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An Insight into what happned with Enron

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  1. 2. <ul><li>“ What we are looking at here is an example of superbly </li></ul><ul><li>complex financial reports. They didn’t have to lie. All </li></ul><ul><li>they had to do was to obfuscate it with sheer </li></ul><ul><li>complexity — although they probably lied too.” </li></ul><ul><li>Senator John Dingell </li></ul>
  2. 3. <ul><li>Enron Corporation was an American energy company based in Houston, Texas. Before its bankruptcy in late 2001, Enron employed approximately 22,000 and was one of the world's leading electricity, natural gas, pulp, paper, and communications companies, with claimed revenues of nearly $101 billion in 2000. Fortune named Enron &quot;America's Most Innovative Company&quot; for six consecutive years . </li></ul>
  3. 4. <ul><li>Enron was originally involved in transmitting and distributing electricity and natural gas throughout the United States. </li></ul><ul><li>The company developed, built, and operated power plants and pipelines while dealing with rules of law and other infrastructures worldwide. </li></ul><ul><li>In just 15 years, Enron grew into one of America's largest companies, but its success was based on artificially inflated profits, dubious accounting practices, and – some say – fraud. </li></ul>
  4. 5. <ul><li>• Enron Wholesale Services </li></ul><ul><li>• Enron Energy Services </li></ul><ul><li>• Enron's Global Assets </li></ul>
  5. 6. <ul><li>Enron Wholesale Services- encompasses Enron's global wholesale businesses, and is divided into four business units. </li></ul><ul><li>• Enron Americas </li></ul><ul><li>• Enron Europe </li></ul><ul><li>• Enron Global Markets </li></ul><ul><li>• Enron Net Works </li></ul>
  6. 7. <ul><li>Enron Energy Services – </li></ul><ul><li> The retail arm of Enron, offers companies away to develop and execute their energy strategies. </li></ul><ul><li>Created as a retail broker of energy services </li></ul><ul><li>Bought energy from utilities; sold to customers </li></ul><ul><ul><li> Created market in retail energy contracts </li></ul></ul><ul><li>Sold energy contracts; hedged in energy market </li></ul><ul><li> Eventually made big bets on direction of energy prices, and lost </li></ul>
  7. 8. <ul><li>Enron Transportation Services </li></ul><ul><li>• oversees Enron's regulated, interstate natural </li></ul><ul><li> gas pipelines </li></ul><ul><li>Enron had assets spread across : </li></ul><ul><li>Central America and the Caribbean </li></ul><ul><li>South America </li></ul><ul><li>Europe </li></ul><ul><li>Asia Pacific </li></ul>
  8. 9. <ul><li>Enron traded in more than 30 different products, including the following: </li></ul><ul><li>Products traded on EnronOnline </li></ul><ul><ul><li> Petrochemical, Plastics,Power, Pulp & Paper, Steel, Weather Risk Management </li></ul></ul><ul><li>Oil & LNG Transportation </li></ul><ul><li>Broadband </li></ul><ul><li>Principal Investments </li></ul><ul><li>Risk Management for Commodities </li></ul>
  9. 10. <ul><li>Shipping / Freight </li></ul><ul><li>Streaming Media </li></ul><ul><li>Water & Wastewater </li></ul><ul><li>Energy and commodities services </li></ul><ul><li>Capital and risk management services </li></ul><ul><li>Commercial and industrial outsourcing services </li></ul><ul><li>Project development and management services </li></ul><ul><li>Energy transportation and upstream services </li></ul>
  10. 11. <ul><li>“ Enron knew they were crooks. But they were profitable crooks.” </li></ul>
  11. 12. <ul><li>What happened? </li></ul><ul><li>Why did it happen? </li></ul><ul><li>What were the results? </li></ul>
  12. 13. <ul><li>Personalities behind the Enron scandal </li></ul><ul><li>Prelude to scandal </li></ul>
  13. 14. Ken Lay, Chairman and CEO • Big picture; optimistic; tended to avoid controversy “ Ken gravitates toward good news” Jeffrey Skilling, President • Proponent of big ideas; less interested in details “ Skilling is a designer of ditches, not a digger of ditches.” Andrew Fastow, CFO • Ambitious; unwilling to let the rules get in the way “ I don’t know that he ever had a moral compass”
  14. 15. • Enron Corp (Houston, TX) .Enron Oil (Valhalla, NY) Enron Oil chiefs involved in irregularities – Lay imposed weak sanctions; allowed execs to continue Enron Oil faced devastating exposure – Division head, CFO had siphoned off money; both fired – Lay surprised both by losses and impropriety
  15. 16. <ul><li>Practice </li></ul><ul><li>Subjective assessment of future gains </li></ul><ul><li> Little incentive for follow-through </li></ul><ul><li>Pressure to accelerate deal flow </li></ul><ul><li>Key Issues: </li></ul><ul><li>a) How do we know future costs? (Hint: not very well) </li></ul><ul><li>b) What if profits don’t pan out? (Contracts should be written down, but…) </li></ul><ul><li>c) How will Wall Street react if deals don’t keep getting bigger? </li></ul>
  16. 17. <ul><li>Because Enron believed it was leading a revolution, it pushed the rules. Employees attempted to crush not just outsiders but each other. Competition was fierce among Enron traders, to the extent that they were afraid to go to the bathroom and leave their computer screen unattended and available for perusal by other traders. </li></ul>
  17. 18. <ul><li>Enron morphed from a sleepy gas pipeline into a rogue trading company </li></ul><ul><li>– Enron officers used their political clout affect policy, e.g., </li></ul><ul><li> electricity deregulation; </li></ul><ul><li>-pressure on Indian officials to push development of expensive </li></ul><ul><li> power plant </li></ul><ul><li>– Enron traders caused California’s energy crisis </li></ul><ul><li>– Enron’s profits were the product of accounting fraud </li></ul><ul><li>– Enron used SPEs to hide billions of dollars of debt </li></ul>
  18. 19. <ul><li>– Skilling left before the collapse because he “knew something” </li></ul><ul><li>– Top management, auditors, and banks were all part of the conspiracy </li></ul><ul><li>– The Board and regulators were asleep at the wheel </li></ul><ul><li>– Lay sold his shares while touting the company to employees and investors </li></ul><ul><li>– Executives were dumping their shares while employees, not allowed to sell from their 401(k)s, saw their retirements wiped out </li></ul><ul><li>– The Enron collapse was the (inevitable?) result of management greed </li></ul>
  19. 20. <ul><li>Individual and collective greed—company, its employees, analysts, auditors, bankers, rating agencies and investors—didn’t want to believe the company looked too good to be true </li></ul><ul><li>Atmosphere of market euphoria and corporate arrogance </li></ul><ul><li>High risk deals that went sour </li></ul><ul><li>Deceptive reporting practices—lack of transparency in reporting financial affairs </li></ul><ul><li>Unduly aggressive earnings targets and management bonuses based on meeting targets </li></ul><ul><li>Excessive interest in maintaining stock prices </li></ul>
  20. 21. <ul><li>Was paid $52 million in 2000, the majority for non-audit related consulting services. </li></ul><ul><li>Failed to spot many of Enron’s losses </li></ul><ul><li>Should have assessed Enron management’s internal controls on derivatives trading—expressed approval of internal controls during 1998 through 2000 </li></ul><ul><li>Kept a whole floor of auditors assigned at Enron year around </li></ul><ul><li>Enron was Andersen’s second largest client </li></ul><ul><li>Provided both external and internal audits </li></ul><ul><li>CFOs and controllers were former Andersen executives </li></ul><ul><li>Accused of document destruction—was criminally indicted </li></ul><ul><li>Went out of business </li></ul>
  21. 22. <ul><li>Enron paid several hundred million in fees, including fees for derivatives transactions </li></ul><ul><li>None of these firms alerted investors about derivatives problems at Enron. </li></ul><ul><li>In October, 2001, 16 of 17 security analysts covering Enron still rated it a “strong buy” or “buy.” </li></ul><ul><li>Example: One investment advisor purchased 7,583,900 shares of Enron for a state retirement fund, much of it in September and October, 2001 </li></ul>
  22. 23. <ul><li>Enron’s outside law firm was paid substantial fees and had previously employed Enron’s general counsel </li></ul><ul><li>Failed to correct or disclose problems related to derivatives and special purpose entities </li></ul><ul><li>Helped draft the legal documentation for the SPEs </li></ul>
  23. 24. <ul><li>Enron’s creation of over 3000 (!) partnerships </li></ul><ul><li>started about 1993 when it teamed with Calpers </li></ul><ul><li>(Calif. Public Retirement System) to create JEDI </li></ul><ul><li>(Joint Energy Development Investments) fund. </li></ul><ul><li>• Why partnerships? As long as Enron could find </li></ul><ul><li>another partner to take at least a 3% stake, Enron </li></ul><ul><li>was not required to report the partnership’s </li></ul><ul><li>financial condition in its own financial statements. </li></ul><ul><li>• Enron used partnerships to hide bad bets it </li></ul><ul><li>made on speculative assets by selling these assets </li></ul><ul><li>to the partnerships in return for IOUs backed by </li></ul><ul><li>Enron stock as collateral! ( over $1 billion by 2002) </li></ul>
  24. 25. <ul><li>• In November 1997, Calpers wanted to cash out of JEDI. </li></ul><ul><li>• To keep JEDI afloat, Enron needed a new 3% partner. </li></ul><ul><li>• It created another partnership Chewco (named </li></ul><ul><li>for the Star Wars character Chewbacca) to buy </li></ul><ul><li>out Calpers’ stake in JEDI. </li></ul>
  25. 26. <ul><li>• Chewco needs $383 million to give Calpers… </li></ul><ul><li>• It gets….. </li></ul><ul><li>— $240 mil loan from Barclay’s bank </li></ul><ul><li>(guaranteed by Enron) </li></ul><ul><li>— $132 mil credit from JEDI (whose only asset is Enron stock) </li></ul><ul><li>• Chewco still must get 3% from some outside source to avoid inclusion in Enron’s books (SEC filing, 1997). </li></ul>
  26. 27. <ul><li>Chewco Capital Structure: Outside 3% </li></ul><ul><li>$115,000 from M. Kopper ( worked at the time for Enron ) </li></ul><ul><li>$11.4 mil loans from Big River and Little River (two new companies formed expressly by Enron for this purpose who get a loan from Barclay’s Bank ) </li></ul>
  27. 28. <ul><li>• Barclay’s Bank begins to doubt the strength of the new companies Big River and Little River. </li></ul><ul><li>• It requires a cash reserve to be deposited (as security) for the $11.4 million dollar loans. </li></ul><ul><li>• This cash reserve is paid by JEDI , whose net worth by this time consists solely of Enron stock, putting Enron in the at-risk position for this amount. </li></ul>
  28. 29. <ul><li>On July 13, 2001, Skilling resigned as CEO. He claimed it was for personal reasons. The real reason was that Enron was heading for trouble, and he didn’t want to face the music. There were at least five reasons that could foreseeably lead to disaster: </li></ul><ul><li>(i) The firm’s stock was down about 40% for the year. If it kept falling, several of Fastow’s SPEs – those primarily financed with Enron stock – would be under water. </li></ul><ul><li>(ii) India had stopped making payments for electricity generated by the Dabhol plant. Enron had shuttered the plant in May and, despite the Bush administration pressuring India on Enron’s behalf, was facing the prospect of writing off its entire $900 million investment. </li></ul>
  29. 30. <ul><li>(iii) The company had recently spent $326 million to buy back shares of the failed Azurix water company. </li></ul><ul><li>(iv) Severe shortages of electricity in California had led to rolling blackouts and accusations that Enron had manipulated prices. </li></ul><ul><li>(v) The venture in bandwidth trading failed lamentably, and ventures in metals and pulp trading wereracking up losses. </li></ul><ul><li>The company was in a cash crunch and was trying to sell assets to raise cash. Skilling could see the writing on the wall, but so could most of Enron’s senior management. Many had been liquidating their holdings in Enron stock for months. </li></ul>
  30. 31. <ul><li>Many people suffered from Enron’s failure, but employees were hit especially hard. Thousands were laid off with just $4,500 in severance pay. </li></ul><ul><li>Enron had encouraged employees to invest their pension assets in the company’s stock. Employees who had foolishly done so lost pension savings as well as their jobs. </li></ul><ul><li>In June 2002, Arthur Andersen was convicted of obstruction of justice for its destruction of Enron documents. Andersen, which was once the largest accounting firm in the U.S., was barred from auditing clients. </li></ul>
  31. 32. <ul><li>The government nearly had a scandal on its hands, as many politicians had Enron as a major contributor to their campaigns. </li></ul><ul><li>The energy industry went through a crisis, since other companies in the industry were Enron copycats and had very similar deals and trading positions in place when Enron went down. And investors took a big hit. </li></ul><ul><li>Finally, even with its downfall, some good has come – regulators are seeking to improve standards and practices in accounting, corporate governance, risk control, and pension fund administration, to ensure that another Enron does not emerge. </li></ul>
  32. 33. Presented By : Vartika Gupta Shelley Sharma Syed Sibtain Omar Fahmeed