Running head: ENRON CORPORATION (FORMER NYSE TICKER SYMBOL ENE

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Enron Corporation (former NYSE ticker symbol ENE) Kevin Tomaszewski Strayer University-Maitland Campus Business Law I LEG 100 Dr. Michael Hanners October 24, 2010

ENRON CORPORATION (FORMER NYSE TICKER SYMBOL ENE) Abstract

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This is an investigation into the various activities which surrounded the historic collapse of Enron Corporation, one of the largest bankruptcies ever recorded. A brief description of the company’s corporate structure is discussed, with a few possible suggestions which could have improved its ethical character. Then a look into the governing style of Enron’s chief officers is examined, both in its early developmental stage, and later on, when the company had transformed into a financial powerhouse within Wall Street investment circles. The overall corporate culture at Enron is also explored in detail. Afterward, the scene moves into the relationships established between Enron and several sellers of its investment securities. Then, a determination is summarized on who could be held liable for the actions of Enron’s representatives and employees. Was only one company responsible for any unethical behavior, or can this be better perceived as a collaborative effort? Finally, a short look at recent legal activity is brought to light, which may have a direct bearing on a key player in Enron’s misfortune.

ENRON CORPORATION (FORMER NYSE TICKER SYMBOL ENE) Enron Corporation (former NYSE ticker symbol ENE) Introduction

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During its business boom years in the late 1990s, it seemed that Enron Corporation could do no wrong, at least where Wall Street was concerned. But on December 2, 2001, Enron declared bankruptcy, the largest ever recorded up to that date. This unprecedented business failure deserves to be examined repeatedly in order to see where errors were made, and if there were steps the executives at Enron could have taken in order to save themselves. Perhaps there were design flaws in the organizational structure from the very beginning? Petrick and Scherer (2003) identified that integrity capacity was the core ingredient missing from Enron’s top management makeup. What is legally permissible today, but morally questionable, may well become legally proscribed tomorrow. Thus, it is important for managers to proactively understand and attend to the multiple dimensions and moral antecedents of illegal activity. Integrity capacity is the individual and collective capability for the repeated process alignment of moral awareness, deliberation, character, and conduct that demonstrates balanced judgment, enhances ongoing moral development, and promotes supportive systems for moral decision making. It is one key intangible asset that acts as a catalyst for reputational capital and its erosion can jeopardize the survival and credibility of organizations and markets. (p.1) How Enron Could Have Been Structured Differently Enron Corporation wasn’t originally formed as an energy trading company. In 1985, Kenneth Lay founded the firm from a merger of two smaller natural gas companies. In those first years, Enron was structured in what was considered to be rather typical for a regulated energy

ENRON CORPORATION (FORMER NYSE TICKER SYMBOL ENE) exploration business, with a limited amount of trading. This strategy would change dramatically

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when original CEO Richard Kinder was replaced by Jeffrey Skilling in 1996. Within a couple of years, Enron would morph into a financial services company specializing in energy derivatives, options, and futures trading, and then expand into a diverse array of commodities (such as broadband). This transformation was designed to take advantage of newly deregulated energy futures pricing, as Lay had in past years been a key advocate within political circles. Skilling was keen to vigorously exploit this ‘new economy’ of intangible resources to the fullest, as he tied bonuses and stock options to executives and traders who would meet their earnings targets. Would Enron have benefitted from a different corporate structure when it changed its focus towards financial services? Reforming the bonus pay program criteria would have proven valuable; otherwise, the company already boasted a strong management control system. Key elements of this control system included an integrated Risk Assessment and Control group, a Peer Review Committee for keeping employees in line with company objectives, and a Code of Ethics so widely admired in outside circles that the Smithsonian Natural Museum of American History put a copy of the Code on public exhibit. These controls were enhanced by the usual standard corporate governing mechanisms, plus external auditing expertise through the wellregarded name of Arthur Andersen, and oversight by the Securities and Exchange Commission (Free, Macintosh and Stein, 2007, p. 4-5.). With such an intricate infrastructure at its disposal, one might presume that it would take too much internal negligence to undermine all of these safety precautions. In hindsight, a lack of moral will on the part of Enron’s officers, financial partners, and oversight accountants created a ‘perfect storm’ of fraudulent activity that managed to subvert the moral integrity and fiscal structure of the company to the majority of its stakeholders.

ENRON CORPORATION (FORMER NYSE TICKER SYMBOL ENE) How could this scenario have been prevented? Two key sets of stakeholders in which Enron’s much-lauded control systems failed to provide enough feedback controls involved employees and shareholders. Top management and other members of the governing board routinely glossed over concerns at shareholder meetings by touting their own public relations images, while at the same time diverting funds into secret accounts, and selling off shares of stock for personal gain. Employee whistleblowers (such as trader Sherron Watkins) were given the quick brush-off, thereby diminishing any significant opportunity for ethical awareness and strategic responsiveness. Did Enron’s Officers Act within the Scope of Their Authority?

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When it comes to business ethics, the general consensus believes that the Chief Executive Officer plays the most important role in the organization. Yet Chairman Kenneth Lay may have set the standard for errant accountability during Enron’s oil trading scandal of 1987, which had almost brought down the company well before Skilling’s tenure as CEO. In 1987, two traders with the Enron International Oil, Inc. unit lost eighty-five million dollars on risky and dangerous bets. As a result, Enron’s profits for that year were cut in half. Kenneth Lay’s public statements in reaction to the incident claimed ignorance of the problem. But he later defended the two traders during an October conference call, even in the face of claims that they had misappropriated funds (Johnson, Prosecutors Link Enron Fall to 1987 Scandal, 2005). This arbitrary approach to accountability may have influenced Enron’s officers in later years, allowing them to act well beyond the boundaries of their assigned duties without fear of retribution. But in those earlier years, original CEO Richard Kinder oversaw operations efficiently on a tight budget, and was known for holding employees accountable for any potential revenue threats. Kinder’s top priority centered around cash management; thus he assigned

ENRON CORPORATION (FORMER NYSE TICKER SYMBOL ENE) budget and expense targets to all business group managers, tying the company’s bonus program directly to those who met these targets on a regular basis. Enron’s Corporate Culture

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However, the arrival of Jeffrey Skilling as CEO in 1996 altered Enron’s corporate culture significantly by the driven force of his personality. Skilling’s management style emphasized risktaking initiatives and creative accounting methods designed to achieve short-term results which would please Wall Street analysts and investors. Skilling’s aggressive and rather mercenary attitude towards Enron’s strategic goals also extended towards his company’s hiring and firing practices. Enron’s performance review system tied too closely to end results than it should have, as it routinely shaved off 15% of its workforce for low numbers, regardless of other employee proficiencies. Subsequently, traders were faced with the dilemma of either delivering higher numbers by any means necessary, or face the inevitability of demotion or termination. Many of them then chose the former, in order to please their boss. Investigations into the scandal, as documented in the 2002 Senate Subcommittee Report, summarized that Enron’s board of directors had willfully created a culture of deception throughout the firm. Chairman Lay was accused of using direct force to eliminate any potential successors who he had personal disagreements with. Other top officers were charged with using indirect force to manipulate workers and stakeholders in order to artificially inflate their own shares of stock for quick sale (Petrick, et al., 2003, p. 4). Alleged Irregularities in the Actions between Sellers of Securities and Enron Under Skilling’s direction, accountants began to record short-term profits from long-term deals which had yet to show any profits. This unconventional approach, referred to as ‘mark-to-

ENRON CORPORATION (FORMER NYSE TICKER SYMBOL ENE) market accounting’ using ‘hypothetical future value’, also put an enormous amount of pressure on the traders for instant results. Where mark-to-market accounting could achive its greatest impact was through Wall Street securities investors and the companies which were assigned to protect their financial interests. Yet instead of protecting the integrity of their clients’ portfolios, companies such as Merrill Lynch, Citibank, and J.P. Morgan Chase continued to mislead them, and accepted Enron’s returns claims at face value without bothering to actually verify the numbers. Supposed ‘outside’ accountants at Arthur Andersen also helped falsify Enron’s bank accounts, and

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accepted and shared inside information with other clients. Credit Suisse First Boston aided Enron on a series of equity transactions repaid to the banks before they were mature, and also served as a recipient for a series of fraudulent commodities deals in which commodities were never actually delivered. Merrill Lynch, in connection with Enron’s CFO Andrew Fastow, helped establish various off-balance sheet ‘special purpose entities’ for the express purpose of hiding the company’s mounting debt load. They also aided the company as an underwriter of stocks and bonds, in lending and fundraising, and even became involved as an illegal investor. Three executives at Merrill Lynch agreed to ‘park’ three Nigerian power-generating barges in order to help Enron fraudulently enhance its financial standing. According to company insiders, the bank bowed to Fastow’s demands, due to his threat that Enron would take its business elsewhere. For its officers’ complicity, Merrill Lynch was eventually cited for conspiracy to commit fraud, falsifying books and records, and perjury. Was Enron Liable for the Actions of its Agents and Employees?

ENRON CORPORATION (FORMER NYSE TICKER SYMBOL ENE) Naturally, legal grievances were filed by numerous victims of these unethical activities. However, the Fifth Circuit Court of Appeals ruled that while the banks’ role in the scandal was far less than praiseworthy, the banks themselves didn’t present any false statements about their own conduct. Thus they are exempt from liability to Enron’s victims, even though they actively

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participated in their schemes to defraud the company’s shareholders. Yet many of the banks that were identified in the complaints have eventually settled out of court with their investors for billions of dollars. One may speculate that these settlements were essentially designed to save public face. However, ethically it seems clear that Enron becomes liable for its employees’ actions through their representation of the firm. Another great tragedy in this case lies in the shattered reputations of many people who actually believed in the promotional spin that the company had been selling to the public. Free, Macintosh and Stein (2007) of the Queen’s School of Business summarized the saga of Enron’s downfall in the following statement. What Enron clearly demonstrates is that once employees align themselves with a particular culture-and invest heavy commitment in organizational routines and the wisdom of leaders-they are liable to lose their original sense of identity, and tolerate and rationalize ethical lapses that they would have previously deplored. Once a new and possibly corrosive value system emerges, employees are rendered vulnerable to manipulation by organizational leaders to whom they have entrusted many of their vital interests (p. 9). Epilogue In the aftermath of the collapse of Enron, subsequent investigations have led to the prosecution of more than sixteen of the corporation’s top executives, and several liability claims

ENRON CORPORATION (FORMER NYSE TICKER SYMBOL ENE)

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continue to this day. However, Kenneth Lay suffered a fatal heart attack during the course of his trial, so sentencing was never completed. On the other hand, Jeffrey Skilling remains imprisoned, although a recent Supreme Court decision in June threatens to overturn his multiple convictions of conspiracy to commit honest services wire fraud, securities fraud, and money or property wire fraud. In a unanimous decision, the Court restricted prosecutors’ interpretation of the honest services statute to cases involving bribery and kickbacks, neither of which Skilling was accused of committing. In her written opinion for the Court, Justice Ruth Bader Ginsburg outlined which aspect of the Constitution could be threatened by a broad interpretation. In view of this history, there is no doubt that Congress intended (this statute) to reach at least bribes and kickbacks. Reading the statute to proscribe a wider range of offensive conduct, we acknowledge, would raise the due process concerns underlying the vagueness doctrine. To preserve the statute without transgressing constitutional limitations, we now hold that (this statute) criminalizes only the bribe-and-kickback core of (earlier) case law. "As to arbitrary prosecutions, we perceive no significant risk that the honest services statute, as we interpret it today, will be stretched out of shape (Flood, 2010). Because of this ruling, the Supreme Court remanded Skilling’s case back to the Fifth Circuit Court of Appeals, to decide whether the honest services inclusion entitles him to a new trial. The hearing is scheduled for November 1st of this year. Prosecutors may argue that the inclusion of the honest services clause was a ‘harmless error’, as jurors most likely voted to convict based on the entirety of the multiple charges filed. However, what is not harmless was the excessive damage that the Enron scandal has inflicted on the public image of corporate

ENRON CORPORATION (FORMER NYSE TICKER SYMBOL ENE) ethics, particularly in the fields of energy, finance and governmental regulation. This extensive damage to the reputations of many will be nearly impossible to repair for many years to come. References

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Bagley, C. S. (2009). Managers and the Legal Environment (6 ed.). Mason, Ohio, United States: Cengage Learning. Caulkins, L. (2010, 9 23). Enron’s Skilling Gets Nov. 1 Hearing on Retrial Bid. Retrieved 10 14, 2010, from Bloomberg: http://www.bloomberg.com/news/2010-09-24/enron-s-skilling-gets-nov-1-hearing-on-retrial-bidupdate1-.html Colvin, G. (2002). Wonder Women of Whistleblowing. Fortune , 146 (3), p. 56. Retrieved 10 16 2010, from EBSCOhost database. Crawford, J. (2010, 6 24). Landmark Supreme Court Decision Could Free Jeffrey Skilling, Conrad Black and Others. Retrieved 10 14, 2010, from CBS News.com: http://www.cbsnews.com/8301-504564_162-20008770504564.html Dettmer, J. B. (2002). Requiem for Enron. Insight on the News , 18 (1), p. 12. Retrieved 10 16 2010, from EBSCOhost database. Elkind, P. G. (Writer), & Gibney, A. (Director). (2005). Enron: The Smartest Guys in the Room [Motion Picture]. Magnolia Pictures. Flood, M. (2010, 6 24). Skilling ruling leaves much undecided. Retrieved 10 24, 2010, from chron.com-Houston Chronicle: http://www.chron.com/disp/story.mpl/special/enron/skilling/7077853.html Free, C. M. (2007). MANAGEMENT CONTROLS: THE ORGANIZATIONAL FRAUD TRIANGLE OF LEADERSHIP, CULTURE AND CONTROL IN ENRON. Ivey Business Journal , 71 (6), p. 1. Retrieved 10 16 2010, from EBSCOhost database. Johnson, C. (2006, 7 6). Enron's Lay Dies Of Heart Attack. Retrieved 10 14, 2010, from The Washington Post: http://www.washingtonpost.com/wp-dyn/content/article/2006/07/05/AR2006070500523.html Johnson, C. (2005, 11 5). Prosecutors Link Enron Fall to 1987 Scandal. Retrieved 10 16, 2010, from The Washington Post: http://www.washingtonpost.com/wp-dyn/content/article/2005/11/04/AR2005110401710.html Petrick, J. &. (2003). The Enron Scandal and the Neglect of Management Integrity Capacity. Retrieved 10 23, 2010, from American Journal of Business: http://www.bsu.edu/mcobwin/majb/?p=126 Robbins Geller Rudman & Dowd LLP. (2010). The Enron Fraud. Retrieved 10 23, 2010, from The Enron Fraud: http://www.enronfraud.com

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