Hiding from Plain Sight:

Breakdown at Enron (2001)

& Satyam (2009)
Business Ethics Assignment

Vishal Bansal | 0445/52

Abstract

In 2001, America's 'most innovative' energy company declared bankruptcy, a year after
claiming revenues of $111 billion. 8 years later, Indian IT major, Satyam Computer Services,
founded by the 'rags to riches' success story Ramalinga Raju, accepts falsification of accounts
to the tune of $1.37 billion. What prompted these actions? Were the moral implications of
these actions ever considered? Were the ideals of transparency in accounting practices & in
general (to stakeholders) revised after these events? How did this shape the study of business
ethics for future managers?

This report will aim to answer the above mentioned questions, providing the chronological
set of events in both cases. These two cases have been chosen in particular due to the
similarities in fraudulent practices but stark contrast pertaining to industries, geographies &
aftermath.

Case Background

Enron Corporation

Founded as HNG/InterNorth Inc. in 1985, Enron Corporation was an American energy,

commodities, and services company based in Houston, Texas. Enron was one of the world's
major electricity, natural gas, communications, and pulp and paper companies with claimed
revenues of nearly $111 billion during 2000. Fortune named Enron "America's Most
Innovative Company" for six consecutive years.

However, at the end of 2001, it was revealed that it’s reported financial condition was
sustained substantially by a meticulously planned accounting fraud, known since as the Enron
scandal. This brought into question the dubious accounting practices followed by firms across
the United States & laid cornerstone to the enactment of the Sarbanes-Oxley act of 2002.
Enron has since become a well-known case of corporate collapse following the violation of
ethics in a business environment.

Following are the key events surrounding the collapse (listed chronologically),

1985 - Texas based American Company Houston Natural Gas merges with InterNorth, a
natural gas company from Omaha forming HNG/InterNorth Inc. HNG CEO Kenneth Lay
takes charge as CEO the following year & renames to Enron Corporation.
1990 - Lay hires Jeffrey Skilling to lead Enron's commodities trading practice in the
deregulated markets. Skilling hires Andrew Fastow later that year.

1997 - Skilling becomes president and chief operating officer of Enron. Fastow creates
Chewco, a partnership to acquire University of California pension fund’s stake in another
joint venture named JEDI. However, Chewco is kept off Enron’s balance sheet, inflating
profits. First instance of corporate fraud.

1998 - Fastow becomes CFO.

1999- Fastow creates LJM, first of the two partnerships to “buy” poorly performing Enron
assets & hedge risky investments, but in fact aids the company to hide debt & inflate profits.
Fastow’s plan to run partnerships that do deals with Enron while continuing as financial chief
approved by Enron directors. Chief accounting officer Causey and former chief risk officer
Rick Buy assigned to monitor such deals to protect Enron's interests.

2000 - Skilling, then president and chief operating officer, to succeed Kenneth Lay as CEO in
February 2001. Lay will remain as chairman. Stock hits 52-week high of $84.87.

2001:

Aug. 14 - Skilling resigns; Lay named CEO again.

Aug. 22 - Finance executive Sherron Watkins meets privately with Lay to discuss concerns of
murky finance and accounting that could ruin the company.

Oct. 16 - Enron published its earnings report for the third quarter reporting $638 million in
losses & $1.2 billion reduction in net asset value largely due to partnership contracts, for
which Fastow was responsible.

Oct. 19 - Securities and Exchange Commission launches inquiry into Enron’s finances &
conflicts arising from the partnership contracts.

Oct. 22 - Enron acknowledges SEC inquiry into a possible conflict of interest related to the
company's dealings with Fastow's partnerships.

Nov. 5 - Enron treasurer Ben Glisan Jr. and in-house attorney Kristina Mordaunt fired for
investing in Fastow-run partnership. Each invested $5,800 in 2001 and received a $1 million
return a few weeks later.
Nov. 8 - Enron files documents with SEC revising its financial statements for previous five
years to account for $586 million in losses.

Nov. 19 - Enron restates its third-quarter earnings and discloses a $690 million debt is due
Nov. 27.

Nov. 28 - Enron stock plunges below $1 as Dynegy Inc. aborts its plan to buy its former rival.

Dec. 2 - Enron goes bankrupt, thousands of workers laid off.

Later, 16 people pleaded guilty of the charges brought against them. Andrew Fastow, the
chief financial officer, was among the five who turned approvers. Kenneth Lay, the CEO, and
Jeffrey Skilling, the chief operating officer, contested the charges, and were convicted in
2006 — less than five years after the scandal surfaced.

Satyam Computers Pvt. Ltd.

Founded in 1987 by Ramalinga Raju, Satyam Computers Private Ltd. was business process
outsourcing (BPO) and consultancy in several IT, engineering and management departments
based in Andhra Pradesh, India. Satyam soon escalated the corporate ladder to be recognized
as the fourth largest IT company in India. Prominent Fortune 500 companies such as Nestle,
GE and GM featured on Satyam’s client list.

On January 7th 2009, Ramalinga Raju admitted that he had been showing nonexistent profits
on the company’s books for the past several years. Satyam’s shares plunged to Rs.11.90
compared to a high of Rs.544 the previous year following the news. The incident, popularly
referred to as ‘India’s Enron Scandal’ raised questions about the standards of transparency &
ethics in India’s corporate sector. The company was taken over by Tech Mahindra in April
2009, four months after the incident.

Following are the key events surrounding the growth & subsequent collapse of the
company(listed chronologically),

1987: Ramalinga Raju with his brother and brother-in-law establishes Satyam Computer in
Hyderabad.

1991: The Company is listed on the Bombay Stock Exchange, IPO oversubscribed by as
much as 17 times.
1999: Satyam Infoway, a subsidiary of Satyam Computer, becomes the first Indian
information and communication technology company to be listed on NASDAQ, and Satyam
expands footprint to 30 countries.

2006: Satyam’s revenues cross $1 billion. Raju becomes the chairman of industry body, The
National Association of Software and Services Companies.

2008: Satyam’s revenues cross $2 billion. In December, the company decides to buy out
Maytas Infra—owned by Raju’s sons—for $1.6 billion. The deal falls through after investors
and board members object, and in a span of four days, four directors of the company quit.
(Maytas is Satyam spelt backwards.)

January 2009: Satyam is barred from doing business with the World Bank for eight years.
The World Bank alleges that Satyam was involved in data thefts and staff bribery. Shares fall
to record low in four years. Satyam employees receive a letter from Raju admitting to the
fraud, following which he resigns as chairman.

Raju and his younger brother B Rama Raju are arrested by police, while the Indian
government steps in and disbands Satyam board.

June 2009: Tech Mahindra, owned by the Mahindra Group, and Satyam merge to form
India’s fifth largest IT exports company. The merged entity is called Mahindra Satyam.

November 2011: Raju gets bail from India’s Supreme Court after the CBI fails to file charge-
sheet.

October 2013: India’s enforcement directorate files a charge-sheet against Raju and 212
others under money-laundering charges.

July 2014: India’s market regulator SEBI bars Raju from the capital markets for 14 years, and
also seeks Rs1, 849 crore as fine.

Later, the special CBI court holds Raju and nine other officials guilty of cheating. Among
those held guilty are two former partners at PwC. Raju, who also has to pay a fine of about
$800,000 (Rs5 crore), has served 32 months in prison so far.
Understanding the Cause

Enron Corporation

Enron had a 64 page Code of Ethics based on respect, integrity, communication, and
excellence. These values were described as follows:

Respect. We treat others as we would like to be treated ourselves. We do not tolerate abusive
or disrespectful treatment. Ruthlessness, callousness and arrogance don’t 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 won’t do it.

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.

Despite this & Ken Lay’s professed commitment to business ethics, Enron still managed to
perpetrate one of corporate world’s biggest frauds, bringing us to the question as to what
really triggered these actions, if not the absence of a strict code of ethics.

The answer to this question seems to be rooted in a combination of the failure of top
leadership & a corporate culture that supported unethical behavior.

Enron’s Top Leadership

In the aftermath of Enron’s bankruptcy filing, numerous Enron executives were charged with
criminal acts, including fraud, money laundering, and insider trading. For example, Ben
Glisan, Enron’s former treasurer, was charged with two-dozen counts of money laundering,
fraud, and conspiracy. Glisan pled guilty to one count of conspiracy to commit fraud and
received a prison term, three years of post-prison supervision, and financial penalties of more
than $1 million. During the plea negotiations, Glisan described Enron as a “house of cards.”

Andrew Fastow, Jeff Skilling, and Ken Lay are among the most notable top-level
executives implicated in the collapse of Enron’s “house of cards.” Andrew Fastow, former
Enron chief financial officer (CFO), faced 98 counts of money laundering, fraud, and
conspiracy in connection with the improper partnerships he ran, which included a Brazilian
power plant project and a Nigerian power plant project that was aided by Merrill Lynch, an
investment banking firm. Fastow pled guilty to one charge of conspiracy to commit wire
fraud and one charge of conspiracy to commit wire and securities fraud. He agreed to a prison
term of 10 years and the forfeiture of $29.8 million. Jeff Skilling was indicted on 35 counts of
wire fraud, securities fraud, conspiracy, making false statements on financial reports, and
insider trading. Ken Lay was indicted on 11 criminal counts of fraud and making misleading
statements. Both Skilling and Lay pled not guilty and are awaiting trial.

The activities of Skilling, Fastow, and Lay raise questions about how closely they
adhered to the values of respect, integrity, communication, and excellence articulated in the
Enron Code of Ethics. Before the collapse, when Bethany McLean, an investigative reporter
for Fortune magazine, was preparing an article on how Enron made its money, she called
Enron’s then-CEO, Jeff Skilling, to seek clarification of its “nearly incomprehensible
financial statements.” Skilling became agitated with McLean’s inquiry, told her that the line
of questioning was unethical, and hung up on McLean. Shortly thereafter Andrew Fastow and
two other key executives traveled to New York City to meet with McLean, ostensibly to
answer her questions “completely and accurately.”

Fastow engaged in several activities that challenge the foundational values of the
company’s ethics code. Fastow tried to conceal how extensively Enron was involved in
trading for the simple reason that trading companies have inherently volatile earnings that
aren’t rewarded in the stock market with high valuations—and a high market valuation was
essential to keeping Enron from collapsing. Another Fastow venture was setting up and
operating partnerships called related party transactions to do business with Enron. In the
process of allowing Fastow to set and run these very lucrative private partnerships, Enron’s
board and top management gave Fastow an exemption from the company’s ethics code.

Contrary to the federal prosecutor’s indictment of Lay, which describes him as one
of the key leaders and organizers of the criminal activity and massive fraud that lead to
Enron’s bankruptcy, Lay maintains his innocence and lack of knowledge of what was
happening. He blames virtually all of the criminal activities on Fastow. However, Sherron
Watkins, the key Enron whistleblower, maintains that she can provide examples of Lay’s
questionable decisions and actions. As Bethany McLean and fellow investigative reporter
Peter Elkind observe: “Lay bears enormous responsibility for the substance of what went
wrong at Enron. The problems ran wide and deep, as did the deception required in covering
them up. The company’s culture was his to shape.” Ultimately, the actions of Enron’s
leadership did not match the company’s expressed vision and values.

Enron’s Corporate Culture

Enron has been described as having a culture of arrogance that led people to believe that they
could handle increasingly greater risk without encountering any danger. According to
Sherron Watkins, “Enron’s unspoken message was, ‘Make the numbers, make the numbers,
make the numbers—if you steal, if you cheat, just don’t get caught. If you do, beg for a
second chance, and you’ll get one.’” Enron’s corporate culture did little to promote the values
of respect and integrity. These values were undermined through the company’s emphasis on
decentralization, its employee performance appraisals, and its compensation program.

Each Enron division and business unit was kept separate from the others, and as a
result very few people in the organization had a “big picture” perspective of the company’s
operations. Accompanying this emphasis on decentralization were insufficient operational
and financial controls as well as “a distracted, hands-off chairman, a compliant board of
directors, and an impotent staff of accountants, auditors, and lawyers.”

Jeff Skilling implemented a very rigorous and threatening performance evaluation

process for all Enron employees. Known as “rank and yank,” the annual process utilized peer
evaluations, and each of the company’s divisions was arbitrarily forced to fire the lowest
ranking one-fifth of its employees. Employees frequently ranked their peers lower in order to
enhance their own positions in the company.

Enron’s compensation plan “seemed oriented toward enriching executives rather

than generating profits for shareholders” and encouraged people to break rules and inflate the
value of contracts even though no actual cash was generated. Enron’s bonus program
encouraged the use of non-standard accounting practices and the inflated valuation of deals
on the company’s books. Indeed, deal inflation became widespread within the company as
partnerships were created solely to hide losses and avoid the consequences of owning up to
problems.

In all, As Salter remarks “Enron is a case about how a team of executives, led by Ken Lay,
created an extreme performance-oriented culture that both institutionalized and tolerated
deviant behavior. It's a story about a group of executives who created a world that they could
not understand and therefore could not control.”

“It's a story about the delinquent society—and I use that phrase intentionally—that grew up
around the company, and here I'm referring to the collusion of Enron's various advisors and
financial intermediaries. And most importantly, Enron is a story about how fraud is often
preceded by gross incompetence: where the primary source of that incompetence is
inexperience, naiveté, an ends-justify-the-means attitude toward life, and so on. And most
importantly, an inability to face reality when painful problems arise."

While we acknowledge that the company have a written code of ethics, the leadership
certainly lacked the competence to implement it leading to a culture which prioritizes success
over ethics.

Satyam Computer Pvt. Ltd.

Although the corporate sector in both India and the U.S. is based on the Anglo- Saxon model,
there are some very important distinctions that need to be made. Culturally speaking, India,
like other Asian countries, is notorious for corruption, cronyism and nepotism. Nepotism
refers to the hiring of members of the same family to positions in an organization. It is widely
held to be unfavorable because it is assumed that people who are given a job or promotion
because of their relation to the higher-ups are not qualified for the positions. Nepotism in the
corporate sector in India has given rise to a unique set of circumstances, making its issues
different from those that are encountered in the U.S. corporate sector. The presence of family
members in high ranking positions has been the crux of many governance problems in India.
In most family owned businesses in India, relatives and kin form the majority shareholders of
the company. With family influence in senior management, decisions often cater to the profit
of the family unit instead of the business or the other stakeholders of the company. As a result
of a lethargic legal system improper recruitment of this type is not prevented by the
government.

The view towards nepotism also differs very widely based on geography. Cross-cultural
studies show that cultural diversities affect the way people in different countries view
nepotism along with its advantages and disadvantages. Legally speaking, even in the U.S.,
nepotism is a complex issue because there are no formal, uniform laws regulating it. Issues
related to nepotism have to be decided on a case-to-case basis, according to the laws of the
state. What makes this issue even more complex is the fact that several cases related to
nepotism clash with prevailing policies that regulate discrimination against marital status,
sex, age and even racial discrimination.

Another reason why nepotism is not a good practice is because of the reputation of
unprofessionalism that gets attached to organizations practicing this form of employee
recruitment. The practice started out when there was no legal protection for assets that were
handed to a non-family member. As a result, most families tried to keep all financial matters
within their control. There is high likelihood for nepotism to occur in “micro-geographies
where several external factors like socio-cultural, economic, educational, and political
structures force people to support their close relatives or friends”. Another reason why family
members were given priority was to encourage and maintain a healthy rapport between the
people responsible for running a successful business. It has been widely accepted that this
ease in relationships creates a homogeneous work environment as people coming into the
organization have pre-formed bonds.

As the corporate sector in India grew, families continued to keep all decision-making
authority in their hands. However, this has not been in the best interest of the minority
stakeholders of the company. The majority shareholders and higher management make all
decisions based on what will be most profitable for the family. The general trend has been to
try and transfer company funds into other family owned businesses; the Maytas incident in
the Satyam scandal is a classic example. There have been rumors that the problems in Satyam
were linked to its connection with Maytas which is a real estate company owned by Mr.
Raju’s sons. Poor and unprofessional land valuation techniques had resulted in the Maytas
properties, which were owned by the Raju family, being valued at a price of one crore rupees
(about twenty thousand dollars) per acre when the value of the property was actually ten lakh
rupees (about two hundred thousand dollars) per acre. When questioned, Mr. Raju declared
that trying to transfer the funds into Maytas was the last remedy that he resorted to, to
disguise the fictional company assets. Fortunately, as this move was strongly opposed by the
shareholders, the deal did not go through. However, the action has nevertheless made foreign
investors question the tendency of Indian companies to employ family members in an
unqualified manner. Some researchers maintain that nepotism in India has created an image
of overly conservative, paternalistic organizations which have poor succession planning and
tunnel vision and which are rampant with role confusion.
While Satyam’s contributions to the Indian society put it on the radar as one of the nation’s
most coveted companies, like other Indian companies, it evidently lacked in basic
transparency and accountability due to nepotism.

Discussion & Learnings

While both Enron and Satyam were involved in corporate crimes where the senior
management of the companies inflated assets, they used very unique means to accomplish the
ends. The first clear difference is the transfer of funds to other entities in order to separate
those transactions from the parent company. In the case of Enron, mark to market accounting
and reliance on SPEs enabled the company to achieve the purpose. Also, Enron was unique in
the sense that the company had placed enormous powers in the hands of its CFO to carry out
transactions which were not scrutinized by the board. Andrew Fastow and his management
team skillfully created hundreds of special purpose entities before their declaration of
bankruptcy in 2001. While the management at Satyam tried to accomplish something of the
same kind through the Maytas deal, the differentiating angle here is the fact that Maytas was
a family holding. Enron found loopholes in the legal system and was eventually successful in
maintaining the pretense of the fake off-shore entities and duping the public, but it had to find
those loopholes. The scene in India seems to be a little different. Even though regulations in
both the countries are almost the same on paper, Indian companies in general seem to find
bending the law, openly and quite directly, easier than U.S. firms. Although the Maytas deal
was not allowed to go through due to investor resistance, there is plenty of evidence to show
the ease with which companies in India disregard regulation and how openly this is done. In a
country where giving and taking bribes is commonplace, legislators will have to pay more
emphasis on drawing future regulations that help avoid such a situation to spread to the
corporate sector of the country. The U.S. attempted to achieve a goal of stricter regulation by
passing the Sarbanes- Oxley; India is in the process of strengthening accountability in higher
management and auditors by making amendments to Clause 49 of the Listings Agreement.

There’s also something to be said about corruption and familial connections within a
company. It is common knowledge that lack of evidence regarding the involvement of board
of directors in a fraud, both in the U.S. and in India, is frustrating for investors. Most people
feel certain that crimes of such high magnitude cannot be conducted without the knowledge
of those people who are closely related to the functioning of the company. This line of
thought takes on more meaning when we consider the degree of nepotism in the Indian
corporate sector. As mentioned previously, in many companies where the majority
shareholder is a family, relatives are directly allotted positions of power. This has been an
unquestioned practice for several years. Family members expect to be given senior positions
and not doing so can sometimes be construed as being a traitor to the community. The
practice is so widely accepted that not much is done in the form of following anti-
discrimination policies. However, while this practice is discriminatory and against the
principles of employment law, it bears even greater consequences when corporate crimes of
this kind become easier. With the whole family involved in the company there’s often the
attitude of wanting the company to earn profits for the family as opposed to benefiting all the
stakeholders. There’s high probability of the family being in cahoots while conducting bogus
transactions and this risk can be eliminated by a stricter adherence to anti-nepotism policies.
While recruiting family is not always a bad thing, especially when worthy heirs are tested for
their merit before being allowed to hold a position, the trade-offs of this policy have to be
kept in mind and emphasis should be placed on developing a system of checks to avoid any
concentration of power once the company starts trading in public securities.

In Enron, crime was possible as a result of cooperation among senior management and an
unhealthy emphasis on aggressive competition. Western culture, and especially the U.S., is
celebrated for its focus on individualism and goal- directed behavior. The ability to work
hard, be competitive and reach the pinnacle of success is admired. This has been true to such
an extent that people from eastern countries come to the U.S. to try to achieve the ‘American
Dream’. A clarification that needs to be made here is that Asian cultures also have a
competitive culture. However, in these countries the kind of competition that is encouraged
differs. In Asian countries competition does not take the aggressive form of driving out
competition but focuses more on improving oneself. It is a more inclusive culture which
respects community norms. Studies have shown that while Americans tend to use words like
‘best’, ‘achievement’ and ‘success’, Asians tend to use words like ‘growth’, ‘endure’ and
‘advancement’. One might assume that America has reached a stage where the culture
expects people to achieve even when it might be injurious to them and people around them in
the long run. A lot can be said about the harmful effects of cultural expectation; in the case of
the U.S., the very culture of competition seems to have led to the downfall of Enron.
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