The Lee Kong Chian School of Business

Academic Year 2021-2022

Loo Khee Sheng

Enron Corporation

Enron

Enron Corporation originated as Northern Natural Gas Company in 1932. It was

reorganised into InterNorth and then merged with Houston Natural Gas to form
HNG/InterNorth Inc in 1985. Not long after the merger, Kenneth Lay, the CEO of
Houston Natural Gas, became the CEO of the merged company. The name of the
company was subsequently changed to Enron.

Enron grew from a traditional energy production and transmission company into a global
enterprise with business in over 30 different products. The business included:-

● trade in natural gas, electricity, energy and related financial instruments

● construction and operation of pipelines and power facilities
● transmission of natural gas and electricity.

Enron reported revenues of $13.3 billion in 1996. By the fiscal year ended 31 Dec 2000
reported revenues were in excess of US$100 billion. Enron became the seventh largest
company in the world.

The awards and recognitions bestowed on Enron included:-

● “America’s Most Innovative Company” by Fortune magazine for 6 consecutive

years (1996 to 2001)
● climate protection award from the US Environmental Protection Agency in 1998
● corporate conscience award from the Council on Economic Priorities

The Fraudulent Schemes

Enron had resorted to various dubious practices to inflate its revenues and profits and hide
its debts and liabilities. Three factors drove Enron’s management to do so:-
 Enron Corporation (Academic Year 2021-2022)

(1) Enron needed cash but it was reluctant to issue equity for fear that the issuance of
equity would depress its stock price.

(2) Enron needed to maintain an investment grade credit rating and its financial
ratios. A company’s credit rating has a bearing on the company, such as the
amount of interest it has to pay on its loans. A higher credit rating means that a
company can borrow money at a lower rate of interest. A lower credit rating will
result in the opposite.

(3) Enron needed to cover up its business failures and losses.

Enron had entered into hundreds of transactions with various Special Purpose Vehicles or
Entities (SPVs or SPEs). An SPV is an entity (eg a company or partnership) that is
created specially for a transaction (eg hold assets or issue securities). These SPVs were
closely linked to Enron. The transactions involved the participation of various financial
institutions, such as Citigroup, JP Morgan Chase, Barclays, BT/Deutsche, Merrill Lynch
and others. Through these transactions and other means, Enron aggressively managed its
financial statements. Enron wrongly inflated the reported revenue, sales and profits. It
reported transactions as sales and profits when they were not so. It wrongly reduced, hid
and disguised its debts and liabilities. Enron also failed to disclose the existence of the
SPVs and the substance of the transactions. It aggressively re-evaluated the value of
assets upwards under the basis of mark to market but did not evaluate the value of assets
downwards under the same rule, when it should. Mark to market is valid, if carried out
correctly, but it can be abused, as in Enron.

Many Enron executives were involved in these dubious practices, including the
following:-

1. Kenneth Lay, Chairman and CEO;

2. Jeffrey Skilling, the President and COO;
3. Andrew Fastow, the CFO.
4. Richard Causey, Chief Accounting Officer.
5. Ben Glisan, Treasurer.

Sherron Watkins

One employee was concerned enough about the financial irregularities. In August 2001
Sherron Watkins, an Enron Vice President of Corporate Development, wrote a memo to
Kenneth Lay raising “suspicions of accounting improprieties". She met with Kenneth
Lay, who promised to investigate. She did not report to government authorities and did
not make the memo public.

_____________________________________________________________________
2
 Enron Corporation (Academic Year 2021-2022)

Enron's Bankruptcy

Despite the schemes, Enron's problems became more and more dire. After a series of
disclosures and restatements, Enron filed for bankruptcy on 2 Dec 2001. Enron’s
bankruptcy led to a loss of US$60 billion worth of investors’ stock value and left 5,600
employees jobless. Sherron Watkin's memo to Kenneth Lay was only made public when
congressional investigators released it six weeks after Enron filed for bankruptcy

The Examiner’s reasons for the failure of Enron

The Bankruptcy Court appointed Mr Neal Batson as the Examiner to report on Enron. In
his 4 Reports he endeavoured to explain how the seventh largest company in the world
could fail so quickly and disastrously. The following are some of the main reasons given
by the Examiner:-

1. There was a need to maintain its high earnings, stock price and investment grade
credit rating, leading to the aggressive management of its accounts and
financial statements (pages 83 to 89 of the Final Report).

2. Enron’s compensation system provided a tempting incentive to distort its

financial results, fuelling a competitive, deal driven corporate culture that valued
outward appearance more than actual results, leading to the management of its
financial statements. During a 3 year period from 1998 through 2000, a group of
21 officers received in excess of US$1 billion in the form of salary, bonus and
gross proceeds from sales of Enron stock (pages 89 to 93 of the Final Report).

3. Enron’s management were “less concerned about making the correct or best
decision, and more concerned with justifying a desired result. Evidence suggests
that Enron’s officers: (i) used accounting rules that did not directly address the
accounting question at issue but provided an argument to justify an aggressive
position; (ii) searched for reasons to avoid public disclosure; and (iii) obtained
professional opinions or advice merely as a necessary procedural step” (page 94
of Final Report).

4. “Evidence suggests that by using Enron’s economic power, Enron officers were
able to pressure third parties, such as financial institutions and Enron’s
professionals, to accommodate Enron’s financial statement objectives. In many
instances, this economic pressure appears responsible for overcoming concerns
about reputational risk or other reservations by these third parties” (page 94 of
Final Report).

_____________________________________________________________________
3
 Enron Corporation (Academic Year 2021-2022)

5. “There are many examples of incomplete disclosure by these officers to the

Enron Board and the public. In some cases, it appears that officers provided hints
or glimpses of facts suggesting possible misuse of SPEs to the Enron Board. In
other cases, Enron officers’ frequent use of misleading terms and jargon in
connection with Enron’s SPE transactions appears to have obscured their
economic substance. Finally, evidence indicates that when information was
presented by the officers to the Enron Board, the information was delivered in a
manner not conducive to a full understanding of the SPEs” (page 94 of Final
Report).

6. Enron’s auditors, Anderson, failed to provide checks and balances against

Enron’s officers’ wrongdoing (pages 110 to 117 of the Final Report). Anderson
failed to provide the requisite information to the Audit Committee preventing the
Audit Committee from performing its function properly. Anderson also failed to
advise the Audit Committee and the Board of Directors and may have
affirmatively misled the Audit Committee into accepting Enron management’s
categorising of transactions.

7. Enron’s in-house attorneys failed to provide checks and balances against Enron's
officers' wrongdoing. They “knew that the Enron Board did not have all relevant
facts before it, but took no action to correct that problem” (pages 110 to 117 of
the Final Report).

8. Kenneth Lay and Jeffrey Skilling failed to provide checks and balances (pages
117 to 119 of the Final Report).

“During the five years leading to the Petition Date, Enron’s organization was
structured with the Office of Chairman, which Lay and Skilling shared, as the top
management position. Thus, the senior officers … either reported directly or
indirectly to Lay and Skilling. … Lay and Skilling, as the CEO and COO of
Enron, respectively, should have been an important check in preventing or
minimizing the impact of the subordinate officers’ conduct. … Giving Lay’s and
Skilling’s intimate knowledge of and involvement with Enron’s affairs, it is
reasonable to infer that they understood the widespread use of the [SPV]
transactions and the significant impact of those transactions on Enron’s publicly-
reported financial condition. … Lay and Skilling should have used their
knowledge of the company to help the Outside Directors understand the
information being presented. Lay and Skilling had the opportunity to provide
meaningful interpretation of the presented information, as they attended almost
every meeting of the Enron Board and its committees…. There is evidence that
Lay and Skilling sometimes participated with their subordinate officers in
providing information to the Outside Directors about [SPV] transactions. There is
also evidence showing that at least Skilling failed to tell Outside Directors

_____________________________________________________________________
4
 Enron Corporation (Academic Year 2021-2022)

important information about [SPV] transactions that might have changed the
outcome of Board decisions, even though he was present at the Board or
Committee meetings during which these matters were reviewed. … It also appears
that Lay and Skilling did little to help the Outside Directors serve effectively as a
check on the wrongful conduct.”

9. The Enron Board failed to provide checks and balances (pages 119 to 136 of the
Final Report).

“In practice …… particularly in circumstances involving complex matters and

obfuscation by officers of a company, there are limitations to a board serving as
an effective check in the area of oversight.” “The Enron Board generally was not
asked to, and did not, approve Enron’s [SPV] transactions …” “As a result, the
Board’s role for most of these transactions consisted primarily of providing
oversight and being alert for signals or red flags of wrongdoing.”

Although Enron had established various policies, such as the Risk Management
Policy and the Asset Divestiture Policy, the transactions slipped through the
policies and were not brought to the Board for approval.

The outside directors also did not understand important aspects about Enron’s
transactions. They did not devote sufficient time to discuss and understand the
matters fully and did not have the expertise for the job at hand. The Enron Board
was unusually large, leading to a tendency for individual directors not to feel
personal responsibility.

10. The oversight by the Finance Committee and the Audit Committee was poor
and they did not serve as an effective check. For example, they did not see or ask
for a complete list of Enron's obligations. The committees also did not properly
review the matters presented before them.

Prosecutions and Suits

The examination and investigations by the Examiner and authorities led to prosecutions
against various parties. In addition, various civil suits were instituted. 16 ex-Enron
executives pleaded guilty to their crimes.

Kenneth Lay was convicted in 2006 of securities fraud and conspiracy but died before he
could be sentenced.

Jeffrey Skilling was convicted in 2006 of securities fraud and conspiracy and was
sentenced to 24 years and 4 months in prison and fined US$45 million. In June 2013, the

_____________________________________________________________________
5
 Enron Corporation (Academic Year 2021-2022)

court approved a sentencing deal to cut 10 years off his sentence. He is eligible for release
in 2017.

Andrew Fastow cooperated with the prosecution and was sentenced to 6 years in prison
and agreed to forfeiture of his assets. He was released in December 2011.

Richard Causey cooperated with the prosecution and was sentenced to 5 ½ years in
prison. He was released in October 2011.

Ben Glisan cooperated with the prosecution and was sentenced to 5 years in prison. He
was released in January 2007.

Time's 2002 Persons of the Year

In early 2002 Sherron Watkins testified before committees of the U.S. House of
Representatives and Senate. She was named one of three TIME's 2002 Persons of the
Year.

ΩΩΩ

Loo Khee Sheng

ksloo@smu.edu.sg
Feedback is welcome.

_____________________________________________________________________
6