80 S.

JHUNJHUNWALA

The Rogue E
Gary, a young and ambitious graduate from a not so elite business school,
got placed in his dream company—Enron, the 7th largest company in
the world valued at as $70 billion (Committee on Governmental Affairs
United States Senate, 2002). On the first day at orientation, he learned
that 80% of the energy giant’s value was in intangibles. The Enron’s board
as the corporate brochure showed was composed of many prominent and
financially sophisticated people of America including Wendy L. Gramm,
a former government regulator and the wife of Senator Phil Gramm,
Republican of Texas; John Wakeham, a member of the British House of
Lords and a former British cabinet member; Norman P. Blake Jr., the
chief executive of Comdisco, a computer services company; Dr. Robert K.
Jaedicke, Dean Emeritus of the Stanford Business School, and a former
accounting professor (see table). Its founder and chairperson Kennet Lay
in his welcome speech emphasized how the company stood for honesty
and fairness, did business with integrity, and played by the rules and exec-
utives stood by their word. Besides his salary if he performed well, he
would earn huge bonus. He was ecstatic at the opportunity, who wouldn’t
be.
Members Since Executive Finance Audit and Compensation Nomination
Committee Committee Compliance Committee Committee
Committee
4

Kennet Lay, Chairman 1986 Member

Jeff Skilling February Member
CEO to
August
2001
John H. Duncan 1985 Chairman Member
(Former UK secretary of
state for energy)
Herbert S. Winokur JR 1985 Member Chairman
Dr. Robert K. Jaedicke 1985 Chairman Member
(Professor of accounting
emeritus)
Dr. Charles A. 1985 Member Chairman
LeMaistre
Norman P. Blake, Jr. 1994 Member Member
(Chairman, President
and CEO, Comdisco)
Robert Belfer Mid Member Member
(Chairman, Belco Oil & 1980s
Gas Corp.)
Wendy L. Gramm 1993 Member Member
(Former chairwoman,
US commodity futures
trading commission)
INTERNAL CONTROL, FINANCIAL OVERSIGHT AND RISK …

John Wakeham 1994 Member Chairman

81
 82

Members Since Executive Finance Audit and Compensation Nomination

Committee Committee Compliance Committee Committee
Committee

Ronnie Chan 1996 Member Member

(Chairman, Hang Lung
S. JHUNJHUNWALA

group., HK)
Paulo Ferraz Pereira 1999 Member Member
(Former President and
CEO, State Bank of Rio
de Janeiro, Brazil)
Frank Savage 1999 Member Member
(Chairman, Alliance
Capital Management
International)
Dr. John Mendelsohn 1999 Member Member
(President, University of
Texas. Anderson Cancer
Center)
Jerome Meyer, 1997 Till Member Member
Chairman, Tektronix 2001

Note Data for the above table have been obtained from websites of The Guardian (2002), Committee on Governmental
Affairs United States Senate (2002) and My Plain View (2002)
 4 INTERNAL CONTROL, FINANCIAL OVERSIGHT AND RISK … 83

Enron a global mega company with over $100 billion in revenues and
20,000 employees worldwide over the years had transformed from a tradi-
tional power company to one creating high-tech financial products such
as trading in online energy contracts (Committee on Governmental Affairs
United States Senate (2002). Gary was assigned to the bankruptcy insur-
ance division. This insurance protected the buyer if their customer went
bankrupt and defaulted.
His team did not welcome him. He was a ‘nobody’. Then, one day
they saw him speaking to a top brass (actually a family friend, but they
did not know that). Mystically he was invited to join them for lunch at
this high-end Japanese restaurant that they drove to in a pricey sports car.
He learned that based on the deals they close with clients they earn huge
bonuses. His team members had bought fancy houses on sizeable monthly
loan instalments and flaunted flashy lifestyles funded out of these bonuses.
The Harvard Business School graduate Jeff Skilling, the new CEO
had introduced mark to market accounting which meant that assets or
liability were valued at current market values. He initiated trading in
energy futures that in effect, were valued “as the company accountants
thought fit” and booked as revenue. Based on these supposedly earned
revenue, hefty bonuses were paid out. The auditors Arthur Andersen and
Securities Exchange Commission (SEC) surprisingly gave their approval,
considering that both energy trading and mark to market accounting were
new ideas. The audit team had their offices inside Enron’s premises and
drew fees of $1 million every week. Skilling created an aggressive corpo-
rate culture where bottom 10% performers were fired. There was a cut
throat competition for survival and huge payouts.
Gary soon made his first big deal. But when the final contract was
drawn up, his estimates had been upped by his seniors. They brushed
aside his concerns explaining that the new figures will give him better
rating and a bigger bonus. He felt he had to go along. And that day, after
work, Gary went and bought a brand new car (of course to be paid from
the bonus he was going to get, he couldn’t afford it on his salary). He
would take his team tomorrow for a ride. They would be impressed. He
had become one of them.
One day Gary’s friend who worked as an analyst at Merrill Lynch called
him about why Enron was not able to present its balance sheet. He told
Gary another analyst John Olson had been fired when he raised questions
about why Enron always had a “BUY” recommendation. The rumour in
his office was that in return Enron gave Merrill Lynch two analyst jobs
that paid $50 million each (Spen & White, 2002).
84 S. JHUNJHUNWALA

Gary found this odd. His company was telling all the employees that
all was well and encouraging them to even buy shares of the company.
He knew Enron spent a lot on building and maintaining its market image;
his small division also had their own PR representative. Was all not well.
He remembered a few days back when he happened to be riding in the
lift with the Chairman he had overhead Lay offering the corporate Jet to
President Bush and suggesting he sell his shares of Enron.
However, the next week results were declared and huge profits
announced. Everyone was initially happy. Share prices would rise and
bonuses paid. But there was a catch. The company had lost over $1 billion
(Barton, 2014) on the Dabhol project in India which ran into trouble from
the beginning with human right activists, bribery allegations and political
controversies. The price at which it decided to sell power was unacceptable
to local Indian government and the plant had to be shut down. Mean-
while, Enron executives had already paid themselves bonuses based on the
future expected gains from the power plant.
Enron was praised for its expansions and ambitious projects and named
“America’s Most Innovative Company” by Fortune for six consecutive
years between 1996 and 2001 (Enron Scandal: The Fall of a Wall Street
Darling, 2018). Over the next few months, several such project failures
can to light, but due to media campaigns the share price of Enron kept
rises reaching a peak of $90. During this time, top executives sold nearly
$1 billion in personal stock, led by Ken Lay and Jeff Skilling who sold
around $300 million and $200 million of their own shares, respectively
(Barton, 2014). At the same time employees were encouraged to pour
their entire live savings into buying shares of Enron.
Using his connections to Bush, Lay manipulated energy regulation.
Facing over $500 million in losses, Enron decided to shut down power
plants in California causing rolling blackouts throughout the state driving
the price of energy upward in order to make a profit (Borger, 2005).
Public outrage of the energy crisis in California eventually caused the
governor to declare a state of emergency, thus regaining control.
Then, one day all employees were called for a meeting where Gary
learnt that Skilling had resigned. The stock prices of Enron began to spiral
downwards. Gary with the help of his analyst friend began to do some
digging. They learned the Enron had taken $ 30 billion in debt to cover
losses and show profits. The debt was hidden in shadow companies created
by CFO Andew Fastow. Fastow created many off-balance sheet SPVs and
raised huge debts through them. The company had hidden its debt by
moving its non-performing assets to the SPVs. The board of directors of
 4 INTERNAL CONTROL, FINANCIAL OVERSIGHT AND RISK … 85

these SPVs was related to the management of Enron which was a clear
conflict of interest (Concept of Special Purpose Vehicle (SPV) and Enron
Accounting Fraud Case Study, 2017). In fact, one of the biggest of them
belonged to Fastow. These assets were hedged with banks and guaranteed
using Enron Stock. 96 of the world’s major banks invested as much as
$25 million each in the project (Barton, 2014).
Gary wondered why the auditors and lawyers had signed off. He real-
ized they were being paid off $50 million annually to keep quite. But was
the board not aware of all this. Why were they approving so risky projects?
Why were they quiet? He heard that Meyer was ticked off for asking ques-
tions that were too critical of management (Salter, 2008). His research
should that Blake sat on the board of Owens Corning Corp., which had
signed a $1 billion energy management deal with an associate company
of Enron in 1999. Duncan was directly linked to a charity supported by
Enron, the Rise Schools of Texas, which includes the Brenda and John
Duncan Rise School in Houston. Kenneth Lay is on the schools’ governing
board. Gramm became a director in Enron, five weeks after leaving the
Commodity Futures Trading Commission, where as chairwoman, she
passed a regulatory exemption for the trading of energy products, which
profited Enron. She is a director of the Regulatory Studies Program of the
Mercatus Center at George Mason University, which has received at least
$50,000 from Enron since 1996. Over the years, through its officers and
employees, Enron made nearly $100,000 in campaign contributions to
her husband, a senator. Enron has long been a ‘big-hearted’ donor, giving
around $600,000 to the Houston Institution led by Charles A. Lemaistre.
As energy secretary of Britain, Wakeham gave permission to Enron to
construct a massive gas-fired power plant at Teeside in the UK. He joined
the company’s board four years later, in 1994. In addition to directors’
fees and reimbursement of expenses amounting to about $79,000 a year,
since September 1996 he is paid $6,000 a month as consultancy fees
from an Enron’s European subsidiary. Winokur is affiliated with National
Tank Co., which has made about $2.5 million in sales to Enron since
1997 (Babineck, 2002). The board had suspended Enron’s code of ethics
to approve the creation of the partnerships between Enron and its chief
financial officer (Abelson, 2002).
By now, the whole world realized things were not right. Credit rating
agencies downgraded Enron. Stock prices were crashing. One morning as
Gary walked into the office, all documents were being put through the
shredder. Employees were queuing up to destroy documents. Even the
86 S. JHUNJHUNWALA

auditors were destroying documents. A SEC investigation was a definite

eventuality.
Finally, on 2 December 2001, Enron declared bankruptcy. Shares were
not even worth a dollar. Gary lost his ‘dream’ job. So did his 20,000
colleagues. They lost their houses, cars and all their savings. Their lives
were turned upside down. Investors too lost billions. Arthur Andersen,
the country’s oldest accounting firm, voluntarily gave up their license.
Over 22,000 Arthur Andersen employees lost their jobs over night. Enron
became 9/11 of the financial world.
Point to Ponder:
1. Can the managers (Directors) of a company such as Enron be trusted
to act in the interest of the owners (Shareholders)?
2. Do you think the auditors acted independently? How can auditors’
accountability be increased?
3. What steps can be taken to ensure financial statements are “true and
fair”?
4. Did political nexus have a role in rise and fall of Enron?
5. What were the causes for Enron’s collapse?
Note: Though the case is based on true facts of Enron the story of Gary
and his friend is fictitious and drawn from the movie The Crooked E.

Strong internal controls, maintenance of proper and adequate

accounting records, and appropriate accounting policies and standards are
to be followed so that the financial statements prepared present a correct
picture of the company’s financial position. CEO and CFO as per regula-
tions in USA and India must certify to the correctness and fairness of the
financial statements and that they are not misleading nor any material facts
omitted. SOX Act (Sec 304) further requires forfeiture of bonuses and
profit from sale of securities of senior executives responsible for financial
statements if they have to be restated due to their misconduct.

Audit and Auditors

As an assurance that the financial statements are reliable, shareholders
appoint auditors to conduct an audit to verify that the financial statements
are true and fair. These external or statutory auditors are independent
accounting professionals who examine the financial records and issue an
opinion regarding the financial statements of the company. They are to