RUAECO501 ASSIGNMENT

Academic Year for Assignment 2021-22

Semester V

Subject Title Microeconomics III

Subject code RUAECO501

Topic Study of Information Asymmetry on

The Enron Scandal
Name and Roll no. Vihaan Vadnere (3625-C)
Raj Jadhav (3306-B)

Class TYBA

Email vihaanvadnere1@gmail.com
rajj45211@gmail.com
Phone no. 9082181539
9082971996

Date of Submission: 18th August 2021

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CERTIFICATE

This is to Certify that Mr. Vihaan Vadnere and Mr. Raj

Jadhav students of TYBA Economics of Ramnarian Ruia
Autonomous College have successfully completed the topic
Study of Information Asymmetry on The Enron Scandal
the Microeconomics Assignment for Academic Year 2021-
22 under the guidance and permission of Miss Varsha
Malwade of Department of Economics.

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Acknowledgement

We wish to express our sincere gratitude

towards Jeffrey Keith Skilling the Convicted CEO of Enron Corporation during the Enron scandal
for providing
us an opportunity to conduct our project
research at their respective firms. We sincerely thank various books in
libraries which helped us collect
information for the project.
We also thank various internet sources
which helped us understand the concepts
mentioned in the project.

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Sr INDEX Page
no. No.
1 Introduction 5

2 Review of Literature 6

3 Methodology 7-12

4 Observation 13-16

5 Conclusion and Suggestion 17

6 Bibliography 18

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Introduction and Beginning of the Enron Scandal

Enron corporation was referred to as a corporate giant. But after some successful years of working, it
failed miserably and ended up as a Bankrupt Business. After the failure and bankruptcy, Enron
Corporation startle also as put tons of employees on the verge of monetary crises. The corporation
had its massive debt alongside their names. They attempt to hide this with the assistance of some
special economic entities also like special purpose vehicles. The corporation traded the very best
market value of 90.75$ in the amount of December 2, 2001. And when this scandal emerged stock
price went right down to a record low of 0.29$ per share. The scandal started with the Enron
misdeeds within the video rental chains. The business engaged with a blockbuster to penetrate the
VOD market; the business overstated the earnings basis for the expansion of the VOD market. The
business executed 350$ in trades, but it didn't last long because the dot com bubble came in. it
spends an enormous amount on broadband products, but the business was unable to recover the
worth which spending made. the corporate was expose to massive exposure, and investors lost
money as market capitalization deteriorated. In 2000, the business began to crumble. CEO Jeffery
skilling concealed all the financial losses resulting from the trading business and broadband projects
by applying the accounting concept of market-to-market accounting. The corporate kept building
assets it reported profits that were yet to be earned. If the particular price earned were but the
reported earnings, the loss was never reported. Additionally, the business transferred the assets to the
off-book corporation. Like this, the corporation kept secret their losses. To add to the suffering, the
chief treasurer of the business Andrew Fastow deliberately resorted to the plan that displayed that the
business is in good financial shape albeit its subsidiaries lost plenty of investor’s money. In 1985,
Enron was incorporated because of the merger of the Huston gas company and Inter-north Ince. In
1995, the business was recognized because the foremost innovative business by the fortune and it
made it successful run subsequent six years. In 1998, Andrew Fastow became the CFO of this
business and therefore the CFO created SPVs to cover the financial losses of Enron. During the first
days of 2000, the shares of Enron traded at the worth levels of 90.56$. In February 2001, Jeffery
Skilling was available to take the place of Kenneth and took over the role once more. After a while,
the broadband division of business reported a huge loss of 137$ million, and therefore the market
prices of stock fell to 39.09$ per share. within the period of mid-October, the CFO’s legal counsel
instructed auditors to destroys the files of Enron and asked to take care of only the utility or
necessary information. The business reported an extra loss of 618$ million and a write-off of 1.25$
billion. The worth of the stock deteriorated to 33.54$. The business came to a search from the
securities and exchange commission on October 22. The impact of this might seem on the stock price
of Enron which was 20.75$. For the primary time in November 2001, the business admitted and
made the revelation that it decreases the income levels by 586 million dollars. Also, that it's been
doing since 1997. On 2nd December 2001, the business files for bankruptcy, and therefore the share
prices find themselves falling at 0.26$ per share.

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Review of Literature
This paper investigates and evaluates the asymmetry of information in Enron’s corporate governance
structures, weaknesses that lead to the collapse of the company. Overall, poor corporate governance
and a dishonest culture that nurtured serious conflicts of interests and unethical behaviour in Enron
are identified as significant findings in this paper. Employing the case study method, the paper
synthesises, analyses, and interprets all aspects of corporate governance that lead to Enron's collapse
based on three main reports: The Powers Report of 2002, the Testimony of Chief Investigation, and
The Subcommittee’s Report (United States Senate’s Permanent Subcommittee on Investigations
2002). Firstly, Enron’s Board of Directors failed to fulfil its fiduciary duties towards the
corporation’s shareholders. Secondly, the top executives of Enron were greedy and acted in their
own self-interest. Thirdly, many of Enron’s employees witnessed the wrongdoings of Enron’s top
executives, and quite a few whistle-blowers came forward. Lastly, Enron outsourced external
auditing for its internal audit function instead of establishing a functionally internal audit mechanism
and its external auditor acquiesced in the application of questionable accounting and fraudulent
financial reporting. This paper contributes to the literature on the numerous weaknesses of Enron's
corporate governance structures, including the following: the role of the Corporation’s board,
especially its top executives; the Corporation's corporate culture and whistle-blowing system; and the
Corporation's internal auditor and external auditors in spreading asymmetric information to carryout
unethical business practices.

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Methodology
What essentially occurred with the Enron scandal was that there was a high degree of information
asymmetry between the management team and investors in the company. It likely occurred due to the
personal incentives that the management team received. For example, many C-suite executives are
compensated in company stock, as well as collect bonuses when the shares hit certain predetermined
price levels. At Enron’s peak in mid-2001, the company’s shares were trading at an all-time high of
$90.75. Then, as the scandal was uncovered, the shares plummeted over several months to an all-
time low of $0.26 in November 2001. What was particularly worrying about the scandal was how
such a large-scale deception scheme was successfully pulled off for so long, and how regulatory
authorities failed to take action in order to stop it. The Enron scandal, in conjunction with the
WorldCom (MCI) fiasco, shed light upon the extent to which companies were exploiting loopholes
in legislation. The newfound scrutiny led to the enactment of the Sarbanes-Oxley Act, which aimed
to protect shareholders by making corporate disclosures more accurate and more transparent. Thus,
Skilling and his team became determined to boost the stock price of Enron in hopes that their
management incentives would translate in bigger compensation for them. Following the Enron
scandal, companies are now much warier of agency issues and the misalignment of corporate
objectives versus management incentives.
Timeline of Events
 1985- Houston Natural Gas merges with Inter North to form Enron.
 1989- Enron enters the natural gas commodities trading market.
 1990- An energy consultant was hired to run a new subsidiary called Enron Finance
Corporation.
 October 16, 2001– Enron announced a third quarter loss of $168 million. The company later
confessed that it overstated its earnings since 1997.
 October 31, 2001- SEC initiates a formal investigation against the company.
 November 2001- There were headlines regarding the merger of Enron with rival company
Dynergy, which was denied by Dynergy.
 January 2002- The US Department of Justice started a criminal proceeding against Enron’s
collapse.
 January 10, 2002- Arthur Anderson LLP, the accounting firm that handled Enron’s audits,
disclosed that the company has destroyed all the relevant documents.
 January 15, 2002- The New York Stock Exchange suspends trading of Enron shares on its
stock exchange.
 January 17, 2002- Enron- Arthur partnership ended.
 March 2002- Arthur declared guilty of obstruction of justice and its licence to audit pubic
companies was revoked.
 2006- The company officials Skilling and Lay were convicted of fraud and conspiracy.
Additional charges of insider trading and making false statement were proved. Lay died of
heart attack while awaiting sentence.
 2008- A class action lawsuit was filed by shareholders and investors of Enron and the
settlement was arrived at in the federal court. An amount of $7.2 billion was paid out by a
group of banks accused of participating in the fraud.
 2013- Skilling’s sentence was reduced as he forfeited $42 million to be distributed among the
victims of Enron fraud.

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Mark to Market Accounting (MTM):-

The principal method that was employed by Enron to “cook its books” was an accounting method
known as mark-to-market (MTM) accounting. Under MTM accounting, assets can be recorded on
the company's balance sheet at their fair market value (as opposed to their book value). Using MTM,
companies can also list their earnings as forecasts instead of actual numbers. An example of a
business that uses MTM accounting is to report projected cash flows generated by new property,
plant and equipment (PP&E) (such as factories). Naturally, the company will be motivated to be as
optimistic as possible about its prospects, as this will help boost the stock price and encourage more
investors to invest in the company. Fair value is difficult to determine, and even Enron CEO Jeff
Skilling has difficulty explaining to financial reporters where all the numbers in the company’s
financial statements come from. Skilling said in an interview that the numbers provided to analysts
are "black box" numbers, which are difficult to determine due to Enron's wholesale nature, but assure
the media that they can be trusted. In Enron's case, the actual cash flow generated by its assets was
much lower than the cash flow originally reported to the U.S. Securities and Exchange Commission
(SEC) under the MTM method. In order to cover up the loss, Enron established a series of special
shell companies, called special purpose entities (SPEs). SPE reports losses based on more traditional
cost accounting methods, but it is almost impossible to connect with Enron. Most SPEs are private
companies that only exist on paper. Therefore, financial analysts and reporters have no idea of its
existence.
Enron’s governance system and culture:-
All players in the Enron case, including the Board of Directors, top executive officers, internal and
external auditors, and whistle-blowers, contributed to the company's demise due to a lack of
corporate governance. Enron's Board of Directors played a crucial role in the company's failures. The
board of directors improperly supervised the company's key businesses and transactions. In addition,
the board of directors failed to effectively control the implementation of the company's code of
conduct or policies, allowing selfish managers to profit at the cost of the company. In addition, the
board of directors has not created an environment in which external auditors, internal audit functions,
and whistle-blowers can operate effectively. Enron's management was greedy and acted in their best
interests, which seriously harmed the company. In the manager, you need to examine the roles of
Enron's chief executive officer (CEO) and chief financial officer (CFO). When the company was in
trouble and on the verge of bankruptcy, both of them raised a lot of money in the form of
compensation. In addition, the Enron whistle-blower is discouraged from coming forward. This is
easy to understand because the corporate culture lacks the integrity to an astonishing degree due to
the role of senior managers in supporting and encouraging misconduct. For example, it is
unbelievable that the top management did not know that a fake energy trading floor composed of
computers, tables, chairs, and traders was built. In such a culture, all attributes of internal corporate
governance will definitely weaken. In this case, the situation worsens because the external auditor is
also acting as the internal auditor and acquiesced in the misconduct of Enron's management.
Contribution by the Board of Directors towards the Scandal:-
The contribution of Enron’s directors to the Company’s demise can be briefly described as
unfulfilled fiduciary duties. Generally, directors are wholly responsible for governing and directing
the company’s affairs in the best interests of the company as a whole and its shareholders. Therefore,
they are required to act in honesty, reasonable care, and competence. As the highest level of the
hierarchical corporate governance structure, Enron’s Board of Directors not only must have known

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about but also supported the Company’s questionable strategies, criticised policies, and devious
transaction.
All Enron board members were aware of and support Enron’s strategies, which are designed to
maintain their investment credit ratings, increase cash flow and reduce the debt burden, even though
they claim to be victims of cruel deception, deceived and misled about the company’s key activities
and plans. The board was not only well-informed but also authorized many hedging transactions
handled by Enron's SPE. The board of directors, especially Kenneth Lay (Chairman and Chief
Executive Officer), was warned of the risks of accounting reviews when conducting these
transactions on the Finance Committee in May 2000, but the board completely ignored the red flags
and approved a series of SPE objectives that covered its SPE. In helping Enron avoid the loss caused
by the decline in its business investment reflected in the income statement. In addition, it was the
board of directors that allowed Chief Financial Officer Andrew Fastow to establish, and to make
matters worse, to become the sole manager of a private equity fund (called LJM Cayman LP, known
as LJM1) to conduct business with Enron it lacks economic substance. He was also approved to be
the general partner of some other companies that were deliberately established at the expense of
Enron. The major impact of these defaults on Enron’s financial situation is that debt is removed from
Enron’s balance sheet, and earnings and cash flows were inflated.
In addition, the Board also supported an asset light strategy, or syndicating the assets, which allowed
Enron to transfer several billion dollars’ worth of its asset with a slow generating cash flow to its
unconsolidated affiliates and record exorbitant earnings. However, such „unconsolidated affiliates
did not meet the requirements for being unconsolidated. Further, the Board was adequately informed
of the increases in making use of prepay transactions, of which prepayments were wrongly treated as
a trading liability and cash flow from operations, instead of debt and cash flow from financing. By
reviewing such facts, there is little doubt that Enron’s Board knew about, and officially approved of,
the application of high-risk accounting practices, specifically billions of dollars in off-the-books
activity, which aimed at significantly improving its financial position as concluded by the Permanent
Subcommittee on Investigations. Enron's directors should have been responsible for allowing Enron's
CFO to establish and manage partnerships, which ultimately brought them millions of dollars
through their dealings with Enron. When the CFO was approved as the sole manager and general
partner of LMJ1, allowing him to earn millions of dollars by executing the Enron Swap sub-
transaction, the conflict of interest became apparent. Surprisingly, it is difficult to understand why
Enron's board believes that the CFO's statement that he, as the general partner of LJM1, owns part of
the Swap Sub, and when negotiating with Enron Swap Sub, the negotiation does not bring any profit.
Failure to avoid conflicts of interest can be understood by viewing company culture as a cruel culture
that makes one employee compete with another. In this sense, the Enron culture can be said to be an
adventure because people trust Andrew Fastow too much. Therefore, this is why he has benefited
from his plan. The failure may be because the board of directors has the same conflicts of interest, to
share the profits of these plans. After all, the auto-negotiated deal with Enron has brought in millions
of dollars for Fastow. However, when it came to the Chewco case, Enron’s directors chose
alternative monitoring measures for conflicts of interest related to Fastow’s proposed role in
Chewco, and conflicts of interest still exist. Appointing Kopper, who was an employee of Enron at
the time, as the manager of Chewco does not comply with Enron's code of business conduct, which
requires his role and participation in Chewco to be approved by the board of directors. In addition, as
a person working for the CFO in the financial field, his role at Chewco, as the only person dealing
with the partnership and fully authorized for the partnership transaction, prompted him to act in the

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best interest of the CFO. Briefly, the role and benefits of Fastow and Kopper in LJM partnerships
can be regarded as typical examples of unresolved conflicts of interests that had long existed in
Enron and enabled self-interested managers to make huge profits at their company’s expense.
In addition to the issue of inappropriate conflicts of interest, the board of directors has also failed to
fulfil its responsibility for adequate monitoring of remuneration. First, the remuneration of the
Association’s CFO was ordered to be reviewed by the Enron Remuneration Committee; even so, as
of the time the CFO’s position in LJM was made public, no review had been conducted. According
to an interview with Doctor LeMaistre, a member of Enron's Executive Committee, Fastow received
an astonishing $45 million in compensation from LJM. Although aware that Enron-LJM's ownership
and equity transactions with Fastow would pose dangers to Enron shareholders, the board of
directors failed to adequately supervise these transactions.
Therefore, if the board of directors properly reviewed and supervised Fastow’s compensation and
fully controlled the Enron-LJM partnership’s transactions, then hundreds of millions of dollars may
remain in the hands of Enron shareholders rather than flow to Fastow and its partners. In addition,
there is evidence that the board of directors mismanaged executive compensation. Enron executives
not only received generous remuneration packages but also received generous annual and special
bonus plans. It is also worth acknowledging that the granting of stock options to executives is one of
the economic incentives for management to implement earnings management, which has been
documented in the audit literature. Surprisingly, Enron’s board of directors did not take any action
when it witnessed the large number of stock options allocated to Enron’s executives and the huge
amount of funds, they obtained through the exercise of stock option grants. Although there is no
consensus on the relationship between executive stock option compensation and the company's
future performance and management income, the board of directors should have regarded the high
executive compensation inspired by stock options as a red flag for fraudulent financial reports. To
make matters worse, when the company's total net income in 2000 was the US $ 975 million, its
executives received an annual bonus of US $ 750 million. An important figure is that Kenneth Lay's
total compensation in 2002 exceeded $ 140 million, which is ten times the average compensation of
CEOs of publicly-traded companies in the US.
The frequency of meetings maintained by the Board of Directors is not necessarily reflected in its
effectiveness, and for incentives to protect the Board, it is stated that they have the possibility that
the company's external directors can increase their supervision. Increase. However, an enclosure that
occurred indicates the need to take these problems into account. As mentioned above, the fault of the
director of Enron is mainly derived from the stem because they did not exercise and exercised
adequate supervision. Therefore, even though Enron's director has no reference to this measure, we
spend more time on the important issue of the company. The efficiency of the Board of Directors can
be harmed by the external directors resulting from time limitations, even if they are not easy to
measure such factors. However, this remains an estimated excuse that has been given many warning
signs in this case.
Corporate governance literature emphasizes the role of external directors, and the Board of Directors
and the Audit Committee is increasing, and the Committee may increase the effectiveness of
corporate governance. Therefore, the presence of external directors of the Enron Board may be
beneficial for the company. Meanwhile, corporate governance literature also reports that an auditor's
objectivity can be harmed by the external auditor and its economic link between its audit clients.
This economic theory usually applies to external directors on the board. Evidence as Enron's

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economic link is that a specific member of the Sensory Board had a financial relationship with
Enron. Therefore, it is impossible to contribute to the invalid monitoring for the management
activities that result at the end of the independence of the Enron Board of Directors.
The Role of Executive Officers in the scandal:-
The role played by executive officials who contributed to Enron Fiasco is important and also
discussing the role of the contribution of CEO and Kenneth Ray. As described earlier, the
establishment and operation of SPE were interested in themselves and satisfied the CFO and some
other coiled employees, and eventually Enron slid into bankruptcy. However, if the CEO acted in the
interest of Enron's shareholders, he could affirm that the difficulties derived from SPE can be
avoided. Under the Enron Conduct Code, the CEO had to review, approve, and control Enron-LJM
association transactions, approve and control, and these transactions have been fair for Enron. In
addition to approving the business with Enron, it is not only to administer the trade between its
association and Enron, but to millions of dollars, it also became possible to convert a partner. In
addition, the CEO also uses the line of credit to highlight the total ($ 77 million) of the amount of
Enron money and pay it with Enron's shares. And the compensation reflects the high-level interest of
the Enron CEO. In this context, the double role of Ken may be persuasive that greatly contributes to
the lack of adequate governance taken bankruptcy to bankruptcy for a long time. This conclusion
recommends that the CEO and the isolation of the Role of the President will strengthen the corporate
governance if a manager is dominated by the administration of the company without compensation.
effect.
The Role played by whistle-blowers in the scandal:-
Enron's culture is dishonest and unethical. As a result, this culture discouraged Enron's accusers
from coming forward. Furthermore, in this context, it's not hard to see why some Enron employees
came forward; however, no action has been taken to ensure tracking. In addition to corporate culture,
it is also important to note that Enron employees reported to the wrong people, including the CEO
and CFO, who were directly involved in such misconduct and acted in the interests of the company.
surname. As a result, although Enron's CEO consulted with law firm Vinson & Elkins, no further
action was taken. Sherron Watkins, vice president of corporate development at Enron, blamed it by
writing an anonymous note to Ken Lay about an elaborate accounting hoax at the Company and
others sent to the public relations department. how the CEO should handle finances. disorder.
However, his letters of denunciation were not followed up. To improve the effectiveness of
whistleblowing as an internal control mechanism, it is essential to create an environment in which
individuals are free to provide upstream communications, not only within but also outside the
organization. Organization. U.S. regulators support this view by stating, in the Sarbanes-Oxley Act
of 2002, that audit committees must establish procedures, called whistle-blower systems, to deal with
employee complaints and concerns about internal accounting controls and accounting and auditing
issues, in particular accounting and auditing issues.

The Role played by Auditors of the company:-

One of the most important mechanisms of internal corporate governance is internal audit. Enron's
internal auditor has been outsourced by Arthur Andersen over the years. The lack of a strong and
competent internal audit department also contributed significantly to Enron's bankruptcy. The reason
is that transactions with undiscovered illegal activities, unobtrusive and suspicious transactions are

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likely to be profit management. External auditors are also grateful that the report was based on a
limited understanding of the business, affecting department efficiency. Therefore, Enron must
establish a self-auditing department so that internal audits can make a greater contribution to
improving the integrity of corporate governance. At that time, internal auditors should achieve the
objectives of monitoring the effectiveness of internal controls, risk assessment, and management
processes, ensuring compliance with procedures including the integrity of IT systems, drafting an
overview of audit committees, and engaging in other corporate governance issues. Enron knowingly
refused information about the company's difficulties because external auditors had consented to
Enron's financial reporting. First, this may have arisen from economic ties, as discussed above.
Arthur Anderson indeed paid Enron $27 million for non-audit services and $25 million for audit
work, and the company was trying to make money.

Thus, the quality of Arthur Anderson's auditing work for Enron is likely to have been compromised
by a conflict of interest between being willing to jeopardize that reputation as a means of retaining its
customers to the maximum by protecting its professional reputation by fulfilling its professional
responsibilities. In addition, it is argued that their acquiescence was due to Arthur Andersen's lack of
ability to detect highly complex financial instruments designed by client management. For whatever
reason, Arthur Andersen was producing a quality audit report and the action of crushing Enron's
document.

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Observation
The Enron Scandal and Moral Hazard:
 Enron, the 7th largest U.S. company in 2001, filed for bankruptcy in December 2001.
 Enron investors and retirees were left with worthless stock.
 Enron was charged with securities fraud (fraudulent manipulation of publicly reported
financial results, lying to SEC.
Brief Time-Line of the Enron Scandal:
 On October 16, 2001, in the first major public sign of trouble, Enron announces a huge third-
quarter loss of $618 million.
 On October 22, 2001, the Securities and Exchange Commission (SEC) begins an inquiry into
Enron’s accounting practices.
 On December 2, 2001, Enron filed for bankruptcy.

Investigative Findings: Enron used complex dubious energy trading schemes, some of the
investigate findings discovered in these schemes were:-
 Enron took advantage of a loophole in the market rules governing energy trading in
California.
 Enron would schedule electric power transmission on a congested line from bus A to bus B in
the opposite direction to demand, thus enabling them to collect a “congestion reduction” fee
for seemingly relieving congestion on this line.
 Enron would then schedule the routing of this energy all the way back so that no energy was
actually bought or sold by Enron in net terms. It was purely a routing scheme.

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 Their accounting schemes consisted methods to reduce Enron’s tax payments, to inflate
Enron’s income and profits, stock price and credit rating, to hide losses in off-balance-sheet
subsidiaries, to engineer off-balance-sheet schemes to funnel money to themselves, friends,
and family, to fraudulently misrepresent Enron’s financial condition in public reports.
 Enron’s rapid growth in late 1990s involved large capital investments not expected to
generate significant cash flow in short term.
 Maintaining Enron’s credit ratings at an investment grade (e.g., BBB- or higher by S&P) was
vital to Enron’s energy trading business.
They Created partnerships structured as special purpose entities (SPEs) that could borrow from
outside investors without having to be consolidated into Enron’s balance sheet. SPE 3% Rule was no
consolidation needed if at least 3% of SPE total capital was owned independently of Enron. Enron’s
creation of over 3000 partnerships started about 1993 when it teamed with Calpers (California Public
Retirement System) to create JEDI (Joint Energy Development Investments) fund. Enron initially
thought of these partnerships as temporary solutions for temporary cash flow problems. Enron later
used SPE partnerships under 3% rule to hide bad bets it had made on speculative assets by selling
these assets to the partnerships in return for IOUs backed by Enron stock as collateral.

In November 1997, Calpers wanted to cash out of JEDI so to keep JEDI afloat, Enron needed new
3% partner. It created another partnership Chewco (named for the Star Wars character Chewbacca)
to buy out Calper’s stake in JEDI for $383 million. Enron planned to back short-term loans to
Chewco to permit it to buy out Calper’s stake for $383 million.

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Chewco needed $383 million to give Calpers .It got $240 mil loan from Barclay’s bank guaranteed
by Enron and $132 mil credit from JEDI whose only asset is Enron stock. Chewco still got 3% of
$383 million (about $11.5 million) from some outside source that is $125,000 from William Dodson
& Michael Kopper (an aide to Enron CFO Fastow ) , $11.4 mil loans from Big River and Little River
(two new companies formed by Enron expressly for this purpose who get a loan from Barclay’s
Bank ) to avoid inclusion of JEDI’s debt on Enron’s books . Barclay’s Bank began to doubt the
strength of the new companies Big River and Little River. It required a cash reserve of $6.6 million
to be deposited (as security) for the $11.4 million dollar loans. This cash reserve was paid by JEDI,
whose net worth by this time consists solely of Enron stock, putting Enron in the at-risk position for
this amount.

Enron received $10 million in guarantee fee + fee based on loan balance to JEDI and received a total
of $25.7 million revenues from this source. In first quarter of 2000, the increase in price of Enron
stock held by JEDI resulted in $126 million in profits to Enron. But everything fell apart when
Enron’s share price started to drop in Fall of 2000. In November 2001, Enron admitted to the SEC
that Chewco was not truly independent of Enron. Chewco went bankrupt shortly after this admission
by Enron.

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People Responsible Downfall of Enron:

 Lax accounting by Arthur Anderson
 Auditor David Duncan , who then fired in January of 2002.
 Enron’s senior management for hiding losses in dubious off-balance-sheet partnerships;
 CFO Andrew Fastow for setting up these partnerships, who then was sentenced 6 years in
prison.
 Timothy Belden for trading schemes
 CEO Jeff Skilling
 CEO Kenneth Lay
 Media exaggeration and frenzy.
 Stock analysts who kept pushing Enron stock.
Bad Accounting Practices:
 Appointment of auditor company is in theory by shareholders but in practice by senior
management
 Audit Committee members often are not independent of senior management – insiders are the
ones with the most accurate understanding.
 Audit Committee members have typically been required to own company stock to align their
incentives with those of company.
 Board of Directors were paid largely in stock to align their interests with shareholders.
 Directors sold out early based on insider information, when senior executives are charged
withailure to abide by SEC rulings, the company typically pays the fine.
Lessons to be learned from the Enron Scandal:
 It demonstrated the importance of old economy questions that how does the company
actually make its money and is it sustainable over the long haul.
 It also demonstrated the need for significant reform in accounting and corporate governance
in the U.S.
Sarbanes-Oxley Act (SOX) of 2002:
 SOX Act Essentially a response to one cause of the financial irregularities: failure by
auditors, SEC, and other agencies to provide adequate oversight.
 Not clear how SOX Act will prevent misuse of “offbalance-sheet activities” that are difficult
to trace.

 SOX Act also does not address other key causes:

 misaligned incentives (e.g., shift from cash to stock option compensation)
 focus on short-run profits rather than longerrun profit performance.

 SPE 3% Rule: Rule permitting Special Purpose Entities (SPEs) created by a firm to be treated
as offbalance-sheet that is no required consolidation with firm’s balance sheets as long as at
least 3% of the total capital of the SPE was owned independently of the firm. • Rule raised to
10% in 2003 following Enron scandal. After more misuse of rule during Subprime Financial
Crisis, Financial Accounting Standards Board (FASB) replaced this rule in 2009 with stricter
consolidation standards on all asset reporting (FASB 166 & 167).

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Conclusion
Enron had faced serious competition within the energy trading business after the various new entries
of the latest companies, Therefore the company’s profit decreased rapidly. Due to the pressure from
stockholders, the company’s executive started using the above-mentioned Mark-to-market
accounting technique on a very large scale, to cover the troubles. In the above-mentioned accounting
technique, the company’s executive gives the illusion of upper profits in the future to the
shareholders. Within the addition the fault operations of special purpose entities, which resulted in
the restrictions of the partnerships with outside parties. Enron performed malpractice by using the
SPE’s as dump sites for its corrupt assets, although many companies shared assets with their SPE’s.
Shifting those faulty assets to SPE’s meant that they kept off Enron’s books. Making its losses books
looks less serious than they were. A number of their SPE’s were traveled by Fastow himself.
Throughout the years Arthur Anderson worked not only as Enron’s auditors but also as a consultant
for the company.
In February 2001, skilling became Enron’s Chief military officer and Lay continues his position as
an MD. In August, skilling all of a sudden resigned, and Lay regained his CEO position by this point
Lay had a thought about the possible accounting scandal through Enron’s vice chairman who had
become worried about the Fastow partnership. The seriousness of this issue has started increasing in
Mid-2001 as a variety of analysts started analyzing Enron’s publicly released budget more seriously.
In mid-October, the investors of Enron company went shocked as Enron announced that it had been
getting to post a 683 million dollars loss for the third quarter and take a 1.2 billion contraction in
shareholding equity as a neighborhood of Fastow’s partnership. After this incident, the (SEC)
securities exchange commission started investing in the transportations and audits between Enron
and Fastow’s SPEs. Even under Anderson, some officials started investing the Enron’s audit more
thoroughly. After the small print of accounting had emerged Enron went into freefall and Fastow
also get fired. Even the stock price of the corporate tumble from the high of 90 dollars per share in
mid-2000 to but 21 dollars by the starting of November. Enron tried to handle this example by
agreeing to be acquired by Dynegy, but after some weeks Dynegy backed out of the deal and
therefore the news caused the company’s share price to subside by 1 dollar per share. On December
2, Enron filed for bankruptcy protection.

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Bibliography

 ASX Corporate Governance Council Book(2003), "Principles of good corporate governance

and Best practice recommendations".

 https://www.wallstreetmojo.com/enron-scandal/

 https://www.journalofaccountancy.com/issues/2002/apr/theriseandfallofenron.html

 https://www.bbc.com/news/business-58026162

 https://www.suredividend.com/actionable-lessons-enron-scandal/

 https://www.impactlaw.com/criminal-law/white-collar/securities-fraud/lawsuits/enron

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