Assignment: Business ethics

Enron Scandal

What is the Enron Scandal?

The Enron Scandal involves Enron duping the regulators by resorting to

off-the-books accounting practices and incorporating fake holding. The
company utilized special purpose vehicles to hide its toxic assets and big
amounts of debts from the investors and creditors.

Explanation
The Enron corporation was regarded as a corporate giant. But after a good
run, it failed miserably and ended up as a bankrupt business. The failure
and bankruptcy of the Enron Corporation jolted Wall Street as well as it
put several employees on the verge of the financial crisis. The
corporation had massive debts in its name. It tried to conceal these with
the help of special economic entities as well as special purpose vehicles.
Enron traded at the highest market price of $90.75 at the period of
December 2, 2001. And when the accounting scandal emerged, stock
prices went down to a record low of $0.26 per share.

Rise of Enron Scandal

The scandal began with the Enron misdeeds in the video rental chains.
The business collaborated with a blockbuster to penetrate the VOD
market. After entering the market, the business overstated the earnings
basis for the growth of the VOD market.

The business executed $350 billion in trades, but it did not last long as the
dot com bubble came in. It spends a significant amount on broadband
projects, but the business was unable to recover costs from the spending
made. The company was exposed to massive exposures, and investors
lost money as market capitalization deteriorated.

In 2000, the business started to crumble. CEO Jeffrey Skilling concealed

all financial losses resulting from the trading business and broadband
projects by applying the accounting concept of mark-to-market
accounting. The company kept building assets. It reported profits that
were yet to be earned. If the actual profit earned were less than the
reported earnings, the loss was never reported. Additionally, the business
transferred the asset to the off-the-books corporation. Like this, the
corporation concealed their losses.
To add to the agony, the chief financial officer of the business Andrew
Fastow deliberately resorted to the plan that displayed that the business
is in good financial shape even though its subsidiaries lost a lot of
investor’s money.

Summary of Enron Scandal with Timeline of Downfall

#1 – Business Background

 The year was 1985, and Enron was incorporated as the merger of
Houston Natural Gas Company and Internorth Ince. In 1995, the
business was recognized as the most innovative business by the
Fortune, and it made it successful run for the next six years. In 1998,
Andrew Fastow became the CFO of the business, and the CFO
created SPVs (Special Purpose Vehicle Definition) to conceal the
financial losses of the Enron. During the period of 2000, the shares
of Enron traded at the price levels of $90.56.

#2 – Initial Ripples
 On February 12, 2001, Jeffrey Skilling came in place of Kenneth as
a chief executing officer. On August 14, 2001, Skilling abruptly
resigned, and Kenneth took over the role once again. Same period,
the broadband division of the business reported a massive loss of
$137 million, and the market prices of stock fell to $39.05 per share.
 In the period of October, the CFO‘s legal counsel instructed auditors
to destroy the files of the Enron and asked to maintain only the utility
or necessary information.
 The business reported a further loss of $618 million and a write off
of
 $1.2 billion. The price of the stock deteriorates to $33.84.

#3 – fall of Giant
 On October 22, the business got into a probe from securities and
exchange commission. With this news, the stock of Enron further
deteriorated and was reported at $20.75. In November 2001, the
business for the first time admitted and made the revelation that it
inflated its income levels by $586 million. In addition, that it has been
doing so since 1997. On 2nd December 2001, the business files for
bankruptcy and the stock prices end up flat at $0.26 per share

#4 – Criminal Probe

 On January 9, 2002, the justice department ordered a criminal

proceeding against the business. On January 15, 2002, the NYSE
suspended Enron, and the accounting firm, along with Arthur
Andersen was convicted on the grounds of obstruction of justice.

Enron Hiding their Debt

 The Enron corporation and its management resorted to an unethical

scheme and malpractice of off-balance-sheet mechanism. It
created a special economic vehicle to hide the massive debt from its
external stakeholders, namely creditors and investors. The special
purpose vehicle was utilized for concealing realities of accounting
rather than focusing on the operating results.
 The corporation transferred some portion of assets that had rising
marketable value to the special economic vehicle, and in return, it
took cash or note. The special purpose vehicle then utilized to such
stock to hedge an asset present on the balance sheet of Enron. It
 ensured that a special purpose vehicle reduced the counterparty
risk.
 The formation of the special purpose vehicles cannot be termed as
illegal, but in comparison with the securitization techniques relating
to debt, it could be termed as bad. Enron disclosed the existence of
special purpose vehicles to the investors and the public, but few
people understood the complexity of transactions done using the
special purpose vehicles.
 Enron assumed that the prices of the stock would continue to
appreciate and that it would not deteriorate or fail as hedge funds.
The primary threat was that the special economic entities were
capitalized with only the stock of the corporation. If the corporation
was compromised, then the special economic entities will not be able
to hedge the deteriorating market price of such stocks. Additionally,
the Enron Corporation had held significant conflicts of interest with
respect to the special purpose vehicles.

MTM in Enron Scandal

 The CEO of Enron Corporation Jeffrey Skilling transitioned the

accounting practice of the Enron Corporation from a historical cost
accounting method to mark to market accounting method. The
transition of the accounting practice received approval from the
securities and exchange commission during 1992. Mark to market
accounting is a practice that reports the fair market value of the
liabilities and assets for a given duration or financial period.
 The mark to market gives insights to an institution and is regarded
as the legitimate practice. The method, however, is also exposed to
some form of manipulation. The Mark to market is based on fair
value rather than taking up the actual value. It caused the business
to fail miserably as they were reported the expected profits as the
actual profits.
Why is the Enron Scandal Important?

 The Enron scandal is significant in terms of learning perspectives for

both new financial professionals and experienced professionals. The
scandal tells us why strong corporate governance is the key to
success for any business to sustain and drive profitable business.
Additionally, it draws insights as to how accounting policies should
not be used and applied. Any misuse can have drastic results or
impacts on the health of the business.
 Due to the bankruptcy of the business, employees lost several perks
and pension benefits. Many came on the verge of the financial crisis.
The crisis was so deep that the shareholders of the business lost an
estimated value of $74 billion. Such corporate fraud should be taken
as learning, and an understanding should be drawn as to why
regulations and compliance are necessary.

Conclusion

 The Enron Corporation was formed as the merger of Houston’s

natural gas company and inter-north incorporation. After the merger,
it grew rapidly and was regarded as the most innovative company.
However, it resorted to bad accounting practices. It was involved in
the creation of special purpose vehicles, utilized to hide the rising
debt of the Enron incorporation, and this led to the failure and
downfall of the business.

Answer the following questions:

1. Based on your understanding of the case identify the causes of

Enron Scandal?
2. Identify the types of unethical conducts and illegal behaviors that top
management committed in Enron and justify your answer?
3. If you are a top decision maker in Enron during the crisis, suggest at
least three solutions in order to avoid the collapse of the firm?
4. Enron reputation and image were damaged badly because of the
scandal, you were selected to be a member of committee that is
responsible to rebuild the company image and reputation suggest
five decisions needs to be taken urgently in order to achieve the task
and justify your answer?