Enron scandal. About Enron, Why is was a scandal, Causes of downfall, Corporate governance issues, Aftermath, Sarbanes-Oxley Act

1. Enron Scandal
By
Niket Ratta – 18032
Shivang Sethi – 11820

2. Introduction
 The Enron scandal (October 2001), led to the bankruptcy of the Enron Corporation,
an American energy company based in Houston, Texas which was formed by
Kenneth Lay in 1985 by merging Houston Natural Gas and Inter-North.
 Also led to the dissolution of Arthur Andersen, which was one of the five largest
audit and accountancy partnerships in the world.
 Enron was cited as the biggest audit failure.
Main Points To Cover :
 About ENRON
 Causes Of Downfall
 Timeline Of Downfall
 Aftermath
 Implications
 Sarbanes-Oxley Act
 Conclusion

3. About Enron
 Enron Corporation - American energy company based in Houston, Texas.
 Formed in 1985 by Kenneth Lay by merging natural gas pipeline companies,
namely, Houston Natural Gas and Inter North.
 Employed approximately 20,000 staff.
 One of the world’s major electricity, natural gas, communications, pulp &
paper companies.
 Revenues of nearly $111 billion in 2000.
 Fortune Magazine named Enron “America’s Most Innovative Company” for
six consecutive years.

4. What made it a “Scandal” ?
The bankruptcy of Enron shook the entire system. Some highlights brought
about when this scandal had been exposed were:
1. $30 million of self-dealings by the Chief Financial Officer.
2. $700 million of net earnings disappeared.
3. $1.2 billion shareholder’s equity disappeared.
4. Over $4 billion in hidden liabilities.
 Many of Enron’s recorded assets and profits were inflated or even
wholly fraudulent and non-existent.
 Debts & equities were put into entities formed “offshores” that were
not included in the company’s financial statements

5. Causes of Downfall
CAUSES
Revenue
Recognition
Special
Purpose
Entities
Corporate
Governance
Issues
Mark-to-
Market
Accountin
g

6. Revenue Recognition
 The company showed entire sales value as revenue in it financial
statements.
 As a result, Enron’s revenues increased from $13.3 billion to $100.8 billion.
 This 65% annual increase was unprecedented in the energy industry
wherein growth of 2-3% is considered respectable.

7. Mark-to-Market Accounting
 When Skilling joined the company, he demanded that the trading business
adopt mark-to-market accounting, citing that it would represent "true
economic value.”
 Income was estimated as present value of net future cash flow. The viability
of the contracts and the related costs were difficult to estimate.
 Investors were given false or misleading reports due to large discrepancies
between profits & cash.
 Enron recognized estimated profits of more than $110 million from the
Enron-Blockbuster Deal (July 2000), even though analysts questioned the
technical viability and market demand of the service.
 When the network failed to work, Blockbuster withdrew from the contract.
Enron continued to recognize future profits, even though the deal resulted in
a loss.

8. Special Purpose Entities
 Enron used special purpose entities, created to fulfill a specific purpose to
fund or manage risks associated with specific assets.
 As a result of one violation, Enron's balance sheet understated its liabilities
and overstated its equity, and as a result, its earnings were overstated.
 Investors were oblivious to the fact that the special purpose entities were
actually using the company's own stock and financial guarantees to finance
the hedged downside risk in its own illiquid investments, protecting itself
from the same.
 Notable examples of special purpose entities that Enron employed were
JEDI, Chewco, Whitewing, and LJM.

9. How they carried it out …

10. Corporate Governance
Even with its complex corporate governance and network of intermediaries,
Enron was still able to "attract large sums of capital to fund a questionable
business model, conceal its true performance through a series of accounting
and financing maneuvers, and hype its stock to unsustainable levels."
Corporate
Governance
Issues
Executive
Compensation
Risk
Management Financial Audit
Audit
Committee
Ethical &
Political
Analysis

11. • Excessive compensations were given to the executives in order
to maximize bonuses. The focus was on short term earnings.
• Executives stressed high volume deals instead of of cash flows
or profit. On December 31, 2000, stock options accounted for
about 13% of the company’s issued shares.
Executive
Compensation
• Enron bankruptcy was attributed to its reckless use of
derivatives and specials purpose entities.
• By hedging its risks with special purpose entities , the
company retained its risks associated with the transactions.
Risk
Management
• Both the audit function and accounting function in Enron
were fraudulent and opaque.
• Management of Enron pressurized the auditors to deviate
from the established auditing standards.
• There was a conflict of interest as the auditors earned more
as consultancy fees much more than audit fees.
Financial
Audit

12. • Ethical explanations centered on executive greed and
hubris, a lack of corporate social responsibility, situation
ethics and get-it-done business pragmatism.
• Political-economic explanations cited post 1970s
deregulation and inadequate staff and funding for
regulatory oversight.
Ethical &
Political
Analysis
• No technical knowledge to question auditors properly on
accounting issues relating to the company’s SPEs.
• Also unable to question the company’s management due
to pressures on the committee.
• Enron collapsed due to reliance on political lobbying,
rent seeking and the gaming of regulations.
Audit
Committee

14. Aftermath
 Enron's shareholders lost $74 billion in the four years before the company's
bankruptcy. To pay its creditors, Enron held auctions to sell assets including
art, photographs, logo signs, and its pipelines.
 In May 2004, more than 20,000 of Enron's former employees won a suit of
$85 million for compensation of $2 billion that was lost from their pensions.
From the settlement, the employees each received about $3,100.
 The next year, investors received another settlement from several banks of
$4.2 billion.
 In September 2008, a $7.2-billion settlement from a $40-billion lawsuit, was
reached on behalf of the shareholders.

15. Implications
Between December 2001 and April 2002, the Senate Committee on Banking,
Housing, and Urban Affairs and the House Committee on Financial Services held
multiple hearings about the Enron scandal and related accounting and investor
protection issues. These hearings and the corporate scandals that followed
Enron led to the passage of the Sarbanes-Oxley Act on July 30, 2002.

16. The main provisions of the Sarbanes-Oxley Act included:
 The establishment of the Public Company Accounting Oversight Board to
develop standards for the preparation of audit reports.
 The restriction of public accounting companies from providing any non-
auditing services when auditing.
 Provisions for the independence of audit committee members, executives
being required to sign off on financial reports, and relinquishment of certain
executives' bonuses in case of financial restatements.
 And expanded financial disclosure of companies' relationships with
unconsolidated entities.
Sarbanes-Oxley Act

17. Sarbanes-Oxley Act (Revised)
In June 2002, the New York Stock Exchange announced a new governance
proposal, which was approved by the SEC in November 2003. The main
provisions of the final NYSE proposal include:
 All companies must have a majority of independent directors.
 Independent directors must comply with an elaborate definition of
independent directors.
 The compensation committee, nominating committee, and audit committee
shall consist of independent directors.
 All audit committee members should be financially literate. In addition, at
least one member of the audit committee is required to have accounting or
related financial management expertise.
 In addition to its regular sessions, the board should hold additional sessions
without management.

18. THANK YOU