Enron

Background
History
 -American Energy Company that was formed through merger of Houston Natural Gas and Internorth, traded natural
gas commodities

Who committed the fraud?

Kenneth Lay – Former CEO and Chairman
 Charged with 11 counts of securities fraud, wire fraud, and making misleading statements
 Told employees to buy more stock while the stock price was falling and personally dumped large portions of stock
Jeffrey Skilling – Former president
 Pushed Enron to use mark to marketing accounting which led to inflated asset valuation
 August 14th: left and sold 60 million of his stake in the company and claimed it was for personal reasons
 Charged with 35 counts of fraud, insider trading, and other crimes relating to the collapse of Enron, but was found
guilty of 1 count of conspiracy, 1 count of insider trading, 5 counts of making flase statements, twelve counts of
securities fraud. Sentenced for 24 years and 4 months in prison and fined 45 million
Andrew Fastow – Former CFO
 Made Enron appear debt free by designing and running the “independent companies”; Enron shifted their liabilities
onto these SPEs
 Pressured analysts to give good ratings because of Enron’s position and power
 Indicted with 78 counts of fraud, money laundering, and conspiracy but was found guilty to two counts of wire and
securities fraud. Sentenced for 6 years

Types of Fraud
Accounting Fraud
 Created Special Purpose Entities (SPEs) to hide debt and create fake revenue for Enron
 Recognized revenue using merchant model to inflate trade revenue of consultants
 Arthur Anderson failed to expose fraud due to conflicts of interest
Management Fraud
 Manipulation of financial statements in Enron’s favor by top management; Jeff Skilling and Andrew Fastow “cooked
the books”

How it was detected

 Bethany Mclean published an article questioning why Enron was trading at 55 times its earnings
 Richard Grubman complained that Enron was the only company that didn’t release a balance sheet along with its
earning statements. Skilling replied “well, thank you very much, we appreciate that… asshole.”
 Jeff Skilling and Kenneth Lay leaving their positions and selling company stock
 Sherron Watkins submitted an anonymous letter (Attempt to whistle blow) questioning the company’s accounting
practices
 Vinson and Elkins, Enron’s law firm with conflicting interests, contended that there was nothing wrong with the
company’s accounting practices

Fraud Triangle
Opportunity
 Board of Directors with conflicting interests that approved several unethical practices
 Enron had leverage over their auditor, Arthur Andersen, because they were such a big client
 Lack of government oversight
Rationalization
 Never caught throughout 1999-2001
 Enron
 Management greed and hubris

Pressure
 Investors expectations, Wall street pressures, and personal well being

Red Flags
1. Fiduciary Failure
Enron Board of Directors failed to safeguard shareholders by allowing Enron to engage in:
 High risk accounting
 Inappropriate conflict of interest transactions
 Extensive undisclosed off-the-books activities
 Excessive executive compensation
2. High Risk Accounting
 By the end of 1999, Enron had moved $27bn of its total $60bn in assets off balance sheet
3. Board of Directors approved excessive compensation for company executives
4. Independence compromised by financial ties between the company and certain Board members and Arthur Andersen
was allowed to provide internal audit and consulting services while serving as Enron’s outside auditor
5. Conflicts of Interest
 Board of Directors approved an unprecedented arrangement allowing Enron’s Chief Financial Officer to establish and
operate the LJM private equity funds which transacted business with Enron and profited at Enron’s expense
 The Board exercised inadequate oversight of LJM transaction and compensation controls and failed to protect Enron
shareholders from unfair dealing
6. Off Balance Sheet Financing
 Board of Directors knowingly allowed Enron to conduct billions of dollars in off-the-books activity to make its
financial condition appear better than reality
 Failed to ensure adequate public disclosure of material off-the-books liabilities that contributed to Enron’s collapse
 Special Purpose Entities
o Used to acquire capital directly from outside lenders
o Relied on management personnel instead of independent investors
o SPEs recorded gains in Enron stock as income
o Tried to manufacture earnings by manipulating the capital structure of SPEs
o Overstated net income by $569 million and overstated shareholders’ equity by $1.2 billion
Prosecution and Aftermath
Prosecution
 U.S. Justice department launches criminal investigation on January 9 th, 2002 and Arthur Andersen surrenders
accounting license on Aug. 31, 2002
Stakeholder Losses
 Thousands of jobs wiped out
 Disappearance of more $60 billion in market value and more than $2 billion in pension plans
 As the lead plaintiff in the class action lawsuit against Enron executives, the University of California obtained more
than $7.2 billion from the executives, accountants, attorneys and financial institutions that organized the fraud
 Enron shareholders and investors split about $7 billion