Enron was an American Energy giant corporation headquarters based in Texas which started on 1985 and prospered fast. Enron was not only limited to energy but expanded its business water companies, electrical energy plants an dmany mother business like fibre optic, broadband cable and newsprint etc. making a profit of upto $101 Billion in the year which increased its share price and fame in the business. However in the year 2001 Enron fell into bankruptcy in spite of it being valued $60 billion. The reason being was Enron venturing into unprofitable business enterprises and forged accounting practices to veil the true financial position of the corporation. It was revealed that the reported financial statements of Enron was a consciously planned and well structured accounting scam which is well known as Enron Scandal.
The consequence of this scandal was immense. It had a remarkable impact in the accounting, commercial; economic and federal regulatory which became a political scandal as well. Arthur Anderson, the accounting firm for Enron was held for carrying out the accounting fraud which resulted in the loss of thousands for investors and workers of Enron and the demise of the corporate giant Enron and the accounting firm Arthur Anderson as well.
Conduct your own research on the events leading to the collapse of Enron and list the series of questionable business deals by Enron, in particular, between Enron and Raptor, and between Enron and Condor. How those deals were accounted for in the financial statements?
Organization is charged with the responsibility to function in an ethical fashion. In the early 2000's the largest or most well known business failure occurred. Enron was exposed for their immoral practices and not only was the organization held responsible, but the individuals involved were also.
Enron grew to be the middleman for energy companies that allowed them to exchange energy contracts. The growth was very impressive and the business expanded into other facets including Internet services. During the time period 1993-2001 Enron formed more than 3000 Special Purpose Entities abbreviated as SPA. SPA's are the entities that are formed to serve a specific purpose as in Enron's case the purpose of such SPA's were to hide the liabilities from the balance sheet of Enron and falsely improving the leverage and equity return and asset return ratios.
With the growth in business Enron needed to borrow more and more money and to hide the liabilities from Enron's record they began to create spin out organizations that were used to hide the loss of $600 Million created by Enron. By hiding their debt, Enron looked like a very successful company until the Securities and Exchange Commission of United States gave notice to start investigation on Enron in 2001.
The first reason for Enron's collapse was because it was leveraged through debt. The second was the fall of the stock price. This caused issues with their debts and resulted in credit downgrades. The third stage was the increased cost of borrowing due to the credit down grades that caused liquidity issues for Enron.
In August 2001, Jeff Skilling placed his resignation from CEO. Then, in October 2001, Enron came out with losses over $600 million. Ironically, that is the same amount that was being sheltered under Chewco Investments.
Arthur Anderson (AA) can also be included in the fall of Enron. As their auditor, AA was an extension of the Enron organization. In October 2001, AA destroyed almost all of Enron's books. Arthur Anderson had helped Enron to form the spin out organizations and hide their losses. All of these behaviours between Enron and Arthur Anderson were reasons for the fall of Enron.
Enron was exposed for their immoral practices and not only was the organization held responsible, but the individuals involved were too. There are specific organizational behaviour theories that could have predicted Enron's failure such as the debt that was hidden under other businesses or the changes in upper management with no clear reason being provided. In addition to the organizational behaviour the leadership, organization, and managerial structures added to the collapse of one of the largest companies in the world.
Their accounting firm, Arthur Anderson, was not innocent in the scandal whatsoever. In the end, leaders and managers from both organizations paid the price for the mess that they had created. Not only were the organizations held responsible, but several individuals reaped the repercussions as well. This situation shows the immense impact that leaders and managers have on an organization. They can control whether an organization acts ethically or if the organization becomes greedy and does whatever necessary to be profitable and viewed positively in the public eye.
Enron involved in partnership business deal with its various SPEs. The deals with CALPERS, ZEDI, RAPTOR, CONDERS were those deals and the accounting treatment of those transactions, were responsible for inevitable demise of the Enron Company.
Raptor and Condor
Raptor and Condor were the subsidiaries, which were created to buy stock and hide debt for Enron. Enron was able to conceal its losses and create imaginary profits by creating ghost companies like Raptor and Condor. These companies shuttled money from banks to Enron, who reported it as profit.
Accounting treatment of the Enron's deals with Raptor and Condor
Enron should have combined the financial reports of Raptor and Condor on its own as they were not autonomous entity and were the division of Enron but Enron recorded all the gain or losses including all the hedge transactions of its SPEs entities and did not consolidate it into its financial statements. The executives of Enron planned the deals in a way that income would show up and not the losses and that too showed up as decrease in shareholder equity and had no effect on income statement.
Enron recognised $800 million in cash flow from condor. In fact Enron should instead have been accounted for as an issuance of stock, But Enron counted it as cash flow.
Question 2:
"I am incredibly nervous that we will implode in a wave of accounting scandals." What accounting scandals was Watkins referring to here? List the questionable and/or fraudulent accounting practices Enron was engaged in. What were the effects of such practices on the reported results of Enron?
Answer:
The accounting techniques used to misrepresent the financial statements was a combination of many different complex tactics. The first tactic was using ghost companies (SPEs) which they would transfer money to and from and different banks which would issue these ghost company loans. The end result was an extraordinarily complex set of financial statements which disguised the loans as cash flow, using their "independent SPEs" to incur Enron's losses on paper and "create" profits. Another tactic that Enron used was by forecasting the futures market of energy sales.
Albrecht, a PhD in the AICPA (American Institution of Certified Public Accountants), states about the role of Enron SPEs involved in the accounting fraud: "Many SPE (special purpose entities) transactions were timed (or illegally back-dated) just near end of quarters so that income could be booked just in time and in amounts needed, to meet investor expectations ."
Enron was able to use EITF (Emerging Issues Task Force) resolution 90-15, created in 1990, which allowed them to create and maintain the SPEs which allowed them to conceal the fraud. EITF 90-15 only requires 3% of capital/assets to be contributed by independent external sources in order for an SPE to exist. Albrecht states in his report that about EITF 90-15:
EITF 90-15" (The 3% rule) Allowed corporations such as Enron to "not consolidate" if outsiders contributed even 3% of the capital (the other 97% could come from the company.) 90-15 was a license to create imaginary profits and hide genuine losses. FAS 57 require disclosure of these types of relationships (FAS 57 was proposed and implemented after the Enron scandal). Enron had a negative $597 million dollar cash flow in the first half 2000 by taking loans from banks such as Citigroup and Morgan-Chase totaling nearly $3.4 billion. Enron accrued approximately 2 million dollars in interest each day, which had to be paid in cash according to Kay. In fact Enron would have recorded actual losses in its last 6 years of business, had its employees not qualified and filed for tax incentives. Damages incurred the monetary damage incurred by the stockholders, employees, and other companies in the Enron scandal involved hundreds of billions of dollars. Employee pension plans can no longer be paid, stock holders saw Enron stock plummet to $0.09 cents a share from over $90 dollars per share, hundreds of millions of dollars in fines were issued to the banks, Andersen Accounting went bankrupt due to fines and civil suits, and other intangibles such as lost time and emotional strain also occurred. The SEC fined Morgan-chase $135 million, and $700 million in two different cases dealing with the Enron collapse. Citigroup was fined a total of over $1.42 billion. In addition to fines and settlements, Citigroup and Morgan-Chase incurred $456 million and $228 million respectively in losses from the Enron bankruptcy. These fines and losses do not cover legal fees or mandatory payments to agencies other than the SEC.
The Enron scandal led to civil and criminal trials involving Citigroup, MorganChase, Merrill-Lynch, and Andersen Accounting, fines issued to the banks involved. Five out of the six criminally charged employees were found guilty, including Dan Boyle the former vice president at Enron's global finance group, James A. Brown, the former managing director of Merrill's strategic asset lease and finance group, Daniel Bayly, the former head of global investment banking at Merrill, William Fuhs, a former vice president, and Robert Furst a managing director in the investment banking division. Sheila Kahanek, the former Enron accountant, was the only party that was acquitted.
The accounting misstatements were discovered starting when on "November 8th of 2001 Enron told investors they were restating earnings for the past 4 and ¾ years" (Albrecht). Declaring bankruptcy shortly after restating its earnings was also a clue. The governmental organizations involved in the Enron investigation are the SEC and IRS. The SEC investigated the fraud, issued fines, and filed criminal and civil charges against the companies involved and the Department of Justice (Enron Task Force) prosecuted the accused firms. The IRS's role is unclear because of the investigative reports involving the scandal not being available due to Enron's rights as a private taxpayer, according to Business Week.
Question 3:
"The overriding basic principle of accounting is that if you explain the 'accounting treatment' to a man in the street, would you influence his investing decisions? Would he sell or buy the stock based on a thorough understanding of the facts? If so, you best present it correctly and/or change the accounting. My concern is that the footnotes don't adequately explain the transactions" What is the context of this comment by Watkins? Why footnotes do not adequately explain transactions?
Answer:
Enron also failed to follow the accounting rules (Generally Accepted Accounting Principles). A completed financial statement with notes should be able to explain to the layman what is happening financially with the company. Any deviations in GAAP need to be noted on the financial statements. The famous note on their financial report mysteriously reports a profit of $500 million - which was in actuality was profit reported in part by the value of Enron stock. This and other extremely risky investments were mentioned very vaguely in the footnotes. If stockholders knew this would they have changed there investments? If the answer is yes, then it must be noted clearly - but it wasn't. The accountants and auditors, who were being paid by Enron, failed to accurately state the position of the company and let these technicalities pass. Accountants also failed to consolidate SPE's into Enron's financial statements when the special purpose entity (Chewco) could no longer be recognized as a separate entity. This lead to a misleading report of the financial health of Enron in turn resulting in a restatement o f income in 2001, which increased Enron's reported debt by over $2.5 Billion and reporting as far back as 1976. As one report said, "You couldn't slip these things by anyone … They're simply too big, and too many people were involved for it to go unnoticed." The Private Securities Litigation Reform Act reduced the auditor's liability for incorrectly reporting income which although not illegal, did not provide any incentive to stop these actions. Morally both upper management of Enron and the accountants served to line their own pockets with money while misleading the investors, creditors, and fellow employees. Upper management even sold stock as they encouraged normal employees to buy it. In the Sherron Walkins whistle-blower letter, she says that without a doubt "executive management of the company must have a clear and precise knowledge of these transactions." They emphasized values in maximizing short term profits through increased stock prices, and placed little value on the creditors, employees, and investors.
Question 4:
Watkin's memo refers to Arthur Anderson & Co (AA) at several places. How was their role as auditors of the company? Critically explain.
Answer:
Watkins, the whistleblower, warned Kenneth L. Lay that the company might "implode in a wave of accounting scandals," in August of 2001. Watkins describes "a veil of secrecy" around partnerships that involves the energy-trader's former chief financial officer, Andrew Fastow.
It was the job of Andersen Consulting to ensure the accuracy and reliability of the financial statements of Enron so that creditors and investors could make good financial decisions. However, it is now Andersen that is under investigation for illegal and unethical accounting practices which places both companies, Andersen and Enron. Enron hired Andersen to conduct corporate financial audits. Enron was one of Andersen's largest accounts, and also a major business partner to Enron as they sold millions of dollars in consulting service. Due to these relationships it was just too easy for both Enron and the accounting firm to work together in covering up financial losses and debt.
Andersen was also responsible for some of Enron's internal bookkeeping, with some of Andersen's employees eventually leaving to work for Enron. At the Andersen reins of this accounting scandal is chief executive officer Joseph F. Berardino. Berardino fired the lead Enron auditor David Duncan after it was learned that he had ordered the shredding of Enron audit related documents that would have disclosed true financial representation. Arthur Andersen also by oversaw some of the key factors that triggered disproportionate earnings and growth. Enron's stock peaked at over $90 per share but quickly bottomed out at 9 cents per share. Stockholders, investors, and creditors wanted to know how one of the nation's top accounting firms could have missed such shifts and irregularities in Enron's accounting practices, which is one factor that led to investigation into the accounting practices of the firm. As a result, the US Department of Justice brought obstruction of justice charges against Andersen which ultimately ran Andersen out of business.
Conclusion:
Enron executives placed their own personal wealth above the welfare of the company and the stockholders. Personal gain, greed, lack of ethics, and a general feeling of being above the law were the factors that brought down Enron. Enron was able to conceal its losses and create imaginary profits by creating ghost companies such as raptor. These companies shuttled money from banks to Enron, who reported it as profit. Arthur Andersen firm overlooked this factor most likely because of their involvement in keeping Enron's books, and the size of Enron itself. After time had elapsed and earnings were restated, an investigation ensued, resulting in prison sentences for some, the collapse of 2 businesses (Enron and Andersen), and enormous fines in the hundreds of millions of dollars. These small repercussions do not come close to the financial backlash of the Enron collapse and the total damage of the ordeal estimated over 100 billion dollars.
Due to accounting frauds of organizations such as Enron, the SEC has begun to take great steps in preventing loopholes within the accounting and financial disclosure system. The Enron case illustrates a number of flaws in the reporting system, which needs to undergo thorough re-evaluation and criticism before making any immediate alterations. Essentially most of the problems faced by Enron derive from the immoral and unethical actions taken on by the board of directors in their attempt to achieve personal profits. In order to prevent these unethical acts from occurring, there needs to be an enormous emphasis on the truthfulness and integrity of executives. In order for companies to prevent an Enron-like scandal, there needs to be supervision over managers and executives as they exercise their own business judgments about what is in the best interest for an organization.
