"It has always seemed strange to me... the things we admire in men, kindness and generosity, openness, honesty, understanding and feeling, are the concomitants of failure in our system. And those traits we detest, sharpness, greed, acquisitiveness, meanness, egotism and self-interest, are the traits of success. And while men admire the quality of the first they love the produce of the second."
This famous quote by John Steinbeck could be a characterization of Enron Corporation, an expression of the dichotomy of its existence and history; its charitable giving versus broken promises; and huge profits versus personal loses. To understand this dichotomy, you must understand Enron's corporate history and culture and how that leads to the scandal, and understand the aftermath of the fraud.
Enron's history begin in April of 1985, the "take over" of Houston Natural Gas by InterNorth of Omaha. Six months after the take over the joint company was renamed Enron.1 Ken Lay the CEO of Houston Natural Gas became of the CEO of the combined company in 1986. In 1990 Lay hires Jeff Skilling to lead the charge in deregulating natural gas commodities market. On May 17, 1991, the Audit Committee of Enron's Board approved the use of mark-to-market accounting.2 Which is, "Assigning a value to an asset equal to the current market price of the asset or one calculated based on related standardized assets for which there is a market."3
Skilling would be named President and Chief Operating Officer in early 1997. "Skilling, constantly focused on meeting Wall Street expectations, pushed for the use of mark-to-market accounting and pressured Enron executives to find new ways to hide its debt. While [Andy] Fastow and other executives,4 "...created off-balance-sheet vehicles, complex financing structures, and deals so bewildering that few people can understand them even now."5 Mark-to-Market Accounting and Special Purpose Entities are two of the corporate policy reasons that lead to Enron's downfall.
The culture of Enron also contributed to its eventual downfall. "Enron's corporate culture best exemplified values of risk taking, aggressive growth and entrepreneurial creativity. These are all positive values. But these values were not balanced by genuine attention to corporate integrity and the creation of customer - and not just shareholder - value. Because the Enron corporate culture was not well grounded, a single scorecard - maximized price per share of common stock - became its reason for being, and even its positive values became liabilities." [5]
Throughout the years of fraudulent accounting practices, company officers, vice presidents, directors took part in either creating this conspiracy or covering it up. From the founder and CEO of Enron, Kenneth Lay to the accounting personnel, there were different levels of involvement. When it finally came to light, lower ranking officers were turning on their bosses to take advantage of a plea bargain agreement the Federal Government offered. In return, some of the charges were dropped for those who pleaded guilty and assisted the government in convicting the main players of this scandal.
Enron Scandal - Particpants
Sitting at the top of the food chain, Kenneth Lay served as a Chief Executive Officer until his resignation in January of 2003. He founded Enron back in 1985 and was the public face of Enron. Lay was one of the top paid CEOs at the time. When the collapse of Enron was emanate, known only to trusted insiders, Lay sold most of his stock for $300 million. After the collapse of the company, he was the number one target of both criminal and civil law suits. When the federal government finally put its case together, Kenneth Lay was indicted of 10 counts of fraud and conspiracy. His trial was backed with testimonies of his former employees who took the plea bargain. He was found guilty of ten counts of conspiracy and fraud and was facing a 20-30 years sentence when he suddenly died. He died while vacationing in Colorado three months before his scheduled sentencing. Autopsy reports indicated heart attack as the possible cause of death.
Second in line was Jeffery Skilling. Skilling served as the president and CEO of Enron. He was famous for drafting the mark-to-market accounting practice that booked future profits as today's profit. He was Mr. Lay's right hand person and was regarded as cut-throat business man. During the final days of Enron, he abruptly resigned as President and CEO, a post Mr. Lay reassumed. After the collapse, Skilling was charged with multiple counts of fraud. His trial was also supported by former executives who testified against him, although he maintained his innocence. After the trial was over, he was convicted of nineteen counts of conspiracy, fraud, false statements and insider trading. Nine other insider trading charges were thrown out. He now serves a twenty-four year sentence as a result of his conviction.
The Chief Financial Officer for Enron during those days was Andrew Fastow. Fastow was one of Mr. Skilling's top hires and played a major role in the fraudulent business practices. He helped setup complex off-the-books partnerships that Enron used to avoid disclosing looses. Not only did he defraud the public, but Mr. Fastow also defrauded Enron millions of dollars using these same partnerships. He was one of the top execs who accepted the plea bargain to testify against Mr. Lay and Mr. Skilling. He pleaded guilty of helping disguise deteriorating finances, for which he received a reduced two and half year sentence in prison. In a civil suit against him, he agreed to serve 10 year sentence and pay over $23 million. Mr. Fastow is also barred from serving as an officer or director of a public company.
Appointed corporate treasurer, Ben Glisan Jr, also helped execute several financing schemes that hid company losses. He is one of four execs who secretly invested in a partnership known as Southampton place. He was initially charged on more than twenty-four counts of conspiracy, fraud and money laundering, but later pleaded guilty of one count of conspiracy to commit wire and securities fraud. He is serving a five year sentence in Beaumont, TX.
While these criminal activities were underway, someone had to keep a straight face and tell the public that everything was okay. That person was Mark Koenig. As the Director of Investor Relations, he was responsible for running conference calls with Wall Street analysts. In one of the most noted calls he presided over, Mr. Skilling reported $425 million in earnings. Mr. Koenig was charged of knowingly participating in efforts to mislead investors into thinking that Enron's financial health was good. He received an 18 month prison sentence and he also settled a separate civil charge paying about $1.5 million in fines.
Not everyone was found guilty of this scandal, however. There were some top players who were scrutinized and questioned by the government but was never charged of any wrong doings. Such person was Lou Lung Pai. Born in China, he headed several divisions at Enron which sold contract to provide natural gas and electricity to companies. He was known for running up large tabs on company expense at strip clubs. His affair with an exotic dancer cost him his marriage that he settled by selling most of his Enron stocks. However, his take of more than $271 million in stock sales is considered the largest by any former employees. He resigned 6 months before Enron filed for bankruptcy. Another person who was highly questioned but never charged was Greg Whalley. He served as a president of the company when Mr. Skilling left. Soon after, he fired Mr. Fastow realizing the depth of Enron's financial problems. He cooperated with federal investigators in bringing charges to other executives, but was never charged.
There were high ranking employees who saw this unethical behavior as detrimental to the survival of the company. Many expressed their fear and opinions prior to the collapse and two are specifically designated as the "Enron whistle-blowers". Sherron Watkins and Vincent Kaminski did just that. Sherron is famous as a corporate whistle-blower after her letter to Mr. Lay detailing the questionable accounting practices became public. She also testified in both Mr. Lay's and Mr. Skilling's trials. She now has her own consulting firm and has since written a book. Mr. Kaminski, former managing Director of Research, also warned his superiors about the unethical accounting practices. Not surprisingly, his warnings were not taken seriously. He now teaches at Rice University and works at another firm.
Enron - Investors and Creditors
In 2000, Enron became one of the first energy companies to begin trading commodities through the Internet anything from weather derivatives to coal. Enron's 2000 Annual Report reported global revenues of $100 billion, which in turn resulted in stock price reaching an all time high of $90 dollars a share. Though it didn't take long for the fall of Enron to begin, by the end of 2000 its competitive edge and huge profit margins began to erode. Kenneth Lay, CEO steps down as Chairman and Jeffrey Skilling takes his place.
In the beginning of 2001, Jeffrey Skilling told his employees the company was doing great and to invest in Enron, as he was selling off his holdings. Energy prices had begun to fall and the world was headed into a recession. On August 14, Skilling resigned specifying "personal reasons" as the cause for his unscheduled departure. As a result, the stocks dropped below $40 dollars a share. By October, stock prices had dipped below $30 dollars. Enron then announced a third-quarter loss of $638 million and a $1.2 billion reduction in shareholders equity. This was a result of write-offs from broadband, water trading ventures and entities backed by falling Enron stocks that were created to hedge inflated asset values and keep millions of debt off their books. Also employee stocks were prevented from being sold. This was done by the company changing plan administrators of the 401k plan. By law this prevents selling their Enron stock for 30 days. By late October the Security and Exchange Commission (SEC) was looking into Enron.
On November 8th, Enron has revised the past five years of Financial Statements and given them to the SEC. This accounted for $586 million in losses and another $638 million in liabilities. This resulted in the stock plummeting to less than $10 dollars a share. Just prior to this, a competitor, Dynegy Corporation, had offered to buy Enron after this announcement they retracted their offer. By November 30th, the stock market closed with Enron at a mere .26 cent per share.
December 2, 2001 was a busy day for Enron it had no choice but to file Chapter 11 bankruptcy. Enron also filed a breach-of-contract suit against the Dynegy Corporation for $10 billion. Employee vested stocks totaling $1.3 million dollars was gone and Investors had lost $1.1 billion dollars in funds.
Finally in November of 2004, the U.S. Bankruptcy Court reorganized Enron to Enron Creditors Recovery Corporation. The purpose of this company was strictly created to sell any assets and redistribute the monies to the creditors. Enron Creditors Recovery Corporation is suing eleven financial institutions who had benefited from their active participation in the fraud. The monies from this will be included in the distribution to creditors. Since its enception, "Enron Creditors Recovery Corp. ("ECRC") has returned approximately $21.598 billion in semi-annual distributions to creditors". "The distribution payments to date represent returns to ECRC's creditors that are greater than 300% of Company's original estimates".6
Once legislation and creditors have all been paid the company will dissolve in its entirety.
Enron - Employees
For employees, the aftermath of Enron "…was a betrayal by executives who hid the corporation's crumbling finances and fattened their bank accounts while their employees' jobs and retirement funds -- built from Enron stock -- disappeared." [6]
In the book, ENRON THE RISE AND FALL by Loren Fox tells the story about the employees who were laid off on what was called Black Monday. On December 2, 2001, Enron had 25,000 employees. On that Monday which Enron calls "Black Monday" four thousand people were laid off. First Enron shut down the computer network and then the employees were gathering in conference rooms and auditoriums. That is where they started to lay off people in bunches. Diana Peter tells how she had half an hour to clear out her office and be gone. Diana tells how people were taking computer and printer and office supplies and the security guards didn't even stop them.
In Loren Fox's book, she talks about the employees who got fire and didn't receive the severance payment like they thought they would. They were supposed to get one week salary for each year they have been employed by Enron and one week salary for each $10,000 of base pay. For most of the fire employees their severance pay came very short of what they actually got to what they should have got. In 2002, a coalition of over four hundred laid-off Enron employees filed a class action lawsuit against Enron and won status as a creditor in the bankruptcy proceedings. [7]
Also employees had their retirement invested in Enron's stocks. Fox tells how Enron was just like most other company and offer a 401(k) but Enron encourage their employees to buy stock in Enron. And like other companies Enron will match employee's contributions with Enron's stock.8 Enron stock value started to go down fast and at the same time Enron was changing administrators of the plan so they did a lock down. Employees could not change their holdings or sell their Enron stock as a result of the lock down. Because of this lock down members of the 401(k) filed two law suits against Enron. One Enron were force to have their falling stock in Enron because of the lock down. Two - the employees didn't feel like Enron didn't let them know that it wasn't really a good idea to invest so much of their savings in Enron Stock. About $1.3 billion of the $2.1 billion of assets in Enron's 401(k) plans was invested in Enron stock by the end of 2000, according to one of the lawsuits. Diana Peters saw her 401(k) savings drop from $22,000 to 4,000 as Enron's stock collapsed. [8]
In the book, Pipe Dreams Greed, Ego and the Death of Enron, Robert Bryce talks about how thousands of employees were not so lucky and got fired. The others were told their jobs were uncertain that to check their emails in the morning. A Sanjoys Pathak, an employee, said coming out of the building, "That's a hell of a thing: getting fired by voice mail." [9]
Robert Bryce dedicated his book to the thousands of current and former Enron employees - hardworking, honest people - who lost so much through no fault of their own. We don't and won't ever know how many people were affected by the fall of Enron. People who work hard and honestly and who were led to believe all was good.
Arthur Anderson - Outcome
Arthur Andersen as a firm failed to meet its obligation of independence under the Generally Accepted Accounting Standards and the AICPA Code of Professional Conduct. The Generally Accepted Accounting Standards requires independence "in all matters relating to the assignment" [10] where the AICPA Code of Professional Conduct requires that "auditors should be independent in fact and appearance" [11] . If a substantive test had been performed for Andersen's independence it would have failed in fact and appearance.
It is a fact that as Enron enjoyed increased success, so did Arthur Andersen. Between 1988 and 1991 Andersen earned $54 million in fees from Enron, in 2000 fees had skyrocketed to $52 million for the year with over half generated by consulting services. But as the fees increased it was at the cost of Andersen's audit team's independence. Per the authors of The Smartest Guys in the Room, "…..the creation of financial structures were far from independent, Arthur Anderson was intimately involved in helping Enron set up various financial structures and were so closely aligned with Enron that they came to see the world in the same way as Enron executives." [12]
Andersen would have also failed the appearance test as over a ten year span Enron had hired at least eighty-six of Andersen accountants, with most of the "important" finance jobs at Enron being held by past Andersen employees. "Many of Andersen and Enron's top number crunchers took annual golf vacations together, making friendly bets on each round. They went on ski outings, schussing down the slopes together. Other would sneak away from the office for Astros games at Enron Field and take turns buying margaritas at Mama Ninfa's, a local Mexican restaurant chain. They played fantasy football against each other over the office computers. In time, insiders at both disgraced firms no say, those close ties eroded the most important role Andersen was supposed to play as Enron's auditor: providing strong, independent verification of its financial reports." [13]
At the beginning of October, Nancy Temple (Andersen Legal Dept.) had been reviewing and advising Andersen partners on wording of sensitive memos. On Friday, October 12, Temple, sent an email to Michael Odom, Houston's Practice Director for Andersen stating, "It might be useful to consider reminding the engagement team of our documentation and retention policy. It will be helpful to make sure that we have complied with the policy." [14] David Duncan, Lead Partner for the Enron account, "was forwarded Temple's reminder about document retention. Although he later said he took it as a coded message to start destroying Enron files." [15] Temple and Duncan were cited as the responsible managers in this scandal as they had given the order to shred relevant documents. The ultimate outcome was that on June 15, 2002, Andersen was convicted of obstruction of justice for shredding documents related to its audit and consulting of Enron. [16] Since the U.S. Securities and Exchange Commission did not allow convicted felons to audit public companies, the firm agreed to surrender its CPA licenses and its right to practice before the SEC on August 31, 2002 - effectively putting the firm out of business in the U.S. Meanwhile, Andersen's non-U.S. practices ceased to be viable due to reputational collateral damage. [17]
On May 31, 2005, in Arthur Andersen LLP v. United States, the Supreme Court of the United States reversed Andersen's conviction due to errors in the jury instructions. It was found that jury instructions were too vague and that were worded so that Andersen could be convicted without proof that they had knowingly destroyed documents of regarding transactions or of substantial information of pending or potential pending litigation.
In attempt to prevent another instance where a major accounting firm could become such a large part of a major fraud, Congress passed the Sarbanes-Oxley Act in 2002. SOX or SarBox addressed many of the elements which permitted the major frauds of the nineties. Sarbox requires that CEOs and CFOs be held responsible for their companies' financial reports; Insider trades are prohibited during pension-fund blackout periods; Mandatory internal audits and review and certification of those audits by outside auditors; Audit firms may no longer consulting services to firms they audit; and publically traded companies must establish internal financial controls and have those controls audited annually. [18]
John Steinbeck's quote seems so appropriate to describe the dichotomy of Enron…..
It has always seemed strange to me... the things we admire in men, kindness and generosity, openness, honesty, understanding and feeling, are the concomitants of failure in our system. And those traits we detest, sharpness, greed, acquisitiveness, meanness, egotism and self-interest, are the traits of success. And while men admire the quality of the first they love the produce of the second.
Society admires the money and ambition of Enron, but hates the greed and self-interest - it difference appears to be where the stock price.
