Enron Overview

Former Type : Public Company

Industry : Energy
Founded : Omaha, Nebraska (1985)
Founder(s) : Kenneth Lay

Defunct : December 2, 2001

Headquarters : Houston , United States
Revenue: $ 101Billion (2000)
Employees: 22,000 (2000)

Enrons Line of Business

Enron traded in more than 30 different products, including the
following:
1.

Petrochemicals

2.

Plastics

3.

Power

4.

Pulp and paper

5.

Steel

6.

Weather Risk Management

7.

Oil and LNG transportation

8.

Broadband

9.

Shipping / freight

10.

Streaming media

11.

Water and wastewater

12.

Principal Investments

The Rise and Fall of Enron

The companys success was based on artificially

inflated profits, dubious accounting practices, and
some say fraud.

Timeline of Enrons Collapse

Date

Event

20 Feb,
2001

Fortune Magazine story calls Enron a highly

impenetrable Co. and stock was overpriced.

14 Aug,
2001

Jeff Skilling resigned as CEO, citing personal reasons.

Kenneth Lay became CEO once again.

12 Oct, 2001 Arthur Anderson legal counsel instructs workers who

audit Enrons books to destroy all but the most basic
documents.
16 Oct, 2001 Enron reports a third quarter loss of $618 million.
24 Oct 2001

CFO Andrew Fastow who ran some of the

controversial SPEs is replaced

Timeline of Enrons Collapse

Date

Event

8 Nov 2001

The company took the highly unusual move of

restating its profits for the past four years. It
admitted accounting errors, inflating income by $586
million since 1997. It effectively admitted
that it had inflated its profits by concealing debts in
the complicated partnership arrangements.

2 Dec,2001

Enron filed for Chapter 11 bankruptcy protection and

on the same day hit Dynegy Corp. with a$10 billion
breach-of-contract lawsuit.

12 Dec 2001

Anderson CEO Jo Berardino testifies that his firm

discovered possible illegal acts committed by Enron.

9 Jan 2002

U.S. Justice department launches criminal

investigation.

Kenneth Lay
Founder, Chairman and CEO

He was a son of Baptist Preacher.

He was an American businessman.
He was the CEO and Chairman of Enron from 1985 to 2002.
He was one of the Crusaders of Deregulation in energy sector specially oil, natural gas
and electricity.
He was Americas highest paid CEOs with a compensation package of $42.4 million in
1999.
Became the Chairman And CEO in Feb,1986

Jeffrey Skilling
President, COO, and CEO

He was a MBA graduate from Harvard Business School.

He worked as a consultant for McKinsey and Company.
He helped Enron in 1987 to create a Forward market in natural gas.

Skilling impressed Kenneth Lay in his capacity as a consultant and was hired as a
chairman and CEO of Enron Finance Corp.

His only condition while joining the company was to adopt Mark to Market accounting.
He quit the company on August 14,2001.

Andrew Fastow
CFO

An American businessmen who served as a Chief Financial Officer of Enron

Corporation.

He was one of the key figures behind the complex web of Balance Sheet SPEs which
were used to conceal Enrons massive losses.

His main job was to keep the stock prices up even though the company had a $ 30
billion debt.

He created hundreds of SPEs designed to transfer Enrons Debt to an outside company

and get it off the books of Enron without giving up the control of the assets that stood
behind the debt.

Rebecca Mark-Jusbasche
Chairman & CEO Enron International
Rebecca Mark, is best known as the former head of Enron International, a subsidiary of
Enron.
Mark was promoted to Vice Chairman of Enron in 1998 and was a member of its board
of directors.
She resigned from Enron in August 2000.

Lou Pai
CEO, Enron Energy Services
Lou is aChinese-Americanbusinessman.
He wasCEOofEnron Energy Services from March 1997 until January 2001.
He was CEO of Enron Xcelerator, a venture capital division ofEnron, from February
2001 until June 2001.
He leftEnronwith over $280 million post which Pai was the second largest land owner
inColorado.
Lou Pai has not been charged with any criminal wrongdoing in theEnron scandal.

Sherron Watkins
Whistleblower
Sherron was Vice President of Corporate Development at theEnron Corporation.
In August 2001, Watkins alerted then-Enron CEOKenneth Layof accounting
irregularities in financial reports.
Watkins has been criticized for not reporting the fraud to government authorities and
not speaking up publicly sooner about her concerns.
Watkins testified about her role in theEnron fraudbefore committees of theU.S. House
of RepresentativesandSenateat the beginning of 2002.

Enrons ethics code

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
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.
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

Enrons Real ethics code

Friedman Doctrine and utilitarian mindset.

Profit for the company come what may.
No regard to customer welfare or government regulations.
No transparency or public accountability.

CULTURE
If you did not agree with the management you werent in Enron.
Rank and Yank-survival of the fittest.
Traders were very powerful, you had to be brazen and
swashbuckling to be a part of Enron trading floor.

 Andersen Received $58 Million In Fees From Enron In 2000 (Less Than Half
Of Which Was From Auditing Services) And $50-55 Million In 2001 .
Documents Produced For Congressional Investigators Show That Partners
In Andersen`s Houston Office Debated Whether To Force Disclosure Of
Billions In Off-balance Sheet Debt, But Decided Against It, Citing Potential
Growth Of Fees From Enron To $100 Million Per Year .
Andersen Thought That The Whole Thing Was A Bad Idea But Is
Convinced That This Is Such A Win- Win Thing, That Everyone Will Buy In.

The U.S. Government Asserted

That, After Investigation Of
Enron Began, Following Its
Bankruptcy , Andersen
Destroyed/Shredded Thousands
Of Documents In Houston,
Portland, London And Possibly
Other Locations

FRAUD PERPETUATED BY
ENRON

Mark-To-Market Accounting

SPE(Special purpose Entities)

It is a legal entity created to fulfill narrow, special or
temporary objectives . They are used to hide debt,
ownership mostly in real market.
These shell firms were created by a sponsor, but managed
by independent equity investor and debt financing.
Enron used SPE to manage risks associated with specific
assets and disclose minimal details of its SPE.
By 2001, Enron had used hundreds of SPEs to hide its
debt. As a result of one violation, Enrons balance sheet
understated its liabilities, overstated its equity and profits.

Accounting Frauds
Enrons nontransparent financial statements did not
clearly depict its operations and finances with
shareholders.
Accrual accounting: actual costs and actual revenues
were received and recorded when selling it.
Mark-to-market accounting: income was estimated as the
PV of future cash flow, but costs were hard to be recorded.

Enrons Accounting Fraud Diagram

Enron

Seller

Buyer

Mark To Market Method

Forecaste
d Future
Price

C
O
M
P
A
R
E

Original
Price
paid for
the
contract

Overstated

Debt

Understated
Special Purpose Entity
Profit
Debt
&
Failing
Investme
nt

Sales
Revenue

Mark to market. What is it?

A measure of the fair value of accounts that can change
over time, such as assets and liabilities. Mark to market
aims to provide a realistic appraisal of an institution's or
company's current financial situation.

The accounting act of recording the price or value of a

security, portfolio or account to reflect its current market
value rather than its book value.
When the net asset value (NAV) of a mutual fund is
valued based on the most current market valuation.

Issues with the scheme

Enron used this scheme to appreciate their share value.
They showed profits that were only an assumption and
never existed in reality.
This way they were able to window dress their share
value.
They exploited the scheme.

Profit making formula

Accoun
t
In
Profit

ENRO
N

4
3

Special
Purpos
e
Entity
(SPE)
2

A huge hole had
opened in the
accounts.
-BBC

Partnership
1. Enron sets up partnership using
stock as funding
2. Partnership sets up SPE
3. SPE agrees contract to pay Enron if
its investment declines in value
4. Payment made as investment
declines

The cover-up
Balance Sheet
Liabilities

Assets
Underperforming
assets
Stressed Assets

Asset
Transfer

Cash
Transfer

SPV

Dhabol Power Plant

Hand in hand with corrupt officials
Human rights issue
Lack of competitive bidding
High cost
Environmental issue

Broadband Business
Bandwidth as commodity
Teaming with Blockbuster
Stock price rises from $68/share to $71.36/share in 2
days
Dubious technology
MTM - $53 Mn in earning

Role of Lawyers, Accountants and

the SEC
Enron Lawyers' Vinson & Elkins were hired to investigate allegations
of financial irregularities lodged by an Enron insider, they asked few
real questions, failed to talk to obvious key witnesses.
The Law Firm blessed Enrons treatment of controversial partnerships
managed by Enrons own chief financial officer,AndrewFastow.
The Law firm was earning around $27 million to $30 million i.e.
around 7% of its revenue from Enron.
They never questioned the earning report which was audited by
Arthur Andersen.
SEC was willing to accept Enrons accounting principle of Mark-ToMarket without suitable guidelines as to how valuation of assets were
to be done.

California Energy Crisis

and Executive Behaviour

California Electricity crisis

Merger with Portland General Electric Company (PGE)
PGEs position on the West coast gave Enron an entry into the market of
California
Took advantage of the partial deregulation legislation of 1996 by the California
Legislature and Governor Pete Wilson
Slowly took over PGEs stocks
Got involved in economic withholding and inflated price bidding in Californias
spot markets.
45 GW capacity was there while California needed only 28-30 GW
Garry Davis-the governor whose name they wanted to spoil
Loss faced by California

Executive Behaviour
There was a pervasive culture among the top executives
in Enron that they were entitled to revenue even when
they were making losses for the company.
Lou Pai was the head of Enron Energy Services in the 90s.
He pocketed a cool $250 million even when his division
was making $1billion in losses.
Senior Execs like CEO Jeff Skilling($200mn), Chairman Ken
Lay($300mn), Ken Rice ($53mn), Cliff Baxter($35mn)
were selling their stocks in their company while asking the
employees invest in Enron Stock. This lead to almost
20,000 employees losing their $2 billion dollars in pension
fund of which they would recover only $85 million.

Andy Fastow
CFO , Enron Corporation

SPV-SIMPLIFIED VERSION???

SPV
Andy Fastow with the blessing of Enron CEO Jeffrey Skilling and
Chairman Kenneth Lay had created SPE known as Special Purpose
Entities which would help Enron avoid putting loss making entities
into Enron Books.
SPVs would buy Enrons Loss making assets thus enabling Enron to
hide those losses from the market.
Andy Fastow would also investment in the same partnership thus
performing a dual role at both Enron and the SPV
which raised conflict of interest issues which were ignored by
Enrons auditor.
Fastow made close to $30 million from such partnerships without
informing the Enrons Shareholders.

LJM1/2
Two of the SPV s were LJM1 and LJM2 which were
essentially private equity funds which were supposed to
invest in Enron Assets and would invest money raised
from institutional investors.
Andy Fastow promised them that he because he had
insider knowledge about the Company he would
guarantee them enormous with the help of his insider
knowledge.
Along with the dreams of impressive returns , it was
explicitly made clear to the Wall Street Banks , unless
they invested in the scheme , they stood to loose out
any Enrons Business.

Arthur Anderson:
"Think straight, talk straight."
Arthur Anderson till then was the biggest auditing and consulting firm
in the world.
By 2001 it had revenues of around $9.3 Billion
As the firm became globalized in the 1980s/1990s , what had earlier
been a traditional old world company became a global behemoth
where profits would be the ultimate goal.
Prior to Enron Scandal , it was also involved in Waste Management Inc.
Scandal and would later be involved in WorldCom Scandal as well.
Auditors would be judged on not only on their work but also on the
business they brought in.

Andersen Worldwide Socit

Cooprative
Arthur Andersen

Andersen Consulting

Would be responsible for Audit Business of the Firm.

Comparatively generated much lesser business than the

Consulting Business.

Andersens strategy was that the Auditing Business would act

as a springboard for the consulting business.

Was the more lucrative arm of Arthur Andersen and was

responsible for

Would be responsible for selling a wide range of services to

Arthur Andersen Clients
To benefit Anderson Consulting , AA Auditors would be asked
to go easy on AAs Clients

Arthur Andersons role in Enron

Arthur Andersen was earning about $1million a week
from Enron from through its consulting and auditing
business.
Arthur Andersen would bend over backwards including
firing auditors who questioned Enrons accounting
methods.
Arthur Andersen approved both mark-to-marketing
accounting principle as well as SPE formed by Andy
Fastow.
Arthur Andersen forgot that it should have been acting
in the interests of the shareholders who were the true
owners of the company rather than the Chairman and

Arthur Andersen role in Enron

(Continued)
Enron never published a detailed Balance Sheet even
though it was a public company as it claimed that doing
so would result in loss of trade secrets.
Arthur Andersens Enron Partner David B. Duncan
ordered ''an expedited effort to destroy documents'' on
Oct. 23, the day after Enron disclosed that the S.E.C.
had begun its inquiry. They did not stop until Nov 9 the
day they were sub poenad by SEC.

Repercussions & Aftermath

How did it progress?

2001:
August: Kynikos Associates Jim Chanos publicly doubts the profitability model
of Enron, the stock price decrease from $80 to 42$ in Aug.
October: Enron announces the total loss for 3th quarter was $618 million.
October: SEC begin to investigate Enron formally.
November: Enron was forced to admit do false account, profit total false nearly
$600 million since 1997.
November: Stock price falls to $0.26 per share.
December: formally apply for bankruptcy protection.

It is quite surprising that Enron got away without an

investigation till 2001. Was it the political influence?
On hindsight, did they pull the right strings to cheat or were
people so nave that they put some 401-K, and other savings
in one basket ?
Is the Wolf of Wall Street culture infectious in the USA?
Why ? The country ranks high on Individualism in the Hofstede
model (91).

Chartered Accountants are considered to be a pillar of

integrity, hence Arthur Anderson had to submit its CPA
license so that the Sec could take action.
All the accused were made to depose before a committee
consisting of Senators and Senate representatives before
heading on to a trial.
The people who deposed include even Bethany McLean,
Kenneth Lay, Andy Fastow and Jeff Skilling.

The Punishments:
CFO Andrew Fastow - 6-year prison sentence
Timothy Belden - 2-year and probation
CEO Jeff Skilling - 24-year prison sentence. Reduced
by ten years in 2013
CEO Kenneth Lay Died in 2006

Chewing on bread crumbs:

Enron closed with $67 billion in dues
In 2004, investors got $84 million as compensation for a
$2 billion loss
In 2005, a $4.2 billion lawsuit was settled and in 2008
$7.2 billion was given for $40 billion lawsuit.

How the Government reacted?

Sarbanes-Oxley Act
All companies must have a majority of independent directors.
All audit committee members should be financially literate. In addition, at
least one member of the audit committee is required to have accounting or
related financial management expertise.
CEOs are required to vouch for the financial statements of their companies.
Boards of Directors must have Audit Committees whose members are
independent of company
senior management.
Companies can no longer make loans to company directors.

Any Questions ?
Ask Why, perhaps?