Enron Scandal Term Paper

Excerpt from Term Paper :

Enron Scandal: Who was Responsible and Why?

Background of Enron Scandal and Timeline of Events

Key Players in Enron Scandal

The Enron Scandal was the biggest accounting fraud in U.S., indeed worldwide, business history. The following paper gives a brief history of the events leading up to the scandal, a timeline for the events surrounding the uncovering of the scandal and the events following the public knowledge of the scandal. Key players in the run-up to the scandal are discussed, as are the people involved in the subsequent investigations.

Background of Enron Scandal and Timeline for Events

The collapse of energy giant Enron is the largest bankruptcy and one of the most shocking failures in United States corporate history. In a little over 15 years, Enron grew into one of the U.S.'s largest companies. It embraced new technologies, established new methods of trading in energy and seemed to be a shining example of successful corporate America. The company's success, however, was based on artificially inflated profits, dubious accounting practices, and - some say - fraud.

In the 1980s, energy corporations lobbied Washington to deregulate the business. Companies including Enron argued that the extra competition would benefit both companies and consumers. Washington began to lift controls on who could produce energy and how it was sold. New suppliers came to the market and competition increased, but the price of energy became more volatile in the free market. Enron saw its chance to make money out of these fluctuations. It decided to act as middle-man and guarantee stable prices - taking its own cut along the way. Kenneth Lay (Chief Executive, Chairman and Board Member of Enron) had been anxious to expand the business right from the word go. Jeff Skilling (Chief Executive, President and Chief Operating Officer of Enron), an ambitious thinker from the world famous consultancy firm McKinsey, offered a way to do this.

Skilling believed that Enron could profit from trading futures in gas contracts between suppliers and consumers - effectively betting against future movements in the price of gas-generated energy. Buyers and sellers use futures markets to get what they hope will be a better deal on commodity prices than they would do on the open market. Enron offered to do the same with gas, by buying and selling tomorrow's gas at a fixed price today. In the deregulated energy world, it appeared to make sense to many suppliers and industry consumers who took up the offer. The new Enron was emerging. In a few short years, Enron became a massive player in the U.S. energy market, at its height controlling a quarter of all gas business. Buoyed by the success, the company went on to create markets in myriad energy-related products.

Enron began to offer companies the chance to hedge against the risk of adverse price movements in a range of commodities including steel and coal. By the end of the decade, it had expanded its trading arm to include hedging against external factors such as weather risk. Enron was not the only company in the game, but through its Enron online trading arm, it was becoming the biggest on what was dubbed Energy Alley - 90% of its income came from trades.

Jeff Skilling wanted to rid Enron of its last physical assets, but the company was also expanding internationally, moving into water in the UK and power generation in India. One question that was already being asked before Enron crashed was this: how much influence did Enron have on Capitol Hill? Enron certainly wasn't the only company lobbying for energy deregulation, but deregulation helped Enron establish the trading markets that became its core business.

Directors built relationships with both Democrats and Republicans. Kenneth Lay himself had strong personal ties to two Republican presidents, George Bush Sr. And his son, George W. Bush. As Enron expanded, there was little scrutiny of how it was managing the expansion, and when it began to unravel, the questions began to pour in. Enron began the year 2000 with a plan to move into broadband internet networks and trade bandwidth capacity as the dot.com economy prospered. Enron's dynamic ideas, coupled with its stable old-economy energy background, appealed to investors and the share price soared.

It was one of the first amongst energy companies to begin trading through the internet, offering a free service that attracted a vast amount of custom. But while Enron boasted about the value of products that it bought and sold online - a mind-boggling $880bn (£618bn) in just two years - the company remained silent about whether these trading operations were actually making any money.

At about this time, it is believed that Enron began to use sophisticated accounting techniques to keep its share price high, raise investment against it own assets and stock and maintain the impression of a highly successful company. Enron could also legally remove losses from its books if it passed these "assets" to an independent partnership. Equally, investment money flowing into Enron from new partnerships ended up on the books as profits, even though it was linked to specific ventures that were not yet up and running.

One of these partnership deals was to distribute Blockbuster videos by broadband connections. The plan fell through, but Enron had already posted some $110m venture capital cash as profit. By the summer, Enron's shares had hit an all time high of more than $90, but there was also controversy. California was suffering an energy crisis, blamed by many on its poor handling of deregulation. Some claimed Enron had profiteered by buying futures in electricity supplies and passing them on at higher costs. Enron dismissed the allegation saying it was merely the market-maker. Enron's 2000 annual report reported global revenues of $100bn, with income that had risen by 40% in three years.

In reality, real revenue would have been far lower had it not been for the special partnerships established by chief finance officer Andrew Fastow.

Enron's growth was increasingly dependent on these accounting tools. Enron made investments and then shifted the debt off of its books to theoretically independent partnerships, in return for potential income that provided a buffer against future losses. Meanwhile, Enron kept up its political donations. Chief among the individual donors was Kenneth Lay himself. Enron and Kenneth Lay each donated $100,000 to incoming President Bush's inaugural committee fund, early in 2001. The incoming president invited Ken Lay to become and advisor to his transition team.

A prime concern for Enron was the new president's planned energy policy review, headed by Vice-President Dick Cheney. Mr. Lay and other Enron directors met Mr. Cheney and others three times in the first half of the year, the last meeting a month before he published his conclusions on 17 May 2001.

The review, as predicted, was favourable to the energy industry. It advocated more power stations, more exploration and a national grid. While it did not meet all of Enron's wishes, it nevertheless was good news. On 14 August 2001, seemingly from nowhere, Jeff Skilling resigned as chief executive, citing personal reasons. Kenneth Lay became chief executive once again. The development was a shock to investors who suddenly began to fear that all was not well in Houston.

Investors sold millions of shares, knocking some $4 off the price by the end of the week. As the price dropped below $40, Mr. Lay insisted that there were "no issues." There was, however, a very large issue - perhaps one that the board was not fully aware of. In May of that year, Enron executive Clifford Baxter left the company, apparently in uncontroversial circumstances. But there were rumours among executives that Mr. Baxter - soon to become a tragic figure in the affair when he took his own life - had clashed with Jeff Skilling over the propriety of some of the partnership transactions. When Mr. Skilling resigned, one executive who knew of Mr. Baxter's concerns decided to act, and warned Mr. Lay that Enron was on the verge of "imploding."

Meanwhile, on 12th October, the depth of Enron's problems were beginning to dawn on Andersen. As Enron had hedged against its own stock, it could never recover its losses while its share price was falling. Andersen told Enron that it had no other choice but to change the way it was accounting for its special partnerships. On 12 October, an Andersen lawyer contacted a senior partner in Houston to remind him that company policy was not to retain documents that were no longer needed. At some point after this, staff in Andersen's Houston office began shredding documents relating to Enron. Around the same time, Enron's internal legal examination of Sherron Watkin's concerns concluded that the partnerships in question, Raptor and Condor, had been approved by Andersen.

From the 1st to the 9th November, despite the air of impending doom, Kenneth Lay found two banks willing to extend credit, but the worst of revelations was still to come. On 8 November, the company took the…

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