Scandal

▪ What is Enron?
▪ What are the awards received by the Enron
during its Post-merger rise?
▪ What method Enron used to hide its financial
losses?
▪ What are the reasons why Enron fell down or
bankrupted?
▪ What are the violations committed by the
members of Enron Corporation?
▪ What happened after the Enron scandal?
▪ Who formed Enron?
▪ Who are the members of Enron?
▪ Who are the defendants during the Enron
Scandal?
▪ Who was the person obliged of hiding the
financial losses of the corporation?
▪ When did the Enron Corporation start?
▪When did the Enron Corporation end?

▪Where was the base of Enron Corporation?

▪ How did Enron hide its financial losses and
deceive the investing public?
▪ How did the Enron defend itself during the Enron
Scandal?
▪ How did the public find out about the fraud that
the members of the Corporation committed?
▪The Sarbanes-Oxley Act of 2002 (SOX) is an act
passed by U.S. Congress in 2002 to protect investors
from the possibility of fraudulent accounting activities
by corporations. The SOX Act mandated strict reforms
to improve financial disclosures from corporations and
prevent accounting fraud. The SOX Act was created in
response to accounting malpractice in the early 2000s,
when public scandals such as Enron Corporation, Tyco
International plc and WorldCom shook investor
confidence in financial statements and demanded an
overhaul of regulatory standards.
 Trouble in Vahalla
During the acquisition of businesses, Enron acquired a
team of financial market speculators whose original
function was to hedge risk that the parent company
incurred in the field of operations. Executives thought
that the profits from these speculators or traders were
dependable, however after some success the traders
began to have some financial problems and no longer
making profits.
It should be noted at this point that before Jeff Skilling
headed the company it had from 1990 to 1996 a real
manager, Rich Kinder, who operated the company based
upon cash flow performance. Kinder was a lawyer by
training and came to Enron by way of Enron's acquisition
of Florida Gas. Kinder and Lay had both been trained at
the University of Missouri.
Ken Lay over the years became more or less a political
public relations specialist, Jeff Skilling was a brilliant
business concept man and Rich Kinder was the real,
brass tacks corporate operations manager. With those
talents the three of them were an awesome force.
Unfortunately, due to nonbusiness circumstances, Enron
lost Rich Kinder. Jeff Skilling moved into the job of CEO
for Enron but Skilling, brilliant though he may have been,
did not have the management skills that Kinder had.
Without the anchor of Rich Kinder the Enron ship went
adrift and eventually collided with hard cash-flow reality
After he left Enron, Rich Kinder went on to build a
multibillion dollar energy company, Kinder Morgan,
proving that his was the talent, rather than those of Lay
and Skilling, which was the essential, critical factor in
building a business.
In 1999, Enron launched an Internet based commodity
trading serves: Enron Online. However, in 2001, a
massive slowdown in technology and Internet which
brought Enron’s stock.

In 2001, Enron experienced a failed merging with

Dynargy Incorporated due to some personal, executive
and management disagreements.

All of these reasons caused a massive loss of 638m and

1.2b reduction in SHE.
Mark-to-the-market accounting – Insisted by Jeff Skilling
(COO). It is a legitimate form of accounting for an
enterprise involved in buying and selling securities. It is a
very dangerous form of accounting for a firm engaged in
building projects. Under Mark-to-the-Market accounting
when a power plant is completed the entire present and
future discounted stream of net cash flows are entered
into the accounts as a credit.
For Example: Suppose a firm decides to build an
electrical power plant which is going to last 50 years and
is expected to bring net cash flows of 1 million USD/year.

P/V of 50 yrs, 10% interest: 9,900,000 USD

Cost of the plant: (4,000,000 USD)
Immediate gain: 5,900,000 USD

This would show up in the balance sheet even though in

reality, the plant had not yet produced any revenue.
Note that in the above it was said that the power plant
was expected to earn $1 million per year. What if that
expectation was not fulfilled? Suppose that events led to
a reduction in the expections to $800,000 per year for
the fifty year life. Under Mark-to-the-Market accounting
that is taken care of by entering a subsequent loss when
the expectations changed by $2 million, the difference
between the present value of $1 million per year and
$0.8 million for fifty years when the market interest rate
is 10 percent..
The practical problem is that once the corporation has
booked a $5.9 million it is very difficult to get any one to
agree to book a loss resulting from a change in
expectations. So the firm under Mark-to-the-Market
ends up with its accounts highly slanted to dubious initial
expectations about the projects
The other major way Enron disguised its losses was to
keep the borrowing necessary to finance the deficits off
the books. This was arranged by Chief Financial Officer
Andrew Fastow. The accounting rules allowed borrowing
to be kept off the books if a portion of the source of the
borrowing was from lenders outside of the company. The
portion was surprisingly small and Andrew Fastow found
it relatively easy to put together lending packages to the
company that were only nominally from outside of the
company.
 Off-the-Balance-Sheet Financing
Enron had a great array of foreign assets such as power
plants and pipelines that were not doing well financially
as the company hoped and counted on its accounting.

- In 1997, Enron set up a subsidiary called “WhiteWing”

- Its purpose was to buy the underperforming assets of
Enron then sell those off to third persons.
- As a subsidiary, the financial state of WhiteWing would
show up in the accounts for its parent company.
- In 1999, Enron sold of slightly more than half of
WhiteWing so it would not be treated as subsidiary.
 Off-the-Balance-Sheet Financing
Whitewing was created to buy the underperforming
assets from Enron at a generous price, a price higher
than it could sell those assets for. So Whitewing was
destined to take losses on its assets acquired from Enron.
In order for Enron to find buyers for the half share in
Whitewing it had to agree to compensate Whitewing for
any losses on its sale of the underperforming assets with
shares of Enron stock. A group of investment bankers
was found to acquire the half share of Whitewing
 Off-the-Balance-Sheet Financing: How WhiteWing
worked. For example:

Cost of plant: 8m
P/V of expected cash flow: 10m
Immediate profit: 2m

Suppose the plant did not perform well;

Market value of the plant: 7m
Effect: Cancellation of 2m profit and incurring 1m loss
(expected to be shown in the balance sheet of Enron)
 Off-the-Balance-Sheet Financing: How WhiteWing
worked. For example:

Asset sold to WhiteWing: 10m

*Cost 8m
Validation of profit: 2m
White wing would sell the asset for 7m and would get
3m of Enron’s stock under the agreement.*
Effect: The 3m stock issued to WhiteWing would not
show up a loss of Enron and thus Enron would have
turned a 1m loss on an investment into 2m of profit.
Due to erratic movements (sudden and abrupt)
movement of Enron’s stock prices (from 90USD to
1USD/share causing 11 billion loss to shareholders) and
innumerable and questionable invisible profits,
investment analysts began to question the company’s
viability in March 2001. By October at that year US
Securities and Exchange Commission (SEC) had opened
an investigation to Enron’s accounting books.
Richard Causey (CAO)
First worked as a senior
manager of Arthur Andersen.
Fired from Enron in 2002 after
SEC has showed evidence of his
crimes and was indicted for
fraud and conspiracy charges.
Kept on pleading non-guilty
until 2005, when he entered a
guilty-plea for 5-7 years of
imprisonment in exchange for
inside information.
Released year 2011 and now
working as an “independent
accounting professional”
Responsible for keeping the books of
Enron.
Was accused of overlooking significant
amount of money that had not been
presented on Enron’s books.
Was found guilty on federal charges that
it obstructed justice by destroying
thousands of Enron’s accounting
documents.
Was forbid by the law to audit.
Currently, it has changed its name to
Anderson Tax and is now America’s
biggest tax firm
Ken Lay (CEO)
Responsible for misinterpretations
of Enron’s accounting books.
Was found guilty by SEC and was
indicted for 10 counts of security
fraud (each fraud = 5-10 years of
imprisonment)
Died Nov. 2006 due to heart
attack, 2 months prior from his
sentencing .
Conviction: vacated
Jeffrey Skilling (COO)
Responsible for Mark-to-Market
accounting.
Indicted for conspiracy, security
fraud, fake statements and illegal
inside trading.
Currently serving 14 years of
imprisonment at Federal Prison
camp with a fine of 45mUSD
▪ led to new regulations and legislation to promote
the accuracy of financial reporting for publicly-held
companies
▪ resulted in other new compliance measures
▪ brought attention to the closely related issues of
financial statement fraud and fraud by executives
▪ thousands lost their jobs and their retirement funds
▪ investors lost millions
▪ created tremendous costs for many companies
▪ compromise of auditor independence in the Enron
debacle has changed the auditing profession forever
▪ corporations will continue to incur costs year after
year as they comply with regulations that came
about after the fall of Enron
▪four year investigation and prosecution of Lay
and Skilling undoubtedly cost massive amounts
of money
▪No prison sentence can restore the public’s full
faith in the financial statements of public
companies
▪Investors and analysts have become more
skeptical