The Enron scandal is a financial scandal that eventually led to the bankruptcy of Enron Corporation, an American energy company based in Houston, Texas, and de facto dissolution of Arthur Andersen, five of the largest auditing and accounting partnerships in the world. In addition to being the largest bankruptcy reorganization in American history at the time, Enron was named the biggest audit failure.
Enron was formed in 1985 by Kenneth Lay after incorporating Houston Natural Gas and InterNorth. A few years later, when Jeffrey Skilling was employed, he developed executive staff who - using accounting loopholes, special purpose entities, and poor financial reporting - were able to hide billions of dollars of debt from failed transactions and projects. Chief Financial Officer Andrew Fastow and other executives not only mislead the Enron Board of Directors and the Enron Audit Committee on high-risk accounting practices, but also pressure Arthur Andersen to ignore the issue.
Enron shareholders filed a $ 40 billion lawsuit after the company's share price, which reached a high of $ 90.75 per share in mid-2000, tumbled to less than $ 1 at the end of November 2001. The US Securities and Exchange Commission (SEC) initiated the investigation, and Houston's competitor, Dynegy, offered to buy the company for a very low price. The deal failed, and on December 2, 2001, Enron filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code. Enron's $ 63.4 billion assets made it the largest corporate bankruptcy in US history to bankruptcy of WorldCom the following year.
Many executives at Enron were indicted on various charges and some were then sentenced to imprisonment. Enron auditor Arthur Andersen was found guilty in a US District Court that illegally destroyed documents relevant to a SEC investigation that canceled a license to audit public companies, effectively shutting down businesses. By the time the decision was canceled in the US Supreme Court, the company had lost most of its customers and had ceased operations. Enron employees and shareholders receive limited returns in lawsuits, despite losing billions in pensions and share prices. As a consequence of the scandal, new laws and regulations are enacted to extend the accuracy of financial reporting for public companies. One part of the law, the Sarbanes-Oxley Act, increases the penalty for destroying, altering, or composing records in federal investigations or to trying to deceive shareholders. It also increases the accountability of audit firms to remain unbiased and independent of their clients.
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Kenaikan Enron
In 1985, Kenneth Lay incorporated Houston Natural Gas and InterNorth natural gas pipelines to form Enron. In the early 1990s, he helped start selling electricity at market prices, and soon after, the US Congress approved a law that deregulated natural gas sales. The resulting market allows traders like Enron to sell energy at a higher price, thereby significantly increasing its revenue. After producers and local governments have criticized the resulting price fluctuations and called for increased regulation, a strong lobby on Enron's part and the other prevents the regulation.
When Enron became the largest natural gas seller in North America in 1992, its contract gas trade generated $ 122 million (before interest and taxes), the second largest contributor to net income. The creation of the EnronOnline trade website in November 1999 enabled the company to better manage its trading business contracts.
In an effort to achieve further growth, Enron pursues a diversified strategy. The company owns and operates various assets including gas pipelines, power plants, pulp and paper mills, water mills, and broadband services worldwide. Corporations also earn additional revenue by trading contracts for the same range of products and services as those involved. These include power generation arrangements in developing countries and emerging markets including the Philippines (Subic Bay), Indonesia and India (Dabhol).
Enron stock increased from the early 1990s to the end of 1998 by 311%, just slightly higher than the average growth of Standard & amp; Index 500 poor. However, stocks rose 56% in 1999 and 87% again in 2000, compared with a 20% increase and a 10% drop for the index over the same year. On December 31, 2000, Enron's stock was valued at $ 83.13 and its market capitalization exceeded $ 60 billion, 70 times profit and six times the book value, an indication of high-market stock expectations about its future outlook. In addition, Enron is rated as America's most innovative major company in Fortune's Most Admired Companies survey.
Maps Enron scandal
Cause of fallout
Enron's complex financial statements baffle shareholders and analysts. In addition, its elaborate business model and unethical practices require companies to use accounting restrictions to describe false income and modify the balance sheet to show good performance.
The combination of these issues then resulted in the bankruptcy of the company, and the majority of them perpetuated by indirect knowledge or direct action from Kenneth Lay, Jeffrey Skilling, Andrew Fastow, and other executives such as Rebecca Mark. Lay has served as chairman of the company in recent years, and accepts Skilling and Fastow's actions even though he does not always ask for details. Continuous skills are focused on meeting Wall Street expectations, advocating the use of mark-to-market accounting (accounting based on market value, which then increases) and pressing Enron executives to find new ways to hide the debt. Fastow and other executives "create off-balance-sheet vehicles, complex financing structures, and deals so it's confusing that few people can understand it."
Recognition of revenue
Enron and other energy suppliers benefit by providing services such as wholesale trade and risk management in addition to building and maintaining power generation, natural gas pipelines, storage, and processing facilities. When accepting the risk of buying and selling products, merchants are allowed to report the selling price as revenue and cost of the product as cost of goods sold. Instead, "agents" provide services to customers, but do not take the same risks as merchants to buy and sell. Service providers, when classified as agents, may report the costs of trades and brokers as revenue, although not for full value transactions.
Although trading companies such as Goldman Sachs and Merrill Lynch use conventional "agency models" to report revenues (where only trade or brokerage fees will be reported as revenue), Enron instead chooses to report the full value of each trade as revenue. This "merchant model" is considered much more aggressive in accounting interpretation than the agent model. Enron's method of reporting increased trade revenues was then adopted by other companies in the energy trade industry in an effort to stay competitive with large corporate earnings increases. Other energy companies such as Duke Energy, Reliant Energy and Dynegy joined Enron in the 50 richest companies of Fortune 500 primarily because of the adoption of the same trade revenue accounting with Enron.
Between 1996 and 2000, Enron's revenues increased by more than 750%, up from $ 13.3 billion in 1996 to $ 100.8 billion in 2000. This vast expansion is 65% annually unprecedented in any industry , including the energy industry that normally considers 2 -3% growth per year to be honorable. For the first nine months of 2001, Enron reported revenue of $ 138.7 billion, which puts the company sixth on the Fortune 500 Global.
Mark-to-market accounting
In Enron's natural gas business, its bookkeeping is fairly easy: in each time period, the company records the true cost of supplying gas and actual revenue received from its sales. However, when Skilling joined the company, he asked the trading business to adopt a mark-to-market accounting, arguing that it would represent "true economic value." Enron became the first non-financial company to use this method to take account of complex long-term contracts. Mark-to-market accounting requires that after long-term contracts are signed, earnings are estimated as the present value of future net cash flows. Often, the continuity of these contracts and their associated costs is difficult to estimate. Due to the big difference in the effort to match earnings and cash, investors are usually given false or misleading reports. When using this method, revenues from projects can be recorded, even though they may never receive money, and in turn increase the book's financial revenues. However, in the coming years, profits can not be included, so new and additional revenue should be included from more projects to develop additional growth to calm investors. As one of Enron's competitors stated, "If you accelerate your earnings, then you should continue to make more deals to show the same or increased income." Despite the potential trap, the US Securities and Exchange Commission (SEC) approved Enron's accounting method in natural gas futures contract trading on January 30, 1992. However, Enron then expanded its use to other areas of the company to help meet Wall Street Projection.
For one contract, in July 2000, Enron and Blockbuster Video signed a 20-year agreement to introduce on-demand entertainment to various US cities by the end of the year. After several pilot projects, Enron acknowledged an estimated profit of more than $ 110 million from the deal, although analysts questioned the technical feasibility and market demand of the service. When the network fails to function, Blockbuster withdraws from the contract. Enron continues to recognize future earnings, even though the deal results in losses.
Destination-specific entities
Enron uses a special purpose entity - a limited partnership or company created to meet a temporary or specific goal to fund or manage the risks associated with a particular asset. The Company chooses to disclose minimum details about the use of a "special purpose entity". These shell companies are created by sponsors, but are funded by independent equity investors and debt financing. For financial reporting purposes, a set of rules determines whether a specific destination entity is an entity separate from the sponsor. In total, in 2001, Enron has used hundreds of special-purpose entities to hide its debts. Enron uses a number of special-purpose entities, such as partnerships at Thomas and Condor's tax shelters, financial asset investment securities (FASIT) trust in Apache deal, real estate mortgage investment channel (REMICs) in Steele deal, and REMIC and real estate investment trusts (REITs ) in the Cochise deal.
Special purpose entities are used for more than just avoiding accounting conventions. As a result of one offense, Enron's balance sheet undermines his obligations and exaggerates his equity, and his income is exaggerated. Enron discloses to its shareholders that they have covered the risk of a decline in their own illiquid investment by using a special purpose entity. However, investors are unaware of the fact that a special-purpose entity actually uses its own company's shares and financial guarantees to finance this hedge. This prevents Enron from being protected from downside risks. Important examples of special purpose entities used by Enron are JEDI, Chewco, Whitewing, and LJM.
JEDI and Chewco
In 1993, Enron established a joint venture in energy investment with CalPERS, a California state pension fund, called Joint Energy Development Investment (JEDI). In 1997, Skilling, serving as Chief Operating Officer (COO), asked CalPERS to join Enron in a separate investment. CalPERS are interested in the idea, but only if it can be terminated as a partner at JEDI. However, Enron does not want to show any debt from the assumption of CalPERS shares in JEDI on its balance sheet. Fastow Chief Financial Officer (CFO) developed a special-purpose Chewco Investments limited partnership (L.P.) that increased the debt secured by Enron and used to acquire a $ 383 million CalPERS joint venture. Due to the Fastow organization of Chewco, JEDI's losses are kept away from Enron's balance sheet.
In the fall of 2001, the arrangements of CalPERS and Enron were found, which necessitated the cessation of previous accounting methods from Enron for Chewco and JEDI. This disqualification reveals that Enron's reported income from 1997 to mid-2001 will need to be reduced by $ 405 million and the company's debt will increase by $ 628 million.
Whitewing
Whitewing is the name of a special-purpose entity used as a financing method by Enron. In December 1997, with $ 579 million funding provided by Enron and $ 500 million by outside investors, Whitewing Associates L.P. formed. Two years later, the entity's arrangements were changed so that they were no longer consolidated with Enron and counted on the company's balance sheet. Whitewing is used to purchase Enron's assets, including shares in power plants, pipelines, stocks, and other investments. Between 1999 and 2001, Whitewing bought assets from Enron for $ 2 billion, using Enron stocks as collateral. Although transactions are approved by the Enron board, asset transfers are not actual sales and should be treated as loans.
LJM and Raptors
In 1999, Fastow formulated two limited partnerships: LJM Cayman. L.P. (LJM1) and LJM2 Co-Investment L.P. (LJM2), for the purpose of buying shares and shares of Enron's underperforming to improve its financial statements. LJM 1 and 2 were created solely to serve as the outside equity investor required for the special purpose entity used by Enron. Fastow had to leave before the board of directors to accept the exclusion of Enron's code of conduct (because he had a CFO degree) to manage the company. Both partnerships are funded with approximately $ 390 million provided by Wachovia, J.P. Morgan Chase, Credit Suisse First Boston, Citigroup, and other investors. Merrill Lynch, which markets equity, also contributed $ 22 million to finance the entity.
Enron is transferred to "Raptor I-IV", four special-purpose LJM-related entities named after velociraptor in Jurassic Park, more than $ 1.2 billion in assets, including millions of shares of Enron common stock and long-term rights to buy millions of shares again, plus $ 150 million of Enron paid papers "as disclosed in the company's financial statements. The special-purpose entity has been used to pay all of this by using the debt instrument of the entity. Footnotes also state that the nominal amount of the instrument amounts to $ 1.5 billion, and an entity notional amount of $ 2.1 billion has been used to enter into a derivative contract with Enron.
Enron uses capital letters Raptors, and, in a manner similar to the accounting used when a company issues shares in a public offering, then records a notes payable issued as an asset on its balance sheet while raising shareholder equity for the same amount. This treatment then became a problem for Enron and its auditor Arthur Andersen for removing it from the balance sheet resulted in a $ 1.2 billion stockholders' equity decline.
Finally, a $ 2.1 billion derivative contract lost significant value. Swap is established when the stock price reaches its maximum. Over the next year, portfolio value under swap declined $ 1.1 billion due to declining share price (loss of value means that a technically-specific goal entity now owes Enron $ 1.1 billion by contract). Enron, which uses the "mark-to-market" accounting method, claims a $ 500 million gain on swap contracts in its 2000 annual report. Gain is responsible for offsetting stock portfolio losses and is associated with nearly a third of Enron's revenues for 2000 (before it was properly restated in 2001).
Corporate governance
On paper, Enron has a board of directors of models of mostly outsiders with significant shareholdings and talented audit committees. In a 2000 review of the best corporate boards, Chief Executive entered Enron among its five best councils. Even with complex corporate governance and intermediary networks, Enron is still able to "attract large amounts of capital to fund a questionable business model, hide its true performance through a series of accounting and financing maneuvers, and shake its shares to unsustainable levels."
Executive compensation
Although Enron's compensation and performance management system is designed to retain and reward its most valuable employees, it contributes to a dysfunctional corporate culture obsessed with short-term earnings to maximize bonuses. Employees always try to start transactions, often ignoring the quality of cash flow or earnings, to get a better rating for their performance appraisals. In addition, accounting results are recorded as soon as possible to follow the company's stock price. This practice helps ensure deal makers and executives receive cash bonuses and large stock options.
The company continues to emphasize its share price. Management is compensated extensively using stock options, similar to other US companies. This stock option policy led management to create rapid growth expectations in an effort to provide a view of reported earnings to meet Wall Street expectations. Stock ticker is located in the lobby, elevator, and on the company's computer. At a budget meeting, Skilling will develop target earnings by asking "What income do you need to keep our stock price up?" and that amount will be used, even if it is not feasible. As of December 31, 2000, Enron has 96 million shares outstanding as a stock option plan (about 13% of outstanding common shares). Enron's proxy statement states that, within three years, this award is expected to be implemented. Using Enron's January 2001 price of $ 83.13 and profitable ownership of directors reported in 2001 proxy, the share ownership value of the director was $ 659 million for Lay, and $ 174 million for Skilling.
Skilling believes that if employees are constantly worried about costs, it will hinder the initial thinking. As a result, massive expenditures are rampant throughout the company, especially among executives. Employees have large expense accounts and many paid executives are sometimes twice that of competitors. In 1998, the top 200 paid employees received $ 193 million of salaries, bonuses and shares. Two years later, the figure jumped to $ 1.4 billion.
Risk management
Prior to his scandal, Enron was praised for his sophisticated financial risk management tool. Risk management is very important for Enron not only because of its regulatory environment, but also because of its business plan. Enron establishes long-term fixed commitments that must be protected to prepare for fluctuations in future energy prices that do not change. The collapse of Enron's bankruptcy is attributed to the use of derivatives and frivolous special purpose entities. By protecting risk with its special-purpose entity, Enron maintains the risks associated with the transaction. This setting has Enron applying the hedge by itself.
Enron's aggressive accounting practices were not hidden from the board of directors, as they were later learned by the Senate subcommittee. The Council is informed of the reasons for using the Whitewing, LJM, and Raptor transactions, and upon approval, receives a status update on the operations of the entity. While not all of Enron's unorthodox accounting practices are widespread on the board, they depend on board decisions. Although Enron relies heavily on derivatives for its business, the Financial Committee and the board of companies do not have enough experience with derivatives to understand what they are told. The Senate Subcommittee believes that if there was a detailed understanding of how the derivatives were organized, the council would prevent its use.
Financial audit
Enron's auditor Arthur Andersen is accused of imposing a reckless standard in its audit due to a conflict of interest over significant consultation fees generated by Enron. During 2000, Arthur Andersen earned $ 25 million in auditing fees and $ 27 million in consulting fees (this amount accounts for about 27% of the public client's audit fees for Arthur Andersen's Houston office). The auditor's method is questionable as a settlement solely for accepting an annual fee or for lack of expertise in reviewing Enron revenue recognition, special entities, derivatives, and other accounting practices.
Enron hires many Certified Public Accountants (CPAs) as well as accountants who have worked on developing accounting rules with the Financial Accounting Standards Board (FASB). Accountants are looking for new ways to save company money, including exploiting loopholes found in Generally Accepted Accounting Principles (GAAP), industry accounting standards. An Enron accountant said "We try aggressively using [GAAP] literature for our benefit, all rules create all these opportunities.We get where we do because we exploit that weakness."
Auditor Andersen was pressured by Enron's management to delay the recognition of fees from a special-purpose entity because of the credit risk known. Since the entity will never make a profit, the accounting guidance requires Enron to take out the deletion, in which the entity's value is removed from the balance sheet. To suppress Andersen to meet Enron's earnings expectations, Enron will sometimes allow accounting firms Ernst & amp; Young or PricewaterhouseCoopers to complete accounting tasks to create the illusion of hiring a new company to replace Andersen. Although Andersen is equipped with internal controls to protect against conflict incentives from local partners, it fails to prevent conflicts of interest. In one case, Andersen's Houston office, which audited Enron, was able to override a critical review of Enron's accounting decisions by partner Chicago Andersen. Additionally, after the US Securities and Exchange Commission (SEC) investigation report on Enron was published, Andersen would then tear apart several tons of relevant documents and remove nearly 30,000 e-mail and computer files, leading to allegations of cover-up.
Revelations on Andersen's overall performance led to the breakup of the company, and the following assessment by the Power Committee (appointed by Enron's board to look into accounting firm in October 2001): "The evidence available to us indicates that Andersen did not fulfill his professional responsibilities in connection with the audit Enron's financial statements, or obligations to draw the attention of the Enron Council (or the Audit Committee and the Compliance Committee) on Enron's internal contracts on related party transactions ".
Audit Committee
The Corporate Audit Committee usually meets only a few times during the year, and its members usually have only simple experience with accounting and finance. The Enron audit committee has more than enough expertise. Already included:
- Robert Jaedicke from Stanford University, a respected accounting professor and former dean of Stanford Business School
- John Mendelsohn, President of the University of Texas Cancer Center M.D. Anderson
- Paulo Pereira, former president and CEO of Bank Negara Rio de Janeiro in Brazil
- John Wakeham, former Secretary of State for Energy and Secretary of the British Parliament for the Ministry of Finance
- Ronnie Chan, Chairman of Hong Kong Hang Lung Group
- Wendy Gramm, former Chairman of the US Commodity Futures Trading Commission
The audit committee of Enron was later criticized for its short meeting which would include a large amount of material. In one meeting on 12 February 2001, the committee met for one and a half hours. The Enron audit committee does not have the technical knowledge to properly question the auditor on accounting issues related to the company's special purpose entity. The committee also can not question the management of the company due to pressure on the committee. Senate Permanent US Senate on Investigation Reports Committee on Government Affairs accuses board members of allowing conflicts of interest to impede their duties as monitoring of corporate accounting practices. When the Enron scandal became public, the conflict of interests of the audit committee was deemed with suspicion.
Ethical and political analysis
Commentators attribute the mismanagement behind Enron's fall to various ethical and political-economic causes. Ethical explanations center on executive greed and pride, lack of corporate social responsibility, business ethics, and business pragmatism. The explanations of the economies cite the post-1970 deregulation, and inadequate staffing and funding for regulatory oversight. A more libertarian analysis suggests that Enron's collapse was caused by the company's dependence on political lobbying, rent-seeking, and regulatory games.
Other accounting issues
Enron made a habit of posting canceled project costs as an asset, arguing that no official letter stated that the project was canceled. This method is known as a "snowball", and although it was originally dictated that such a practice was only used for projects worth less than $ 90 million, it was later increased to $ 200 million.
In 1998, when analysts were given tours to the Enron Energy Services offices, they were impressed with how the employees worked very excitedly. In fact, Skilling moved other employees to the offices of other departments (instructing them to pretend to work hard) to create the impression that the division was bigger than ever. This hoax is used several times to trick analysts about the progress of the various fields of Enron to help boost stock prices.
Timeline of fallout
In February 2001, Chief Accounting Officer Rick Causey told the budget manager: "From an accounting standpoint, this will be our easiest year, we had 2001 in the pocket." On March 5th, Bethany McLean's article Fortune Is Enron Too Expensive? questioned how Enron can maintain its high stock value, which trades on 55 times its earnings. He argues that analysts and investors do not know exactly how Enron earns his income. McLean was first attracted to the company's situation after an analyst suggested he look at the company's 10-K report, where he found "weird deals", "uncertain cash flow", and "big debt." He called Skilling to discuss his findings before publishing the article, but he called it "unethical" for not researching the company properly. Fastow quotes two Fortune reporters that Enron can not reveal earnings details because the company has more than 1,200 trade books for various commodities and does "...... do not want anyone to know what's in the book We do not want to tell anyone where we make money. "
In a conference call on April 17, 2001, Chilling Executive Officer Skilling verbally attacked Wall Street analyst Richard Grubman, who questioned Enron's unusual accounting practices during a conference call. When Grubman complained that Enron was the only company that could not release the balance along with the earnings report, Skilling replied, "Thank you very much, we appreciate that... asshole." This is a joke among many Enron employees, mocking Grubman for being interfered with rather than Skilling's carelessness, with slogans such as "Ask Why, Asshole", a variation of Enron's official "Ask why" slogan. However, Skilling's comments were filled with shock and shock by the press and the public, as he had previously downplayed criticism of Enron with calm or humor.
In the late 1990s, Enron shares traded at $ 80-90 per share, and few seemed to focus on the opacity of corporate financial disclosures. In mid-July 2001, Enron reported revenues of $ 50.1 billion, almost tripling year-on-year, and beat analyst estimates of 3 cents per share. Nevertheless, Enron's profit margin stays at a modest average of about 2.1%, and its share price has declined by more than 30% since the same quarter of 2000.
As time passed, a number of serious problems confronted the company. Enron recently faced some serious operational challenges, namely the logistical difficulties of operating a new broadband communications communication unit, and the loss of the Dabhol Power project development, a major power plant in India. There is also increasing criticism of the company for the role that its subsidiary Enron Energy Services had in the California 2000-2001 electricity crisis.
On August 14th, Skilling announced he had resigned from his position as CEO after just six months. Skilling has long served as president and COO before being promoted to CEO. Skilling mentioned personal reasons for leaving the company. Observers note that a few months before he left Skilling had sold at least 450,000 Enron shares for approximately $ 33 million (though he still had over a million shares on his departure date). Nevertheless, Lay, who serves as chairman at Enron, convinces a shocked market watcher that there will be "no change in performance or outlook of the company going forward" from Skilling's departure. Lay announced that he himself would be back in the position of chief executive officer.
However, the next day, Skilling admitted that a very significant reason for his departure was Enron's faltering price on the stock market. Economist Paul Krugman asserts in his column New York Times that Enron is an illustration of the consequences of deregulation and commodification of things like energy. A few days later, in a letter to the editor, Kenneth Lay defended Enron and company philosophy:
The broader aim of the recent [Krugman] attack against Enron seems to be to discredit the free market system, a system that entrusts people to make choices and enjoy their work, skills, intelligence and hearts. He seems to be relying on a government-controlled or sponsored monopoly system to make choices for people. We disagree, find ourselves lacking in trust in the integrity and goodwill of their institutions and leaders.
Examples cited by Mr. Krugman's raging "finance" (California electricity market) is the exact product of his system, with the government's active intervention at every step. Indeed, the only winners in California's failure were the utilities owned by the Los Angeles, Pacific Northwest and British Columbia governments. The disaster that wasted California's wealth was born out of rule by a handful of people, not by the market of many people.
On August 15, Sherron Watkins, vice president for corporate development, sent an anonymous letter to Lay warning him about the company's accounting practices. One statement in the letter said: "I am very nervous that we will explode in a wave of accounting scandals." Watkins contacted a friend who worked for Arthur Andersen and he compiled a memorandum to be given to the audit partner about the points he raised. On August 22, Watkins met personally with Lay and gave him a six page letter further explaining Enron's accounting problems. Lay asked him if he had told anyone outside the company and then vowed to have the firm's law firm, Vinson & amp; Elkins, review the problem, although he argues that using a law firm will create a conflict of interest. Lay consulted with other executives, and although they wanted to fire Watkins (because Texas law does not protect the company's whistleblower), they decided not to file a lawsuit. On October 15th, Vinson & amp; Elkins announced that Enron had made no mistake in his accounting practices because Andersen had agreed on every issue.
Declining investor confidence
At the end of August 2001, the company's stock value was still down, Lay named Greg Whalley, president and COO of Enron Wholesale Services and Mark Frevert, to a position in the chairman's office. Some observers claim that Enron investors are in dire need of certainty, not just because the business of the company is hard to understand (even "read") but also because it is difficult to describe the company in the financial statements. An analyst stated "it is very difficult for analysts to determine where [Enron] earns money in a certain quarter and where they lose money." Lay accepts that Enron's business is very complex, but insists that analysts will "never get all the information they want" to satisfy their curiosity. He also explained that business complexity is largely due to tax strategies and hedging positions. Lay's efforts seem to meet with limited success; on September 9, one of the leading hedge fund managers noted that "[Enron] shares are trading under the cloud." Skilling's sudden departure combined with the opacity of Enron's accounting books makes the right judgment difficult for Wall Street. In addition, the company claimed to repeatedly use "related party transactions," which it feared could be too easy to use to transfer any losses that may arise in Enron's own balance sheet. A very disturbing aspect of this technique is that some "related party" entities have or are being controlled by CFO Fastow.
After the September 11, 2001 attacks, media attention shifted from the company and its problems; less than a month later, Enron announced its intention to begin the process of selling lower margin assets to support the core business of gas and electricity trading. This policy includes selling Portland General Electric to another Oregon utility, Northwest Natural Gas, for about $ 1.9 billion in cash and stock, and possibly selling 65% of its stake in the Dabhol project in India.
Restructuring loss and investigation SEC
On October 16, 2001, Enron announced that restatement of its financial statements for 1997 to 2000 was required to correct the accounting violations. The restatement for that period reduced revenues of $ 613 million (or 23% of reported earnings over the period), an increase in liabilities by the end of 2000 by $ 628 million (6% of reported liabilities and 5.5% of reported equity) , and reduced its equity by the end of 2000 by $ 1.2 billion (10% of reported equity). In addition, in January Jeff Skilling has confirmed that the broadband unit alone is worth $ 35 billion, claims are also not trusted. Analysts at Standard & amp; Poor said, "I do not think anyone knows what a valuable broadband operation is."
The Enron management team claims the loss is largely due to investment losses, along with a cost of about $ 180 million in money spent restructuring the troubled broadband trading business unit. In a statement, Lay revealed, "After reviewing our business thoroughly, we decided to take this fee to clear up the issue that has obscured the performance and earning potential of our core energy business." Some analysts feel nervous. David Fleischer at Goldman Sachs, an analyst called 'one of the strongest supporters of the company' confirms that Enron's management "... loses credibility and has to reprimand themselves." They need to convince investors that this revenue is real, that the company is for real and that growth will come true. "
Fastow disclosed to Enron's board of directors on October 22 that he earned $ 30 million in compensation arrangements when managing LJM-limited partnerships. That day, Enron's share price dropped to $ 20.65, down $ 5.40 in one day, after an announcement by the SEC that it was investigating some suspicious transactions attacked by Enron, characterizing them as "some of the most opaque transactions with insiders never seen ". Seeking to explain the cost of billions of dollars and soothe investors, the disclosure of Enron speaks of "the division of collar agreements at no cost," "derivative instruments that eliminate the contingent nature of existing limited contracts," and strategies that serve "to protect the investments of certain traders and other assets." This puzzling expression made many analysts feel unconcerned about how Enron manages his business. Regarding the SEC's investigation, Lay's chairman and CEO said, "We will cooperate fully with S.E.C. and look forward to any opportunity to pay any attention to this transaction for rest."
Two days later, on October 25, though a few days earlier were convinced, Lay ignored Fastow from his position, saying, "In my ongoing discussion with the financial community, it became clear to me that restoring investor confidence would require us to replace Andy as a CFO. "However, with Skilling and Fastow now gone, some analysts are worried that revealing the company's practices will become increasingly difficult. Enron stock is now trading at $ 16.41, after losing half its value in a little over a week.
On October 27, the company began buying back all of its commercial paper, worth about $ 3.3 billion, in an effort to calm investor fears about Enron's cash supply. Enron financed repeat purchases by spending its line of credit in several banks. While the company's debt rating is still regarded as the level of investment, its bonds are trading at a slightly lower rate, making future sales into trouble.
As the moon draws near, serious attention is raised by some observers as to the possibility of Enron's manipulation of accepted accounting rules; However, the analysis was claimed to be impossible based on incomplete information provided by Enron. Industry analysts fear that Enron is the new Long-Term Capital Management, the hedge fund whose bankruptcy in 1998 threatened the systemic failure of the international financial markets. The enormous presence of Enron worries some of the consequences of a possible corporate bankruptcy. Enron's executives receive questions in writing only.
Credit downgrade
The key short-term hazard to Enron's survival at the end of October 2001 appeared to be his credit rating. It was reported at the time that Moody and Fitch, two of the three largest credit rating agencies, have appointed Enron to be reviewed for possible downgrades. The downgrade will force Enron to issue millions of shares to cover secured loans, which will further lower the value of existing stocks. In addition, all types of companies begin reviewing existing contracts with Enron, especially in the long run, in case Enron rankings are lowered below the investment level, possibly a bottleneck for future transactions.
Analysts and observers continue to complain about the difficulties or the impossibility of judging companies whose financial statements are very vague. Some people fear that no one in Enron apart from Skilling and Fastow can fully explain the years of mysterious transactions. "You have mastered my head," Lay said at the end of August 2001 in response to detailed questions about Enron's business, a reaction that concerns analysts.
On October 29, responding to growing concerns that Enron may not have enough cash, news spread that Enron is looking for $ 1-2 billion more in financing from banks. The next day, as feared, Moody's downgraded Enron's credit rating from Baa1 to Baa2, two levels above the junk status. Standard & amp; Poor's affirms Enron's ranking of BBB, equivalent to Moody's Baa1. Moody also warned that it would lower the ranking of Enron's commercial paper, a consequence that is likely to prevent companies from finding further financing sought to keep the solvent.
November begins with the disclosure that the SEC is now conducting a formal investigation, fueled by questions related to Enron's transactions with "related parties". The Enron Council also announced that it will commission a special committee to investigate transactions directed by William C. Powers, dean of the University of Texas law school. The next day, the editorial at The New York Times demanded an "aggressive" investigation of the matter. Enron was able to earn an extra $ 1 billion in funding from Dynegy's cross-town rivals on Nov. 2, but the news was not universally admired because it was secured by assets from valuable Northern Natural Gas and Transwestern Pipeline.
Purchase proposed by Dynegy
Sources claim that Enron plans to explain its business practices more fully in the coming days, as a confidence-building movement. Enron stock is now trading around $ 7, as investors are worried that the company will not be able to find a buyer.
After receiving a broad spectrum of rejection, Enron's management apparently found a buyer when Dynegy's board, another Houston-based energy trader, chose late on Nov. 7 to get Enron at a very low price of about $ 8 billion in stock. Chevron Texaco, which by then had about a quarter of Dynegy, agreed to provide Enron with $ 2.5 billion in cash, specifically $ 1 billion initially and the remainder when the deal was completed. Dynegy will also be required to assume nearly $ 13 billion in debt, plus other debts that until now have been clogged by Enron's secret business practices, perhaps as much as $ 10 billion in "hidden" debt. Dynegy and Enron confirmed their agreement on November 8, 2001.
The commentator told a different corporate culture between Dynegy and Enron, and on the "straight talking" personality of Dynegy's CEO, Charles Watson. Some people wonder whether Enron's problems are not only caused by innocent accounting mistakes. In November, Enron insisted that the "one-time" cost of a billion more disclosed in October should in fact be $ 200 million, with the rest only an active accounting error correction. Many are afraid of other "mistakes" and re-statements may not have been revealed.
Another major correction of Enron's revenues was announced on Nov. 9, with a reduction of $ 591 million from revenues declared from 1997-2000. The allegations are said to have come from two special purpose partnerships (JEDI and Chewco). Corrections resulted in the abolition of virtual profits for fiscal year 1997, with significant reductions for other years. Despite this disclosure, Dynegy stated it was still intended to buy Enron. The two companies are said to be keen to accept the official assessment of the proposed sales from Moody's and S & P likely to understand the effect of the settlement of the purchase transaction will be on the credit rating of Dynegy and Enron. In addition, concerns arise related to antitrust regulatory restrictions that result in the possibility of divestiture, along with what for some observers is a very different corporate culture than Enron and Dynegy.
Both companies promote the deal aggressively, and some observers hope; Watson is praised for trying to create the largest company in the energy market. At the time, Watson said: "We feel [Enron] is a very solid company with plenty of capacity to withstand whatever happens in the months ahead." An analyst says the deal is "a big lie...... very good financially, of course it should be strategically good, and provide direct assistance to Enron."
Credit problems are becoming increasingly important. Around the time the purchase was made public, Moody's and S & amp; P both reduce Enron ratings to just one level above the junk status. If the firm's rankings fall below the level of investment, its ability to trade will be very limited if there is a reduction or elimination of credit limits with competitors. In a conference call, S & amp; P confirms that, is Enron not purchased, S & amp; P will reduce its rating to low BB or high B, the rank is recorded as in junk status. In addition, many traders have restricted their involvement with Enron, or stopped doing business altogether, fearing bad news. Watson once again tried to reassure, proving in a presentation to the investor that there was "nothing wrong with Enron's business". He also acknowledged that profitable measures (in the form of more stock options) had to be taken to correct the hostility of many of Enron's employees to management after it was revealed that Lay and other officials had sold hundreds of millions of dollars worth of stock during the month before the crisis. The situation was not helped by the disclosures that Lay, "ragged reputation", stood up to receive a $ 60 million payment as a change control charge after the Dynegy acquisition, while many Enron employees have seen their retirement accounts, mostly based on Enron shares, prices fall by 90% within a year. An official at a company owned by Enron stated "We have several married couples who both work who lost as much as $ 800,000 or $ 900,000.It pretty much wipes out every employee's savings plan."
Watson assured investors that the true nature of Enron's business had been shown to him: "We have comfort where no other shoe falls, if there are no shoes, this is a nice phenomenal transaction." Watson further confirms that Enron's share of energy trade alone is comparable to the price that Dynegy pays for the entire company.
In mid-November, Enron announced plans to sell assets worth about $ 8 billion, along with a general plan to reduce the scale for financial stability. On November 19, Enron revealed to the public further evidence of his critical condition. The most pressing thing was that the company had a debt obligation in the range of $ 9 billion at the end of 2002. Such debt was "far exceeded" from the available cash. Also, the success of measures to conserve its solvency is not guaranteed, particularly as asset sales and debt refinancing. In a statement, Enron said "The bad results in relation to these matters will likely have a material adverse impact on Enron's ability to continue as a survival."
Two days later, on Nov. 21, Wall Street expressed serious doubts that Dynegy would continue the deal altogether, or would attempt to renegotiate radically. Furthermore, Enron discloses in a 10-Q submission that almost all money recently borrowed for purposes including buying his commercial paper, or about $ 5 billion, has been exhausted in just 50 days. Analysts are amazed at the revelation, especially since Dynegy is reportedly also unaware of the level of Enron's cash usage. To terminate the proposed purchase, Dynegy needs to legally indicate "material change" in the circumstances of the transaction; until November 22, sources close to Dynegy are skeptical that the latest revelations are a sufficient basis.
SEC announced it has filed a civil lawsuit fraud against Andersen. A few days later, sources claimed Enron and Dynegy renegotiated their regulatory requirements. Dynegy now demands Enron to agree to be bought for $ 4 billion rather than $ 8 billion previously. Observers reported difficulties in ensuring which Enron operations, if any, were profitable. The report describes a massive business shift to Enron's competitors for the reduction of risk exposure.
Bankruptcy
On November 28, 2001, two of Enron's worst results came true: Dynegy Inc. unilaterally break away from the company's acquisition plan, and Enron's credit rating is reduced to junk status. Watson then said "In the end, you can not give it [Enron] to me." Companies have very little money to use, much less to meet the enormous debt. Its share price fell to $ 0.61 by the end of trading that day. An editorial observer wrote that "Enron now stands for a perfect financial storm."
The systemic consequences are felt, when Enron's creditors and other energy trading companies suffer losing some percentage points. Some analysts feel Enron's failure indicates the post-September 11 economic risks, and encourages traders to lock in profits where they can. The question now becomes how to determine the total market exposure and other traders for Enron's failure. The initial calculation was estimated at $ 18.7 billion. A counselor stated, "We do not really know who is out there on Enron credit, I tell my clients to prepare for the worst."
Enron is estimated to have approximately $ 23 billion in liabilities both from unpaid loans and secured loans. Citigroup and JP Morgan Chase in particular seem to have a significant amount to lose to Enron bankruptcy. In addition, many of Enron's key assets promised to lenders to get loans, causing doubts about what, if any, creditors are unsecured and eventually shareholders may receive in bankruptcy proceedings.
Enron's European operations filed for bankruptcy on November 30, 2001, and he sought refuge in Chapter 11 two days later on December 2. It became the largest bankruptcy in US history, going beyond the 1970s Penn Central bankruptcy (bankruptcy of WorldCom the following year surpassed Enron's bankruptcy so the degree was short), and resulted in 4,000 job losses. On the day Enron filed for bankruptcy, employees were told to pack their things and were given 30 minutes to clear the building. Nearly 62% of the 15,000 employee savings plans rely on Enron shares purchased at $ 83 in early 2001 and are now practically worthless.
On January 17, 2002, Enron dismissed Arthur Andersen as his auditor, citing accounting advice and document destruction. Andersen denied that it had ended his relationship with the company when Enron went bankrupt.
Trial
Enron
Fastow and his wife, Lea, both pleaded guilty to the charges against them. Fastow was initially charged with 98 allegations of fraud, money laundering, insider trading, and conspiracy, among other crimes. Fastow pleaded guilty to two counts of conspiracy and was sentenced to ten years without parole in bargaining to testify against Lay, Skilling, and Causey. Lea was charged with six criminal charges, but the prosecutor then dismissed them for one allegation of a violation. Lea was sentenced to one year for helping her husband hide income from the government.
Lay and Skilling were on trial for their part in the Enron scandal in January 2006. The 53-indictment, 65-page indictment includes various financial crimes, including bank fraud, making false statements to banks and auditors, securities fraud, fraud wire, money laundering, conspiracy , and insider trading. US District Judge Sim Lake earlier denied the defendants' movement to conduct a separate trial and move the case from Houston, where the defendants argued that negative publicity about Enron's death would make it impossible to obtain a fair trial. On May 25, 2006, the jury in the Lay and Skilling trial returned the verdict. Skilling was sentenced to 19 of 28 allegations of securities fraud and wire fraud and released on the remaining nine, including insider trading allegations. He was sentenced to 24 years and 4 months in prison. In 2013 the United States Department of Justice reached an agreement with Skilling, which resulted in ten years cut off from his sentence.
Lay pleaded not guilty to eleven criminal charges, and claimed that he was misled by the people around him. He attributes the main cause of death to Fastow. Lay was convicted on all six counts of securities and wire fraud in which he had been tried, and he was sentenced to a maximum of 45 years in prison. However, before being sentenced, Lay died on July 5, 2006. At the time of his death, the SEC has been seeking over $ 90 million from Lay in addition to civil penalties. The case of Lay's wife, Linda, is a difficult one. He sold nearly 500,000 Enron stocks ten minutes to thirty minutes before the information that Enron collapsed was published on November 28, 2001. Linda was never charged with any of the events related to Enron.
Although Michael Kopper worked at Enron for more than seven years, Lay did not know Kopper even after the company's bankruptcy. Kopper is able to keep his name anonymous throughout the affairs. Kopper was the first Enron executive to plead guilty. Chief Accounting Officer Rick Causey was charged with six criminal charges to disguise Enron's financial condition during his tenure. After pleading not guilty, he later turned to be guilty and sentenced to seven years in prison.
All said, sixteen people pleaded guilty to the crimes committed in the company, and five others, including four former Merrill Lynch employees, were found guilty. Eight former Enron executives testify - the main witness is Fastow - against Lay and Skilling, his former boss. The others are Kenneth Rice, former head of Enron Corp.'s high-speed Internet unit, who works together and whose testimony helps Skilling and Lay inmates. In June 2007, he received a 27-month sentence.
Michael W. Krautz, former Enron accountant, was among the defendants who were acquitted of the scandal-related charges. Represented by Barry Pollack, Krautz was acquitted of federal crime fraud charges after a one-month jury trial.
Arthur Andersen
Arthur Andersen was indicted and found guilty of blocking justice for tearing up thousands of documents and deleting e-mails and company files binding the company to audit Enron. Although only a small number of Arthur Andersen's employees were involved with the scandal, the company was effectively ostracized; The SEC is not allowed to receive audits from convicted criminals. The company submitted the CPA license on August 31, 2002, and 85,000 employees lost their jobs. The conviction was later canceled by the US Supreme Court because the jury was not properly instructed on charges against Andersen. The Supreme Court's decision theoretically leaves Andersen free to resume operations. However, the damage to the Andersen name has been so great that it has not returned as a viable business even on a limited scale.
NatWest Three
Giles Darby, David Bermingham, and Gary Mulgrew working for Greenwich NatWest. The three English men had worked with Fastow on a special purpose entity which he began to refer to as the Swap Sub. When Fastow was being investigated by the SEC, the three men met the UK Financial Services Authority (FSA) in November 2001 to discuss their interactions with Fastow. In June 2002, the United States issued a warrant for their arrest of seven counts of wire fraud, and they were later extradited. On July 12, an Enron candidate who was scheduled to be extradited to the United States, Neil Coulbeck, was found dead in a park in north-east London. Coulbeck's death was finally ordered to commit suicide. The US case alleges that Coulbeck and others conspired with Fastow. In a bargain in November 2007, the trio pleaded guilty to one count of wire fraud while six other charges were dismissed. Darby, Bermingham, and Mulgrew were each sentenced to 37 months in prison. In August 2010, Bermingham and Mulgrew reclaimed their recognition.
Aftermath
Enron shareholders lost $ 74 billion in the four years before the company's bankruptcy ($ 40 to $ 45 billion was linked to fraud). Because Enron has nearly 67 billion dollars, its creditors, employees and shareholders receive limited assistance, if any, apart from severance from Enron. To pay off its creditors, Enron held an auction to sell assets including art, photos, logo signs, and pipelines.
In May 2004, more than 20,000 former Enron employees won a $ 85 million lawsuit for the $ 2 billion compensation lost from their pensions. From settlement, each employee receives about $ 3,100. The following year, investors received another settlement of several banks of $ 4.2 billion. In September 2008, a $ 7.2 billion settlement of a $ 40 billion lawsuit was reached on behalf of shareholders. The settlement was distributed among the main plaintiffs, the University of California (UC), and 1.5 million individuals and groups. UC law firms, Coughlin Stoia Geller Rudman and Robbins, received $ 688 million in fees, the highest in cases of US securities fraud. At the time of distribution, UC announced in a press release "We are very pleased to be able to refund this money to class members until this is a long and challenging effort, but the results for Enron investors are unprecedented."
Sarbanes-Oxley Act
Between December 2001 and April 2002, the Senate Committee on Banking, Housing and Urban Affairs and the House Committee on Financial Services held several hearings on the Enron scandal and related accounting and investor protection issues. This hearing and corporate scandal that followed Enron led to the passage of the Sarbanes-Oxley Act on 30 July 2002. The law is almost "Enron's mirror image: corporate perceived corporate governance failures are matched almost to the point in the principal terms of the Act. "
The main provisions of the Sarbanes-Oxley Act include the establishment of a Public Company Accounting Supervisory Board to develop standards for the preparation of audit reports; restrictions on public accounting firms from providing non-audit services when auditing; provisions for the independence of members of the audit committee, the executive is required to sign the financial statements, and the release of certain executive bonuses in the case of financial statements; and expanding financial disclosure of corporate relationships with non-consolidated entities.
On February 13, 2002, due to a case of law violation and corporate accounting, the SEC recommended changes to the stock exchange rules. In June 2002, the New York Stock Exchange announced a new governance proposal, which was approved by the SEC in November 2003. The main provisions of the latest NYSE proposal include:
- All companies must have a majority of independent directors.
- Independent directors must abide by a clear, independent definition of the board of directors.
- The compensation committee, nomination committee, and audit committee shall consist of independent directors.
- All members of the audit committee must be financially literate. In addition, at least one member of the audit committee must have accounting expertise or related financial management.
- In addition to its regular sessions, the board should hold additional sessions without management.
See also
- The Crooked E: The Unshredded Truth About Enron - a television movie about the rise and fall of Enron, based on Anatomy of Greed , a 2002 book by
Source of the article : Wikipedia
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