The Rise And Fall Of Enron Accounting Essay

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THE RISE AND FALL OF ENRON

Introduction

2001 was a devastating year for our nation. As the year began it brought along with it a new century and along with it one of the most life changing events for the next generation. On September 11, 2001, the country was exposed to one of its' worst attack in the nation's history that will resonate for lifetimes to come. People were blind sided by the terror and shock engulfed the nation. Within the next few months' society felt as if there was physical void that would never be refilled. The initial shock turned into remorse, and with the year coming to a close, individuals were not even on the brink of returning to a sense of normalcy.

With all of this devastation surrounding the nation, it was it the unfortunate timing when a Fortune 500 company called Enron announced that it was filing for bankruptcy. Enron had become the largest U.S. company in the nation's history to file for bankruptcy. The company at one point had dominated the market, and was praised by analysts for its superior performance and diversity. Enron was known for showing profits during times of economic deficiency and had made a reputation of consistent profit. On paper, it seemed that Enron had everything going its way. The company initially started off as a simple natural gas company, then blossomed into a global powerhouse. Enron expanded itself out to reach numerous different business sectors of the world. They were energy traders at heart, but also dealt internet infrastructure equipment, water systems, plastics, computer chips and even broadband. Enron had the Dahlbol Power Project in Bombay; which at the time was the single largest foreign investment in India. The company simply spread reached sectors all over the globe, "Enron controlled the Brazilian electricity distributor Elektro Eletricidade e Servico. It had investments in Asia, Latin America, Africa, and the Middle East.  In the past two years, Enron handled more than $1 trillion in transactions, and in 2000 it reported sales of over $100 billion. On Wall Street Enron was seen as a capitalist "success story"-a model of operating in today's leaner, meaner, more competitive global capitalist environment." With all this praise and glory fueling the company, Enron mercifully went under at the end of the year.

Once Enron's pioneering leaders, Kenneth Lay and Jeff Skilling, brought down not only themselves, but also the thousands of employees that worked for Enron, the millions of investors that trusted the company, and the hundreds of businesses that believed Enron would lead to monetary success. The catastrophic effects of Enron's debacle aftermath of Enron are something that is near impossible to completely apprehend. Consumers lost their trust in the market and financial reports. Banks and investors suffered from large losses. As thousands were left unemployed via Enron, there were even more individuals worldwide that found themselves without an occupation. Enron changed the way people were allowed to do business, and it certainly had an effect on corporate management and emphasized the importance of high quality auditing. From the beginning till the end, and now from beyond the grave, Enron changed the complexion of the world from many different facets.

Historical Background

The early beginnings of Enron can be first dated back to 1931, when the Northern Natural Gas Company established itself in Omaha Nebraska. The company later restructured itself under another the InterNorth company in 1979. InterNorth was a large energy company that specialized in natural gas pipelines. They also ventured off into the plastics, coal, and petroleum industries. At the time, they operated the largest natural gas pipeline in North America. Six years later, the company purchased the Houston Natural Gas company, and this is where the beginnings of Enron truly began.

The merger with this small Houston based company appointed Kenneth Lay the CEO of the new joint venture. Lay initially began to reinvest money in improving the Omaha environment, but eventually centralized the company in Houston. Six months into the merger, Samuel Segnar left the company. Samuel Segnar was the CEO of the InterNorth Company, and his departure gave Kenneth Lay the opportunity to help move the direction of business of which Enron operated.

In its start, the company would deal mainly with natural gas. The company would involve, "…the transmission and distribution of electricity and gas throughout the United States and the development, construction, and operation of power plants, pipelines, and other infrastructure worldwide." The company was profitable, but knew there was more money to be made in different sectors of energy. The Azurix Corporation was created by Enron to cover more of the water sector market share. This company was never really successful, but was a big diversification element. As the company grew, it became greedy. It began to trade and sell commodities that people never realized could be traded before. They were in the business of selling and they found a method to make bandwidth and financial derivatives marketable. They would trade weather derivatives making it seem like it was a necessity for companies to hedge their weather risks. A weather derivative is, "An instrument used by companies to hedge against the risk of weather-related losses. The investor who sells a weather derivative agrees to bear this risk for a premium. If nothing happens, the investor makes a profit. However, if the weather turns bad, then the company who buys the derivative claims the agreed amount." All of these new innovate methodologies of business did not go unnoticed. From 1996 to 2001, Enron was ranked by Fortune Magazine as "America's Most Innovative Company".

From the outside world's perspective, everything seemed like it was working in the right direction for Enron. Acknowledged as one of the best companies to work for in America, the mere environment at Enron made the employees enthused. The environment alone had been acknowledged as an ideal corporate template, "…it had offices that were, in hindsight, stunning in their opulence. Enron was hailed by many, including labor and the workforce, as an overall great company, praised for its large long-term pensions, benefits for its workers and extremely effective management until its exposure in corporate fraud." The company was being run by individuals that were driven and goal oriented. There innovative businesses and skilled employees simply could not help company avoid bankruptcy. The seed company of which grew this corporate monster, Northern Natural Gas was reoccupied and relocated by Omaha investors. This completed the great rise and fall of the energetic corporation.

Business Downfall

When a company like Enron fails, it can not be because of just one reason or one person. Multiple individuals and elements have to have gone wrong for the company to be unable to continue operating. Enron was a company that started off so promising and conducted business in a truly innovative manner. However, this level of innovation was later on found to be fraud and deceit. The company wasn't always covering its tracks and making it seem like it was successful. They honestly began as a profitable potential superstar. They started to falter when they company's expectations kept rising, and they could not meet analyst's predictions. Under the pressure, they began to cook their books to meet the predictions to make sure the company would be deemed a success. As the company continuously attempted to bend the rules of business ethics temporarily, the more they found themselves being a hole. Enron would use a combination of fictitious business entities and creating accounting practices to make money seem legitimate to investors, while at the same effect millions of individuals' daily lives by playing taking advantage of the deregulated energy and power systems. These opportunities lead to Enron building itself up as corporate powerhouse, when in reality it was not.

During its existence, Enron made deals with numerous companies. In any business, any business transaction or deal is to better the company and in the end make more money. In 2000, Enron decided that it was going to have a joint venture with the video rental leader, Blockbuster. The company made a satisfying claim that this was going to be the future of video and media. Kenneth Lay himself explained the power of such a business deal, "Entertainment on-demand is perhaps the most visible example of the power of Enron's broadband applications. With Blockbuster's extensive customer base and content at that time, and Enron's network delivery application and the capabilities of the distribution providers, we have put together the 'killer app' for the entertainment industry." Some might think that this acquisition really was intended to occur, because Enron felt that they would make money on this lucrative twenty year contract. After looking at what really occurred at Enron, this seems like it would have been a keen marketing technique to make money off pure speculation. The plan with Blockbuster seemed very legitimate, "The plans announced in the press release were for Enron and Blockbuster to introduce the entertainment on-demand service in multiple U.S. cities by year-end. Beginning in 2001, Blockbuster expected to extend the service to other domestic and international markets. Enron would encode and stream the entertainment over its global broadband network infrastructure, provision bandwidth on-demand, store the entertainment content and provide quality of service."

This seemed as if it were to work. The two companies also had providers signed up to create a high-performance network to properly construct the project. However, none of these promised became fulfilled, and Blockbuster eventually decided not to go through with the idea. Surprisingly, the mere speculation that Blockbuster could be partnering up with Enron, allowed Enron to gain a lot of money. The company claimed that due to the possibility of the joint venture they were receiving large sums of money from numerous investors. They would cite companies that were created by Enron executives. These counterfeit special business entities would be used to lure investors into investing themselves. Enron would then use a creative accounting technique to factor this business into the reports, and make it seem like everything is a success.

Enron initially signed a 20-year agreement with Blockbuster. Then a series of pilot projects were established by Enron in Portland, Seattle, and Salt Lake City. This consisted of a series of streaming movies being relayed from a basement server into upper level apartments. Enron then created a partnership called "Braveheart." The purpose of this partnership was to lure an investment bank into supplying Enron with an advance, based off the potential profits the company would be making through the deal. This allowed Enron to raise $115 million dollars from a Canadian bank, with the agreement that the bank would be receiving earnings from the deal. Enron would finally then take this information, and calculate out the potential revenue it was suppose to make and factor that into its financial reports. This allowed them to report over $110 million dollars in profits, which was approved by Arthur Andersen, as there bottom line.

The reason the accounting firm allowed this is because Enron was using a controversial accounting practice known as mark-to-market accounting. Essentially all mark-to-market accounting is a method to integrate future earnings into current financial periods. The article by William Thomas explains, "Under mark-to-market rules, whenever companies have outstanding energy-related or other derivative contracts (either assets or liabilities) on their balance sheets at the end of a particular quarter, they must adjust them to fair market value, booking unrealized gains or losses to the income statement of the period." This means that companies can look at the next decades potential earnings from current financial setups, and estimate how much money will be making in the future. This estimation is adjusted for today's fair market value and it is integrated in the financial statements. This can be a very deceiving process, because the money that is showing up on the statements is being viewed as earned by the investors. This how Enron continuously was able to meet predictions. Thomas continued to explain, "A difficulty with application of these rules in accounting for long-term futures contracts in commodities such as gas is that there are often no quoted prices upon which to base valuations. Companies having these types of derivative instruments are free to develop and use discretionary valuation models based on their own assumptions and methods." This shows that the Enron really took advantage of a poor loop hole in the accounting system. When applying mark-to-marketing methods, Enron had incredible flexibility in the how and where they were creating their profit calculations. The bottom line never came up a negative amount. Enron was a company that was under tremendous pressure to beat the estimates, which caused them to ridiculously overstate earnings. The unrealized trading gains that were created by mark to market accounting accounted for more than half of the $1.41 billion reported pretax profits in 2000 alone.

Aside from these creative accounting techniques, Enron became incredibly creative and deceptive with the way that they conducted business. They were under constant pressure to perform, thus they implemented the accounting strategies to make the company seem that it was at an acceptable level. This level of acceptability wasn't accomplished simply through the accounting practices; other unethical measures were also taken. An individual by the name of Andrew Fastow helped Enron continuously improving the company's credit rating, "Fastow continually lobbied the ratings agencies to raise Enron's credit rating, apparently to no avail. That notwithstanding, there were other ways to lower the company's debt ratio. Reducing hard assets while earning increasing paper profits served to increase Enron's return on assets (ROA) and reduce its debt-to-total-assets ratio, making the company more attractive to credit rating agencies and investors." Enron had a slew of "special purpose entities" to access capital and hedge risk. These entities were used heavily as a leveraging tool to increase return on assets without having to report debt on its balance sheet. These entities have a specific process that make them functional, "By using SPEs such as limited partnerships with outside parties, a company is permitted to increase leverage and ROA without having to report debt on its balance sheet. The company contributes hard assets and related debt to an SPE in exchange for an interest. The SPE then borrows large sums of money from a financial institution to purchase assets or conduct other business without the debt or assets showing up on the company's financial statements." Enron could have also sold leveraged assets to the entities to record a profit in its books.

One would think there would be proof of the entities existence, but Enron found a way around all of the technicalities. The company avoided classifications of the entities by keeping the entities below the ownership requirement of 3% by an outside investor. Enron created an immensely complicated mirage of special purpose entities to keep the hologram going of the company's success. Lead by Fastow, Enron took the use of special purpose entities to a whole new level, "As its financial dealings became more complicated, the company apparently also used SPEs to 'park' troubled assets that were falling in value, such as certain overseas energy facilities, the broadband operation or stock in companies that had been spun off to the public. Transferring these assets to SPEs meant their losses would be kept off Enron's books." It was a constant juggle for Enron, as these entities became more and more complex to keep the company's name above the water. Many investors understood that they were taking a higher level of risk. To compensate for this risk, Enron offered the investors additional shares. The shares were an enticing offer to investors because Enron stock prices were continuously on the rise. To cover up for earning owed to other investors, Enron would create an even more creative and complex offer to other investors to cover their losses. This debt to investors began to compound, and Enron tried to issue more stock to compensate. The issuance of the stock diluted the market causing the value of the stock to fall. Enron's special purpose entities provided a deep pocket payout for the individuals involved. Andrew Fastow earned over $30 million in management fees with these entities and did so with the approval of Enron's board of directors.

While these two methods of increasing or deceiving monetary amounts, Enron also played a roll in effecting peoples' daily lives. When in dire need for money, Enron began to take money by any means necessary, even if it meant putting people in the dark, literally. Early 2001, California was having numerous energy difficulties and power plants were under a federal order to supply a full output of electricity. Enron attempted to take advantage of another situation, deregulation. Deregulation was initially intended for the consumer's benefit, "The basic idea is to deregulate the generation of electricity and allow consumers to choose where they buy their power (as they can choose their long-distance phone company). Local utility distributors would continue to deliver the power, for a fee, over their lines. This form of deregulation is being decided on a state-by-state basis. Each state faces a different energy situation and is taking a different approach." Deregulation gave energy providers the power to control supple of power to consumers. Energy is one item that will be in constant demand. Simple supply and demand rules shows that low supplies of energy would cause the prices of energy to sky rocket. What Enron began to do is that they would purposely cause blackouts in California; this caused the price of energy to go up and resulted in massive profits for Enron.

Audio tapes of Enron associates playing with the power supply are evidence that they did such malicious things. Bill William, an Enron trader, was recorded saying, "We want you guys to get a little creative and come up with a reason to go down." After agreeing to take the plant down, the Nevada official questioned the reason. "O.K., so we're just coming down for some maintenance, like a forced outage type of thing?" The following day, January 17, 2001, a plant was manually shut down at the trader's demand. The state of California assumed that it was a power emergency and over half a million consumers were left with no electricity due to rolling blackouts. These occurrences began to happen constantly in 2001. Enron had no disregard for the people they were affecting; they simply wanted to make money.

There were a lot of things that went wrong for Enron, but they brought it on themselves. They put up a façade that the company was successful when in reality the company was using unethical accounting techniques, special purpose entities and deregulation. Mark to market accounting was an accounting practice that should have been allowed to use, and should have been caught by the auditors, Arthur Andersen. The special purpose entities were head by unethical individuals that did not have the investors' interests at mind when conducting business. Enron even neglected millions of consumers, by irresponsibly toying with individuals' homes and lives via rolling blackouts. The company used a series of immoral methods to keep a once promising corporation going, but eventually still resulted of fall of Enron.

Notable Individuals

An interesting phenomenon with the human race is that individuals work hard to make sure that he or she receives credit when due for extraordinary work. People fight for the acknowledgement; sometimes even they didn't earn it. However, the exact opposite is true as well. When there is no more glory, there is simply hardship and losses, individuals scour for other individuals to pass blame onto. It takes truly strong willed figures to stand up for his or her mistakes, and take responsibility for what had occurred. The Enron Corporation had many individuals that were praised for exemplary work when the company's stock price was soaring and being acknowledged for its innovation. Three key figures that brought Enron to the top and allowed Enron to self-destruct, were Kenneth Lay, Jeffrey Skilling, and Andrew Fastow. They had all played their own role in the demise of the company.

Kenneth Lay truly was an influential figure for Enron and for our time. His name will forever be synonymous with the Enron scandal because what he contributed to the company. Named to the position of chairman and chief executive officer for Enron in February 1986, Kenneth offered promising beginnings to the freshly merged company. In the summer of 2004, he was indicted on 11 counts of securities fraud, lying to the public, investors, and Enron employees. In doing so Kenneth collected a decent amount of earnings, "Ken Lay had total compensation of over $100,000,000 in 2001 alone and even during the stock's collapse recommended that employees buy the stock. Enron became one of the largest corporate bankruptcies in US history. He recently passed away of heart failure and after being convicted on charges brought against him in the biggest corporate collapse the world has ever seen." Some say he had it easy dying from heart failure before being sentenced to serve life in prison and really experiencing difficulties.

The other man that was praised in Enron's supposed climb to success was Jeffrey Skilling. Jeffrey was Kenneth Lay's right hand, as he served as the chief executive officer right below Lay. Growing up, Jeffrey accomplished a lot. Growing up as famed weather man, Tom Skilling's, little brother he knew greatness was in his blood. He went to Harvard Business School, and then landed a position with McKinsey Consulting. In 1987, he was hired to work for Enron, and he quickly moved his way up into the company. He had dreams for Enron to be one of the greatest companies ever to venture into the corporate realm. His dreams are what drove his fraudulent and scandalous behavior, as he tried so hard not to let them go. Tom was indicted on 35 counts of fraud, insider trading, and numerous other charges that he pleaded not guilty to. On May 25, 2006 he was, "found guilty on 19 counts of conspiracy, fraud, false statements and insider trading. He was found not guilty on nine counts of insider trading."

Although not the last of the main characters in this movie-like case, Andrew Fastow was one of the most influential. Fastow was a key player in boasting the special purpose entities, which lead to millions of dollars worth of falsely earned investors' money. He was once the chief financial officer for Enron and pleaded guilty to conspiracy in dealings. He was first hired in 1990 by Jeffrey Skilling, and later became indicted on 98 counts of wire securities fraud, money laundering, conspiracy, and having various fictitious financial schemes to monetarily benefit him. Fastow came out of Enron making incredible amounts of money through his dealings, earning at least $45 million alone from his LJM partnerships, which were named after his wife and two children.

Life after Enron

Clearly, what happened with Enron did not serve to be beneficial for anyone. Justice was served when the catalysts behind corporate fraud were convicted, but the over all resonating effect of Enron shutting down was devastating all across the board. Investors clearly did lose their trust with corporations in the market, which will not be regained until a proven period of time. Enron did more than just lose society's trust; they made honest employees lose their financial security by having the company discontinue operations. This was just the beginning of the amount of destruction Enron caused.

It is estimated that over 5,000 employees were let go by Enron when they filed for bankruptcy. These employees not only lost their jobs but they also lost their benefits and their futures. They were left unemployed without any health benefits or retirement plans. Kenneth Lay and Jeffrey Skilling always stressed and promoted investing in Enron. The money invested in Enron stock was virtually all lost by the employees, as it was deemed worthless after filing for bankruptcy. There were individuals who were months away from retiring, assuming that their invested money into retirement funds would support them for the rest of their lives, but that too was deemed worthless. These individuals were lied to, and manipulated into believing the company, and when they did, they lost nearly everything.

Aside from the individuals at Enron, the 28,000 employees for Arthur Andersen lost their jobs as well. Arthur Andersen was the accounting firm that was in charge of auditing Enron's financial reports. It was considered to be one of the top five accounting firms. Yet, the firm did not do what they were required to do, which was adequately audit Enron's operations and financial reports, to reassure that they were accurate for investors and consumers. They turned their heads when Enron began to implement mark-to-market accounting. They did not speak up when they felt that there were unusual business items found. Not only were they irresponsible in that sense but when some of their auditors were put on trial for what had happened they admitted that some of Enron's financial techniques were just too complicated and so they were never truly investigated. Even though theses two acts were quite disturbing on the parts of Arthur Anderson's employees, on of the most astonishing acts was still to come. In the days leading to Enron's trial Arthur Anderson's management team had ordered the destruction of several paper and electronic documents containing viable information of Enron. Later on Arthur Anderson would be convicted for obstruction of justice in the shredding documents related to Enron's investigation. Arthur Andersen had become one of the greatest case studies of irresponsible accounting practices.

Stemming from this irresponsible behavior by Arthur Andersen and Enron came the US passed law know as the Sarbanes-Oxley Act of 2002. This act revamped the way in which public accounting firms must operate in order to better serve and protect investors. State senators Paul Sarbanes and Michael Oxley created the act, which puts more responsibility on the accounting firms and corporate executives to truthfully output a high quality. It requires that the CEO of the company write a letter in testimony and sign off on financial reports stating that they are being presented fairly and accurately. The act also established the Public Company Accounting Oversight Board, which is in charge of inspecting and regulating the public accounting firms. Section 404 of the act is the most important part of the act provision as it asked for numerous changes. A statement of management's responsibility for having proper internal control was essential. They also had to provide framework used by management to evaluate the internal control. They were required to access the internal control at least once a year. They also were required to disclose any material weakness, along with a statement from auditors stating that they issued an attestation report to the management's assessment. All of these issues were needed and essential in creating a more trustworthy environment.

Although Enron's demise caused hard times for numerous individuals, it also gave individuals a chance at new beginnings. Many of the Arthur Andersen employees migrated over to their competitor, Deliotte and Touche. Other individuals stood strong and took this situation as an opportunity to venture off into new businesses. One of the products of this was the consulting company, Huron Consulting. Huron Consulting was created by former Andersen employees and is blossoming into one of the quickest growing and promising companies in the country. Initially starting with only 213 consultants based in Chicago in 2002, they have now grown to have locations internationally. These former employees took their experience and resources and made the best of their situation. Other smaller firms companies such as Altair Advisors and NDH Group, Ltd were formed as well. They too, continue to grow and prosper.

Overall, the demise of Enron was lesson learned for everyone involved. Companies endure an immense amount of pressure to perform up to predictions, and individuals in upper management many times lose sight of the bigger picture when they try to embellish the bottom line. The longer this juggling act of lies and deceit occurs, the bigger the hardship will be once the company goes under because there will be more people effected. Enron forced the face of the nation to be altered. Millions of individuals were infected directly and indirectly. Investors, employees, related companies, and even commoners were affected either monetarily or sitting without electricity. It did help the country out for the better because now investors are more conscious when they invest money. The government is stricter on corporations to provide an honest portrayal of the company's financials, and there were great new companies formed from the honest employees that lost their jobs in the middle of this scandal. Only the future will tell how this case will truly affect the face of the nation.

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