BUSINESS ETHICS

Final Project
ENRON






To:
Sir Kumail Raza Hemani



By:
Muhammad Moin Bhiriya (1018173)
Rehan Latif (1018177)




Case:
Enron was named the 7
th
largest company in the USA; the most innovative company in America
in Fortune magazines April 2001 issue, but just six months (2-December-2001) on the road
Enron filed for bankruptcy. It was labeled the The greatest accounting fraud of the 20
th

century. This resulted in 12000 employees losing their jobs and to make matters worse, they
had invested their savings in Enron stock. On a grander scale, others also suffered, as the stock
value plummeted from $70billion to 0!
Enron was formed in 1985 by Kenneth lay, an economist and undersecretary at the U.S Interior
Department, by merging two natural gas companies; resulting in Enron becoming first company
is capable of distributing natural gas all to utilities around the country. Lay expanded the
company by borrowing money to buy up other companies and by 1987 Enrons debt was 75% of
its stock market value, which created an ongoing problem for the company. The first scandal of
Enron started in 1987; in which Enrons two oil traders bided, this generated tons of profit for the
Enron and the bidder. However the luck soon ran out; the bidders easily disappeared with the
profits, leaving Enron encumbered in loss; this even lead to the conviction of Lou Borget on the
charges of money laundering and fraud. There and then, Enrons shareholders bore a loss of $64
million through window-dressing but actual loss was $ 140 million.
In those hard times the famous Bush family supported Enron, by helping Enron getting more
subsides and played a vital hand in Kenneth Lay becoming an ambassador of deregulation of the
market. Later, in 1989, a young man named Jeffrey Skilling (Harvard MBA) was hired by
Kenneth Lay to be head of finance department. In that same year, the energy business was
deregulated by US government; which made gas prices to fluctuate widely, making the natural
gas market very risky for both buyers and sellers. Jeffrey Skilling thought of plan, in which
Enron will become an intermediary between both the buyer and the seller, so as to reduce the risk
of deregulation. The plan was to be accomplished on the basis of signing contracts with the
sellers to buy their gas at fixed price over number years and on the side, also signing contracts
with buyers to sell Enron gas during the years in which gas has the same price; this included a
profit, which Enron kept for itself. After its implementation Enron became the leading company
in the profitable energy trading business. To maintain the performance of the company Skilling
came up with an idea in which he created team of traders which included MBAs and fired 10%
each year and highly rewarded the top performers.
Enron decided to implement the same trading idea to other commodity markets, which resulted
in traders trading 1800 different kinds of products. This was also achieving through contracts and
price fixing. Andrew Fastow was hired by Jeffrey Skilling in 1990 to help to manage trading
business. Fastow came with an idea of mark to market accounting method, in which the
forecasted values are recorded as current values this would help to overstate the profits of the
company. The method actually works by forecasting cash flows and applying discount rates and
compute net present value. The net present value was reported as a true value. Later, Skilling
was made President and COO of Enron and Fastow became CFO.
Enron met another financial problem which was due entering many of the markets it traded in;
they needed to borrow funds to buy infrastructure, which is needed to transport, store, and
deliver commodities which were been traded Furthermore they couldnt borrow the load as they
already had huge debts at pending. If further loans where to be taken it could reduce investors
investments; and it would also lead to the banks to recall their previous and then -current loans.
Interestingly, Enron found a way to get access to more funds---this one done by not reporting
debts on the financial statements. The real innovator behind the idea was Andrew Fastow
CFO. He paid handsomely to Arthur Andersens consulting division, as it was with their
assistance they created the limited partnership named as Special Purpose Entities.
The laws of Accounts allow the company to exclude a special purpose entity from the financial
statements; if this independent party owned at least 3% of special purpose entity. According to
these conditions Fastow appointed himself and other Enron employees as the heads of the special
purpose entities and to make it other 97%, he transferred enough Enron stock into the entity.
Entities were ready to borrow money using Enron stock as collateral. The money borrowed here
was used to buy Enrons overvalue contracts on its books and other failing investments and to
add to that, some of it was recorded as sales revenues. Thus, Enrons debt was taken over by
special purpose entities; namely: Jedi, Chewco, Talon, Condor and Raptor. (All the names were
taken from Star wars). The heads of the entities were paid millions of dollars salaries and their
financial statements were certified by Arthur Andersens auditing division that made investors
think these reports are accurate.
The whistle blower was Sherron Watkins, who started working for Enron in 1993 and became
the vice president in couple of years. She was working under Fastow, and was quite aware of the
accounting practices which were being used to maintain the stock prices as high as possible, but
she also cautioned that if the stock price was to fall, it would lead to the dissolution of the entities
and debts and overvalued assets would comeback in the Enrons financial reports.
In 1999, Fastow was allowed to run a private company named LJM by the board of directors.
This was created only to do business with Enron in which LJM bought poorly performing Enron
assets. This was another technique used by Fastow to hide Enrons debts and inflate profits.
There were 69 banks involved in the LJM by investing 25 million each in its account. From 2000
Kenneth Lay starts selling Enron shares.
In 2001, California was hit by rolling blackouts; something from which again Enron took an
advantage to make more money. Enron traders with help of Enron engineers created artificial
blackouts leading to an increase in energy prices by 300% to 400%. The real money, however,
was made by the West coast traders by betting money on the fact that energy prices will go up---
they made $2 billion for Enron. The stock traders and other financial analysts were becoming
suspicious about the Enron performance. Skilling already committed a Securities fraud and now
was hiding from the investors--- he made false presentations and misleading advertisements to
the investors. An old friend of Kenneth Lay; George W Bush become the president, so Lay got
the help what he wanted. Bush asked Federal regulation commission in not to interfere in the
price regulations and let the price be deregulated. However, in the second half of 2001, stock
price of the company started to decline and accountants tried to regroup the debts and assets to
prevent them from having them appear on companys financial statements.
The stock price dropped to $47 per share in 2001, July. This made investors suspicious. And to
put the final nail in the coffin Skilling resigned from president and CEO and citing personal
reasons. , showing world that the company was headed towards disaster. Later, Sherron Watkins
exposed the accounting methods being used to Kenneth lay. Lay and his attorney knew that they
would have to dismantle the special purpose entities if the stock price went further down. Lay
lied to the investors and employees about what the company was heading towards. Meanwhile he
and other executives started selling their share of Enron stock quietly.
Enron decided to take on the debts and assets of special purpose entities which resulted in
increasing the debt by $544 million and reduced shareholder equity by $1.2 billion. On 16
October 2001, SEC announced to take notice on debt and decided to investigate Enrons special
purpose entities, and on 22 October 2001. Fastow was fired.
The company announced that they had overstated since the last five years by $586 million, on
November 2001. The company restatements showed that the company was bearing $2.6 billion
of debts and their shareholder equity had reduced by $2.1 billion. At the end of the month the
stock price reached to $1 a share and company became bankrupt.
Sherron Watkins publicly revealed about the companys accounting practices, on 2002 February.
The personnel from the auditors division of Arthur Andersen was caught certifying Enrons
financial statements and setting up special purpose entity and shredding important papers which
revealed the involvement of Arthur Andersen with Enron.









Ethical Code:
The first ethical issue was bribery, they started bribery with the traders, government
officials and foreign officials (to get the contracts), then the banks and finally the lawyers
and employees.
The second ethical issue was the accounting practices; even though the practices they
used are allowed according to rules but they intentionally manipulated the accounts in
order to increase shareholders wealth and maintain the name of the company. They
created fake entities and companies to hide their debt.
The third ethical issue was that they violated the utilitarian principal. According to the
Adam smith theory that the unregulated free market has an objective to increase net
social benefits, but in the case of Enron they went ahead with their personal benefits, the
social benefits a mere flicker of the past.
The fourth ethical issue was deceptive marketing. They were hid their securities fraud
and others such misfortunes by falsely advertising it. They mislead the investors to invest
in the company by ensuring that their money would be increased. Kenneth Lay ensured
employees and investors that the company would go on to make profits in the near future.
They used the mark to market accounting method to record future forecasted cash flow as
present cash flow--- which overstates the profit.
The final issue was consumer protection; the people of California were not protected. The
company used artificial rolling blackouts to increase the price of the energy which lead to
major accidents, shops being closed for several days , patient mortality in hospitals to
increase, and etc.

Recommendation for Enron:
Restructing of the departments should have done.
Quality improvement strategies should have been introduce and this would have decrease
loss
They should have sold their some assets in the beginning inorder to manage debt.
What they did in California they shouldnt have done that.
Appendix: