The Rise and Fall of Enron
What
is Enron?
Enron
is the company that altered international finance forever. The
company shook the corporate world. This company became the catalyst
for many changes in federal and international law as well as other
policies dealing with corporate accounting practices. Inquiries
surrounding the rise and fall of Enron emerged because of the shifty
techniques used to deceive investors and corporate watchdogs. How did
this corporation pull the wool over so many people’s eyes? This
essay will briefly describe the rise, fall, and international
aftermath of the Enron Corporation.
Before
delving into the gruesome details, let us go over the details of the
Enron Corporation. In 1985 the Northern Natural Gas Company, became
what will be known as the core of the Enron Corporation when the
company purchased the smaller Houston Natural Gas Company. With the
latest acquisition, Enron was formed. The new formed company
originally dealt in the transmission and distribution of gas and
electricity in the United States. In later years leading up to
ultimate demise, the company dealt with multiple of other companies
such as water sector, broadband, plastics, and steel. The company
also became one of the world’s largest energy companies. Enron
became the seventh largest corporation in the United States which
interestingly enough also became the largest business scandal in
United States’ history. At its epitome, its profits were $101
billion and employed over 20,000 individuals. The question arises,
were these claims actual profits? This is where the accounting
practices and techniques used by Enron come into question.
Let
us briefly introduce the main players. We will focus on three main
players. These men are Kenneth Lay, Andrew Fastow, and Jeffrey
Skilling. Kenneth Lay is the Founder and former Chairman. Andrew
Fastow is the Chief Financial Officer. Jeffrey Skilling is the former
Chief Executive Officer, who “dreamed of creating a new business
model that could change American capitalism forever”. (Swartz and
Watkins, p. 40)
The
Rise and Fall
The
rise of Enron is beautiful. From 1985 forward, the company grew
substantially. “Enron grew wealthy, it claimed, through its
pioneering, marketing and promotion of power and communications
bandwidth commodities and related derivatives as tradable financial
instruments, including exotic items such as weather derivatives.”[1]
(wikipedia.com)
Enron gained prominence not only through its acquisition, but also
through publicity of awards. It was named “America’s Most
Innovative Company” by Fortune
Magazine
for six consecutive years, from 1996 to 2001, the year of the
disclosures. Another award was also given by Fortune
magazine.
Ironically, this time it was Fortune’s
year
2000 list of “100 Best Companies to Work for in America”.
The
fall begins one day when Skilling explains to the risk management
team of a plan to keep the money they made off investments in smaller
businesses, specifically Rythms NetConnections. Rhythm NetConnections
company value jumped over time to about $300 million. Enron could not
sell the investment value earned. This plan would insure that Enron
would keep the profits made by the sudden rise in the market. Andrew
Fastow designed the plan.
“The
plan was to create a private partnership in the Cayman Islands that
would protect -- or hedge -- the Rhythms investment, locking in the
gain. Ordinarily, Wall Street firms would provide such insurance, for
a fee. But Rhythms was such a risky stock that no company would have
touched the deal for a reasonable price. And Enron needed Rhythms:
The gain would amount to 30 percent of its profit for the year.”
(Behr and Witt)
This
entity that Fastow creates is named LJM after his wife and kids. In
the future LJM buys poor performing Enron assets. These poor
performing assets became burdens on Enron and hurt its bottom-line.
The profits were taking hits because of the lack of performance of
these smaller companies. In effect, the LJM partnership became a
device used to hide Enron’s debt.
“The
whole thing was really just an accounting trick. The arrangement
would pay Enron to cover any losses if the tech stock dropped. But
Skilling proposed to bankroll the partnership with Enron stock. In
essence, Enron was insuring itself. The risk was huge.”(Behr &
Witt)
The
accounting trick allowed Enron to embellish its profit record for its
investors. This in effect raised stock prices due to the lack of
information of the company’s business practices.
The
demise started when these tricks and improper use of accounting
began. From 1999 to 2000 the profits rose 50%. Profits in 1999 were
around $50 billion, whereas in 2000 profits rose to $100 billion.
This dollar amount would be impressive, but under just one year it
raised some eyebrows. “Some people had nagging suspicions. But like
the cowed townspeople in the children's story, few questioned the
emperor's new clothes.” (Behr & Witt)
Indictments
and Trial
Once
the company’s fault was released to the public the slippery slope
to bankruptcy was inevitable. Though everything was not disclosed to
the public at first, as things were still kept secret, investigations
started. Several top executives were charged with multiple counts of
securities fraud, or other illegal business activities. Skilling was
indicted with 28 counts of securities fraud and wire fraud, and Lay
was indicted with six counts of securities and wire fraud.
The
trial began January 30, 2006. Within five months, the jury reached
its verdict. Lay and Skilling were found guilty. In the sentencing
that took place October 23, 2006 Skilling was convicted of 19 of the
28 counts of securities fraud and wire fraud. However, the other nine
he was acquitted. Lay on the other hand was convicted on all six
counts of securities and wire fraud. However, Lay passed away 3
months before the sentencing occurred. Upon autopsy, Kenneth Lay died
of a heart attack. The judge therefore vacated his conviction on
October 17, 2006. Several other individuals were found guilty from
other companies such as Merrill lynch.
There
are certain aspects that the demise of this company has had on our
society. It has been estimated that $60 billion was lost in
investments. In the wake of the collapse, there have been numerous
companies to follow Enron’s path. Investor awareness has risen.
Companies are held more accountable for their accounting as well as
there business practices. Congress suddenly pushed through
legislation on accounting reform. The terms of the bill creates an
oversight board. When violations occur in corporations, each
accounting violation is punished, the “chief executives and
financial officers must certify the accuracy of financial statements.
White-collar criminals will face fines will face fines as high as $5
million and prison terms of up to 20 years.”(Behr & Witt)
Enron’s
Global Influence: Europe
Wing
and Mark
In
the late 1980s, Margaret Thatcher was trying to deregulate the UK’s
utility markets. This was fabulous for Enron’s big ideals, for they
were trying to execute a plan to get their first big power plant
online in the global market. Enron had to convince larger British
power companies to support an ambitious young company to build such a
massive power plant project. The plant would be “the world’s
largest natural gas-fired power plant.” It would generate both
electricity and steam. The massive plant would add 4% to the United
Kingdom’s power grid. (Swartz, p. 37) Teesside would cost $1
billion to construct, which included contracts and other construction
costs, but brought in more than $200 million profits for Enron.
(Swartz, p. 37) The success of this power plant made Enron a power
player in the global market.
The
ambitious Teesside project for Enron was lead by a “Brilliant
strategist” (Swartz & Watkins, p. 36) whose name is John Wing.
Wing was responsible for Enron’s first big power plant in Texas
City, Texas; it is no surprise that he had much bigger plans in
store for this up and coming multifaceted company. As stated in the
previous paragraph, the Teesside plant was a massive power plant that
brought in a lot of revenue, but one of the big changes brought forth
from this project was that Wing persuaded Lay to approve a “new way
of compensating Enron executives on project development deals”.
(Swartz & Watkins, p. 37) This new way allowed Wing to receive
the compensation when the deal was closed, not before the plant went
online.
Wing
was a tough executive. He abused people, and treated individuals
lower than they should have been treated. His protégé felt a lot of
this pressure and abuse, but through this trial, she came out
transform. His protégé was Rebecca Mark, a young woman who was in
the right place at the right time, learning all the she could from
examples in the corporate world as well as traditional education,
earning her MBA from Harvard. Once John Wing left Enron, Rebecca Mark
was promoted. Ken Lay did not promote her slightly, he gave her a CEO
position of her own company, Enron Development Corporation. “Her
mandate was to open energy markets for Enron around the world.”
(Swartz & Watkins, p 40)
Now
let us shift gears and explored other effects of this company. Though
the huge energy giant was based in Houston, Texas, its
scope of influence and power spread across the globe. Therefore, its
collapse created an aftershock. Enron was not only in the energy
market across the globe, but it was in numerous European sectors.
This paper will discuss several areas of the world where Enron
influenced and subsequently was affected by its collapse.
Pricewaterhousecooper,
the accounting firm was named the administrator of European arm of
Enron Thursday, November 29, 2001 in a move that is similar to the
Chapter 11 bankruptcy in the United States. The same day as the
firm taking over, Enron Europe stopped its wholesale electricity and
was expected to cut jobs of its 5400.(Pfanner)
Pricewaterhousecooper, also took over PX limited a company that was
set up to operate and manage the 1875 MW Teesside power and gas
station. Therefore Enron’s collapse did not greatly effect this
power plants production in England.
The
initial response would point fingers at the banks because of their
continued support of a fraudulent company. Between the years 2000 and
2001 Milan Bank loaned Enron an estimated $20 million.(Fairlamb) The
Royal Bank of Scotland reportedly gave the largest loan to
Enron, which was between $500 and $800 million. (Fairlamb) “Deutsche
Bank AG said its exposure was $100 million; Centrica PLC, a british
trader, put its exposure at $43 million.” (Pfanner) All totaled the
European banks have loaned $2 billion. (Fairlamb) Monetarily these
companies are at fault for supporting Enron, but giving the
circumstance that Enron was the company with whom you do not say no
to because they control vast amount of the markets. “…Enron’s
reach is so vast – it accounts for 20 percent of the energy trading
in the United States and Europe…” (Pfanner)
At
first, the concept of the fall of Enron in European minds was “the
product of flawed U.S. accounting practices”. (Fairlamb) They
shrugged it off as something that was solely in the United States.
But as the investigations of this huge and spectacular collapse
unfolded, corporate fraud not only in accounting but in the
leadership was found. The European Union realized that its own
companies were vulnerable to the same corporate fraud. The collapse
of Enron pushed the European Union to reflect on its own management
and regulation of its Capital Markets. “Getting regulation right is
critical to successful economic management, and to our long-term
growth prospects.” (Fairlamb)
Not
only were the investigations pushing regulation of the markets in
Europe, but the United States Congress legislated with the
Sarbanes-Oxley Act, which was aimed at avoiding a repeat of corporate
disasters, pushed it as well. The act which was passed in 2002 covers
any company worldwide that is traded on the U.S. stock markets.
“Foreign companies had less than a year to get in line with the
Sarbanes-Oxley Act, which came into force in June 2005.” (Stamp)
What firms must
and must not do
|
Financial
disclosures must be complete and fairly present financial
position
Internal
controls must be adequate and any deficiencies reported
Store
e-mails and other electronic data for at least five years
Ban on
extending personal loans and most forms of credit to executives
All
off-balance sheet transactions must be reported
Audit
committees must be set up and chief auditor rotated every five
years
Auditors
must register with new regulatory body
|
(http://news.bbc.co.uk/1/hi/business/3849867.stm)
The
Sarbanes-Oxley Act is having far-reaching impact on Europe. “Adecco,
the Swiss recruitment company, is currently being investigated by the
U.S. Securities and Exchange Commission after it revealed that it had
discovered ‘material weaknesses’ in the internal controls of its
North American subsidiary.” (Stamp) The cost of compliance has been
costly to some of the companies. Many of the companies are not happy
with the legislation. These companies see the rising costs as more
significant than the benefits.
After
the reflection on its own practices in its Capital Markets, the
European Union as a whole started tightening corporate financial
reporting and accounting standards. This regulation required all E.U.
listed companies to apply International Accounting Standards. The
next tightening was the enforcement of accounting standards, “to
ensure harmonized application of I.A.S. within the E.U.” (Fairlamb)
However
before the E.U began its centralized corporate governance, the United
Kingdom developed corporate governance through certain reform effort.
“In the early 1990s, the United Kingdom explored governance reforms
on a ‘comply or explain’ basis through the adoption of the
Cadbury Code,” which later became the Combined Code. (Philips &
Saft)
The
Combined Code is the Cadbury Code, which was published in 1990, and
several other important contributions were added over the years to
form a set of voluntary practices, which “governed” the companies
that were traded on London Stock Exchange. “Companies must disclose
whether they comply with its provisions and if not, why.” (Philips
& Saft) The combined code has over the years influenced rules and
regulations governing these publicly traded companies. Other E.U.
states have adopted the same comply-or-explain methodology of
compliance. With the collapse of Enron these methodologies along with
new ideas were adopted to help prevent corporate fraud.
Enron
International Today
On
March 19, 2003, Enron’s Board of Directors voted to create a new
entity that it would be able to transfer its 3 North American
pipelines to, instead of selling its interests in the areas. The new
company will be temporarily called “PipeCo”. (Palmer)
On
May 9, 2003 Enron Corporation announced that it was creating a new
entity that will be temporarily called “InternationalCo”. This
company was determined a viable option to maximize value, which will
be distributed to its creditors. As the press release says,
“InternationalCo is expected to hold all or portion of Enron’s
interests in its international electric and natural gas utilities and
pipelines.” (Ambler)
Business Interests Expected
to be Held by InternationalCo
|
Asset
|
Current
Enron Ownership*
|
Location
|
Description
|
Gas
Transboliviano S.A. (GTB)
|
30%
|
Bolivia
|
Gas
Pipeline 348 miles
|
Transportadora
Brasileira Gasoduto Bolivia - Brasil S.A. (TBG)
|
7%
|
Brazil
|
Gas
Pipeline 1620 miles
|
Transredes S.A.
|
25%
|
Bolivia
|
Gas &
Liquids Pipeline 3,437 miles
|
Centragas
|
55%
|
Colombia
|
Gas
Pipeline 357 miles
|
Gasoriente
Boliviano Ltda. (GasBol)
|
50%
|
Bolivia
|
Gas
Pipeline 226 miles
|
Gasocidente
Do Mato Grosso Ltda. (GasMat)
|
56%
|
Brazil
|
Gas
Pipeline 175 miles
|
Accroven SRL
|
49%
|
Venezuela
|
NGL Facility
|
Vengas S.A.
|
97%
|
Venezuela
|
LPG
Distribution
|
Elektro
Eletricidade e Servicos S.A.
|
88%
|
Brazil
|
Electric
Distribution Company
|
Bahia Las
Minas Corp.
|
51%
|
Panama
|
Power
Generation 280 MW
|
Empresa
Energetica de Corinto Ltd.
|
35%
|
Nicaragua
|
Power
Generation 71 MW
|
Puerto
Quetzal Power LLC (PQP)
|
38%
|
Guatemala
|
Power
Generation 234 MW
|
Smith/Enron
Cogeneration LP (SECLP)
|
85%
|
Dominican
Republic
|
Power
Generation 185 MW
|
Empresa
Producora De Energia Ltd. (Cuiaba EPE)
|
72%
|
Brazil
|
Power
Generation 480 MW
|
Trakya
Elektrik Uretim ve Ticaret A.S.
|
39%
|
Turkey
|
Power
Generation 478 MW
|
SK-Enron Co.
Ltd
|
50%
|
Korea
|
City gas
distribution, LPG importer and marketer
|
Enron
America del Sur S.A. (EAS)
|
100%
|
Argentina
|
Power
Generation 70 MW
|
Elektrocieplownia
Nowa Sarzyna Sp. z.o.o. (ENS)
|
75%
|
Poland Power
Generation 116 MW
|
|
Marianas
Energy Company LLC (Guam)
|
50%
|
Guam
|
Power
Generation 88 MW
|
|
*All or a
portion of such interests are expected to be held in
InternationalCo
|
http://www.enron.com/corp/pressroom/icoassets.html
March
1, 2007, Enron Corporation legally changed its name to Enron
Creditors Recovery Corporation. The name change was prompted because
it better applies to the companies duties at this time.
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Pfanner,
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[1] Wikipedia.com
is not used as a source. It is used for the specific wording of the
sentence.