ENRON DOWN FALL A CASE STUDY

An overview of the Company

Former type Public company Industry Energy, commodities, services Successor(s) Dynegy & Prisma Energy International

Founded Omaha,

Nebraska (1985) Founder(s) Kenneth Lay Defunct December 2, 2001

 Headquarters Enron

Complex 1400 Smith Street Houston, Texas United States Revenue $101 billion (2000) Employees approx. 22,000 (2000) Website www.enron.com

Key people Kenneth Lay, Founder, Chairman and CEO Jeffrey Skilling, former President, CEO and COO Andrew Fastow, former CFO Rebecca MarkJusbasche, former Vice Chairman, Chairman and CEO of Enron International Stephen F. Cooper, Interim CEO and CRO

Americas most innovative company

-FORTUNE

We the people...

Kenneth Lay

Founder, Chairman and CEO of Enron

Jeffrey Skilling

President and Chief Operating Officer . Served as CEO from Feb. Aug.2001

Andrew Fastow

Chief Financial Officer

Sherron Watkins

Corporate Developmen t Executive

THE SCAM
institutionalized,

systematic, and creatively planned accounting fraud also brought into question the accounting practices and activities of many corporations throughout the United States(Led to the creation of the SarbanesOxley Act of 2002) dissolution of the Arthur Andersen accounting firm.[2]

 Enron

filed for bankruptcy protection in the Southern District of New York in late 2001 and selected Weil, Gotshal & Manges as its bankruptcy counsel

Enron's

nontransparent financial statements did not clearly depict its operations and finances with shareholders and analysts

 earnings

and modify the balance sheet to portray a favorable depiction of its performance The combination of these issues later led to the bankruptcy of the company

So Why Did Enron Happen?

Individual and collective greedcompany, its employees, analysts, auditors, bankers, rating agencies and investorsdidnt want to believe the company looked too good to be true Atmosphere of market euphoria and corporate arrogance High risk deals that went sour Deceptive reporting practiceslack of transparency in reporting financial affairs Unduly aggressive earnings targets and management bonuses based on meeting targets Excessive interest in maintaining stock prices

The Motivation
Enron

delivered smoothly growing earnings (but not cash flows). Wall Street took Enron on its word but didnt understand its financial statements. Price of the stock. Enron was a trading company and the main aim of ENRON was to maintain an upward trend in stock prices In its last 5 years, Enron reported 20 straight quarters of increasing income. Enron, that had once made its money from hard assets like pipelines, generated more than 80% of its earnings from a vaguer business known as wholesale energy operations and services.

CAUSES OF DOWNFALL
Revenue

recognition Mark-to-market accounting Special purpose entities Corporate governance Other accounting issues

REVENUE RECOGNITION
Use

of merchant model instead of agent model

Revenues increased by more than 750%, rising from $13.3 billion in 1996 to $100.8 billion in 2000. Growth rate of 65% unprecedented. Reported $138.7 billion in revenues, ranking 6th position on the Fortune Global 500.

Mark-to-market accounting
Once

a long-term contract was signed, income was estimated as the present value of net future cash inflows. Income from projects could be recorded, although they might not have ever received the money. Enron and Blockbuster Video signed a 20year agreement to introduce on-demand entertainment. , Blockbuster pulled out of the contract. Enron continued to recognize future profits(> $110 M), even though the deal resulted in a loss.

Income Statement

SPE: Special Purpose Entities

Limited partnerships or companies created to fulfill a temporary or specific purpose. Objective- to fund or manage risks associated with specific assets. By 2001, Enron had used hundreds of special purpose entities to hide its debt.

FASITs: Financial Asset Securitization Investment Trusts in the Apache deal. REMICs: Real Estate Mortgage Investment Conduits in the Steele deal.

 Notable

examples of special purpose entities that Enron employed were

JEDI & Chewco : used to hide the debt of $628M by inflating earnings by $405M. Whitewing : bought assets from Enron worth $2 billion, using Enrons stock as collateral. LJM and Raptor: funded with around $390M.

CORPORATE GOVERNANCE
Chief

Executive included Enron among its top five boards. Able to "attract large sums of capital to fund a questionable business model. Conceal its true performance through a series of accounting and financing maneuvers, and hype its stock to unsustainable levels.

Executive compensation : Focus only on short-term earnings to maximize bonuses; often disregarding the quality of cash flow or profits. The top 200 highest-paid employees received $193 million from salaries, bonuses, and stock.

Risk management : Reckless use of derivatives and special purpose entities led to inevitable bankruptcy.

Financial audit Arthur Andersen, was accused of applying reckless standards in its audits because of a conflict of interest as it earned $25M in audit fees and $27M in consulting fees from ENRON.

Audit committee brief meetings that would cover large amounts of material. Undue pressure on committee. Conflict of interest.

Impact
Dissolution

of ARTHUR ANDERSON

Charged with and found guilty of obstruction of justice for shredding the thousands of documents and deleting emails. The firm surrendered its CPA license on August 31, 2002, and 85,000 employees lost their jobs and ultimately DISSOLUTION. The Supreme Court ruling theoretically left Andersen free to resume operations. Apparently so much damage had been caused that it did not even resume on a smaller level.

AFTERMATH

Enron's

headquarters in Downtown Houston was leased in valuing $285M in the 1990s; was sold for $55.5M IN 2004. Enron's shareholders lost $74 billion in the four years before the company's bankruptcy. 20,000 JOBS were lost in the debacle.

Sarbanes-Oxley Act
In

the Titanic, the captain went down with the ship. And Enron looks to me like the captain first gave himself and his friends a bonus, then lowered himself and the top folks down the lifeboat and then hollered up and said, 'By the way, everything is going to be just fine. U.S. Senator Byron Dorgan This act is a "a mirror image of Enron.

The main provisions of the Sarbanes-Oxley Act included:

Establishment of the Public Company Accounting Oversight Board to develop standards for the preparation of audit reports. The restriction of public accounting firms from providing any non-auditing services when auditing Provisions for the independence of audit committee members, executives being required to sign off on financial reports Relinquishment of certain executives' bonuses in case of financial restatements

Lessons Learned
It

can be summarized as failures of diligence, ethics, and controls. Fiduciary duties must not be neglected The Board must be independent from the corporation and its management. Related party transactions carry high risks. Conflict of interests need to be monitored closely. External auditors must be independent

 The

accounting and auditing profession must act competently. corporate culture must be committed to integrity and proper compliance procedures. market players, such as banks and analysts must play their own proper roles free of conflicts of interests.

The

Other

References
http://en.wikipedia.org/wiki/Enron_scand

al http://www2.econ.iastate.edu/classes/ec on353/tesfatsion/enron.pdf http://www.uwosh.edu/llce/conted/lir/co urse-listings/Enron%20Scandal.pdf http://www.efham.net/Uploads/EfhamElb orsa/Enron.pdf