ENRON: The Rise &

Collapse

ANIKA MARY VARKEY

ASB|PGDM 15
ROLL NO: 18

CONTENTS
TOPICS

SLIDE NO

ENRON

ENRON: LINE OF BUSINESS

ENRON SCANDAL

5-6

KEY ISSUES

7- 26

KEY PLAYERS

27-34

WHO ALL ARE AFFECTED?

34-38

ETHICAL ISSUES

39-41

AFTERMATH OF ENRON SCANDAL

42-43

CONCLUSION

44

LEARNINGS

45

REFERENCES

46
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ENRON

Houston based natural gas pipeline company formed by merger of

Houston Natural Gas & Inter north natural gas in 1985.

The 1st nationwide natural gas pipeline network.

One of the world's major electricity, natural gas, communications, and

pulp and paper companies.

Employed approximately 20,000 staff

Dramatic growth: From 1998-2000, its revenues grew from $31 billion
to more than $100 billion, Assets grew 38%, revenues grew more
than 60%, and earnings grew 12%.

Named Enron "America's Most Innovative Company" for six

consecutive years by Fortune.

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ENRONS LINE OF BUSINESS

Enron was originally involved in transmitting and distributing

electricity and natural gas throughout the United States.

The company developed, built, and operated power plants and

pipelines while dealing with rules of law and other infrastructures
worldwide.

Enron owned a large network of natural gas pipelines, which stretched

ocean to ocean and border to border.

Traded in more than 30 different products.

Entered into derivative business.

By 2000, even stepped into the dot.com business

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ENRON SCANDAL

In March 2001, a investment agency boss publicly doubts the profitability

model of Enron, the stock price decrease from $80 to 42$ . Media
questioned share prices.

August CEO, Skilling resigned; Lay took over. Lay makes a false claim
about financial health.

On October 16, 2001, in the first major public sign of trouble, Enron
announces a huge third-quarter loss of $618 million.

On October 22, 2001, the Securities and Exchange Commission (SEC)

begins an inquiry into Enrons accounting practices.

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8, Nov. Enron was forced to admit false accounts- total false profit was

nearly $600 million since 1997.

ENRON SCANDAL

At the end of 2001, it was revealed that its reported financial condition
was sustained substantially by institutionalized, systematic, and
creatively planned accounting fraud, known as the "Enron scandal.

After a series of revelations involving irregular accounting procedures

conducted throughout the 1990s, Enron was on the verge of
bankruptcy by November of 2001.

30, Nov. stock price falls to $0.26 per share

A white knight rescue attempt by a similar, smaller energy company,

Dynegy, was not viable. Company tries to sell itself to Dynegy for $8.9
Bn; unsuccessful.

On December 2, 2001, Enron files for bankruptcy.

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KEY ISSUES

Deregulation: Tentacles in Politics

Financial issues

Auditing issues

Security Analyst issue

Corporate Culture

Corporate Governance issue

Leadership Failure

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DEREGULATION

Energy companies lobbied congress in the 1980s for deregulation

of the energy business.

Through large contributions towards election campaignsInfluenced policy making.

Energy policy was changed and Washington lifted controls on who

could produce energy and how it was sold .

Jeff Skilling took an aggressive approach to expand Enron by

trading futures in gas contracts.

Creation of natural gas bank by Jeff Skilling.

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DEREGULATION

Under Skillings new plan, Enron bet against future movements in

the price of gas-generated energy

Enron bought and sold tomorrows gas at a fixed price today.

With every trade, Enron took a cut for transaction costs

Using the internet to promote trading, Enron became the most

successful player in the futures game; 90% of Enrons income came
from trades.

Being the first mover, Enron soon became a market marker for
gas: trading firm that stood ready to make deals in order to keep
the flow of trades going.

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DEREGULATION

Enrons trading functions immediately assumed by others.

Many other firms became well positioned to challenge Enrons

dominance, including large gas producers, such as Mobil, gas
marketers such as Coastal and Clearinghouse etc.

In comparable and deregulated markets, early rents to first-movers

had quickly dissipated as competitors entered.

The Internet provided a low-cost platform for existing or potential

competitors to develop energy markets that could compete with
Enron Online.
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FINANCIAL ISSUE

1993-2001: Enron also used complex & dubious accounting

schemes

to reduce Enrons tax payments;

to inflate Enrons income and profits;

to inflate Enrons stock price and credit rating;

to hide losses in off-balance-sheet subsidiaries;

to engineer off-balance-sheet schemes to funnel money to
themselves, friends, and family;

to fraudulently misrepresent Enrons financial condition in11/47

public reports.

FINANCIAL ISSUE
Mark-to-Market Accounting

Skilling demanded to change Enron's accounting system from a

straightforward kind of accounting were Enron had listed actual revenue and
costs of supplying and selling gas to the mark-to-market accounting system.

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. 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 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 the12/47
cash crisis had struck them.

FINANCIAL ISSUE
Special Purpose Entity:

Enrons rapid growth in late 1990s involved large capital investments

not expected to generate significant cash flow in short term.

Maintaining Enrons credit ratings at an investment grade was vital to

Enrons energy trading business.

One perceived solution: Create partnerships structured as special

purpose entities (SPEs) that could borrow from outside investors
without having to be consolidated into Enrons balance sheet.

SPE 3% Rule: No consolidation needed if at least 3% of SPE total

capital was owned independently of Enron.
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FINANCIAL ISSUE

Enrons creation of over 3000 partnerships started about 1993

when it teamed with Calpers (California Public Retirement
System) to create JEDI (Joint Energy Development
Investments) fund.

Enron initially thought of these partnerships as temporary

solutions for temporary cash flow problems.

Enron later used SPE partnerships under 3% rule to hide bad

bets it had made on speculative assets by selling these assets
to the partnerships in return for IOUs backed by Enron stock as
collateral! (over $1 billion by 2002)

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AUDITING ISSUES

Auditor- ResponsibleforensuringaccuracyofEnronsfinancialstatements
and internal bookkeeping.

Potential investors used Andersens reports to judge Enrons financial

soundness and future potential before they decided to invest.Expected
the certifications to be independent and free of conflicts of interest.

Andersens extensive consulting work for Enron have compromised its

independence and its judgment in determining the nature, timing, and
extent of audit procedures and in asking that revisions be made to
financial statements, which are the responsibility of Enrons management.

Andersen failed to ask Enron to explain its complex partnerships before

certifying Enrons financial statements.

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SECURITY ANALYST ISSUE

Securities analysts employed by investment banks provide research

and make buy, sell, or hold recommendations for the use of their
sales staffs and their investor clients.

These recommendations are widely circulated and are relied upon by

many investors throughout the markets.

Analyst support was crucial to Enron because it required constant

infusions of funding from the financial markets.

On November 29, 2001, after Enrons stock had fallen 99% from its
high, and after rating agencies had downgraded its debt to junk
bond" status, only two of 11 major firm analysts rated its stock a

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sell.

How did Enrons culture

foster fraudulent practices?

Enrons culture was apparently influenced by the leadership style of

Jeff Skilling who pressed for a cowboy capitalism structure.

In Enron, bonuses and incentives in form of cash or stock options

came in bundles, only if you were good enough and if you were
considered one of the money makers. This mentality made Enron a
very competitive work place.

Everyone was in a hurry to close deals (good or bad) because right

after a closed deal, they got their bonuses regardless of the result of
the deal. This became a problem since there were a lot of projects
being made but no follow-ups.

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How did Enrons culture

foster fraudulent practices?

Enron culture was heavily influenced by competition and since the

employees were motivated by fat bonuses and scared of getting
laid off if they did not perform well, and in effect resulted to an
unhealthy competition between the co-workers.

The colleagues would rather stab each other in the back than help
one another to close a deal. Employees getting paid in stock did
not help, neither the working environment nor the competition
among colleagues.
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How did Enrons culture

foster fraudulent practices?

The company did not respect integrity and actions of the top
management signalled winding up of ethical values. The fraud
culture was perpetuated through selection of new employees
and systematic indoctrination of people during daily
conversations, legends or official ceremonies.

It was rationalised by employees who consistently observed

the organization favouring leaders with unethical conduct.

The proven management control system crumbled as the risk

assessment and control (RAC) members themselves became 19/47
reluctant to decline projects fearing repercussions from

How did Enrons culture

foster fraudulent practices?

A culture of arrogance buoyed with intense internal competition and stock

option compensation schemes, soon led the Enron employees to tamper the
account books and create special entities to opaque the earnings and debt
levels.

The change of top leadership at Enron from Kinder to Jeffrey Skilling

virtually devastated the management control model promoted by Kinder.

Skillings aggressive style and unconcerned approach to business ethics led

people to change the track in accordance to his demands and show
performance or face the axe. His strong background and extreme capitalism
ideologies pressurized the employees and dented the prevalent RAC group.
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ENRONS CODE OF ETHICS

Respect: We treat others as we would like to be treated

ourselves. We do not tolerate abusive or disrespectful treatment.
Ruthlessness, callousness and arrogance dont belong here.

Integrity: We work with customers and prospects openly,

honestly and sincerely. When we say we will do something, we will
do it; when we say we cannot or will not do something, then we
wont do it.

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ENRONS CODE OF ETHICS

Communication: We have an obligation to communicate.

Here we take the time to talk with one another . . . and to
listen. We believe that information is meant to move and that
information moves people.

Excellence: We are satisfied with nothing less than the very

best in everything we do. We will continue to raise the bar for
everyone. The great fun here will be for all of us to discover
just how good we can really be.
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CORPORATE GOVERNANCE
ISSUE
The role of a companys board of directors is to oversee corporate
management to protect the interests of shareholders. Enrons board failed
to restrain the firms management from engaging in risky behaviour that led
to the firms failure.

Failed to ensure the equitable treatment of all shareholders, including

minority and foreign shareholders.

Failed to ensure that timely and accurate disclosure is made on all material
matters regarding the corporation, including the financial situation,
performance, ownership, and governance of the company.

Internal control mechanisms were short-circuited by conflicts of interest that

enriched certain managers at the expense of the shareholders.

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LEADERSHIP FAILURE
Moral

Failure at the Top- ethical shortcoming of Enron leaders.

Abuse
Excess

of Power eliminated corporate rivals and intimidated subordinates

Privilege

Deceit- manipulated information to protect their interest and to deceive public.

Inconsistent

Treatment of Internal and External Constituencies- Average

workers were forced to vest their retirement plans in Enron stock and then, during the crucial period
when the stock was in free fall, were blocked from selling their shares. Top executives, on the other
hand, were able to unload their shares as they wished.
Misplaced

and Broken Loyalties- Enron officials put their loyalty to themselves above

those of everyone else with a stake in the companys fate stock holders, business partners, rate
payers, local communities, foreign governments, and so on. They also betrayed the trust of those
who worked for them.
Irresponsible

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Behaviour - Enron officials acted irresponsibly by failing to take needed
action,

failing to exercise proper oversight, and failing to shoulder responsibility for the ethical miscues of

ETHICAL THEORIES &

LEADERSHIP
Altruism, Communitarianism, and Servant Leadership are three
ethical perspectives that drive leadership duties and responsibilities:

Altruism is a universal value that is particularly important to leaders

who, by virtue of their roles, are to exercise influence on behalf of
others. Leaders cannot articulate the concerns of followers unless
they first understand their needs.

Leaders driven by altruism pursue organizational goals rather than

personal achievement and are more likely to give power away.

But the Enron Leaders seek self-benefit focus on personal

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achievements, and controlled followers through coercion and reward.

ETHICAL THEORIES &

LEADERSHIP

Communitarianism emphasizes the need for individual and corporate

responsibility. Citizens and institutions have obligations to the larger
community. When making decisions, leaders and followers must look beyond
the immediate interests of themselves and their organizations to the needs
of the local community and society as a whole.

Servant leadership is a model that puts the needs of followers first.

Servant leaders continually ask themselves what would be best for their
constituents and measure their success by the progress of their followers.
Driven by a concern for people, they seek to treat others fairly and recognize
that they hold their positions in stewardship for others.

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KEY PLAYERS

Kenneth Lay

Former CEO of Enron, helped start the company.

He quit as CEO in February 2001 and returned as CEO in August 2001

until he resigned on Jan. 23, 2002.

Hemanagedtoconcealmassivedebtsthroughquestionableaccounting
.

Onknowingthe accounting scandals of the company and the possibility

of the collapse of the company, the CEO publicly re-assured the future
prospects of the company, but secretly he off-loaded his possession
of
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the Enron share in the market.

KEY PLAYERS

Kenneth Lay

He took advantage of the privileged information that was not

available to the general public and became guilty of insider trading.

Manipulated the off-balance-sheet partnerships to take on debts, hide

losses andkick-off inflated revenues while banning employees' stock
sales.

98 counts on him including fraud, money laundering, conspiracy and

obstruction of justice.
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KEY PLAYERS

Jeffrey Skilling

Enron's chief executive in the first half of 2001

Since joining the company in 1990, Skilling helped transform Enron

from a natural-gas pipeline company into an energy-trading
powerhouse.

Held equally responsible for The Enron scandal.

Hired accountants to do poor financial reporting in order to hide debts.

Involvement In : Government deregulations, Securities Fraud

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Between January and August 2001 he sold off about $20 million

Enron stock

KEY PLAYERS

Andrew Fastow

Brighter Side

Darker Side
Fastow joined Enron in 1990 And
Fastow was accused of being
took it to soaring hieghts.
mastermind behind the deceptive
Enron's chief executive in the
accounting practices.
first half of 2001
He surrendered $30 million dollars
Former Chief Financial Officer of
in cash and also accepted 10
Enron
years
His expertise awarded him CFO
Lea Fastow (his wife) also plead
excellence award for capital
guilty to signing and filing a tax
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structure management.
return that did not include income

KEY PLAYERS
Arthur & Andersens

Enron's chief auditor

He is accused of ordering the shredding of thousands of Enron-related

documents in an effort to hide them from SEC investigators.
Arguments about conflict of interest had been thrown at Andersen
since they acted as both auditors and consultants to Enron.

Andersen Also Provided Consulting Services, Helping Set Up And Opine

On The Validity Of Enron`s SPEs Under Accounting Rules .

The company earned large fees from its audit work for Enron and
from related work as consultants to the same company.

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KEY PLAYERS
Investment Banks

Credit Suisse First Boston (CSFB) played a central role in creating the
controversial partnerships that Enron used to hold billions of dollars of
unprofitable assets and that eventually contributed to its bankruptcy.

Another US investment bank, JP Morgan Chase, was a major lender to

Enron. Loan losses related to Enron contributed to the bank's 2001
fourthquarter loss around $ 332 million and JP Morgan was forced to
put aside another $ 510 million in case of future loan defaults.

JP Morgan is also under probe by federal prosecutors as to whether the

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bank could have helped Enron disguise loans as part of its normal

trading.

KEY PLAYERS
Credit Rating Agencies
Credit rating agencies like Moodys, Standard & Poors and Fitch
IBCA, whose main duty is to provide guidance to investors on a
borrowers' creditworthiness i.e. inform investors how risky buying a
companys bonds might be, failed to spot any problems with Enron
until the company was nearly bankrupt.

The Government
According to reports, 35 administration officials have held Enron
stock, some had six figure investments. Several, less senior officials,
have served as paid consultants for Enron. Enron donated more than $
500,000 to the Bush campaign, thus making Enron the Presidents33/47
largest single patron. Bush has championed some issues Enron

The Whistle Blower

Sherron Watkins, an Enron vice-president, wrote an anonymous

letter to Kenneth Lay setting out her fears of an impending
scandal.

Against Watkins letter Lay, the CEO ,arranged to have a ENRONS

Law Firm Vinson and Elkins that looked after all questionable
deals.

Watkins continued to do her work.

In February 2002,she revealed the various facts regarding ENRON
partnerships and finally resigned in November.
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Not really a whistle-blower because she never went public with

WHO ALL ARE AFFECTED?

Stockholders: Shareholders lost their investment as Enrons stock

plummeted.Enron's shareholders lost $70 billion .

The Executive Management: A number of former Enron executives have

been accused of wrongdoings or at least failing to steward the interest of the
companys stakeholders. A few of them have been prosecuted. As a result,
their reputations have been ruined.

Customers : Customers were left in wilderness as the services shut down.

Houston community got affected by loss of jobs and sinking of share wealth.
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WHO ALL ARE AFFECTED?

Enron employees: Most employees of Enron have lost their jobs

as well as their lifetime retirement savings as a result of the
companys collapse. Employees contributed to the company
401(k) retirement plan suffered considerable from the companys
bankruptcy. Employees were not given a chance to sell their
stocks in the companys 401(k) plan while the executives did so.

Creditors: Since the company declared bankruptcy, numerous

creditors will have to wait for restructuring agreements, and they
will likely receive pennies on the dollar, if anything.
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WHO ALL ARE AFFECTED?

International accounting firm of Arthur Anderson: The scandal

resulted in the dissolution of Arthur Anderson, which was one of the five
largest audit and accountancy partnerships in the world because its
involvement in shredding some important Enron documents even after
the warning from the SEC. It is alleged that Andersen, as a virtual arm
of Enron, took part in the clients aggressive and fraudulent maneuvers.

Competitors: Generally, a collapse of a firm would boost the

businesses of its competitors. The Enrons debacle, however, had a
negative impact on its competitors in the same industry by losses in
their stock values. Investors have drawn a parallel between the Enrons
energy trading and other firms similar businesses.

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WHO ALL ARE AFFECTED?

Business firms at large: The accounting and financial malpractices at

Enron have created a wave of suspicion about the way that many
American companies disclose their financial information. This reflection
has been costly for a number of companies. Investors have become
sceptical about the practices of especially large and conglomerate
companies.

Governmental bodies: Governmental regulatory agencies (e.g. the

Securities and Exchange Commission) are also blamed for not effectively
scrutinizing Enrons misconduct of its finances and accounting activities.

To a great extent the economy as a whole

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ETHICAL ISSUES

Transparency: This scandal clearly illustrates the lack for

transparency and thorough auditing within organizations. The
deontologist insist that it is the duty of executive management to offer this
transparency to the stakeholders that they serve. This duty corresponds to
the positional rights granted through the position as an executive.

Failure to perform ethically: Stakeholders invested in an organization

expect executive management to fulfil their positional duties of serving
the best interests of the company in an ethical and transparent manner.
This scandal could have been prevented if Arthur Anderson had fulfilled
their duty to audit the companys financial statements accurately.
Executive management motives were not aimed exclusively towards
benefiting the organization.

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ETHICAL ISSUES

Fiduciary failure: The Enron Board of Directors failed to safeguard Enron

shareholders by allowing Enron to engage in high risk accounting,
inappropriate conflict of interest transactions, extensive undisclosed offthe- books activities, and excessive executive compensation.

Lack of Independence: The independence of the Enron Board of

Directors was compromised by financial ties between the company
and certain Board members. The Board also failed to ensure the
independence of the company's auditor, allowing Andersen to provide
internal audit and consulting services while serving as Enron's outside
auditor.
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ETHICAL ISSUES

Inappropriate Conflicts of Interest: conflict of interest between

the two roles played by Arthur Anderson

Insider trading:

Insider

Trading generally refers to the practice of buying or

selling securities on the basis of non-public information that one

has obtained as an insider.

Linda, Lays wife, sold roughly 500,000 shares of Enron ten

minutes to thirty minutes before the information that Enron was
collapsing went public.

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The lack of truthfulness by management about the health of

SARBANES-OXLEY ACT

Enron - the catalyst for the Sarbanes-Oxley legislation.

Sarbanes-Oxley provides for increased corporate governanceandcorporate

accountability.

SOX is in place to be sure that fraud on the scale of Enron never takes place
again.

The intent of the SOX Act was to protect investors and all stakeholders in a
business firm, by improving the accuracy and reliability of corporate disclosures.

The SOX Act holds company CEOs and CFOs responsible for the information
presented by their company in the financial statements.

It created new standards of accountability for corporations as well as penalties

for those standards of accountability that are not met.

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Getting Rid of SPE 3% Rule

SPE 3% Rule: Rule permitting Special Purpose Entities (SPEs)

created by a firm to be treated as off balance-sheet i.e., no
required consolidation with firms balance sheets as long as at
least 3% of the total capital of the SPE was owned independently
of the firm.

Rule raised to 10% in 2003 following Enron scandal

After more misuse of rule during Subprime Financial Crisis,

Financial Accounting Standards Board (FASB) replaced this rule in
2009 with stricter consolidation standards on all asset reporting
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(FASB 166 & 167).

CONCLUSION
The crash of Enron was caused by the negligent mismanagement of
resources of corporate managers and some key stakeholders.

Many people such as retirees and employees were hurt financially by the
collapse of this institution.

There were internal factors such as poor leadership and external oversights
by the government regulators who failed to act, that could have prevented
this nightmare from taking place.

Ultimately, the corporate managers, stakeholders, and policy makers

collective failure allowed this to happen.

Preventative measures by each of these levels, with the appropriate

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oversight and intervention, will prevent similar events from happening
in the

LEARNING

Securitization and other legitimate structured finance deals have to be disclosed

with sufficient depth and detail to adequately inform sophisticated investors.

Management has to be free of material conflicts of interest because

private investors rely on their business judgment.

Concern over conflict of interest between auditing and consulting raises the
need for accounting firms to separate their consulting activities from
their auditing businesses.

The importance of taking corporate codes of conduct seriously and

carefully thinking through their implementation.

There should be a healthy corporate culture in a company.

Intense rivalry tends employees to be disloyal and unethical.

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REFERENCE

The Enron scandal: Chalmers University of Technology

Fraud Case Analysis: Enron Corporation

Enron: The Fall from Grace/ The Worlds Biggest Fraud

The Enron Collapse: An Overview of Financial Issues

The Case Analysis of the Scandal of Enron

The Fall of Enron: Paul M. Healy and Krishna G. Palepu

Reasons of Systemic Collapse in Enron

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