's report states. For example, financial fraud cases investigated by the U.S. Securities and Exchange Commission tripled from a median figure of $4.1 million in 1999 to $12.1 million 2007, the report showed. Failure to spot these frauds, in turn, contributed to the boom/bust cycles that damaged public confidence in the economy.
Restoring Public Confidence
For Sundem, Congress's passage of the Sarbanes-Oxley Act marked a crucial first step in restoring public confidence. One key provision required all accounting activity to become a self-supporting function, instead of being subsidized by consulting or other services. The law also created a Public Company Accounting Oversight Board to regulate the accounting profession, and make executives accountable for false statements. However, Sundem held off in judging the law's long-term impact -- mainly because the corporate culture of short-run profit that prevailed before Enron's collapse still exists, he says.
