Case Study: Enron Scandal

Case Study: Enron Scandal

Enron Leaders

Jeffrey Keith Skilling:- He was the former CEO of the Enron Corporation.In 2006, Skilling was found guilty on nineteen of twenty eight-counts which includes securities and wire fraud. On October 23, 2006, Skilling was sentenced to 24 years and 4 months in prison.

Kenneth Lay :-He was the CEO and chairman of Enron Corporation. Lay was convicted to all 10 charges he faced (securities and wire fraud) and subject to a maximum of 45 years in prison.

• It claimed revenues of nearly $111 billion during 2000.

• One of the world's major electricity, natural gas, communications, and pulp and paper companies.

• Its major products include:-

Plastics

Power

Pulp and paper

Steel

Enron History

Andrew Stuart Fastow:- He was was the chief financial officer of Enron Corporation, Fastow was one of the key figures behind the complex web of off-balance-sheet special purpose entities (limited partnerships which Enron controlled) used to conceal Enron's massive losses in their balance sheets. Andy was sentenced 10 years without parole in exchange of testifying against Lay, Skilling and other former Enron executives.

• Enron Corporation was an American energy, commodities, and services company based in Houston, Texas.

• It was formed with the merge of Houston Natural Gas with Internorth.

• Enron employed approximately 20,000 staff and was one of the world's major electricity, natural gas, communications, and pulp and paper company.  

Enron Success

• As Enron became the largest seller of natural gas in North America by 1992, its trading of gas contracts earned $122 million (before interest and taxes), the second largest contributor to the company's net income.

• The November 1999 creation of the EnronOnline trading website allowed the company to better manage its contracts trading business.

• In an attempt to achieve further growth, Enron pursued a diversification strategy.

• The company owned and operated a variety of assets including gas pipelines, electricity plants, pulp and paper plants, water plants, and broadband services across the globe.

• The corporation also gained additional revenue by trading contracts for the same array of products and services with which it was involved.

Sarbanes-Oxley Act

Sarbanes-Oxley Act is a US federal law that came after the Enron scandal. The act contains a set of standards that regulate public company boards, management and public accounting firms. Some of the main regulations is that all companies must have a majority of independent directors, nominating and compensation committee has to have independent directors also the audit committee should consist of members that are financially educated and one of the members have to been an expert

Enron Downfall

There are many factors for the downfall:

• Mark to market accounting
• Special Purpose Entities
• Aggressive Nature of Enron

Enron's auditor, Arthur Andersen, was found guilty in a United States District Court of illegally destroying documents relevant to the SEC investigation which voided its license to audit public companies, effectively closing the business. Arthur Andersen was one of the five largest audit and accountancy partnerships in the world.

Case Study:

Enron Scandal

Mark-to-Market Accounting

Conclusion

• The mark-to-market method requires estimations of future incomes when a long-term contract is signed. These estimations were based on the future net value of the cash flow.
• This means that the estimated income from projects were included in Enron's accounting even though the money was not yet received.
• Investors were given misleading information because of the deviation in the estimations.

The Enron scandal, revealed in October 2001, eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas.

Many executives at Enron were indicted for a variety of charges and some were later sentenced to prison.

Introduction of Enron -Marc

Enron Leaders -Megha

Enron Success -Jumana

Enron Downfall -Ashwini

Question and Conclusion -Dhiraj

• From their comments it appears that Enron and the banks both believed that what they were doing was legal and acceptable.

• Enron was engaged with highly reputed firms such as Citigroup, J. P. Morgan and Merrill Lynch and used prepays. Prepays were basically loans that Enron booked as operating cash flow. Enron secured new prepays to pay off existing one and to support rapidly expanding investments in new business.

• The use of mark-to-market accounting later backfired. The company's aggressive accounting had corrupted Enron's books and had allowed the company to be far too optimistic in it's assumptions about the future profits. Cash is a necessity for any company to run and Enron mostly had paper revenue, so by the middle of 2001, they came to the conclusion that the cash crisis had struck them.

Special Purpose Entities (SPEs)

• An elaborate process was set up in order to hide the losses and the company's debt so that it would appear to be profitable.

The investment banks advising Enron did

this for them making large profits for

themselves.

• The intention was to hide losses and debt and to show a profit, while at the same time borrowing more money. This money would not have been forthcoming had investors known the true state of affairs.

• Special purpose entities are legal entities that are created only to carry out a specific or temporary task. The purposes are to handle assets either by funding or by risk management.
• A sponsor creates the entities but the funding comes from investors.
• In Enron's case the special purpose entities were not only used to dodge the traditional accounting conventions but also so they could hide debts.
• The entities made it possible for Enron to underestimate, hide, its debts and overestimate its equity.

How did the investment banking community contribute to the ethical collapse of Enron?

• In order to hide losses and fabricate earnings, Andrew Fastow created multiple SPEs.
• Some SPE's are Chewco, LJM1, LJM2 and Raptor. When news about the debt hiding surfaced, Enron's stock began to fall and several SPEs began to collapse as a result of the drop of Enron's stock price.

Performance review committee

Role of Investment & Commercial Banks

• Performance review committee was also a factor why employees in Enron were so aggressive. It created a culture within Enron that replaced cooperation with competition.

• The committee gave ratings from 1 to 5, 1 being the highest and in Enron, the 1 mark meant that you will get a good sum of bonus.

• Enron paid several hundred million in fees, including fees for derivatives transactions.
• None of these firms alerted investors about derivatives problems at Enron.
• In October, 2001, 16 of 17 security analysts covering Enron still rated it a “strong buy” or “buy.”
• Example: One investment advisor purchased 7,583,900 shares of Enron for a state retirement fund, much of it in September and October, 2001.

Sherron Watkins

Sherron Watkins  was Vice President of Corporate Development at the Enron Corporation. Watkins testified about her role in the Enron fraud before committees of the U.S. House of Representatives and Senate at the beginning of 2002

Timeline of Enron’s Collapse