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Enron – Facts and Findings

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Table of Contents

ENRON – The Company

Business Verticals

Key Executives

The Promise

What went wrong

The Cover-up

The Aftermath

3ENRON – The Company

InterNorth Houstan Natural Gas

Key Dates:1930: The company is founded as Northern Natural Gas Company in Omaha, Nebraska.

1947: The company is listed on New York Stock Exchange.

1980: The company's name is changed to InterNorth, Inc.

1985: A merger with Houston Natural Gas Corp. takes place.

1986: The company's name changed to Enron; the new company is headquartered in Houston.

1991: Enron begins overseas expansion.

1999: Launches EnronOnline.

2001: Files for bankruptcy after previously hidden losses come to light.

Sixth largest company in the United States

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ENRON – The Company

Three major events that shaped Enron

Ethical Dilemma In early 1987, it was discovered that several traders were booking and settling falsified trades, instead of shutting down the unit, they reorganized the unit and altered it’s reporting structure

Outside Influence on Key decisions

Jeff Skilling a consultant advised creating gas bank, a natural gas trading business. Later, when he joined the firm this idea was accepted

Using new financial reporting techniques

Using the MTM ( mark-to-market) accounting. MTM allowed Enron to recognize the sales and earnings on deals today, although the cash flows would occur in future

Kenneth Lay He was a son of Baptist Preacher. He was an American businessman. He was the CEO and Chairman of Enron from 1985 to 2002. He was one of the Crusaders of Deregulation in energy sector specially oil, natural gas and electricity. He was America’s highest paid CEO’s with a compensation package of $42.4 million in 1999.

Jeffrey Skilling He was a MBA graduate from Harvard Business School. He worked as a consultant for McKinsey and Company.

He helped Enron in 1987 to create a Forward market in natural gas.

Skilling impressed Kenneth Lay in his capacity as a consultant and was hired as a chairman and CEO of Enron Finance Corp.

His only condition while joining the company was to adopt Mark to Market accounting.

He quit the company on August 14,2001.

Key Executives

6 Andrew Fastow An American businessmen who served as a Chief Financial Officer of Enron Corporation.

He was one of the key figures behind the complex web of off Balance Sheet SPE’s which were used to conceal Enron’s massive losses.

His main job was to keep the stock prices up even though the company had a $ 30 billion debt.

He created hundreds of SPE’s designed to transfer Enron’s Debt to an outside company and get it off the books of Enron without giving up the control of the assets that stood behind the debt.

Rebecca Mark Rebecca Mark, is best known as the former head of Enron International, a subsidiary of Enron. Mark was promoted to Vice Chairman of Enron in 1998 and was a member of its board of

directors. She resigned from Enron in August 2000. Ideological conflict and rivalry within Enron arose between Mark, who specialized in hard assets

and facilities, and fellow top executive Jeff Skilling, who pushed for the company to develop and expand its financial trading and risk management sectors instead.

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Business Vertical

Enron International

• CEO – Rebecca Mark• Asset Heavy• Power projects and

pipeline

Enron Capital and Trade Finance

• CEO – Jeff Skilling• Asset light• Trading activities and power sales

Factors responsible for robust growth of ENRON

Deregulation of US energy (gas and electricity) market

Acceptance of MTM method of accounting

First mover advantage in the gas trading business

Since Enron connected suppliers and consumers they had access to market intelligence which their competitors lacked, they used this info for gas trading

Principal Subsidiaries: Enron Engineering and Construction; Enron Renewable Energy Corp.; Enron Ventures Corp.; EOG Resources Inc.; EOTT Energy Partners LP; Florida Gas Transmission Co.; Transwestern Pipeline Co.; Enron Wind Corp.; Louisiana Resources Co.; Northern Border Pipeline Co.; Northern Plains Natural Gas Co.; Northern Transportation & Storage; Linc Corp.; Azurix Corp.; Enron Corp

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In 1995, Enron CEO Kenneth Lay promised investors that Enron's profits would rise by 15 percent a year over the next five years

The Promise

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Rebecca Mark’s Shopping spree

Loss making broadband business

Water Business Disaster

Flawed Accounting Practice

Limited effect of energy deregulation

What went wrong…….

In 1998, they bought Wessex British water utility company for $2.4 billion. They created Azurix, a water utility company, trading in water rights

In January 2000 Enron announced an ambitious plan to build a high-speed broadband telecommunications network and to trade network capacity, or bandwidth. It lost about $2 billion on Telecom capacity when the internet bubble bust

Rebecca signed and sealed new deals at break neck speed. These projects locked-in Enron’s cash flows. Deals were characterized by inadequate due diligence, aggressive bidding leading to unprofitable margins. Example of failed project – Dhabol Power Project were they lost ~$2.8 billion

Unrealized trading gains accounted for slightly more than half of the company’s $1.41 billion reported pretax profit for 2000 and about one-third of its reported pretax profit for 1999. This resulted in huge discrepancies between earnings and cash flows. Profits from projects were calculated before actual returns

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What went wrong…….

Locked –in cash flows due to the commitment to various projects

Left the company with stressed and underperforming assets

Huge debt pile on the company’s balance sheet

Deviated from core business

Increased focus on short term gain at the cost of long term, sustainable growth

THIS LEFT ENRON IN A FRAGILE FINANCIAL CONDITION

11 Were there any Indicators to spot the loom ?• Global energy crises by late 90s.

• In India, lost the Dabhol Power project, in which Enron had committed $2.9bn.

• Beginning of Dot.Com bubble crises and fallout of blockbuster internet deal.

• Enron delivered smoothly growing earnings (but not cash flows). • Global energy crises by late 90s.

• In India, lost the Dabhol Power project, in which Enron had committed $2.9bn.

• Beginning of Dot.Com bubble crises and fallout of blockbuster internet deal.

• Enron delivered smoothly growing earnings (but not cash flows).

Enron’s Accounting Fraud Diagram

Enron

Profit

Understated

Forecasted Future Price

COMPARE

Mark To Market Method

Seller Buyer

Overstated

Debt

Special Purpose Entity

Debt&

FailingInvestment

Sales Revenue

Original Pricepaid for the

contract

This slide should be included if you can explain this

properly

“Profit” making formula (SPE)

ENRON

Partnership

SpecialPurposeEntity(SPE)

AccountIn

Profit

3

4

2

1

5

1. Enron sets up partnership using stock as funding2. Partnership sets up SPE3. SPE agrees contract to pay Enron if its investment

declines in value4. Payment made as investment declines5. Payment posted as profit, even though it is Enron’s

own money

”“A huge hole had opened in the accounts.

-BBC

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The cover-up

Balance SheetLiabilities Assets

• Underperforming assets

• Stressed Assets

SPV

Asset Transfer Cash Transfer

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The cover-up

The main dark areas…

White collar crime done by the vital executive in an organization (Enron and Arthur Andersen)

The crime is included not only as the crime in Law point of view but also as the organizational fraud which effect the whole shareholder of the organization.

The Enron deception was practicing the accounting fraud by creating the SPS (Special Purpose Entity) which exchange the debt and failing investment into sales revenue in financial statement.

This Fraud is done by the cooperation of Enron CFO, few of Enron people and Andersen’s chief auditor for Enron

This slide and next 2 slides should be

consolidated into one

Role of Arthur Andersen•Andersen executives including chief Enron auditor David Duncan, decided to consult lawyers over whether or not the partnerships were legal.

•Andersen told Enron that it had no other choice but to change the way it was accounting for its special partnerships.

•At some point after this, staff in Andersen’s Houston office began shredding documents relating to Enron. •Arthur Andersen was one of the world’s five leading accounting firms.

•Legal examination of Sherron Watkins's concerns concluded that the partnerships in question, Raptor and Condor, had been approved by Andersen.

•Was paid $52mn in 2000, the majority for non-audit related consulting services.

Timeline of Enron’s CollapseDate Event

20 Feb, 2001 Fortune Magazine story calls Enron a highly impenetrable Co. and stock was overpriced.

14 Aug, 2001 Jeff Skilling resigned as CEO, citing personal reasons. Kenneth Lay became CEO once again.

12 Oct, 2001 Arthur Anderson legal counsel instructs workers who audit Enron’s books to destroy all but the most basic documents.

16 Oct, 2001 Enron reports a third quarter loss of $618 million.

24 Oct 2001 CFO Andrew Fastow who ran some of the controversial SPE’s is replaced

Timeline of Enron’s Collapse

Date Event8 Nov 2001 The company took the highly unusual move of restating its profits for

the past four years. It admitted accounting errors, inflating income by $586 million since 1997. It effectively admittedthat it had inflated its profits by concealing debts in the complicated partnership arrangements.

2 Dec,2001 Enron filed for Chapter 11 bankruptcy protection and on the same day hit Dynegy Corp. with a$10 billion breach-of-contract lawsuit.

12 Dec 2001 Anderson CEO Jo Berardino testifies that his firm discovered possible illegal acts committed by Enron.

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

Enron's shareholders lost $74 billion in the four years before the company's bankruptcy ($40 to $45 billion was attributed to fraud).

Enron’s more than 20,000 former Employees lost $2 billion in pensions. Employees lost more than $1.2 billion in retirement funds. Enron’s top executives cashed in $116 million in stock. 20,000 employees lost there jobs and medical insurances. On April 09, 2002 David Duncan, Enron’s Auditor pleads guilty to obstruction. Further, On August 31, 2002 the

firm surrenders its license to practice accounting. In addition, On Oct 16, 2002 sentenced to probation and a $500,000 fine and banned from auditing public companies. Additionally, On March 13, 2007 Arthur Anderson will pay $72.5 million to investors who sued the firm for its involvement in Enron Scandal.

The Aftermath

ProsecutionsAndrew Fastow –

faced 98 counts, pleaded guilty to one charge of conspiracy to commit wire fraud and one charge of conspiracy to commit wire and securities fraud. Fastow has agreed to serve 6 years in prison and forfeit $23.8 million, including homes in Galveston and Vermont; and forfeit claims on another $6 million held by third parties.

Jeffrey Skilling –

Named in 35-count indictment, Skilling pleads not guilty to wire fraud, securities fraud, conspiracy, insider trading and making false statements on financial reports.

On May 25, 2006 Skilling convicted on 19 of 28 counts of conspiracy, fraud, insider trading, and false statements. Skilling gets 24 years and 4 months of imprisonment and forfeits $45 million.

Kenneth Lay –

Indicted on 11 criminal counts of fraud and making misleading statements , Ken Lay, surrenders to the FBI. After pleading not guilty.

On May 25,2006 Lay convicted on all six counts of conspiracy and fraud, In July Lay dies before sentencing.

Can be consolidated with earlier slide, The

Aftermath

Stock heading South

•8th Nov, 2001 – Told investors that they were restating earnings for past 4 and ¾ years.

•By end of Nov, 2001 stock reached $0.3 falling from its peak price $90 in just 8 months.

•2nd Dec, 2001 – Filed Bankruptcy.

Should give all time high for

the stock

Conclusion

Enron was a massive failure, partly because of its size, partly because of its complexity, partly because the controls to protect the integrity of capital markets failed, and especially because of the massive greed and collusion of key participants. Management failed, auditors failed, analysts failed, creditors/bankers failed, and regulators failed. The intersection of multiple failures sent a signal of structural problems. Suddenly, the consequence of deceptive financial data resulting from structural failure in the capital markets was not merely a hypothetical possibility. The speed with which the system responded indicates the importance of fairly presented financial information.

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