Introduction

The failure of Enron in the early 2000’s is one of the largest bankruptcies in US history.
Shareholders were wiped out, and tens of thousands of employees left with worthless retirement
accounts. This book recounts the rise and fall of Enron, and how the company constructed a
massively complex accounting scandal that was doomed to failure.

Enron’s bankruptcy filing in November 2001 marked the beginning of an unheard signal of
corporate scandals. Officials at World Com, AOL Time Warner, ImClone, Tyco, Adelphia, Global
Crossing, Quest and Charter Communications joined Enron executives as targets of congressional
hearings, stockholder lawsuits, SEC search and criminal indictments. Enron’s problem, which had
been center stage, was soon pushed to the background by subsequent revelations of corporate
wrongdoing. Enron failed in large part because the unethical practices of its senior officials.
Examining the ethical shortcomings of Enron’s executives as well as the factors that contributed
to their misbehaviors can provide important detection how to address the topic of ethics in the
leadership and more recent instances of corporate corruption should not diminish the importance
of Enron as a case study in moral failure.

Enron Corporation Historical background

Enron Corporation can call as one of the largest fraud scandals in the world history. As a result of
the fraud investigations, the company in December 2001 was forced to file for bankruptcy. Enron
was “a provider of products and services in natural gas, electricity and communications to
wholesale and retail costumers”. Enron Corporation has its roots in Omaha, Nebraska. In 1985,
Houston Natural Gas merged with Inter North to form an energy company based in Huston, Texas.
The company created the first nationwide natural gas pipeline system by integrated several pipeline
systems. In 1986 Ken Lay, former chief executive officer of Houston Natural Gas, was named
chief executive officer and chairman at the fresh energy company, after discovering the oil traders
in New York have overextended the company's accounts by almost one billion dollar, the company
works its loss down to 142 million dollar in 1987. The loss immediately leads Enron to reduce the
risk of price swings by developing different services. After one year, Enron Corporation in
England opened its first overseas office; the company’s pursue unregulated markets by regulated
pipeline business as new strategy which revealed to the senior officials. Jeffrey Skilling joined
Enron Corporation in 1989 and launch Gas Bank, a program under which at fixed prices buyers of
natural gas could lock in long-term supplies and corporation at the same time for oil and gas
producers started to offer financing. Enron Corporation by acquiring Transport adora de Gas del
Sur expended to South America and started to push to extend on the continent in 1992. In England
after one year Enron’s Teesside power plant began operations as the first successes for Enron’s
international strategy. The corporation made its first electricity trade in 1994 and in the next years
it turns into one of biggest profit centers for Enron. In London by establishment of a trading center,
Enron in 1995 entered the European wholesalers market as part of Enron Europe. In 1996, Dabhol
power plant construction started in India. However, the project would be plagued by political
problems and eventually Enron put the project up for sale in 2001. After one year, Enron bought
Portland General Electric Corporation, the utility serving the Portland, Oregon (USA), which
would be sold for about 1.9 billion Dollars in 2001 to Northwest Natural Gas Co, in the same year,
Enron Energy Services was formed to provide energy management services to commercial and
industrial customers. Enron continued its policy of acquiring companies and in 1998 acquired
Wessex Water in the United Kingdom which formed the basis for its water subsidiary Azurix. But
in 1999, when in an action one-third of Azurix sold to the public, the company’s problems become
apparent as the shares fell sharply after an early rise. The same year, Enron Online, the company's
commodity trading Internet site, started to operate. Enron Energy Services turned its first profit in
the last quarter of the year.

Enron’s annual revenues reached one hundred billion Dollars in 2000, which was reflecting the
growing importance of trading. However, the problems with Azurix continued and Rebecca Mark
resigned from her position of chairwoman while Enron announced the intention to take the
subsidiary private. The same year, The Energy Financial Group ranked Enron the sixth-largest
energy company in the world, based on market capitalization.2 In April 2001 Enron disclosed it
had owned 570 million Dollar by bankrupt California utility Pacific Gas & Electric Co. While the
top executives were likely aware of the debt and the illegal practices, the fraud was not revealed
to the public until October 2001 when Enron announced that the company was actually worth 1.2
billion Dollar less than previously reported. This problem prompted an investigation by the
Securities and Exchange Commission3 , which has revealed many levels of deception and illegal
practices committed by high-ranking Enron executives, investment banking partners, and the
company’s accounting firm, Arthur Anderson. At the end of the year Enron’s shares closed at 8.63
Dollar per share, an 89 percent drop since the beginning of the year. The critical dates in the scandal
are October 16, 2001 and November 8, 2001. On October 16, Enron announced that it had made a
loss of 618 million Dollar in 3 months, while on the second date it announced that it had
exaggerated its revenue since 1997 by 586 million Dollars. In Fact, accounts of Enron had not
shown the true state of its huge indebtedness on that time.

Analyzing the Fraud: Timeline and Financial Highlights

Enron Corporation until December 2001 appeared very strong, voluntary made the decision to
restate its financial statements. This proved to be mortal. While the bankruptcy of a small company
is taken as a routine, the corporation had to go for a bankruptcy. During the 1990s, Enron expended
into several areas quickly such as developing a pipeline and a power plant, however, this expansion
required long gestation period and large initial capital investments. Enron raised a lot of debt funds
from the market hence any other attempt to raise funds would affect Enron’s credit rating. Enron
had to maintain the credit ranking at investment rate in order to continue business but Enron was
not making enough profits. Hence, Enron began making partnerships and other special
“arrangements” like SPE or Special Purpose Entity. These companies were used to keep Enron’s
debts and losses away from its balance sheets, therefore allowing it to have a good credit rating
and showing good look in front of the investors. Enron goal was to overcome the rules of
consolidation and, in the same time increase credibility. If a parent company (in this case Enron)
financed less than 97 percent of an initial investment in a SPE, it didn’t have to consolidate in into
its own accounts4. In order to achieve non-consolidation, according to GAAP,5 two conditions
must be met first the assets must be legally isolated from the transferor and second an independent
third party owner has to make a substantive capital investment which should amount to at least 3
percent of the SPE’s total capitalization. The independent third party owner must exercise control
over the SPE in order to avoid consolidation. The third party control and the legal isolation over
the SPE, reduce the risk of the credit. Therefore, off-balance sheet treatment of such a SPE involves
enough third party equity which must be “at risk”, otherwise the transferor would be required to
consolidate the SPE into its own financial statements. Therefore, thoughts solution of Enron was
to find outside investors willing to enter into financial arrangements with them and started several
structured entities in the name of SPEs. To allow the SPE to borrow from the market, in many
cases Enron provided credit support such as guaranty. Enron’s off-balance sheet treatment was
subject to achieved of all its SPEs, without test of accounting to determine to know whether the
SPE should be consolidated or not. The Enron followed this policy in financing which ultimately
would enable it to be valued more attractively by rating agencies and Wall Street analysts. after
word the huge debt took place into the subsidiaries and many obligations flew from US companies
into Enron’s SPEs, while the contracts likely to end up in loses were mentioned unclearly in the
footnotes of company accounts. Enron used several dependent sectors in rising of equity and
structured its financial arrangements by using existed weakness of laws and trying to not
consolidate into its accounts by intentionally not fulfilling certain conditions.

The Causes of Enron’s Bankruptcy

1. Truthfulness
The truthfulness was missed by management of Enron about the health of the company, according
to Kirk Hanson, the executive director of the Markkula Center for Applied Ethics. He believed
Enron had to be the best at everything it did and that they had to protect their reputations and their
compensation as the most successful executives in the U.S.A. There is no evidence that when
Enron’s CEO told the employees that the stock would probably rise and he was selling stock.
Moreover, the employees would not have learned of the stock sale within days or weeks, as is
ordinarily the case. Only the investigation surrounding Enron’s bankruptcy enabled shareholders
to learn of the CEO stock sell-off before 14 February 2002 which is when the sell-off would
otherwise have been disclosed. The stock was sold to the company to repay that the CEO’s owed
money and the sale of company stock qualifies as an exception under the ordinary director and
officer disclosure requirement. It does not have to be reported until 45 days after the end of the
company’s fiscal year.34

2. Interest
It has been suggested that a lack of independent oversight of management conflicts and interest
by Enron's board contributed to the firm's collapse. In addition some have suggested that Enron's
compensation policies engendered a myopic focus on earnings growth and stock price. Moreover,
recent regulatory changes have focused on enhancing the accounting for SPEs and strengthening
internal accounting and control systems. We review these issues, beginning with Enron's board.
35 the conflict of interest between the two roles played by Arthur Andersen While investigations
continue, Enron has sought to salvage its business by spinning off various assets. It has filed for
bankruptcy under Chapter 11, allowing it to reorganize while protected from creditors. Former
chief executive and Chairman Kenneth Lay have resigned, and restructuring expert Stephen
Cooper has been brought in as interim chief executive. The energy trading arm has been tied up in
a complex deal with UBS Warburg as Enron's core business. The bank has share some of the
profits with Enron but has not paid for the trading unit.

3. Enron and the reputation of Arthur Andersen

In the third quarter of 2001 the revelation of accounting irregularities at Enron caused regulators
and the media to focus extensive attention on Andersen. The magnitude of the alleged accounting
errors, combined with Andersen's role as the widespread media attention and Enron's auditor
provide a seemingly powerful setting to explore the impact of auditor reputation on client market
prices around an audit failure. CP investigates the share price reaction of Andersen's clients to
various information events that could lead investors to revise their beliefs regarding Andersen's
reputation.36 Most damaging to Andersen's reputation Perhaps was their admission on 10 January
2002 that employees of the firm had destroyed documents and correspondence related to the Enron
engagement. Office clients of Andersen's Houston, where Enron was headquartered, experienced
a negative market reaction than Andersen's non-Houston clients.37 Overall, CP concludes the
shredding announcement had a significant impact on the perceived quality of Andersen's audits,
and that the resulting loss of reputation had a negative effect on the market values of the firm's
other clients.

An important factor: accounting fraud (using “mark to market” and SPE as tools)

In addition there are new findings that shed light on an auditor reputation effect which is important
to auditors and their clients. In this regard, there is an important factor namely “accounting fraud”
which using “marks to market” and SPE as tools which will be discussed below.
 4. Mark to Market
As a public company, Enron was subject to external sources of governance including market
pressures, oversight by government regulators, and oversight by private entities including auditors,
equity analysts, and credit rating agencies. In this section we recap the key external governance
mechanisms, with emphasis on the role of external auditors. This method requires that once a long-
term contract was signed, the amount of which the asset theoretically will sell on the future market
is reported on the current financial statement. In order to keep appeasing the investors to create a
consistent profiting situation in the company, Enron traders were pressured to forecast high future
cash flows and low discount rate on the long-term contract with Enron. The difference between
the calculated net present value and the originally paid value was regarded as the profit of Enron.
In fact, the net present value reported by Enron might not happen during the future years of the
long-term contract. There is no doubt that the projection of the long-term income is overly
optimistic and inflated.

5. SPE (Special Purpose Entity)

Accounting rule allow a company to exclude a SPE from its own financial statements if an
independent party has control of the SPE, and if this independent party owns at least 3 percent of
the SPE. Enron need to find a way to hide the debt since high debt levels would lower the
investment grade and trigger banks to recall money. Using the Enron’s stock as collateral, the SPE,
which was headed by the CFO, Fastow, borrowed large sums of money. And this money was used
to balance Enron’s overvalued contracts. Thus, the SPE enable the Enron to convert loans and
assets burdened with debt obligations into income. In addition, the taking over by the SPE made
Enron transferred more stock to SPE. However, the debt and assets purchased by the SPE, which
was actually burdened with large amount of debts, were not reported on Enron’s financial report.
The shareholders were then misled that debt was not increasing and the revenue was even
increasing.
 6. Abuse of Power
Both Lay and Skilling could wield power ruthlessly. The position of vice-chair was known as the
“ejector seat” because so many occupants were removed from the position when they took issue
with Lay or appeared to be a threat to his power. Skilling, for his part, eliminated corporate rivals
and intimidated subordinates. Abdication of power was also a problem at Enron. At times,
managers did not appear to understand what employees were doing or how the business which was
literally creating new markets operated. Board members also failed to exercise proper oversight
and rarely challenged management decisions. Many were selected by CEO Kenneth Lay and did
business with the firm or represented non-profits that received large contributions from Enron.

7. Excess Privilege
Excess typified top management at Enron. Lay, who began life modestly as the son of a Baptist
preacher turned chicken salesman, once told a friend, “I don’t want to be rich, I want to be world-
class rich”.39 At another point he joked that he had given wife Linda a $2 million decorating
budget for a new home in Houston which she promptly exceeded40. The couple borrowed $75
million from the firm that they repaid in stock. Linda Lay fanned the flames of resentment among
employees when she broke into tears on the Today Show to claim that the family was broke. This
was despite the fact that the Lays owned over 20 properties worth over $30 million.41 During
Enron’s heyday, some of the perks filtered down to followers as well. Workers enjoyed such
benefits as lavish Christmas parties, aerobic classes, free taxi rides, refreshments, and the services
of a concierge.

8. Deceit
Enron officials manipulated information to protect their interests and to deceive the public,
although the extent of their deception is still to be determined. Both executives and board members
claim that they were unaware of the extent of the company’s off-the-books partnerships created
and operated by Fastow and Kopper. However, both Skilling and Lay were warned that the
company’s accounting tactics were suspect.42 The Senate Permanent Subcommittee on
Investigations, which investigated the company’s downfall, concluded, “Much that was wrong
with Enron was known to the board”43 Board members specifically waived the conflict of interest
clause in the company’s code of ethics that would have prevented the formation of the most
troublesome special partnerships Employees were quick to follow the lead of top company
officials. They hid expenses, claimed nonexistent profits, and deceived energy regulators and so
on.

9. Misplaced and Broken Loyalties

Enron officials put their loyalty to themselves above those of everyone else with a stake in the
company’s fate stock holders, business partners, rate payers, local communities, foreign
governments, and so on. They also betrayed the trust of those who worked for them. Employees
apparently believed in the company and in Lay’s optimistic pronouncements. In August 2001, for
example, he declared “I have never felt better about the prospects for the company”44. In late
September, just weeks before the company collapsed, he encouraged employees to “talk up the
stock” because “the company is fundamentally sound”45. These exhortations came even as he was
unloading his own shares. The sense of betrayal experienced by Enron employees only added to
the pain of losing their jobs and retirement savings.

The collapse of ENRON and Moral Responsibility

From Individuals’ Angle
As corporate acts originate in the choices and actions of human individuals, these individuals who
must be seen as the primary bearers of moral duties and moral responsibility. The then chairman
of the board, Kenneth Lay, and CEO, Jeffrey Skilling, to allowed the then CFO, Andrew Fastow,
to build private cooperate institution secretly and then transferred the property illegally. The CFO,
Andrew Fastow, violated his professional ethics and took the crime of malfeasance. When the
superior, the chairman of the board of Kenneth Lay and CEO Jeffrey Skilling, ordered
conspiratorial employees to carry out an act that both of them knowing is wrong, these employees
are also morally responsible for the act. The courts will determine the facts but regardless of the
legal outcome, Enron senior management gets a failing grade on truth and disclosure. The purpose
of ethics is to enable recognition of how a particular situation will be perceived. At a certain level,
it hardly matters what the courts decide. Enron is bankrupt which is what happened to the company
and its officers before a single day in court. But no company engaging in similar practices can
derive encouragement for any suits that might be terminated in Enron’s favor. The damage to
company reputation through a negative perception of corporate ethics has already been done.
Arthur Andersen violated its industry specifications as a famous certified public accountant.
From Corporation’s Angle
The acts of a corporation's managers are attributed to the corporation so long as the managers act
within their authority. However, the shareholders of Enron didn't know and realize this matter from
the superficial high stock price. Therefore, the whole corporation was not of responsibility for this
scandal. Actually, if the board and other shareholders paid more attention to those decisions made
by the chief, CEO, CFO and those relevant staffs, ENRON can avoid this result.

Conclusion
In summary, top officials at Enron abused their power and privileges. They manipulated
information while engaging in inconsistent treatment of internal and external constituencies. These
leaders put their own interests above those of their employees and the public, and failed to exercise
proper oversight or shoulder responsibility for ethical failings. Therefore, there is need the
directors to follow particular examples in following matters:

First, there should be a healthy corporate culture in a company. In Enron’s case, its corporate
culture played an important role of its collapse. The senior executives believed Enron had to be
the best at everything it did and the shareholders of the board, who were not involved in this
scandal, were over optimistic about Enron’s operating conditions. When there existed failures and
losses in their company performance, what they did was covering up their losses in order to protect
their reputations instead of trying to do something to make it correct. Therefore, the “to-good-to-
be-true” should be paid more attention by directors of board in a company.

Secondly, a more complete system is needed for owners of a company to supervise the executives
and operators and then get the idea of the company’s operating situation. There is no doubt that
more governance from the board may keep Enron from falling to bankruptcy. The boards of
directors should pay closer attention on the behavior of management and the way of making
money. In addition, Enron’s fall also had strikingly bad influence on the whole U.S. economy.
Maybe the government also should make better regulations or rules in the economy.

Thirdly, “Mark to market” is a plan that Jeffrey Skilling and Andrew Fastow proposed to pump
the stock price, cover the loss and attract more investment. But it is impossible to gain in a long-
term operation in this way, and so it is clearly immoral and illegal. However, it was reported that
the then US Security and Exchange Commission allowed them to use “mark to market” accounting
method. The ignorance of the drawbacks of this accounting method by Securities and Exchange
Commission also caused the final scandal. Thus, an accounting system which can disclose more
financial information should be created as soon as possible. And fourthly, maybe business ethics
is the most thesis point people doing business should focus on. As a loyal agent of the employer,
the manager has a duty to serve the employer in whatever ways will advance the employer's self-
interest. In this case, they violated the principle to be loyal to the agency of their Enron.