Enron: Questionable Accounting Leads to Collapse

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CASE 9

Enron: Questionable Accounting Leads to

Collapse
CASE NOTES FOR INSTRUCTORS
The purpose of this case is to show how it is possible for a well-known and respected company to become
swept up in unethical and illegal business practices, which can result in damage to thousands of
employees, investors and other stakeholders. Although this case is complex and involves many actors, one
important point that emerges is how a number of individuals, including attorneys, auditors, executives,
and employees, apparently worked together to achieve Enrons objectives, even though these objectives
were unethical and often not in the best interests of stakeholders.
The Enron case did not end with the collapse of the company. In addition to the complex ethical issues
involved in Enrons collapse, the company, its partners, and its employees have been caught in several
ongoing legal struggles. In 2004, Enron's new board of directors sued 11 financial institutions for helping
Lay, Fastow, Skilling, and others to hide Enron's true financial condition. The proceedings were dubbed
the "megaclaims litigation." Among the defendants were Royal Bank of Scotland, Deutsche Bank, and
Citigroup. Enron sold its last business, Prisma Energy, in 2006. In early 2007, it changed its name to
Enron Creditors Recovery Corporation. The sole goal of the newly-named organization was to pay off
Enron's remaining creditors and wrap up Enron's affairs. By 2008 Enron had settled with all involved
institutions, with Citigroup being the last. Enron was able to obtain nearly $20 million to distribute to its
creditors as a result of the megaclaims litigation.
Since the collapse of Enron, many executives who worked for the company or had business dealings with
it have been swept up in the investigations and prosecutions of the former energy giant. Many of the

people convicted of crimes connected to Enron have already served their sentences, but Jeff
Skilling remains in prison after being convicted of honest services fraud. However, in June 2010
the United States Supreme Court ruled that Skilling should not have been tried under the honest
services law because it was intended for bribes and kickbacks, not for conduct that is ambiguous
or vague. However, the courts decision did not overturn Skillings conviction, but sent the case
back to a lower court for evaluation.
Although this case may not seem so shocking now in the wake of Bernard Madoff and the failure of so
many of Wall Streets most venerable firms, students should keep in mind that at that time this case sent
shock waves around the world. Instructors may wish to have students compare aspects of this Enron case
with other cases provided in this book, such as Countrywide Financial, AIG, Bernard Madoff, and the
Galleon Group. These cases share elements, such the type of misconduct and pervasiveness of unethical
behavior in the companies corporate cultures. The Enron case now stands as a precursor for business
misconduct that dominated the early 21st century, and it remains a valuable case.

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Enron: Questionable Accounting Leads to Collapse

QUESTIONS AND DISCUSSION

1. How did the corporate culture of Enron contribute to its bankruptcy?
Most students will agree that Enron appears to have had a highly unethical corporate culture. However,
this point may be missed by students who are unfamiliar with business ethics and by those who view
Enrons difficulties as stemming from accounting or auditing problems. In reality, the root of the
companys downfall lay in its corporate culture that fostered a poor ethical climate and opportunities for
misconduct. The rank and yank system created a climate of fear in which performance was prized
above all other things. In order to meet performance goals, employees bent the rules when necessary.
Ruthlessness toward some stakeholders seems to have been the norm. This culture also focused on shortrun earnings rather than long-term strategy, and Enron did not consider the effects that company actions
would have on employees, shareholders, and society at large. If people had not feared for their jobs, there
is a chance that unethical conduct might have been uncovered before it became a full-blown disaster. To
the end, Ken Lay asserted that he was an ethical person; Enron even had a code of ethics. The problem
seems to have been a fundamental conflict between the companys stated beliefs and the examples set by
top management and the performance incentives for employees.

2. Did Enrons bankers, auditors, and attorneys contribute to Enrons demise? If so, how?
All corporations are supposed to have a number of different gatekeepers in place who ensure that the
business dealings are transparent and in compliance with the law. However, in the case of Enron, these
gatekeepers, such as accountants, independent auditors, and government regulators, failed to make sure
that Enron conducted business in a way that was in stakeholders' interests. For example, the auditors
appeared not to have held Enron to generally accepted accounting standards, which resulted in Enron
receiving certification on financial reports that did not accurately indicate Enrons financial health.
Financial reports are a key piece of information for investors and the financial community. It also appears
that the attorneys may have been involved in enabling the creation of certain questionable transactions.
Other large financial institutions around the world were also likely involved in enabling Enron to carry
out its business unimpeded by questioning stakeholders. Again and again, one finds gatekeepers and other
stakeholders willing to look the other way and not ask questions, so long as the firm continued to make
large profits.
Students can also take this opportunity to discuss the roles of individuals and personal responsibility
within the larger corporate structure. Several gatekeepers and employees had opportunities to uncover and
report ethical lapses, but very few people ever questioned Enron's practices. Highly idealistic students
could argue that individuals could have prevented the company's collapse and worked to influence the
corporate culture; however, other students may argue that it is easy to become swept away in an unethical
environment, particularly if the organization is powerful and respected like Enron was.
Instructors may wish to use Table 1 as a supplement to the Enron case. They may want students to
analyze the sentences that were handed down after researching what each key player did and what his/her
position was in the company. Instructors can also discuss the sentencing in white collar crime versus
normal crimes. Students can look at mandatory minimum prison sentences for a variety of violent and
white collar crimes at http://www.cga.ct.gov/2008/rpt/2008-R-0619.htm. After students realize that, for
example, having a handgun without a permit or the illegal sale or transfer of a handgun to a person under
age 21 carries a mandatory one year sentence, but taking thousands of employees pensions (which could
lead to bankruptcy, spousal or child abuse, alcoholism, drug addiction, and suicide) only yields probation,
students can have a rousing debate on the fairness of white collar sentencing. Some students will argue
about the inequality in the treatment of poor versus rich defendants and the sentences they receive. Others
will argue that, because a violent act was not involved, the penalties for white collar crimes should be less

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Enron: Questionable Accounting Leads to Collapse

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than for violent crimes. Students might also discuss the meaning of prison sentences, such as whether
they are meant to deter or punish. Instructors may wish to debate whether there should be mandatory
minimum sentences for white collar offenses.

3. What role did the companys chief financial officer play in creating the problems that led to
Enrons financial problems?
This question should help students better understand the role of the chief financial officer (CFO), a role
filled at Enron by Andrew Fastow, who was key in creating Enrons financial problems. Representing the
final word on a corporations finances, the CFO plays a very important role in most firms. At Enron, most
believe that it was Fastow who masterminded many of the unethical/illegal financial transactions that
ultimately led to the destabilization and demise of the company. In his position as CFO, Fastow had
access to information and numbers to which Skilling and Lay did not. He was in a unique position to
manipulate Enrons financial reports to make Enron appear strong and profitable no matter how unstable
the company actually was.
For much of the past few decades, the role of CFO has been a contentious one. The CFO was associated
with major mergers and acquisitions deals in the early 1990s and was reputed for seeking out loopholes
and accounting tricks in the late 1990s. However, a good CFO should be a highly ethical person because
of his or her powerful and potentially sensitive position within the firm. CFOs are expected to present
reliable financial information to stock analysts, as well as to ensure that their companies achieve projected
financial goals.
Even upstanding CFOs often become scapegoats if their companies perform poorly. Because of the
pressure, their average tenure is only about four years. After the Enron bankruptcy and the passage of the
Sarbanes-Oxley Act, CFOs have necessarily been focused on the fundamentals within their companies
(such as financial controls, internal auditing procedures, and accounting practices). In the case of Enron,
CFO Andrew Fastow seemed to have been singularly focused on making certain that Enron hit the
numbers, even at the expense of his duty as a gatekeeper. He should have been equally focused on being
certain that financial controls, internal auditing procedures, and accounting practices were in place and
operating correctly in order to protect stakeholders.

ADDITIONAL RESOURCES

Ungagged.net: The Other Side of the Enron Story offers the perspectives of Enron employees
who believe they were the victims of the federal governments desire to get convictions and place
blame. http://ungagged.net

Interactive graph of Enrons stock price and the actions of important Enron executives and
partners: http://www.time.com/time/interactive/0,31813,2013797,00.html

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98

Enron: Questionable Accounting Leads to Collapse

Key Enron Figures and Their Sentences

Name

Sentence

Jeffrey Skilling

24 years and 4 months in prison

$45 million in fines
Scheduled for release on February 21, 2028, when he will be 74 years old.

Andrew Fastow

6 years in prison
$23.8 million in cash and property

Lea Fastow

1 year in prison
1 year of supervised release.

Richard Causey

5 years and 6 months in prison

2 years of probation
$25,000 fine
Agreed to pay another $1.25 million to the victims' funds
Forfeited a claim to about $250,000 in deferred compensation

Ben Glisan Jr.

5 years in prison

Michael Kopper

37 months in prison, served 23 months

Jordan Mintz

$25,000 in civil fines

$1 in disgorgement
2 year ban from practicing before the SEC

David Duncan

$25,000 in civil fines

$1 in disgorgement
2 year ban from practicing before the SEC

Timothy Belden

$2.1 million in fines

2 year ban from practicing before the SEC

Larry Lawyer

2 years of probation

Jeffrey Richter

2 years of probation

Kevin Howard

1 year of probation

Rex Shelby

3 months in a halfway house

3 months of house arrest
$3.6 million in fines

Dan Boyle

3 years and 10 months in prison

$320,000 in fines

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Enron: Questionable Accounting Leads to Collapse

David Delainey

2 years and 6 months in prison

$8 million in fines

Paula Rieker

2 years of probation

Kenneth Rice

27 months in prison
$15 million in fines

John Forney

2 years of probation

Mark Koenig

18 months in prison
$50,000 in fines.

Kevin Hannon

2 years in prison
2 years of probation
$125,000 fine

Timothy Despain

4 years of probation
$10,000 in fines

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