ENRON CORPORATION

I. Information about Enron corporation

-   Enron was formed in 1985 by Kenneth Lay after merge the natural gas pipeline companies of Houston Natural Gas and InterNorth.

-   Headquarters Houston, Texas, United States.

-   In the early 1990s, Enron helped to initiate the selling of electricity at market prices. After that, the United States Congress passed legislation deregulating the sale of natural gas -> Enron sell energy at higher prices - > increasing its revenue.

-     In 1992, Enron rose to become the largest seller of natural gas in North America (earnings before interest and taxes of $122 million).

-     Enron pursued a diversification strategy (including gas pipelines, electricity plants, pulp and paper plants, water plants, and broadband services across the globe).

-    Enron's stock rose from the start of the 1990s until year-end 1998 by 311%.

                +  In 1999 increased by 56% .

                + In 2000 increased by 87%.

                + In 2000, Enron’s stock was priced at $83.13.

                + Market capitalization exceeded $60 billion.

-    In addition, Enron was rated the most innovative large company in America in Fortune's Most Admired Companies survey

 II. Cause to downfall

-          Enron's nontransparent financial statements did not clearly depict its operations and finances.

-          Complex business model and unethical practices required -> accounting limitations to misrepresent earnings, modify the balance sheet

-          Corporate governance.

1. Revenue recognition.

-              Enron providing services such as wholesale trading and risk management in addition to building and maintaining electric power plants, natural gas pipelines, storage, and processing facilities to earned profits.

-              Enron are able to report trading and brokerage fees as revenue, although not for the full value of the transaction (because used “merchant model” method for reporting revenue).

-              Enron's method of reporting inflated trading revenue -> Enron in the top 50 of the Fortune 500.

2. Mark-to-market accounting

-              When Skilling joined the company, he demanded that the trading business adopt mark - to-market accounting.

-              Mark-to-market accounting requires that once a long-term contract was signed, income was estimated as the present value of net future cash flows

-              Often, the viability of these contracts and their related costs were difficult to judge

-              Enron later expanded its use to other areas in the company to help it meet Wall Street projections.

EXAMPLE: In July 2000, Enron and Blockbuster Video signed a 20-year agreement to introduce on-demand entertainment to various U.S. cities by year-end. When the network failed to work, Blockbuster pulled out of the contract. Enron continued to recognize future profits, even though the deal resulted in a loss.

3. Special purpose entities

-      Enron used special purpose entities, which limited partnerships or companies created to fulfill a temporary or specific purpose, to fund or manage risks associated with specific assets.

-     In total, by 2001, Enron had used hundreds of special purpose entities to hide its debt.

Ex:  Jedi, Chewco, Whitening, LJM

4. Corporate governance

-              Enron had a model board of directors and a talented audit committee which helped Enron to attract large sums of capital, conceal its true debt, raise its stock to unsustainable levels.

5. Executive compensation

-              Enron’s compensation and performance management system contributed to a dysfunctional corporate culture+ management was extensively compensated using stock options.

-              Therefore, extravagant spending was rampant throughout the company.

6.Risk management

-              Enron used derivatives and special purpose entities incautiously

-              As a result, the risks associated with the transactions were increasing.

-              The lack of comprehensive backgrounds of Enron’s Finance Committee and the board.

7. Financial audit.

-              Enron hired an auditor firm- Andersen- and numerous certified public accountants to look new ways to save the company money.

-              The accountants looked for new ways to save the company money, including capitalizing on loopholes found in Generally Accepted Accounting Principles (GAAP).

-              Andersen's auditors were pressured by Enron's management to defer recognizing the charges from the special purpose entities as its credit risks became clear. ->The revelations concerning Andersen’s overall performance led to the break-up of the firm 

8. Audit committee

-              Brief meetings were often held to cover large amount of material=> not enough to deal with the company’s issues

-              Didn’t have the technical knowledge to properly question and unable to question the company’s management.

9. Other accounting issues.

-              Enron made a habit of booking costs of cancelled projects as assets, with the rationale that no official letter had stated that the project was cancelled. This method was known as "the snowball".

-              Skilling had moved other employees to the office from other departments (instructing them to pretend to work hard) to create the appearance that the division was bigger than it was. This ruse was used several times to fool analysts about the progress of different areas of Enron to help improve the stock price.

III. Timeline of downfall

-              On March 5 2001, Bethany McLean's Fortune article Is Enron Overpriced? McLean was first drawn to the company's situation after an analyst suggested she view the company's 10-K report, where she found "strange transactions", "erratic cash flow", and "huge debt”.

-              In a conference call on April 17  2001,  then-Chief Executive Officer (CEO) Skilling verbally attacked Wall Street analyst Richard Grubman, When Grubman complained that Enron was the only company that could not release a balance sheet along with its earnings statements. Skilling replied "Well, thank you very much, we appreciate that ... asshole."

-              Enron share price had dropped by over 30% since the same quarter of 2000, opposed the balance sheet.

-              Enron had recently faced several serious operational challenges, namely logistical difficulties in running a new broadband communications trading unit, and the losses from constructing the Dabhol Power project, a large power plant in India. Addition Enron Energy Services had played in the power crisis of California in 2000–2001.

-              On August 14, Skilling announced he was resigning his position as CEO after only six months. -> Kenneth Lay announced he himself would re-assume the position of chief executive officer.

-              By the end of August 2001, his company's stock still falling

-              After the September 11, 2001 attacks, media attention shifted away from the company and its troubles; a little less than a month later Enron announced its intention to begin the process of shearing its lower-margin assets in favor of its core businesses of gas and electricity trading. This move included selling Portland General Electric to another Oregon utility, Northwest Natural Gas, for about $1.9 billion in cash and stock, and possibly selling its 65% stake in the Dabhol project in India.

-              Enron announced on October 16 that restatements to its financial statements for years 1997 to 2000 were necessary to correct accounting violations. The restatements for the period reduced earnings by $613 million (or 23% of reported profits during the period), increased liabilities at the end of 2000 by $628 million (6% of reported liabilities and 5.5% of reported equity), and reduced equity at the end of 2000 by $1.2 billion (10% of reported equity).

-              On October 23, Lay attempted to reassure investors that the company's cash resources were ample. Lay adamantly insisted there were no improprieties regarding Enron's transactions with partnerships run by Fastow and emphasized his support for the CFO.

-              Two days later, on October 25, despite his reassurances days earlier, Lay removed Fastow from his position.

-              On October 27 the company began buying back all its commercial paper, valued at around $3.3 billion, in an effort to calm investor fears about Enron's supply of cash.

-              On October 29, Moody's lowered Enron's credit rating from Baa1 to Baa2, two levels above junk status. Standard & Poor's also lowered Enron's rating to BBB+, the equivalent of Moody's rating.

-              Enron management apparently found a buyer when the board of Dynegy, another energy trader based in Houston, voted late at night on November 7 to acquire Enron at a fire-sale price of about $8 billion in stock.

+             Around the time the buyout was made public, Moody's and S&P both lowered Enron's rating to just one notch above junk status. S&P would cut its rating to low BB or high B, ratings noted as being within junk status.

+             By mid-November, Enron announced it was planning to sell about $8 billion worth of underperforming assets, along with a general plan to reduce its scale for the sake of financial stability.

+             A few days later, sources claimed Enron and Dynegy were renegotiating the terms of their arrangement. Dynegy now demanded Enron agree to be bought for $4 billion rather than the previous $8 billion.

-              On November 28, 2001, Enron's credit rating fell to junk status. The company, having very little cash with which to run its business, let alone satisfy enormous debts, imploded. Its stock price fell to $0.61 at the end of the day's trading

-              Enron's European operations filed for bankruptcy on November 30, 2001, and it sought Chapter 11 protection two days later on December. -> the largest bankruptcy in U.S. history, resulted in 4,000 lost jobs.

-              On January 17, 2002 Enron fired Arthur Andersen as its auditor, citing its accounting advice and the destruction of documents. Andersen countered that it had already severed ties with the company when Enron entered bankruptcy.

IV. Conclusion

-              Many executives at Enron were indicted for a variety of charges and were later sentenced to prison. Enron's auditor.

+   Arthur Andersen, was found guilty in a United States District Court, but by the time the ruling was overturned at the U.S. Supreme Court, the firm had lost the majority of its customers and had shut down.

+  Lay was found guilty on May 25, 2006, of 10 counts against him; the judge dismissed the 11th. Because each count carried a maximum 5- to 10-year sentence, legal experts said Lay could have faced 20 to 30 years in prison. However, he died while vacationing in Snowmass, Colorado on July 5, 2006. He died of a heart attack.

+ In 2006 Jeffrey Skilling was convicted of multiple federal felony charges relating to Enron's financial collapse, and is currently serving a 24-year.

+  Fastow is serving a six-year prison sentence for charges related to these unlawful acts