Corporate

Governance &
Ethics
ENRON
SCANDAL
Name                        PRN#
Rahul Taneja         20020348009
Sakshi Dubey         20020348011
Rohas Udas                        20020348010
Sridhar K 20020348012
Nishant Shrivastava                        20020348007
 About Enron
ØEnron Corporation was an American energy,
commodities, and services company based in Houston, Texas.
ØIt was founded in 1985 by Kenneth Lay as the result of
a merger between Houston Natural Gas and  InterNorth.
ØEnron Corporation was one of the leading suppliers of
Natural Gas, Communications, Pulp and Paper
ØEnron employed approximately 20,000 staff with
claimed revenues of $101 billion during 2000.
ØFortune named Enron "America's Most Innovative Company"
for six consecutive years.
WHAT MADE IT A SCANDAL?
• During 2001, after a series of revelations involving irregular 
accounting procedures bordering on fraud perpetrated throughout 
the 1990s involving Enron and its accounting company Arthur  Ande
rsen, Enron suffered the largest
Chapter 11 bankruptcy in  history
• Some highlights of the scandal are:-
 $30 Million of self dealings by the Chief Financial Officer
 $700 Million of Net earnings disappeared
 $1.2 Billion of Equity Shareholders disappeared
 Over $4 billion hidden liabilities
• Many of Enron’s recorded assets and profits were inflated or totally
fraudulent and non-existent. Debts and losses were put into entities
formed offshore that were not included in the company’s financial
statements
Key Players of Scandal
 KENNETH LAY
• Enron founder and former CEO
• Lay took up the reins at Enron in 1986. Prior to Enron’s collapse,
he  was credited with building Enron's success. Lay resigned as
CEO in  December 2000, and was replaced by Jeffrey Skilling. In
August 2001,  he resumed leadership after Skilling resigned. Lay
resigned again in  January 2002. He Drew Down His $4 Million
enron credit line  repeatedly and then repaid the company with
the enron shares after  becoming the focus of the anger of
employees, stockholders and  pension fund holders who lost
billions of dollars in this disaster.
 Jeffrey Skilling
• Former Chief Executive, President and Chief Operating Officer.
• He joined Enron in 1990 from the consultancy firm McKinsey,
where  he had developed financial instruments to trade gas
contracts. He  was also seen as a key architect of the company’s
gas-trading strategy. He resigned his post as Enron’s chief executive
in August  2001 without a pay-off.
 Andrew Fastow
• Former Chief Financial Officer.
• He was fired in October 2001, when Enron made
losses  amounting to $ 600 million. He was allegedly 
responsible for engineering the off-balance sheet 
partnerships that allowed Enron to cover its losses.
He  was also found by an internal Enron investigation
to  have secretly made $30 million from managing
one of  these partnerships.
 David Duncan
• Enron’s Chief Auditor at Andersen
• His job was to check Enron’s accounts. He is accused
of  ordering the shredding of thousands of Enron
related  documents in an effort to hide them from the
Securities  and Exchange Commission.
 Enron’s accounting firm –Arthur Andersen
• Arthur Andersen, was Enron’s auditing firm.
• It’s job was to check that the company’s accounts 
were a fair reflection of what was really going on. 
The company earned large fees from its audit
work  for Enron and from related work as
consultants to  the same company. When the
scandal broke, the US  government began to
investigate the company’s  affairs, Andersen’s Chief
Auditor for Enron, David  Duncan, ordered the
shredding of thousands of  documents that might
prove compromising. That was  after the Securities
and Exchange Commission (SEC)  had ordered an
investigation into the speculative  actions of
Enron. Andersen fired Duncan.
WHISTLE BLOWER
Sherron Watkins was Vice President of Corporate Development at
the Enron Corporation. In June 2001, she was given the task of
finding some assets to sell off but it was very difficult for her. She
prepared a Memo regarding the various problems and placed it into
the box but this Memo was not taken into consideration. On August
22,Watkins handed CEO Lay a seven page letter and told him that
ENRON would implode in a wave of accounting scandals.
• In August 2001, Watkins alerted then-Enron CEO Kenneth Lay of
accounting irregularities in financial reports. In February 2002,she
revealed the various facts regarding ENRON partnerships and finally
resigned in November. But Watkins Revealed all the facts only after
Enron filed for bankruptcy.
• However, Watkins has been criticized for not reporting the fraud
to government authorities and not speaking up publicly sooner
about her concerns, as her memo did not reach the public until five
months after
What Went
Wrong
AUDITING AND ACCOUNTING
 ISSUES
 As per federal securities law, accounting statement of publicly traded
corporations be certified by an independent auditor.

 Enron’s auditor, Arthur Andersen, turned a blind eye to improper

accounting practices as well as he was actively involved in devising
complex financial structures and transactions.

 Enron’s auditor also violated GAAP( general accepted accounting

principles and permit corporation to play “number games”.

 As an organization of public accountant, Arthur Andersen violated the

regulations of the public Accountant practices because Andersen was
not only as the internal auditor but also as the external auditor of
Enron.
SPE (SPECIAL PURPOSE ENTITIES)

 SPE’s reflect a common financing technique for

companies. Companies can cut their risk by moving assets
into separate partnerships that can be sold to outside
investors.
 In Enron’s case, assets that were losing money were sold
to partnerships. Enron listed the sales of these assets as
earnings. However, to be legitimate, accounting rules
require that an SPE be legally isolated from the company
that created it.
 In Enron’s case this was not true. The SPE’s relied upon
Enron managers for leadership and Enron stock for capital.
When outside auditors told Enron to treat some of the
4,000 SPE’s it had created as part of Enron, the company
had to take the $1-billion charge against earnings.
 PENSION ISSUES
 Enron sponsored a pension plan for it’s employees
that contribute a portion of their pay on deferred tax
basis.
 Almost 62% of assets held in corporation’s 401(k)
retirement plan consist of Enron’s stock.
 Shares traded in Jan 2001 for more than $80\share
become worth less than 70% in Jan 2002.
 While the investments grow in the employees 401k
account, they do not pay any taxes on it.
 Employees accounts were wiped out and losses
suffered by participants.
BANKING ISSUES
 There was a questionable relationship
between Enron and bankers Citigroup and
J.P Morgan Chase also contributed to the
downfall of Enron.

 Enron was lucrative investment banking

business for the banks. In exchange of
potential profits, the banks had lend money
to Enron and promote it’s derivative and
securities.
 ENERGY DERIVATIVE
ISSUES
• Since the markets in which Enron traded are
largely unregulated, with no reporting
requirements, little information was available
about the extent or profitability of Enron’s
derivative activities.
 SO WHY DID ENRON SCANDAL
HAPPEN?
• Due to the lack of corporate social responsibility, situation
ethics, and get-it-done business pragmatism.
• Due to the large discrepancies of attempting to match profits
and cash, investors were typically given false or misleading
reports as it was difficult to estimate cost and viability of
contracts.
• Atmosphere of market euphoria and corporate arrogance.
• High risk deals that went sour.
• Deceptive reporting practices—lack of transparency in
reporting financial affairs.
• Excessive interest in maintaining stock prices.

© 2003 by the AICPA

Impact of accounting fraud on
different parties
 Impact on employees
a) Thousands of employee lost their jobs as well as their  retireme
nt savings with the company.
b) The pension fund for the employees was obliterated.
c) After bankruptcy, Enron fired 5000 workers, one quarter of its
21000 employees. The company expects to fire more workers
as it sells or shut s down business units.
d) Laid off workers received $4500 severance payment, no
matter how many years they had worked for the company.
e) Lower-level employees were prevented from selling their
stock due to 401k restriction and many subsequently lost
their life savings.
f) More than half of employees invested about $1.2billion in
Enron stock.Those shares are now nearly worthless.
IMPACT ON SHAREHOLDERS
a) Enron share holders received limited returns in law suits despite
losing billions in stock prices.
b) Eligible shareholder whose Enron holding became worthless when the
company crumbled in scandal will receive $7.2billion in settlements
under a distribution plan approved in federal court.
c) No one wants to do any more investment in the Enron
d) Undermine the investors trust in the reliability of mandated
corporate filings
e) At Enron peak ,its shares were worth $90.75 but after the company
declared bankruptcy on  december2,2001,they plummeted to $0.67
by  January 2002.
IMPACT ON COMPETITORS
a)On November9,2001,rival energy trader Dynegy Inc. decided
to purchase the company for $8 billion in stock.
b)By the end of the month, Dynegy had backed out of the deal,
citing Enron’s downgrade to “junkbond”status and continuing
financial irregularities.
IMPACT ON CUSTOMERS
a)Plans to develop natural gas deposits are being
cut  back dramatically.
b)Lose their source ultimately it results in power
shortages and higher cost in  future years, the burden
will fall on the consumers.
c)Lose their source of supply.

IMPACT ON GOVERNMENT
a) ENRON's fraud promted the US Congress to pass
Sarabanes-Oxly Corporate Accountability Law, which
forces corporate executives to take personal
responsibility for the accuracy of the company
accounts
b) Suffered economic losses.
AMENDMENTS DONE AFTER TH
E  SCANDAL
The Enron scandal was certainly enough to
show the American public and its
representatives in congress that new
compliance standards for auditing and public
accounting were needed. Since the Enron
collapse an array of new laws and regulations
has been adopted to tighten corporate
oversight.
SARBANES-OXLEY
ACT
In July of 2002,President George W. Bush signed into law the Sarbanes-
Oxley Act.

The act was passed in response to a number of accounting scandal

between 2000-2002.

The act heightened the consequences for destroying, altering or

fabricating financial record, or for trying to defraud shareholders.

It created Public Company Accounting Oversight Board (PCAOB),

which is in charge of registering and inspecting public accounting firms,
and for modifying audit standards.
This act aims at public accounting firms that participate in audits of
corporation.
In response to the role of Arthur Anderson firm, in
Enron’s fraudulent behavior, SOX also changes the way
corporate boards deal with their financial auditors. All
companies, according to SOX must provide a year-end,
report about the internal controls they have in place and
the effectiveness of those internal controls.
Although the Sarbanes-Oxley Act 2000 is generally
credited with having reduced corporate fraud and
increasing investor protection.
FINANCIAL ACCOUNTING
STANDARDS BOARD
It existed since 1973 as one of the most widely recognized
organizations responsible for establishing standards of financial
accounting and reporting.
 The legacy of Enron/Arthur Andersen live on various changes
to the profession.
Prior to this case the accounting field was supervised by
Public Oversight Board (POB).
But after this case came to the light SEC (Securities Exchange
Commission) Chairman, Harley L. Pitt, in 2002 made a series of
enquiry about the system of self-regulation in the accounting
profession without consulting the POB.
This ultimately led to the POB voting to disband in
May,2002. As a result, FASB emerged as the leader of the
system of self-regulation and has taken a significant role
in the reform of accounting rules.
In January, 2003, the FASB announced new accounting
rules designed to force US companies to move billions of
dollars from off-balance sheet entities into companies’
balance sheets.
COMPANIES TO REPORT
LEASES
After 15 years of the scandal, FASB has issued a final rule
that changes how companies account for most of their
leases.
Regulators started to consider a change in lease
accounting after the collapse in 2001 of Enron, whose
executives made the company look stronger by keeping
some of its financial obligations “off-balance sheet”.
The new rule requires that the most common type of
lease be included on company’s balance sheet, potentially
giving investors a more accurate picture of company’s
health.
CHANGES IN SPE 3% RULE
SPE 3% Rule: Rule permitting Special Purpose Entities
(SPE) created by a firm to be treated as “off-balance
sheet”, i.e. no required consolidation with firm’s balance
sheet-as long as 3% of the total capital of the SPE was
owned independently of the firm.
 Rule raised to 10% in 2003 following Enron scandal.
After more misuse of rule, Financial Accounting
Standards Board (FASB)replaced this rule in 2009 with
stricter consolidation standards on all asset reporting.
Lessons
Learned From
ENRON Scam
 RELATED TO AUDITING
• Conflict of interest between the two roles played by
Aurthur Andersen, as auditor but also as a
consultant.
• Stamp of approval by Andersen to Enron's
poor practices.
• GAAP (Generally Accepted Accounting
Principles) were not followed properly .
• Documents were destroyed.
• Mandatory rotation is suggested, every four year
and so, both of audit partners, so that individual do
not become too committed to their clients like in
this case, Andersen was playing an active role as
the auditor.
RELATED TO BOARD OF
DIRECTORS
• Board of directors did not pay attention to their
employees, considered themselves as a
representatives of shareholders.
• Closer attention to the behavior of management and
the way the company is making money.
• In this case, when the stock is rising and the
shareholders are getting rich there is little incentive
for board of director to question executives closely.
Therefore, it must become acceptable and mandatory
to question management closely.
• The arrogance of corporate executives who claim they
are the best are the red flag for investor and public.
 RELATED TO SPE 
• Company cannot use special purpose
entity to hedge its losses, as in this case it
can’t do it for a long time.
• The bubble burst very easily, that about
4000 SPE’s have been created by
Enron.
 OTHER LESSONS:

• This scandal demonstrates the need for

significant reforms in accounting and corporate
governance in the united states, as well as for a
close look at the ethical quality of culture of
business corporations.
• Complicated financial disclosure adds another
page to the scandal, and so companies should
disclose their financial statements closely and in a
manner that is it understandable to its
stakeholders.
Thank You