[a] What are the responsibilities of a company’s board of directors? [b] Could the board of directors at Enron—especially the audit committee—have prevented the fall of Enron? [c]Should they have known about the risks and apparent lack of independence with Enron's SPEs? What do you think they should have done about it?

Question

What will be an ideal response?

Answer 1

[a] The board of directors is responsible for ensuring that a firm’s management is acting in the best
interest of the firm’s owners. As such, directors can be held liable by shareholders and others if they
are negligent in their duties.
[b] Although we will never know if the board of directors could have prevented the fall of Enron,
the board could have taken several steps to improve corporate governance. In a recent report by
the U.S. Senate Permanent Subcommittee of Investigation, the Subcommittee placed a good deal
of blame on the board of directors and the audit committee and recommended that boards take
several steps to improve corporate governance. The overall recommendations from that report
follow:
“Based upon the evidence before it and the findings made in this report, the U.S. Senate Permanent
Subcommittee on Investigations makes the following recommendations:
“(1) Strengthening Oversight. Directors of publicly traded companies should take steps to:

(a) prohibit accounting practices and transactions that put the company at high risk of non-
compliance with generally accepted accounting principles and result in misleading and inaccurate

financial statements;
(b) prohibit conflict of interest arrangements that allow company transactions with a business owned
or operated by senior company personnel;
(c) prohibit off-the-books activity used to make the company’s financial condition appear better
than it is, and require full public disclosure of all assets, liabilities and activities that materially
affect the company’s financial condition;
(d) prevent excessive executive compensation, including by
(i) exercising ongoing oversight of compensation plans and payments;
(ii) barring the issuance of company-financed loans to directors and senior officers of the
company; and
(iii) preventing stock-based compensation plans that encourage company personnel to use
improper accounting or other measures to improperly increase the company stock price for
personal gain; and
(e) prohibit the company’s outside auditor from also providing internal auditing or consulting
services to the company and from auditing its own work for the company.

“(2) Strengthening Independence. The Securities and Exchange Commission and the self-
regulatory organizations, including the national stock exchanges, should:

(a) strengthen requirements for Director independence at publicly traded companies, including by
requiring a majority of the outside Directors to be free of material financial ties to the company
other than through Director compensation;
(b) strengthen requirements for Audit Committees at publicly traded companies, including by
requiring the Audit Committee Chair to possess financial management or accounting expertise,
and by requiring a written Audit Committee charter that obligates the Committee to oversee the
company’s financial statements and accounting practices and to hire and fire the outside auditor;
and
(c) strengthen requirements for auditor independence, including by prohibiting the company’s
outside auditor from simultaneously providing the company with internal auditing or consulting
services and from auditing its own work for the company.”2
Many of these calls for change have been added to listing requirements for NYSE and NASDAQ
registrants. Some of these calls have been addressed by Congress in the Sarbanes-Oxley Act.
[c] The board may have been able to discover the risks and lack of independence of Enron's SPEs if
it had followed the recommendations listed above. However, the inherent limitations of boards of
directors must be understood. They meet only periodically, do not have an independent investigative
arm (and thus rely on management, internal and external auditors, and general counsel for accurate
information), and do not monitor the companies they serve on a full-time basis.