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Enron scandal

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Enron scandal

  1. 1. Enron Scandal: A Corporate View Analyzed and prepared by Group 6:
  2. 2. Introduction Enron Corporation was an American energy, commodities, and services company based in Houston, Texas. Enron's predecessor was the Northern Natural Gas Company, which was formed during 1932, in Omaha, Nebraska. It was reorganized during 1979 as the main subsidiary of a holding company, Inter-North which was a diversified energy and energy related products company. During 1985, it bought the smaller and less diversified Houston Natural Gas company. The company initially named itself "HNG/Inter-North Inc. however was later renamed to Enron.  Employed approximately 20,000 staff  One of the world's major electricity, natural gas, communications, and pulp and paper companies.  Revenues of nearly $101 billion.  Named Enron "America's Most Innovative Company" for six consecutive years by Fortune. Source:
  3. 3. Enron’s Line of Business Enron was originally involved in transmitting and distributing electricity and natural gas throughout the United States. The company developed, built, and operated power plants and pipelines while dealing with rules of law and other infrastructures worldwide. Enron owned a large network of natural gas pipelines, which stretched ocean to ocean and border to border. Enron traded in more than 30 different products, including the following: 1. Petrochemicals 2. Plastics 3. Power 4. Pulp and paper 5. Steel 6. Weather Risk Management 7. Oil and LNG transportation 8. Broadband 9. Shipping / freight 10. Streaming media 11. Water and wastewater 12. Principal Investments 13. Risk management for Commodities etc. Source:
  4. 4. What made it a “SCANDAL”? In 1990’s corporate self regulation in the United States of America had been widely thought to have reached a high plateau of evolutionary success due to proliferating good practices and sophisticated institutional monitoring. However, the bankruptcy of Enron shook the entire system. Some highlights brought about when this scandal had been exposed were: 1. $30 million of self dealings by the chief financial officer 2. $700 million of net earnings disappeared 3. $1.2 billion shareholders equity disappeared 4. Over $4 billion in hidden liabilities Many of Enron's recorded assets and profits were inflated or even wholly fraudulent and Nonexistent. Debts and losses were put into entities formed "offshore" that were not included in the company's financial statements, and other sophisticated and arcane financial transactions between Enron and related companies were used to eliminate unprofitable entities from the company's books. Source: Analyzed inputs from Research papers printed at The George Washington University
  5. 5. Date (Yr 2001) Stock Price ($’s) Events January 01 83.12 February 12 79.80 Skilling named CEO March 26 LJM transactions restructured; Chewco closed out April 17 60 First quarter profits of $536 million announced May 5 59.78 August 14 43 Skilling resigns August 15 40.25 Sherron Watkins delivers letter to Lay October 15 33.17 October 16 33.84 Third quarter loss of $618 million announced October 17 32.20 Rumors of $1.2 billion equity write off circulate on Wall Street October 17 32.20 401(k) plans frozen October 17 32.20 Wall Street Journal reports Fastow rake of $30 million October 18 29 Wall Street Journal reports the $1.2 billion write off October 22 SEC launches investigation of Enron accounting October 24 16.41 Fastow terminated October 25 16.35 Merger discussions with Dynegy commence October 31 13.90 Form 8-K filed; reveals LJM and Chewco earnings write offs November 8 8.41 Dynegy merger agreement executed and delivered November 9 8.63 Form 10-Q filed; reveals hidden guarantees, cash flow crisis November 19 9.06 S&P downgrades Enron to junk status November 28 0.61 November 28 0.61 Dynegy cancels merger November 30 0.26 December 2 0.40 Chapter 11 filing (BANKRUPTCY) Source: Figures have been extracted from Research papers printed at The George Washington University
  6. 6. Catalysts to the Scam!!!  Fraud on the part of Enron’s certified Independent Auditor Arthur Anderson possibly arising out of conflict of interest from the consulting services engagements between both the parties.  Enron used Special Purpose Entities to exclude losses and liabilities from the parent companies balance sheet thus displaying a very desirable and flawlessly profitable business.  In 2001, followed by then CEO Jeffrey Skilling’s resignation was a disclosure of losses incurred by Enron 1st time in 4 years. Furthermore, the losses incurred were to the tune of $586 million which included re-adjustment of earnings since 1997.  Corporate Governance Issues: While the board of directors is to oversee corporate management with the purpose of protecting interest of the shareholders, in 1999, Enron’s board waived conflict of interest rules to allow CFO Andrew Fastow to create private partnership to do business with the firm.  Enron’s 401(k) pension scheme: Like most large organizations, Enron also sponsored a pension plan for it’s employees who can contribute to this with a portion of their pay on deferred tax basis. Almost 62% of this pension scheme was Enron’s stock which crashed drastically from over $80 in early 2001 to a mere few cents by the end of the same year. This questioned the laws and policies concerning such pension schemes. Relationship with Bankers: Questionable relationship between Enron and bankers Citigroup and J.P Morgan Chase also contribute to the downfall of Enron. Enron was lucrative Investment banking business for the banks. In exchange of the potential profits from IB services, the banks had lend money to Enron and promote it’s derivates and securities. Source: Random articles available on Government websites and news articles
  7. 7. Organization for Economic Co- operation and Development – Corporate Governance The 1999 OECD Principles cover five basic subjects: (i) protection of the rights of shareholders; (ii) equitable treatment of shareholders, including full disclosure of material information and the prohibition of abusive self dealing and insider trading; (iii) recognition, and protection of the exercise, of the rights of other stakeholders (iv) timely and accurate disclosure and transparency with respect to matters material to company performance, ownership and governance, which should include an annual audit conducted by an independent auditor (v) A framework of corporate governance ensuring strategic guidance of the company and effective monitoring of its management by the Board of Directors as well as the Board’s accountability to the company and its shareholders.
  8. 8. Enron’s ethics code was based on respect, integrity, communication, and excellence. These values were described as follows: • Respect. We treat others as we would like to be treated ourselves. We do not tolerate abusive or disrespectful treatment. Ruthlessness, callousness and arrogance don’t belong here. • Integrity. We work with customers and prospects openly, honestly and sincerely. When we say we will do something, we will do it; when we say we cannot or will not do something, then we won’t do it. • Communication. We have an obligation to communicate. Here we take the time to talk with one another . . . and to listen. We believe that information is meant to move and that information moves people. • Excellence. We are satisfied with nothing less than the very best in everything we do. We will continue to raise the bar for everyone. The great fun here will be for all of us to discover just how good we can really be
  9. 9. Corporate culture and ethics. These dimensions of a firm overlap with corporate governance, since good corporate governance will not be achieved in the absence of an ethical corporate culture. The dividing line between corporate governance and corporate ethics is difficult to specify.
  10. 10. Conclusion The Fate of Enron shook the entire US economy and it’s global perception of a well monitored and ethical economy. The scandal made the authorities realize the importance of ethics and importance of INTERNAL CONTROL in business enterprises. It also helped understand the real meaning of Shareholder’s Wealth Maximization and the boundaries within which this key objective is to be achieved. Enron’s opaque financial statements and records helped conceal the true and sordid fate of it’s investor’s money. Subsequently in 2002, US economy’s face-off with reality resultant corporate accounting scandals like Enron, Tyco, WorldCom etc, the Corporate and Auditing Accountability, Responsibility, and Transparency Act was introduced/presented.
  11. 11. CorporateandAuditing Accountability, Responsibility,andTransparencyAct of 2002 or Sarbanes-OxleyAct Introduced to the House on 14th February, 2002 Passed the house on April 24, 2002 Passed the Senate as the "Public Company Accounting Reform and Investor Protection Act of 2002" on July 15, 2002 Reported by the joint conference committee on July 24, 2002; agreed to by the House on July 25, 2002 and by the Senate on July 25, 2002 Signed into law by President George W. Bush on July 30, 2002 Source:
  12. 12. Sarbanes-Oxley Act The Sarbanes –Oxley Act or more popularly know as the SOX act was passed in 2002. It is also known as the 'Public Company Accounting Reform and Investor Protection Act and 'Corporate and Auditing Accountability and Responsibility Act This law set new or enhanced standards for all U.S. public company boards, management and public accounting firms. It is named after sponsors U.S. Senator Paul Sarbanes (D-MD) and U.S. Representative Michael G. Oxley. The main intent of this law is for the top management must now individually certify the accuracy of financial information. In addition, penalties for fraudulent financial activity are much more severe. Also, SOX increased the independence of the outside auditors who review the accuracy of corporate financial statements, and increased the oversight role of boards of directors Source:
  13. 13. SOX Act: Contd… The act contains 11 titles, or sections, ranging from additional corporate board responsibilities to criminal penalties, and requires the Securities and Exchange Commission (SEC) to implement rulings on requirements to comply with the law. 1. Public Company Accounting Oversight Board (PCAOB) 2. Auditor Independence 3. Corporate Responsibility 4. Enhanced Financial Disclosures 5. Analyst Conflict of Interest 6. Commission resources and Authority 7. Studies and Reports 8. Corporate and Criminal Fraud Accountability 9. White Collar crime penalty enhancement 10. Corporate Tax Return 11. Corporate Fraud Accountability Source:
  14. 14. Important Sections and Provisions of the Sox Act  Section 302: Disclosure controls Under Sarbanes–Oxley, two separate sections came into effect—one civil and the other criminal. - Civil: 15 U.S.C. § 7241 (Section 302) - Criminal: 18 U.S.C. § 1350 (Section 906) Section 302 mandates: 1. Set of internal procedures designed to ensure accurate financial disclosure. 2. The signing officers must verify- • They are responsible for establishing and maintaining internal controls • They have designed such internal controls to ensure that material information relating to the company and its consolidated subsidiaries is made known to such officers by others within those entities, particularly during the period in which the periodic reports are being prepared • The officers must "have evaluated the effectiveness of the company's internal controls as of a date within 90 days prior to the report" and "have presented in the report their conclusions about the effectiveness of their internal controls based on their evaluation as of that date Source:
  15. 15. Important Sections and Provisions of the Sox Act contd.. Sarbanes–Oxley Section 401: Disclosures in periodic reports (Off-balance sheet items) This act required the disclosure of all material off-balance sheet items. It also required an SEC study and report to better understand the extent of usage of such instruments and whether accounting principles adequately addressed these instruments. Sarbanes–Oxley Section 404: Assessment of internal control This act requires management is required to produce an "internal control report" as part of each annual Exchange Act report. The report must affirm "the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting Sarbanes–Oxley Section 906: Criminal Penalties for CEO/CFO financial statement certification Section 906 states: Failure of corporate officers to certify financial reports: - Each periodic report containing financial statements SOX is to be accompanied by a written statement by the chief executive officer and chief financial officer (or equivalent thereof) of the issuer - Information contained in the periodic report fairly presents, in all material respects, the financial condition and results of operations of the issuer - If the periodic report accompanying the statement does not comport with all the requirements set forth in this section shall be fined not more than $1,000,000 or imprisoned not more than 10 years, or both or willfully certifies any statement that does not comport with all the requirements set forth in this section shall be fined not more than $5,000,000, or imprisoned not more than 20 years, or both. Source:
  16. 16. Equivalent Indian Law and provisions CARO(Companies Auditor report)order 2003 In exercise of the powers conferred by sub-section (4A) of section 227 of the Companies Act, 1956 (1 of 1956) The law states that: “In the case of listed companies and/or other companies having a paid-up capital and reserves exceeding Rs. 50 lakhs as at the commencement of the financial year concerned, or having an average annual turnover exceeding five crores rupees for a period of three consecutive financial years immediately preceding the financial year concerned, whether the company has an internal audit system commensurate with its size and nature of its business?” The purpose of internal audit is to ensure three things: 1. Ensuring compliance with the existing internal controls in place; 2. Appraising the adequacy of existing internal controls; 3. Ensuring the promptness in recording the business and other transactions of the entity. The Internal Audit team is not a sub function of Finance or accounts. It can be a team consisting of engineers, consultants etc. Source: ICAI Website
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