Notes to Remember:

 It is also a good example to illustrate how ethics drives culture which in turn pushes the ethical
boundaries and is a key influence on all the four other key elements of good corporate governance.
 Suspicions grew that Enron’s earnings had been manipulated and in late summer 2001 it emerged
that its Chief Finance Officer had privately made himself rich at Enron’s expense through the off-
balance sheet vehicles. 
 Enron did this by hiding the losses in the derivative section (loans were presented in the form of prepaid
commodity swaps) (Konar, 2018).

Some reasons why fraudulent transactions happened:

1. Gas and electricity market deregulation.

2. Absence of accounting standards for prepaid commodity swaps. (Konar, 2018)

3. Political ties to the then president of America George W. Bush

Market Effects Due To The Rise And Fall Of Enron.

1. Positive.

a. Stricter regulations were set to govern the market and auditors now have a stricter independence role

b. Sarbanes-Oxley reforms that make sure that CEOs and CFOs have to specify the signatures on their financial
statements so that they can not deny they ever saw them. (Goodell, 2018)

2. Negative

a. Thousands of employees lost their jobs.

b. Shareholders saw their investments shrink to a fraction of the previous value. (Leg, 2020)

c. Auditors who survive by reputation like Arthur Anderson did not survive the scandal. This means investors avoid
companies audited by them, which is bad for business.

Accountants and Auditors were also at fault.

Investors were not made aware that Enron was failing. Losses were ‘creatively’ accounted for as new joint ventures and
partnerships. This false accounting kept stock prices high and some of the executives even sold some of their shares in
the company.

Suddenly the company announced losses and it came to light that it had been erroneously reporting its earnings for
several years. Their accountants, the firm of Arthur Andersen, even went as far as destroying documents that showed
damning irregularities in Enron’s bookkeeping and financial reporting.

They failed to fulfill their duty to the public and investors who expected them to objectively access the company’s
stability in order to inform their investment in the business. They were in breach of the Ethical Laws and Professional
Accounting Standards. They were sanctioned by Congress during their investigations into the case.

The Government of the day

Several politicians were corrupt and on several occasions are believed to have received bribes from Enron in the
advancement of their causes. No one was keeping the accountants/auditors accountable and their word was generally
held to be true. The SEC authorization of Mark to Market Practices by Enron also enabled the company to defraud many
of their investors ‘legally’.
 Profits that had been soaring sky high were wiped away and replaced with enormous losses and charges that
were never recorded properly.
 The company has political connections (Bush) Enron was the single biggest contributor in bush campaign

 There were 2 oil traders working for enron gambled enormously on Enron’s behalf shifting money on fake
accounts named as Mr. M Yass the auditors told Lay that they found the 2 traders moving money into their own
account manipulating the earnings and gambling on trades beyond their capacity. Instead of firing the traders
Lay made no changes and didn’t mind what they’re doing as long as they make money for the company. Later on
the were convicted of fraud. One of the convicted trader was sent to jail.

 Skilling introduced the Mark-to-market accounting in the company, an idea that would allow the company to
fraudulently reap billions.

 The security and exchange commissions approved the accounting trick for Enron

 If you have a company and it can't explain in one sentence....what it does...it's illegal."

 Mark to market (MTM) is a method of measuring the fair value of accounts that can fluctuate over time, such as
assets and liabilities. Mark to market aims to provide a realistic appraisal of an institution's or company's current
financial situation based on current market conditions.

 Mark to market is an accounting practice that involves adjusting the value of an asset to reflect its value as
determined by current market conditions. The market value is determined based on what a company would get
for the asset if it was sold at that point in time.

 It is basic accounting that you don't record equity until you get cash, and a note doesn't count as cash,

Role Of Financial Instruments In Downfall Of Enron.

In order to finance their corporation and subsidiaries, Enron was able to attract investors and trading partners
through offering their reputation as the most innovative company, credit, expertise in energy, political backup and
praise because of its expansion and ambitious projects. (Company Man, 2017).

Enron knew as long as the company met or exceeded its endless expectations their stock price would keep rising.
Enron’s executive management committee, therefore, violated the accounting regulations under Generally Accepted
Accounting Principles (GAAP) to hide losses and debt (Lemus, 2014) in order to cover up the true value of their
corporation.

This is how;

1. Off-Balance Sheet

Enron understood that the information delivered to the market participants has a direct effect on the returns that
can be made. They used of special purpose vehicle (SPV) known as a special purpose entity (SPE) to hide large debts
and toxic assets from creditors and investors. They set up side companies in which they pushed their debt over to
them hence solving the ‘debt problem’.

They also colluded with JPMorgan Chase, Citigroup bank which helped report loans as cash flow from operations for
the period 1992–2001 (B. Aven, 2015). Also, Arthur Andersen who audited their financial statements.

2. Mark-To-Market
MTM is based on ‘fair value’ not the ‘actual value’ so it can be manipulated by allowing organizations to log
estimated profits as actual profits as in the case of Enron.

An example is the case of the partnership of Enron broadband services and Blockbuster where they entered or
logged expected earnings based on the expected growth of the VOD market. Or in the case of the Indian power
plant where immediately after building the power plant, Enron claimed the profits in its books even when the
company had not even made a dime.

3. Futures Speculation

Enron’s executives believed that their stock would continue to appreciate. Enron being the counterparty and in total
control of their assets and trading enabled them to manipulate the prices of their stocks to fit their desire.

4. Manipulation of Derivatives

Enron did this by hiding the losses in the derivative section (loans were presented in the form of prepaid commodity
swaps) (Konar, 2018).

Some reasons why fraudulent transactions happened:

1. Gas and electricity market deregulation.

2. Absence of accounting standards for prepaid commodity swaps. (Konar, 2018)

3. Political ties to the then president of America George W. Bush