ENRON

Introduction
Kenneth Lay, an energy economist became chairman and chief executive As the energy markets, and in particular the electrical power markets were deregulated, Enrons business expanded into brokering and trading electricity and other energy commodities. Enron followed the Financial Accounting Standards Boards rules for energy traders which permit such companies to include in current earnings those profits they expect to earn on energy contracts and related derivative estimates Enron would trade in energy and offer electricity for sale around the country by locking in supply contracts at fixed prices
Enron was born in July 1985 when Houston Natural Gas merged with Omaha-based Inter-North.

 They would then hedge on those contracts in other markets as well Enron rolled out its online trading of energy as a commodity and had 1800 contracts in that online market When the competition began to heat up in energy trading, Enron started diversification activities which proved to be a disaster They invested money in power plants in Brazil and India and forayed into fibre optics and the broadband market Their 1 billion investment in the Indian power plant got into dispute due to which the government stopped paying its bill for the power

 Over anticipation of the market let Enron to experience losses in the broadband segment On October 16, 2001, in the first major public sign of trouble, Enron announces a huge third-quarter loss of $618 million. On October 22, 2001, the Securities and Exchange Commission (SEC) begins an inquiry into Enrons accounting practices. On December 2, 2001, Enron files for bankruptcy.

Enrons Breach of Ethics: Energy Trading Strategy

Enron would schedule electric power transmission on a congested line from bus A to bus B in the opposite direction to demand, thus enabling them to collect a congestion reduction fee for seemingly relieving congestion on this line. Enron would then schedule the routing of this energy all the way back to bus A so that no energy was actually bought or sold by Enron in net terms. It was purely a routing scheme.

Accounting Schemes
Enrons creation of over 3000 partnerships started about 1993 when it teamed with Calpers (Calif. Public Retirement

System) to create JEDI (Joint Energy Development Investments) fund. Why partnerships? As long as Enron could find another

partner to take at least a 3% stake, Enron was not required to report the partnerships financial condition in its own financial statements. Enron used partnerships to hide bad bets it made on speculative assets by selling these assets to the partnerships in return for IOUs backed by Enron stock as collateral! (over $1 billion by 2002)

 Enron received $10 million in guarantee fee + fee based on loan balance to JEDI. Enron received a total of $25.7 mil revenues from this source. In first quarter of 2000, the increase in price of Enron stock held by JEDI resulted in $126 million in profits to Enron. But everything fell apart when Enrons share price started to drop in Fall 2000 (dot.com bubble burst ). In November 2001, Enron admitted to the SEC that Chewco was not truly independent of Enron. Chewco went bankrupt shortly after this admission by Enron.

Where Enron Faltered

The practice of mark to market accounting proved to be particularly hazardous for Enron management because their bonuses and performance ratings were tied to meeting earnings goals The result was that their judgment on the fair value of these energy contracts was greatly biased in favour of present recognition of substantial value The assumptions and variables used in this practice is not discussed in financial statements The company also made also made minimal disclosures about its off- the- balance-sheet liabilities that it was carrying The death star scheme

Who is to blame?
CEO Kenneth Lay Charges: Fraud,False Statements Died 23/7/06 with charges pending CEO Jeffrey Skilling Charges: Conspiracy, securities fraud, false statement, insider trading 24 year prison sentence (23/10/06)

 David Duncan Charges: Rogue auditor from Arthur Anderson Fired on 15/1/02 CFO Andrew Fastow Charges: Conspiracy, securities fraud, False statement, insider trading, setting up the partnerships
(6 year prison sentence on 26/9/2004)

Conclusion
Demonstrated the need for significant reform in accounting and corporate governance in the U.S. U.S. legislative response to recent spate of accounting scandals was the compliance with comprehensive reform of accounting procedures is now required for publicly held companies

Sarbanes Oxley Act 2002

Companies must list and track performance of their material risks and associated control procedures. CEOs are required to vouch for the financial statements of their companies. Boards of Directors must have Audit Committees whose members are independent of company senior management. Companies can no longer make loans to company directors.

Suggestions
They should not have diversified into broadband and power plants where they invested a lot of money They created a complex web of partnerships which should have been avoided They should have kept their accounting transparent and avoided deception