Volume 12 Number 1 January 2003
The Enron story: you can fool
some of the people some of
the time . . .
Alyson Tonge, Lesley Greer and Alan Lawton
Introduction
While the investigators continue to pick over the
remains of the giant that once was Enron, the
story is still unfolding and parts of that story will
probably remain untold. However, it is possible to
piece together much of that story and to reflect
upon the issues that Enron raises for a business,
academic and general public audience. This article,
therefore, seeks to:
& unravel the complex financial dealings that
Enron used
& describe the roles played by key individuals
& identify the ethical issues that arise from the
case
& discuss the implications of Enron for corporate
governance, audit and the relationships be-
tween business and government.
We recognise that in an article of this length
we cannot do full justice to the Enron story. How-
ever, in seeking to understand the complex financial
dealings we hope to show how senior executives at
Enron managed to operate in the way that they
did even though the ‘emperor was proved to have
no clothes’. We dwell on the financial dealings at
length because they are the key to understanding
the story. At the same time, however, a whole host
of ethical issues are raised and the article identi-
fies, and discusses, the key ones.
4 UK and 350 Main St, Malden, MA 02148, USA.
The background
Enron was formed in 1986 from the merger of
natural gas pipeline companies Houston Natural
Gas and Internorth, and in the following 15 years
diversified to provide products and services related
to natural gas, electricity and communications. The
operations at the time of the 2 December 2001 filing
for Chapter 11 bankruptcy protection include the
transportation of natural gas through pipelines;
the generation, transmission and distribution of
electricity; marketing of natural gas, electricity
and other commodities and related risk manage-
ment and financial services; development and
operation of power plants and energy related
assets; the delivery and management of energy
commodities and capabilities to industrial and
commercial sectors and the development of a
network platform to provide bandwidth manage-
ment services and the delivery of high bandwidth
communication applications.
Enron failed when the market lost confidence in
it following major profit and asset write-downs in
the third quarter of 2001. This caused loans to
become due as stock market collateral collapsed
making new borrowings impossible. Enron suffered
the usual fate of a failed business; it simply ran out
of cash. However, the lost confidence was not the
cause of the collapse but merely its latest symptom.
Enron failed because in the words of one com-
mentator1 it was the proverbial ‘Emperor’s New
# Blackwell Publishing Ltd 2003, 9600 Garsington Road, Oxford OX4 2DQ,
 Business Ethics: A European Review
Clothes’. The assets and expected earnings which
underpinned its meteoric rise to residence in the
Fortune top ten were largely illusory, while the
tangled web of related companies and financial
deals hid a huge burden of debt. Its aggressive
accounting practice and market power ensured
that the secret was safe, at least in the short term.
In 1997 the company reported operating results
of $515m and profits of $105m as a result of non-
recurring charges of $410m that ‘allow us to clear
the decks for future growth’ [Enron press release
20 January 19982]. From this point to summer 2001
the published financial results were spectacular,
with the company meeting or exceeding rising
earnings targets in 20 successive quarters.3 Oper-
ating results were $698m in 1998, $957m in 1999
and $1.266bn in 2000, the last full year so far
reported. No 2001 report will be made following
the Chapter 11 filing. Stock rose to an all-time
high of $90.56 on 23 August 2000, a multiple of 70
on its earnings, compared with 20 for Goldman
Sachs (McLean 2001a). It fell back to around $70
in January 2001 before the announcement of final
quarter 2000 earnings took it back to $80 when the
company revealed it had ‘breakout performances
in all our operations’. The operating margin was
5% in early 2000 falling to 2% in early 2001, but
with return on capital invested staying at 7%.
Balance Sheet debt rose from $3.5bn in 1996 to
$13bn by the end of 2000. In 2001, fuelled by US
recessionary fears and the ending of the dotcom
boom, a continuing slide in the market resulted in
the share price falling below $40 by August. Follow-
ing the October disclosure of a third quarter loss
of $618m and the subsequent write down of share-
holders’ funds by $1.2bn relating to partnership
transactions disclosed in an 8 November 2001 press
release from the company, the share price fell to
just 70 cents and was downgraded to ‘junk’ status
on 28 November. A failed merger attempt with rival
Dynergy led to the Chapter 11 filing on 2 December
2001.4 The bankruptcy filing lists $31.2bn of debt.
This has more recently been revised to $40bn
(Murphy and Berger 2002). Asset values have
similarly been adjusted; estimated at $62bn in the
Chapter 11 filing, they were revised to $38bn in the
quarterly return to the Securities and Exchange
Commission (SEC) in April 2002.
# Blackwell Publishing Ltd. 2003
The fallout has been immense and it is likely to
be many years before the full cause and extent of
Enron’s demise is understood. The numerous inves-
tigations and hearings since the Chapter 11 filing
have revealed failures at the most significant level
in Enron itself, by the auditors, Andersen, the US
financial system and US Generally Accepted
Accounting Principles (US GAAP). This calls into
question the effectiveness of corporate govern-
ance, the value of financial market systems in
regulating corporate entities and the ability of a
rule based accounting and reporting regime to
provide safeguards for investors and employees.
Enron had been the darling of corporate
America: it was voted its most innovative com-
pany, adviser to US Government, a Fortune 500
top ten player, backed by the world’s biggest
banks and rated by the top market analysts. An
intricate corporate web of financial dealing was its
ultimate downfall.
The financial practices
(i) Managing earnings
Earnings have become the main determinant of
corporate value in the US. Earnings predicted on a
quarter-by-quarter basis as well as annually, and
the successful achievement of the earnings drives
the analysts’ grading (from Junk to Investment)
and thence the stock price. Quarterly submissions
of the 10Q5 to the SEC are preceded by unaudited
financial information by press release. The market
tends to react to the press release, and where the
statements are different to the subsequently filed
10Q it is rarely commented upon in the media.
Continuing improved performance is signalled by
growing earnings and this has become the market
measure of success. It matters in two ways:
& A company’s ability to borrow is determined by
the security it can offer – either backing loans
by stock or by ongoing strong performance.
Investment grade rating may be key to ongoing
liquidity.
& Executive compensation, often in the form of
stock may be determined by the achievement of
earnings. Taken to its final point the higher the
5
 Volume 12 Number 1 January 2003
earnings, the more stock is allocated which in
turn is more valuable when the stock price rises
on the back of met or exceeded earnings’
predictions.
Jeff Skilling, Enron’s Chief Executive Officer
from February 2001 until 14 August 2001 (when
he unexpectedly resigned ‘for personal reasons’)
is quoted as saying that his priority as Chief
Executive Officer (CEO) was ‘to keep the stock
price up’. When Ken Lay resumed as CEO he
repeatedly emphasised the need to reinforce the
message about the value of the company’s shares.
Earnings measured against an asset heavy
balance sheet are ineffective as the rate of return
is lower. Assets must therefore be removed from
the balance sheet to maximise earnings possi-
bilities and allow new borrowing. The device of
‘off balance sheet finance’ is legal, safeguarded by
accounting regulation and is an effective leverage
device. The Financial Accounting Standards Board
(FASB) has drawn up rules for its application, and
it is expected (in the US) that a company will
maximise its position in this way.
In the case of Enron earnings were managed
aggressively by:
& Financing and asset deals through Special
Purpose Entities (SPEs) keeping balance sheet
gearing within sector norms and analysts’
expectations.
& Mark to market accounting.
It has recently come to light that Enron not only
used these tactics but also marketed a service in
structured finance to other companies (Barboza
2002). ‘Enron was known for its financial engin-
eering’, said one Broadband executive, ‘We knew
how to accelerate earnings. But it’s a nasty little
treadmill. You can only run for so long’. Senator
Joe Lieberman (2002), in an address to students at
New York University’s Stern School of Business,6
said, ‘As we saw with Enron, the drive for earnings,
unchecked by other values, usually ends in disaster’.
(ii) Special Purpose Entities
The original use of SPEs by Enron dates back at
least to the early 1990s as vehicles to generate cash
6 # Blackwell Publishing Ltd. 2003
without publicly revealing the extent of borrow-
ing. Their use at that time was within prescribed
legal limits and constraints. Later it is alleged that
they were used for multiple transactions, often of a
circular nature which did not involve third parties,
and by June 1999, to move some $1.27bn of assets
off the Enron balance sheet, delay reporting losses,
hide debt, inflate profit and revenues and enrich
some of the executives who ran them. Four
examples of the complex SPE and financial
structure are given below. The accounting prac-
tices mask severe underlying financial problems,
and the combined effects of the ‘Byzantine’
structures ultimately brought the company down.
JEDI and Chewco
The original Joint Energy Development Investment
(JEDI) partnerships were formed to enable Enron
to work with the Californian Public Employees
Retirement System (Calpers) in 1993. The Calpers
stake was $383m which they wished to sell in 1997.
The sale was achieved by the creation of Chewco,
a seemingly independent investment partnership.
Chewco was managed by Andrew Fastow, Enron’s
Chief Financial Officer who passed on this re-
sponsibility to his subordinate, Michael Kopper,
who in turn invested $125,000. Michael Kopper’s
involvement was disguised through intermediate
and holding company devices, Little River Fund-
ing and Big River Funding. The reason for this is
not immediately apparent. Chewco’s purchase
from Calpers was financed by $132m from JEDI
(in whom it was buying a 50% share) and $240m
from Barclays. To achieve the 3% external invest-
ment7 required to keep Chewco off Enron’s Balance
Sheet, a further $11.4m was to be provided by
outside investors with Barclays backing the
purchase with a loan for which they required cash
collateral of $6.6m. JEDI provided this collateral
thus compromising the critical 3% rule. Andersen,
the auditors, alleges that this fact was kept from
them until 2001. The accounting adjustments then
required were an important link in the chain that
led to Enron’s downfall. The Chewco device
allowed $405m in profits to be claimed by Enron
from 1997 to 2000, simultaneously hiding $600m
in debt. Enron bought out Kopper and Dodson’s
stake in March 2001 for $10.5m, paying their tax
 Business Ethics: A European Review
(against General Counsel’s advice) of $2.6m. The
JEDI partnerships are included at fair value as
Unconsolidated Equity Affiliates in the financial
statements, but should have been consolidated
from 1997, according to Enron’s 8 November 2001
Press Release.
In January 2000 Enron were preparing to an-
nounce a deal with Sun Microsystems which was
expected to make the Enron stock price rise.
Enron executives wished to maximise the earnings
impact of this as JEDI owned 12 million shares in
Enron. As Enron shares rose, the value of JEDI
rose and, under the accounting treatment Enron
used, earnings could be taken. However, as hedges
were in place JEDI would not be able to pass on
this increase in value. The hedges were removed
allowing additional earnings of $126m in the first
quarter when the stock price rose from $53.50 to
$67.375 in a single day. This was reported in the
income statement as an increase in equity in earn-
ings of unconsolidated affiliate. The Sun deal did
not happen but little publicity was given to this
fact.
LJM and the Raptors
The LJM partnerships were set up by Andrew
Fastow. Despite his close relationship to Enron
and the latter’s Code of Ethics, the Board waived
that code in October 1999 allowing Fastow to
manage the partnerships. The Board asked
Causey, Buy and Skilling to oversee the relation-
ship. One of the companies, LJM2, set out to raise
$200m and eventually raised $349m; investors
(including Citicorp, the American Home Assurance
company and an investment partnership affiliated
with Morgan Stanley) were given more informa-
tion about Enron’s financial situation than the
company’s stockholders. The prospectus said that
investors would benefit from the expertise of
Enron insiders and the combination of financial
engineering – ‘innovative financial structures’ –
and rapid deal making. The investment banking
arm of Merrill Lynch underwrote the LJM2
offering. LJM set up a series of companies, the
Raptors. These were financed by Enron stock and
used as a vehicle to invest in publicly traded stock,
largely in the energy and technology markets. In
2000 the investments rose in value providing
# Blackwell Publishing Ltd. 2003
$500m in revenue. The Raptors could only stay
off the Enron books if they remained financially
healthy, if the structure failed more than $504m
would have to be written off. By early 2001 as the
market in technology stock fizzled out, the value
of the investments plummeted by $500m; at the
same time the value of the Enron stock backing
Raptor also fell. The triggers on Enron stock in
the Raptor financing deals (at $57.78, $47 and
$28) caused concern as the stock price fell to below
$60 by March 2001. A refinancing deal was put
together in Spring 2001 in time to avoid the write
off, but it simply bought time as the complex
transactions were still vulnerable to further falls in
the Enron share price. Despite the deal’s signifi-
cance it was not revealed to shareholders when
the first quarter profits of $425m were reported.
Andersen were aware of the deal but it was not
brought to the attention of the Audit Committee,
and the risk assessment report on Raptor by Mr
Buy’s department went to Fastow and Skilling
and not the Enron Board. Andersen admitted a
mistake in relation to this partnership which
should have been consolidated from 1999.
Whitewing
Whitewing was a subsidiary formed in 1997 which
went off Balance Sheet in 1999 when half the
control passed to an unnamed investor. As Enron
reprofiled its business away from operating energy
facilities towards becoming a global broker of
energy and a trader of financial contracts, White-
wing’s role was to purchase assets from Enron and
sell them off; ‘monetise’ became a key business
model. Writing in the Financial Times, Chaffin
and Fidler (2002a) said, ‘Enron did not want to
finance under-performing assets, including foreign
projects that had soured, by raising straight debt
in the bond market, because that would damage
its credit rating and thereby jeopardise the com-
pany’s key trading business’. Enron guaranteed
that if the assets were sold at a loss Enron would
make up the difference with shares in its common
stock or with cash, i.e. Enron backstopped the
deal. One such asset, Promigas was sold to White-
wing to generate cash flow for Enron in 1999. The
day-to-day management team of Promigas did not
change and the sell back clause meant the funds
7
 Volume 12 Number 1 January 2003
treatment was not allowable. The deal was done to
ensure a better match of earnings and cash flow
and allowed Enron to escape reporting losses on
assets that were no longer worth their original
purchase price. When the stock price fell a trigger
in the deal became operational and Enron had to
pay $690m to Whitewing. The Promigas and White-
wing deals were possibly amongst the ‘accounting
scandals’ that Sherron Watkins8 referred to as
‘valuation issues with our international assets’.
Whitewing’s initial capital was secured on notes
from another Enron linked company Osprey (which
was also invested in by LJM). In turn these were
backed by Enron shares if value was not main-
tained to 2003 or by cash if this became im-
possible. Another entity, Condor, held a special
Enron security that was convertible to Enron
stock should the need to repay Whitewing
investors emerge. The Whitewing connection is
disclosed in a footnote to the Annual Accounts in
1999 and 2000 as an Unconsolidated Equity
Affiliate. In 1999 Enron received revenue of
$192m from Whitewing and a further $632m in
2000.
Other mini-group structures were created to
raise cash. Using a template devised by Goldman
Sachs involving Monthly Income Preferred Stock
(MIPS) Enron created a company, Sequoia, with
related companies, Cherokee, Cheyenne, Choctaw
and Zephyrus, which bought Enron’s accounts
receivable using funds raised through JP Morgan
Chase. Reciprocal transactions exist across the
structure (Henriques 2002).
By July 2001 the entire partnership structure
was under intense scrutiny on Wall Street. On
August 14 Skilling left Enron for ‘personal
reasons’. In the previous year the stock price had
fallen by 50 per cent. At this point James Charnos,
president of Kynikos Associates, says ‘we started
to realise that there was this so called toxic cycle
that could start . . . the partnerships would be
technically insolvent, they would call upon Enron
to make good, the Street would get wind of that,
the stock would go down’ (Hill and Fidler 2002).
As the price fell Enron needed to raise cash in
order to stay afloat. In September to November
2001 there was a major ‘cash burn’. Cash came
from a number of sources, including an equity
8 # Blackwell Publishing Ltd. 2003
infusion, $1.9bn in short term loans, $1bn in post
deposits and a further $1bn in refinancing deals.
One such deal will be the subject of litigation in
Europe as insurers try to argue that it represented
a loan deal not a forward supply contract.
Mahonia
On 28 September 2001 a deal was struck with
Mahonia Ltd of Jersey which allegedly disguised
more than $350m in new bank loans. The trans-
action’s form was a trade to protect about the
future rises in the price of natural gas but its
substance was a short-term bank loan from JP
Morgan Chase to Enron using Mahonia as an
intermediary. Westdeutche Landesbank supported
the transaction through letters of credit but claims
now in relevant court documents that JPMC
‘deliberately camouflaged a loan to Enron as a
commodity transaction in order to perpetrate a
fraud’ (Atlas 2002).
(iii) Mark to market accounting
In a stable or growing company that regularly
produces solid earnings performance, tax should
be paid and cash flow generated. Enron paid only
$17m of taxation between 1996 and 2000 despite
posting pre-tax profits of $1.79bn. In addition
they received rebates totalling £381m (Hill et al.
2002). Enron’s cash flow from trading was poor
but was masked by the deals it made including the
continuous refinancing and swap deals it latterly
engaged in. Its earnings performance outstripped
the cash generated despite the cash objective of
many SPE deals. In the period from 1997 to 2000
the ratio of operating cash flow to income
declined. After an improvement due to accounts
payable in 2000 it worsened in the first two quarters
of 2001. In the first half of 2001 net income of
$810m resulted in a negative cash flow from
operations of $1.3bn (McLean 2001b). One reason
for this is the use of mark to market accounting,
described in the notes to the financial statements.
The use of fair value accounting for investments is
required by US GAAP, which assumes that fair
value (as determined by the market) can reason-
ably be determined and that assumptions made
can be audited. In the case of Enron many of the
 Business Ethics: A European Review
transactions underlying the fair value were some
distance away in time and estimates were made as
to fair value which could not always be indepen-
dently verified. From the start of deregulation of
the energy markets in 1997, Enron entered into
transactions with companies such as Owens-
Illinois and Eli Lilly which included Enron
advancing funds at the beginning of the deal,
treating this as a loan and booking the revenue
from the whole contract (Barboza 2002). When an
agreement was made to provide power at a fixed
price Enron made predictions that energy prices
would fall enough in the future to guarantee a
profit. The profit, suitably discounted for risk and
time, was reported when the contract was signed
although the payments would not occur for some
years (Goodley 2002). The Emerging Issues Task
Force agreed that this was appropriate treatment
following a meeting with Enron in 1999. Enron
had been using the accounting method prior to the
meeting. As Enron was contracting in as yet un-
deregulated markets its gamble on falling prices
was a fairly safe bet (Norris and Eichenwald
2002).
Another deal, in February 2001 with Quaker Oats
(Hill et al. 2002), involved Enron Energy Services
(EES) signing a contract to supply 15 Quaker Oats
plants with energy and staff to maintain boilers
and pipes and to secure spare parts. EES guaran-
teed a $4.4m saving on Quaker’s 1999 energy bill.
The deal was set to last 10 years and $23.4m profit
was booked before any trading began. Other recent
long-term energy management clients include JC
Penny, Saks Incorporated, IBM and Compaq.
These names are included in the quarterly press
releases which predict earnings growth.
Enron moved into Internet content and distribu-
tion and as recently as May 2001 executives were
briefing the Board that the division was expanding
rapidly and positioned for success, predicting that
Broadband activity would add $40 to the share
price. The most visible service in this area was the
planned 20 year deal with Blockbuster in which
the two companies set up a pilot project to stream
videos to a small number of apartment blocks in
Oregon from servers set up in the basement using
broadband technology. Enron opened up a partner-
ship called Braveheart, raising $115m in exchange
# Blackwell Publishing Ltd. 2003
for the promise of earnings as the project with
Blockbuster rolled out. Enron argued that this
was a transfer of financial assets and could be
reported on a mark to market basis resulting in
revenue of $110m being reported. Andersen
approved the accounting.
In 2001, Enron set up swap deals with com-
panies such as Qwest (Stern 2002, Lambeth 2002,
Barboza and Feder 2002) to establish market
prices for dark fiber.9 In the case of the Qwest deal
both companies bought something of little use to
them at inflated prices. The impact of this on
Enron is not determined as the deal occurred too
late to reach the financial reports. Current
examination of these deals by the SEC and others
suggests that they are flawed and other companies
are beginning write-downs. Enron Broadband
Services went on to lose $494m in the first three
quarters of 2001, including $102m on revenue of
$16m in the April to June quarter (Glater and
Brick 2002, Behr 2002).
Former Enron employees have suggested
(Goodley 2002) that the timing of deals at the
end of reporting periods to focus on generating
‘reportable net earnings’ (often with reverses
taking place early in the following quarter) and
the adjustment of underlying models to increase
reported earnings was commonplace.
The valuation bases used by Enron and the risk
exposure of the deals and their accounting treat-
ment is in the small print to the financial reports,
and some of the risks are described as dependent
on Enron stock prices which were not at the time
under any real pressure, other than the general
downward pressure of the market in a period of
recession and following the bursting of the dotcom
bubble.
It is not true to say that US GAAP is entirely to
blame in that the rule based system is the deter-
minant of form before substance – indeed an
earlier case, Continental Vending reaffirmed the
US equivalent of the UK’s ‘substance over form’
and ‘true and fair’ requiring financial reports to be
stated fairly (Wilson 2002). Exemption from rules
relating to commodity and derivative trading
assisted Enron in structuring its financial deals
and accounting and contributed to the opaqueness
of the financial statements.
9
 Volume 12 Number 1 January 2003
Roles and responsibilities
In terms of providing protection for all stake-
holders, including shareholders and employees a
company should be regulated and a series of
checks and balances be in place, from the internal
mechanisms of Boards of Directors, executives
acting within their authority and with integrity,
through to auditors and outside bodies such as the
SEC, FASB and government acting within their
respective codes. The following outlines some of
the key events in the recent history of Enron which
suggest that the checks and balances failed simul-
taneously.
(i) Board of Directors
The Board of Directors is responsible to the
shareholders for the company’s business. They
should be the guardians of the ethical code and
sufficiently in touch with the business to be effec-
tive. Enron’s board appear to have fallen short in
many respects. They were not fully briefed on the
extent of the partnerships, allegedly taking only
fifteen minutes to review some of the more dubious
transactions underlying the surge in earnings
(Cowan and Abelson 2002). In June 1999 at an
hour long meeting that also dealt with other
business, they allowed the Code of Ethics to be set
aside for Andrew Fastow to manage the partner-
ships; in October 1999 they waived the ethics code
again to allow a larger partnership to be set up;
the February 2000 Audit Committee review of the
partnerships consisted of receiving a report by
Fastow on their status and did not follow up that
the safeguards required had been put in place; an
agreement by the Finance Committee in October
2000 to monitor Fastow’s compensation had no
follow through (Abelson 2002). The Powers
Report harshly concluded that the board ‘failed
in its oversight duties’, whilst accepting that they
had been kept in the dark by many dealings that
had troubled employees and auditors (Cowan and
Abelson 2002).
The names and main employment details of
directors are shown in Table 1 together with
information about committee memberships and
executive compensation.
10
(ii) Audit committee
This committee has the power to ask the questions
that should have stopped Enron from setting up
the deals that led to its collapse. The committee
failed to ask the right questions despite having
an arguably strong constitution including retired
accounting professor Robert Jaedicke and John
Wakeham a Chartered Accountant and former
Leader of the House of Lords in the UK. The
committee did not apparently involve itself in any
activity connected to risk assessments, either by
Buy’s department or the auditors. Nor did it follow
up on the Board’s requirement for scrutiny having
waived the Code of Ethics for Fastow despite its
remit to review ‘compliance with Enron’s policies
regarding business conduct’ (Peel and Hill 2002).
There are questions about membership, tenure
and geographical diversity of the committee and the
independence of its members from the management
of Enron. All members were directors and one at
least, John Wakeham, acted as a paid consultant
for the company’s European operations.
(iii) Executives and senior management
It is generally considered that the key determinant
of the ethical culture of an organisation is the
example set by senior management. Enron is no
exception. In principle Enron claimed to subscribe
to a morally worthy set of values insofar as Respect,
Integrity, Communication and Excellence are at the
core of its Mission Statement. Respect is defined
as ‘We treat others as we would like to be treated
ourselves. We do not tolerate abusive or disrespect-
ful treatment. Ruthlessness, callousness and arro-
gance don’t belong here.’ As our account above
demonstrates these latter qualities belonged pre-
cisely there, along with bullying, manipulation
and lying!
We have already seen how the company’s code
of ethics was waived so that Fastow could run
partnerships, and how Lay lied to staff about the
state of the company. However, insider accounts
(Chaffin and Fidler 2002b) demonstrate the risk-
taking culture of Enron and how bonus incentives
encouraged staff to manipulate profits estimates.
Unethical practices were encouraged and were rife
# Blackwell Publishing Ltd. 2003
 Business Ethics: A European Review

...........................................................................................................................................................................................................
Table 1: Company Directors

Name Office held Enron Committees Information

Robert Belfer #. Chairman, Belco Oil and Gas Corporation, Executive Sold more than a million
New York Finance shares
Norman Blake # CEO US Olympic Committee Finance Sold $1.7m shares in
Compensation 2000
Ronnie Chan Chairman, Hang Lung Development Audit Resignation announced
Company, Hong Kong Finance 13 February 2002
John Duncan #. Former Chairman, Gulf and Western Executive* Sold $2m shares in May
Industries, Inc. Compensation 2001
Resignation announced
13 February 2002
Wendy Gramm # Director of the Regulatory Studies Program Audit
at George Mason University, Former Nominating
Chairman, US CFTC
Ken Harrison Former Chairman,Portland General Electric
Company, Oregon
Robert Jaedicke Professor Emeritus Graduate School of Audit* Sold $841k shares
Business, Stanford University Compensation Resignation announced
13 February 2002
Ken Lay # Chairman and CEO Executive Resigned 4 February
2002
Charles Lemaistre #. Former President of University of Texas Executive Resignation announced
Compensation* 13 February 2002
John Mendelsohn . President, University of Texas, M.D. Audit
Anderson Cancer Center Nominating
Jerome Meyer Chairman,Tektronix, Oregon Finance
Nominating
Paulo Ferraz Pereira Executive Vice President of Group Bozano, Audit Resignation announced
Rio de Janeiro, Brazil Finance 13 February 2002
Frank Savage . Chairman, Alliance Capital Management Finance
International, Connecticut Compensation
Jeffrey Skilling President and CEO Executive Resigned 14 August
2001 for personal
reasons
John Urquhart Senior advisor to Chairman, Enron and Finance
former Senior Vice President of Industrial
and Power Systems, General Electric
Company
John Wakeham Former UK Secretary of State for Energyand Audit Resignation announced
Leader of Houses of Lords and Commons Nominating* 13 February 2002
Herbert Winokur Jr. President,Winokur Holdings,Inc. and former Executive
#. Senior Executive Vice President, Penn Finance*
Central Corporation
# Being sued for insider trading
. Had trading or sponsorship relationship with Enron
* Chairman of committee
...........................................................................................................................................................................................................

# Blackwell Publishing Ltd. 2003 11

 Volume 12 Number 1 January 2003
throughout much of the organisation. An em-
ployee’s appraisal scheme, the Performance Review
Committee (know locally as ‘rank and yank’)
resulted in promotions and bonuses for the top
employees and dismissal for the bottom ones. One
commentator says, ‘the main factor that discour-
aged questioning of Enron’s business practices
was a ruthless and reckless culture that lavished
rewards on those who played the game, while
persecuting those who raised objections’ (Chaffin
and Fidler 2002b).
Executives benefited from compensation pack-
ages, share option schemes and in some cases
private investment in, and management fees from,
SPEs. Bonus payments and special cash distribu-
tions amounted to $320m in 2001. Much of this
related to the Performance Unit Plan which linked
compensation to earnings performance, based not
on published information but on internal estimates
derived from the company’s models. A vast number
of shares were sold by executives in the two years
prior to collapse, a time when they were talking the
shares up, including $116m in nine months to
August 2001. In January 2001, Jeff Skilling said that
Broadband would add $40 a share and the true
price was $126; after he resigned Lay emailed all
staff to reassure them that Enron was in good shape
and was explicit about Andersen’s approval of the
accounting; in September Ken Lay reassured
employees about their stock and said it was a
good investment and that they should talk up the
stock and talk positively about Enron – he had
already sold $16m dollars since the turn of the
year. From 29 October to 12 November Enron
employees could not access their 401(K) plan as
the administrators were being changed. Confusing
information may have been released by the
company on this with some employees allegedly
believing that the 401(K) could not be accessed
from about 22 October (Oppel 2002a). The share
price stood at $23.50 on the 22nd, $15.15 on the
29th and $9.24 by 11 November.
A number of executives and senior staff were
involved in a partnership called Southampton Place.
This was created in March 2000 with a group of
Enron employees investing small amounts of
capital in LJM1. Limited information is available
about the deals but Andrew Fastow’s family
12
invested $25,000 and received $4.5m back after
six weeks, Glisan and Mordaunt picked up about
$1m for small capital sums. The staff involved are
identified in the tables below. All were sacked by
the company when their involvement came to light
in October 2001.
Table 2 shows the Enron Corporate Policy
Committee as listed in the Annual Report 2000
together with relevant details of major compen-
sation and stock sales as reported by the press.
It also highlights key areas of involvement and
information.
Table 3 lists other senior members of staff who
played important roles in Enron’s downfall.
Executives are accused of manipulating prices in
many fields (Quaker Oats, Quest, Blockbuster) to
make and influence markets. There are also
suggestions of inappropriate manipulation of
prices and supplies of electricity in California
(Stevenson 2002, Hirch 2001).
In an interview on 28 March 2001 with FRONT-
LINE11 about the California power crisis Jeff
Skilling said, ‘We are the good guys. We are on
the side of the angels’. His interviewer asked him,
‘A general comment that I’ve heard about Enron,
and to a certain extent about you [is] that you’re
very, very smart, very, aggressive. You’ll lay out
your argument, ‘‘The rules in California are
terrible’’, but then once you see what the rules
are, you guys push those rules to the edge in an
effort to make a buck’. Skilling replied, ‘That’s
probably fair, yes. Once you set the rules to a
marketplace, we adhere to the rules. If that’s what
you’re saying, that’s what we do.’ Interviewer,
‘But you know what I mean – you play the game
hard. You take it right down to the . . .’. Skilling,
‘We adhere to the rules. If they set up the rules, we
adhere to them. It’s like the tax code. No one
expects you to pay more taxes than you owe. And
so you’re expected to interpret the rules and
conduct your business in that fashion . . .’.
(iv) Auditors
Andersen acted as auditors for Enron. They also
undertook the internal audit and consultancy
work, giving rise to the question of conflict of
interest and loss of independence. Since the Enron
# Blackwell Publishing Ltd. 2003
 Business Ethics: A European Review

...........................................................................................................................................................................................................
Table 2: Enron Corporate Policy Committee

Name Executive Compensation Share sales Information

Job title
Ken Lay Paid $12m in 2000 and Share sales $4m on1.2.01 Advised employees shares
Chairman exercised $123m stock of and further $45m as the were a safe investment but
options year progressed sold his own
Paid $3.6m on 11.1.01, Resigned 23 January 2002
$7m on 5.2.01

Jeff Skilling Paid $1.9m on11.1.01, Sold shares for $62m in Resigned 14 August 2001
President and Chief 4.6m on 5.2.01 2000 for personal reasons
Executive Officer forfeiting $20m in
severance pay and being
liable to repay a loan of $2m
Told the market the shares
were worth $126 but sold
his own!!

Cliff Baxter Resigned 2 May 2001

Vice Chairman and Chief
Strategic Officer

Richard Causey Paid $350k on11.1.01, $1.2m Role was to mediate

Executive Vice President on 5.2.01 conflict of interest issues
and Chief Accounting between Enron and
Officer partnerships

Andrew Fastow Had $3m in remuneration Southampton Place

Executive Vice president Jan and Feb 2001 investor
and Chief Financial Officer
Made $30m through the Sacked 24 October 2001
LJM partnerships

Mark Frevert Appointed Vice Chairman

Chairman and CEO, Enron 28 August 2001
Wholesale Services

Lou Pai Sold $268m of stock mostly

Chairman and CEO, Enron at more than $72 per share
Xcelerator
Greg Whalley Appointed President and
President and CEO, Enron Chief Operating Officer
Wholesale Services (COO) 28 August 2001

Kevin Hannon Stan Horton Steve Kean Ken Rice

Chief Operating Officer, Chairman and CEO, Enron Executive Vice President Chairman and CEO, Enron
Enron Broadband Services Transportation Services and Chief of Staff Broadband Services
John Sherriff Dave Delaney Jim Derrick
President and CEO, Enron Chairman and CEO, Enron Executive Vice President
Europe Energy Services and General Counsel
...........................................................................................................................................................................................................

# Blackwell Publishing Ltd. 2003 13

 Volume 12 Number 1 January 2003

...........................................................................................................................................................................................................
Table 3 Senior staff

Name Executive Compensation Share sales Information

Job title
Michael Kopper $2.3m in remuneration in Resigned July 2001
Managing Director, Global 2001
Equity Markets Group
$10m windfall from $115k Southampton Place investor
investment in Chewco
Paid $2m in management
fees for Chewco

Sherron Watkins ‘I feel we will implode on a wave of

Vice President accounting scandals’

Kristina Mordaunt Southampton Place investor

Lawyer Sacked November 2001

TomWhite Sold $12m stock Became Secretary of the US Army

Vice Chair, Enron Energy June ^ October 2001 in May 2001
Services

Jeff McMahon Paid $1.1m on 5.2.01 Became COO January 2002,

Chief Financial Officer resigned from June 2002

Richard Buy Paid $75k on 11.1.01, $900k

Chief Risk Officer on 5.2.01 and $1.4m on
7.2.01

Ben Glisan Paid $600k on 5.2.01 Southampton Place investor

Treasurer
Told Andersen that records relating
to Chewco could not be accessed
as it was a third party (relates to
1997 Accounts in early1998)
Fired November 2001 when it was
discovered that he made $1m from
$5,800 investment
...........................................................................................................................................................................................................

scandal broke all big five accounting firms have to bullying tactics from Enron when the former’s
ceased to act as both internal and external auditors employees raised concerns about the accounting
for a single client. (See Government agencies below.) methods used (Schmidt 2002). In December 1999
There has been criticism of the work done by Carl Bass was removed from Andersen’s Enron
Andersen, on both audits. Despite high ratings for team having suggested in relation to one deal that
risk in some divisions (notably Enron Online and it ‘looks like there is no substance’ (Goodley 2002).
Retail Energy Services) this was not followed Partners and senior managers have allowed them-
through in terms of additional testing by the selves to be persuaded on accounting issues that
external audit or flagging for the attention of the ‘pushed the envelope’ and represented Enron’s
audit committee. Andersen allegedly succumbed view to the SEC and FASB. Opportunities to raise

14 # Blackwell Publishing Ltd. 2003

 Business Ethics: A European Review
issues do not appear to have been followed
through. An example of this is at the February
2000 Audit Committee where Andersen said they
were signing off the financial statements without
qualification despite close judgement calls on how
to account for Enron’s transactions with related
parties like the LJM partnership. Board minutes
do not show Andersen suggesting any additional
level of scrutiny by the Committee even though
this had been discussed a week earlier in Andersen’s
Houston office (Eichenwald and Glater 2002).
Andersen had a policy of document shredding,
keeping only formal audit papers. This was
formulated following Andersen being found guilty
based on its own papers in a previous case, Waste
Management. Andersen staff were reminded about
the policy in October before the SEC inquiry be-
gan. The motive for this (i.e. was it obstruction of
justice?) is the subject of the Justice Department’s
case against Andersen. The destruction policy did
not bar shredding after the SEC investigation
started, but David Duncan’s admission of guilt,
that the shredding was not innocent, has under-
mined Andersen’s defence.
Andersen’s failure to act according to their own
professional ethics, to comply with the require-
ment of giving an opinion based on ‘fairly stated’
accounts and to follow the spirit of accounting
regulation has destroyed the firm.
(v) Analysts and banks
Analysts are the market makers in shares. Their
judgement and rating can make or break a
company. Almost without exception the analysts
backed Enron giving buy ratings even when the
stock had started to fall. Any analysts who failed
to back Enron were likely to run into difficulties
with their employer – particularly those linked
to the network of banks and investors who were
selling Enron stock and making huge commissions
or whose senior staff were benefiting personally
from investing in the many partnerships. Paine
Webber sacked Chung Wu from its Houston office
for violating company policy on direct email even
though he had used this method of communicat-
ing before. His email suggested on 21 August that
Enron investors should ‘take some money off the
# Blackwell Publishing Ltd. 2003
table’ as the financial situation was deteriorating
(Oppel 2002b). On the same day Ken Lay sent
employees (many of whom would be Paine
Webber clients) a message by email saying the
company was in good shape.
The New York District Attorney, Eliot Spitzer
has recently acted against Merrill Lynch forcing
better disclosure of fees received from client firms.
The independence of the Wall Street analysts has
been under scrutiny since the demise of dotcom
companies which were rated strong buys but failed
to deliver on earnings. Similar questions are being
asked on both sides of the Atlantic (Ringshaw 2002,
Cowie and Steed 2002, English 2002, O’Harrow
2002). There appears to be evidence that across
the market, analysts are overly bullish on stocks to
protect lucrative investment banking fees. Merrill
has now revised its disclosure policy.
When Bethany McLean of Fortune magazine
began asking how Enron made its money in
February 2001, Jeff Skilling called her unethical
for failing to do more research. Three Enron
executives flew to New York to see her and Ken
Lay called Fortune’s managing editor to complain,
but her work continued. The resulting story ‘Is
Enron Overpriced’ is described as ‘prescient but
it sank’. Ms McLean is one of only a handful of
analysts who cast doubt on Enron (Barringer 2002).
On 25 April 2002, the SEC announced an
investigation into the analysts and potential
conflicts of interest following Enron and other
high profile cases.
(vi) Government and its agencies
Enron was a major contributor to both political
parties (Drinkard and Farrell 2002). It was
influential in Texas and Washington, and Enron
executives were closely linked through all levels of
society and government. Enron’s principal business
of commodities trading was made possible follow-
ing deregulation in the market and exemption
from oversight by the Commodity Futures Trading
Commission (CFTC). The Commissioner at the
time, Wendy Gramm, became an Enron Director.
The SEC is responsible for regulating the com-
panies listed on the markets. It receives quarterly
and annual reports and oversees accounting. It
15
 Volume 12 Number 1 January 2003

can fine companies who breach rules and require US GAAP is tightly rule bound and it appears
restatements of the accounts. The SEC also makes almost fair game for accountants, advisers and
the rules (despite this constitutionally being the lawyers to find ways to avoid the letter of the rule.
role of government) and has in the past provided Enron has shown that compliance with GAAP
amendments to assist in some of the accounting does not necessarily present fairly the financial
Enron wanted. For example an order in March situation of a company. FASB’s Emerging Issues
1997 gave Enron’s foreign operations a broad Task Force (EITF) supported accounting treat-
exemption from the Investment Company Act ments proposed by Enron.
1940 after Congress had refused to make the
change (Labaton 2002a, Samples 2002). Congress
(viii) Corporate governance
did however roll back regulation of electronic
trading in futures in the Commodity Futures As we have seen above, Enron certainly had some
Modernization Act 2000. of the trappings of corporate governance in place
The SEC backed off imposing tough conflict of including a code of ethics and an audit committee,
interest rules on the accounting industry in 2000 neither of which worked in practice. How did
following lobbying calls from Senators (Labaton Enron match up against other key indicators of
2002b). If the rules had come into force Andersen corporate governance? Table 4 demonstrates this
would not have been able to both audit ($25m) and comparison.
consult ($27m) for Enron. Andersen had a lobbying
budget of $1.6m in 2000 and was the fifth largest
contributor to Mr Bush’s presidential campaign. Conclusions
There will be different views held on the import-
(vii) Financial Accounting Standards Board
ance and the implications of the Enron case. One
FASB is responsible for US GAAP, the rules that view may be that it is just another corporate
guide the construction of the Financial Reports. bankruptcy, albeit of the seventh largest company

...........................................................................................................................................................................................................
Table 4 Corporate Governance

Key indicators of corporate governance Characteristics of the Enron experience

Investor communication Lying
Relationship with regulatory authorities Manipulative
Number of independent non-execs Independence in question (seeTable 1)
Background of non-execs SeeTable 1
Code of conduct Waived
Audit committee Ineffective and possible conflicts of interest
Remunerations committee The Chair of the Compensation Committee is being sued
for insider trading
Stakeholder remuneration in directors remuneration SeeTable 1 for the number of shares sold by directors
Clear distinction between internal and external auditors No. Possible conflicts of interest involving Andersen

Conflicts of interest regulation Presumably ignored

Definitions of roles and responsibilities of directors Kept in the dark and failed in oversight responsibilities

Enforcement of rules No
Non-executive involvement in company affairs Minimal
...........................................................................................................................................................................................................

16 # Blackwell Publishing Ltd. 2003

 Business Ethics: A European Review
in America, and, while we might feel sorry for
them, the unlucky shareholders invested on the
understanding that share prices can go up as well
as down. Another view might be that the collapse
of Enron raises much more profound issues that
have threatened to undermine our basic trust in
an economic system and must lead to a reappraisal
of how parts of that system work. This latter view
was expressed by Senator Olympia J. Snow
(Republican, Maine) at the hearing of the Senate
Commerce Science and Transportation Com-
mittee into the collapse of Enron (12th February
2002):
‘It certainly shows that corporate corruption can
have a profound influence in undermining the
public’s confidence in the underpinnings of our
economic institutions.’ (quoted in the New York
Times, 13th February 2002)
It is interesting to note in Table 1 that, of the
seventeen Directors, seven are being sued for
insider trading and six had a trading or sponsor-
ship relationship with Enron. The implications
are that the stewardship of major public corpor-
ations is a public trust. We share that view.
Enron’s business was built on market trust and the
extent to which market analysts are culpable is
an interesting point. Enron employees who knew
that something was wrong may have trusted the
analysts to get it right, believing that ‘they
must know something that we don’t’. It is always
possible of course that the investors and analysts
may have promoted a business that they did not
really understand, any caution submerged under
aggressive accounting and financial manipula-
tion.
At the same time, inside Enron, rewards were
lavished on those who ‘played the game’, while
those who raised objections were persecuted. The
Performance Review Committee controlled em-
ployees and forced them into line. Appraisal was
supposed to be based upon how well employees had
delivered the core values; in reality appraisal was
based upon how much paper profit the employee
had generated. By all accounts Enron was an
exciting place to work and it undermines those
who argue that the macho ‘greed is good’ culture
did not survive the late 1980s and early 1990s.
# Blackwell Publishing Ltd. 2003
Could it happen in Europe? The ‘revolving
doors’ between government and business is less
obvious in Europe but, as the present Labour
government in the UK will testify, fears are being
raised about the (too) close relationship between
government and business and the role of lobbyists.
Indeed Enron is known to have paid for dinner
tables at Labour Party Conferences in recent
years. Arguably, the relationship between large
corporations and their auditors is more of an arms
length relationship than existed between Enron
and Andersens. However, following the Enron
collapse the UK trade and industry secretary,
Patricia Hewitt, announced the creation of a high
profile body charged with reviewing the UK’s
financial reporting and auditing rules.
We have touched upon a range of issues
including:
& Finance and accounting
& The role of auditors and the audit committee
& The role of non-executive directors
& The links between government and business
& The role of investors and analysts
& Organisational culture
& Corporate governance.
All of these are worthy of an article in their own
right. This article has sought to highlight the key
issues, to make sense of the financial dealings and
to point to key failings in the controls, both
formal and informal, that underpin our economic
system.
Notes
1. Bethany McLean of Fortune Magazine suggested
in January 2001 that Enron might not be all it said
it was.
2. Enron press releases and financial reports were
found on www.enron.com
3. Each quarter companies issue financial results and
earnings expectations. This information is used by
stakeholders and analysts as a measure of a
company’s progress.
4. The share price movements and key events from
Jeff Skilling’s resignation to the Chapter 11 filing
are included in Appendix 1.
17
 Volume 12 Number 1 January 2003
5. The 10Q is the quarterly audited financial report to
the SEC.
6. www.bettermanagement.com
7. The 3% external funding rule evolved from an
agreement involving leasing in the early 1990s. The
authorities were persuaded to accept the account-
ing which began to be used for a range of trans-
actions. The authorities did not intervene.
8. Sherron Watkins is an Enron Vice President who
was examining Enron’s risk exposure in Summer
2001. Concerned at the SPE structure she wrote to
Ken Lay that she feared Enron would ‘implode on
a wave of accounting scandals’ and asked Lay as
CEO to engage external parties to investigate. The
ensuing investigation was undertaken by Vinson and
Elkins, Enron’s own lawyers who were instructed
not to try to second-guess accounting treatments.
9. Dark fiber is the term applied to broadband
capacity that is not being used. The failure of the
dot com industry to expand as predicted, and to
shrink in the medium term has resulted in an over
capacity in the network.
10. William Powers, Dean of Texas Law School, was
appointed a Director on 31 October 2001 to chair
a special committee into the transactions between
Enron and its partnerships. The report was
published on 2 February 2002 and he resigned on
14 February 2002. Raymond Troubh, a financial
consultant in New York who has served as a
director of more than 25 companies, was also
appointed to the Board to join the investigation
on 28 November 2001. The third member of the
special committee was Herbert Winokur, the
Chairman of the Finance Committee and a long-
standing director. The text of the Powers Report
can be found on the Houston Chronicle website at
http://www.chron.com
11. See www.pbs.org for the full text
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19
 Volume 12 Number 1 January 2003

Appendix 1
...........................................................................................................................................................................................................
Date Notable event Price ($) Analysts Exec Sales
14-Aug-01 Skilling resigns, Lay retakes 40.00
CEO job
15-Aug-01 One page letter to Lay from 40.25 Merrill Lynch downgrade to
Watkins LongTerm (LT) Neutral/Long
Term Accumulate
20-Aug-01 Watkins calls Andersen about 36.25
her concerns
21-Aug-01 Lay emails employees 36.88
assuring them that the
company is on a sure footing
23-Aug-01 36.96 Lay sells $4m stock, and
continues to sell during
the next three months
10-Sep-01 11/9 World Trade Centre 32.76 Bernstein upgrade from
disaster.Wall Street closed to Market Perform to Outperform
17 September
26-Sep-01 In an online chat, Lay tells 25.15 AG Edwards upgrade from
employees that shares are an Accumulate to Buy
incredible bargain
4-Oct-01 33.10 AG Edwards downgrade from
Strong Buy to Buy
9-Oct-01 33.39 Merrill Lynch upgrade from
NearTerm (NT) Neutral/LT
Accumulate to NT Neutral/LT
Buy
16-Oct-01 Third quarter loss of $618m 33.84 Merrill Lynch upgrade to NT
announced Accumulate
19-Oct-01 26.05 AG Edwards downgrade from
Buy to Hold
22-Oct-01 SEC begin enquiry, 20.65 Prudential downgrade from
employees believed 401(K) Buy to Hold
lockdown started
23-Oct-01 At a conference call Lay 19.79 Lay sold $1.5m shares
affirms faith in Fastow
24-Oct-01 Fastow is forced out 16.41 Prudential downgrade from White sold $1.96m shares
Hold to Sell, JPMC downgrade
Buy to LongTerm Buy
26-Oct-01 15.40 Banc of America downgrade
from Strong Buy to Market
Performer
29-Oct-01 Start of 401(K) lockdown 13.81 Lay sold 125k shares
30-Oct-01 11.16 White sold shares $1.1m
31-Oct-01 SEC enquiry becomes formal 13.90 Lay sold 10,000 shares
investigation

20 # Blackwell Publishing Ltd. 2003

 Business Ethics: A European Review

1-Nov-01 11.99 Merrill Lynch downgrade from

NTAccum/LT Buy to NT
Neutral/LT Neutral
7-Nov-01 9.05 AG Edwards downgrade from
Hold to Sell
8-Nov-01 Dynergy talks start, restated 8.41
earnings going back 4 years
filed at SEC. Shareholders
funds written down
9-Nov-01 Dynergy talks reported at $10 8.63
per share
12-Nov-01 End of 401(K) lockdown 9.24 Prudential Upgrade from Sell
to Hold
19-Nov-01 Restatement of third quarter 9.06
earnings, Enron tries to
restructure $690m obligation
21-Nov-01 Enron reaches deal on 4.11 Goldman Sachs downgrade
refinancing $690bn from Recommended List to
Market Perform; CIBC
Downgrade from Buy to Hold
26-Nov-01 4.01 UBS Warburg downgrade
Strong Buy to Hold
28-Nov-01 Opened at $3.70; 345,367,800 0.61 UBS Warburg downgrade from
shares traded. Dynergy seeks Strong Buy to Hold
to cut amount of buyout
29-Nov-01 Dynergy deal collapses 0.36 RBC Capital Markets
downgrade from Buy to
Market Underperform
2-Dec-01 Chapter 11 filing 0.29
...........................................................................................................................................................................................................

# Blackwell Publishing Ltd. 2003 21

 Volume 12 Number 1 January 2003

22 # Blackwell Publishing Ltd. 2003