Enron: What Caused the Ethical Collapse?

Introduction
Kenneth Lay, former chairman and chief executive officer (CEO) of Enron Corp., is quoted in Michael ova!"s #oo! Business as a Calling: Work and the Examined Life as sayin$, %& 'as fully exposed to not only le$al #ehavior #ut moral and ethical #ehavior and 'hat that means from the standpoint of leadin$ or$ani(ations and people.) &n an introductory statement to the revised Enron Code of Ethics issued in *uly +,,,, Lay 'rote- %.s officers and employees of Enron Corp., its su#sidiaries, and its affiliated companies, 'e are responsi#le for conductin$ the #usiness affairs of the companies in accordance 'ith all applica#le la's and in a moral and honest manner.) Lay 'ent on to indicate that the /01pa$e Enron Code of Ethics reflected policies approved #y the company"s #oard of directors and that the company, 'hich en2oyed a reputation for #ein$ fair and honest, 'as hi$hly respected. Enron"s ethics code also specified that %.n employee shall not conduct himself or herself in a manner 'hich directly or indirectly 'ould #e detrimental to the #est interests of the Company or in a manner 'hich 'ould #rin$ to the employee financial $ain separately derived as a direct consequence of his or her employment 'ith the Company.) Enron"s ethics code 'as #ased on respect, inte$rity, communication, and excellence. 3hese values 'ere descri#ed as follo's4espect. 5e treat others as 'e 'ould li!e to #e treated ourselves. 5e do not tolerate a#usive or disrespectful treatment. 4uthlessness, callousness and arro$ance don"t #elon$ here. &nte$rity. 5e 'or! 'ith customers and prospects openly, honestly and sincerely. 5hen 'e say 'e 'ill do somethin$, 'e 'ill do it6 'hen 'e say 'e cannot or 'ill not do somethin$, then 'e 'on"t do it. Communication. 5e have an o#li$ation to communicate. 7ere 'e ta!e the time to tal! 'ith one another . . . and to listen. 5e #elieve that information is meant to move and that information moves people. Excellence. 5e are satisfied 'ith nothin$ less than the very #est in everythin$ 'e do. 5e 'ill continue to raise the #ar for everyone. 3he $reat fun here 'ill #e for all of us to discover 2ust ho' $ood 'e can really #e. 8iven this code of conduct and Ken Lay"s professed commitment to #usiness ethics, ho' could Enron have collapsed so dramatically, $oin$ from reported revenues of 9:,: #illion in +,,, and approximately 9:0, #illion durin$ the first three quarters of +,,: to declarin$ #an!ruptcy in ;ecem#er +,,:< 3he ans'er to this question seems to #e rooted in a com#ination of the failure of top leadership, a corporate culture that supported unethical #ehavior, and the complicity of the investment #an!in$ community.

Enrons Top Leadership

&n the aftermath of Enron"s #an!ruptcy filin$, numerous Enron executives 'ere char$ed 'ith criminal acts, includin$ fraud, money launderin$, and insider tradin$. =or example, >en 8lisan, Enron"s former treasurer, 'as char$ed 'ith t'o1do(en counts of money launderin$, fraud, and conspiracy. 8lisan pled $uilty to one count of conspiracy to commit fraud and received a prison term, three years of post1prison supervision, and financial penalties of more than 9: million. ;urin$ the plea ne$otiations, 8lisan descri#ed Enron as a %house of cards.) .ndre' =asto', *eff ?!illin$, and Ken Lay are amon$ the most nota#le top1level executives implicated in the collapse of Enron"s %house of cards.) .ndre' =asto', former Enron chief financial officer (C=O), faced @A counts of money launderin$, fraud, and conspiracy in connection 'ith the improper partnerships he ran, 'hich included a >ra(ilian po'er plant pro2ect and a i$erian po'er plant pro2ect that 'as aided #y Merrill Lynch, an investment #an!in$ firm. =asto' pled $uilty to one char$e of conspiracy to commit 'ire fraud and one char$e of conspiracy to commit 'ire and securities fraud. 7e a$reed to a prison term of :, years and the forfeiture of 9+@.A million. *eff ?!illin$ 'as indicted on BC counts of 'ire fraud, securities fraud, conspiracy, ma!in$ false statements on financial reports, and insider tradin$. Ken Lay 'as indicted on :: criminal counts of fraud and ma!in$ misleadin$ statements. >oth ?!illin$ and Lay pled not $uilty and are a'aitin$ trial. 3he activities of ?!illin$, =asto', and Lay raise questions a#out ho' closely they adhered to the values of respect, inte$rity, communication, and excellence articulated in the Enron Code of Ethics. >efore the collapse, 'hen >ethany McLean, an investi$ative reporter for =ortune ma$a(ine, 'as preparin$ an article on ho' Enron made its money, she called Enron"s then1CEO, *eff ?!illin$, to see! clarification of its %nearly incomprehensi#le financial statements.) ?!illin$ #ecame a$itated 'ith McLean"s inquiry, told her that the line of questionin$ 'as unethical, and hun$ up on McLean. ?hortly thereafter .ndre' =asto' and t'o other !ey executives traveled to e' Dor! City to meet 'ith McLean, ostensi#ly to ans'er her questions %completely and accurately.) =asto' en$a$ed in several activities that challen$e the foundational values of the company"s ethics code. =asto' tried to conceal ho' extensively Enron 'as involved in tradin$ for the simple reason that tradin$ companies have inherently volatile earnin$s that aren"t re'arded in the stoc! mar!et 'ith hi$h valuationsEand a hi$h mar!et valuation 'as essential to !eepin$ Enron from collapsin$. .nother =asto' venture 'as settin$ up and operatin$ partnerships called related party transactions to do #usiness 'ith Enron. &n the process of allo'in$ =asto' to set and run these very lucrative private partnerships, Enron"s #oard and top mana$ement $ave =asto' an exemption from the company"s ethics code. Contrary to the federal prosecutor"s indictment of Lay, 'hich descri#es him as one of the !ey leaders and or$ani(ers of the criminal activity and massive fraud that lead to Enron"s #an!ruptcy, Lay maintains his innocence and lac! of !no'led$e of 'hat 'as happenin$. 7e #lames virtually all of the criminal activities on =asto'. 7o'ever, ?herron 5at!ins, the !ey Enron 'histle#lo'er,

maintains that she can provide examples of Lay"s questiona#le decisions and actions. .s >ethany McLean and fello' investi$ative reporter Feter El!ind o#serve- %Lay #ears enormous responsi#ility for the su#stance of 'hat 'ent 'ron$ at Enron. 3he pro#lems ran 'ide and deep, as did the deception required in coverin$ them up. 3he company"s culture 'as his to shape.) Gltimately, the actions of Enron"s leadership did not match the company"s expressed vision and values.

Enrons Corporate Culture

Enron has #een descri#ed as havin$ a culture of arro$ance that led people to #elieve that they could handle increasin$ly $reater ris! 'ithout encounterin$ any dan$er. .ccordin$ to ?herron 5at!ins, %Enron"s unspo!en messa$e 'as, HMa!e the num#ers, ma!e the num#ers, ma!e the num#ersEif you steal, if you cheat, 2ust don"t $et cau$ht. &f you do, #e$ for a second chance, and you"ll $et one.") Enron"s corporate culture did little to promote the values of respect and inte$rity. 3hese values 'ere undermined throu$h the company"s emphasis on decentrali(ation, its employee performance appraisals, and its compensation pro$ram. Each Enron division and #usiness unit 'as !ept separate from the others, and as a result very fe' people in the or$ani(ation had a %#i$ picture) perspective of the company"s operations. .ccompanyin$ this emphasis on decentrali(ation 'ere insufficient operational and financial controls as 'ell as %a distracted, hands1off chairman, a compliant #oard of directors, and an impotent staff of accountants, auditors, and la'yers.) *eff ?!illin$ implemented a very ri$orous and threatenin$ performance evaluation process for all Enron employees. Kno'n as %ran! and yan!,) the annual process utili(ed peer evaluations, and each of the company"s divisions 'as ar#itrarily forced to fire the lo'est ran!in$ one1fifth of its employees. Employees frequently ran!ed their peers lo'er in order to enhance their o'n positions in the company. Enron"s compensation plan %seemed oriented to'ard enrichin$ executives rather than $eneratin$ profits for shareholders) and encoura$ed people to #rea! rules and inflate the value of contracts even thou$h no actual cash 'as $enerated. Enron"s #onus pro$ram encoura$ed the use of non1standard accountin$ practices and the inflated valuation of deals on the company"s #oo!s. &ndeed, deal inflation #ecame 'idespread 'ithin the company as partnerships 'ere created solely to hide losses and avoid the consequences of o'nin$ up to pro#lems.

Complicity of the Investment Banking Community

.ccordin$ to investi$ative reporters McLean and El!ind, %One of the most sordid aspects of the Enron scandal is the complicity of so many hi$hly re$arded 5all ?treet firms) in ena#lin$ Enron"s fraud as 'ell as #ein$ partners to it. &ncluded amon$ these firms 'ere *.F. Mor$an, Citi$roup, and Merrill Lynch. 3his complicity occurred throu$h the use of prepays, 'hich 'ere #asically loans that

Enron #oo!ed as operatin$ cash flo'. Enron secured ne' prepays to pay off existin$ ones and to support rapidly expandin$ investments in ne' #usinesses. One of the related party transactions created #y .ndre' =asto', !no'n as L*M+, used a tactic 'here#y it 'ould ta!e %an asset off Enron"s handsE usually a poor performin$ asset, usually at the end of a quarterEand then sell it #ac! to the company at a profit once the quarter 'as over and the Hearnin$s" had #een #oo!ed.) ?uch transactions 'ere #asically smo!e and mirrors, reflectin$ a relationship #et'een L*M+ and the #an!s 'herein %Enron could practically pluc! earnin$s out of thin air.)

Epilogue
3he Enron Code of Ethics and its foundational values of respect, inte$rity, communication, and excellence o#viously did little to help create an ethical environment at the company. 3he full extent and explanation of Enron"s ethical collapse is yet to #e determined as le$al proceedin$s continue. =ourteen other Enron employeesEmany hi$h levelEhave pled $uilty to various char$es6 :+ of these are a'aitin$ sentencin$, 'hile the other t'o, one of 'hom is .ndre' =asto'"s spouse, have received prison sentences of at least one year. *uries have convicted five individuals of fraud, as 'ell as .rthur .ndersen, the accountin$ firm hired #y Enron that shared responsi#ility for the company"s fraudulent accountin$ statements. 3hree of the convicted individuals 'ere Merrill Lynch employees involved in the i$erian #ar$e deal 'ith =asto'. Ken Lay and *eff ?!illin$, alon$ 'ith 4ichard Causey, Enron"s former chief accountin$ officer, are a'aitin$ trial. Lay faces :: criminal counts, ?!illin$ faces BC criminal counts, and Causey faces B: criminal counts. =ive executives from Enron"s #road#and division are also a'aitin$ trial. 3hree #an! executives from >ritain 'ho had #een involved in a complicated series of deals in a =asto' partnership are fi$htin$ extradition. &n addition, there are ::0 unindicted co1conspirators in the federal $overnment"s case a$ainst Lay and ?!illin$.

uestions for !iscussion

:. 5hat led to the collapse of Enron under Lay and ?!illin$< +. 7o' did the top leadership at Enron undermine the foundational values of the Enron Code of Ethics< B. 8iven Kenneth Lay"s and *eff ?!illin$"s operatin$ #eliefs and the Enron Code of Ethics, 'hat expectations re$ardin$ ethical decisions and actions should Enron"s employees reasona#ly have had< 0. 7o' did Enron"s corporate culture promote unethical decisions and actions< C. 7o' did the investment #an!in$ community contri#ute to the ethical collapse of Enron< ?ources
3his case 'as developed from material contained in the follo'in$ sourcesEl!ind, F., McLean, >. (*uly :+, +,,0). Ken Lay flun!s i$norance test. =ortune, http-II '''.fortune.com, accessed ;ecem#er :C, +,,0. Enron Code of Ethics. 3he ?mo!in$ 8un 5e# site, http-II'''.thesmo!in$$un.com, accessed ;ecem#er :C, +,,0. Enron- 7ouston Chronicle ?pecial 4eport. (;ec. ::, +,,0). 7ouston Chronicle, http-II '''.chron.comIcsIC;.Istory.htsIspecialIenronI:/+0A++, accessed ;ecem#er :C, +,,B.

Enron 3imeline. 7ouston Chronicle, http-II'''.chron.comIcontentIchronicleIspecialI ,:IenronItimeline.html, accessed ;ecem#er :C, +,,B. =o'ler, 3. (Octo#er +,, +,,+). 3he pride and the fall of Enron. 7ouston Chronicle, http-II '''.chron.comIcsIC;.Istory.htsIspecialIenronI:/+0A++, accessed ovem#er +C, +,,B. =lood, M. (?eptem#er :,, +,,B). Ex1Enron executive $oin$ to prison- 8lisan plea may speed cases. 7ouston Chronicle, http-II'''.chron.comIcsIC;.Istory.htsIspecialI enronI+,@,@0B, accessed ovem#er +C, +,,B. McLean, >. (;ecem#er @, +,,:). 5hy Enron 'ent #ust. =ortune, http-II'''.fortune. com, accessed ;ecem#er :C, +,,0. McLean, >., El!ind, F. (Octo#er :B, +,,B). Fartners in crime. =ortune, http-II'''. fortune.com, accessed ;ecem#er :C, +,,:. McLean, >., El!ind, F. (Octo#er :B, +,,B). Fartners in crime, part +. =ortune, http-II '''.fortune.com, accessed ;ecem#er :C, +,,:. Mehta, ?. . (Octo#er :0, +,,B). Employees are the #est line of defense. =ortune, http-II '''.fortune.com, accessed ;ecem#er :C, +,,0. ova!, M. (:@@/) >usiness as a Callin$- 5or! and the Examined Life. e' Dor!- 3he =ree Fress. ?trip clu#s, daredevil trips, 9: million paychec!s. (Octo#er +, +,,B). Excerpt from >. McLean and F. El!ind, 3he ?martest 8uys in the 4oom, printed in =ortune, http-II'''.fortune. com, accessed ;ecem#er :C, +,,0.