executive action no.
15 february 2002
The Enron Ethics Breakdown
By Ronald E. Berenbeim
It is perhaps the most compelling business ethics case in
a generation—a textbook version of what can go wrong in
an organization that lacks a true culture of ethical com-
pliance. Investors and the media once considered Enron
to be the company of the future, but as its demise sug-
gests, it was in reality not a particularly modern business
organization, especially in its approach to ethics. On the
surface, at least, it appeared to reject progressive innova-
tion in governance and ethics programs and instead
sought to circumvent systems that were designed to pro-
tect the company and its shareholders.
The purpose of this report is not to comment on the
legal or political ramifications of the case but rather to
focus on the business ethics issues raised by the conduct
of the company’s directors and officers, its accountants,
and lawyers as it is known to date. It is meant to be a
reminder that simply having a detailed code of ethics
on the books (as Enron certainly did) is not enough.
Organizations need to infuse ethics and integrity
throughout their corporate culture as well as into their
definition of success.
After all, being ethically literate is not just about giving
large sums of money to charity—something that Enron
did. It is about recognizing and acting on potential ethi-
cal issues before they become legal problems. Here,
Enron appears to get a failing grade. Now a detailed look
into the ethics breakdown at Enron and what it can
teach companies about the importance of developing an
ethics-based corporate culture.
Failure of the Market to Perform
and Professional Dilemmas
In reality, there is nothing wrong with markets failing to
fulfill their task of leveling the playing field between
buyer and seller. Such market failures are in fact how
many organizations make their money—through patents
(temporary monopolies) and the use of expertise that is
not universally available (competitive advantage). Yet
there are certain forms of this type of market failure that
are so egregious that they unreasonably interfere with
the rights of others and endanger the credibility of all
legitimate transactions.
 The most common form of market failure is informa-
tion asymmetries—the business decision-maker knows
something that the person at the other end of the
transaction does not. Most of the time this is fine but
there are circumstances where the unfairness of this
asymmetry exceeds simple competitive advantage and is
a threat to the rights of others and to the effective
operation of the free market as a whole. This appears
to be the case at Enron.
Insider trading is one of the indefensible exploitations
of information asymmetries. In due course, we will
have a legal determination regarding whether or not
Enron officers or directors engaged in this practice. But
legal determinations aside, Enron officers should have
been far more alert to the perception that they might
benefit from exploitation of information asymmetry.
Again ethical literacy is all about recognizing potential
ethical issues before they become legal problems. And
incidentally, since the U.S. Supreme Court’s Texas Gulf
and Sulfur case in 1969 it has been unlawful for direc-
tors, as the Enron chairman was, who have inside price
sensitive information to trade in that stock.
2 executive action the enron ethics breakdown the conference board
Truth and Disclosure
“Falsehood ceases to be falsehood, when the truth
is not expected to be spoken”, wrote Henry Taylor, a
19th century statesman. It is recognized that a certain
amount of puffing, exaggeration, and bluffing is part of
the business game. But how much is too much?
The “Taylor rule” certainly does not apply to audited
financial statements, and it probably does not cover
statements made to employees who were also con-
cerned shareholders (according to media reports, 60
percent of employee 401(K) plans consisted of Enron
stock). Were these statements false? It is a fact that the
financial statements had to be amended. While the
employees were administered the soothing electronic
balm of e-mail reassurance, the author of the missive
and his colleagues were selling their stock.
The courts will determine the facts but regardless of
the legal outcome, Enron senior management gets a
failing grade on truth and disclosure. The purpose of
ethics is to enable recognition of how a particular situa-
tion will be perceived. At a certain level, it hardly mat-
ters what the courts decide. Enron is bankrupt—which
is what happened to the company and its officers
before a single day in court. But no company engaging
in similar practices can derive encouragement for any
suits that might be terminated in Enron’s favor. The
damage to company reputation through a negative per-
ception of corporate ethics has already been done.
Accountants, Analysts and Lawyers Too
Enron is not the only party that is vulnerable on the
issue of truth telling. Its accountants and many Wall
Street analysts ratified and legitimized the company’s
scenarios and statements regarding its prospects. Were
the accountants misled and otherwise, in U.S. Supreme
Court Justice Benjamin Cardozo’s classic formulation
(applied to an accounting firm) “skilled and careful in
their calling”? The accountants and analysts are cer-
tainly making the case for Enron deception but “if the
truth is not expected to be spoken” which certainly is
the case, then it is their job to pierce the veil. No poten-
tial client thinks otherwise. The role of accountants and
analysts is to serve shareholders and potential share-
holders in rectifying the information asymmetries that
exist when shareholders deal directly with the company.
Perceptions of Gifts, Side Deals, and Payoffs
Here one need dwell only briefly on the recipients of
Enron beneficence and the public perception. John
Mendelsohn was President, University of Texas MD
Anderson Cancer Center. Enron donated more than
$600,000 to the cancer center since 1996. Wendy
Gramm is Director of the Mercatus Center at George
Mason University. Enron has given the Mercatus Center
$50,000. Drs. Mendelsohn and Gramm are on the Audit
Committee of Enron’s Board.
This problem may not go away. William C. Powers, Jr.,
Dean of the University of Texas is Chair of the Special
Committee to examine transactions between Enron and
its partnerships. The University of Texas Law School has
thus far received $252,000 in Enron donations.
executive action the enron ethics breakdown
Evidently, Powers’ potential conflict of interest did
not interfere with his judgement. (On February 3, 2002,
the Special Committee issued a report that was highly
critical of Enron’s senior management.) In this regard,
the Enron case may not be all that unusual. U.S. law
and Board of Director practice has been far too slow
in recognizing the potential conflicts of interest and
incidental benefits inherent in gifts to board members’
favorite charities.
Whistleblowers
Suffice it to say that Enron had them. At least one
was fired. On the question of just how thoroughly the
allegations of a second were investigated, the future
of one of Houston’s most influential law firms may
hang. An organization with a strong ethical compliance
culture encourages whistelblowing and certainly does
not discourage it by ignoring or sacking those who
speak up or warn of possible ethical lapses.
Managers and Directors: Fiduciary Duties
The Enron board “waived” the company’s own ethics
code requirements to allow the company’s CFO to serve
as general partner for the partnerships that it was using
as a conduit for much of its business.
The fiduciary obligation is difficult to define. No less an
authority than Felix Frankfurter, Justice of the Supreme
Court and before that a Harvard Law School professor,
said that any discussion of the fiduciary obligation
begins with the question “to whom am I a fiduciary, and
for what?” Ordinarily, officers and directors do not owe
a fiduciary duty to the company’s employees but many
employees were shareholders.
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 The duty that is owed is one of good faith and full
disclosure. There is no evidence that when Enron’s CEO
told the employees that the stock would probably
rise that he also disclosed that he was selling stock.
Moreover, the employees would not have learned of the
stock sale within days or weeks, as is ordinarily the case.
Only the investigation surrounding Enron’s bankruptcy
enabled shareholders to learn of the CEO stock sell-off
before February 14, 2002 which is when the sell-off
would otherwise have been disclosed. Why the delay?
The stock was sold to the company to repay money that
the CEO owed Enron—and the sale of company stock
qualifies as an exception under the ordinary director
and officer disclosure requirement. It does not have to
be reported until 45 days after the end of the com-
pany’s fiscal year.
Enron’s CEO had a revolving credit line of $7.5 million.
All he had to do to postpone disclosure of a sale that he
wanted to make was to borrow money and pay it back
by selling shares to the company. Regardless of his
intent in making the sale, the defense that the disclo-
sures could be legally deferred for an extended period
of time is an ethically specious one.
Beyond the specific elements of the law, much of the
writing on fiduciary obligations concentrates on the
need for avoiding the appearance of impropriety.
Essentially, the concern with a fiduciary’s appearances
is based upon the fiduciary’s implicit role in assuring
that the enterprise will observe the spirit as well as the
letter of the law. One example of a way to achieve this
extra measure of prudence comes from Jewish oral law.
The Rabbis developed the principle of “erecting fences
4 executive action the enron ethics breakdown the conference board
round the law” to prevent even accidental breaches.
Because we can’t be absolutely certain of the date, most
Jewish holidays are celebrated on two days rather than
one. The Passover prohibition against leavened bread
was enlarged to proscribe wheat, other grains, and
eventually anything that can be ground into flour.
Extra measures of prudence are necessary to make sure
that core legal requirements are not violated.
The fiduciary’s role is to erect and to guard those
fences—not to test through the waiver of the company’s
own ethical code and the use of technicalities in the
sale of stock just how far in from their original position
the fences can be moved.
No Ethics Culture: Stiffer Fines
In the interest of “erecting fences round the law” U.S.
Organizational Sentencing Guidelines provide incen-
tives in the form of mitigation of criminal fines and
penalties for companies that have strong compliance
programs and can demonstrate that its misfeasance
were the work of a few rogue actors. Further relief may
be available to companies that cooperate fully in prose-
cutorial investigations of bad practices.
A company whose board waived its own code of ethics
to permit a senior officer to serve as a general partner
for partnerships that were dealing with the company
and which may have shredded documents when a
Federal investigation was imminent is not a candidate
for sentencing guidelines leniency.
Enron and Product Liability
One might hypothesize that product liability has
nothing to do with Enron. Such a hypothesis would
be wrong.
Consider the cases of A.H. Robins Dalkon Shield and
Dow Corning Silicon Breast Implants, which raise issues
that are highly relevant to the Enron case. Because at
the time surgical implants, unlike pharmaceuticals, did
not require Federal Food and Drug Agency Approval,
both companies expected to find huge profits in unregu-
lated businesses in which they had no experience. Both
companies had highly defective corporate governance
structures. Robins was a tightly controlled family busi-
ness and Dow Corning was a joint venture that relied
for its directors on senior Dow and Corning executives.
Enron went hunting in the same tall grass. It traded
in energy futures and it successfully lobbied to exempt
energy futures trading from commodities trading regula-
tion. The company had no institutional expertise in
commodity trading but at least it knew something
about energy. What did Enron know about broadband
and pulp and paper?
Duties in Primary Markets
In a celebrated case American securities lawyers
commonly called Barchris, company directors relied
on the fact that earnings statements had been “exper-
tised”—approved by accountants— as a legal defense.
The Court said that this defense was not available. As
directors, they were expected to exercise prudence in
the management of the company’s affairs. They could
not sign off on a statement simply because the accoun-
tants had done so.
executive action the enron ethics breakdown
The ruling in Barchris suggests that the early skirmish-
ing between Enron and its accountants over responsibil-
ity may in the end not amount to very much. It is
unlikely that Arthur Andersen’s approval of financial
statements can insulate the company or its directors and
senior management from any liability—particularly since
the company was the source of the information in the
first place.
Developing a Successful
Corporate Ethics Culture
To be successful ethically, companies must go beyond
the notion of simple legal compliance and adopt a val-
ues-based organizational culture. Though companies
with a legal compliance approach may place lawyers at
the program’s helm, the value-based approach is cap-
tained by company managers. Narrowly circumscribed
rationale for company ethics programs has limitations,
and it is not responsive to many of the day-to-day con-
cerns that managers and employees typically confront.
And importantly, it goes against the healthy trends of
empowering employees in decision making.
Conference Board research shows that successful ethics
programs are rooted in organizational culture rather
than mandated by law. Developing effective anti-corrup-
tion programs and strategies entails the promotion and
maintenance of a culture of compliance. Four elements
are essential in a compliance culture:
High Level Commitment—High profile CEO and
Board involvement is essential. But companies with
successful programs are much more likely to have
other senior executives such as the General Counsel,
the Chief Financial Officer, and Chief Internal Auditor
play a significant role. Country managers also
participate in all phases (development, implementation,
monitoring) of company efforts.
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 Statements, Policies and Operating Procedures— About the Author
Successful companies are much more likely to have Ronald E. Berenbeim is a Principal Researcher and
an anti-corruption statement and detailed procedures Director of The Conference Board’s Working Group
for disseminating it widely to employees, suppliers, on Global Business Ethics Principles. An authority on
and joint venture partners. These efforts are often business ethics and corporate governance issues,
supported by training and discussion groups and Mr. Berenbeim is a graduate of Cornell University;
suppliers and joint venture partners are more likely Balliol College, Oxford University (Keasbey
to be bound by the company’s ethics policies. Scholarship); and Harvard Law School. Mr. Berenbeim
is currently an Adjunct Professor at the Stern School
Management Responsibility, Supervision and
of Business, New York University, where he teaches
Resources—Corporate involvement in company
Markets, Ethics and Law.
anti-corruption efforts is heavy. According to a
Conference Board survey about half of the companies
with successful programs manage their initiative
directly, while slightly more than one-third issue
guidelines to local offices and require country
managers to certify compliance with corporate policy.
For more details on Global Corporate Ethics
The small remaining group coordinate local initiatives
see these Conference Board reports:
from company headquarters.
Company Programs For Resisting Corrupt Practices:
Record Keeping, Reporting and Whistleblowing— A Global Study R-1279-00-RR
These are the least well developed elements of most
Global Corporate Ethics Practices:
programs. Successful companies regard compliance A Developing Consensus R-1243-99-RR
certification and the reporting of questionable
practices to be critical to the success of their
initiatives. Low employee utilization of whistleblowing
systems (hotlines) continues to be a problem, but
major business and labor advisory committees to the
OECD have endorsed them on the grounds that it is
better to “encourage staff to raise worries within the
organization than to put people in the position where
they feel driven to approach the media.”

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