Enron: How Not to Behave

Lecture: Enron – actions speak louder than words

Ethical lapses involved in the 2008 financial crisis

- Complex financial schemes. Innovative and reckless schemes for deregulation of energy. Mark-to-market accounting Andy Fastow special purpose entities. Special purpose entities

- Myopia of success. Narrowmindedness. Intolerance to questioning. Success and increased financial rewards made people bolder and more apt to taking risk. Opposing positions and warnings were dismissed or stopped all together. Focus was on short term gains, rather than long term consequences. Refusal to appreciate risk. Greed. People knew to question large financial success but did not.

- Malfunctioning government oversight. Government officials missed a number of warning signs. Lead to Sarbanes-Oxley. Numerous financial principles ignored by wall street and unchecked by government. Washington passed laws that allowed the situation to occur.

- Securities and exchange commission (sec) missed many warning signs. Led to Dodd-Frank or wall street reform law. Sec admitted it failed to carry out oversight of bear stearns

Introduction to enroll

- People at Enron said all the right things. “we’re going to make money without having to do anything but the right thing” Andy Fastow, chief financial officer, Enron. “we are doing gods work. We are on the side of Angels”. Jeffrey Skilling, chief executive officer, Enron

- As you will see they did not engage in the right conduct

- Words are not important, it is behavior that is judged.

History of enron

Timeline

- 1985-2000 grew to what appeared to be one of the largest, most profitable companies in the world

- September 2001, a month before the collapse, enron came in at the 30th position on fortunes list of the 50 fastest growing companies. By far the largest company on the list.

- Six consecutive years through 2000, it was voted the most innovative of fortunes most admired companies and it was duly hailed by analysts, reporters, and business school professors

How did it continue to make money every year

- Created mark-to-market accounting. Calculating the daily market value rather than the actual value. Allows corporate discretion in reporting earnings. Calculating the value of a security on a daily basis to determine its current market value rather than its actual book value. The numbers enron used were completely subjective and hazardous for enron management because bonuses and performance ratings were tied to meeting these earning goals.

- Created offshore entities. Used for planning, avoiding taxes, and raising profitability of its businesses. Allowed fictitious companies to hide the companies losses by purchasing them. Made enron look more profitable than it actually was. Enron had over 880 of these corporations, 700 of them were in the cayman islands because that’s where corporations operate tax free. Additional deceptions and illusions of profitability. Enron paid little or no federal income taxes between 1997 and 2000.m officers had to create additional techniques and deceptions to create illusions of billions of profits while the company was actually losing money. Invested in weather futures which drove stock price to new levels. People began to question how enron was making money when their cash flow and margins didn’t match what their earning records were enron executives went on the attack and accused people of just not getting it. For example Bethany mcclean the fortune magazine reporter who co wrote the smartest guys in the room, she asked questions about revenue and margins, Ken Lay called her editor and asked her that she be removed from the story and jeff skilling called her unethical. So instead of being transparent the enron executives became more of a bully and they failed to provide clear information.

- Executives began working on insider information, trading millions of dollars of enron stock. Executives knew of the deceptions and losses, but didn’t tell investors. Kept telling people to invest and took advantage of the investors. CFO andy Fastow manipulated the deals to provide himself and his family and friends with hundreds of millions of dollars at the expense of the shareholders.

The people behind enron

- Ken Lay – the son of a Baptist minister. 1984 became chairman and ceo of Houston natural gas which became enron. Politically connected to both bushes. When bush became president many thought he would become energy secretary. Convicted of 6 counts of fraud, conspiracy, wire and bank fraud, making false statements, and other bank fraud related to personal banking. Died 6 weeks after conviction, judgement thrown out.

- Jeff Skilling – Harvard MBA. Joins enron in 1990 and by 1997 is president and COO, then rises to CEO in 2001; he resigns 6 months later. Convicted on 19 of 28 counts. Sentenced to 24 years in prison

- Andy Fastow – Northwestern MBA (Kellogg). Joins enron in 1990 and is skillings protégé. Set up the partnerships that hid debt and inflated revenue. Faced 98 counts and plead guilty. Sentenced to 6 years in prison. “I believe I was very greedy and that I lost my moral compass”.

Enron is the story of people – a human tragedy

- Espoused vs real values. Enron eganged in culture of gambling.

- Culture of greed and aggressive risk

- Lost sight of proper values

- Most people of enron were ethical

- The few top managers left their mark on everyone who ever worked there.

- Reveals collateral damage of defective ethics. Selfish behavior and greed.

- Top executives more concerned with money than consequences. Weren’t concerned with doing things the right way and they didn’t address the ethical failures but they encouraged them.

- Movie the smartest guys in the room. Excellent ethics movie. Great way to understand what occurred at enron

Examples of enron’s history of ethical problems

- Enron oil in Valhalla scandal. 1987, company two years old. Two executives louis borgett and Tom masteroni started market scams, skimming cash into off-shore accounts, and keeping double books. They were