the Study on fall of such a Big structure - Enron - The facts and findings

1. Enron – Facts and Findings
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2. Table of Contents
 ENRON – The Company
 Business Verticals
 Key Executives
 The Promise
 What went wrong
 The Cover-up
 The Aftermath
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3. ENRON – The Company
InterNorth Houstan
Natural Gas
Key Dates:
1930: The company is founded as Northern
Natural Gas Company in Omaha, Nebraska.
1947: The company is listed on New York
Stock Exchange.
1980: The company's name is changed to
InterNorth, Inc.
1985: A merger with Houston Natural Gas
Corp. takes place.
1986: The company's name changed to
Enron; the new company is headquartered
in Houston.
1991: Enron begins overseas expansion.
1999: Launches EnronOnline.
2001: Files for bankruptcy after previously
hidden losses come to light.
 Sixth largest company in the United States
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4. ENRON – The Company
Three major events that shaped Enron
Ethical Dilemma In early 1987, it was discovered that several
traders were booking and settling falsified trades,
instead of shutting down the unit, they
reorganized the unit and altered it’s reporting
structure
Outside Influence on Key
decisions
Jeff Skilling a consultant advised creating gas
bank, a natural gas trading business. Later, when
he joined the firm this idea was accepted
Using new financial reporting
techniques
Using the MTM ( mark-to-market) accounting.
MTM allowed Enron to recognize the sales and
earnings on deals today, although the cash flows
would occur in future
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5. Kenneth Lay
 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 America’s highest paid CEO’s with a compensation package of $42.4 million in 1999.
Jeffrey Skilling
 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.
Key Executives

6. 6 Andrew Fastow
 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 off Balance Sheet SPE’s which were
used to conceal Enron’s 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 SPE’s designed to transfer Enron’s 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
 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.
 Ideological conflict and rivalry within Enron arose between Mark, who specialized in hard assets
and facilities, and fellow top executive Jeff Skilling, who pushed for the company to develop and
expand its financial trading and risk management sectors instead.

7. Business Vertical
Enron International
• CEO – Rebecca Mark
• Asset Heavy
• Power projects and
pipeline
Enron Capital and
Trade Finance
• CEO – Jeff Skilling
• Asset light
• Trading activities
and power sales
Factors responsible for robust
growth of ENRON
 Deregulation of US energy
(gas and electricity) market
 Acceptance of MTM method of
accounting
 First mover advantage in the
gas trading business
 Since Enron connected
suppliers and consumers
they had access to market
intelligence which their
competitors lacked, they used
this info for gas trading
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Principal Subsidiaries: Enron Engineering and Construction; Enron
Renewable Energy Corp.; Enron Ventures Corp.; EOG Resources Inc.; EOTT
Energy Partners LP; Florida Gas Transmission Co.; Transwestern Pipeline Co.;
Enron Wind Corp.; Louisiana Resources Co.; Northern Border Pipeline Co.;
Northern Plains Natural Gas Co.; Northern Transportation & Storage; Linc
Corp.; Azurix Corp.; Enron Corp

8. In 1995, Enron CEO Kenneth Lay promised investors that Enron's profits
would rise by 15 percent a year over the next five years
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The Promise

9. 9
Rebecca Mark’s
Shopping spree
Loss making broadband
business
Water Business Disaster
Flawed Accounting
Practice
Limited effect of energy
deregulation
What went wrong…….
In 1998, they bought Wessex British water utility company for $2.4 billion.
They created Azurix, a water utility company, trading in water rights
In January 2000 Enron announced an ambitious plan to build a high-speed
broadband telecommunications network and to trade network capacity, or
bandwidth. It lost about $2 billion on Telecom capacity when the internet
bubble bust
Rebecca signed and sealed new deals at break neck speed. These projects
locked-in Enron’s cash flows. Deals were characterized by inadequate due
diligence, aggressive bidding leading to unprofitable margins. Example of
failed project – Dhabol Power Project were they lost ~$2.8 billion
Unrealized trading gains accounted for slightly more than half of the
company’s $1.41 billion reported pretax profit for 2000 and about one-third of
its reported pretax profit for 1999. This resulted in huge discrepancies
between earnings and cash flows. Profits from projects were calculated before
actual returns

10. 10
What went wrong…….
 Locked –in cash flows due to the commitment to various projects
 Left the company with stressed and underperforming assets
 Huge debt pile on the company’s balance sheet
 Deviated from core business
 Increased focus on short term gain at the cost of long term, sustainable growth
THIS LEFT ENRON IN A FRAGILE FINANCIAL CONDITION

11. Were there any Indicators to spot the loom
?
• Global energy crises by late 90s.
• In India, lost the Dabhol Power project, in which Enron had committed $2.9bn.
• Beginning of Dot.Com bubble crises and fallout of blockbuster internet deal.
• Enron delivered smoothly growing earnings (but not cash flows).
• Global energy crises by late 90s.
• In India, lost the Dabhol Power project, in which Enron had
committed $2.9bn.
• Beginning of Dot.Com bubble crises and fallout of blockbuster internet deal.
• Enron delivered smoothly growing earnings (but not cash flows).
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12. Enron’s Accounting Fraud Diagram
Enron
Profit
Understated
Forecasted
Future Price
C
O
M
P
A
R
E
Mark To Market Method
Seller Buyer
Overstated
Debt
Special Purpose Entity
Debt
&
Failing
Investment
Sales
Revenue
Original Price
paid for the
contract
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13. “Profit” making formula (SPE)
ENRON
Partnership
Special
Purpose
Entity
(SPE)
Account
In
Profit
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4
2
1
5
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
5. Payment posted as profit, even though it is Enron’s own money
”“A huge hole had opened in the
accounts.
-BBC

14. 14
The cover-up
Balance Sheet
Liabilities Assets
• Underperforming assets
• Stressed Assets
SPV
Asset Transfer Cash Transfer

15. 15
The cover-up

16. The main dark areas…
 White collar crime done by the vital
executive in an organization (Enron and
Arthur Andersen)
 The crime is included not only as the
crime in Law point of view but also as the
organizational fraud which effect the
whole shareholder of the organization.
 The Enron deception was practicing the
accounting fraud by creating the SPS
(Special Purpose Entity) which exchange
the debt and failing investment into sales
revenue in financial statement.
 This Fraud is done by the cooperation of
Enron CFO, few of Enron people and
Andersen’s chief auditor for Enron
This slide and next 2
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consolidated into one
Role of Arthur Andersen
•Andersen executives including chief Enron auditor
David Duncan, decided to consult lawyers over whether
or not the partnerships were legal.
•Andersen told Enron that it had no other choice but to
change the way it was accounting for its special
partnerships.
•At some point after this, staff in Andersen’s Houston
office began shredding documents relating to Enron.
•Arthur Andersen was one of the world’s five
leading accounting firms.
•Legal examination of Sherron Watkins's concerns
concluded that the partnerships in question, Raptor
and Condor, had been approved by Andersen.
•Was paid $52mn in 2000, the majority for non-audit
related consulting services.

17. Timeline of Enron’s 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 Enron’s 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 SPE’s is replaced

18. Timeline of Enron’s 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.

19.  Enron's shareholders lost $74 billion in the four years before the company's bankruptcy ($40 to $45 billion was
attributed to fraud).
 Enron’s more than 20,000 former Employees lost $2 billion in pensions.
 Employees lost more than $1.2 billion in retirement funds.
 Enron’s top executives cashed in $116 million in stock.
 20,000 employees lost there jobs and medical insurances.
 On April 09, 2002 David Duncan, Enron’s Auditor pleads guilty to obstruction. Further, On August 31, 2002 the
firm surrenders its license to practice accounting. In addition, On Oct 16, 2002 sentenced to probation and a
$500,000 fine and banned from auditing public companies. Additionally, On March 13, 2007 Arthur Anderson
will pay $72.5 million to investors who sued the firm for its involvement in Enron Scandal.
The Aftermath

20. Prosecutions
Andrew Fastow –
faced 98 counts, pleaded guilty to one charge of conspiracy to commit wire fraud and one
charge of conspiracy to commit wire and securities fraud. Fastow has agreed to serve 6
years in prison and forfeit $23.8 million, including homes in Galveston and Vermont; and
forfeit claims on another $6 million held by third parties.
Jeffrey Skilling –
Named in 35-count indictment, Skilling pleads not guilty to wire fraud, securities fraud,
conspiracy, insider trading and making false statements on financial reports.
 On May 25, 2006 Skilling convicted on 19 of 28 counts of conspiracy, fraud, insider trading,
and false statements. Skilling gets 24 years and 4 months of imprisonment and forfeits
$45 million.
Kenneth Lay –
Indicted on 11 criminal counts of fraud and making misleading statements , Ken Lay,
surrenders to the FBI. After pleading not guilty.
On May 25,2006 Lay convicted on all six counts of conspiracy and fraud, In July Lay dies
before sentencing.
Can be consolidated
with earlier slide, The
Aftermath

21. Stock heading South
•8th Nov, 2001 – Told investors that they were restating earnings for
past 4 and ¾ years.
•By end of Nov, 2001 stock reached $0.3 falling from its peak price
$90 in just 8 months.
•2nd Dec, 2001 – Filed Bankruptcy.
Should give all
time high for
the stock

22. Conclusion
 Enron was a massive failure, partly because of its size, partly
because of its complexity, partly because the controls to protect
the integrity of capital markets failed, and especially because of
the massive greed and collusion of key participants. Management
failed, auditors failed, analysts failed, creditors/bankers failed, and
regulators failed. The intersection of multiple failures sent a signal of
structural problems. Suddenly, the consequence of deceptive
financial data resulting from structural failure in the capital markets
was not merely a hypothetical possibility. The speed with which the
system responded indicates the importance of fairly presented
financial information.
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