Enron Essay

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Enron is the name of the company that caused a major corporate accounting scandal and related financial irregularities in 2001 that disrupted financial markets. In 1985, Houston Natural Gas merged with InterNorth, a natural gas company based in Omaha, Nebraska. The new company was renamed Enron, and in 1986, Kenneth Lay becomes chief executive. At the same time, Lay found another avenue for greater wealth: deregulation of the natural gas industry. He used his connections and had Enron make political donations in order to influence Congress to make natural gas an unregulated, tradable commodity. In 1989, as the natural gas was deregulated, Lay created the Gas Bank. This initiative was to form a bridge between producer and consumer, ensuring consumers long-term supplies at set rates while stockpiling reserves of natural gas bought from producers.

In 1990, Lay hired former business consultant Jeffrey Skilling to look after the companies’ energy trading operation. Andrew Fastow, who later became the mentor of the firm’s dubious accounting practices, was one of the first hires. The same year, Lay was given $1.5 million in cash compensation, along with millions of shares of Enron stock. Enron’s chief financial officer (CFO), Andrew Fastow, found a new use for the Gas Bank: he created Cactus, the first of what would eventually amount to 3,500 dummy companies created by Enron. Enron would make phony deals with the Gas Bank and assume, as supposedly separate and independent companies, any debts the Gas Bank incurred. By keeping Cactus off the books, Enron’s actual indebtedness would be hidden. Thanks to Cactus and other dummy companies created by Fastow, none of Enron’s earning’s reports would be accurate, but to unsuspecting observers Enron seemed to do very well.

Enron’s corporate culture changed radically during the mid-1990s. Bonuses and salaries became dependent on the closing of deals, and employees starting battling each other for the rights of each deal made. In May 1995, James Alexander, an executive in Enron’s Global Power & Pipelines division, warned Lay of suspicious accounting of the division’s finances. Lay did not act on the warning. In 1997, Skilling was promoted to president and chief operating officer. Fastow created a series of companies-codenamed Chewco and Jedi-designed to keep debt away from Enron’s books while inflating the firm’s profits. That year, Fortune magazine named Enron the most innovative company in the United States. In 1999, Fastow set up the first of the secret partnerships, which generated huge bonuses for him and his associates, while hiding Enron’s many poorly performing assets and investments. At the same time, Enron launched its broadband services unit and Enron Online, the company’s website for trading commodities, which soon became the largest business site in the world. About 90 percent of its income would eventually come from trades over Enron Online.

By August 2000, Enron shares reached a peak of $90. That year, California learned what Enron had wanted from a deregulated marketplace. For years afterward, Enron employees would insist that the catastrophe was California’s fault and that Enron had done nothing wrong. Government investigators discovered that Enron’s dummy companies had traded natural gas and electricity among themselves, with each trade increasing in price, until the commodities were sold to California for several times their actual market value.

In August 2001, an Enron employee, Sherron Watkins, met Lay to alert him to her concerns about dodgy finance and accounting practices at the firm. Later, on October 16, Enron shocked the markets by announcing a $638 million loss for the previous three months, and write-offs worth $1.2 billion; three days later the U.S. stock market watchdog launched an inquiry into Enron’s finances. A week later, CFO Andrew Fastow was replaced. On November 2001, rival firm Dynegy made an offer to buy Enron. Shortly thereafter, Enron announced even further losses and previously undisclosed debt. As Enron’s share price fell below $1, Dynegy broke off the takeover talks. On November 8, 2001, Enron filed a Form S-K with the SEC, announcing that its failure to account properly for transactions with partnerships known as KLM Cayman, L.P. and Chewco Investments, L.P. required the company to adjust its financial statements for 1997-2001. The Securities and Exchanges Commission added accountancy firm Arthur Andersen, the auditor for Enron, to its investigation. In December 2001, Enron filed for bankruptcy protection, the largest bankruptcy in the United States history at that time. Thousands of employees were laid off.

In January 2002, Lay resigned. Arthur Andersen declared that its employees destroyed a “significant but undetermined” number of Enron documents. The transnational company was later fined for its actions. In October 2002, Fastow was arrested on the charges of fraud, money laundering, and other accusations. Enron defendants faced over 30 felony charges, including alleged violations of the Securities and Exchange Act of 1934. The charges stated that Enron knew and did not disclose actual earnings and hedges to the public. In May 2006, Lay and Skilling were found guilty of conspiracy, fraud, and other charges. The collapse of Enron raised new questions about the adequacy of U.S. corporate governance rules. The secret partnerships and deceitful accounting hurt Enron’s shareholders, customers, and employees and tarnished the reputation of senior managers. The failure of Enron caused damage in the world of accounting that stretched far beyond Arthur Andersen. The Sarbanes-Oxley Act, a measure that attempted to improve the audit process for public companies in the United States, passed largely as a result of the Enron failure.

Bibliography:

  1. Sayan Chatterjee, “Enron’s Incremental Descent into Bankruptcy: A Strategic and Organization Analysis,” Long Range Planning (v.36/2, 2003);
  2. Brian Cruver, Anatomy of Greed: The Unshredded Truth from an Enron Insider (Carroll & Graf Publishers, 2002);
  3. C. Steven and M.J. Epstein, “The Fragility of Organizational Trust: The Lessons From the Rise and Fall of Enron,” Organizational Dynamics (v.32/2, 2003);
  4. Bethany McLean and Peter Elkind, The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (Portfolio, 2003);
  5. Jean-Luc Moriceau, “What Can We Learn from a Singular Case Like Enron,” Critical Perspectives on Accounting (v.16/6, 2005).

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