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Risk Management Failure

Case Study Enron







Presented & Submitted by

Jayesh Dubey: PRN 09020842010
Ram Prakash Singh: PRN 09020842033
Semester 4
Corporate Risk & Insurance Management
Assignment 1

Prof. MVS Prasad
20
th
March 2011
Enron The Rise & Fall

1. Enron was based in Houston, Texas, US and was founded in July 1985 when Kenneth Lay
merged the natural gas pipeline companies of Houston Natural Gas and InterNorth to form
Enron

2. Enron Corporation was one of the largest global energy, services and commodities
company.

3. It sold natural gas and electricity, delivered energy and other commodities such as
bandwidth internet connection, and provided risk management and financial services to
the clients around the world.

4. Its revenues made up US $139 billion, assets equaled $62 billion, and the number of
employees reached more than 30,000 people in 20 countries around the world.

5. Enron filed for bankruptcy in late 2001. It was revealed that its reported financial condition
was sustained substantially by institutionalized, systematic, and creatively planned
accounting fraud.

6. It emerged from bankruptcy in November 2004, pursuant to a court-approved plan of
reorganization.

7. On September 7, 2006, Enron sold its last remaining business .
Accounting Scandal
1. In 1993, Enron established numerous limited liability special purpose entities, however, it
also allowed Enron to place liability so that it would not appear in its accounts, allowing it
to maintain a robust and generally growing stock price and thus keeping its critical
investment grade credit ratings.

2. Many of Enron's recorded assets and profits were inflated or even wholly fraudulent and
nonexistent.

3. Debts and losses were put into entities formed "offshore" (units which may be used for
planning and avoidance of taxes ) that were not included in the firm's financial statements.

4. These entities made Enron look more profitable than it actually was, and created a
dangerous spiral, in which each quarter, corporate officers would have to perform more
and more contorted financial deception to create the illusion of billions in profits while the
company was actually losing money

5. Other sophisticated and arcane financial transactions between Enron and related
companies were used to take unprofitable entities off the company's books.

6. Enron adopted mark to market accounting, in which anticipated future profits from any
deal were tabulated as if real today. Thus, Enron could record gains from what over time
might turn out to be losses, as the company's fiscal health became secondary to
manipulating its stock price on Wall Street

Enron
Profit
Understated
Forecasted
Future Price
C
O
M
P
A
R
E
Mark To Market Method
Seller Buyer
Overstated
Debt
Special Purpose Entity
Debt
&
Failing
Investment
Sales
Revenue
Original
Price
paid for the
contract
Accounting Fraud Diagram
ENRON
Partnership
Special
Purpose
Entity
(SPE)
Account
In
Profit
3
4
2
1
5
1. Enron sets up partnership using stock as funding
2. Partnership sets up SPE
3. SPE agrees contract to pay Enron if its
investment declines in value
4. Payment made as investment declines
5. Payment posted as profit, even though it is
Enrons own money


A huge hole had
opened in the
accounts.
-BBC
How Did SPEs Worked
Much complex relations?
Role of SPEs: Enron, in
order to circumvent
the outside ownership
rules funneled money
through a series of
partnerships that
appeared to be
independent
businesses, but which
were controlled by
Enron management.
Year Reported
Income
Revised
Income
True debt
restated by
True equity
restated by
1997 $105m $77m Up $771m Down $258m
1998 $733m $600m Up $561m Down $391m
1999 $893m $645m Up $685m Down $710m
2000 $979m $880m Up $628m Down $754m
Reported and revised income, debt and shareholder equity 1997-
2000 following special partnership revelations.
Enrons Accounts: The Restated Figures
The True Picture
Synthesized Cash Flow from Selected Filings in 2000
The True Picture
J P Morgan:
$900m
Sumitomo Mitsui Corp:
$210m
Citigroup:
$800m
Nikko Cordial:
$207m
Credit Lyonnais:
$250m
Principal Financial Group:
$171m
Bank of Tokyo Mitsubishi:
$248m
Abbey National:
$164m
Chubb Corp:
$220m
National Australia Bank:
$104m
Canadian Imperial Bank:
$215m
Duke Energy Corp:
$100m
Some 25 further companies have declared Enron exposure totaling an
estimated $1bn.
Total global investment exposure of at least $4bn
Enrons Debt Exposure
Key Players & Scheme
1. Chairman Kenneth Lay had indirect knowledge but he did not do anything to get into the
details and stop it.

2. President & CEO Jeff Skilling, constantly focused on meeting Wall Street expectations,
pushed for the use of mark-to-market accounting and pressured Enron executives to find
new ways to hide its debt.

3. Chief Financial Officer Andrew Fastow and other executives created off-balance-sheet
vehicles, complex financing structures, and deals so bewildering that general public and
people could not understand them.

4. Sherron Watkins, an Enron vice-president, wrote an anonymous letter to Kenneth Lay
setting out her fears of an impending scandal.

5. Enron's Nontransparent financial statements did not clearly depict its operations and
finances with shareholders and analysts.

6. Complex business model and unethical practices required that the company use
accounting limitations to misrepresent earnings and modify the balance sheet to portray
a favorable depiction of its performance.


Other Players
1. Government policy making bodies

2. Regulatory authorities

3. Commodities Futures Trading Commission (CFTC)

4. Securities and Exchange Commission (SEC)

5. Arthur Anderson

6. Vison & Elkins

7. Dynergy

8. Citi Bank

9. J.P. Morgan Chase
1. Deregulation: Government decision to let gas prices float with the currents of the market
2. Highly decentralized financial control and decision-making structure
3. Strict and harsh hierarchy and performance evaluation system
4. Absence of corporate culture
5. Extravagant Corporate Expenditure.
6. Clear accountability
7. Lack of
Ethical Values
Respect.
Integrity.
Communication.
Excellence
8. Priority of gaining profit irrespective of methods thereof
9. Employees were motivated to take to different questionable practices and were rewarded
for bringing income to the organization.
10. The entire managerial machine participated
11. Funding Political Parties and draw favors.
12. Insider Trading / Fraudulent Online Business Trading
13. Role of the Auditors:
As an organization of public accountant Arthur Andersen violated the regulation of
the Public Accountant practices because Andersen was not only as the internal
auditor but also as the external auditor of Enron.
Improper approval of Enron's off-balance-sheet partnerships, called "special
purpose entities", which the company used illicitly to hide losses from investors.
Obstruction of justice by destroying documentary evidences.

Other Factors
The Enron scandal grew out of a steady accumulation of habits
and values and actions (massive greed and collusion of
participants) that began years before and finally spiraled out of
control highlighting Complete Failure & Collapse of Risk
Management System.



The primary motivations for Enron's accounting and financial
transactions have been
to keep reported income and reported cash flow up, asset values
inflated, and liabilities off the books.
Bottom Line
Risk management is not and should not be viewed as a substitute for
sound corporate governance

Enrons investment losses strongly underscore the need for
comprehensive, enterprise-wide risk measurement techniques that
consolidate physical asset and business exposures together with financial
exposures.

Sound risk management must include evaluations of the adequacy of a
firms capital structure to support its business activities.

Firms should rely on independent valuation sources to revalue their
positions.

Literal compliance with rules like FAS133 is not a substitute for risk
managementi.e., just because something is marked to market does not
mean it has been correctly valued
Risk Management Lessons
Thank You !!
http://specials.ft.com/enron/FT3LTT9G2XC.html

http://www.time.com/time/business/article/0,8599,193520,00.html

http://www.federatedinvestors.com/commentaries/equity/01-11-30_madden.asp

http://en.wikipedia.org/wiki/Enron

http://www.personal-writer.com/sample/business-analysis/the-collapse-of-enron-managerial-aspect

http://www.oppapers.com/essays/The-Collapse-Of-Enron-Case-Study/398855


Source & References

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