enron scam analysis

8/9/2019 Enron Scam Analysis

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R O H A N R A J M I S H R A

I I F M

P F M 0 9 - 1 1

Enron Scam


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Synopsis

y Overview

y Timeline of events

y Reasons for the Debacle

y Modus Operandi

y Cases JEDI and Chewco

Whitewing

LJM and Raptors

y The Downfall


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Overview

y American energy company based in Houston Texas

y Main Business area : Transmission and Distribution

of Electricity and Natural Gas throughout U.S.

y Later on it was in trading of 30 different products


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Timeline of Events

y Till 2000-2001: Enron is performing well

y Early 2001: Speculations start company is keeping Wall Street in dark

y

Mid 2001: Irregularities in investments come to light Overstated revenues and understated liabilities Sudden change in management

y Late 2001: Investors confidence declines and stocks starts falling

Company admitted accounting errors Filed for chapter 11 bankruptcy protection

y Jan 2002 U.S. Justice department launches criminal investigation


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Reasons for the Debacle

y Poor Accounting Practices

Mark-to-Market Accounting

Extensive reliance on SPEs

y Focus of CEO Jeff Skilling towards meeting WallStreet Expectations

y Poor performance in low margin high risk diversifiedbusinesses


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Poor Accounting Practices

y Mark-to-Market Accounting

It requires that a long-term contract once signed,

Income would be recorded at

the present value of net future cash flowsy Special Purpose Entities(SPEs)

Shell companies with distinct legal identity

Created to fulfill narrow, specific or temporary objectives.

SPE's are typically used by companies to isolate the firm fromfinancial risk.


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Modus Operandi

y Enron registered huge revenues with the helpof Mark-to-market accounting

y It used off-balance sheet entities to hide

debts/liabilitiesy It inflated revenues using SPEs by showing

loans as sales

y Booked costs of cancelled projects as assets

y Stretched accounting practices by complexbusiness models


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JEDI and Chewco

y Jt. Energy Devp Inv. A JV of Enron &CalPERS(Pension fund)

y In order to encourage CalPERS to divest its stake,

Enron needed to purchase JEDIs Equity.y To avoid Debt Financing of the deal, Enron

guaranteed Chewco LPs Debt and Chewco boughtstake in JEDI on behalf of Enron


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Whitewing

y SPE used as financing vehicle by Enron

y Bought assets from Enron using Enron Stock ascollateral

y Transactions were approved by Enron

y Assets transferred were treated as sales but thosewere loans given


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LJM and Raptors

y Enron organized two LPs to participate as an outsideequity investors in SPEs

LJM Cayman. L.P. (LJM1)

LJM2 Co-Investment L.P. (LJM2)y LJM Related SPEs Raptor I - IV

y Transferred more than $1.2bn assets to these SPEs


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Simplified View: An Irony


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The Downfall

y With help of SPEs, company raised debt finance forits non-core businesses

y It reported some of its debts and hid the others

y

This situation was good until the Stock Priceremained high.


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The Downfall

y When the Stock Prices fell, the off-balance-sheetliabilities put pressure on debt agreements

y Causing downgrade of credit ratings

y

With businesses with thin margins, a lower creditrating increased the cost of borrowings to the pointthat the company fell in a liquidity trap.


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Rise & Fall of Enron

Movement of Enrons share price (USD)


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And that is how you can bring

a company claimingassets worth almost 62bn

to

bankruptcy

In a matter of months


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Thank You

enron scam analysis

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