The Enron Scam

8/19/2019 The Enron Scam

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THE ENRON SCAMENRON AND ARTHUR ANDERSEN


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BACKGROUND

ENRON:

Merger of Houston Natural Gas and InterNorth in1985.

The largest seller of natural gas in North America b 199!.

"i#ersi$cation strateg % gas &i&elines' electricit &lants' &u&a&er &lants' (ater &lants' and broadband ser#ices across th

)egan to trade commodities from $*ed assets +&i&elines,' tointangibles +contractual rights to commodities,.

ARTHUR ANDERSEN:

Among the most &restigious international accounting $rms i

-nron (as Andersens second largest client.


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INTRODUCTION

At its &ea/' -nron (as America0s se#enth largest cor&orat

Illusion % a stead com&an (ith good re#enue.

ealit % a large &art of -nrons &ro$ts (ere made of &a&e

Ho( it ha&&ened % masterfull designed accounting and m

2uestionable acts b traders and e*ecuti#es.

esult % dee& debt and surfacing information about hidingga#e big &roblems' and

In the late !331 -nron declared ban/ru&tc under 4ha&tenited 6tates )an/ru&tc 4ode.


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ENRON’S SURGE TO THE TOP

1. FROM ENERGY TO TRADING:

-arl 19930s 7 the nited 6tates congress a&&ro#ed a legthat deregulated the sale of natural gas.

Ga#e -nron the o&&ortunit to sell their energ at higher leading to greater re#enue.

6tart of -nron0s ourne from an energ com&an to a tracom&an.

The focus (ent from energ mar/ets to $nding ne( (asmone. arge in#estments (ere made around the (orld tits business and o&en itself for ne( mar/ets.


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2. MARK TO MARKET ACCOUNTING:

4hange in -nron0s accounting sstem from a straightfor(ard /indaccounting to the mar/%to%mar/et accounting sstem.

-arlier % listed actual re#enue and costs of su&&ling and selling g

Mar/%to%mar/et method % estimations of future incomes (hen a locontract is signed.

-stimations based on the future net #alue of the cash :o(.

4osts related to the contract (ere often hard to &redict.

It means that the estimated income from &roects (ere included ethe mone (as not et recei#ed.

In#estors gi#en misleading information because of the de#iation i

estimations.


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3. SPECIAL PURPOSE ENTITY:

6&ecial &ur&ose entit % legal entit created onl to carr s&eci$c or tem&orar tas/.

;ur&ose % to handle assets either b funding or b ris/ ma

A s&onsor creates the entiti but the funding comes from In -nron0s case the s&ecial &ur&ose entities (ere not onl

dodge the traditional accounting con#entions but also to

The entities made it &ossible for -nron to underestimate' debts and o#erestimate its e2uit.


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ENRON’S COLLAPSE

1. MARK-TO-MARKET ACCOUNTING:

The use of mar/%to%mar/et accounting later bac/$red.

4orru&ted its boo/s and allo(ed it to be far too o&timisticassum&tions about the future &ro$ts.

4ash is a necessit for an com&an to run and -nron mo&a&er re#enue.

) the middle of !331' the came to the conclusion that tcrisis had struc/ them.


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2. THE ENRON CULTURE:

)onuses in form of cash or stoc/ o&tions came in bundlesou (ere considered one of the mone%ma/ers.

Made -nron a #er com&etiti#e (or/ &lace.

-#erone (as in a hurr to close deals +good or bad, beca

after a closed deal' the got their bonuses regardless of tthe deal.

;roblem % there (ere a lot of &roects being made but no No one (anted to be res&onsible of a done deal' the ustclose it and get their bonus.

A culture that re&laced coo&eration (ith com&etition.


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3. SPECIAL PURPOSE ENTITY: In order to hide losses and fabricate earnings' multi&le 6;

created.

re2uirements? +>@ of the e2uit had to come from outside in#estors +i.e. -nron,' +!, the entit could not be controlled b -nron' an-nron (as not liable for an loans or other liabilities.

)ut the (ere not inde&endent % run b -nron em&loees

Therefore' had to be disclosed in -nron0s $nancial statem

de&ressing earnings and debt le#els se#erel.


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AUDIT ISSUES - ANDERSEN

1. COMMERCIALIZATION AND INDEPENDENCE:

Auditors must be inde&endent of management and e#aluate thre&resentations of management for all users of $nancial statem

ess than >3@ of the fees Andersen recei#ed from -nron cameauditing' (hile the balance from consulting.

Andersen acted as -nrons e*ternal auditor and as its internal a(or/ as a consultant raises se#eral 2uestions.


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2. INTERNAL CONTROL WEAKNESSES AT ENRON: T(o serious (ea/nesses % the 4=C (as e*em&ted from a co

interest &olic' and internal controls o#er 6;-s (ere a shamform but not in substance.

Man $nancial oDcials lac/ed the bac/ground for their obs(ere not &hsicall secured.

The trac/ing of dail cash (as la*' debt maturities (ere notoE balance sheet debt (as ignored although the obligation and com&an%(ide ris/ (as disregarded.

Internal controls (ere inade2uateF contingent liabilities (eredisclosedF and

Andersen ignored all of these (ea/nesses.


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3. EVALUATION OF ACCOUNTING MATERIALITY:

Auditors focus on material misre&resentations.

Material % if /no(ledge of the misre&resentation (ould chdecisions of the user of $nancial statements.


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ANDERSEN CONVICTED

une !33! % Andersen con#icted in a 6 federal court of thobstructing ustice b shredding (or/ing &a&ers related toaudits.

)ecause Andersen &ersonnel /ne( that the &a&ers (oulde#idence in a 6-4 +6ecurities and -*change 4ommission,in#estigation.

A criminal con#iction (ould mean that Andersen could noregistrants.

Andersen announced its intent to go out of business befotoo/ formal action.

August !33! % the Te*as 6tate )oard of ;ublic Accountanc

Arthur Andersens license to &ractice accounting in the 6t Te*as because of the $rms &rofessional and ethical misco


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SARBANES-O!LEY ACT

6arbanes%C*le Act % a 6 federal la( that came after thescandal.

4ontains a set of standards that regulate &ublic com&anmanagement and &ublic accounting $rms.

All com&anies must ha#e a maorit of inde&endent direc

audit committee should consist of members that are $naneducated and one of the members ha#e to been an e*&er

Increased &enalties for destroing' altering' or fabricatingfederal in#estigations or for attem&ting to defraud shareh

Increased the accountabilit of auditing $rms to remain uand inde&endent of their clients.


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CONCLUSIONS

Morall 2uestionable acts (ere made from both e*ecuti#etraders. Cne thing that is una#oidable is the fact that em-nron (ere &artiall &aid in stoc/s (hich moti#ated the (ta/e actions that (ere unethical in order to raise the stoce2ui#alentl their o(n mone.

Mar/%to%mar/et accounting mi*ed (ith the use of 6;-s mloo/ $nanciall health (hen it actuall (as bleeding' blese#erel. Misleading information (as gi#en to the in#estothe accounting sstem' (hich e#entuall led to decreasin&rice (hen the information about this started to surface.

Documents

The Enron Scam