Midterm Test



EnronCase (93-98)

Enronwas a conglomerate formed by small oil and energy firms. The companyreported huge profits and minimum losses. The management reportedprofits on the basis of what their ventures could make, and not onthe grounds of what they were actually worth. They also cancelledloses with offshore shell firms in order to continue reportingprofits. Enron established Chewco, a special purpose enterprise, withthe objective of retaining a controlling shareholding of 97 %, butwas unlucky to locate an investor willing to buy the extra 3% by theend of the year.

Afterappointing Michael Kopper as the owner of the 3 % shares in Chewco,Enron was able to transfer assets at manipulated profits. Enron couldunderstate its obligations by withdrawing funds borrowed by Chewcowithout indicating that they would be repaid (Lemus, 2014). Otherethical issues related to Chewco include the payment of excessivemanagement fee to Kopper, overvaluation during the winding-up,indemnification of Kopper from tax liability at $ 10.5 million,non-recourse loan of $ 15 million made to Kopper, and advanced bookedrevenues (Brooks &amp Dunn, 2014). Enron formed another firm, LJMI,and used it to hedge itself against loss in 1999 and 2000. LJMI wasalso wound up in 2000 and overvalued by $ 70 million.

TheSOX Act was developed to help the U.S. prevent the occurrence ofscandals like the one that affected Enron. The act was enacted in2002, with the objective of enhancing transparency and disclosure inprocess of financial reporting. The need to formulate the act wasbased on the increase in cases of corporate fraud, including theEnron Scandal. The act provides different type of requirements forcompliance with the reporting standards into 11 titles. It addressedthe prevailing weaknesses in financial reporting by focusing onseveral issues, including the creation of an oversight board,enhanced auditor’s independence, disclosure, conflicts of interest,corporate fraud, and sharpened attorney’s responsibility (Brooks &ampDunn, 2014).

Themain ethical dilemma that is seen in the case of Enron involves theprotection of personal interests versus compliance with reportingstandards. For example, the management of Enron understood that afull compliance with the existing reporting standards would reducethe profit, leading to a decline in the price of the company’sshare. In addition, employees (including Mr. Kopper) needed toprotect the going concern of the company as part of the measures tosecure their jobs, which resulted in the cheating throughovervaluation of assets and reporting of excess profits.

Thereare five major sections that could have played a critical role inpreventing the occurrence of Enron. First, Section 404 mandates themanagement teams to ensure that their companies have adequateinternal controls. Section 404 part 1 states (summary)

Thecommission is mandated to prescribe specific rules that require eachannual report that is prepared under the Securities Exchange Act,section 13 (a) or 15 (d), to contain a report of internal controls.The report shall indicate the specific responsibility of thecompany’s management in establishing as well as maintaining thecontrols and procedures (SEC, 2012, 789).

Secondly,section 402 reformed the requirements for reporting the off-balancesheet transactions. It states (summary)

Thecommission has been mandated to provide rules requiring that annualas well as quarterly financial reports should disclose any materialoff-balance sheet transactions, obligations, and arrangements. Thereports should also disclose any relationships that the company haswith unconsolidated entities that may have a material current as wellas the future effect on corporation’s financial condition (SEC,2012, 787).

Third,section 302 gives the responsibility of ascertaining the suitabilityof the financial reports to two individuals, including the CEO andthe CFO. The two executives are required to confirm the accuracy,proper documentation, and submission of internal control structuresas well as the financial reports. Section 302 states (Summary)

Thecommission shall require that each corporation that files its reportsunder the provisions of the Securities and Exchange Act that wasenacted in 1934 have their principle financial officer and executiveofficer certify that they have reviewed the annual and quarterlyfinancial reports. These officers are required to state that thefinancial reports do not contain any misrepresentation of materialfacts (SEC, 2012, 777).

Fourth,section 406 was developed with the objective of increasingaccountability on the part of the senior financial officers. Thissection mandated the SEC to ensure that all senior financial officersadhere to the code of ethics that guide them in their work. Section406 states (Summary)

TheCommission is mandate to issue rules that require all issuerstogether with the periodic reports that are submitted in line withSecurities Exchange Act sections 13 (a) or 15 (b) to disclose whetherthey have adopted the code of ethics developed for senior financialofficers. The code is applicable to the principle financial officerand controller or persons who are expected to perform similar tasks(SEC, 2012, 789).

Fifth,section 206 was developed to reduce the risks associated with theconflicts of interest. This section states that (Summary)

Itis unlawful for a registered accounting firm to audit the accounts ofan issuer, if the CEO, controller, CFO, chief accountants, and otheremployees with equivalent positions were employed by the entityduring the one-year period that precede the data of the onset of theaudit process (SEC, 2012, 774).

Eachof the aforementioned sections of SOX Act would have prevented theoccurrence of the dilemma that Enron faced in different ways. Section404 would have limited the ability of Enron’s management to takeadvantage of weaknesses in the internal control systems. Most of theexecutive officers who were held responsible for Enron scandal statedthat they were not aware of the fact that the financial statementshad material misrepresentations (Brooks &amp Dunn, 2014). Undersection 404, the management would have been held responsible for theabsence of adequate internal controls. For example, the waiver of thecode of conduct in order to allow the management to create the SPEwould have been difficult.

Section402 would have prevented the management from creating otherindependent companies and using them to report off-balance sheettransactions in a fraudulent way. For example, the Enron would nothave been able to use Kopper to create a fictional company that wasconsidered as an independent firm through which the managementunderstated its obligations (Brooks &amp Dunn, 2014). Enron wouldnot be able to use its Special Purpose Entities to hedge its losses.

Section302 would reduce the chances for the occurrence of the Enron Scandalby placing the role of ascertaining the accuracy of the financialstatements on the CFO and the CEO. The section would ensure that thetwo officers understand that they would be held personally liable forany false information that will be discovered in the financialreports at a later date. Therefore, they would be more conscious andavoid using other employees (such as Kopper) to facilitate fraudulentactivities, since they will be increasing the risk of being punishedby the law.

Section406 would have prevented the dilemma effectively because the SECwould have ensured that the senior financial officers working forEnron were well infirmed and pressured to observe the code of ethics. For example, the chief Finance officer named Andrew Fastow misledthe company’s board as well as the auditor, Arthur Andersen, aboutthe high-risk accounting practices that resulted in a mega scandal.This can be attributed to the fact that there was no one to overseeand ensure that Andrew was adhering to a code of ethics in his dailypractices. Section 406 fills this gap by ensuring that the SEC willmake a follow-up to ensure that the financial officers of allreporting entities adhere to the code of ethics.

Thespirit of Section 206 is to increase the level of auditorindependence minimize the probability of the conflicts of interestthat could interfere with the audit. The section would have preventedthe dilemma by helping the auditor, Arthur Andersen, from assumingthe role of consultant in SPE projects and an auditor at the sametime. The relationship between the employees of Enron and the Auditfirm had become too close to an extent that it interfered with theindependence of the accounting firm. Therefore, the section wouldhave enhanced the level of independence and reduced the conflicts ofinterest.

Inconclusion, the Enron Scandal involved a dilemma in which the partiesacted contrary to the reporting rules in order to satisfy theirpersonal interests. The management of Enron was able to takeadvantage of the weaknesses in the existing reporting standards.These weaknesses allowed Enron‘s management to create several SPEsfor the purposes of hedging losses and obligations. Therefore, SOXAct was a reactionary measure that sealed the weaknesses. Forexample, section 404 of the SOX Act ensured that all listed companieshave adequate internal controls. Section 402 was developed to denycompanies the opportunity to use the off-balance sheet transactionsto commit fraud. Section 302 gave the CEO and CFO the responsibilityof ascertaining the accuracy of the financial reports. Section 406was established in order to increase the level of accountability ofthe financial officers. Legislators reduced the chances for theoccurrence of the conflict of interest by formulating section 206.

Case:Wal-Mart Bribery in Mexico (122-124)

Wal-Martis considered as the largest retail chain company in the world.However, the occurrence of a scandal n Mexico affected its reputationin a negative way. The management of the Wal-Mart segment operatingin Mexico bribed authorities in order to access different licensesfaster. For example, the company was able to have the zoning of itsmaps changed, make the environmental objections vanish by bribing theMexican authorities. Investigations were initiated, but theexecutives of Wal-Mart could not allow them to materialize due to thefear of the negative impact on the company’s image. For example,officers in Mexico and the U.S. decided to the keep the matter quietand frustrate the efforts made to hire qualified investigators(Brooks &amp Dunn, 2014).

Themanagement of Wal-Mart operations in Mexico found itself in asituation where it had to balance between the compliance with a slowlicensing process and the aggressive strategic growth plan. Thecompany had become the largest employer in the private sector with atotal of 209,000 members of staff. However, the exponential growthplan was thwarted by bureaucracy that forced the company to takemonths to access construction licenses. Therefore, the managementsought to give a bribe of $ 24 million, which was an unethical way ofaddressing the dilemma.

Thereare two major sections of SOX Act that would have prevented theoccurrence of the dilemma. First, Section 404 was formulated to givethe management of listed companies the responsibility of ensuringthat their corporations have adequate and effective internalcontrols. Section 404 states (Summary)

Publiclytraded companies are mandated to develop internal controls as well asprocedures that will facilitate the financial reporting. Thesecompanies are also mandated to test, document, and maintain theirinternal controls in order to confirm their effectiveness (SEC, 2012,790).

Secondly,section 806 protects employees of companies that are publicly tradedfrom being mistreated by the employer when they act aswhistleblowers. Section 806 states (summary)

Nocorporation that has its shares listed under the Securities ExchangeAct that was enacted in 1934 and reports its financial statementsunder section 15 (d) of the same act shall discharge, suspend,demote, harass, or threaten its contractor, employee, subcontractor,or officers because of their engagement in lawful acts (SEC, 2012,802).

Section802 prohibits the company executives or any other stakeholders frominterfering with crime investigation processes. The section states(Summary)

Anyonewho alters, conceals, destroys, falsifies, makes false entry orcover-up records, tangible objects, or documents shall, with theobjective of obstructing investigation shall be punished by the law.The perpetrators will be fined under Title VIII or imprisoned for aperiod that does not exceed 20 years (SEC, 2012, 800).

Section902 was established to prevent the occurrence of white collar crimes.The section prevents these crimes by issuing a threat of penaltieswhose intention is to scare aware executives. Section 902 states(Summary)

Anyonewho conspires or attempt to engage in any kind of offense under thisChapter will be subjected to similar penalties as those that areprescribed for crimes for which the commissioner was the object ofconspiracy or attempt (SEC, 2012, 805).

Section401was established with the objective of increasing the level ofdisclosure. The aim was to ensure that no material transaction ishidden from the consumers of the financial reports. Section 401 (a)(i) states (Summary)

Allfinancial reports that contain financial statements and that arerequired to be prepared in line with the generally acceptableaccounting principles under Title IV and filed with SEC shall reflectall material correcting adjustments that are identified by the publicaccounting firm. These material adjustments are supposed to bedisclosed as per the rules set by SEC or the generally acceptedaccounting principles (SEC, 2012, 785).

TheSOX sections discussed above would have prevented the occurrence ofthe scandal in different ways. The occurrence of any form of fraud(including the issue of bribery) is a clear indication of thenonexistence or the presence of weak and ineffective internalcontrols. Section 404 gives the management the responsibility todevelop and test internal controls, with the objective of holdingthem accountable, in case a fraud occurs (Navran, 2016). Therefore,executives of Wal-Mart would have avoided giving the bribe if thissection had been formulated.

Section806 would have minimized the risk of the dilemma by protectingemployees and the auditor who blew the whistle from being mistreatedby the executives. The executives of the Wal-Mart Corporation in theU.S. and Mexico had decided to frustrate any fruitful investigationsince it could damage the image of the company. One of the keystrategies that they used was to retrench the auditor and relieveinvestigators of their duties (Brooks &amp Dunn, 2014). The presenceof section 806 would have given the auditor and investigators thecourage to stop these frustrations from the executives. In addition,the executives would have avoided engaging in bribery due to the fearof the restrictions outlined in the section.

Section802 would have prevented the dilemma by warning the executives in theU.S. and Mexico from impending investigations about the issue ofbribery. From the case study, the executives of Wal-Mart in the U.S.shut investigators down upon realizing that the officers sent fromthe U.S. had identified the paper trail leading a bribe worth $ 24million. These executives would have avoided interfering with theongoing investigation if section 802 had been enacted.

Section902 would have reduced the chances for the Wal-Mart executives tobribe the government officials in Mexico since the punishment forwhite collar crimes would have been heightened. Initially, there wereno strict laws to punish executives who engaged in while collarcrimes, but this section filled the gap. Executives are now afraid ofbeing imprisoned and for conspiring or attempting to engage incrimes.

Section401 would have played a role in prevention of the dilemma by makingit clear that all material transactions and adjustments that arelikely to affect the financial position of the company are disclosedproperly. From the case study, the management of Wal-Mart focused onconcealing transactions that led to bribery, instead of disclosingthem accordingly. Although their intention was to protect the imageof the company, section 401 would have contained their conduct byforcing them the material adjustments.

Inconclusion, the executives of the Wal-Mart company in Mexico engagedin fraudulent activities since the law did not give them theresponsibility of formulating and testing the effectiveness of allinternal controls. In addition, the lack of strict laws to protectstakeholders who assumed the role of whistleblowers subjectedinvestigators and the auditor to the risk of being harassed by theexecutives. Sections 404 and 806 of the SOX Act sealed these gaps.Section 404 addressed the challenge of inadequate internal controls.The legislators protected whistleblowers of listed companies byestablishing section 806. The possibility of executives interferingwith criminal investigations was addressed through section 802.Section 902 was established in order to discourage executives fromengaging in white collar crimes. The law makers increased the levelof disclosure in order to ensure that listed companies provide allrelevant information by developing section 401.

AppleCase Study

Ethicaltheories are developed to help decision makers address dilemmas. Theutilitarianism and the theory of deontology are the most common typesof presuppositions. Utilitarianism holds that any action can beconsidered to be ethical when it maximizes the wellbeing of themajority. The theory help decision makers assess their actions on thebasis of their consequences. An ethical action should be able tomaximize the utility (Brooks &amp Dunn, 2014). The theory ofdeontology, on the other hand, helps decision makers assess theethical background of their actions depending on what they aremorally obligated to do. An action can be considered to be ethical ifthe decision maker had an obligation to take it (Brooks &amp Dunn,2014).

Thetwo theories can be used to address the dilemma facing Apple. Underthe utilitarianism, Apple’s decision to refuse to assist the lawenforcers compromise the privacy of the suspected terrorist can bejudged on the basis of its consequences. The decision puts the livesof millions of citizens at the risk of being attacked while enhancingthe happiness of a single customer.

Underthe dentological perspective, Apple is obligated to serve theinterests of its customers and obey the laws. Although the company isexpected to protect the privacy of all clients, it is evident that aruling had been made requiring it to assist the law enforcers carryout their duty of conducting investigation. Under such circumstances,Apple is obligated to obey the law, even if such as an action willbreach the privacy of an individual who is suspected to havethreatened the lives of the people.

Theapplication of the two theories could lead to similar outcomes. Theuse of the utilitarian theory would result in a conclusion that it isethical for the Apple to help the law enforcers breach the privacy ofa terror suspect. This decision will enhance the wellbeing ofcitizens, law enforcers, and all parties that need to be protectedfrom terrorists. The theory of deontology will lead to a conclusionthat Apple has a duty to obey the law. Therefore, assisting the lawenforcers is more ethical than protecting the privacy of a terrorsuspect.

Inconclusion, apple can use the Apple can use the outcomes obtainedfrom the two theories to implement practical solutions. The twotheories lead to a conclusion that it would be ethical for Apple tocollaborate with the law enforcers. Therefore, the management ofapple should discuss with the law enforcers to determine the type ofinformation that they need in the customers’ gadget. The companyengineers should then break through the security barriers and gatherthe required information.


Brooks,J. &amp Dunn, P. (2014). Businessand professional ethics.Boston: Cengage Learning.

Lemus,E. (2014). The financial collapse of the Enron Corporation and itsimpact in the United States Capital Market. GlobalJournal of Management and Business Research,14 (4), 1-11.

Navran,J. (2016). Corporate ethics and Sarbanes-Oxley. ThomsonReuters.Retrieved October 29, 2016, fromhttp://corporate.findlaw.com/law-library/corporate-ethics-and-sarbanes-oxley.html

U.S.Securities and Exchange Commission (2012). Publiclaw 107-204.Washington, DC: SEC.