Enron's Scandal

Enron's Scandal

Enron is an energy and power company based in Houston, Texas that deals with the energy trade on an international and domestic basis. The company was founded in 1985 by Kenneth Lay when Houston natural gas merged with Internorth. Ken Lay helped to initiate the selling of electricity at market prices and, soon after according to (Enron: The Smartest Guys in the Room) President Bush senior helped Ken Lay in giving government subsidy to Enron international and promoted Ken Lay as deregulating ambassador at large. The resulting markets made it possible for traders to sell energy at higher prices, allowing them to prosper.

In 1992, Enron was considered to be the largest merchant of natural gas in North America. The gas trading business became the second largest contributor to Enron's net income, with earnings before interest and taxes of $122 million. In 1999 the creation of the online trading enabled the company to further develop and extend its abilities to negotiate and manage its trading business.

Enron's accounting use to be straightforward in listing the actual revenues received from selling energy. But however when Louis Borget and Thomas Mastroeni two oil traders were gambling beyond their means and threatened to bankrupt the company, Mike Muckleroy, oil and gas executive bluffed the Market and saved the company. After Borget and Mastroeni were fired for having to threaten the company, Lay hired Jeffrey Skilling to join the company. When Skilling joined the company, he demanded that the trading business adopt the Mark-to-Market accounting system. Arthur Anderson their auditor signed off on it and Securities and Exchange Commission (SEC) approved it. Enron became the first nonfinancial company to use the Mark-to-Market method. This method requires a long-term contract deal to be signed and then income was estimated as the present value of net future cash flows. Often these contracts and their related costs were very difficult to measure. Due to the large discrepancies of attempting to match profits and cash, investors were typically given false or misleading reports. Income from projects could be recorded, which increased financial earnings, but later on when projects could not be included, Enron had to figure out away to include new and additional income from more projects to develop additional growth just to satisfy investors.

Later on in the company as times were becoming hard for Enron to bring in income, Enron figured out away for their financial statements to be nontransparent, which is meant for the statement not to be so clearly detailed with its operations and finances with shareholders and analyst. Its complex business representation required that the company use accounting limitations to manage earnings and modify the balance sheet to portray a favorable interpretation of their performance. According to (Enron: The Smartest Guys in the Room) the Enron scandal grew out of a steady accumulation of habits, and values to actions that began years before and finally spiraled out of control. According to Bodurtha J. N. (2003) from the late 1997 until the day it collapse, their primary motivations were that the accounting and financial transactions seem to have been to keep reported income and cash flow up, assets values extravagant, and liabilities off the book (p.2).

All of these scandals later led the company to file for bankruptcy. Majority of these actions were perpetuated by the direct actions of Kenneth Lay, Jeffrey Skilling, Andrew Fastow and other executives. Fastow's jobs were to create off-balance sheet, complex financing structures and to do deals so confusing that few people can understand them. Fastow created 100 special companies to perform a system called "The Black Magic." It helped Enron's dept disappear, but to investors it looked like cash was coming in. When in reality, Enron was hiding their debt into Fastow's companies where investors couldn't see it.

Enron made it a habit of booking costs of cancelled projects as assets, with no justifications of an official letter stating that the project was cancelled. This method was known as "The Snowball" and although it was initially dictated that Snowballs stay under $90 million, it was later extended to $200 million.

As times got worse for Enron, Skilling announced he was resigning his position as CEO after only six months on August 14. According to The New York Times (2001) the company, having little cash to run its business, let alone to satisfy its enormous debts, Enron finally caved in. At the end of the day trading stock price fell to $.61 and Enron was estimated to have about $23 billion in liabilities, both debt outstanding and guaranteed loans. Citigroup and JP Morgan chase in particular appeared to have significant amounts to lose with Enron's fall and many of Enron's major assets were guaranteed to lenders in order to secure loans, throwing into doubt what if anything unsecured creditors and eventually stockholders might receive in bankruptcy proceedings.

According to (Enron: The Smartest Guys in the Room) on January 17, 2002 Enron fired Arthur Anderson as their auditor, demanding that they destroyed all documents. Anderson contradicted themselves by saying that they had already severed ties with the company when Enron entered bankruptcy.

Anderson was convicted of obstruction of justice for shredding documents related to the audit of Enron's account. Nancy Temple who worked in the legal department for Anderson, and David Duncan the lead partner for the Enron account were both mention as the responsible managers in the scandal as they had given the order to shred the relevant documents. Since the U.S. SEC does not allow convicted felons to audit public companies the firm agreed to surrender their CPA licenses and their rights to practice before the SEC on August 31, 2002 effectively putting the firm out of business in the US, while Anderson's non US practices came to an end due to reputational collateral damages.

Anderson's overall performance on the audit of Enron led the firm to fall apart and to the following assessment by the power committee which was appointed by Enron's board to look into the firms accounting on October 2001. According to Cornford, A. (2004) The evidence that was available to the power committee suggested that Anderson did not fulfill their professional responsibilities in connection with their audits of Enron's financial statements, or their obligation to bring to the attention of Enron's Board the concerns about Enron's internal contracts over the related-parties transactions.

On May 31, 2005 the Supreme Court of the United States unanimously overturned Anderson's conviction due to the errors in the jury instructions. In the court's view, the instructions were far too unclear to allow a jury to find any obstruction of justice had really happen. The instructions allowed the jury to convict Anderson without having any proof that the firm knew it broke the law or that there was any link of any kind to an official preceding that forbid them to destroy the documents.

Despite the ruling, Anderson may never be able to be a particle business. The firm was bringing in 9.3 billion in annual revenue, but when they were charged the firm lost nearly all of their 2,300 clients including Kerr-McGee, Freddie Mac, Federal Express, and Delta, now if such large clients fired Anderson as their auditor; than many other clients were likely to do the same. Till this day there are over 100 civil suits pending against the firm for the audits of Enron and other companies with similar audits. Anderson's reputation was so badly damaged that no company wanted to have Anderson's name on an audit just to avoid any alleged problems, and even before voluntarily surrendering their right to practice before the SEC, they had many of their state licenses revoked. The firm began winding down the American operations after the indictment, and many of the accountants left the firm to join other firms. The firm downsized from a high of 85,000 employees worldwide to just about 200 employees based in Chicago. Most of their attention is on handling the lawsuits and managing over the ending of the company. The firm sold most of the American operations to other companies, such as Ernst & Young, Grant Thornton LLP and many more.

The Sarbanes-Oxley Act of 2002 also known as Sarbox, SOX is a United States federal law enacted on July 30, 2002. The bill was enacted as a reaction to the accounting scandal of Enron and a number of other major corporate that have done the same such as Tyco International and WorldCom. These scandals, which cost investors billions of dollars when the share prices of affected companies collapsed has shaken the public's confidence in the nation's securities markets.

Although the legislation does not apply to privately held companies it does set new or enhanced standards for all U.S. public company boards, management and public accounting firms. The act contains 11 titles, or sections, ranging from additional corporate