by Merlin Hernandez

Ethical dilemmas in corporate governance can arise from the need for truth in reporting. Issues of whether notional income from projected sales should be included on the income statement, the pressure to demonstrate financial health to stakeholders, or issues of social responsibility and the prevention of job loss if reports should illustrate a need for cut backs all have the potential to compromise a company’s ethical perspective and integrity. The Enron experience in the evolution of the US business regulatory environment was pivotal in that it brought business ethics and conflicts of interest into sharp focus. It was more than organizational malfeasance at one company but a systemic failure of the legal and regulatory structure that would provide the framework for corporate behavior and financial reporting.

Before the Enron debacle, the regulatory climate allowed an organizational culture that was inevitably self-destructive. Large firms like Enron contracted consulting services and allowed these same firms to audit both financial statements and processes – the consultants were signing off on their own work – while internal audits were conducted by employees of the firms. All possible avenues for preventing, detecting, and correcting failures in accountability were effectively contained within a management elite who were essentially laws into themselves. Against this backdrop, many businesses conducted their operations in a manner where fiscal controls and transparency were sacrificed in order to conceal inefficiencies and fraudulent activity, and to manipulate stock prices.

With the collapse of Enron, a maze of corporate fraud revealed inventive manipulations of partnerships with subsidiaries created to conceal huge debts and heavy losses, while published financial statements revealed robust fiscal health. The accounting firm, Arthur Andersen, operating as both financial consultant and external auditor, was implicated in what is now known as one of the largest frauds in corporate history. In response to the financial fall-out that resulted from Enron’s bankruptcy, the Sarbanes-Oxley Act was enacted in 2002 to provide a body of rules for Corporate Governance and to legislate accuracy and reliability in corporate disclosures for public companies. Violations can bring fines up to $500,000.00 and/or 20 years in prison. The Act mandates the company CEO and CFO to make an assessment of the internal controls they have in place while an external auditor must attest to the efficiency of those controls and issue a separate report to the SEC.

Both financial statements and process systems are auditable. CEO/CFO assessments involve documentation and implementation of the control environment. External auditors engage in the testing and reporting (attestation) of processes and transactional cycles, tracking all transactions back to the financial statement. The rules are designed to make all financial activity of publicly traded companies accurate, subject to checks and balances, made a part of the public record available for public scrutiny. But many privately held companies have embraced these rules to guide their corporate ethics.

Businesses, however, remain challenged by issues of corporate social responsibility, company loyalty, and the personal self-interest of managers, all of which can serve to blur the lines between what is ethical and what is expedient.