Question

Class: ACCT-301 - Week 2 Discussion Board. - WEEK 2: ETHICS

Please summarize the Enron scandal for the rest of us. Describe how you think the elements of fraud were present in this scandal. What do you think could have or should have been done to prevent this from occurring?

Answer 1

Enron Corp reached a dramatic high but it fell more dramatically. Its collapse shook thousands of investors and the employee. AT peak Enron share was trading at $90 which ultimately fell to $0.26 on the date of bankruptcy.

Enron was formed in 1985, after a merger with Houston Natural Gas Co. and Omaha-based InterNorth Inc. After the merger, Kenneth Lay, who had been the chief executive officer (CEO) of Houston Natural Gas, became Enron's CEO and chairman and quickly rebranded Enron into an energy trader and supplier. Deregulation of the energy markets allowed companies to place bets on future prices, and Enron was poised to take advantage. In 1990, Lay created the Enron Finance Corp. To head it, he appointed Jeffrey Skilling, whose work as a McKinsey consultant had impressed Lay. Skilling was at the time one of the youngest partners at McKinsey.

Skilling joined Enron at an auspicious time. The era's regulatory environment allowed Enron to flourish. At the end of the 1990s, the dot-com bubble was in full swing, and the Nasdaq hit 5,000. Revolutionary internet stocks were being valued at preposterous levels and consequently, most investors and regulators simply accepted spiking share prices as the new normal.

One of Skilling's early contributions was to move Enron from a traditional historical cost accounting method to a mark to market (MTM) accounting method, for which the company got official SEC approval in 1992. MTM is a measure of the fair value of accounts that can change over time, such as assets and liabilities. Mark to market aims to provide a realistic appraisal of an institution's or company's current financial situation. It is a legitimate and widely-used practice. However, in some cases, it can be manipulated, since MTM is not based on "actual" cost but on "fair value," which is harder to pin down. Some believe MTM was the beginning of the end for Enron, as it essentially started logging estimated profits as actual ones.

Fastow and others at Enron orchestrated a scheme to use off-balance-sheet special purpose vehicles (SPVs), also known as special purposes entities (SPEs) to hide its mountains of debt and toxic assets from investors and creditors. The primary aim of these SPVs was to hide accounting realities, rather than operating results.

The standard Enron-to-SPV transaction would go like this: Enron would transfer some of its rapidly rising stock to the SPV in exchange for cash or note. The SPV would subsequently use the stock to hedge an asset listed on Enron's balance sheet. In turn, Enron would guarantee the SPV's value to reduce apparent counterparty risk.

Fastow and others at Enron orchestrated a scheme to use off-balance-sheet special purpose vehicles (SPVs), also known as special purposes entities (SPEs) to hide its mountains of debt and toxic assets from investors and creditors. The primary aim of these SPVs was to hide accounting realities, rather than operating results.

The standard Enron-to-SPV transaction would go like this: Enron would transfer some of its rapidly rising stock to the SPV in exchange for cash or note. The SPV would subsequently use the stock to hedge an asset listed on Enron's balance sheet. In turn, Enron would guarantee the SPV's value to reduce apparent counterparty risk.