ENRON CORPORATION:
THE 2001’s FALL OF A WALL STREET DARLING
MIDTERM ACTIVITY in
UPDATES IN FINANCIAL REPORTING STANDARDS
SUBMITTED BY:
AGUILA, PAULO TIMOTHY DR.
CALLEJA, RHEALYN M.
PINO, NICOLE JANE B.
SUBMITTED TO:
SIR JAN HERALDACE TUBIGAN
APRIL 2021
I. Company Background.
Enron Corporation has its roots in Omaha, Nebraska, in 1930 after it was organized by
three other companies, the North American Light & Power Company, United Light & Railways
and Lone Star Gas Corporation. The company's founding came just a few months after the stock
market crash of 1929, an inauspicious time to launch a new venture. When these companies sold
their share of Northern to public, brought by changes in Northern's regulation and ownership,
Northern continued expanding during the 1970s and changed its name to InterNorth in 1980s.
InterNorth gives way to the formation of Enron Corporation after it was merged from other
gas company named Houston Natural Gas in 1985. Enron Corporation was an American energy,
commodities, and services providing company based in Houston, Texas. Before its bankruptcy on
December 2, 2001, Enron employed approximately 20,000 staff and was one of the world's major
electricity, natural gas, communications, and pulp and paper companies, with claimed revenues
of nearly $101 billion during 2000. Fortune, an American business magazine, named Enron
"America's Most Innovative Company" for six consecutive years.
Kenneth Lay, the former chairman of Houston Natural Gas, emerged as the top executive
of the newly created firm. Lay quickly adopted the aggressive growth strategy that had long
dominated the management policies of InterNorth and its predecessor. Lay hired Jeffrey Skilling
in 1992 to serve as one of his top subordinates. Skilling becomes the former Enron president and
CEO but then resigned in August 2001 for what he said were personal reasons after more than a
decade at the company. Aside from the two top executives that have mentioned, part of the
central management of Enron were Andrew Fastow, Executive Vice President and Chief
Financial Officer, Enron Corp., since July 1999; Lou Pai, Chairman and Chief Executive Officer,
Enron Accelerator, since February 2001.Chairman of the Board and Chief Executive Officer of
Enron Energy Services from March 1997 until February 2001; J. Clifford Baxter, Vice Chairman,
Enron Corp., since October 2000 and Chief Strategy Officer since June 2000; Mark A. Frevert,
Chairman and Chief Executive Officer, Enron Wholesale Services, since June 2000; Stanley C.
Horton, Chairman and Chief Executive Officer, Enron Transportation Services, since January
1997; Kenneth D. Rice, Chairman and Chief Executive Officer, Enron Broadband Services, Inc.,
since June 2000; Richard B. Buy, Executive Vice President and Chief Risk Officer, Enron Corp.,
since July 1999; Richard A. Causey, Executive Vice President and Chief Accounting Officer,
Enron Corp., since July 1999; James V. Derrick, Jr., Executive Vice President and General
Counsel, Enron Corp., since July 1999; Steven J. Kean, Executive Vice President and Chief of
Staff, Enron Corp. since July 1999. Senior Vice President, Government Affairs, Enron Corp., from
1997 to 1999. From 1989 to 1997, Mr. Kean held a variety of management position in Enron
Corp. subsidiaries; Mark E. Koenig, Executive Vice President, Investor Relations, Enron Corp.,
since July 1999 Senior Vice President, Investor Relations, Enron Corp., from July 1997 until July
1999. Vice President, Investor Relations, Enron Corp., from December 1992 until July 1997, and
J. Mark Metts, Executive Vice President, Corporate Development, Enron Corp., since August
1999. Partner, Vinson & Elkins L.L.P. from January 1991 until August 1999.
Enron Corporation was one of the largest integrated natural gas and electricity
companies in the world. It marketed natural gas liquids worldwide and operated one of the largest
natural gas transmission systems in the world, totaling more than 36,000 miles. It was also one of
the largest independent developers and producers of electricity in the world, serving both
industrial and emerging markets. Enron was a major supplier of solar and wind renewable energy
worldwide, managed the largest portfolio of natural gas-related risk management contracts in the
world, and was one of the world's biggest independent oil and gas exploration companies. In
North America, Enron was the largest wholesale marketer of natural gas and electricity. Enron
pioneered innovative trading products, such as gas futures and weather futures, significantly
modernizing the utilities industry. Aside from these Enron’s world major contribution, they also
traded in more than 30 different products, including the products traded on Enron Online such as
petrochemicals, plastics, power, pulp and paper, steel and weather risk management; Oil and
LNG transportation; Broadband; Principal investments; Risk management for commodities;
Shipping/freight; Streaming media; and Water and wastewater.
The Enron Corporation provides the highlight and overview of the figures of their annual
financial report in year 2000. In that year, the Enron reported a drastic increase of their revenue
comparing from the year 1996 to 1999. It is amounted to $100,789 in millions. Furthermore, the
net income of the corporation also represents that there are unbelievable rapid changes in the
value between the past years. With the difference of their operating results and items impacting
comparability, the net income was reported amounting to $979 million. Also, the corporation listed
a very high increase in their earnings per share which is $1.12. It is arrived also by the difference
of their operating result (1.47) and their items impacting comparability (.35). Moreover, the
corporation’s total asset is $65,503, while the cash from operating activities is $3,010 both in
millions. Lastly, Enron annual financial report highlights their $3,314 in millions capital
expenditures and equity investments.
II. Discussion of the Case.
In 1992, Jeff Skilling that was hired by Kenneth Lay, devised and introduced a new
accounting technique called Market to Market (MTM). This is the principal method that was
employed by Enron to “cook its books”. Under MTM accounting, assets can be recorded on a
company’s balance sheet at their fair market value (as opposed to their book values) and
captured the difference as gain or revenue. With MTM, companies can also list their profits as
projections, rather than actual numbers.
Despite of the possible effects of MTM method, it is surprisingly got approved by the
Securities and Exchange Commission (SEC) also in that year. The effect of using the MTM
technique has been incredible for revenue and for stock performance in general. There were
revenue overstatements and weak internal control recognition. From 1992 to 2000, the stock has
gone from approximately $10 per share to somewhere around $85 dollars per share.
In the case of Enron, the actual cash flows that resulted from their assets were
substantially less than the cash flows that they initially reported to the Securities and Exchange
Commission (SEC) under the MTM method. In an attempt to hide the losses, Enron set up a
number of special shell corporations known as Special Purpose Entities (SPEs). By setting up an
SPE dedicated to the acquisition and financing of specific assets, the parent corporation is
protected in case of bankruptcy, loan default or other loss on those assets. Another use for an
SPE is managing a single asset that has exceptionally complex financial transactions and
requires numerous permits for its operation, such as a factory or a power plant. Therefore, there
is a manipulation of Financial Statement.
The losses would be reported under more traditional cost accounting methods in the
SPEs but were almost impossible to link back to Enron. The majority of the SPEs were private
corporations that only existed on paper. Thus, financial analysts and reporters simply did not
know that they existed.
As corporate acts originate in the choices and actions of human individuals, it is these
individuals who must be seen as the primary bearers of moral duties and moral responsibility.
The then chairman of the board, Kenneth Lay, is responsible for conviction(s) fraud and false
statement. On the other hand, CEO, Jeffrey Skilling is held accountable for conviction(s)
conspiracy, securities fraud, false statement, and insider trading. They both in charged by the
then CFO, Andrew Fastow, to build private cooperate institution secretly and then transferred the
property illegally. The CFO, Andrew Fastow, violated his professional ethics and took the crime of
malfeasance. When the superior, the chairman of the board of Kenneth Lay and CEO Jeffrey
Skilling, ordered conspiratorial employees to carry out an act that both of them knowing is wrong,
these employees are also morally responsible for the act. In January 10, 2002, Arthur Andersen
says its employees destroyed a "significant but undetermined “number of Enron documents.
David Duncan was cited as the responsible managers in this scandal as they had given the order
to shred relevant documents.
The fraudulent act made by the perpetrators did not discovered not until August 14, 2001.
Jeffrey K. Skilling abruptly resigned as chief executive, citing “personal reason”, then Lay
reassumed the position of CEO. This is the beginning of the end of Enron. On August 15,
Sherron Watkins, an Enron VP, wrote an anonymous letter to Kenneth Lay that suggested
Skilling had left because of accounting improprieties and other illegal actions. She questioned
Enron's accounting methods and specifically cited the Raptor transactions. This the beginning of
the discovery of the perpetrated fraud.
Later that same month, Chung Wu, a UBS PaineWebber broker in Houston, sent an e-
mail to 73 investment clients saying Enron was in trouble and advising them to consider selling
their shares. Sherron Watkins then met with Ken Lay in person, adding more details to her
charges. She noted that the SPEs had been controlled by Enron's CFO, Fastow, and that he and
other Enron employees had made their money and left only Enron at risk for the support of the
Raptors. (The Raptor deals were written such that Enron was required to support them with its
own stock.) When Enron's stock fell below a certain point, the Raptors' losses would begin to
appear on Enron's financial statements
The Enron scandal not only shook the Wall Street and the whole U.S economy but also
shook the whole world. This company which reached highest peaks latter was down to ashes due
to its internal fraud and poor governance. It has become a symbol of corruption for the whole
Western economic system which definitely ruined the image of the wall street darling.
The collapse of Enron has left thousands of people out of work. Thousands lost their
personal investments and pensions after the scandal broke out and Enron's stock plunged. Many
employees had personal pension funds made up of Enron shares - a common situation in
America, where occupational schemes based on final salary payments are increasingly rare and
money purchase schemes, known as 401(K) plans, are the norm. Employees at Enron were
encouraged to do so by the company, which also forbade them from selling their stocks, when
the company share price came down. In contrast, many Enron executives were able to cash in
their share options when the company’s fate became clear. The pension fund for the company's
employees was obliterated. Citizen’s trust in the American economic system was destroyed.
Losses on the financial market amounted to the worst stock value loss in peaceful times. Banks
were suspected of collusion. The auditing firm Arthur Anderson lost its accreditation. The close
ties of the company's founder, Kenneth Lay, to US President George W. Bush – Lay was an
important financial supporter of Bush – came under sharp criticism.
In response to the auditing and accounting problems laid bare by Enron and other
corporate scandals, Congress enacted the Sarbanes-Oxley Act of 2002 (P.L. 107-204),
containing perhaps the most far-reaching amendments to the securities laws since the 1930s.
Part of this act is the creation of a new oversight board to regulate independent auditors of
publicly traded companies – a private sector entity operating under the oversight of the Securities
and Exchange Commission. It requires top corporate management and audit committees to
assume more direct responsibility for the accuracy of financial statements. The act also enhances
disclosure requirements for certain transactions, such as stock sales by corporate insiders,
transactions with unconsolidated subsidiaries, and other significant events that may require “real-
time” disclosure.
On October 16, Enron announced a third quarter loss of $618 million. During 2001,
Enron's stock fell from $86 to 30 cents. On October 22, the SEC began an investigation into
Enron's accounting procedures and partnerships. In November, Enron officials admitted to
overstating company earnings by $57 million since 1997. Enron, or "the crooked E," filed for
bankruptcy in December of 2001.
As a legal action against perpetrators, Kenneth Lay and Jeff Skilling were arrested and
prosecuted. The prosecution lasted from 2001 all the way to 2006. During which in 2006, Lay
died from a heart attack as he was having health issues prior to the prosecution and stress
brought by the scandal he was into. Jeff Skilling, on the other hand, was convicted and penalty
imprisoned for 24 years and 4 months and he fined $45 million. On October 31, 2002, Fastow
was indicted by a federal grand jury in Houston, Texas on 78 counts including fraud, money
laundering, and conspiracy. On January 14, 2004, he pled guilty to two counts of wire and
securities fraud, and agreed to serve a ten-year prison sentence. He also agreed to become an
informant and cooperate with federal authorities in the prosecutions of other former Enron
executives in order to receive a reduced sentence. As for David Duncan, he pleaded guilty on
April 9, 2002. The maximum sentence for his crimes is ten years, but since he pleaded guilty and
became a witness for the prosecution, he would have presumably received a much smaller
sentence.
After the bankruptcy, Enron sold its last business, Prisma Energy, during 2006, leaving
Enron asset-less. During early 2007, its name was changed to Enron Creditors Recovery
Corporation. Its goal is to repay the old Enron's remaining creditors and end Enron's affairs.
III. Synthesis and Recommendation.
Enron Scandal of 2001 was a massive failure and a downfall for the reputations of both
company and the whole corporations in the United States. The sudden collapse of one of the
prosperous companies during that time leads from many reasons. It was due to the size of the
company, the complexity of the business operations and activities and lastly, the main
contributing factor of the massive greed and the collusion of key participants. It was also a
mixture of audit failure, accountant deception, the absence of operational audit, lack of internal
control insufficiencies, and failure in the firm’s leadership system and management control. The
top management of Enron Corporation that must be in the first line for the company’s sake and
protection, failed to do their responsibilities and the ones who did fraudulent act. Its focus on
positioning itself as a “new economy” stimulated employee to engage in unfair activities in order
to achieve the desired objective. The auditor also failed in a sense that he forgot the integrity in
auditing. The other big consequence of the fall of Enron is the enactment of Sarbanes-Oxley Act.
With this act, organization will be able to identify internal weakness, have a more compliant
culture within the organization, and, develop new policies and procedures. Lastly, the case only
concludes that even the brightest and successful business can have a dark side just like the fall
of a wall street darling.
The case also emphasized the perpetrated fraudulent activity mainly involving the
revenue account. Enron Corporation as the subject of this case is not just the only corporate
scandal that has been targeted revenue account for this kind of fraud. Overstating the revenue is
one of the common deceiving activity that perpetrated do. Increasing revenues is a sign of good
financial health of a business and a makeup that can conceal the bad side of their financial
status. During the time of Enron, the incredible increased in revenue account makes investors,
especially the retail and institutional investors believed that the company is a good place to invest
in. The greater the numbers of investors, the higher the chances that the Enron may continue
with the industry. Furthermore, the perpetrators of Enron scandals include key central
management as well as the CFO. Therefore, revenue account as one of the easiest to
manipulate becomes much possible for them to control. As for Enron Corporation, the shocking
boost of their revenue growth from 1985 to 2001 has an effect to an appealing debt to equity ratio
which the company shows tons of profits and inflated the retained earnings. The result of these
factors is the unbelievable stock price. By just merely cooking its revenue account, offender
committed their dark plan and lots of people and also the company’s operation was affected.
Accounting fraud seems to be very common for the corporate issues around the world.
Because the financial statements are the basis for measuring the performance of a company, this
kind of fraud not only damages the confidence of investors, but also harms all management
analyzes in regards to business performance. Fraudulent activities especially the preparation and
disclosures of corporate financial statement have received significant amount of attention.
Therefore, detection of such deceiving act like fraud is as crucial as it looks like. In this matter,
accounting standards and principles play a vital role in discovering and correcting the fraud
committed. In its definition, accounting standards ensure the financial statements from multiple
companies are comparable. Because all entities follow the same rules, accounting standards
make the financial statements credible and allow for more economic decisions based on accurate
and consistent information. When Enron scandal was discovered, accounting standards help the
case to be done as soon as possible. The Securities and Exchange Commission (SEC) by the
compliance to accounting principles and procedures, then began the investigation by comparing
the current financial statement of the accused corporation based on the other companies.
Through this comparability, the SEC found out that the corporation is actually overstating the
company earnings since 1997. Generally, accounting standards must be abided to easily
determine the perpetrated activities in the corporation.
Since the fraudulent act was made with the target of overstating the revenue account,
this case is connected with IFRS 15 entitled Revenue from Contracts with Customers. However,
even if the Enron fraud is not particularly in lined with contracts among customers, there is
specific provision in the standards that could help Enron in avoiding such committed fraud. Part of
the dishonesty made by the perpetrators is the usage of Special Purpose Entities to conceal their
deception. This means that the corporation do not actually disclosed the necessary information
that the users need to know. Therefore, this is the thing that IFRS 15 may focused. According to
the disclosure objective stated in the standard, an entity, must disclose sufficient information to
enable users of financial statements to understand the nature, amount, timing and uncertainty of
revenue and cash flows arising from contracts with customers. Therefore, an entity should
disclose qualitative and quantitative information. With this the possible fraud might be avoided
because the reports are transparent, unlike to what the Enron did wherein the manipulated data
were almost impossible to link on them.
One of the most important lessons that Enron offers is that sometimes, managers lie and
boards fail to do their jobs. The most valuable things that the Enron case may offer relate to
corporate governance, financial disclosure, accounting practices, and the management of
pension funds. The case also offers illuminating key points that may be found in the reaction of
jurists, legal scholars, the media, corporate professionals, elected officials and the investing
public to the Enron collapse. The general sense of public outrage is as large as the huge financial
loss suffered by investors and the employee. But this also gives extreme implications to the
similar companies not just in the United States but also to the whole corporate world. Companies
from similar nature and industry as the Enron, in some point also investigate their internal control
and accounting procedures and practices to ensure that they will not walk in the same path and
agony. Companies suffer from intimidation and doubt from their investors making them becomes
more transparent and careful enough with regards to their financial status. Furthermore, they
become more critical in choosing their central management to avoid poor corporate governance.
On the other hand, the fall of the wall street darling also provides a positive implication to
its common industry. This is because of the enactment of the new act entitled Sarbanes Oxley
(SOX) Act of 2002. This is a law mainly created to help investors against fraudulent financial
reporting in the corporation. However, this act is also the reason why companies were forced to
rethink their reporting to avoid penalties, bringing significant benefits for them. The new approach
to financial reporting that SOX created engenders greater market trust. SOX compliance
benefits companies by giving them a starting point for asset analysis. It articulates expectations,
so that organizations can predict the standard they will be held to. Understanding risks means
being able to more effectively target your controls. In addition, one benefit of SOX compliance is
better control awareness; how these controls fit into the big picture becomes more transparent. It
also provides better audit and efficient financial reporting. SOX compliance requires deeper and
more frequent collaboration among internal stakeholders. In other words, the implementation of
Sarbanes Oxley Act has strengthened the public market and the performance of the corporations.
In the end, the former Enron Corporation has its chance to continue and to be better
since it has been changed into another corporation named Enron Creditors Recovery
Corporation. To be able to attain its main goal in repaying the old Enron’s creditors, the
corporation should have considered some recommendations. Enron should have adopted a
progressive-adoptive culture. This culture focuses on generation of new ideas and openness to
new ideas. However, it does not force employees to implement the ideas hence it does not
enhance unhealthy competition. It would also have been important for the firm to consider
nurturing a community-oriented culture, which mainly seeks to ensure a high level of collaboration
and cooperation amongst employees. Adoption of such cultures would have played an important
role in providing employees with direction. Another key point to consider is the effectivity of the
reporting. To ensure effective reporting, Enron should have incorporated accrual method of
reporting to ensure accurate description of the company’s value. Lastly, with regard to control
issues, the firm should have adopted a more current control system by reviewing its policies,
procedures, and rules. The policies and procedures should have focused on nurturing integrity
and ethics. The firm should have remained strict in implementing ethical policies and procedures
to refrain employees from unethical behavior. These recommendations if will be reviewed and
think about by the new management of Enron can help them deal the challenges the corporation
have experienced.
IV. Bibliography.
Baser, A. (2016). Enron Corporation: A Case Study. Tusher Ghosh.
https://www.academia.edu/28328128/Enron_Corporation_A_Case_Study
Bektashi M. and Bektashi M. (2015). Detection Techniques of Fraud in Accounting. Research
Gate.
https://www.researchgate.net/publication/318459332_Detection_Techniques_of_Fraud_in_Accou
nting
Document Type Sequence. Securities and Exchange Commission. Washington D.C. 20549
https://www.sec.gov/Archives/edgar/data/1024401/000102440101500010/ene10-k.txt
Li, Y. (2010). International Journal of Business and Management: The Case Analysis of the
Scandal of Enron. Research Gate.
https://www.researchgate.net/publication/46302792_The_Case_Analysis_of_the_Scandal_of_En
ron
Obringer, LA. (2016). How Cooking the Books Work of Enron: Discovering Fraud. How Stuff
Worfs. https://money.howstuffworks.com/cooking-books8.htm
Sarker, P. et. al. (2016). A Report on Accounting Fraud: A Study on Enron Scandal. Slide Share.
https://www.slideshare.net/PanthoSarker/accounting-fraud-a-study-on-enron-scandal
