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2002-2007
Id rather be a huge part of the problem than a tiny part of the solution.
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On December 2, 2001, Enron Corporation sought protection under Chapter 11 of the U.S. Bankruptcy Code It is the second largest bankruptcy in U.S. history (after WorldCom) Enrons auditors, Arthur Andersen, were convicted of obstruction of justice for destroying documents related to the Enron account in anticipation of an SEC investigation; conviction was overturned Ten congressional committees have investigated the collapse of Enron Thousands of employees were fired, two former CEOs were convicted of criminal charges and more than 30 executives have been indicted; many are serving jail terms Cliff Baxter, a former Enron Vice-Chairman, committed suicide in despair over the companys demise; he tried vainly to call attention to Enrons misdeeds
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More Darkness
Enron expanded first to the UK, then India, China, Latin America and the Middle East, but its energy prices were perceived as very high, especially in developing countries Lay and Skilling pushed hard for deregulation of electric generation and transmission markets, expending huge amounts on lobbyists globally Enrons executives drove hard bargains with Wall Street, demanding the best financing terms and pressuring analysts at investment banks to rate its debt/equity offerings highly, while refusing to disclose earnings by business segments, and changing its business strategy frequently In the late 1990s, Enron saw its return on equity declining from huge investments in power generation and acquisitions, and Skilling shifted to an asset light strategy, emphasizing trading commodities over owning assets
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V&Es Conclusions
V&E concluded: The facts disclosed through our preliminary investigation do not . . . warrant a further widespread investigation by independent counsel and auditors. Our preliminary investigation, however, leaves us with concern that because of the bad cosmetics involving [these] transactions . . . there is a serious risk of adverse publicity and litigation. V&E noted that it had reported its conclusions verbally to Mr. Lay and to the Chairman of the Audit Committee of Enrons Board of Directors and at his direction, gave a verbal summary of their review and conclusions to the full Audit Committee.
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Chewco Chewco was another Enron effort to keep debt off its balance sheet. In this case, the crucial 3% outside equity was supposedly put into Chewco by independent entities. But Enron itself backed much of the 3% infusion, eventually forcing the company to reverse more than $400 million in earnings.
Source: The Wall Street Journal, April 30, 2002
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Accusations in California
On May 6, 2002 the Federal Energy Regulatory Commission released memos from Enron that indicate Enron and others may have intentionally manipulated Californias power market using at least ten strategies The memos refer to market-manipulation strategies known as Death Star, Fat Boy and Ricochet; these strategies, which may not be illegal, created artificial conditions in the states power grid that may have resulted in substantial profits to Enron and other power traders One Enron memo described the net effect of the Death Star strategy to be that Enron gets paid for moving energy to relieve congestion without actually moving any energy or relieving any congestion
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Accusations in California
Under the Fat Boy strategy, Enron allegedly bought power in California under price caps and sold it into other states where it could get a better price. An Enron memo said that This strategy appears not to present any problems other than . . . the fact that such (electricity) exports may have contributed to . . . a Stage 2 Emergency yesterday Ricochet involved sales of energy generated in California to adjoining states which were then imported into California, to avoid price caps From 1999 to 2001 Enrons energy trading revenue in California increased from $50 million to $800 million Enrons chief energy trader pleaded guilty to conspiracy to commit fraud charges in manipulating energy prices in California; the head of Enrons California trading desk also pleaded guilty to charges of wire fraud and lying to federal investigators A judge at the FERC ruled that Enron should repay $32.5 million for violating FERC rules during this crisis
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Executive Compensation
In 2001, Enron paid $745 million in cash and stock awards to 144 senior executives, including at least $104 million to Ken Lay Enron CFO Fastow received over $30 million from his partnership interests serving while he had a conflict of interest 5,000 employees who were fired after the bankruptcy received a maximum of $13,500 each ($34 million total) in severance pay
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Mahonia
In a transaction referred to as Mahonia, Chase Manhattan Corporation allegedly accepted deliveries of natural gas which Enron then sold to them in a so-called round trip trade. A J. P. Morgan executive said in an email, [Enron] loves these deals as they are able to hide funded debt from their equity analysts because they book it as deferred rev or (better yet) bury it in their trading liabilities.
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Government Investigations
Enrons activities were investigated by both the U.S. House and Senate (at least 32 bills introduced to change laws) Vice President Dick Cheney was sued by the General Accounting Office, which sought release of information on secret meetings held by Lay with Cheney on energy policy. The GAO lost the case which Cheney won using an executive privilege argument; now on appeal to the US Supreme Court President Bush has distanced himself from Lay and Enron. His administration has been heavily lobbied to intervene but apparently has not
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Government Investigations
The Financial Times has reported that Enron gave over $10.2 million to Washington politicians over two election cycles, and in 1997-2000 gave $1 million to Texas political action committees and state candidates, while contributing $139,000 to Texas Supreme Court candidates and spending $4.9 million on Texas lobbyists In England, Enron gave over $1.13 million to a charity run by Prince Charles; sleaze allegations have been made against the UK party in control
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Ken Lay
Ken Lay was convicted of fraud, lying to Enron shareholders and other securities law violations. He appealed his conviction but died of a heart attack before the appeal was heard. His conviction was overturned since he was not able to complete his appeal. Civil suits against his estate continue.
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Jeff Skilling
Skilling received a 24 year jail sentence which he is now serving in Minnesota. His case is on appeal. He may have to pay up to $60 million in fines.
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Whats Next?
Enrons plan of reorganization calls for distributions of about 20 cents on the dollar to secured creditors; three businesses to be spun off Andersen is no longer functioning as a going concern Key executives lost tens of millions of dollars in personal fortunes Congress enacted Sarbanes Oxley legislation that requires CEOs to certify financials and put bonuses, fees at risk if misleading
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Whats Next?
Many companies are now expensing stock options and looking at new forms of compensation FASB rules on SPEs changed to require higher equity investment, truly at risk (but will still be too low) FASB Interpretation Number 46 became effective July 1, 2003 and will require many off balance sheet entities to be reported on the balance sheet SEC, others mandated a divestiture of advisory practices from audit practices and whistleblower rules for lawyers A crisis of confidence in Wall Street ensued, leading to calls for greater Board oversight and revamping of executive compensation
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Lessons Learned
There are other Enrons out there; it can happen again (HealthSouth, WorldCom, Qwest, Tyco and Xerox) Enrons demise was not the result of concerted crimes; it was brought about by a series of significant personal leadership failures and creeping mistakes; passing new laws and regulations will help, but not prevent such failures Ethical Standards to Apply Wall Street Journal standard: If you dont want to read about it in the Journal, dont do it! It is not enough to say its okay to do it if its legal
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Postscript
Even today, It cant happen in my company is a prevalent attitude among CEOs and business owners; many companies have ethics compliance policies but dont emphasize hiring ethical leaders over superstars Some complain that Sarbanes Oxley is too expensive and are lobbying for major changes in accounting rules Its too late to begin to teach ethical values in business school or to senior executives; efforts need to begin at home, in elementary school and throughout the education process If its too good to be true, it probably is remains great advice when investing; the days of triple digit P/E multiples are (hopefully) gone
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