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Enron Case Study 971103 [Compatibility Mode]

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  • 1. MBA Lecture Corporation Gone Away p y The Fall of Enron Empire Professor Andrew B.C. Huang National Taiwan Tech University, Management School huang.prof@gmail.com huang prof@gmail com 2008 Winter
  • 2. Corporation: An ingenious (clever and skillful) device for obtaining profit without individual responsibility. Ambrose Bi A b Bierce, The Devil’s Dictionary, 1906
  • 3. The Fall of Enron Empire p The World No. 1 Energy Trader Goes Bankruptcy
  • 4. Enron’s Rise and Fall A sudden collapse In less than two decades Enron grew from a small decades, Dec. Dec 2000 Midwestern gas pipeline company (established in Enron files its annual report in which it claims to 1984) into the world's largest energy trader with a have tripled its revenues since 1998. pipeline business on the side. Jan. 2000 Fortune magazine ranks Enron no. 24 among the quot;100 Best Companies to Work for in America.quot; April 2001 Since 1997, Kenneth Lay and his wife contributed a total of $444,960 in political donations, mostly to members of the Republican Party. July 2001 New CEO Jeff Skilling gets hit in the face with pie from a protester who blamed Enron for California's energy crisis. California consumer groups and politicians accused Enron of price-gouging during California's power shortage. Enron stock drops to $42.93. Nov. 8 2001 N 8, Enron revises its financial statements to reduce earnings by an additional $586 million over the past four years, due to losses with suspect partnerships. It is also disclosed that Fastow made $30 million in fees and profits from his involvement with outside p partnerships. Enron announces it must pay a $690 million in debt, with another $6 billion by next year.
  • 5. Enron: Fallen Giant From US$83.5 Drop to 0.83 Per Share in A Year
  • 6. “Enron never owned anything that created real Enron value and made real money. We have a record of nothing but years of bad business and mismanagement, kept hidden by cover-up. “ Kurt Eichenwald, “Flinging Billions to Acquire Assets That No One El W ld Touch.” (U O Else Would T h ” (Unveiling th secret d l th t ili the t deals that allowed Enron to hide bad business decisions) The New York Times, October 3, 2002
  • 7. Enron s Enron’s Fraudulent Financial Engineering Five Ghosts to Exchange Loses and Revenues In 2001 I 2001, endgame began, and E d b d Enron empire all f ll apart f i ll fell t from it hi h of its high f $90, reached in late Fall 2000. Even through Enron said that it had a healthy profits, but in fact it had never profitable under any common acceptable definition of “profitability” in last five years. “profitabilit ” fi e ears But why Enron could stated that it is profitable, it took the following fraud and false methods 五鬼搬運 1.To generate the profits from unreal futures trading; 2.To hide the losses in accounting book; 3.To avoid paying income tax by establishing 900 offshore p y g y g subsidiaries in tax-heaven countries; 4.To turn accounting division to as a profit center; 5.To 5 To build profitable consulting relationships with outside auditors.auditors
  • 8. How Did Enron Go Bankruptcy p y With 21,000 employees in over 30 countries and stated revenues $100 billion Time Things Happen/Key Events Early July •Enron said it would post a $500million loss in quarterly statement, due to blamed losses on the California energy crisis, poor investments in India and crisis 2001 South America, and a moribund broadband Internet market. The Stock $50 August •CEO Jeffrey Skilling unexpectedly resigned and claimed the move was for The Stock $40 quot;personal reasons,quot; but investors were left stunned and anxious about the stability of Enron. July-October •The Securities and Exchange Commission began an inquiry into Enron's y troubling losses. October •Enron said it would reduce shareholder value by $1.2 billion. It was blamed The Stock $20.65 the losses on its broadband division, international subsidiaries, and its partnerships, like LMJ and Chewco. Two weeks •Enron fired Andrew Fastow, the chief financial officer, for allegedly arranging deceptive and failing partnerships what were being used to hide Later millions of dollars in Enron losses.
  • 9. How Did Enron Go Bankruptcy With 21,000 employees in over 30 countries and stated revenues $100 billion Time Things Happen/Key Events •The SEC publicly upgraded its inquiry into a formal investigation of Enron's suspec ed audu e suspected fraudulent financial statements. Enron claimed profit $53million in a c a s a e e s. o c a ed p o $53 o July-September but turned to $21billion lose. Early •Enron conceded it had overstated its profits by nearly 16 percent, or $600 million, since 1997. Enron's auditors, Arthur Andersen alerted shareholders November not trust any financial reports issued before June 30, 2001. •Enron's shareholders and investors sold their shares as fast as they could. •Enron's credit rating was reduced and had to pay back a part of its debt immediately, consequently, its deal with Dynegy fell through. December 2 •Faced with paying back millions of dollars in debt, Enron's executives and company board agreed to seek Chapter 11 bankruptcy ti d b d dt k Ch t b k t protection. By Liz Harper, Online NewsHour (June 2002)
  • 10. The Wheels of Misfortune Enron’s Fraudulent Profitability Method The New Culture: Ambition and greed Nothing mattered except getting rich The New Accounting: False Profits Accounting Fraud Profit Center, mark-to-market Lock in future income Hedge Derivatives Outside partnerships Misreported Lucrative consulting relationships Trading Loses ad g oses Revenue O Outside auditors, investment analysts, , y , Banks Settlements Trading Loses Claims Lawsuits Rescue Questionable Fund required Trades
  • 11. Enron’s Wrongdoing g g The ultimate failure of the system Enron I ’t Real but Risk Money E Isn’t R l b t Ri k M had never been profitable under any acceptable definition of “profitability” •The financialization of all things Integrity: Everything rested •Hedge derivatives with derivatives on the reputation •Refer tax division as a profit center Auditing VS Consulting •Sell underperforming assets to improve balance Internal conflicts •Never owned anything that created Kept silent to the checks and balances real value and make real money Arthur Andersen Had Profited form its participation The Wall Street Fixation Everybody knows that the market has to be kept happy The only real things Enron had --were sold to raise quarterly earnings The Market need huge funds to grow their assets And that need coincides nicely with the opportunity of insiders To make a huge amount of money by manipulating stock and cashing in options
  • 12. The Common-Size Financial Statements Where’s the Black Holes That Enron Made Black Holes 資產Assets •Cash and marketable security Created s set of investment vehicles called the Raptors such as •Accounts receivables Accounts Chewco to be an independent company that doesn’t show up on the p p y p •Inventories book, to hedge, or lock in the profits from other start-up ventures. •Properties plant and equipments This accounting irregularity raised Enron’s profits by 75%; keeping •其他 Others assets it going for the next 3 years resulted in $396 million in inflated profits. profits 負債 Liabilities Formed a partnership with some other outside parties to buy none- •Accounts payable profitable investment’s shares, to hide the loses. •Other current expenses Oth t •Long-term debt •Capital leases Enron’s skill in locating its partnerships offshore and keeping cash •Other long-term liabilities flow small had made the tax division a significant “profit center” by •Salary payable S l bl saving $1billion in 5 years. •Tax payable 股東所得 Shareholder’s equity
  • 13. Common Size Common-Size Income Statements Where’s the Falsenesses that Enron Made Revenues 收入 Falsenesses Sales Federal regulators permitted Enron to use “mark-to-market” accounting, a way of evaluating future income that works Other revenues reasonably well in securities trading. It allowed Enron to calculate projected income as present profit in 1999, Enron claimed a $65 million profit based on a natural-gas natural gas sales from South American pipeline had yet to be built. Expenses支出 Pay no income tax by making good use of about 900 subsidiaries in tax-haven countries,. Cost of goods sold Marketing, general, administrative In 2000, Enron got $278million in refunds, since options, need Interest expense not reported to the shareholders as an expense, and can be Taxation, current and deferred deducted from company’s income for tax purposes. Net Income淨利 Total assets/ Total revenues
  • 14. What If Enron’s New Accounting g When the van crashes into the retaining wall at 120 mph The driver who lost control (was he paying attention?) The Th engine that i h brought the van to that speed (was it operating properly?) The brakes that failed or not
  • 15. In Enron’s Crash Enron s When the new accounting process The S Th Same Model M d l Results R l The drivers were who were apparently zipping along without a the managers of Enron g roadmap with little regard to the safety of the p g y passengers (let alone the pedestrians 行人) The engine was Enron’s unrestrained culture of greed and confidence in organizational culture the business community that p y permeated the nation as a whole The brakes were who were supposed to be making good business the bankers, analysts, , y , judgments about the soundness of Enron’s decision- and auditors making.
  • 16. Sentenced to Imprisonment Greedy, a waken dream
  • 17. Arthur Andersen LLP Arthur Andersen LLP is one of the Big Five accounting firms, grossing over $9 billion in sales during 2001. The company, with 85,000 employees working in 84 countries, audits th fi dit the financial statements of most publicly t d d companies i th U S Whil i l t t t f t bli l traded i in the U.S. While their profits come directly from corporate clients' payments, they are accountable to both the SEC and the public. Andersen served as Enron's sole auditor throughout the energy giant's sixteen years, also performing i t l f i internal audits and consulting services. A l dit d lti i According t E di to Enron's fi ' financiali l statements, Andersen earned $25 million for audit work and $27 million in non-audit fees in 2000. Shortly after Enron's sudden bankruptcy, the SEC questioned Andersen CEO Joseph Berardino about his firm s inaccurate audit statements and Enron's overstated profits firm's Enron s profits. Berardino told the SEC that Enron's audited statements were misleading since Andersen accountants did not include Enron's money-losing partnerships, like Chewco, in the main financial statements. The General Accepted Accounting Principles (GAAP) state that the degree of a company's investment in partnerships determines whether such partnerships should be consolidated into the main balance sheets. Enron exceeded the three percent maximum investment in many of its partnerships, such as Chewco therefore Andersen should have recalculated earnings by including Chewco, the business deals into Enron's overall balance sheet. Berardino told the SEC that Andersen restated Enron's earnings in 2001 after learning that Enron had invested much more money into the partnerships than it originally claimed.
  • 18. Andersen also accused Duncan of directing quot;the deletion of thousands of e mails and the rushed disposal of large numbers of paper e-mails documents.quot; As the breadth of Enron's alleged fraud became apparent Andersen fired Houston Enron s apparent, partner David Duncan on Jan. 16, 2002, saying he ordered the destruction of Enron documents the day after it was learned the government was investigating its financial statements. When asked to testify before the congressional hearing, Duncan cited his Fifth Amendment rights, declining to discuss his involvement or knowledge of the case. The SEC and several congressional committees continue to investigate whether or not Andersen compromised its professional ethics or violated standards set by GAAP. y Andersen has recently been involved in several other major auditing scandals. Last year, the SEC fined the firm $7 million for 'improper professional conduct', including overstating client Waste Management's earnings by $1.4 billion. It was the first successful case against an auditor in over 20 years. In May 2001, Anderson also paid $110 million to Sunbeam shareholders t settle l illi t S b h h ld to ttl lawsuits stemming f it t i from it i fl t d its inflated earnings statements. Both Sunbeam and Waste Management restated their earnings after admitting fraud in their financial statements. In mid-June, a federal jury convicted Arthur Andersen of obstruction of justice by destroying Enron-related materials to impede an investigation by securities regulators. d t i E l t d t i l t i d i ti ti b iti l t The accounting firm, which vowed to appeal the verdict, informed the SEC it would cease auditing public companies by Aug. 31.
  • 19. Penalty for Corporate Criminal Deception 對企業欺詐犯行的懲罰
  • 20. Aiming to restore trust in America's financial markets, President Bush on Tuesday signed the corporate responsibility bill passed by Congress last week. In a signing ceremony in the East Room of the White House the president enacted new legislation that toughens House, penalties for corporate fraud, establishes an independent accounting board and increases spending for the Securities and Exchange Commission. Lauding the bill as quot;the most far-reaching reforms of American business practicesquot; since the Depression, Mr. Bush said the bill would send a strong message urging corporate America to quot;uphold their responsibilities,quot; or otherwise be quot;exposed and punished.quot; The legislation quadruples the maximum jail time for corporate executives and auditors indicted for wire or mail fraud, setting sentences at 20 years. The bill also classifies securities fraud as a crime that could carry a prison sentence of up to 25 years. A new independent board will oversee the accounting industry, which largely had been monitored by members of its own profession. Following the indictment of Enron auditors Arthur Andersen, the accounting self-regulatory system has come under pressure to reform. reform quot;This law says to accountants: 'The high standards of your profession will be enforced without exception,quot; the president said. quot;The auditors will be audited, the accountants will be held to account.'quot; quot;In the aftermath of September 11 we refused to allow fear to undermine our economy and we will not allow fraud to undermine it either,quot; Mr. Bush told a group of Democratic and Republican lawmakers and administration officials p present at the signing ceremony. g g y Despite the president's pledge to crack down on corporate fraud, a rally on Wall Street was humbled by a dismal new report on consumer confidence. The Conference Board released its monthly Consumer Confidence Index Tuesday morning, showing a sharp fall for July. The index, based on its monthly survey of 5,000 U.S. households, tumbled to 97.1 points, its lowest level since , y y , , p , February. While quot;consumers' expectations for the next six months have soured,quot; consumer confidence has not struck a historic low, the Conference Board said.
  • 21. Wall Street’s Penalty Street s Provide misleading stock advice
  • 22. In one of the largest settlement deals ever, Citigroup, J.P. Morgan Chase, Credit g p, g , Suisse First Boston and Merrill Lynch, must pay the fine and implement sweeping structural reforms to resolve the alleged conflicts of interest between corporate banking and stock research.
  • 23. quot;This agreement will permanently change the way Wall Street operates, operates quot; New York state Attorney General Eliot Spitzer one of the Spitzer, settlement's lead negotiators, said on Friday. quot;The objective throughout this investigation has been to protect small The investors by ensuring integrity in the marketplace,quot; Spitzer said. quot;Hopefully, the rules that are embodied in this potential settlement will restore investor confidence by restoring integrity to the marketplace.quot; To address the alleged conflicts of interests, the settlement requires that the ten firms separate their stock research and investment banking divisions. It also bars stock analysts from being paid for equity research by their firms' investment banking division and from attending their firms' meetings with g g g potential investment banking clients. The firms must also spend $450 million over five years on independent stock analysis and information to ensure their investors receive unbiased research, research and pay another $85 million for a nationwide investor education program. The agreement requires brokerage firms to discontinue the Wall Street practice of quot;spinning,quot; or giving lucrative initial public offerings to corporate executives whose companies h ti h i have i investment b ki b i t t banking business with th ith the brokerage firms. Regulators have argued this practice could exert an undue influence on investment banking decisions.
  • 24. The ten firms were not required to acknowledge any wrongdoing or admit to allegations they knowingly promoted stocks in which they had, or desired, a financial interest. No individual civil charges were brought against any stock analysts or the executives who managed them, although state and national regulators could still investigate whether some Wall Street executives or analysts violated securities laws. The Salomon Smith Barney unit of Citigroup will pay the largest fine of $325 million, while Credit Suisse must pay $150 million. Seven other banks -- Goldman Sachs, J.P. Morgan Chase, Bear Stearns, Morgan Stanley, Lehman B th St M St l L h Brothers, D t h B k and UBS P i W bb -- are Deutsche Bank d Paine Webber expected to pay $50 million each. Merrill Lynch, the nation's largest brokerage firm, agreed to pay a $100 million fine as part of a settlement it reached with Spitzer last May. Merrill Lynch, which is not required to pay additional fines as part of this agreement, had similarly agreed to separate its stock research division from p g y g p investment banking. The money from the fines will be divided about evenly between the states and national regulators, which include the Securities and Exchange Commission, the National Association of Securities Dealers and the New York Stock Exchange. An unspecified amount of the money will go to a restitution fund for affected investors. The agreement comes after five months of haggling between regulators and the firms regarding the settlement amount. Spitzer had initiated investigations into Wall Street brokerage activities shortly after energy giant Enron and several other large companies declared bankruptcy, causing thousands of investors to lose millions of dollars. As Spitzer and his office discovered serious conflicts of interest within Wall Street stock analysis and finance activities, other federal agencies joined the attorney general's investigation.
  • 25. Topics to Discuss An this is also your middle-term report Legally, Legally corporations are “fictitious persons” created by the law and empowered with fictitious persons certain rights and abilities that allow them to be recognized as financial entities, capable of carrying on commercial transactions, and as institutional citizens that can be held accountable to regulation and taxation. Is a corporation responsible only to its stockholders? And is fiduciary success the only measure of corporate success? Greed, as Plato pointed out, is essentially unlimited. It seems that If people are enjoying a comfortable existence now, they will immediately see that with more money they could enjoy a luxurious existence. What you opinion to most of people existence people, do you believe, they want it, also immediately? And how to deal with it? Accounting firm Arthur Anderson has to take critical responsibility for Enron’s hurt to the pubic, since it had assumed the role of corporate honesty guarantor. What’s the main reason why shredding of Arthur Anderson’s p y g professional trust and moral integrity? Do you think Enron’s case is also an ethical issue? Why? And can corporations be held morally accountable for their decisions and behaviors? All term are requested to deliver your group papers (Within 8 pages power point) before November 17.