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The Enron Scandal

Essay by review  •  January 5, 2011  •  Case Study  •  1,811 Words (8 Pages)  •  1,915 Views

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The Enron Scandal

One of the most popular business bankruptcies and collapses known to date is that of the Enron Corporation. Enron, once known as "America's Most Innovative Company" by Fortune Magazine six straight years from 1996 to 2001. Enron seemed to be doing very well until the summer of 2001 generating a lot of cash and new businesses, but in October of 2001 Enron was forced to disclose that their accounting practices had been very creative, and failed to follow generally accepted accounting principles. Profits that had been soaring sky high were wiped away and replaced with enormous losses and charges that were never recorded properly. Unfortunately, Enron executives who were responsible for the shady accounting practices, were able to escape this debt by selling off most or all of their shares in the company (valued at over 10 million dollars) before the stock price fell greatly. They also froze employee's pension plans, and many people lost their jobs in the wake of the collapse and found out their retirement was history (Anonymous, 2002).

For five straight years Enron had investors and shareholders believe that everything was fine in the corporation with their creative bookkeeping. External and Internal agencies that should have found the problems in the accounting practices did not do so until it was painfully obvious to all of America. Now, as America lies in the wake of the Enron scandal, the Securities and Exchange Commission has tightened its grip on accounting practices for all corporations and with the Public Company Accounting Reform and Investor Protection Act of 2002 they can keep a close eye on all financial reporting. It isn't completely in the fault of Enron; through millions of dollars of donations to political legislation, Enron was able to deregulate the energy industry, which removed all of the government oversights on energy. Without these government oversights Enron could do as they pleased and is the reason why they became a 100-billion dollar business (Lindstrom, 2004).

Enron began business in 1986 as a small pipeline company out of Houston. At that time Enron's goal was to create the first national gas pipeline. Unfortunately for Enron, the gas industry was regulated by the government, meaning they were told how much to charge for power, and profits were set a maximum. Through American-style bribery, also known as political donations, Enron was able to deregulate the gas market (Anonymous, 2004). With the help of Chief Executive Officer, Kenneth Lay, Enron was able to successfully enter into the energy market. Again, through political donations by Enron to political legislation they were able to deregulate the energy market, bringing together buyers and sellers of energy, and dominate trade contracts made possible through the use of financial instruments called derivatives (Lindstrom, 2004).

"A derivative is an instrument whose value is "derived" from the underlying value of something else, such as a stock, a bond, or in the case of Enron's derivatives, a unit of electricity. Derivatives are useful because they enable an investor to hedge against a decline in value. For example, Enron could enter a contract with a purchaser of electricity, such as a utility, guaranteeing that the purchaser would pay a certain price for a certain amount of electricity at a certain date in the future. Enron could then hedge its bet by signing a derivatives contract with a supplier of electricity who would guarantee that it would sell electricity at the purchaser's price on the agreed upon date (Lindstrom, 2004)." Through use of these derivatives Enron was able to dominate about 25 percent of the energy and gas business and was also able to start a new brokerage firm which acted as a middleman for a wide range of commodities. In 1999, Enron became a bandwidth broker and started Enron Online which steadfastly rose to become the number one e-business website in the world (Lindstrom, 2004). The company was doing so well according to its revenues; it continued to invest in other facilities worldwide and became a major power with over 21,000 employees.

Enron seemed to be doing well into 2001 until March when the first sign of internal problems with Enron took place when a deal with Blockbuster Inc. fell through, that would have brought Blockbuster movies to users of the internet. In August, Jeffrey Skilling, CEO of Enron, announced his resignation, which was a huge sign that turmoil was about at Enron, thereby launching an SEC investigation into the problems of Enron. In October 2001, Enron was forced to disclose a third-quarter loss of 618 million dollars. Through bad accounting practices, Enron somehow overstated the company's net worth of about 1 billion dollars (Lindstrom, 2004). Enron entered into this mess when they started taking losses as a result of bad business ventures. They hid the losses by moving Enron's assets into these special purpose entities, and when they did so they reported the assets as sales to external companies. These SPE's are supposed to be isolated from the parent company but in Enron's case this was untrue and the SPE's depended on Enron management and stock capital. When auditors forced Enron to bring these SPE's back into the company the sales from moving the assets into the SPE's was lost and this explains the 1 billion dollar charge. Arthur Andersen, LLP, should have noticed these problems internally and been fixed sooner, but due to very complicated financial maneuvers they were never found. Andersen did not move to ever investigate Enron, because they were so closely tied with Enron executives and they were making a lot more money serving as a consulting firm to Enron then they were as auditors. When Andersen finally found the problem with the accounting procedures they knew an SEC investigation would take place, therefore they began shredding internal documents that could be used against them in court. Andersen was correct, although the federal government could not prove that the auditing procedures used by Andersen were illegal, they did charge Andersen with obstructing justice for shredding internal documents.

Enron in some cases just didn't just hide the losses of the SPE's they created profits that the entities could not possibly produce. Finally, they reported future incomings much higher then that were actually expected. When the truth came out, investors and creditors panicked, and Enron's stock plummeted and all lending that Enron had enjoyed for so long ceased. Enron soon after was forced to

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