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March 17, 2010

Prole of Enron: The Rise and Fall

In our opinion, managements assertion that the system of internal control of Enron Corp. and its subsidiarieswas adequate to provide reasonable assurance as to the reliabilities of nancial statements, and the protection of assets from unauthorized acquisition, use or disposition is fairly stated, in all material respects, based upon current standards of control criteria.2 Arthur Andersen LLP, February 23, 2001 Enron stock was at $84.63 on December 24, 2000, and closed at $0.26 on November 30, 2001. It led for bankruptcy on December 2, 2001.3 This case describes how Enron rose so high, fell so low, and impacted the lives of so many. What could have been done, when, by whom, and at what cost?

From Pipelines to Market Maker

One of Lays rst big actions as CEO was to hire the consulting rm McKinsey & Co. to help with the development of new products. Jeff Skilling, who worked on the Enron job for McKinsey, created an innovative nancial product that had never been applied to the gas business.9 As a result of this work, Lay offered Skilling a position as the head of Enrons trading business.10 In contrast to Lays easy-going management
Published by GlobaLens, a division of the William Davidson Institute at the University of Michigan. 2010 Scott A. Moore. This prole was written by Scott A. Moore, Associate Professor, Ross School of Business, University of Michigan, as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.

Unauthorized reproduction and distribution is an infringement of copyright. Please contact us for permissions: Permissions@GlobaLens.com or 734-615-9553.

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In July 1985, two natural gas pipeline companies, InterNorth and Houston Natural Gas (HNG), merged to form a company valued at $2.3 billion that would come to be known as Enron.4 Although, at the time of the merger, Ken Lay was the 42-year-old chairman of the smaller HNG, he emerged as the CEO of the combined entity.5 Lay was a likable, hard-working man who easily mingled with workers at all levels.6 Over time Lays easy-going management style manifested itself in the new organization. The companys divisions operated almost autonomously; they were even allowed to set up their own salary and bonus plans.7 He also encouraged the units to take big risks so that they could reap big rewards. Because of their early successes, the units came to think of themselves as invincible.8

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In our opinion, the nancial statementspresent fairly, in all material respects, the nancial position of Enron Corp. and subsidiaries as of December 31, 2000. Arthur Andersen LLP, February 23, 2001

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style, Skilling was intense. He exuded an intensity his body language radiating importance and urgency and making clear that few should dare to take a moment of his time.11 The innovative nancial product on which Enron built its success was hedging contracts that allowed buyers to shield themselves from risk by locking up long-term prices for gas while simultaneously allowing suppliers to lock up stable long-term prices. Enron acted as a middleman, taking a piece of every transaction and making money regardless of the price of gas.12 The job of Enron traders was to manage risk but also to be creative in making deals.13 Under Skilling, the trading operation acquired a cutthroat reputation, even in a company as aggressive as Enron. In the trading unit, he used a system called rank-and-yank. This employee performance review process periodically ranked the performance of all employees and then red the lowest ranking ones.14 One outcome of this system was that employees tended to work on projects that they knew would provide a payback before the next six-month review. In an interview with The New York Times, one manager described the system as follows: Get it done. Get it done now. Reap the rewards. Whether the deal made money, or even made sense, was somebody elses problem, he said.15 The trading operation promised much higher paybacks with a much smaller investment than the traditional business of power plants and pipelines. Although Enron still touted itself as the most successful developer of energy infrastructure in the world in the companys 1996 annual report, over time Lay and Skilling came to the conclusion that they wanted Enron to focus more on the trading business than on its historical strength in the power delivery business.16

King of the World

Enron Financial Data (in $ millions, except share price data)

1991 Revenues 5,698 232 Net income 1992 6,415 306 1993 7,986 333 14.50 1994 8,984 453 15.25 1995 520 19.06 1996 584 21.56 1997 20,273 105 22,552 20.78 1998 31,260 703 29,350 28.53 1999 893 33,381 44.38 2000 979 65,503 83.13

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Table 1
11.56
2

Enrons Stardom In December 1996, Skilling was named president of Enron.17 He rose to this position on the relative strength of the performance of his trading group compared to Enrons asset development group, in which some costly power plants had dragged down the returns.18 As can be seen in Table 1, Enron was in the midst of a decade of signicant growth in revenue, assets, and stock price. After Skilling was named president, this trend accelerated.

Total assets

10,070 8.75

10,312 11,504 11,966 13,239 16,137

Closing stock price

All data from Enron annual reports from 1995 and 2000.

By the late 1990s, Enron was gaining recognition and publicity for its high-ying ways during the Internet boom. In April 1999, Enron agreed to pay more than $100 million over 30 years to name the Houston Astros new baseball stadium Enron Field.19 In October of that year, because of the remarkably innovative nancing masterminded by Enrons Andrew Fastow, he was given the 1999 CFO Excellence Award for Capital Structure Management by CFO Magazine.20 A few months later, in a survey by Fortune asking executives to

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40,112 100,789

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rank their most admired companies, Enron was ranked #1 in innovativeness and quality of management.21 It now had received this top score in innovation four years in a row.22 The company won more praise in business media. See, for example, the excerpt from an article in Fortunes April 2000 issue below: Imagine a country-club dinner dance, with a bunch of old fogies and their wives shufing around halfheartedly to the not-so-stirring sounds of Guy Lombardo and his All-Tuxedo Orchestra. Suddenly young Elvis comes crashing through the skylight, complete with gold-lame suit, shiny guitar, and gyrating hips. Half the waltzers faint; most of the others get angry or pouty. And a very few decide they like what they hear, tap their feetstart grabbing new partners, and suddenly are rocking to a very different tune. In the staid world of regulated utilities and energy companies, Enron Corp. is that gate-crashing Elvis.23 In August 2000, Fortune magazine picked ten stocks that they think will be winners over the coming decade. Enron was on that list.24 A piece in Time stated that Enron may be the most interesting oldeconomy company around.25 In October 2000, Fortune ranked Enron #25 on the list of the worlds most admired companies.26 Skilling Skillings rise through the company matched Enrons performance in the market. He was revered in and out of the company. In December 2000, Skilling was promoted from president to CEO.27 Richard Causey, Enrons chief accounting ofcer, said this of Skilling: Hes the most innovative guy Ive ever been around.28 BusinessWeek called Skilling hypercondent.29 His management style had not changed much from his early years. Executives under him reported that he still combined tight risk-related controls with a loose, entrepreneurial culture.30

[I]t has pioneered the nancialization of energy, making the company more akin to Goldman Sachs than Consolidated Edison. Its impressive prot stream is squeezed out of a torrent of often low-margin trades, in which it buys and sells a dazzling variety of contracts.32 Market Making Skilling believed that Enron could take this approach to markets for data storage, steel, and advertising space.33 These vast new opportunities would only add to sales earned in its traditional markets; Enron projected that sales in its traditional markets should grow at least 35% annually for the foreseeable future.34 Enron was now in the market making business and was seen as a pioneer in the eld during the Internet boom. The advantages of Enrons business model were perceived by the press and its competitors to be highly protective of the rms position. First, Enron was perceived as having an expertise in the model, which it developed over its years of operation. Next, the company employed dozens of PhDs and even hired a former shuttle astronaut to schedule satellite time.35 Third, the market allowed the trading of many commodities with many buyers and sellers. Finally, Enrons size and cash reserves ensured that its market would stay liquid.

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Skilling had now set Enrons sights beyond the energy market. In fact, by 2001 Enron had basically given up on the business of building power plants and pipelines.31 BusinessWeek pointed out that it was a mistake to group Enron with utility companies because of how little power it produced:

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Customers and analysts were all impressed by Enrons operations and the benets that it provided. The vice chairman at Chase Manhattan, an Enron customer, was impressed with Enrons use of nancial derivates to cut electricity prices and reduce Chases risk of rising costs. Derivatives used properly have enormous win-win possibilities.36 A Goldman Sachs analyst posited that Enron has built unique and, in our view, extraordinary franchises in several business units in very large markets.37 Far-reaching Inuence Enrons inuence was not restricted to the business world. Enron was known to have a lobbying operation that had the ear of many in Washington. Enron was involved early on in the election campaign of George W. Bush in 2000; it was the largest contributor to his campaign that year.38 As a result, Enron is at the top of the top group of corporations that has the ear of George W. Bush.39 Its lobbying was generally concerned with deregulation, taxes, trade, and the environment. For the 2000 election, Enron and its executives gave $1.1 million to the Republican Party and $0.5 million to the Democratic Party.40 This was just a part of the nearly $6 million Enron contributed to political candidates and parties between 1989 and 2001.41 By the beginning of 2001, Enron was able to point to a long period of sustained growth (see Table 1). Over the previous nine years, the compound annual growth was 37.6% in revenue, 17.3% in net income, and 23.1% in total assets, and the closing stock price for the year grew by an average of 28.4% annually. In early 2001, Skilling predicted that Enron would have more than $200 billion in revenue; this would make it the #2 US energy company behind ExxonMobil.42

Uncovering the Issues

[M]uch of [Enrons] recent prots constitute unrealized, noncash gains. Frequently, these prots depend on assumptions and estimates about future market factors, the details of which the companies do not provide, and which time may prove wrong. And because of minimal disclosure standards in these kinds of cases, its difcult for investors to assess whose assumptions might be too aggressive, or what market changes might invalidate the assumptions -- and force earnings revisions.[A]t the heart of the situation is an accounting technique that allows companies to include as current earnings those prots they expect to realize from energy-related contracts and other derivative instruments in future periods, sometimes stretching over more than 20 years.If, for instance, the market price for natural gas rises above the price specied in a companys contract to buy gas, generally the company will record an unrealized gain. That gain is recognized as income and recorded as an asset on the companys balance sheet.Yet, in their nancial reports, the companies only vaguely describe the methods they use to come up with fair-value estimates on the contracts.[W]ith some long-term derivative instrumentscompanies are allowed to base valuations on their own undisclosed estimates, assumptions, and pricing models.Ultimately, theyre telling you what they think the answer is, but theyre not telling you how they got to that answer, says Stephen Campbell, an analyst at Business Valuation Services in Dallas. That is essentially saying trust me.43

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In September 2000, the rst rumblings concerning Enrons skyrocketing prots and valuation came to light. Jonathan Weil of the Wall Street Journal explained the situation this way:

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Clearly, this was troublesome for investors; however, it was not the case that governing organizations were unaware of the possibility of abuse and damage. As Weil wrote: A co-author of the US Securities and Exchange Commission (SEC) rules on market-risk disclosures for nancial instruments compares the current situation for energy traders with the accounting controversies that engulfed subprime automobile and residential lenders during the late 1990s. Many investors complained they were blindsided, in part because these lenders generally hadnt disclosed their assumptions about prepayment rates and other variables. After the crash, subprime lenders routinely began disclosing the key assumptions used to value their mortgage portfolios.44 Another warning related to Enrons earnings came from James Chanos, a Wall Street trader who focused on short-selling. He investigated Enron and wondered if he would nd a reason to anticipate Enrons stock price falling: We were also troubled by Enrons cryptic disclosure regarding various related party transactions described in its 1999 Form 10-K as well as the quarterly Form 10-Qs it led with the SEC in 2000 for its March, June, and September quarters. We read the footnotes in Enrons nancial statements about these transactions over and over again but could not decipher what impact they had on Enrons overall nancial condition. It did seem strange to us, however, that Enron had organized these entities for the apparent purpose of trading with their parent company, and that they were run by an Enron executive.45 Chanos met with several analysts who followed Enron in early 2001. He found that he was not alone in his inability to decipher Enrons nancials. They conceded that there was no way to analyze Enron, but that investing in Enron was instead a trust me story.46 Chanos brought his concerns to the attention of a reporter for Fortune, Bethany McLean.47 With a background as an analyst for Goldman Sachs, she had the ability to look into the troubling numbers and reports that Weil and Chanos had been examining. In March 2001, she wrote an article that raised many of those same issues but this time in a national business magazine. She pointed out that since 1990 Enron had changed from 80% of its revenue coming from its gas pipeline business to 5% coming from that same line of business in 2000. Given that so much of its revenues came from the buying and selling of energy, McLean pointed out that it was surprising that no one could gure out the details of how it made money from this line of business. This worried McLean: [T]he inability to get behind the numbers combined with ever higher expectations for the company may increase the chance of a nasty surprise.48 Enron maintained that how it made money was proprietary and a company secret on par with Coca-Colas secret formula.49 Enron did not take kindly to McLeans article.50 Skilling called her unethical, saying that she did not do enough research. Three other executives met with Fortune editors in an attempt to convince them that she was wrong. Chairman Ken Lay even called Fortunes managing editor to complain about the reliability of the sources she used in writing the article. In addition to these articles and the unclear nancials, two other warning signs surfaced. In early 2001, senior executives began leaving Enron. At the same time, many senior executives were selling (and not buying) a large amount of Enron stock. Both of these signs indicated a lack of evidence on Enrons part by those in the best position to justify the companys nancials.51 For worried analysts, Enron was still participating in the related party transactions for which the company failed to provide sufcient, detailed information to its investors.52
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The Public Scandal

The effect of the worries was a rapid decrease in the value of Enrons stock. It fell from a high of $90.56 in August 2000 to $42.93 on August 14, 2001.53 Later that day, Skilling resigned as president and CEO. Soon afterward Ken Lay regained those titles. By walking away from his position, Skilling gave up a severance payment of at least $19.9 million; he also became responsible for paying back a $2 million loan from the company.54 Due to these stipulations, it was hard for investors to believe that there was not an underlying problem with Enron that had not been announced. By August 24th, the stock fell an additional 14% to around $36.55. On that date, Lay made a public statement: There are absolutely no problems that had anything to do with Jeffs departure. There are no accounting issues, no trading issues, no reserve issues, no previously unknown problem issues. There are no surprises. We did le our 10-Q a few days ago. And, if there were any serious problems, they would be in there. If theres anything material and were not reporting it, wed be breaking the law. We dont break the law.55 By October 2001, 11 of the 13 analysts who covered Enron recommended it as at least a buy.56 On October 19, the Wall Street Journal broke the story about a limited partnership organized by Fastow, Enrons chief nancial ofcer.57 It was revealed that he, along with some associates, made from this partnership more than $7 million in fees and $4 million in capital increases in 2000 on transactions made with Enron. This revealed a conict of interest, since Enrons CFO would be on both sides of the negotiating table for all of the transactions involving this partnership. At an Enron board meeting four days later, the board asked Fastow for the rst time how much he had made from this and related partnerships. His answer was a surprise to them: $45 million. This was much more than they had believed he had made from the partnerships. Also, it turned out that the related party transactions did not meet accounting requirements for an off-book partnership, since the owners were not investors independent of the company. Given that they were not independent, the debt issued by these partnerships was really Enrons debt, and this went back to 1997.58 Enron forced Fastow to resign on October 24.59 All details about these partnerships were arguably unknown to Ken Lay.60 Enron was now having serious trouble in the nancial markets. On October 24, the market for very short-term loans that are used by companies to pay salaries and handle other routine cash needs denied all of Enrons applications.61 This squeeze required that Enron executives look more closely at the companys cash position. At this point, it became apparent to Enrons acting CFO that the company had no way of tracking its cash or the current maturity schedule for its debt. The company had always focused its energies on the excitement of deals and increasing earnings but had ignored the boring, but necessary, details vital to monitoring the companys nancial health. This was not the end of its nancial troubles. TheStreet.com reported the following:

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The battered energy trader has done business with at least 15 other related entities, according to documents supplied by lawyers for people suing Enron. Moreover, Enrons new CFO, who has been portrayed by bulls as opposing the related-party dealings of his predecessor, serves on 12 of these entities. And Enron board members are listed as having directorships and other roles at a Houston-based related entity called ES Power 3. [T]he existence of these partnerships could feed investors fears that Enron has billions of dollars of liabilities that dont show up on its balance sheet. If thats so, the companys nancial strength and growth prospects could be much less than has generally been assumed on Wall Street, where the company was long treated with kid gloves.62
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On November 10th, Enron agreed to be acquired by its rival, Dynegy.63 During negotiations, Dynegy discovered that Enron did not have a business plan. To come up with projections for the next year, Enron simply increased the current years results by a percentage.64 The companies realized that there were great differences in culture, but Enron was in no position to argue. In contrast to Enrons culture of competitiveness, Dynegy emphasized teamwork.65 The public backlash continued to get worse for Enron. On November 10th, Chanos, who had been one of the rst people to raise worries about Enrons nances, said more evidence pointed to the conclusion that Enrons energy trading operations were not as protable as they appeared from their nancial statements: There appears to be a culture at Enron of aggressively booking prots and deferring or obscuring losses.66 Enron also had nished its preliminary investigation of the related party transactions. In a ling with the SEC, it disclosed that it had overstated earnings by almost $600 million since 1997. There was no assurance that this would be the nal restatement of earnings.67 On November 12th, Citibank called Enrons treasurer to notify him that Enron now owed Citibank $690 million (because of a trigger on a nancing deal) to be paid 15 days from the time when Enrons debt was downgraded. No one at Enron knew about the existence of the trigger or that it had already been tripped.68 Soon afterward, Enrons debt was downgraded to junk status. Now almost every dollar that Enron had borrowed was due.69 The companys end was near. Enrons stockholders knew it. Their shares were the most actively traded stocks on the NYSE on November 20. The closing price was around $7 per share.70 Because of the ongoing drama, disclosures, and issues at Enron, on November 28 Dynegy pulled out of its agreement to buy Enron.71 By now, partners and rivals were not answering calls from Enrons energy trading desks which, just months before, were the worlds leaders.72 Days later, Enron stock closed at $0.28.73 Finally, on December 2, Enron led for bankruptcy.74

Discoveries

It was only after Skilling resigned that other organizations and the media actually began to investigate Enrons operations. Many details that Enron wanted to keep secret or from public scrutiny came out as Enron neared bankruptcy. Enrons Corporate Culture Enron was an intensely competitive and impersonal place to work;75 by the late 1990s, employees were routinely laid off via e-mail. The competitiveness was generally attributed to Skillings rise at Enron.76 Skilling was known by those at Enron to be a control freak, someone who wanted be involved in everything.77 The competitiveness and risk-taking went to extremes. Skilling took associates on bone-rattling adventure tours, rewarding those who pushed the envelope and set an anything-goes tone, former Enron employees said.78 Consider an example of how employees would test the boundaries:

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At a worldwide meeting of the corporations vice presidents in 2000, he singled out Louise Kitchen for praise. Ms. Kitchen had started the companys Internet-based trading operation, Enron Online, even though Mr. Skilling had repeatedly refused to allow her to do so. Instead, she pulled the new network together in secret, using funds allocated for other purposes. A former vice president who attended that meeting was aghast: The moral of this story is, You can break the rules, you can cheat, you can lie, but as long as you make money, its all right.79

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Enrons extravagance was uncovered. Secretaries received Waterford crystal as gifts, ofce lunches were held at Houstons best restaurants, and employees received free laptops, rst-class plane tickets, and bookings in ve-star hotels.80 At one meeting, a live elephant was brought in to illustrate a concept.81 Divisions did not have to demonstrate prots in order to partake in the extravagance, and self-control and risk controls were almost entirely lacking. Within Enron, a few employees became increasingly worried about Enrons accounting practices. Sherron Watkins, a vice president, wrote a letter to Ken Lay in which she warned that Enron might implode in a wave of accounting scandals.82 She was a former Arthur Andersen accountant so she was familiar with Enrons practices. In the letter she pointed out the primary problems: top execs who, at best, appeared to close their eyes to questionable accounting maneuvers; a leadership that had lost sight of ordinary investors and the basic principles of accounting; and watchdogs--the outside auditors and lawyers whose own involvement may have left them too conicted to query the nature of the deals.83 Lay talked with her for an hour about the contents of her letter. Lay responded by ordering Vinson & Elkins, the companys longtime Houston law rm, to investigate the allegations.84 This same law rm was familiar with much of what she had written about because they had worked on some of the partnerships. Going in to the investigation, V&E agreed with Enron that it would not question Arthur Andersens accounting decisions (since they are not accountants) or analyze the transactions in detail.85 Perhaps not surprisingly, in the October 15 report back to Enron, V&E concluded that a widespread investigation was not warranted. It simply warned that there was a serious risk of adverse publicity and litigation.86 The next day, Enron reported a $1.2-billion write-down of shareholder equity related to the troublesome partnership accounting. In public, Lay maintained that he knew nothing about the details of these deals.87 Enron did not stop its questionable accounting practices even as it came under more scrutiny. On September 30, 2001, the last day of the third quarter, an Enron subsidiary and Qwest bought $112 million in communication network capacity from each other.88 Qwest, which was not in good nancial shape at the time, already had a new and mostly unused ber-optic network. Enron Broadband paid $112 million of a $195-million purchase of optical network capacity while Qwest paid $112 million of a $308-million contract for cable capacity between Salt Lake City and New Orleans.89 Skilling gave sworn testimony to the SEC for two days. In an interview with The New York Times, Skilling said he did not believe he would face sanction by the SEC or criminal charges. I didnt do anything wrong. After much soul-searching, given the information at the time, I would not have done anything different.90 In his testimony, Skilling expressed surprise about the details related to the partnerships involving Fastow. He knew they were set up to save money for Enron, but he did not know Fastow was making so much money off them.91 He also denied knowing about the details of the partnership transactions involving Fastow and conjectured that Arthur Andersen must have been deeply involved in those partnerships.92 Vice President Watkins had this to say about Skilling: He was very involved in Mr. Fastows endeavors, and I nd it very hard to believe that he was not fully aware of transactions with Mr. Fastows partnerships.93 Problems at Arthur Andersen Several ties bound together Arthur Andersen and Enron. First, Arthur Andersen was Enrons auditor from its inception.94 This meant that the rm certied that Enrons nancial statements were correct and trustworthy every year. Second, Enron paid Andersen $27 million for consulting services (compared with $25 million for auditing work) in 2000.95 Third, many former auditors from Andersen worked at Enron at the highest reaches of management.96 This created a situation where former co-workers (and possibly friends), as well as companies that had a nancial interest in keeping a good working relationship, were in an auditing relationship.
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Andersen employees and partners were not wholly of the mind that the partnerships and off-balancesheet deals were being handled correctly. Carl Bass, an Andersen partner, expressed concern in March 2000 that these deals were not being accounted for according to the letter of the law.97 One year later he was taken off the account because he disagreed with the way that Enron and Andersen were handling the accounting related to the partnerships. On August 20, 2001, ve days after Sherron Watkins sent her letter to Lay, she followed up by sending the letter to an Andersen audit partner. He passed along her concerns to the senior Andersen employee working on the Enron account. As before, she indicated that there might be some issues to investigate related both to off-balance-sheet debts and losses and to the income Enron created by Enron doing business with itself.98 It is not known what action Andersen took in response to this letter. On October 12, David B. Duncan, the senior Andersen partner in charge of the Enron account, ordered Andersen employees to shred documents related to Enron.99 He instructed them to destroy all audit material, except for the most basic work papers. And thats what they did, over a period of several weeks.100 Several times over the next few weeks, up to and perhaps after when the SEC subpoenaed their documents related to the Enron account, Andersen supervisors reminded employees about these instructions.101 Duncan later claimed that he was just following Andersens policies.102 Another signicant issue was that Enron went bankrupt after 15 years without ever reporting an annual loss or a bad quarter.103 After the fact, it became obvious that much of the prot reported in recent years should not have been reported as such. Andersen knew about these troublesome prots, but as Floyd Norris of The New York Times explained: Andersen allowed itself to be persuaded that the amount of the prots, even though it was millions of dollars, was not material, to use the jargon of the industry, and therefore they could allow the prots, the phony prots, to be reported. Thats one of the things that always shocks me: that auditors discover what they believe to be wrongly reported prots and allow them to be reported together on grounds of materiality. That is however legal under the current accounting rules.104 In December 2001 Andersen admitted that it did not adequately adjust its auditing process with Enron after the natural-gas market was deregulated.105 Consequently, the industry had become more competitive, the company more complex, and the accounting more sophisticated. For example, Enron had 874 offshore subsidiaries.106 Furthermore, in January, Andersen conceded that it had destroyed documents related to Enron.107 Partners Enron not only wanted to manage its earnings, but it also wanted to hide billions of dollars of debt. It needed help to do this. One such company that got involved was Toronto-based Canadian Imperial Bank (CIBC). Over a three-year period ending in October 2001 CIBC and Enron put together 34 transactions in which loans were structured as asset sales, a subterfuge that allowed Enron to misrepresent to investors and analysts the extent of its overall liabilities.108 These deals allowed Enron to report $1 billion more in earnings and $2 billion more in cash ow, and hide more than $2.6 billion of debt.109 CIBC had to pay the SEC $80 million to settle the allegations.110

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Internal Oversight Two internal groups are responsible for overseeing managements activities: the board of directors and the auditing committee. In October 2000 Enrons board was named by Chief Executive magazine as one of the ve best boards in the US.111 Nevertheless, The New York Times uncovered some issues surrounding Enrons board of directors: In hindsight, there appears to have been ample evidence that Enrons board might not have been up to the job of preventing what is becoming one of the greatest debacles in the history of corporate America. Some directors had consulting contracts or other business arrangements with Enron. Others were afliated with institutions that beneted from gifts from the company or its chief executive, Kenneth L. Lay.112 When Skilling left in August 2001, the board did not launch its own investigation into why he left,113 though the stocks performance and other issues were troublesome. Furthermore, the auditing committee was not performing at its highest level. Given Enrons complex accounting techniques, this committee must have relied on Andersen to speak up if something was amiss,114 but Andersen did not report any problems. The committee was at the mercy of an auditor whose interests were not necessarily independent of Enrons management. The audit committee included Wendy Gramm; she had previously led the Commodity Futures Trading Commission. When in that position, she had the reputation for being a lax regulator.115 External Oversight Many external organizations or groups could have exposed Enron but little action was taken until it was too late. In spite of the fact that the two major credit rating agencies, Moodys Investor Service and Standard & Poors, had great access to Enrons data, they did not lower Enrons rating below investment grade until a few weeks before it went bankrupt. Since these companies are responsible for assessing the risk to investors and Enrons accounting practices were somewhat opaque, the rating agencies should have described what they were able to interpret and what they could not comprehend. It is possible that the rating agencies were pressured by banks that had loaned to Enron and wanted Enrons credit rating to be high so that they could nd a buyer. The business press, with a few exceptions, was passive in its reporting of Enron. Business reporters generally rely on the work of business analysts when judging a companys performance. BusinessWeek scolded the press (including itself):

Even after Skilling resigned, the media did not raise suspicions. Skilling and Lay were able to convince the press that Skilling was leaving following some vague, personal catharsis.117 There is a denite amount of groupthink among business reporters and editors. Companies that are doing well have positive stories written about them while those in trouble get more negative stories. That pattern was not broken in this case. It was not just the Andersen auditors who were affected by conict of interest. Wall Street analysts who worked for investment banks that did business with Enron seemed to be conicted. Even as late as October 2001, most analysts were still advising investors to buy Enron stock. The SEC disclosure requirements
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It celebrated Skillings vision of Enron as a virtual company that could securitize anything and trade it anywhere. The press blithely accepted Enron as the epitome of a new, post-deregulation corporate model when it should have been much more aggressive in probing the companys opaque partnerships, off-balance-sheet maneuvers, and soaring leverage.116

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related to off-balance-sheet nancing certainly did not make detection of Enrons true nancial situation any easier. As BusinessWeek put it, Enron made a mockery of public disclosure.118 In response to this case the SEC planned to clean up those requirements to ensure this type of situation would not happen again. Some thought the SEC plan would not be sufcient: [M]any suggest that a more effective move would be to ban accounting rms from providing consulting services to clients they audit.Such a ban was proposed by former SEC chairman Arthur Levitt, but was abandoned in the fact of industry opposition.119

Summary of Resulting Events

After Enron went into bankruptcy, many investigations began and the effects reverberated in the US and around the world for most of the rest of the decade. In brief: January 15, 2002: UBS Warburg purchased Enrons trading operation for no cash up front, only paying one-third of pre-tax prots for the next two years.120 January 15, 2002: David Duncan was red by Andersen.121 January 2002: There were twelve separate government investigations into accounting, securities, and pension practices at Enron.122 There were 47 class action suits again Enron and its executives and directors.123 February 2002: An internal investigation by Enron concluded that Jeff Skilling certainly knew or should have known of the magnitude and the risks associated with [the partnerships]. It concluded that Skilling bears substantial responsibility for the failure of the system of internal controls to reduce the risks in the partnerships.124

August 31, 2002: Arthur Andersen said it would stop auditing publicly held companies.126 This put 85,000 people out of work.127 January 16, 2003: The Financial Accounting Standards Board changed the rules related to the accounting of special purpose entities and off-balance-sheet accounting. The SEC also ruled that it would be illegal for a rm to issue nancial statements in such a way that the gures are misleading.128

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May 1, 2003: Andrew Fastow and his wife were indicted for fraud. By this time he faced a total of 109 charges.129 July 8, 2004: Ken Lay was indicted on 11 charges related to fraud and conspiracy.130 July 12, 2005: Enron agreed to a settlement of $356 million related to a class-action suit with 20,000 former employees. Expectations were that employees would receive less than 20% of that claim.131 The average Enron worker had 62% of his or her corporate retirement plan in Enron stock; according to the plans rules an employee could not sell it until age 50.132 July 17, 2005: Enron agreed to pay up to $1.52 billion to resolve charges that Enron used a series of sham trades and other tactics to inate the price of electricity.133 August 2, 2005: CIBC agreed to pay $2.4 billion to settle charges that it helped Enron create phantom prots.134

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July 24, 2002: The US House and Senate came to agreement on the Sarbanes-Oxley bill, which was a sweeping overhaul of accounting and corporate-governance laws in an effort to prevent scandals like those that brought down Enron and WorldCom.125

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2005: In separate cases, J.P. Morgan Chase ($2.2 billion for the largest of multiple charges it faced), Citibank ($1.66 billion), and Toronto-Dominion Bank ($130 million total damages) all agreed to pay in order to settle charges related to fraud in the Enron bankruptcy. May 2006: Lay and Skilling were convicted of fraud and conspiracy after a nearly two-month trial.135 July 5, 2006: Lay suffered a fatal heart attack.136 September 26, 2006: Fastow was sentenced to six years in prison.137 October 23, 2006: Skilling was sentenced to about 24 years in prison.138 February 22, 2008: Three bankers from the National Westminster Bank of England were sentenced to 37 months in prison on conspiracy charges related to deals with Fastow.139 As of 2010, Enron was the sixth-largest bankruptcy in world history.140

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Endnotes
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