Enron Corporation A Case Study PDF

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Enron Corporation: A Case Study Course Name: Corporate Financial Reporting Course Code: AIS 3202

Submitted to Abdul Alim Baser Lecturer, Department of AIS University of Barisal

Submitted by Tusher Ghosh On behalf of Group 05 12 AIS 058 6th Semester Batch: 1st Department of AIS University of Barisal

Date of submission 13 March, 2016

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List of Group Members: S.N.

Name

Roll Number

01

 Sumona Sarmin

12 AIS 007

02

 Nowrin Akter

12 AIS 016

03

 Kamrun Nesa Moumita

12 AIS 017

04

 Aysha Arabi

12 AIS 028

05

 Nipa Akter

12 AIS 046

06

 Farjana Akter Papri

12 AIS 056

07

 Tusher Ghosh (GL)

12 AIS 058

08

 Md. Tanjil Biswas

12 AIS 066

Table: Member list of Group 05

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Acknowledgement Enron, a corporation headquartered in Houston, operated one of the largest natural gas transmission networks in North America, totaling over 36,000 miles, in addition to being the largest marketer of natural gas and electricity in the United States. Enron managed the world's largest portfolio of natural gas risk management contracts and pioneered innovative trading products. The company was on Fortune's "Most Innovative" in the United States listing for several years running and reached #7 on the Fortune 500 list in 2000. Its bankruptcy in December 2001 was the largest such filing in United States history. The name Enron became synonymous with corporate greed and corruption, and its demise cost investors and employees over $70 billion in lost capitalization and retirement benefits. As a part of academic program, we have prepared this report on “Enron Corporation: A Case Study”. Our endeavor will come true if the actual purpose of this study becomes fulfilled.

At the very first, we would like to express our cordial and deep respect to the course teacher, Abdul Alim Baser, Lecturer, Department of AIS, for his proper guidance, valuable advice, instructions which helped us a lot to complete this study. We are very lucky for getting this opportunity to complete this report under his guidance and supervision.

We owe our deepest gratitude to our parents and family members. We would not be able to complete the study successfully devoid of their continuous inspiration and encouragement.

Finally, all praise and indebtness to the Almighty God, the Lord of Glory and Honor, for all the blessing showers upon us to complete such a study.

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Letter of Transmittal 13 March, 2016 Abdul Alim Baser Lecturer Department of AIS, University of Barisal, Barisal. Subject: Submission of Report on “Enron Corporation: A Case Study”. Dear Sir, This is the report which is suggested by you as a part of our academic program for the Course of Corporate Financial Reporting, Course code: AIS 3202. This report has been prepared to cover topic “Enron Corporation: A Case Study”. We have tried our level best to make it done as per your instructions. Our level best trying has given here to carry out a meaningful and effective study on this topic to make the study efficient enough. We shall be always available for any supplementary interoperation & thank you for giving us the opportunity to complete a report on the above topic. We do sincerely hope this report will live up to your expectation.

Sincerely yours, Tusher Ghosh On behalf of Group 05 12 AIS 058 6th Semester Batch: 1st Department of AIS University of Barisal

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Declaration I, on behalf of Group 05, do hereby solemnly declare that the work presented in this report has been carried out by myself and has not been previously submitted to any other University/College/Organization for an academic qualification / certificate/ diploma or degree.

The work I have presented does not breach any existing copyright and no portion of this report is copied from any work done earlier for a degree or otherwise.

I, on behalf of Group 05, further undertake to indemnify the Department against any loss or damage arising from breach of the foregoing obligations.

Tusher Ghosh On behalf of Group 05 12 AIS 058 6th Semester Batch: 1st Department of AIS University of Barisal

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Chapter 01: Overview of Enron Corporation 1.1 Preface 1.2 History of Enron Corporation 1.2.1 Birth of the Company 1.2.2 Public Offerings in 1940s 1.2.3 Growth through Acquisitions 1.2.4 Rename to Enron 1.2.5 Enron: Before Collapse 1.3 Enron’s Corporate Profile 1.3.1 Central Management of Enron Corporation 1.3.2 Products of Enron Corporation 1.3.3 Enron’s Financial Performance (1996-2000) 1.4 Conclusion

Chapter 02: The Enron Collapse 2.1 The Fall of Enron 2.2 Why Enron Fell from Grace 2.2.1 SPE 2.2.2 Accounting Issue 2.2.3 The Crash of Enron 2.2.4 Enron’s Auditor (Arthur Andersen) 2.2.5 Links with The Government (Bush Administration) 2.2.6 The Link of Enron with The British Front 2.3 The consequences of Enron Collapse 2.3.1 The Victim: Employees and Pension Fund Holders 2.3.2 Creation of Sarbanes-Oxley Act 2.4 Punishment 2.5 What then is the Solution? 2.6 Conclusion

Chapter: 03 Case Questions Solution 3.1 Questions 1-7 & Answers (Auditing Cases- Knapp 8th edition, Case 1.1 Enron Corporation) 3.2 Conclusion

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Chapter 01: Overview of Enron Corporation 1.1 Preface Enron Corporation was an American energy, commodities, and services providing company based in Houston, Texas. Before its bankruptcy on December 2, 2001, Enron employed approximately 20,000 staff and was one of the world's major electricity, natural gas, communications, and pulp and paper companies, with claimed revenues of nearly $111 billion during 2000. Fortune, an American business magazine, named Enron "America's Most Innovative Company" for six consecutive years. The story ends with the bankruptcy of one of America's largest corporations. Enron's collapse affected the lives of thousands of employees, shareholders and other investors. At the end of 2001, it was revealed that its reported financial condition was sustained by an institutionalized, systematic, and creatively planned accounting fraud, known since as the Enron scandal. Enron has since become a wellknown example of willful corporate fraud and corruption. The scandal also brought into the question of the accounting practices and activities of many corporations in the United States and was a factor in the enactment of the Sarbanes–Oxley Act of 20021. The scandal also affected the greater business world by causing the dissolution of the Arthur Andersen accounting firm. 1.2 History of Enron Corporation 1.2.1 Birth of the Company Enron began as Northern Natural Gas Company, organized in Omaha, Nebraska, in 1930 by three other companies. North American Light & Power Company and United Light & Railways Company each held a 35 percent stake in the new enterprise, while Lone Star Gas Corporation owned the remaining 30 percent. The company's founding came just a few months after the stock market crash of 19292, an inauspicious time to launch a new venture. Several aspects of the Great Depression actually worked in Northern's favor, however. Consumers initially were not enthusiastic about natural gas as a heating fuel, but its low cost led to its acceptance during tough economic times. High unemployment brought the new company a ready supply of cheap labor to build its pipeline system. In addition, the 24-inch steel pipe, which could transport six times the amount of gas carried by 12-inch cast iron pipe, had just been developed. Northern grew rapidly in the 1930s, doubling its system

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The Sarbanes-Oxley Act of 2002 (often shortened to SOX) is legislation passed by the U.S. Congress to protect shareholders and the general public from accounting errors and fraudulent practices in the enterprise, as well as improve the accuracy of corporate disclosures. The U.S. Securities and Exchange Commission (SEC) administers the act, which sets deadlines for compliance and publishes rules on requirements. 2 The Wall Street Crash of 1929, also known as Black Tuesday (October 29) that began on October 24, 1929 and was the most devastating stock market crash in the history of the United States.

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capacity within two years of its incorporation and bringing the first natural gas supply to the state of Minnesota. 1.2.2 Public Offerings in 1940s The 1940s brought changes in Northern's regulation and ownership. In 1941, United Light & Railways sold its share of Northern to the public, and in 1942 Lone Star Gas distributed its holdings to its stockholders. North American Light & Power would hold on to its stake until 1947, when it sold its shares to underwriters who then offered the stock to the public. Northern was listed on the New York Stock Exchange that year. 1.2.3 Growth through Acquisitions Northern continued expanding during the 1970s. During the 1970s, Northern became a principal investor in the development of the Alaskan pipeline3. When completed, that pipeline allowed Northern to tap vast natural gas reserves it had acquired in Canada. In 1980, Northern changed its name to InterNorth, Inc. Over the next few years, company management extended the scope of the company’s operations by investing in ventures outside of the natural gas industry, including oil exploration, chemicals, coal mining, and fuel-trading operations. But the company’s principal focus remained the natural gas industry. In 1985, InterNorth purchased Houston Natural Gas Company for $2.3 billion. That acquisition resulted in InterNorth controlling a 40,000-mile network of natural gas pipelines and allowed it to achieve its long-sought goal of becoming the largest natural gas company in the United States. 1.2.4 Rename to Enron In 1986, InterNorth changed its name to Enron. Kenneth Lay, the former chairman of Houston Natural Gas, emerged as the top executive of the newly created firm that chose Houston, Texas, as its corporate headquarters. Lay quickly adopted the aggressive growth strategy that had long dominated the management policies of InterNorth and its predecessor. Lay hired Jeffrey Skilling to serve as one of his top subordinates. During the 1990s, Skilling developed and implemented a plan to transform Enron from a conventional natural gas supplier into an energy-trading company that served as an intermediary between producers of energy products, principally natural gas and electricity, and end users of those commodities. In early 2001, Skilling assumed Lay’s position as Enron’s chief executive officer (CEO), although Lay retained the title of chairman of the board. 1.2.5 Enron: Before Collapse Enron’s 2000 annual report discussed the company’s four principal lines of business. Energy Wholesale Services ranked as the company’s largest revenue producer. That division’s 60 percent increase in transaction volume during 2000 was fueled by the rapid development of EnronOnline, a B2B (business-to-business) electronic marketplace for the energy industries created in late 1999 by Enron. During fiscal 2000 alone, EnronOnline processed more than 3

One of the world's largest pipeline systems. It is 800 miles (1,287 km) pipeline with the diameter of 48 inches (122 cm) that conveys oil from Prudhoe Bay, to Valdez, Alaska.

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$335 billion of transactions, easily making Enron the largest e-commerce company in the world. On the other hand Lay’s position as the chief executive of the nation’s seventh-largest firm gave him direct access to key political and governmental officials. In June 2001, Skilling was singled out as “the No. 1 CEO in the entire country,” while Enron was hailed as “America’s most innovative company. Enron’s chief financial officer (CFO) Andrew Fastow was recognized for creating the financial infrastructure for one of the nation’s largest and most complex companies. In 1999, CFO Magazine presented Fastow the Excellence Award for Capital Structure Management for his “pioneering work on unique financing techniques.”

1.3 Enron’s Corporate Profile 1.3.1 Central Management of Enron Corporation - Kenneth Lay: Chairman, and Chief executive officer -

Jeffrey Skilling: President, Chief operating officer, and CEO (February–August 2001) Andrew Fastow: Chief financial officer Triton Dietrich: Chief accounting officer Rebecca Mark-Jusbasche: CEO of Enron International and Azurix Lou Pai: CEO of Enron Energy Services Forrest Hoglund: CEO of Enron Oil and Gas Dennis Ulak: President of Enron Oil and Gas International Jeffrey Sherrick: President of Enron Global Exploration & Production Inc. Richard Gallagher: Head of Enron Wholesale Global International Group Kenneth "Ken" Rice: CEO of Enron Wholesale and Enron Broadband Services J. Clifford Baxter: CEO of Enron North America Sherron Watkins: Head of Enron Global Finance Jim Derrick: Enron General Counsel Mark Koenig: Head of Enron Investor Relations Joan Foley: Head of Enron Human Resources Richard Kinder: President and COO of Enron (1990-December 1996); co-founder of Kinder Morgan Greg Whalley: President and COO of Enron (August 2001– Bankruptcy) Jeff McMahon: CFO of Enron (October 2001-Bankruptcy)

1.3.2 Products of Enron Corporation Enron traded in more than 30 different products, including the following: 

    

Products traded on EnronOnline o Petrochemicals o Plastics o Power o Pulp and paper o Steel o Weather Risk Management Oil and LNG transportation Broadband Principal investments Risk management for commodities Shipping / freight

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 

Streaming media Water and wastewater

1.3.3 Enron’s Financial Performance (1996-2000)

Exhibit: 1 Enron Corporation 2000’s Annual Report Financial Highlight Table (In millions except per share amount) 1.4 Conclusion The Enron Scandal is considered to be one of the most notorious within American history. At the time of Enron's collapse, it was the biggest corporate bankruptcy ever to hit the financial world. The Enron scandal drew attention to accounting and corporate fraud, as its shareholders lost $74 billion in the four years leading up to its bankruptcy, and its employees lost billions in pension benefits.

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Chapter 02: The Enron Collapse

2.1 The Fall of Enron In May 2001, Enron’s executive Clifford Baxter left the company, apparently in uncontroversial circumstances. It was rumored that Baxter, who later committed suicide, had clashed with Jeff Skilling (Enron’s CEO), over the righteousness of Enron’s partnership transactions. On 14th August 2001, Jeff Skilling resigned as Chief Executive, citing personal reasons and Kenneth Lay became Chief Executive Officer. Skilling’s departure was prompted by concerns over Enron's bungled accounting and bad management. In mid August 2001, Sherron Watkins, Enron’s Corporate Development Executive, who was later referred to as the “whistleblower” in the Enron scandal, wrote a letter to Kenneth Lay warning him of accounting irregularities that could pose a threat to the company. This development shocked investors who suddenly panicked. The lack of transparency sent a selling wave in the market. Investors sold millions of shares, knocking almost $ 4 off the price to less than $40 over the course of the third week of August 2001. In spite of the drop in price, management still insisted all was well. Despite the air of impending doom, Kenneth Lay found two banks willing to extend credit. But the worst of revelations were to come yet. On 8th November 2001, the company took the highly unusual move of restating its profits for the past four years. Enron effectively admitted that it had inflated its profits by concealing debts in its complicated partnership arrangements (Special Purpose Entities). On 9th November 2001, the humiliation of Enron appeared complete as it entered negotiations to be taken over by its much smaller rival, Dynegy. The following graph shows how Enron’s restated accounts.

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Reported and revised income, debt and shareholder equity 1997 – 2000 following special partnership revelations; Source: Enron/Powers Special Report

Enron filed for bankruptcy in December 2001 and filed a suit against Dynegy for pulling out of the proposed merger. Enron’s share price collapsed from around $ 95 to below $ 1. Enron’s employees lost their savings as well as their jobs. Mr. Kenneth Lay, the once renowned visionary chairman of the firm, resigned in January 2002. It appears now that the phenomenal success of Enron was a daydream and it seems to have sunk into a financial predicament that is largely of its own creation. In just sixteen years, Enron grew into one of America's largest companies; however, its success was based on artificially inflated profits, questionable accounting practices and fraud. Several of the company’s businesses were losing operations; a fact that was concealed from investors using off balance sheet vehicles or structured finance vehicles. 2.2 Why Enron Fell from Grace 2.2.1 SPE A special purpose entity, sometimes called a special purpose vehicle, is a legal entity created for one very limited, particular task. Typically, SPEs are subsidiaries of a larger corporation. Usually the task of a special purpose entity is to isolate risk. By setting up an SPE dedicated to the acquisition and financing of specific assets, the parent corporation is protected in case of bankruptcy, loan default or other loss on those assets. Another use for an SPE is managing a single asset that has exceptionally complex financial transactions and requires numerous permits for its operation, such as a factory or a power plant. By placing the asset in the SPE, it’s easier to keep track of income and expenses associated with this entity. Plus, if the owner wants to sell the asset, any required permits will transfer with the SPE, eliminating the need to assign them over separately. This greatly simplifies a potentially difficult sale.

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2.2.2 Accounting Issue Enron was one of the first amongst energy companies to begin trading through the internet, offering a free service that attracted a vast amount of customers. But while Enron boasted about the value of products that it bought and sold online around $880 billion in just two years, the company remained silent about whether these trading operations were actually making any money.

It is believed that Enron began to use sophisticated accounting techniques to keep its share price high, raise investment against its own assets and stock and maintain the impression of a highly successful company. These techniques are referred to as aggressive earnings management techniques Losses from its books if it passed these “assets” to these partnerships. 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. It now appears that Enron used many manipulative accounting practices especially in transactions with Special Purpose Entities (SPE) to decrease losses, enlarge profits, and keep debt away from its financial statements in order to enhance its credit rating and protect its credibility in the market. The main reason behind these practices was to accomplish favorable financial statement results, not to achieve economic objectives or transfer risk. These partnerships would have been considered legal if reported according to present accounting rules or what is known as “applicable accounting rules”. One of these partnership deals was to distribute Blockbuster videos by broadband connections. The plan fell through, but Enron had posted $110 million venture capital cash as profit. Although these practices were generally disclosed to Enron’s investors, the disclosure was inadequate. This inadequacy may have stemmed from conf...