ENRON

A GLORIOUS DOWNFALL

Enron An Overview
20,000 staff, $101 B in 2000

1985, Houston, Texas

Houston Natural gas & Internorth

Americas Most Innovative Companies

Energy, commodity, services

25% of Gas business

energy brokering, electronic energy trading, global commodity and options trading, etc.

Electricity, natural gas, communications, pulp &paper

7th largest co., largest natural gas & electricity

Key Players in Enron Scandal

Was CEO of Enron until Feb. 2001 Returned as CEO in Aug. 2001 Approved of the actions of Skilling and Fastow Kenneth Lay Known as the Enron whistleblower Was Enrons VP of Corporate development Wrote a letter to Kenneth about suspicion of accounting improperties

Sherron Watkins ENRON

Jeffrey Skilling

David Duncan

Andrew Fastow

Appointed CEO in first half of 2001 Resigned in Aug 2001 Focused on meeting wall street expectations Advocated mark-to-market accounting Found new ways of hiding debt - SPE

Enrons chief auditor at Arthur Anderson His job was to check Enrons accounts Accused of ordering shredding of Enron related documents

Former CFO at Enron Mastermind behind deceptive accounting techniques Advocated merchant model Created off-balance-sheet vehicles

The Scam in Numbers

SHARE PRICE

IN Yr.2000 $90

SHAREHOLDERS LOST

$ 11 MILLION

IN Yr.2001 $0.3

Tools of Fraud

SPE

MERCHANT MODELREVENUE RECOGNITION

MARK-TO-MARKET ACCOUNTING

SCAM

Merchant Model-Revenue Recognition

AGGRESSIVE

Entire value of transaction recorded as revenue

IMPACT ON REVENUE

Inflated revenue Enron's revenues increased by more than 750%

IMPACT ON COMPETITORS

Same method later adopted by other companies in the energy trading industry to stay competitive

SPE - Special Purpose Entity

WHAT

Limited partnerships or companies created to fulfil a temporary or specific purpose Created to fund or manage risks associated with specific assets

WHY

FRAUD

Enron actually using the company's own stock and financial guarantees to finance these hedges
Enron's balance sheet understated its liabilities and overstated its equity

IMPACT

EXAMPLES

JEDI, Chewco, Whitewing, and LJM

Mark-to-Market Accounting

WHAT

Income is estimated as the present value of net future cash flows

HOW

Income from projects recorded on basis of expected benefit

IMPACT

Large discrepancies of attempting to match profits and cash Increasing financial earnings on the books SEC approved this accounting method for Enron Enron became the first non-financial company to use this method

LAPSE

The Scam
PARTNER ENRON

SPE

MARK-TO-MARKET

MERCHANT MODEL

HIDDEN DEBT

INCREASED REVENUE

INFLATED BOOKS OF ACCOUNTS

A.ANDERSEN-AUDITOR

BOARD OF DIRECTORS

How they were Caught

Earnings 1997 2000 ($ millions)

Year 1997 1998 1999 2000 Original 105 703 893 979 Restated in 2001 77 570 645 880

Penalties Imposed

Suspension of trading on NYSE

Key Members charged with charges of forgery, money laundering

Monetary Fines

Partial Payment to creditors

Downfall of Enron

Lays efforts were not much successful DECLINE IN Related Party Transactions INVESTORS CONFIDENC E

LIQUIDITY CONCERNS

Enrons stock lost half its value over a week Bonds trading little below making future sales problematic

BANKRUPTC Y

Dynegy Inc. unilaterally disengaged from the proposed acquisition Stock price fell to $0.61 at the end of 28th November 2001

Downfall of Enron (Contd.)

Restructuring losses and SEC investigation

Reduced earnings by $613 million (or 23% of reported profits during the period)

Increased liabilities at the Reduced equity at the end of end of 2000 by $628 million 2000 by $1.2 billion (10% of (6% of reported liabilities reported equity) and 5.5% of reported equity)

Changes in Law

SarbanesOxley Act Implementation

Launching of Public Company Accounting oversight Board(PCAOB) to regulate the auditors of publicly traded companies To ensure corporate financial statements are subject to tough outside scrutiny and that auditor client relationship is free from commercial conflicts of interest

Accounting for Stock Options

Previously, stock options granted to executives and employees were not counted as a cost to the company so as to help companies retain skilled employees. After the scandal, it was required to expense the stock options. Also, an excise-tax was imposed on stock-based compensation

Changes in Law (contd.)

Derivatives Accounting

Financial derivatives are instruments without an intrinsic claim on financial assets. Many of them may not have a trading market and their fair value are calculated according to the firms own valuation model subject to manipulation. Rules and regulations were implemented to account for such derivatives

Principle-based Accounting

Previously, rules-based accounting was used which were not only ignored by companies but were very complex to understand. Accounting based on few principle rules that would not only provide a clear picture of the firms financial status but also prevent the creation of loopholes in the detailed set of rules

Current Situation

Regulations such as Public Company Accounting Reform and Investor Protection Act were amended. The fall of Enron lead to the dissolution of the accounting firm Arthur Anderson which at the time was among the best five accounting firms. In November 2004 Enron emerged from its bankruptcy and on September 2006 they sold Prisma Energy International their last business. As of 2007 Enron changed its name to Enron Creditors recovery Corporation By October 2008, Enron Creditors Recovery Corporation has returned 21.428 billion to its creditors By 2009, Enron will make an additional final distribution of any remaining assets to its creditors.

Thank You!

Shantanu Mittal Taranjit Bhasin Utsav Sharma Vasu Sharma Srishti Baul Vandana Jha