Question

CASE 20 Enron: Not Accounting for the Future* INTRODUCTION Once upon a time, there was a gleaming office tower in Houston, Texas. In front of that gleaming tower was a giant "E" slowly revolving, flashing in the hot Texas sun. But in 2001, the Enron Corporation, which once ranked among the top Fortune 500 companies, would collapse under a mountain of debt that had been concealed through a complex scheme of off-balance-sheet partnerships. Forced to declare bankruptcy, the energy firm laid off 4,000 employees; thousands more lost their retirement savings, which had been invested in Enron stock. The company's shareholders lost tens of billions of dollars after the stock price plummeted. The scandal surrounding Enron's demise engendered a global loss of confidence in corporate integrity that continues to plague markets today, and eventually it triggered tough new scrutiny of financial reporting practices. In an attempt to under- stand what went wrong, this case will examine the history, culture, and major players in the Enron scandal ENRON'S HISTORY The Enron Corporation was created out of the merger of two major gas pipeline companies in 1985. Through its subsidiaries and numerous affiliates, the company provided goods and services related to natural gas, electricity, and communications for its wholesale and retail customers. Enron transported natural gas through pipelines to customers all over the United States. It generated, transmitted, and distributed electricity to the northwestern United States and marketed natural gas, electricity, and other commodities globally. It was also involved in the development, construction, and operation of power plants, pipelines, and other energy-related projects all over the world, including the delivery and manage- ment of energy to retail customers in both the industrial and commercial business sectors. Throughout the 1990s, Chairman Ken Lay, CEO Jeffrey Skilling, and CFO Andrew (Andy) Fastow transformed Enron from an old-style electricity and gas company into a $150 billion energy company and Wall Street favorite that traded power contracts in the investment markets. From 1998 to 2000 alone, Enron's revenues grew from about $31 * This case was developed by Jennifer Sawayda, Harper Baird, Jennifer Jackson, Michelle Urban, and Neil Herndon for and under the direction of O.C. and Linda Ferrell. The authors conducted personal interviews with Ken Lay in 2006 in the development of this case. In 2014 they invited Andy Fastow to speak and had the opportunity to assess his current perspective on Enron and how to prevent financial misconduct. It was prepared for classroom discus- sion rather than to illustrate either effective or ineffective handling of an administrative, ethical, or legal decision by management. All sources used for this case were obtained through publicly available material © 2019.

Answer 1

Question 1: How did the Corporate Culture at Enron contribute to its bankruptcy?

The corporate Culture at Enron could have contributed to its bankruptcy in many ways. Its corporate culture supported unethical behavior without question for as long as the behavior resulted in monetary gain for the company. It was describe as having a culture of arrogance that led people to believe that they could handle increasingly greater risk without encountering any danger.

Its culture did little to promote the values of respect and integrity it instead rewarded ‘innovation’ and punished employees deemed week. The performance evaluation process for employees that was dubbed “rank and yank” utilized peer evaluations, and each of the company’s divisions was arbitrtly forced to fire the lowest ranking employees. This created cut-throat competition not only against Eron’s external competitors but also within the organization. It pitched employees against each other. The internal rivalry created in turn contributed to less communication between operations for fears of being fired. The “survival for the fittest” atmosphere reached the point where illegal activity was deemed necessary to stay on top of the game.

Enron’s compensation plans also seemed less concerned with generating profits for shareholders than with enriching officer wealth. Its culture encouraged flaunting the rules and even breaking them.

Each Enron division and business unit was kept separate from the others and as a result very few people in the organization had the big picture perspective of the company’s operations.

All these aspects of the corporate culture at Eron contributed separately to its eventual bankruptcy.

Question 2: Did Enron’s Bankers, auditors and attorneys contribute to Enron’s demise? If so, what was their contribution?

Yes the bankers, auditors and attorneys contributed to Enron’s demise. This is because they took sides with Enron’s management instead of acting impartial and professionally.

They contributed in Enron’s demise in the following ways:-

Banker – Merrill Lynch

It facilitated Enron to sell Nigerian Barges therefore making Enron record about $12 million in earnings and thereby meet its earnings goals at the end of 1999. This was a sham.

It facilitated Enron in fraudulently manipulating its income statements by entering into a deal whereby Enron would buy Merrill Lynch in 6 months time with a guaranteed 15% rate of return.

Merrill Lynch replaced a research analyst after his coverage of Enron which displeased Enron’s executives. This coverage would have saved Enron from demise if Merrill Lynch would have prevailed upon Enron to implement it.

Merrill Lynch gave in to threats by Enron that it would be excluded from a coming $750 million stock offering and instead, the replacement analyst is reported to have upgraded his report on Enron’s stock rating. This was unethical and unprofessional.

Auditors – Arthur Andersen LLP

They were responsible for ensuring accuracy of Enron’s financial statements and internal bookkeeping. Potential investors used Andersen’s reports to judge Enron’s financial soundness and future potential before they decided whether to invest. Current investors used those reports to decide if their funds should remain invested there. As such, the investors expected that Andersen’s certifications of accuracy and application of proper accounting procedures would be independent and without any conflicts of interest. However, this was not the case and the investors were deceived by relying on the reports of Andersen.

On the other hand, Andersen was a major business partner of Enron and some executives of Andersen accepted jobs from Enron. This was a conflict of interest. Additionally, in March 2002, Andersen was found guilty of obstructing justice by destroying Enron related auditing documents.

Moreover, Andersen failed to ask Enron to explain its complex partnerships before certifying Enron’s financial statements.

This was purely unethical and unprofessional. Andersen were playing a very important role of ensuring that the financial statements and book keeping is accurate and should they have played their role well as professionals, then Enron should not have collapsed.

Attorneys – Vinson & Elkins

They helped to structure some of Enron’s special purpose partnerships. The firm supported the legality of these deals. They were a great facilitator of these deals through transaction opinion letters. As seen from the article, these deals are the ones that contributed to the demise of Enron.

Question 3: What role did the chief financial Officer play in creating the problems that led to Enron’s financial problems?

In order to prevent the losses from appearing on its financial statements, Enron used questionable accounting practices. To misrepresent its true financial condition, Andrew Fastow, the Enron’s CFO, took his role by involving unconsolidated partnerships and special purpose entities - ”SPE’s”, which would later become known as the LJM partnership. Taking advantage from the SPEs’s main purpose, which provided the companies with a mechanism to raise money for various needs without having to report the debt in their balance sheets, Enron’s CFO directly ran these partnerships and designed them to purchase the underperforming assets (such as Enron's poorly performing stocks and stakes). Although being recorded as related third parties, these partnerships were never consolidated so that debt could be getting off its balance sheet and the company itself could boost and have not had to show the real numbers to stockholders. Andrew Fastow was using SPE’s to conceal some $1 billion in Enron debt. Overall, according to Enron, Fastow made about $30 million from LJM by using these partnerships to get kickbacks which were disguised as gifts from family members who invested in them and enriching himself. His manipulation of the off-balance-sheet partnerships to take on debts, hide losses and kick off inflated revenues while banning employees' stock sales was one of the reasons triggered the collapse of the company and its bankruptcy.