THE FALL OF ENRON (Case Analysis)

In 2001, Enron Corporation was a colossal energy company, with an annual revenue of
more than 100 million. At that time, it ranked 7th in terms of revenue. Enron was formed in 1985
through the merger of Houston Natural Gas and InterNorth of Nebraska. During its early years,
Enron had a simple business model, operating as a natural gas pipeline company centered on the
delivery of specific amounts of natural gas to utilities and other customers. However, after the
deregulation of the electricity market in the early 1990s, Enron's business evolved from hard
assets to more complex and speculative energy derivatives. It also began to trade natural gas
commodities. These, among others, increased the risk in Enron's operations.
Meanwhile, to finance projects and its ambitious aggressive business strategies, Enron's
debts and its debt ratio increased. These movements in Enron's financial leverage could affect the
company's stock price and, consequently, the stock options of corporate executives. Because of
these, corporate executives began to window dress Enron's accounting records to make it appear
that the company's financial condition is sound. Enron officials at that time were Chief Executive
Officer (CEO) Jeffrey Skilling, Chief Financial Officer (CFO) Andrew Fastow, and Board Chair
Kenneth Lay.
One of the questionable accounting practices applied to Enron's corporate financials was
perpetrated through the use of improper transactions involving "special-purpose entities" (SPES).
SPEs are legal entities set up to accomplish specific and very narrow corporate objectives.
However, in the case of Enron, many special purpose entities (SPEs) were simply created to
conduct improper off-balance sheet accounting intended to hide massive losses and debts from
the eyes of the investing public.
The audit committee members who were supposed to ensure proper accounting treatment
merely performed a cursory review of these SPE transactions. It was found out later that those
members of the audit committee such as John Mendelsohn and John Wakeham (Enron's
independent directors) were receiving sizable "perks" from Enron. Mendelsohn, for instance, was
the president of MD Andersen Cancer Center which receives cash donations from Enron.
On the accounting side, these SPE transactions involved Enron receiving borrowed funds
that were made to look like revenues, without recording the liabilities on the company's
statement of financial position. This effectively resulted to high revenues which bolstered the
company's profit ratio while, at the same time, showed a manageable leverage or debt level. As
such, investors and stock analysts were made to believe that Enron was doing well, at least
financially.
The SPE loans were guaranteed with Enron stock which, at that time, was trading at over
$100 per share in the New York Stock Exchange (NYSE). The start of the collapse was when
Enron's stock price declined. Creditors of Enron started to recall the loans due to the decline in
the company's valuation. The company found it too difficult to maintain its financial position.
 In August 2001, Jeffrey Skilling resigned as CEO. This created a firestorm of
controversies over the ability of the company to continue business operations and led to loss of
Enron's reputation. The day after Skilling resigned, Enron's Vice President for Corporate
Development, Sherron Watkins, sent an anonymous letter to Kenneth Lay. In her letter, Watkins
expressed her fears that Enron "might implode in a wave of accounting scandals."
Enron eventually reported a third quarter 2001 loss of $618 million and a one-time
adjustment decreasing shareholders' equity by a staggering $1.2 billion. The adjustment was
related to transactions with partnerships run by CFO Fastow. Fastow had created those off-
balance sheet partnerships for Enron and for himself. He personally earned $30 million dollars in
management fees from deals with those partnerships. Fastow's conflict of interest was allowed
because Enron's Code of Ethics was not strictly implemented.
Hopes of financial rescue from corporate "white knights," Dynergy and
ChevronTexacoCorp., almost bailed out Enron from bankruptcy when they announced a
tentative agreement to buy the company for $8 billion. However, Enron's credit rating was
downgraded to "junk" status in November. Eventually, Dynergy and ChevronTexaco Corp.
withdrew their purchase agreement. After the purchase withdrawal, any hope of financially
resuscitating of Enron collapsed. Enron's stock price plummet to only $0.40 per share and the
company for bankruptcy.
After the Enron bankruptcy, the Sarbanes-Oxley Act was passed with the objective of
protecting corporate investors through strengthening of corporate governance, strict regulation of
the audit profession and internal controls over financial reporting.

Source:
Book – Governance, Business Ethics, Risk Management, and Internal Control
Authors – Jesse Rey L. Meneses, CPA, CrFA, MBA and Eugenio V. Villaceran, CPA, MBA,
CTT
Rex Education (First Edition – 2022)