Enron Scandal the Collapse of a Wall Street Darling

                                                 Enron Scandal

(The Collapse of a Wall Street Darling)

Group Report

Names of Group Members:

ANDI Akhmad Fachrul - 12416177

VITHANAGE Don Marian Anuka - 12216195

DHUNGANA Rojina - 12416227

MONGKOLSUNTONCHOT Napatchanok - 12216091

GOPAL - 12416044

Business Ethics EA

Instructor: Kim Rebecca

Ritsumeikan Asia Pacific University

Date: 2019/February/5

Table of Contents

1. Case Background
2. Methodology
3. Body

1. Enron’s Financial Reporting
2. Problems/ Reasons of Failures
3. Governance and Intermediation Failures
4. Business Ethics and theories
5. Applied solutions by Enron

1. Possible Solutions and recommendations
2. Conclusion

1. Case Background

     The definition of ethics is a way of understanding, analyzing, and distinguishing matters of good or bad, right or wrong, and admirable or deplorable while also taking into account the well-being of and the relationship among sentient beings. A direct reflection of several factors such as religions or family upbringings affects how a person derives to their current beliefs of right or wrong. That is, it plays a major part in the direct choices a person makes in their day-to-day lives. While some people, regardless of the situation can stick to their personal beliefs, some other people are heavily influenced by others.

     In the business world, the influence of money and power has cost people their living as well as compromised their self-dignity on many levels. In this report, we are taking the highly publicized Enron Scandal as our case study and main topic. The part that many questions, up to this day, is when the story unfolded. It was announced that several people in the top positions were totally aware of the unethical practices being done but decided to turn a blind eye. The motive behind what an individual will do remains limitless, as it is seen in this rather unfortunate tale of greed and lies in one corporation.

     Enron was an American energy commodities and services, a product of a merger between Houston Natural Gas Company and Omaha-based InterNorth Incorporation, established in 1985. It was initially a pipeline business, but it later involved in transmitting and distributing electricity, as well as natural gas trading. In early 2001, it already had become a conglomerate company and it was even named America’s Most Innovative Company by Fortune Magazine for six successive years. However, by the end of the exact same year, it collapsed in the most unusual way in circumstances that led the scandal to become the largest bankruptcy and stock collapse in the US history. In the next paragraphs, we will look at the events that led up to the collapse and failure of a company that was at the peak of its success and how all of that would change within a matter of seconds.

1. Methodology

     As for the reference sources in order to gain all the information required to support our report, we utilized a number of Enron Scandal and business ethics-related books, journals, and online articles.

1. Body

1. Enron’s Financial Reporting

     This section of the report seeks to describe the events, especially with regards to the methods Enron used to report its financial information, led to its eventual downfall. Around the time that Jeffrey Skilling joined Enron as the head of Enron Finance Corp., the regulatory environment at that time enabled Enron to flourish. During the latter half of the 1990s, the dot-com bubble was in full effect, and the NASDAQ hit 5,000. And at the time, Internet stocks were being valuated at unbelievable amounts and consequently, most investors and regulators simply accepted spiking share prices as the new norm.

Mark-to-Market:  

     One of Skilling's early contributions was to change Enron’s traditional historical cost accounting method to a mark-to-market (MTM) accounting method, for which Enron got official SEC (U.S. Securities and Exchange Commission) approval in 1992. The mark-to-market accounting method refers to a measure of the ‘fair value’ of accounts, which can change over time, such as assets and liabilities. Mark-to-market seeks to provide a realistic evaluation of an institution's or a corporation’s current financial situation. It is apparently a legitimate and widely used practice. However, evidence suggests that in some cases it can be manipulated, since mark-to-market is not based on ‘actual’ cost but on ‘fair value’, which is harder to identify. According to the extract (Segal, 2018), it is assumed that adopting this accounting method was the beginning of Enron’s downfall, as it basically started listing estimated profits as actual profits in its records.

     Around the fall of 2000, Enron was starting to collapse in on itself. As it was mentioned above, Skilling used the mark-to-market accounting method as a means of evaluating its assets at incredible highs and used it as a method of hiding the financial losses of Enron’s trading activities and other operations (Segal, 2018). This was achieved by simply measuring and recording the value of a security based on its current market value, instead of its book value.

Enron’s Use of SPVs to Hide its Debt

     According to the article, Andrew Fastow and others at Enron organized a plan to use off-balance-sheet special purpose vehicles (SPVs), also known as special purposes entities (SPEs), to cover up its heaps of debt and toxic assets from investors and creditors. The main goal of setting up these SPVs was to hide accounting realities, rather than operating results. In terms of as to how Enron used its SPVs to hide its debt: Enron would transfer a certain amount of its rapidly rising stock to the SPV in exchange for cash or notes receivable (Catanach et al, 2003). The SPV would then consequently use the stock to hedge an asset listed on Enron's balance sheet, basically insuring the asset.

     By the summer of 2001, Enron was in a free fall. CEO Ken Lay had retired in February, making Jeff Skilling the CEO, August of that year, Skilling resigned as CEO due to "personal reasons”. During the same time, analysts began to lower their rating for Enron's stock, and the stock fell to a 52-week low of $39.95. By the 16th of October, Enron reported its first quarterly loss and closed its "Raptor" SPV so that it would not have to distribute 58 million shares of stock, which would in turn reduce earnings even further. And lastly, this action caught the attention of the authorities at the SEC.