Anurag

Bhargava 42918154

The Fall of Enron

Prepared for

Dr Rahat Munir

By

Anurag Bhargava

42918154

20th October 2014

Anurag Bhargava 42918154

Contents
Enron: The beginning ..................................................................................................... 3
Rise ................................................................................................................................... 4
Fall .................................................................................................................................... 5
Enrons internal and external checks .......................................................................... 6
Continuous Auditing ...................................................................................................... 8
Enrons Demise ............................................................................................................... 9
Breaches of accounting and ethical conduct that occurred within Enron ......... 11
Four lessons ................................................................................................................... 12
Effects of unethical business practices on society & community .......................... 14
References .................................................................................................................... 15

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Enron: The beginning

Enron Corporation was founded by Kenneth Lay on 1985. It was the seventh
largest company in America. This company was formed by the merging of two
natural gas pipelines companies named Internorth and Houston Natural Gas.
Enron owned about 37000 miles of intra as well as interstate pipelines for the
purpose of delivering natural gas. The company has expanded their business in
a large number of non-energy- related fields such as risk management, Internet
bandwidth, weather derivatives but their principal business remained in the
spread and the distribution of power. Due to some regulatory changes in the
natural gas market, Enron made a huge profit for enhanced supply of gas and
flexibility. Moreover, Enron also introduced a diversification strategy. The
company expanded the natural gas model for the purpose of becoming the
market maker and financial trader in steel, electric power, pulp and paper and
others. Several international projects of construction and management of
energy facilities were also undertaken by Enron (Prebble, 2009).
The gas trading business of Enron was a huge success and by 1992 Enron was
the largest merchant of natural gas in North America. Furthermore, the
development of the on-line trading model, EnronOnline in November 1999
aided the company to improve their business and expand it abilities to
collaborate and mange the financial contracts. Enron had about 20,000 staff
and it was considered as one of the world's major natural gas, communication,
electricity, and pulp and paper companies (McLean and Elkind, 2003). This clearly
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suggests that Enron's domestic trading and international business flourished

spectacularly during the late 1990s. The capital markets were very impressed by
this growth of Enron. As per the Fortune Magazine, Enron was the most
innovative company of America for a continuous period of six years from 1996 to
2001.
Rise
Enron was really a successful company which made a huge progress in its
business. Kenneth Lay, in early 1990, enabled the company to sell electricity at
market price. However, the change in regulation for the sale of natural gas
enabled the company to earn huge profits. The new regulation deregulated the
cost and also allowed more flexible arrangements between the producers and
pipelines and thereby increased the spot market transaction use. Enron was the
owner of the largest interstate network and as a result it made huge profits with
the increased gas supply and flexibility. Due to this regulation Enron was able to
sale it energies at a very high price thus considerably it increased its revenue
(Fox, 2003).

Thus by 1992, Enron became the largest seller of natural gas in North America.
The trading gas contract of the company earned revenue of $122 million which
was the second largest contributor to the net income of the company. For the
purpose of managing its trading business in a better way, EnronOnline was
implemented in 1999. The company also introduced a diversification approach

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for the purpose of expanding its business. The company possessed and
managed a large number of assets such as electricity plants, water plants,
pipelines, pulp and paper industry and broad band services throughout the
world. Supplementary revenue was also gathered by the company by trading
contracts for the same collection of products and services with which it was
involved (Bryce, 2002).
The stock of Enron was increased by about 311% from 1990 to 1998 which was
slightly higher than the average rate of growth in the Standard and Poor Index
500. But there was increase in stock by 56% in 1999 and further 87% in 2000.
Moreover, the price of the stock was $83.13 by 31st December, 2000 and the
market capitalization increased by about $60 billion. This showed six times book
value and seventy times earnings and thereby pointed high future expectation
of stock market (Swartz and Watkins, 2003).
Fall
The seventh largest corporation in United State, Enron, collapse towards the end
of 2001. The complex and the difficult financial statements of Enron were very
difficult for analysts and the shareholders. Furthermore, its difficult business model
and immoral and dishonorable practices made it mandatory for the company
to misrepresent earnings as well as modify the balance sheet to indicate
favorable functioning and performances (Cruver, 2002).

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The basic reason for the collapse of Enron was the excessive, extravagant and
voracious desire for wealth. There was no shortage of assets in Enron. The basic
problem was that there were more liabilities than assets in the company.
Furthermore, it ran out of intractable cash flow. The employees intentionally
made wrong entries in the book of accounts. The auditor of Enron named Arthur
Andersen was aware of the fact but he did not take any steps to improve it in
order to maintain a good relation with the employees. However, at the time of
inspection, the auditor overlooked his faults and made the employees guilty for
making entries in the book of accounts.
The boards of directors were unable to complete their fiduciary duties towards
the shareholders of the company. The greed of the top executives of Enron
made them to work for their own self-interest. Most importantly, the external
auditing was outsourced for its internal auditing function in Enron. In place of
developing a functionally internal audit apparatus and proper checking, the
external auditors agreed to the statement of questionable accounting and
fraudulent financial reporting (Sterling, 2002).
Enrons internal and external checks
The main reasons for the failure of audit actually lie in the fact that various
business relationships are worsened by the wicked incentives and the
disagreements in the interest. Usually, auditors of a company are appointed
independently by the stakeholders of the company. The auditors are

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answerable to them. In general, the auditors are chosen by the bosses of the
company to whom they are very grateful. In the 21st century the fraud in
accounting system would be impossible for the efforts of corporate compliance
and a corporations internal checks and balances, although this was proved
wrong by Enron. The internal compliance officers, executives, lawyers, board of
directors as well as external agencies like Arthur Anderson, their law firm Vinson
& Elkins, the SEC and the credit rating agencies have either overlooked or have
ignored the fraudulent accounting practices of Enron (Benston, 2003).
In supporting the organizational reliability, the external governance plays a very
important part. Here, the question arises such as what was the reason that Arthur
Anderson, who was the external auditor of Enron and was considered to be the
chief player publicly, disclosed Enrons judgment and went on authorizing
Enrons questionable financial statements. It was the external auditors duty to
make sure whether the entries made in Enrons books are accurate for
protecting the interests of stakeholders. As there was a very close relationship
between Arthur Anderson and Enron, it discouraged them to whitsleblow on one
of their largest clients (Lay, 1990). In this case they earned much money from
consulting fees rather than from their work of auditing at Enron. In the year 2000,
as per the financial statement of Enron, Arthur Anderson acquired $25 million as
auditing fees and $27 million as non-auditing fees. As already mentioned there
was a close relationship between Arthur Anderson and Enrons employees
which is totally not feasible and therefore this lead Arthur to overlook the faulty
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books of Enron. In October 2001, just to prove the Enron employees guilty Arthur
Anderson tore up all auditing documents related to Enron. it lead to the fall of
Enrons internal and external checks and balances thereby failed to answer the
stakeholders about the fall (Klimt and Yang, 2004).
Continuous Auditing
The fall of Enrons external and internal checks and balances took place due to
the irresponsibility of Arthur Anderson as there grew a good relationship
between them and the employees of Enron, which should not happen and this
lead Arthur Anderson to overlook the faulty books of Enron. They made $27
million only by consulting the financial statement of Enron and by auditing they
made $25 million. The main concerns of the companies are that they mainly
focus on their appearance and damage control and they do not entertain the
examination that would root out the problem of trust violation. As per the
information the executives of Enron were just focusing on cashing their own
stock and they made sure that Enron appears to be successful on papers. They
did not bother to examine their own trust violations and did not try to rectify their
own misdeeds.
In the year 2000, the Congress passed Sarbanes-Oxley Act (SOX). The main
target of SOX is to protect investors by improving the dependability of corporate
discovery made agreement to the security laws. In order to get perfect
corporate accountability SOX has been implemented and strict penalties will be

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applied on those who will fail to obey. This act diminished the possibility of the
CEO or the CFO to state that they were totally unaware of the financial
problems of the company (Bratton, 2001). On the other hand the executives are
held responsible to sign all the financial statements of the company and the
signature should be done after ensuring the complete accuracy of the financial
statement. Again, the SOX have made compulsory to include all the internal
control reports of the company. The act framed this rule so that not only to show
the accuracy of the financial data but the companys confidence in them as
the adequate controls are in place to protect the financial data. At last, the
SOX have designed the Public Company Accounting Oversight Board (PCAOB)
whose duties are to register and inspect the public accounting firms and to
adopt and adjust the standard of audit. If Arthur Anderson inspected the audit
of the company properly keeping aside its relationship with the company then
the failure in the internal and external checks and balances would not have
taken place.
Enrons Demise
The Audit committee is provided with the regular presentations made on the
financial statement of Enron, the accounting practices and the audit results by
Anderson. Then the Chairman of the audit committee represents the reports to
the full board. Usually, the Audit Committee meetings were attended by three
of the most experienced members of Andersons Houston office namely, D.
Stephen Goddard, who is the head of the Houston office, David Duncan, head
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of Anderson engagement team and H (Gordon, 2002). Thomas Bauer who is

another head of the Enron engagement team. The Audit Committee offered
Anderson the scope of presenting information to them personally in the
absence of the management. The Corporate Secretary kept Minutes
summarizing Committee and Board meetings that took notes that were usually
hand written. At subsequent meeting the draft minutes were presented before
the Committee and board for their approval. Outside the formal meetings of the
committee and the Board, the directors of Enron had very little interaction or
communication between the Board members and Enron or Andersen personnel
or among the members of the Board. This continued until the company faced
such severe problems in October 2001. The Board held numerous meetings,
sometimes the meetings were held on a daily basis from the month of October
till 2nd December 2001, when the company faced bankruptcy. The members of
the Board of Enron were compensated with cash, phantom stock units,
restricted stocks and stock options. In the year 2000, the total cash and equity
compensation made to the members of the Board of Enron was about $350,000
or it may have been twice more than the national average for the Board
compensation at a U.S publicly traded corporation (Sims and Brinkmann, 2003).
The Board of directors has certain policies that are to be followed during the
auditing. The Board of directors prepared the financial statements in a
complicated manner and thus it became very confusing for the shareholders
and analysts as the results were also complicated. Again, on the other hand, the
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business models and unethical practices were undertaken by the company and
it made misrepresentations on the earnings and modified the balance sheet in
order to misrepresent that they are undergoing favorable performance.
Breaches of accounting and ethical conduct that occurred within Enron
At the time of financial reports the team proved to be very dishonest. Although
Enron have faced huge success, it found that several financial reports were
either missing or included false information. Through the Securities and Exchange
Commission, the Enron Company went under investigation. Houston competitor
Dynegy, the rival of Enron, offered to purchase the company at a very low
price. Though the deal failed as the decisions of Jeffery Skilling and the other
executives resulted in the bankruptcy and downfall of the company. Due to this
reason several employees of Enron became jobless and on the other hand
many of the employees had their whole savings invested in the companys
stock that have become worthless. Despite of losing billions in pension and stock
prices, the shareholders and the employee of Enron received very low returns in
lawsuits. Later, Skilling and other executives were sent to prison for the breaches
they made.
Though Enron had to face a big misfortune it also violated various accounting
guidelines. Ethical rules, boundaries and measurements were all broken and
violated. As far as the question arises regarding boundaries and measurement
rules, the company failed to throw light on its debts. As Enron proved to be a

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failure by not including various important information in the financial statement,

it had faced the violation of ethical rules. Due to the violation of guidelines and
ethical rules the company faced bankruptcy, several employees lost their jobs,
many investors lost their money and executives were sent to prison (Holt, 2008).
Although, the breach of ethical rules has resulted in the downfall of the
company, it affected the people in the negative way, other companies used as
their example. Many companies are following the accounting ethics properly by
accurately handli8ng the books and ensure that all the financial information is
correctly prepared. In order to have a successful business, accounting ethics
should be followed properly.
Four lessons
The case study reveals that extreme greed can result in the failure of an
extremely successful and powerful company. The public accountants were
unable to bring out the problems earlier. They were also unable to prevent Enron
managers to attest and produce misleading financial statements. These failures
of the accountants lead to strong criticism and, therefore, made a call for some
new reforms and remedies. The failure shows that how the lack of a government
agency to regulate and monitor the financial statement disclosure can affect
the working of successful business firm. The Securities and Exchange Commission
of USA which introduces the normally accepted accounting and auditing
standard had also the responsibility to review the financial statements and

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disapprove the statements which are inadequate to their requirements. But the
major problem with this agency is that it deals with small publicly traded
corporations. The lack of conducting investigations and recommending civil
and criminal actions by SEC can also be seen in this case.
The collapse of Enron was highlights the fact that there is a need for restricting
the CPA firm from presenting audit financial statements to their clients. The
individual CPA has to develop new disciplinary body headed by nonaccountants that may impose extra sanction against them. Thus the lesson from
the collapse of Enron has to be specified for the purpose of undertaking
remedial action that may prevent the occurrence of such cases further in future.
Furthermore, the principles of the governance need to be changed a little.
There is a vital need for the board of directors to have more focus on the
management behavior and also scrutinize the way in which the company is
making money. Rules should be established to question the management about
their working. There is also a vital need of prohibiting the ownership of both
auditing and consulting services by the same accounting firm. Again, excessive
corporate compensation and options of stock enabled corporate executives to
obtain too many incentives and to manipulate stock prices and the financial
accounts of the company.
It can be clearly understood that financial cleverness is not a better option than
a good corporate strategy and polices. Money can be earned in new economy

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only by providing goods and services that have accurate value and not by
displaying false accounts. The extra arrogance and the proud of the corporate
executives should be taken as a warning by the directors, investors and public.
There is also a need to update the government rules and policies for this
purpose (Holt, 2008).
Effects of unethical business practices on society & community
The downfall of Enron was really a major shock to the economy of USA. This was
one of the biggest bankruptcies in United States. The greed of the people and
the lack of sense of duty destroyed a very successful business company. About
4500 employees lost their jobs and became unemployed. About sixty billion
dollars were lost by the company within a few days. The pension fund of the
company employees was destroyed. The company which audited Enron lost its
accreditation.
It is evident that how the unethical business practices lead to the destruction of
a company which also had far reaching effects on the society and the people.
Due to the loss in the financial market, there was loss in the value of stock. Even
the banks were suspected that they were also involved in the case. The belief of
the citizen in the American economic system was lost. Thus it can be seen that
the fall of Enron has created a financial shockwave throughout the economy of
United States.

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References
Benston, G. (2003). Following the money. 1st ed. Washington, D.C.: AEI-Brookings
Joint Center for Regulatory Studies.
Bratton, W. (2001). Enron and the dark side of shareholder value. Tul. L. Rev., 76,
p.1275.
Bryce, R. (2002). Pipe dreams. 1st ed. New York: PublicAffairs.
Cruver, B. (2002). Anatomy of greed. 1st ed. New York: Carroll & Graf Publishers.
Fox, L. (2003). Enron. 1st ed. Hoboken, N.J.: Wiley.
Gordon, J. (2002). What Enron means for the management and control of the
modern business corporation: some initial reflections. The University of
Chicago Law Review, pp.1233--1250.
Holt, M. (2008). The Sarbanes-Oxley Act. 1st ed. Amsterdam: CIMA.
Klimt, B. and Yang, Y. (2004). Introducing the Enron Corpus.
Lay, K. (1990). The Enron story. 1st ed. New York: Newcomen Society of the
United States.
McLean, B. and Elkind, P. (2003). The smartest guys in the room. 1st ed. New York:
Portfolio.
Prebble, L. (2009). Enron. 1st ed. London: Methuen Drama.
Sims, R. and Brinkmann, J. (2003). Enron ethics (or: culture matters more than
codes). Journal of Business ethics, 45(3), pp.243--256.
Sterling, T. (2002). The Enron scandal. 1st ed. New York: Nova Science Publishers.
Swartz, M. and Watkins, S. (2003). Power failure. 1st ed. New York: Doubleday.

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