Creative Accounting<br />Accounting practices that may follow the letter of the rules of standard accounting practices, but certainly deviate from the spirit of those rules.<br />Non-operational incomes (sale of fixed assets) being major source of income.<br />Deferment of revenue expenses to inflate bottom line.<br />Extension of Accounting year to include major gains in coming months.<br />No provision for doubtful debts to inflate bottom line.<br />
Rising Star in America-Enron<br />Deregulation in energy power market started<br />In 1985 Enron was born from the merger of Houston Natural and Inter North<br />Contracts with gas sellers and buyers.<br />Soon got the control of over 25% of all gas business<br />“Mid 1980s: Enron business entirely in the USA, focused on gas pipelines and power”<br />
Rising Star in America-Enron<br />Entered into the derivative business<br />Began trading in commodities like steel, coal, pulp, paper, etc.<br />By 2000, even stepped into the dot.com business – Enron Online<br />Most innovative company for six years<br />“2001: Enron trading in hundreds of commodities <br />Interests in: USA, South America, Europe, Asia and Australia”<br />
Indicators to spot the loom ?<br />In India, lost the Dabhol Power project, in which Enron had committed $2.9bn<br />Beginning of Dotcom bubble crises and fallout of blockbuster internet deal<br />Enron delivered smoothly growing earnings (but not cash flows)<br />Enron was a trading company, yet was given very high PE of 70 as compared to PE of 20, given to other trading companies<br />
Facts<br />No tax paid for four out of last five years<br />Among those left holding Enron stock or debt were major pension funds and investment banks<br />On 8 Nov,2001 It admitted accounting errors, inflating income by $586 million since 1997<br />
Creative Accounting in Enron <br />Enron used accounting limitations to its advantage in managing both its earnings and balance sheet to portray a favourable depiction of its performance.<br />Mark-to-market accounting- Present value framework.<br />Special purpose entities.<br />
Some more practices… <br />Conceal its losses from market, by making an appearance that investments were hedged by a third party.<br />But the third party was simply an SPE of Enron, where only Enron had a substantial stake.<br />Asset sales- close to the end of reporting period <br />
Feb 20, 2001 - A Fortune story calls Enron a highly impenetrable Co. that is piling on debt while keeping the Wall Street in dark.<br />May 2001 – Mr. Baxter the Vice Chairman resigns.<br />Aug 14, 2001 – Jeff Skilling resigns as the CEO, citing personal reasons.<br />Oct 12, 2001 – Authur Anderson legal counsel who audit Enron to destroy all but the most basic documents.<br />Oct 16, 2001 - Enron reports a third quarter loss of $618 million.<br />Nov 8, 2001 – Enron told investors that they were restating earnings for the past 4 years.<br />
Dec 2,2001 – filed bankruptcy under chapter 11 bankruptcy protection and on the same day hit Dynegy Corp. with a $10 billion breach-of-contract lawsuit.<br />Dec 12, 2001 - Anderson CEO Jo Berardino testifies that his firm discovered possible illegal acts committed by Enron.<br />Jan 9,2001 - U.S. Justice department launches criminal investigation.<br /> Hence within three months Enron had gone from being a company claiming assets worth almost £62bn to bankruptcy. Its share price collapsed from about $95 to below $1.<br />
I KNOW FIGURES<br /> DON’T LIE, YOUR <br />JOB IS<br />TO MAKE THEM!!<br />Role of Arthur Anderson<br />The Auditing Firm of Enron<br />
<ul><li>It was one of the world’s five leading accounting firms.
Andersen executives including chief Enron auditor David Duncan, decided to consult lawyers over whether or not the partnerships were legal.
Andersen told Enron that it had no other choice but to change the way it was accounting for its special partnerships.
At some point after this, staff in Andersen’s Houston office began shredding documents relating to Enron.
Legal examination of Sherron Watkins's concerns concluded that the partnerships in question, Raptor and Condor, had been approved by Andersen.</li></li></ul><li><ul><li>Was paid $52mn in 2000, the majority for non-audit related consulting services.
Jan 10, 2002 - Arthur Andersen admits that its employees destroyed significant but undetermined no. of Enron documents
David Duncan from Houston office held responsible manager for shredding documents.
He pleaded guilty on April 9,2002 and hence his prosecution received smaller sentence than expected. (became witness for prosecution)
Andersen Ended 89 years practice of Auditing.</li></li></ul><li>New Regulations After The Scandal<br />Sarbanes – Oxaley act of 2002<br /><ul><li> Auditor Independence
Public company accounting oversight board</li></li></ul><li>What next…<br />Enron Creditors Recovery Corp.<br />ECRC has successfully undertaken legal action to hold responsible the major financial institutions that it contends assisted the pre-bankruptcy Enron deceive the public.<br />ECRC is in the midst of restructuring various businesses for distribution as ongoing companies to its creditors and liquidating its remaining operations.<br />
ECRC’s Mandate<br />Obtain the highest value from the company's remaining assets and distribute the proceeds to the company's creditors. <br />As part of its efforts, ECRC has successfully undertaken legal action to hold responsible the major financial institutions that it contends assisted the pre-bankruptcy Enron deceive the public.<br />Those legal efforts have, to date, resulted in settlements of almost $2 billion in cash. Additionally, as part of these settlements, the defendants have agreed not to receive distributions upon claims against Enron worth approximately $1.38 billion<br />Once ECRC has completed all outstanding litigation and monetized all assets, it will make a final distribution to creditors. After that, the company will cease to exist.<br />
In 2004, Enron Creditors Recovery Corp. (ECRC) sued many of Enron’sformer investment banks, alleging that they aided and abetted Enron’sinsiders’ breach of their fiduciary duties and perpetrated a massive<br />financial fraud on Enron’s creditors<br />Counsel for ECRC retained BatesWhite Partner and Stanford University Professor Douglas Bernheimto analyze issues of causation, forseeability, damages, and apportionment.<br />Working closely with Bates White staff, Dr. Bernheim developeda theory of causation and damages focused on the effect of the fraudulently reported transactions on Enron’s investment grade credit rating.<br />POST MORTEM<br />
According to Dr. Bernheim’s theory, if the true economic substance ofthe transactions had been disclosed, more likely than not, Enron wouldhave been downgraded below investment grade well before November2001. <br />According to Dr.Bernheim’s theory, by delaying the market’s discovery of Enron’s true financial condition, the fraudulently reported transactions directlycaused the substantial incremental losses sustained by Enron’s creditorsand the estate.<br />The loss of an investment grade rating would have triggered massivecollateral obligations associated with Enron’s commodity tradingoperations and would have forced Enron to confront its problemsearlier—through bankruptcy or otherwise—thus saving Enron’s creditorsand the estate billions of dollars in further losses. <br />