ENRON

CASE:
SPECIAL
PURPOSE
ENTITY

WHOS LOSING?
WHOS GAINING?

 Enron's shareholders lost $74

billion in the four years before
the company's bankruptcy ($40
to $45 billion was attributed to
fraud).
More than 20,000 Enrons former
Employees lost $2 billion in
pensions.
Employees lost more than $1.2
billion in retirement funds.
Retirees lost $2 billion in pension
funds
20,000 employees lost there jobs
and medical insurances.
Enrons top executives cashed in
$116 million in stock.

 In the three years

leading up to the
company's demise :

Ken Lay cashed out

US$184.5
million
in
stock.
Jeff Skilling sold US$70.7
million
Andy Fastow pulled in
US$33.7 million
Add up all the stock
sales by senior Enron
executives
over
that
period, and it comes to
US$1.2 billion.

HOW DID ENRON

FALL?

The Fall Of Enron

N
o

Date

Juli 2001 Enron announced a large loss in its quarter statement

Description

Enron blamed losses on the California energy crisis,

poor results from its investments in India and South
America, and a broadband Internet market
2

14
Agustus
2001

Jeff Skilling Resigned as CEO, because of personal

reasons
Jeff Skilling was Replaced by Kenneth lay
Sheeron Watkins an Enron VP, wrote Anonymous
letter to Kenneth Lay expressing concerns many of
the misleading accounting treatments used by Enron
Watkins describes her reservations about the lack of
disclosure of the substance of related party
transactions with SPEs run by the CFO of Enron,
Andrew Fastow

Lay sells $2M(83,000 shares) worth of shares and

dishonestly told employees and others that Enron stock
was an incredible bargain even after he had been

N
o

Date

Description

16
Oktober
2001

Enron Corporation, announced:

reduction in its after-tax net income by $544
million;
reduction in its shareholders equity by $1.2
billion.
Moodys downgraded Enrons debt.

22
Oktober
2001

3rd qtr loss of >$600 million and surprised

Wall Street.

The

Enron announced that SEC was looking into related

party transactions between Enron and partnerships
owned by its CFO Andrew Fastow.
5

17 OktNov 19
2001

Enron Employees were not allowed to sell their

Enron stock in 401K plans due to a change in
their pension fund administrator while the
executives were cashing in stock options During
this time
the stock plummeted from $32 to $9.06 when it

No Date

Description

23 Oktober
2001

Arthur Anderson shreds 1 ton of Enron related

documents

31 Oktober
2001

SEC inquiry upgraded to a formal investigation

8
November
2001

Enron announced to investor that enron

restatement of its financial statements for 1997
thru 2000(4 Year) to reflect consolidation of SPEs.
it had omitted as well as to book adjustments
recommended by Arthur Andersen for those
years, which Enron
had previously deemed
immaterial
these restatements reduced previously reported
net income as follows:

N
o
9

Date

Decemb Enron filed for bankruptcy under

er 2,
Chapter 11 of US Bankruptcy
2001
Code With assets of $63.4 billion,
largest US corporate bankruptcy
in history
10 January Enron fires Arthur Andersen as its
17,
independent
auditor
Cites
2002
document destruction and lack of
guidance on accounting policy
issues
11 Enrons When Enrons collapse:
collapse Skilling made over $200M in

Timeline for Enron

Juli

16 Oktober

17 Okt- 19 Nov

31 Oktober

2 Desember

Bankruptc

14 Agustus

23 Oktober

22 Oktober

8 November

17 January

2001
<Juli
2001

Prosperous Business(looks like)

17 Okt-19
Nov

Enron Employees were not allowed

to sell stock

Juli

a large loss in its quarter

statement

23 Oktober

shreds 1 ton of Enron Dociument

31 Oktober

Investigation by SEC

14
Agustus

Jeff Skilling Resigned as CEO

8 November

restating earnings for the past 4 and

years

16
Oktober

Moodys downgraded Enrons

debt

HOW THEY DID IT?

 Trading bussiness model involved

complex long term contracts
Mark to Market Accounting long term
contract was signed, present value of
future contract inflow was recognized as
revenue, present value of expected
costs to fulfilling the contract was
expensed

Structured finance transaction that

used as part of its hedging strategy
SPE

SPE (Special Purpose

Entities)
Shell companies created to acquire specific
cash flows generated from Enrons customer
contract with gas buyer, and funded by
independent equity investors and lenders

Consolidate or not ?
3% RULE : independent third party owner have a
substantive equity stake that was at risk in the SPE
independent third party owner had to have a
controlling (more than 50%) financial interest in the
SPE

CHEWCO
Formed to maintain
JEDI as an
unconsolidated entity
Fastow initially
proposed to act as a
manager, but then
Kopper, an Enron
employee,
substituted as the
proposed manager of

1997 : - $28
mio

1997 : +$711
mio

1998 : -$133
mio

1998 : + $561
mio

1999 : -$153
mio

1999 : + $685
mio

Reported Debt

Reported Net
Income

EFFECT CHEWCO ON ENRONS

FINANCIAL STATEMENT (as
restated in 2001)

W
E
H
C
O
C

CALPERS
(California
Pension
Retirement
System)

50% interest
$ 250 mio in
cash

50% interest
$ 250 mio in
enron stoks

JEDI (Joint
Energy
Development
Investment
Limited
Partnership

CALPERS
Short term
loans

$ 383 mio
buyout

$ 383 mio

CHEWCO

JEDI

$ 11,4
mio
Guarante
e loan

BARCLAYS
BANK

$ 240
mio
loan

CHEWCO
JEDI

$ 132
mio loan

$ 6,6 mio

Big River &

Little River

$ 11,4
mio

$
125,000

William
Dodson &
Michael
Kopper

 Michael Kopper was paid :

$ 2 million in fees relating to chewco
General Partner (December 1997
December 2000)
$ 500,000 as annual management fee to
SONR#1 (Kopper was sole manager)

Arthur Andersen CPA firm, received $

80,000 for reviewing Chewco in 1997

Recognition Issue
Recognize revenue from JEDI partnership
fees paid to Enron by JEDI and Chewco
Enron guaranty fee for loan by Barclays to
Chewco ($17,4 million) $7 mio from
JEDI contribution, remainder from
revolving credit agreement with JEDI
guaranty fee income should be
recognized over the guaranty period

Recognition Issue (contd)

Required payment to Enron March 31,
1998, Enron recognized $25,7 million in
income should be recognized only when
services were rendered should be
recognized income over the covered period
Not recognize declined in value of Enron
stock hold by JEDI in 2001 approximately
$94 million but recorded increase in
value of Enron stock held by JEDI in 2000
and prior years

WHY THEY DID

THAT?

FRAUD
TRIANGL
E

- Top executives, managers, and

employees bonuses is stock or
stock option
- PRC feedback system
- Maintaining credit rating at
investment grade

- Loophole in regulations
- Deregulations in Energy
Industries

- Arthur Andersen CPA firm

approved
- Vinson & Elkins Law Firm
approved
- Bankers know well the transaction

WHOS THE
CRIMINAL?

Kenneth Lay
2001 : Lay sold large amounts of
Enron stock in September and
October as its share price fell., he
liquidated more than $300 million
in Enron stock from 1989 to 2001.
July 2004 : Lay was indicted for his
role in the company's collapse,
including 11 counts of securities
fraud, wire fraud, and making false
and misleading statements.
May 25, 2006 :Lay was found guilty
on all six counts of conspiracy and
fraud.
July 5, 2006 : died of heart attack
caused by coronary artery disease

Jeff Skilling

August 2001 : unexpectedly

resigned and sold almost $60
million in Enron shares.
December 2001 : company
declared bankruptcy
2006 : Skilling convicted of
multiple federal felony charges,
including insider trading,
securities fraud, and making false
statements to auditors.
fined $45 million and was
currently serving a 24-year, 4month prison sentence
2013 : a federal judge reduced
Skillings sentence by a decade.
As part of the deal, Skilling
dropped his remaining appeals
and turned over $40 million in
restitution which had been held up

Andy Fastow
1990 : Andrew Fastow joined Enron
2001 : was the companys chief financial
officer when it went under investigation
for concealing massive losses
October 31, 2002 : was indicted on 78
counts including fraud, money laundering,
and conspiracy.
2012 : pleaded guilty to two counts of
wire and securities fraud and struck a deal
with federal authorities to become an
informant of other former Enron
executives in exchange for a reduced
sentence.
release on December 16, 2011. working as
a document review clerk for a law firm in
Houston
His wife, former Enron assistant treasurer
Lea Fastow, was sentenced to one year in
federal prison and one year of supervised
release in a halfway house.

Andy Fastow

No one ever asked me to give a presentation

when I was CFO of Enron. But I get invited
every week to give a presentation now, and
the only reason is because I was in jail.

Lou Lung Pai

March 1997 - January 2001 : CEO
of Enron Energy Services
February - June 2001 : CEO of
Enron Xcelerator, a venture
capital division of Enron
left Enron with over $280 million.
Pai was the second largest land
owner in Colorado and his division
losing $1 billion
has not been charged with any
criminal wrongdoing in the Enron
scandal
forfeited $6 million due to him
from Enron's insurance policy for
company officers to a fund for
Enron shareholders.

Michael
Kopper
first Enron executive to admit
guilt and pledge cooperation
with federal prosecutors.
has pleaded guilty to charges
of money laundering and wire
fraud, and has promised to
pay back $12m of ill-gotten
gains.
expected to spill the beans
on Enrons top bosses,
allowing the prosecution to
put together a stronger case.

HOW THE
REGULATORS
REACT?

 enforcing the
federal
securitieslaws,
proposing
securities
rules, and
regulating the
securities
industry, the
nation's stock
and options
exchanges,
and other
activities and
organizations,
including the
electronic
securities
markets in the
United States

NYSE

SEC

FASB

establish and
improve
standards of
financial
accounting and
reporting that
foster financial
reporting by
nongovernmental
entities that
provides
decision-useful
information to
investors and
other users of
financial
reports.

To add value to
the capitalraising and assetmanagement
process by
providing the
highest- quality
and most costeffective selfregulated
marketplace for
the trading of
financial
instruments,
promote
confidence in and
understanding of
that process, and
serve as a forum
for discussion of
relevant national
and international
policy issues

FASB post Enron case

The FASBs immediate response to Enrons SPE accounting (FASB, 2002) suggests that the
economics ideology is too strong for a revisionist revolution overthrowing the asset-liability
framework. It concludes that the accounting lesson from Enron is that US accounting is a
badly holed ship

FASB issued a proposed interpretation

of ARB No. 51, Consolidation of Certain
Special-Purpose Entities (August,
2002)

Transactions involving SPEs have become increasingly common, and the

existing literature related to SPEs is fragmented and incomplete. Current
accounting standards require an enterprise to include

subsidiaries in which it has a controlling financial

interest in its consolidated financial statements.
That requirement usually has been applied to subsidiaries in which an
enterprise has a majority voting interest, but in many circumstances, the
enterprises consolidated financial statements do not include
SPEs with which it has fundamentally similar relationships (FASB,
2002, p.i).
Some enterprises appear to have used SPEs to avoid reporting assets
and liabilities for which they are responsible, to defer the
reporting of losses that have already been incurred, or to report
gains that are illusory (FASB, 2002,p.13).

FASB reform SPE Enron

Accounting
an SPE should be consolidated by its primary beneficiary
when the SPE lacks sufficient independent economic
substance. An SPE is an entity that supports the primary
beneficiarys activities.
It was ruled that an SPE has sufficient independent
economic substance if, at all times during its life, it is able
to fund or finance its operation without the assistance
from, or reliance on, the primary beneficiary.
The new rule would require independent outside
investors to provide cash amounting to at least
10% (vs 3%) of the SPEs capital for it to avoid the
requirement for consolidation. The ruling will apply to
existing partnerships

NYSE Action Post

Enron
February 13, 2002 : the SEC
recommended changes of the stock
exchanges' regulations.
June 2002 : theNew York Stock Exchange
announced a new governance proposal,
November 2003 : the governance
proposal was approved by the SEC.

NYSE Action Post

Enron
The main provisions of the final NYSE proposal include
All companies must have a majority of independent directors.
Independent directors must comply with an elaborate definition
of independent directors.
The compensation committee, nominating committee, and audit
committee shall consist of independent directors.
All audit committee members should be financially literate. In
addition, at least one member of the audit committee is
required to have accounting or related financial management
expertise.
In addition to its regular sessions, the board should hold
additional sessions without management.

Chhaochharia, Vidhi; Yaniv Grinstein (March 2007).

"Corporate Governance and Firm Value: the Impact of the 2002 Governance Rules" (PDF).Johnson School
Research Paper Series No. 23-06(Johnson School of Management ): 79. Archived fromthe originalon 201010-17. Retrieved2010-10-17.

SEC recommendation
post
Enron
1. Review More Filings and Review Them More
2.
3.
4.
5.

Wisely and Efficiently

Look for Fraud
Follow Up To Ensure That Commission Mandates
Are Met
Supplement Aggressive Enforcement With Other,
More Proactive Measures
Coordinate Better With Other Agencies

Sumber :
Financial oversight of Enron :The Sec and Private sector watchdogs
Commitee on Governmental Affairs United State Senate