Enron Scandal free essay sample

Accounting scandals are political or business scandals which arise with the disclosure of financial misdeeds by trusted executives of corporations or governments. These days, not too often, these scandals are splashed as headlines across media. Why? Because there are complex groups of stakeholders who might be seriously affected by the scandals. Enron scam was the most remarkable scandal in 20 centuries by their institutionalized, systematic, and creatively planned accounting fraud. The scandal also brought into question the accounting practices and activities of many corporations in the United States. The scandal also affected the greater business world by causing the dissolution of the Arthur Andersen accounting company. This report will reveal the whole story of Enron scam and auditors role from the situation in more depth. It will also include the current situation of those responsible for the fraud. 2. Background of U. S in 1990s The 1990s of U. S were a time of prosperity and this prosperity period is originated from growth in IT corporates and in accordance with increase in productivity as technology develops with IT. We will write a custom essay sample on Enron Scandal or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page In the mid- to late-90s, society’s expectations of what the Internet could offer were unrealistic. Many investors foolishly ignored the fundamental rules of investing in the stock market and instead, investors and entrepreneurs became preoccupied with new ideas that were not yet proven to have market potential. Furthermore, they ignored the blatant signs that the bubble was about to burst. (IT Bubble in 90s) There are two main reasons for the bubble; with investors` optimistic expectation, there were a lot of ‘Window dressing’ in accounting. As Enron collapsed, the growth of the tech sector proved to be illusory, and bubble started to sober. 3. Enron- who are they? Enron Corporation is an energy trading, communications company which was formed in 1985 based in Houston, Texas. Enron marketed electricity and natural gas, delivered energy and other physical commodities. Company branched into many non-energy-related fields as well, including such areas as high-speed Internet bandwidth, and financial and risk management with 21,000 employees at mid-2001. The company reported revenues of $101 billion in 2000. It has stakes in nearly 30,000 miles of gas pipeline, owns or has access to a 15,000mile fiber optic network and has a stake in electricity generating operations around the world. 4. Enron- what they did? The Enron fraud case is extremely complex. There are several main characters who are spearheading the Enron scam. One of them was Jeff Skillng. Jeff Skillng, who was a consultant in Mckinsey, took charge in consulting Enron. He found problems and also potentiality of Enron and he proposed the idea of â€Å"gas bank† to Enron, which is a system that is combining financial system and gas supply and demand system, and taking the margin from the two system(as bank does). This was an ideal idea in theory and Enron asked him to take charge for this business, and later he became the president of Enrons trading operations. Also, he convinced federal regulators to permit Enron to use an accounting method known as mark to market. Using this method allowed Enron to count projected earnings from long-term energy contracts as current income. This was money that might not be collected for many years. It is thought that this technique was used to inflate revenue numbers by manipulating projections for future revenue. The problem is that it doesn`t match realised profit and real cash flow. especially, Enron`s main trading was long term future contract which is hard to make valuation for the future. Use of these techniques made it difficult to see how Enron was really making money. The numbers were on the books so the stock prices remained high, but Enron wasnt paying high taxes. When the telecom industry suffered its first downturn, Enron suffered as well. Eventually, the house of cards began falling. When Enrons stock began to decline, the Raptors began to decline as well. On August 14, 2001, Enrons CEO, Jeff Skilling, resigned due to family issues. Enron chairman Ken Lay stepped in as CEO. 5. One example of fraud Enron`s â€Å"too much Off-Balance Sheet Transactions† Enron used â€Å"off-balance-sheet†technique for anytime, for many purposes, because it would enable Enron to present itself more attractively as measured by the ratios favored by analysts and investors. Skillng used securitisation to supply more liquidity and also to clean up the assets that is hardly generating income from it. He also hided most of the debt by securitisation. So, Enron needed Special purpose entities(SPE) for the securitization purpose. JEDI was one of the SPE. California PERS and Enron invested by $25000m each. As soon as the JEDI established, Enron started to sell energy related stock to JEDI and it grew JEDI by 23% per year on average. It made Skillng`s ECT business bigger and bigger. 6. Consequences for the stakeholders The key stakeholders affected by the collapse of Enron were its employees and retirees. Stakeholders and mutual funds investors lost $ 70billion market value. Banks were also affected by the meltdown of the company. Not only the stakeholder and bondholder lose out, the confidence in the company also fell. This was the major setback for the company. The actions of Enron management left a deep scare for its 4000 employees which lost out their jobs and also impacted others around them. Some blamed Arthur Andersen; Enron’s accounting firm and some blame the board of directors for insufficient oversights. The damage was so big that it was likely to take years for the court to sort the wreckage. The company did not think of its future and took many bad steps just to earn money. The CEO should have looked into the company matters long time ago and took action so that hundreds of jobs could have been saved. The companies who were associated with the big firm were affected on a very large scale. This was the biggest bankruptcy of a firm with $63. 4 billion in assets. 7. Auditors in this scandal, and their role The external auditing body of Enron company was Arthur Anderson LLP, formerly one of the ‘big 5’ accounting firms, providing auditing, tax, and consulting services to large corporations. Andersen definitely Knew Enron Was in Trouble but they overlooked at it and even conspired with Enron to manipulate the financial statements. They knew Enron was in trouble as early as Feb.  2001, a company memo showed, and Andersen debated dropping the collapsed energy firm all together, Reuters reported. Additionally, Andersen knew in mid-August of a senior Enron employees concerns about improprieties in the energy companys accounting practices. Andersen confirmed that a memo dated Feb. 6 recounted a meeting between Andersen executives about whether Andersen should retain the now-b ankrupt Enron as a client. Auditors are responsible directly under the law especially the international standards to report directly to the shareholders on the status of the company’s or a bank’s account at a particular point in time. They heavily misconducted as auditors as they received money and hided about Enron`s truth. 8. Ramifications It is not easy to implement rigorous standards without changing Incentives. This situation can be seen in South East Asian countries like: Singapore, Thailand, Hong Kong, China. Each country can implement its own accounting standards, but did not implement the substantial institutional changes required to make these standards effective. According to various studies conducted in this area, new standards did not result in better-quality financial reporting.9. Conclusion: In search of better standards and ethics The ENRON Scandal is considered to be one of the most notorious within American history; an unofficial blueprint for a case study on White Collar crime. Enrons behaviour has confirmed that the treatment of off-balance-sheet dodge, American accounting standards are too lax. It is time for another effort to realign the system to function more in shareholders interests. Comp anies need stronger non-executive directors, paid enough to devote proper attention to the job. Enron Scandal free essay sample Enron Corporation was an American energy company based in the Enron Complex in Downtown Houston, Texas. Enron traces its roots to the Northern Natural Gas Company, which was formed in 1932, in Omaha, Nebraska. It was reorganized in 1979 as the leading subsidiary of a holding company, Inter North . In 1985, it bought the smaller and less diversified Houston Natural Gas. The separate company initially named itself HNG/Inter North Inc. , even though Inter North was the nominal survivor. It built a large and lavish headquarters complex with pink marble in Omaha (dubbed locally as the Pink Palace), that was later sold to Physicians Mutual. However, the departure of ex-Inter North and first CEO of Enron Corp Samuel Segnar six months after the merger allowed former HNG CEO Kenneth Lay to become the next CEO of the newly merged company. Lay soon moved Enrons headquarters to Houston after swearing to keep it in Omaha and began to thoroughly re-brand the business. We will write a custom essay sample on Enron Scandal or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page Lay and his secretary, Nancy McNeil, originally selected the name Enteron, but, when it was pointed out that the term approximated a Greek word referring to the intestines, it was quickly shortened to Enron. The final name was decided upon only after business cards, stationery, and other items had been printed reading Enteron. Enron traded in more than 30 different products, including the following: * Products traded on Enron Online * Petrochemicals * Plastics * Power * Pulp and paper * Steel * Weather Risk Management * Oil and LNG transportation * Broadband * Principal investments * Risk management for commodities * Shipping / freight * Streaming media * Water and wastewater It was also an extensive futures trader, including sugar, coffee, grains, hog, and other meat futures. At the time of its bankruptcy filing in December 2001, Enron structured into seven distinct business units. Early history As Enron rose to become the largest seller of natural gas in North America by 1992, its gas contracts trading earned earnings before interest and taxes of $122 million, the second largest contributor to the companys net income. The November 1999 creation of the Enron Online trading website allowed the company to better manage its contracts trading business. In an attempt to achieve further growth, Enron pursued a diversification strategy. The company owned and operated a variety of assets including gas pipelines, electricity plants, pulp and paper plants, water plants, and broadband ervices across the globe. The corporation also gained additional revenue by trading contracts for the same array of products and services it was involved in. As a result, Enrons stock rose from the start of the 1990s until year-end 1998 by 311% percent, a significant increase over the rate of growth in the Standard amp; Poor 500 index. The stock increased by 56% in 1999 and a further 87% in 2000, compared to a 20% increase and a 10% decline for the index during the same years. By December 31, 2000, Enron’s stock was priced at $83. 3 and its market capitalization exceeded $60 billion, 70 times earnings and six times book value, an indication of the stock market’s high expectations about its future prospects. In addition, Enron was rated the most innovative large company in America in Fortunes Most Admired Companies survey. Special purpose entities Enron used special purpose entities—limited partnerships or companies created to fulfill a temporary or specific purpose—to fund or manage risks associated with specific assets. The company elected to disclose minimal details on its use of special purpose entities. These shell firms were created by a sponsor, but funded by independent equity investors and debt financing. For financial reporting purposes, a series of rules dictates whether a special purpose entity is a separate entity from the sponsor. In total, by 2001, Enron had used hundreds of special purpose entities to hide its debt. The special purpose entities were used for more than just circumventing accounting conventions. As a result of one violation, Enrons balance sheet understated its liabilities and overstated its equity, and its earnings were overstated. Enron disclosed to its shareholders that it had hedged downside risk in its own illiquid investments using special purpose entities. However, the investors were oblivious to the fact that the special purpose entities were actually using the companys own stock and financial guarantees to finance these hedges. This setup prevented Enron from being protected from the downside risk. Notable examples of special purpose entities that Enron employed were JEDI, Chewco, Whitewing, and LJM. Launching Internet-based trading operation In 1999, Enron launched EnronOnline, an Internet-based trading operation, which was used by virtually every energy company in the United States. Enron president and chief operating officer Jeffrey Skilling began advocating a novel idea: the company didnt really need any assets. By pushing the companys aggressive investment strategy, he helped make Enron the biggest wholesaler of gas and electricity, trading over $27 billion per quarter. The firms figures, however, had to be accepted at face value. Under Skilling, Enron adopted mark to market accounting, in which anticipated future profits from any deal were tabulated as if real today. Thus, Enron could record gains from what over time might turn out to be losses, as the companys fiscal health became secondary to manipulating its stock price on Wall Street during the Tech boom. But when a companys success is measured by agreeable financial statements emerging from a black box, a term Skilling himself admitted, actual balance sheets prove inconvenient. Indeed, Enrons unscrupulous actions were often gambles to keep the deception going and so push up the stock price, which was posted daily in the company elevator. An advancing number meant a continued infusion of investor capital on which debt-ridden Enron in large part subsisted. Its fall would collapse the house of cards. Under pressure to maintain the illusion, Skilling verbally attacked Wall Street Analyst Richard Grubman, who questioned Enrons unusual accounting practice during a recorded conference call. s Though the comment was met with dismay and astonishment by press and public, it became an inside joke among many Enron employees, mocking Grubman for his perceived meddling rather than Skillings lack of tact. Peak and decline of stock price In August 2000, Enrons stock price hit its highest value of $90. At this point Enron executives, who possessed the inside information on the hidden losses, began to sell their stock. At the same time, the general public and Enrons investors were told to buy the stock. Executives told the investors that the stock would continue to climb until it reached possibly the $130 to $140 range, while secretly unloading their shares. As executives sold their shares, the price began to drop. Investors were told to continue buying stock or hold steady if they already owned Enron because the stock price would rebound in the near future. Kenneth Lays strategy for responding to Enrons continuing problems was in his demeanor. As he did many times, Lay would issue a statement or make an appearance to calm investors and assure them that Enron was headed in the right direction. Corporate governance Healy and Palepu write that a well-functioning capital market creates appropriate linkages of information, incentives, and governance between managers and investors. This process is supposed to be carried out through a network of intermediaries that include assurance professionals such as external auditors; and internal governance agents such as corporate boards. On paper, Enron had a model board of directors comprising predominantly outsiders with significant ownership stakes and a talented audit committee. In its 2000 review of best corporate boards, Chief Executive included Enron among its top five boards. Even with its complex corporate governance and network of intermediaries, Enron was still able to attract large sums of capital to fund a questionable business model, conceal its true performance through a series of accounting and financing maneuvers, and hype its stock to unsustainable levels. Risk management Before its fall, Enron was lauded for its sophisticated financial risk management tools. Risk management was crucial to Enron not only because of its regulatory environment, but also because of its business plan. Enron established long-term fixed commitments which needed to be hedged to prepare for the inevitable fluctuation of future energy prices. Enrons bankruptcy downfall was attributed to its reckless use of derivatives and special purpose entities. By hedging its risks with special purpose entities which it owned, Enron retained the risks associated with the transactions. This setup had Enron implementing hedges with it. Enrons aggressive accounting practices were not hidden from the board of directors, as later learned by a Senate subcommittee. The board was informed on the rationale for using the Whitewing, LJM, and Raptor transactions, and after approving them, received status updates on the entities operations. Although not all of Enrons widespread improper accounting practices were revealed to the board, the practices were dependent on board decisions. Even though Enron extensively relied on derivatives for its business, the companys Finance Committee and board did not have comprehensive backgrounds in derivatives to grasp what they were being told. The Senate subcommittee argued that had there been a detailed understanding of how the derivatives were organized; the board would have prevented their use. Financial audit Enrons auditor firm, Arthur Andersen, was accused of applying reckless standards in their audits because of a conflict of interest over the significant consulting fees generated by Enron. In 2000, Arthur Andersen earned $25 million in audit fees and $27 million in consulting fees (this amount accounted for roughly 27% of the audit fees of public clients for Arthur Andersens Houston office). The auditors methods were questioned as either being completed solely to receive its annual fees or for their lack of expertise in properly reviewing Enrons revenue recognition, special entities, derivatives, and other accounting practices. Enron hired numerous Certified Public Accountants (CPA) as well as accountants who had worked on developing accounting rules with the Financial Accounting Standards Board (FASB). The accountants looked for new ways to save the company money, including capitalizing on loopholes found in Generally Accepted Accounting Principles (GAAP), the accounting industrys standards. One Enron accountant revealed We tried to aggressively use the literature [GAAP] to our advantage. All the rules create all these opportunities. We got to where we did because we exploited that weakness. Andersens auditors were pressured by Enrons management to defer recognizing the charges from the special purpose entities as their credit risks became clear. Since the entities would never return a profit, accounting guidelines required that Enron should take a write-off, where the value of the entity was removed from the balance sheet at a loss. To pressure Andersen into meeting Enrons earnings expectations, Enron would occasionally allow accounting firms Ernst amp; Young or PricewaterhouseCoopers to complete accounting tasks to create the illusion of hiring a new firm to replace Andersen. 54] Although Andersen was equipped with internal controls to protect against conflicted incentives of local partners, they failed to prevent conflict of interest. In one case, Andersens Houston office, which performed the Enron audit, was able to overrule any critical reviews of Enrons accounting decisions by Andersens Chicago partner. In addition, when news of SEC investigations of Enron were made public, Andersen attempted to cover up any negligence in its audit by shredding several tons of supporting documents and deleting nearly 30,000 e-mails and computer files. Revelations concerning Andersens overall performance led to the break-up of the firm, and to the following assessment by the Powers Committee (appointed by Enrons board to look into the firms accounting in October 2001): The evidence available to us suggests that Andersen did not fulfill its professional responsibilities in connection with its audits of Enrons financial statements, or its obligation to bring to the attention of Enrons Board (or the Audit and Compliance Committee) concerns about Enrons internal contracts over the related-party transactions. Audit committee Corporate audit committees usually meet for just a few times during the year, and their members typically have only a modest background in accounting and finance. Enrons audit committee had more expertise than many. It included Robert Jaedicke of Stanford University, a widely respected accounting professor and former dean of Stanford Business School; * John Mendelsohn, President of the University of Texas M. D. Anderson Cancer Center * Paulo Pereira, former president and CEO of the State Bank of Rio de Janeiro in Brazil * John Wakeham, former United Kingdom Secretary for Energy * Ronnie Chan, a Hong Kong businessman * Wendy Gramm, former Chair of U. S. Commodity Futures Trading Commission Enrons audit committee was later criticized for its brief meetings that would cover large amounts of material. In one meeting on February 12, 2001, the committee met for an hour and a half. Enrons audit committee did not have the technical knowledge to properly question the auditors on accounting questions related to the companys special purpose entities. The committee was also unable to question the companys management due to pressures placed on the committee. The Permanent Subcommittee on Investigations of the Committee on Governmental Affairs report accused the board members of allowing conflicts of interest to impede their duties as monitoring the companys accounting practices. When Enron fell, the audit committees conflicts of interest were regarded with suspicion. Accounting scandal of 2001 Enron scandal After a series of revelations involving irregular accounting procedures bordering on fraud perpetrated throughout the 1990s involving Enron and its accounting firm Arthur Andersen, Enron stood on the verge of undergoing the largest bankruptcy in history by mid-November 2001 A white knight rescue attempt by a similar, smaller energy company, Dynegy, was not viable. As the scandal unraveled, Enron shares dropped from over US$90. 00 to just pennies. Enron had been considered a blue chip stock, so this was an unprecedented and disastrous event in the financial world. Enrons plunge occurred after it was revealed that much of its profits and revenue were the result of deals with special purpose entities (limited partnerships which it controlled). The result was that many of Enrons debts and the losses that it suffered were not reported in its financial statements. Enron filed for bankruptcy on December 2, 2001. In addition, the scandal caused the dissolution of Arthur Andersen, which at the time was one of the worlds top accounting firms. The firm was found guilty of obstruction of justice in 2002 for destroying documents related to the Enron audit and was forced to stop auditing public companies. Although the conviction was thrown out in 2005 by the Supreme Court, the damage to the Andersen name has prevented it from returning as a viable business. Enron also withdrew a naming rights deal with the Houston Astros Major League Baseball club to have its name associated with their new stadium, which was formerly known as Enron Field. Details about the Scandal: The Enron scandal, revealed in October 2001, eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas, and the dissolution of Arthur Andersen, which was one of the five largest audit and accountancy partnerships in the world. In addition to being the largest bankruptcy reorganization in American history at that time, Enron was attributed as the biggest audit failure. Enron was formed in 1985 by Kenneth Lay after merging Houston Natural Gas and InterNorth. Several years later, when Jeffrey Skilling was hired, he developed a staff of executives that, through the use of accounting loopholes, special purpose entities, and poor financial reporting, were able to hide billions in debt from failed deals and projects. Chief Financial Officer Andrew Fastow and other executives not only misled Enrons board of directors and audit committee on high-risk accounting practices, but also pressured Andersen to ignore the issues. Shareholders lost nearly $11 billion when Enrons stock price, which hit a high of US$90 per share in mid-2000, plummeted to less than $1 by the end of November 2001. The U. S. Securities and Exchange Commission (SEC) began an investigation, and rival Houston competitor Dynegy offered to purchase the company at a fire sale price. The deal fell through, and on December 2, 2001, Enron filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code. Enrons $63. 4 billion in assets made it the largest corporate bankruptcy in U. S. history until WorldComs bankruptcy the following year. Many executives at Enron were indicted for a variety of charges and were later sentenced to prison. Enrons auditor, Arthur Andersen, was found guilty in a United States District Court, but by the time the ruling was overturned at the U. S. Supreme Court, the firm had lost the majority of its customers and had shut down. Employees and shareholders received limited returns in lawsuits, despite losing billions in pensions and stock prices. As a consequence of the scandal, new regulations and legislation were enacted to expand the accuracy of financial reporting for public companies. One piece of legislation, the Sarbanes-Oxley Act, expanded repercussions for destroying, altering, or fabricating records in federal investigations or for attempting to defraud shareholders. The act also increased the accountability of auditing firms to remain unbiased and independent of their clients.