Enron's fraudulent accounting practices and corporate downfall

Enron

Dubbed as one of the most celebrated cases in contemporary business cataclysm in the U.S., the scandal shadowing the collapse of Enron have brought forth economic devastation to the American commerce during a time of economic boom in the late nineties towards the new millennium. Many have been wondering about the reasons that lead to the demise of one of the most successful companies in terms of revenues and stratagem.

For six straight years, Enron have been regarded by several business critics including Fortune magazine top billing Enron as "America's Most Innovative Company" from 1996 to 2001. The bankruptcy of Enron has greatly affected and gave a dent to striving economy in the midst of December 2001. With the company's attempt to conceal reports of losses, the company's predicament was later on revealed to the public that Enron have intentionally failed to disclose profit losses by utilizing un-accepted accounting methods and strategies based on the U.S. conventional accounting procedures. The fraudulent accounting of Enron's financial status was hidden by means of sustaining its reported fiscal condition through systematic camouflage and creative accounting methods. Relatively, controls over the auditing of the company's financial standing either internal or external have failed to detect the gradual decline of its profits with the disguising of financial losses for several years. With the revelation of this accounting schemes have directed the dissolution of the Arthur Andersen accounting firm, one of the top five accounting firms in the U.S.

However, the company's misfortune have not affected the luxurious lives of Enron's top managers who early on to the dwindling of Enron's stocks have managed to escape with million of dollars by selling their stocks even before its prices crashed down.

The faith of the Enron's employees was not as that lucky compared to their devious managers. With the collapse of Enron many lost their jobs including most of their entire savings and retirement fund which were all invested in Enron's stocks.

The collapse of Enron has revealed other important issues that have greatly affected both the economic and political atmosphere in the U.S. From the company's rise to economic glory to its downfall several events overshadowing Enron's bankruptcies that are still being taken up in courts until this day.

COMPANY HISTORY

Enron was established and found its roots with the merger of two natural gas companies, Northern Natural Gas Co. And Houston Natural Gas Company in 1986. Enron's corporate headquarters is based in Houston Texas which was formerly based in Omaha.

Trivia: Initially, the company was to be named Enteron, but when it was pointed out that the term approximated a word referring to the intestine, it was quickly shortened to Enron" (Wikipedia Encyclopedia, 2005)

With the efforts of the federal government to deregulate both the industry of natural gas and electricity emerged Enron's advantage in gaining controls most of its market both in the U.S. And over seas. The creation of Enron was intended mostly for the purpose of dominating the first U.S. wide natural gas pipeline. And so it did, with its newly appointed CEO former CEO of Houston Natural Gas, Enron took great advantage of the energy deregulation and catapulted the company to great heights. Enron engaged itself to nationwide distribution being a power player in the industry of energy and natural gas.

Expanding its horizons, Enron not only became a provider of natural gas but also served as a middleman for energy bringing together buyers and sellers of energy. Enron dominated the trading of energy contracts and financial instruments known as derivatives (MSN Encarta, 2006)."

The company also diversified its service portfolio not only in the U.S. But in other countries as well. During its corporate evolution, Enron became a major provider of electricity and gas involving itself to the overall growth and improvement of the company starting from the conceptualization of plans, construction of infrastructure and operations of power plants and pipelines covering the U.S. And also other infrastructure in other countries.

Partnering with other companies at par with its class, Enron also engaged in other ventures such as oil well exploration and operations with then CEO of Spectrum, present U.S. president George W. Bush. The company also entered in water distribution and maintenance creating Azure Corp in 1998 to 1999 but later on was losing money due to incapability to penetrate the required market share. Azure was later on announced to be liquidated and sell its assets in the early stages of Enron's collapse. Enron traded products in the market that would include petrochemicals, plastics, principal investments, pulp and paper, risk management for different commodities, shipping, steel and streaming media.

The company also continued to invest in physical facilities. Enron bought into utilities in Brazil, India, and the United Kingdom. All of this required billions of dollars, which were raised from investors or borrowed from lenders. By 2000 Enron had 21,000 employees and $100 billion in revenue" (MSN Encarta, 2006).

During its glory days, hailed as an inspiration to new market players, Enron fully diversified its portfolio with its other ventures such as the marketing and promotion of power and trading derivatives in the world market. Among its other major citations,

Enron was named by Fortune Magazine as "America's Most Innovative Company" for six straight years, starting from 1996 to 2001. Enron was also hailed by Fortune Magazine's list of the Top 100 Best Companies to Work For in the U.S. " (Wikipedia Online)

Fortune 500 article published in April, 2002 (six months after Enron filed for bankruptcy filing) moved Enron from the 6th to the 5th spot, estimating the company would gross $138 Billion" (Corporate Narc)

Before the exposure of the corporate fraud of Enron to the public, different sectors of labor and other workforce praised the company's policies and benefits it gives to its employees and workers. Long-term pension plans and other benefits have put Enron's employees to a much greater advantage compared to employees of other companies up until 2001.

Prospecting a new range of market during the entry of the new millennium, by November 1999, Enron launched its website, Enron Online, which traded commodities and products in the world market via cyberspace. This new venue allowed customers to buy, sell and trade which gave Enron an edge and eventually as a source of revenue for survival. By August of 2000 the price of Enron's stocks reached its peak at $90.00 per share. During this time, the company have been experiencing the early stages of financial difficulties due to losses attained from Enron's other ventures.

ENRON'S DECLINE

With serious allegations of bribery, use of political influence and pressure to gain favors and contracts all over the globe, Enron started to dwindle its remaining last days of glory. Its reputation started to tarnish amidst the different controversies the company is facing. Enron was accused of using connections to exert pressure in the Clinton and Bush administration in gaining controversial billion dollar contracts in the U.S. And other countries.

Enron pursued a business strategy that exploited relationships with elected officials and regulators to pursue policies narrowly tailored to benefit Enron's immediate income needs. Enron purchased these alliances through aggressive financing of election campaigns and spearheaded a national crusade to de-regulate energy markets. It is important that Enron spent $3.45 million in lobbying expenses in 1999 and 2000 to deregulate the trading of energy futures, among other issues that were thrown at Enron during the early stages of its collapse." (Blind Faith, 2001).

The company's interest lies on countries within Central America, South America, Africa, India and the Philippines.

The climax of its steady decline broke in the news on November 2001 with allegations that Enron is camouflaging the true status of its finances by altering results on its financial statement. The company allegedly was using un-acceptable practice and fraudulent methods of accounting. This consequences lead to the filing of bankruptcy of Enron on December 02, 2001.

With the revelation of the Enron Scandal, the value of Enron stocks dwindled to an unprecedented drop from $90.00 per share to $.30 being the one worst case recorded in the financial world. Enron shares were considered as a blue chip stock with most of its shares belonging to its employees and the general public. Adding insult to injury, top management already informed by internal information through insider trading that the stocks are pressing down to its worst level, they were still able to sell their shares gaining favorable amounts of money months before the announcement of bankruptcy by Enron. However, insider information provided false information to the public that the current decline of the Enron Stocks are only temporary and will then rebound to a possible range of $120 to $140 per share. This information mislead the public by buying more stocks which were eventually from shares of top management having hold of the insider information about the hidden losses. Enron's stocks had a gradual decline from August 15, 2001 from 90$ falling to $42. By October stocks came to a close of $15 per share.

THE PEOPLE BEHIND THE RISE AND FALL OF ENRON

Kenneth Lay being one of the pioneers of Enron from its establishment in 1986, had lead the way of Enron's emergence as one of the leading company in the U.S. And eventually to its collapse and declaration of bankruptcy on December 2001. Kenneth Lay held the position as the CEO and chairman of Enron from 1986 to January 23, 2002. Lay is regarded directly to Enron's over all corporate history. One of the noted businessmen in Houston, Lay closely monitored the development of Enron from a startup company to billion dollar energy giant in the late 90's.

Kenneth Lay with his flaring tactics have influenced different sectors of the government in the interest of Enron which only have lead to more outrage among consumers.

Enron and its chief executive officer, Kenneth Lay, have been remarkably successful in lobbying the executive branch, leaders in Congress and various federal regulatory officials to withdraw government monitoring of many corporate activities within domestic energy markets. As a result of Enron's influence over the last several years, the government has abandoned enforcement powers that prevent corporate abuses of market power. Enron's pursuit of treating electricity as a speculative commodity resulted in millions of consumers paying significantly more for their power and subjected an entire state to forced power outages" (Tyson Slocum, Blind Faith, 2001).

When the Enron Scandal was revealed to the public on November 2001, Kenneth Lay was one of the person that were accused of misleading its investors and public trust by issuing assuring statement that what was happening with Enron was only temporary and urged the investors to buy stocks that were gradually declining towards the last quarter of 2000 to 2001. With the first hand knowledge of the true status of Enron's financial crisis, Lay sold more than $70 Million worth of stocks and his wife selling almost $1.2 Million that eventually was directed to charity by means of her foundation. Lay resigned as the CEO of Enron on January 23, 2002.

Kenneth Lay was charged of several cases of financial crimes, bank frauds, money laundering, insider trading among other cases filed in court. From July 7, 2004 to May 25, 2006 Lay was put on trial by and was found guilty on a number of security and financial fraud charges wand was facing a maximum sentence reaching 20 to 30 years in prison. On July 05, 2006, Kenneth Lay died due to a massive heart attack while on vacation in Snowmass Colorado. Because of his death the court abated his guilty verdict leaving only Jeffrey Skilling to face trial and conviction.

Jeffrey Skilling widely noted in the U.S. business world as the disgraced CEO of Enron, started his career in Enron in 1987 until then chairman and CEO of Enron Keneth Lay hired J. Skilling with the position of chief executive officer of Enron Finance Corporation. Skilling was one of the people that conceptualized and pushed through with the launching Enron Online. By February 12, 2001, Skilling was appointed as the CEO of Enron leading the way to the demise of Enron on the same year.

Living in a fast phased and dangerous life, Enron's CEO. Jeffrey Skilling proved to be ruling a more refined Enron management but was attributed to tolerate immorality, corruption and greed within top management of Enron. He became very idealistic in terms of his vision for Enron. He wanted to make Houston as an alternative to the Wall Street Banks.

He wanted to recruit the best, which meant persuading the leading business school graduates, from places such as Harvard and Stanford, to choose Houston over New York or Silicon Valley. He did so by creating the same culture of unself-conscious greed and reward which Wall Street was forced to suppress by the insider-trading scandals of the late 1980s. He built his own Bonfire of The Vanities in Houston and everyone wanted to feel its warmth" (Broughton, 2002).

With his passion landed Enron to its brink by the start of the new millennium. With its declaration of Bankruptcy on December, 2001, Jeffrey Skilling was indicted for fraud, insider trading and other crimes that lead the way to the collapse of Enron. Quite similar to the practice of other company personnel who has insider information about the hidden losses of Enron, Jeffrey Skilling was able to sell almost $60 of his share before resigning from Enron. Skilling was tried in court from February 2004 and resumed January 30, 2006 until his sentencing on October 23, 2006 when he was sentenced to 24 years and 4 months in prison with a corresponding fine of $45 million because of the bankruptcy and collapse of Enron.

On April 2004, because of the underlying predicament of his trial and conviction, Skilling had a nervous breakdown on the streets of New York City. Paranoid of total strangers he perceived as FBI agents tracking him down.

Andrew Fastow, the chief financial officer of Enron and was directly hired by Jefferey Skilling on May, 1990. Andrew Fastow is an expert in raising funds as demonstrated in his work with Continental bank which also bended its company to disintegration during the bank and financial crisis in the U.S.

Andrew Fastow together with Jeffrey Skilling changed the business strategy and corporate culture of Enron. In the process, they appeared to make Enron very innovative and very profitable. When the stock is rising and the shareholders are getting rich, there is little incentive for the board of directors and the investment community to question the executives very closely. The board is at fault for permitting the suspension of Enron's own code of conduct to permit the conflicts of interest inherent in the off-books corporations controlled by Fastow. A few analysts recommended their clients stay out of Enron, but not many" (Hanson, 2002).

However, this scheme has been one of the reasons for Enron's downfall. With a scheme that only entails pretenses deceiving Enron's investors of the high gain in shares but concealed losses in its books and financial statements. Andrew Fastow was charged by the federal courts of Houston Texas with 78 counts with cases of frauds, money laundering and conspiracy to conceal losses of the company from 2000 to 2001. He was then convicted on September 26, 2006 even with the presence of a plea bargain sentenced with a 6-year term in jail in the Federal Correctional Institution at Bastrop, Texas.

Paula Reiker, former manager of Enron's Investors Relations, was one of the person inside Enron that knew about the losses of the company in its other investment. She was able to sell her shares which she purchased at $15.51 per share to 49.77 per share on July of 2001, about 5 months before the scandal has gone public. On May 19, 2004, after being charged of insider trading,

Rieker, 49, of Spring Branch, Texas, entered the guilty plea today before Judge Melinda Harmon at U.S. District Court in Houston, Texas. Rieker pleaded guilty to a one-count information charging her with insider trading, in violation of 15 U.S.C. 78ff and 78j (b). Rieker faces a maximum sentence of up to 10 years in prison and a fine of up to $1 million at her sentencing, which will be scheduled at a later date. As part of her plea agreement, Rieker has agreed to cooperate fully with the government's ongoing criminal investigation of the collapse of the Enron Corporation" (Department of Justice, 2004).

Arthur Andersen, one of the top five accounting firms in the U.S. was charged of obstruction of justice with the shredding of valuable documents as evidences that could help the case of the Enron Scandal to pin down the culprits of its downfall and bankruptcy. Due to the early trial by publicity of the celebrated case - the Enron Scandal, Arthur Andersen was forced into dissolution being one of the first casualties of the fall of Enron.

Although the jury convicted the entire firm, it focused the blame on a single person, Andersen's Chicago-based lawyer Nancy Temple, who, according to the legalese, played the "corrupt persuader" who led others astray. Knowing the Securities and Exchange Commission was starting to scrutinize Enron's books, Temple told David Duncan, who supervised the account, to remove her name from a file memo that disagreed with Enron's characterization of a $1 billion loss as "non-recurring" (Cathy Boot Thomas, Time Magazine, 2002)

Although the firm is very much ready to appeal to higher courts, it would be a hopeless act.

Even an acquittal would probably not have saved the firm. "The verdict doesn't matter anyway," says Arthur Bowman, editor of Bowman's Accounting Report. "Arthur Andersen is dead. Once the indictment was handed down, clients started jumping faster than they did off the Titanic." (Cathy Boot Thomas, Time Magazine, 2002)

AFTERMATH AND LESSONS

The events that have occurred in the bankruptcy of Enron resulted to different events and undertakings of both the federal government and the public. Enron's objective in misleading the public with the real conditions of Enron's financial capability to survive have brought forth a stigma of awareness and vigilance of the public in making transaction with stock corporations.

The Enron scandal played a major role in shaking investor confidence in American business because the firm was able to hide its losses for nearly five years. Outside agencies, such as accounting firms, credit-rating businesses, and stock market analysts failed to warn the public about Enron's business losses until they were obvious to all. Internal controls did not work, either. Enron's board of directors, and especially its audit committee, apparently did not understand the complicated financial activities undertaken and consequently did not provide adequate oversight." (Encarta MSN, 2006).

The Enron Scandal caused caution to the federal government to reform legislation on accounting practices and enforces stricter guidelines and fortifies the capability of the Securities and Exchange Commission to detect such deception in financial statements and other fraudulent means of accounting.

This scandal has proven to endow new lessons in economy, management, governance and ethics. Following the statements of Kirk Hanson regarding his notion on the lessons to be extracted with the Enron Scandal, he pointed five ethical principles.

You make money in the new economy in the same ways you make money in the old economy - by providing goods or services that have real value.

Financial cleverness is no substitute for a good corporate strategy.

The arrogance of corporate executives who claim they are the best and the brightest, "the most innovative," and who present themselves as superstars should be a "red flag" for investors, directors and the public.

Executives who are paid too much can think they are above the rules and can be tempted to cut ethical corners to retain their wealth and perquisites.

Government regulations and rules need to be updated for the new economy, not relaxed and eliminated.