Running head: ENRON CORPORATION (FORMER NYSE TICKER SYMBOL ENE) 1

Enron Corporation (former NYSE ticker symbol ENE)

Kevin Tomaszewski

Strayer University-Maitland Campus

Business Law I

LEG 100

Dr. Michael Hanners

October 24, 2010

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Abstract

This is an investigation into the various activities which surrounded the historic collapse

of Enron Corporation, one of the largest bankruptcies ever recorded. A brief description of the

company’s corporate structure is discussed, with a few possible suggestions which could have

improved its ethical character. Then a look into the governing style of Enron’s chief officers is

examined, both in its early developmental stage, and later on, when the company had

transformed into a financial powerhouse within Wall Street investment circles. The overall

corporate culture at Enron is also explored in detail. Afterward, the scene moves into the

relationships established between Enron and several sellers of its investment securities. Then, a

determination is summarized on who could be held liable for the actions of Enron’s

representatives and employees. Was only one company responsible for any unethical behavior,

or can this be better perceived as a collaborative effort? Finally, a short look at recent legal

activity is brought to light, which may have a direct bearing on a key player in Enron’s

misfortune.
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Enron Corporation (former NYSE ticker symbol ENE)

Introduction

During its business boom years in the late 1990s, it seemed that Enron Corporation could

do no wrong, at least where Wall Street was concerned. But on December 2, 2001, Enron

declared bankruptcy, the largest ever recorded up to that date. This unprecedented business

failure deserves to be examined repeatedly in order to see where errors were made, and if there

were steps the executives at Enron could have taken in order to save themselves. Perhaps there

were design flaws in the organizational structure from the very beginning?

Petrick and Scherer (2003) identified that integrity capacity was the core ingredient

missing from Enron’s top management makeup.

What is legally permissible today, but morally questionable, may well become legally

proscribed tomorrow. Thus, it is important for managers to proactively understand and

attend to the multiple dimensions and moral antecedents of illegal activity. Integrity

capacity is the individual and collective capability for the repeated process alignment of

moral awareness, deliberation, character, and conduct that demonstrates balanced

judgment, enhances ongoing moral development, and promotes supportive systems for

moral decision making. It is one key intangible asset that acts as a catalyst for

reputational capital and its erosion can jeopardize the survival and credibility of

organizations and markets. (p.1)

How Enron Could Have Been Structured Differently

Enron Corporation wasn’t originally formed as an energy trading company. In 1985,

Kenneth Lay founded the firm from a merger of two smaller natural gas companies. In those first

years, Enron was structured in what was considered to be rather typical for a regulated energy
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exploration business, with a limited amount of trading. This strategy would change dramatically

when original CEO Richard Kinder was replaced by Jeffrey Skilling in 1996. Within a couple of

years, Enron would morph into a financial services company specializing in energy derivatives,

options, and futures trading, and then expand into a diverse array of commodities (such as

broadband). This transformation was designed to take advantage of newly deregulated energy

futures pricing, as Lay had in past years been a key advocate within political circles. Skilling was

keen to vigorously exploit this ‘new economy’ of intangible resources to the fullest, as he tied

bonuses and stock options to executives and traders who would meet their earnings targets.

Would Enron have benefitted from a different corporate structure when it changed its

focus towards financial services? Reforming the bonus pay program criteria would have proven

valuable; otherwise, the company already boasted a strong management control system. Key

elements of this control system included an integrated Risk Assessment and Control group, a

Peer Review Committee for keeping employees in line with company objectives, and a Code of

Ethics so widely admired in outside circles that the Smithsonian Natural Museum of American

History put a copy of the Code on public exhibit. These controls were enhanced by the usual

standard corporate governing mechanisms, plus external auditing expertise through the well-

regarded name of Arthur Andersen, and oversight by the Securities and Exchange Commission

(Free, Macintosh and Stein, 2007, p. 4-5.). With such an intricate infrastructure at its disposal,

one might presume that it would take too much internal negligence to undermine all of these

safety precautions. In hindsight, a lack of moral will on the part of Enron’s officers, financial

partners, and oversight accountants created a ‘perfect storm’ of fraudulent activity that managed

to subvert the moral integrity and fiscal structure of the company to the majority of its

stakeholders.
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How could this scenario have been prevented? Two key sets of stakeholders in which

Enron’s much-lauded control systems failed to provide enough feedback controls involved

employees and shareholders. Top management and other members of the governing board

routinely glossed over concerns at shareholder meetings by touting their own public relations

images, while at the same time diverting funds into secret accounts, and selling off shares of

stock for personal gain. Employee whistleblowers (such as trader Sherron Watkins) were given

the quick brush-off, thereby diminishing any significant opportunity for ethical awareness and

strategic responsiveness.

Did Enron’s Officers Act within the Scope of Their Authority?

When it comes to business ethics, the general consensus believes that the Chief Executive

Officer plays the most important role in the organization. Yet Chairman Kenneth Lay may have

set the standard for errant accountability during Enron’s oil trading scandal of 1987, which had

almost brought down the company well before Skilling’s tenure as CEO. In 1987, two traders

with the Enron International Oil, Inc. unit lost eighty-five million dollars on risky and dangerous

bets. As a result, Enron’s profits for that year were cut in half. Kenneth Lay’s public statements

in reaction to the incident claimed ignorance of the problem. But he later defended the two

traders during an October conference call, even in the face of claims that they had

misappropriated funds (Johnson, Prosecutors Link Enron Fall to 1987 Scandal, 2005).

This arbitrary approach to accountability may have influenced Enron’s officers in later

years, allowing them to act well beyond the boundaries of their assigned duties without fear of

retribution. But in those earlier years, original CEO Richard Kinder oversaw operations

efficiently on a tight budget, and was known for holding employees accountable for any potential

revenue threats. Kinder’s top priority centered around cash management; thus he assigned
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budget and expense targets to all business group managers, tying the company’s bonus program

directly to those who met these targets on a regular basis.

Enron’s Corporate Culture

However, the arrival of Jeffrey Skilling as CEO in 1996 altered Enron’s corporate culture

significantly by the driven force of his personality. Skilling’s management style emphasized risk-

taking initiatives and creative accounting methods designed to achieve short-term results which

would please Wall Street analysts and investors.

Skilling’s aggressive and rather mercenary attitude towards Enron’s strategic goals also

extended towards his company’s hiring and firing practices. Enron’s performance review system

tied too closely to end results than it should have, as it routinely shaved off 15% of its workforce

for low numbers, regardless of other employee proficiencies. Subsequently, traders were faced

with the dilemma of either delivering higher numbers by any means necessary, or face the

inevitability of demotion or termination. Many of them then chose the former, in order to please

their boss.

Investigations into the scandal, as documented in the 2002 Senate Subcommittee Report,

summarized that Enron’s board of directors had willfully created a culture of deception

throughout the firm. Chairman Lay was accused of using direct force to eliminate any potential

successors who he had personal disagreements with. Other top officers were charged with using

indirect force to manipulate workers and stakeholders in order to artificially inflate their own

shares of stock for quick sale (Petrick, et al., 2003, p. 4).

Alleged Irregularities in the Actions between Sellers of Securities and Enron

Under Skilling’s direction, accountants began to record short-term profits from long-term

deals which had yet to show any profits. This unconventional approach, referred to as ‘mark-to-
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market accounting’ using ‘hypothetical future value’, also put an enormous amount of pressure

on the traders for instant results. Where mark-to-market accounting could achive its greatest

impact was through Wall Street securities investors and the companies which were assigned to

protect their financial interests.

Yet instead of protecting the integrity of their clients’ portfolios, companies such as

Merrill Lynch, Citibank, and J.P. Morgan Chase continued to mislead them, and accepted

Enron’s returns claims at face value without bothering to actually verify the numbers. Supposed

‘outside’ accountants at Arthur Andersen also helped falsify Enron’s bank accounts, and

accepted and shared inside information with other clients. Credit Suisse First Boston aided Enron

on a series of equity transactions repaid to the banks before they were mature, and also served as

a recipient for a series of fraudulent commodities deals in which commodities were never

actually delivered.

Merrill Lynch, in connection with Enron’s CFO Andrew Fastow, helped establish various

off-balance sheet ‘special purpose entities’ for the express purpose of hiding the company’s

mounting debt load. They also aided the company as an underwriter of stocks and bonds, in

lending and fundraising, and even became involved as an illegal investor. Three executives at

Merrill Lynch agreed to ‘park’ three Nigerian power-generating barges in order to help Enron

fraudulently enhance its financial standing. According to company insiders, the bank bowed to

Fastow’s demands, due to his threat that Enron would take its business elsewhere. For its

officers’ complicity, Merrill Lynch was eventually cited for conspiracy to commit fraud,

falsifying books and records, and perjury.

Was Enron Liable for the Actions of its Agents and Employees?
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Naturally, legal grievances were filed by numerous victims of these unethical activities.

However, the Fifth Circuit Court of Appeals ruled that while the banks’ role in the scandal was

far less than praiseworthy, the banks themselves didn’t present any false statements about their

own conduct. Thus they are exempt from liability to Enron’s victims, even though they actively

participated in their schemes to defraud the company’s shareholders. Yet many of the banks that

were identified in the complaints have eventually settled out of court with their investors for

billions of dollars. One may speculate that these settlements were essentially designed to save

public face.

However, ethically it seems clear that Enron becomes liable for its employees’ actions

through their representation of the firm. Another great tragedy in this case lies in the shattered

reputations of many people who actually believed in the promotional spin that the company had

been selling to the public. Free, Macintosh and Stein (2007) of the Queen’s School of Business

summarized the saga of Enron’s downfall in the following statement.

What Enron clearly demonstrates is that once employees align themselves with a

particular culture-and invest heavy commitment in organizational routines and the

wisdom of leaders-they are liable to lose their original sense of identity, and tolerate and

rationalize ethical lapses that they would have previously deplored. Once a new and

possibly corrosive value system emerges, employees are rendered vulnerable to

manipulation by organizational leaders to whom they have entrusted many of their vital

interests (p. 9).

Epilogue

In the aftermath of the collapse of Enron, subsequent investigations have led to the

prosecution of more than sixteen of the corporation’s top executives, and several liability claims
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continue to this day. However, Kenneth Lay suffered a fatal heart attack during the course of his

trial, so sentencing was never completed. On the other hand, Jeffrey Skilling remains

imprisoned, although a recent Supreme Court decision in June threatens to overturn his multiple

convictions of conspiracy to commit honest services wire fraud, securities fraud, and money or

property wire fraud. In a unanimous decision, the Court restricted prosecutors’ interpretation of

the honest services statute to cases involving bribery and kickbacks, neither of which Skilling

was accused of committing. In her written opinion for the Court, Justice Ruth Bader Ginsburg

outlined which aspect of the Constitution could be threatened by a broad interpretation.

In view of this history, there is no doubt that Congress intended (this statute) to reach at

least bribes and kickbacks. Reading the statute to proscribe a wider range of offensive

conduct, we acknowledge, would raise the due process concerns underlying the

vagueness doctrine. To preserve the statute without transgressing constitutional

limitations, we now hold that (this statute) criminalizes only the bribe-and-kickback core

of (earlier) case law. "As to arbitrary prosecutions, we perceive no significant risk that

the honest services statute, as we interpret it today, will be stretched out of shape (Flood,

2010).

Because of this ruling, the Supreme Court remanded Skilling’s case back to the Fifth

Circuit Court of Appeals, to decide whether the honest services inclusion entitles him to a new

trial. The hearing is scheduled for November 1st of this year. Prosecutors may argue that the

inclusion of the honest services clause was a ‘harmless error’, as jurors most likely voted to

convict based on the entirety of the multiple charges filed. However, what is not harmless was

the excessive damage that the Enron scandal has inflicted on the public image of corporate
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ethics, particularly in the fields of energy, finance and governmental regulation. This extensive

damage to the reputations of many will be nearly impossible to repair for many years to come.

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