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prepared by :Sourav Daga

Danish Irshad
Naveen Sharma
Tirthesh

In 1985 after federal deregulation of natural gas

pipelines, Enron was born from the merger of Houston
Natural Gas and Inter North, a Nebraska pipeline
company.

Enron incurred massive debt and no longer had exclusive

rights to its pipelines.

Needed new and innovative business strategy

Kenneth Lay, CEO, hired McKinsey & Company to assist in

developing business strategy. They assigned a young
consultant named Jeffrey Skilling.

His background was in banking and asset and liability

management.
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Created Energy derivative

Lay created a new division in 1990 called Enron Finance

Corp. and hired Skilling to run it

Enron soon had more contracts than any of its competitors

and, with market dominance, could predict future prices with
great accuracy, thereby guaranteeing superior profits

Created Performance Review Committee (PRC) that became

known as the harshest employee ranking system in the
country---based on earnings generated, creating fierce
internal competition

Was devoid of any boundary system

Enrons core business was losing moneyshifted its

business to trading of derivatives

During 2000, Enrons derivatives-related assets increased

from $2.2 billion to $12 billion and derivates-related
liabilities increased from $1.8 billion to $10.5 billion

Enrons top management gave its managers a blank order

to just do it

Deals in unrelated areas such as weather derivatives, water

services, metals trading, broadband supply and power
plant.
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 Created by the merging of two pipeline

companies in the mid-1980s

Moved slowly away from its hard-assets

roots
From pipelines and energy plants

To transmission and energy trading

To innovative commodities trader (energy, bandwidth,

advertising time/space)
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Because Enron believed it was leading a revolution, it pushed

the rules. Employees attempted to crush not just outsiders
but each other. Competition was fierce among Enron
traders, to the extent that they were afraid to go to the
bathroom and leave their computer screen unattended and
available for perusal by other traders.

Enrons banner in lobby: Changed from The

Worlds Leading Energy Company to
THE WORLDS LEADING COMPANY

Accounting: Special Purpose Entities (SPEs)

Non-compliance with FAS 57
Used for hedging transactions
Used to accomplish asset sales
Leveraging the Company
To finance operations
Guaranteeing Obligations of SPEs
Enrons Culture (Advancement and Incentive Plans)
Promoted Greed Culture
Encouraged employees to hide problems
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Traditionally used
securitization

by

finance

companies

for

Also used to isolate risky asset ( aircraft leasing ,real

estate development)

In late 1990 many companies used SPEs to accelerate

revenue recognization

Really a joint venture between sponsoring company and

a group of outside investors

Cash flows from the SPE operations are used to pay

investors
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Governed by Financial Accounting Standard 57

Allows SPEs to be kept off the balance sheet if:
Outside owner invests equity capital for a 3%
or greater share of the SPE
Outside owner exercises control over the SPE

If both criteria are met, gains and losses from

transactions with the SPE can be recorded
Assets and liabilities of the SPE are not
consolidated
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To hide bad investments and poor-performing assets

Declines in value of assets would not be recognized by Enron

Quick execution of related-party transactions at desired

prices. (LJM1 and LJM2)

To report over $1 billion of false income

To hide debt

To manipulate cash flows, especially in 4th quarters

Many SPE transactions were timed (or illegally back-dated)

just near end of quarters so that income could be booked just
in time and in amounts needed, to meet investor
expectations
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Example
Joint Energy Development Investment (JEDI) (formed in
1993)
Properly established with CalPERS as controlling 50%
partner
Enron records gains from transactions with JEDI but
does not consolidate JEDIs debt on its balance sheet
1997 CalPERs wants to cash out
Enron needs a new partner to avoid consolidating JEDI
on it balance sheet
Enron executives form Chewco
Chewco invests borrowed capital (Enron guarantees
Chewco debt)

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Success of JEDI and Chewco inspire additional SPEs

New SPEs used to:
Sell hard assets to increase income
Engage in hedging transactions

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2000 Annual report shows a debt load of $37 billion

(up from $14 billion in 1999)

Many lending agreements

reduction triggers

containing

debt

14

Enron made promises to lenders to secure capital for

itself and SPEs
Loans and credit facilities contained credit rating
payment clauses
If Enrons credit rating fell below a set level
payment would become due immediately
Pledged stock and options to secure borrowings for
SPEs

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Accounting and reporting standards for marketable

securities, derivatives and financial contracts are found in
FAS 115 and FAS 133.

Changes in market values are reported in the income

statement

Gains often determined by proprietary formulas depending

on many assumptions about interest rate, customers, costs
and prices

Enron often recognized revenue at the time contracts (even

private) were signed based on net present value of all future
estimated revenues and costs.
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Incentive Plans
Cultivating Greed
compensation plans tightly geared to stock price
incentive to promote earnings growth and stock
price
Employees focused on earnings growth instead of

business lines or products

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Advancement Practices
Corporate Culture Promoted Self-Interest
Bottom 20% of performers forced out
Incentives based on Enrons earnings per
share (rewarded with stock options)

Practices led to:

Following the letter but not the spirit of FAS 57
(and sometimes not the letter)
Sold assets to SPEs, transferred stock to
SPEs to cover debts, and guaranteed loans to
SPEs
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Headline: Enron Reports Recurring Third Quarter Earnings

of $0.43 per diluted share

Projected recurring earnings for 2002 of $2.15

Enron actually lost $618 million or $0.84 per sharethey had

mislabeled $1.01 billion of expenses and losses as nonrecurring.

Shockingly, there was no balance sheet or cash flow

information with the release

There was no mention of a $1.2 billion charge against

shareholders equity, including what was described as a $1
billion correction to an accounting error
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stock price
$90
$80
$70
$60
$50

stock price

$40
$30

$20
$10
$0

01.08.2000

15.08.2001 $42

31.10.2001

$15

28.11.2001 $0.8

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drop of share price by 30% in the year 2000

Year 2001 :-Erratic cash flow and huge debt found by

McLean

Losses from different projects like logistic and dabhole as

well as from India.

resignation of CEO,Mr.Skilling.

Selling of fixed assets and projects to different in the year of

2001
On Dec 2,Enron filled bankruptcy.

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Greed on a spectacular scale

Following resignation of Jeff Skilling, Enron and

Arthur Andersen pulled the plug on certain SPEs
originally deemed to satisfy the requirements for
off-balance sheet treatment
review led to recategorizing SPEs and restating
income and debt

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The beginning of the end

October 16, 2001

$544 million after-tax change related to SPEs being

consolidated
reduced shareholder equity by $1.2 billion
November JEDI and Chewco arrangement exposed

forced consolidation of JEDI financials

Enron financials for 1997-2001 restated
increased reported debt by $711 million in 1997, $561
million in 1998, $685 million in 1999, and $628 million
in 2000
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Increase in reported debt from JEDI and Chewco led

to reexamination of Enrons debt rating by Moodys
and S&P (downgraded to barely investment grade)
Moodys and S&P further downgrade Enron's debt to
junk
Downgrading trips debt triggers in Enron loans ($4
billion becomes due immediately)

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Was paid $52 million in 2000, the majority for non-audit

related consulting services.

Failed to spot many of Enrons losses

Should have assessed Enron managements internal controls

on derivatives tradingexpressed approval of internal
controls during 1998 through 2000

Enron was Andersens second largest client

Provided both external and internal audits

CFOs and controllers were former Andersen executives

Accused of document destructionwas criminally indicted

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Enron paid several hundred million in fees, including fees

for derivatives transactions.

None of these firms alerted investors about derivatives

problems at Enron.

In October, 2001, 16 of 17 security analysts covering Enron

still rated it a strong buy or buy.

Example: One investment advisor purchased 7,583,900

shares of Enron for a state retirement fund, much of it in
September and October, 2001

27

Enrons outside law firm was paid substantial fees and had
previously employed Enrons general counsel

Failed to correct or disclose problems related to derivatives

and special purpose entities

Helped draft the legal documentation for the SPEs

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The three major credit rating agenciesMoodys, Standard

& Poors and Fitch/IBCAreceived substantial fees from
Enron

Just weeks prior to Enrons bankruptcy filingafter most of

the negative news was out and Enrons stock was trading for
$3 per shareall three agencies still gave investment grade
ratings to Enrons debt.

These firms enjoy protection from outside competition and

liability under U.S. securities laws.

Being rated as investment grade was necessary to make

SPEs work
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Individual and collective greed company, its employees,

analysts, auditors, bankers, rating agencies and investors

Atmosphere of market euphoria and corporate arrogance

High risk deals that went sour

Deceptive reporting practiceslack of transparency in

reporting financial affairs

Unduly aggressive earnings targets and management

bonuses based on meeting targets

Excessive interest in maintaining stock prices

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Corporate
Record keeping and Corporate Governance

Accounting - FAS 57

Securities and Exchange Commission Rules

Reporting Requirements
Enforcement Authority

Lending Practices - reporting of debt triggers

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THANK YOU

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