ENRON 101 A lesson about the

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ENRON 101A lesson about the 1 energy company
that wanted to be the 1 company in the world
Econ 295 Houghton College September 18, 2002
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Quote from Enron 401 (k) Plan Details (for
Employees)

• Lack of money is the root of all evil.
• George Bernard Shaw

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Enron Grows
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On the Rapid Rise to 7

• if Enron had recorded trading profits as
  revenues (like brokerage firms do), instead of
  recording the entire transaction amount, then
  Enron would have only 6.3 billion on the revenue
  lineslightly less than the 100 billion that put
  Enron in its current 7 spot in the Fortune
  500between Citigroup and IBM.
• the revised number would put Enron at 287,
  right next to Campbells Soup.

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What were Enrons sins?

• Insider trading
• Conflicts of interest
• Hiding debt
• Overstating income
• Execs sold stock while propping up its price

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Enrons Corporate Culture

• On Paper
• Upbeat values
• Commitment to ethical behavior
• In Practice
• Focus on earnings per share at any cost
• Aggressive and arrogant attitude
• Willing to ignore risks and conflicts of
  interests
• Pitiless
• fired 15 of workers per year to maintain
  excellence
• managers horse-traded as to who had to go to meet
  targets

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Accusations about Enron

• Make insiders rich
• Rush jobs to get bonuses
• Subic Bay (Philippines), Dabhol (India)
• Other plants in Guatemala, Puerto Rico, Dominican
  Republic
• Mute doubters and critics No bad news!
• 1995 report of gas leaks in San Juan, Puerto Rico
• 1996 San Juan gas explosion killed thirty
• Confuse observers with reorganizations, etc.
• Encourage managers to lie to promote the firm
• Capture auditors
• Fired internal auditors
• Hired inexperienced accountants from Anderson to
  take over internal audits.

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Why Did Enron Fail?

• Perverse incentives of bonuses for deal makers
• Deals put on books immediately at full value of
  long-term contracts
• Discounted present value of stream of future
  earnings
• Depends on deal-makers estimate of future price
• Deal-makers bonus varied directly with estimated
  prices
• Failure of internal controls
• Risk Assessment and Control (RAC)reviewed deals
• Numbers often didnt add up (inflated deal
  values)
• Deal makers threatened RAC analysts to pass them
• RAC understaffed and overruled
• Andy Fastow allowed to create huge conflicts of
  interests
• Death Spiral of a business out of favor

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Why Did Enron Execs Hide the Facts?

• Value of their stock options depended on
  maintaining a high value of market price of Enron
  shares (ENE, NYSE)
• Value of the business depends on successful
  marketing, on media and Wall Street accepting
  Enrons positive PR spin.

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How Did Enron Hide Its Problems?

• Rigged the books of the firm to show more net
  income and greater net worth(owners equity).
• Income statement
• Revenue - Expenses Net Income
• Overstate revenue
• Balance Sheet
• Assets - Liabilities Net Worth
• Hide debt (a liability) with subsidiaries
• Value of shares of stock depend on
• Return on Investment Net Income / Net Worth
• Earnings per Share

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Examples of Cooking the Books

• Prepays turned into loans.
• Close dealing with Andy Fastows LJM2 partnership
• Merrill Lynch execs put up money and sought other
  financing for LJM2.
• Fastow promised that LJM2 would be dealing with
  Enron assets (that he, being on both sides of the
  deal, would price assets).
• Merrill put up money for Enron barges (with
  hidden promise to find a buyer in 6 months)
• Fastow found a buyer (LJM2)
• Merrill was asked to lend LJM2 money shortly after

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Other Schemes to Hide Enrons Problems

• In 1998, senior management brought in financiers
  to see a new trading operation It was all a
  fake.
• Increasingly used fraudulent deals with
  subsidiaries.
• Shredding Documents after SEC announced it was
  investigating.

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Others Were Also Complicit

• The press loved Enron, eagerly covering its new
  business ventures.
• Bankers played along in schemes to hide debt.
• Merrill Lynch, Citigroup, Chase and others
  exposed
• The external auditors were not asleep at the
  wheel, they were greasing the skids.
• Wall Street failed to look critically
• If a company condemned ENE, it would lose future
  business deals and the revenue.
• Yet Bush Whitehouse refused a bailout.

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SummaryEffects of Enrons sins?

• Many pensioners lost wealth.
• Houston businesses and charities were hurt.
• Banks have exposure to losses and lawsuits.
• Trust is low in financial markets.
• Markets are repricing assets reflecting higher
  risk
• Markets and government are rethinking rules and
  regulations.
• Corporate boards are rethinking incentive
  structures and their oversight responsibilities.

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Enron Declared Bankruptcy

• Sunday, Dec. 2nd, 2001

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Whats What Whos Who

• Enron Corporation energy, plus
• Main Offices, Houston, TX
• Jeff Skilling, CEO
• Kenneth Lay, President
• Brian Cruver, MBA, employed in March 2001 by
  Enrons newest division, the Risk Management
  Group

• Dark Side the Empire
• The Death Star
• Darth Vader
• The Emperor
• another Jedi goes over to the dark side (email
  from a Cruver friend)

I didnt mind joining the Death Star
eitherafter all, the Empire offered great pay
and excellent benefits. Cruver
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Other Players

• Indicted for fraud
• in secret, asked for a transfer, and quietly sold
  her Enron stock.

• Andrew Fastow, CFO
• Sherron Watkins, CPA who blew the whistle

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The Crooked E

• I relaxed at my new desk for about half a second
  when the phone rang.
• Cruver! Welcome to the Crooked E! It was
  another friend from business school who was
  calling from fifteen floors above.
• The Crooked E? It was true the Enron logo was
  the letter E tilted at forty-five degrees, though
  the tilt was not exactly what he was referring
  to.
• Brian Cruver, Anatomy of Greed The Unshredded
  Truth
• from an Enron Insider, Carroll Graf, 2002, p.
  9.