be - enron from paragon to parish

:FROM PARAGON TO PARISH

Raymond Edward

Trie Yudha Gautama

William

ENRON

E

nron is a American energy company based in Houston, Texas, US.

E

nron founded in 1930 as Northern Natural Gas Company, a

consortium of Northern American Power and Light Company, Lone

Star Gas Company, and United Lights and Railways Corporation.

C

onsortium ownership is gradually and surely dissolved between

1941 and 1947 through public offering.

ENRON

I

n 1979, Northern Natural Gas organized itself as a holding company,

InterNorth, which exchange Northern Natural Gas in New York Stock

Exchange.

E

nron was one of the popular company in electricity, natural gas, pulp, and

paper.

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nron claimed that they have profit $ 101 billion in 2000.

E

nron bankrupt in 2001.

PIPES TO RICHES IN WONDERLAND

K

enneth L. Lay became chairman and COO (Chief Operation Officer) of

Houston Natural Gas in June, 1984.

C

ompany owned pipelines, and it transported natural gas to customers.

H

e snapped up a small pipeline company in Florida then (July, 1985) merged

with InterNorth, Inc., to give him 40.000 miles of pipelines.

H

e change the company name into Enron in 1986.


D

ue to the lobbying efforts of Kenneth L. Lay and others of his mind, most of

the regulation came off the production and sale of the energy in the last

years of 1980s.

B

y 1989 Enron was trading natural gas on the commodities market.

I

n 1990, Kenneth L. Lay hired Jeffry K. Skilling, a Harvard MBA, away from

his consulting job at McKinsey & Co., to head up the new energy-trading

operations.


I

t was Jeffrey K. Skilling who transformed the operation from a simple

transportation service to an immense trading center, a ”gas bank”

purchasing large amounts of natural gas from the producers and

reselling it to customers here and abroad on long-term contracts.

B

y the end, they were selling broadband, water, and weather

derivatives-hedges against bad weather that might affect business

operations.


F

ederal regulators permitted Enron to use “mark-to-market”

accounting, a way of evaluating future income that works reasonably

well in securities trading.

I

n Enron’s case, it allowed the company to calculate projected income

as present profit, a practice that can be taken to extremes; in 1999,

for instance, the company claimed a $65 million profit “based on its

projections of natural-gas sales from a South American pipeline

project. The pipeline had yet to be built.”

JEDI I

I

n 1993 Enron had formed a partnership with the California Public

Employees Retirement System (Calpers) to invest in energy trades;

each partner put in $250 million.

T

he partnership, a “special purpose entity” (SPE) was called the Joint

Energy Development Investment (JEDI), and prospered, so they started

another one.

B

ut Calpers wanted to cash out its first investment (JEDI I), to the tune

of $383 million at that point, before it started JEDI II.

JEDI I

T

hat posed a problem for Enron because JEDI was not on its balance sheets

(since, as an SPE, it was an outside partnership), and simply buying out

Calpers would have put it on Enron’s books, cutting the company’s

reported profits and increasing its debt by over half a billion dollars.

S

o Enron found, or more accurately founded, Chewco Investments, a

partnership of Enron executives and unidentified others.

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nron lent Chewco $132 million and then guaranteed a $240 million loan,

toward Chewco’s purchase of Calpers share in JEDI I.

JEDI I

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hat left $11.5 million of Calper’s share to complete the purchase.

T

he amount was significant: 3% of Chewco’s capital had to come from

“outsiders” in order for Chewco to be an independent company that

doesn’t show up in the books, and $11.5 million

I

n the event, even that amount was largely underwritten by Enron in the

form of loan and subsidies, leading to the conclusion that from 1997 on,

both Chewco and JEDI I should have showed up on Enron’s books as

one enormous debt. But they didn’t.

JEDI I

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EO of Andersen later explained that Enron had

concealed its subsidies to that last three percent.

F

or the moment, this accounting irregularity raised

Enron’s 1997 profits by 75%; keeping it going for the

next 3 years resulted in $396 million in inflated profits.

RAPTORS

L

JM2, again in company with its parent Enron, created a new set of four investment

vehicles called the Raptors.

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t is funded with Enron Stock, and with stock from New Power, a publicly traded

company that had been founded and spun off by Enron.

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ew Power’s stock providing Enron with a $370 million profit.

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he purpose of the Raptors was to hedge, or lock in, that profit, and profit from

other start-up ventures.

RAPTORS

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nron was insuring itself, and if anything happened to

the price of New Power stock, Enron would have to

absorb the loss both as stockholders and as insurer.

“TAX FREE”

E

nron had paid no income taxes in four of the last five years, making good use

of about 900 subsidiaries in tax-haven countries to cover their revenues.

I

t even collected $382 million in tax refunds.

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n the year 2000, the company got $278 million in refunds.

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nron’s skills in locating its partnerships offshore and keeping cash flow small

had make the tax division a significant “profit center” for the company,

saving $1 billion over the five years.

STRATEGY

T

he impression left by all of the above is that Enron is in

constant motion, always innovating, always daring, always out

in front of some field, but also doing rather little to earn a

living.

S

hortly, Enron’s financial activities well outstripped its pipelines

and its natural gas trade in the amount of money generated.

ENRON’S CULTURE

T

he Enron’s nature: ambition, greed, and contempt to everyone who

wasn’t part of the cheering section.

N

othing mattered except getting rich, very rich, and the company was

led by people who were completely convinced that rich was what they

deserved to be.

E

nron’s day-to-day managers sent clear signals to ignore the law, the

rules, the accounting practices, and all other manifestations of the

lesser breeds without the New Economy.

ENRON’S CULTURE

T

hose who stood in the way of the top people were quickly silenced,

transferred, fired.

W

hen banks hesitated to invest in the new funds, they were given to

understand that their continued opportunity to do business with Enron

required that they overcome their hesitations.

W

hen Arthur Andersen auditors objected to keeping those new funds off

the books, they were warned that Enron might take its lucrative

consulting business to another auditing firm.

ENRON’S CULTURE

E

ven at the end, in August 2001, when Chung Wu, a broker at UBS Paine

Webber from Houston, e-mailed his clients to consider selling their

Enron shares, given the difficulties that the company was experiencing,

his employer rapidly reversed his recommendation and fired him.

T

here’s no indication that any organization would have put up more

resistance to Enron, ranked in March 2000 as the 6th largest energy

company in the world (7th in the Fortune 500).

THE NEW ACCOUNTING

T

he “mark-to-market” accounting allowed Enron to record as

profits assets that were very difficult to evaluate, contracts

for future income, income projected from deals made but

not implemented, income fantasized.

T

he permission to use that accounting had come from the

general government itself.

THE NEW ACCOUNTING

B

ut the major problem facing the others responsible for

monitoring American business, the banks, the investment

analysts, the accountants-Enron’s outside auditors, Arthur

Andersen Inc.- was that they had a very lucrative

consulting relationship with Enron, and they were given to

understand that they would lose it if they asserted and

maintained accounting standards for Enron’s deals.

ENDGAME BEGINS

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n the beginning of year 2001, Enron’s stock had been good,

high $90, and reached $83 in late Fall 2000.

J

effrey Skilling may not have known how bad things were

when he accepted the office of CEO of Enron in February

2001; at the time the price of the stock was $79; and he

cheerfully proclaimed that it should be $126.

ENDGAME BEGINS

M

ost of the SPEs that he had helped put together depended for their

creditworthiness on the value of the Enron stock that backed them up.

I

f the Raptors and other SPEs started losing money, Enron had promised

to repay the investors with Enron stock.

B

y March, 2001, a second rescue operation had to be mounted for the

failing Raptors; 12 million Enron shares, worth at that moment $700

million was needed to bail them out - Arthur Andersen had been

inclined not to approve it.

ENDGAME BEGINS

E

nron would have to report $500 million loss for the first quarter of 2001.

T

hat news would have wiped out all the rest of the partnership.

T

he stock was below $50 in June 2001 when Federals regulators finally

responded to the California crisis by putting strict price controls on the

Western electricity market; it had not yet sunk below $40 on August 14,

2001, when Jeffry Skilling resigned from Enron.

H

e swore that when he left the company was in good financial shape.

ENDGAME BEGINS

K

enneth L. Lay returned from his own retirement to take on the post

of CEO.

V

ice President Sherron S. Watkins tell Kenneth L. Lay about

everything.

S

he gotten a temporary assignment to look into the LJM partnerships,

including the Raptors, and was horrified by what she saw.

ENDGAME BEGINS

O

n August 15, the day after Skilling resigned, Watkins wrote a

long anonymous letter to Lay suggesting that Skilling knew what

he was running away from.

T

he letter spoke the danger that “we will implode in a wave of

accounting scandals,” when the problems with Condor and

Raptor came out; there would be “suspicions of accounting

improprieties,” because of Enron’s “aggressive accounting.”

ENDGAME BEGINS

B

ut the warning fell stillborn; Lehman Brothers went on to

recommended buying Enron’s stock on August 17, when it had

dropped to $36 per share.

A

n internal investigation, led by Enron’s law firm, Vinson & Elkins LLP,

began.

A

ndrew Fastow reassured the investigators that the deals, while

apparently questionable, were really sound, and repeated pledges of

confidence in Enron’s golden future.

ENDGAME BEGINS

O

n September 26, when the stock fell to $25 per share.

A

s the end of the third quarter became imminent, the habits acquired in

previous years reasserted themselves.

E

nron worked out one more “prepay” deal for $350 million on September 28.

E

nron and Qwest arranged a purchase of networks for another $112 million,

a deal that made very little business sense.

ENDGAME BEGINS

W

ith all that cash to pump up earnings, third-quarter losses still had to

be admitted, and somehow spun to the Wall Street analysts on whose

approval the company depended.

O

n October 8, Lay addressed the company’s outside board of directors

with the same bad news.

W

hen the meeting was over, in which the demise of the Raptors had been

cheerfully described as a one-time setback, the directors left thinking

the company was basically in the good shape.

ENDGAME BEGINS

O

ctober 16, Enron’s news release on its third-quarter problems had much

the same message; the losses were one-time, non-recurring, and the

company’s future was roxy.

A

n accounting error, he told a reporter on the phone, resulted in a $1.2

billion loss in equity.

S

eems Enron had counted a Raptors’ acknowledgement of $1.2 billion

transferred from Enron to the SPEs as “shareholder equity.”

ENDGAME BEGINS

O

n October 18, when the Wall Street Journal found out about that

one, it wrote a sharp article calling for better explanations.

L

ay responded to the investment fund manager concerns, and the

question triggered by the article, by attacking the press and

promising, over and over, that the loss was a one-time thing, that

there were no more write-offs hiding in the books.

ENDGAME BEGINS

N

ot quite satisfied with that explanation, on October 22 the SEC launched

an investigation into Enron.

B

y the end of the day the stock stood at $20.65.

O

n October 28, Lay announced the formation of a special investigative

committee, headed up by the Dean of the University of Texas Law

School, William Powers, who hired William R. McLucas, former SEC

enforcement chief and currently with the law firm of Wilmer, Cutler &

Pickering to do the actual investigating.

ENDGAME BEGINS

M

cLucas hired some accountants from Deloitte & Touche to

look into the books, and they found all those hidden

overstatements of profits, and there was no longer any

chance of keeping them hidden.

W

hen McLucas issued his report, the company was

essentially finished.

ENDGAME BEGINS

T

here was one more attempt to save the company by selling it, to its

smaller rival Dynegy.

C

ash was draining rapidly, as creditors called in debts, banks refused to

lend, and even EnronOnline, the computer energy trading company, that

generated most of Enron’s actual revenue, was losing money.

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t’s European trading operations, for which it had claimed a $53 million

operating profit in the July-September quarter, turned out to have

actually lost $21 billion.

ENDGAME BEGINS

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eanwhile, this was too much for Dynegy.

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n November 26, the deal officially died.

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n December 2, 2001, Enron filed bankruptcy.

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n the end, Kenneth L. Lay sold $37.683.887 in stock just before the crash

came; Jeffry Skilling cashed out $14.480.755; Lou Pai, Unit CEO, received

$62.936.552; Andrew Fastow had made $45 million on his LJM entities.

THE SHREDDING OF ARTHUR ANDERSEN

A

rthur Andersen is an accounting firm and they are one of the most powerful

arguers, and arguments for trusting the profession with the job of telling

the truth to the public.

A

rthur Andersen has to take some of the responsibility for was happened in

Enron. They signed off on all of the deals that Enron had made.

C

arl Bass one of auditors had protested the practices of Enron in the past,

about aggressive hedging strategy of derivatives. By the request of Enron,

Arthur Andersen fired Bass in 2000.


I

n March 2001 matters came to a head when Fastow and Skilling rescued

failing Raptors by “cross collateralization”

A

rthur Andersen had been fined $ 7 million by SEC due to signed off on false

and misleading financial statements issued, the largest case ever assessed

against an accounting firm, the Waste Management case.

T

he Waste Management case had used as evidence the contents of Anderson

own files, seized by the SEC and used against them.


I

n the first weeks of October instructions came down in

Houston and in Chicago to “follow the firm document

retention policy of destroying “extraneous” or unneeded

documents. Duncan’s office got to work and started destroying.

O

ver the week end of October 13-14, 2001, bag after plastic bag

was filled with the shredded remains of Enron document.


E

nron’s late “firing” of Andersen as its Auditors was

inconsequential the state-by-state decisions to suspend the firm’s

license to practice and has been fined $500,000

A

fter the case, Andersen’ s reputation for in integrity was gone, its

clients left immediately for other accounting firms, its partners

quickly hired away to continue works else where and very soon

after the verdict the firm closed its doors.


B

y the time sentence was handed down, there were

about 2,000 employees left, closing out operations of

the 85,000 they had had at one time.

THE ULTIMATE FAILURE OF THE SYSTEM

W

hat they do so the system became failure:• Buy, sell, trading, and otherwise using “derivatives”• Creative accounting generally, the purpose of which

is to get profits and losses (selectively) off the books, off the shore, off the tax rolls.

• Make Tax division as a profit center.


Enron’s board approved the creation of the SPE and allowed

Andrew Fastow to run them was told that they would allow the

company to sell underperforming assets to improve its balance

sheet.

A

ccording to the government, Andrew Fastow struck a secret

agreement with Richard A. Causey – Enron’s Chief Accounting

Officer – promising that the assets could be sold back to

Enron at a profit.


I

n September 1999, Fastow created LJM to buy part of the Cuiaba, the

power plant in Brazil that wasn’t making money, to take it off the books.

I

n December 1999, Merrill Lynch bought a share of the Nigerian Barges,

three electricity-generating power barges anchored off the coast of

Nigeria, which were making no money, for $7 million, enough to get

them off the books.

O

n June 29, 2000, LJM2 bought Merril’s stake for $7.5 million, and Enron

paid LJM2 a solid fee for the deal.


T

hen there was AVICI, the profit on whose stock was locked in by a

hedging agreement with the SPE Raptor I, specifying future sale of

AVICI at a high price (the stock was falling at the time).

R

aptor I was actually a subsidiary of Talon, which was financed by

Enron and LJM2.

F

astow lied about Talon’s independence, backdated the hedge so that

Enron could avoid loss.

be - enron from paragon to parish

Documents

northern natural gas

american energy company

gas bank

gas sales

lone star gas company

light company

popular company

holding company