The Fall of…The Fall of…

Enron and Arthur Enron and Arthur AndersenAndersen

http://money.cnn.com/news/specials/enron/

What you will learnWhat you will learn

1.1. History of Enron and AndersenHistory of Enron and Andersen

2.2. Key Players in ScandalKey Players in Scandal

3.3. How investors were scammedHow investors were scammed Types of white-collar crimeTypes of white-collar crime

4.4. How scandal was discoveredHow scandal was discovered

5.5. Verdicts in Court Verdicts in Court

6.6. Effects on the financial industry: Effects on the financial industry: New legislationNew legislation

What was Enron?What was Enron? Enron (former NYSE ticker Enron (former NYSE ticker

symbol: ENE) symbol: ENE) world's leading electricity, natural world's leading electricity, natural

gas, and gas, and energyenergy company company based in Houston, Texas, based in Houston, Texas, 21,000 employees in over 30 21,000 employees in over 30

countries countries stated stated revenues revenues of more than of more than

$100 billion$100 billion in the 1990s in the 1990s

What was Arthur Andersen What was Arthur Andersen Accounting?Accounting? one of the Big Five one of the Big Five

accounting firmsaccounting firms for for public and private public and private companies around the world companies around the world

over $9 billion in sales over $9 billion in sales during 2001. during 2001.

85,000 employees working 85,000 employees working in 84 countriesin 84 countries

Key EventsKey Events

1.) August 15, 2001 Sherron 1.) August 15, 2001 Sherron Watkins sends a memo to (CEO) Watkins sends a memo to (CEO) Kenneth Lay about accounting Kenneth Lay about accounting issues.issues.

2) October 16, 2001- Enron 2) October 16, 2001- Enron announces a third quarter loss announces a third quarter loss of $618 millionof $618 million

3) October 31, 2001- The SEC 3) October 31, 2001- The SEC opens a formal investigation opens a formal investigation into Enron’s transactionsinto Enron’s transactions

Key Events Continued…Key Events Continued…

In October, Enron said it would reduce In October, Enron said it would reduce shareholder value by $1.2 billion. shareholder value by $1.2 billion. The company now blamed the losses on The company now blamed the losses on

Andrew Fastow,Andrew Fastow, the CFO, for allegedly the CFO, for allegedly arranging deceptive and failing arranging deceptive and failing partnerships what were being used to partnerships what were being used to hide millions of dollars in Enron losses. hide millions of dollars in Enron losses.

Falsifying SalesFalsifying Sales Falsifying recordsFalsifying records

Key Events Continued…Key Events Continued…4.) During this time, the SEC publicly upgraded its 4.) During this time, the SEC publicly upgraded its

inquiry into a formal inquiry into a formal investigation investigation of Enron's of Enron's suspected fraudulent financial statements. suspected fraudulent financial statements.

5.) In early November, Enron conceded it had 5.) In early November, Enron conceded it had overstated its profits by nearly 16 percent, or $600 overstated its profits by nearly 16 percent, or $600 million, since 1997. million, since 1997.

Enron's auditors, Arthur Andersen, also Enron's auditors, Arthur Andersen, also alerted shareholders that they should not trust any alerted shareholders that they should not trust any financial reports issued before June 30, 2001.financial reports issued before June 30, 2001.

Enron's market value plunged, as shareholders and Enron's market value plunged, as shareholders and investors sold their shares as fast as they could. investors sold their shares as fast as they could.

Key Events Continued…Key Events Continued…

6.) Faced with paying back millions of 6.) Faced with paying back millions of dollars in debt, Enron's executives and dollars in debt, Enron's executives and company board agreed to seek Chapter company board agreed to seek Chapter 11 bankruptcy protection in early 11 bankruptcy protection in early December of 2001. December of 2001.

•The breathtaking speed of the The breathtaking speed of the energy giant's collapse became the energy giant's collapse became the subject of multiple investigations, subject of multiple investigations, including a criminal investigation into including a criminal investigation into the company's allegedly the company's allegedly fraudulent fraudulent accounting methodsaccounting methods.. •On paper, it took Enron 24 days to go bankrupt !

Key peopleKey people 1.) Kenneth Lay1.) Kenneth Lay

Enron's CEO and Enron's CEO and chairmanchairman

from 1986 to January 2002.from 1986 to January 2002.

Key people: Key people: http://www.youtube.com/watch?v=hPqH3DrWEEU

2.)Jeffrey Skilling2.)Jeffrey Skilling

President of Enron, heading President of Enron, heading Enron's North American Enron's North American

operations. operations.

Key peopleKey people3.)Andrew Fastow3.)Andrew Fastow CFOCFO Fastow, who was promoted to CFO in Fastow, who was promoted to CFO in

his mid-thirties, earned accolades for his mid-thirties, earned accolades for diminishing Enron's debt and diminishing Enron's debt and restructuring the company's finances restructuring the company's finances to allow Enron to diversify its to allow Enron to diversify its business. business.

Created false business partnerships Created false business partnerships with fictional companies throughout with fictional companies throughout the world in order to hide debtthe world in order to hide debt

0

10

20

30

40

50

60

70

80

90

Jan. 25

Aug. 14

Oct. 16

Oct. 22

Oct. 29

Nov. 8

Nov. 12

Dec. 2

Jan. 15

Enron’s Stock Price from Jan 2001- Jan 2002

Key peopleKey people

4.) Arthur Andersen4.) Arthur Andersen

Andersen served as Enron's Andersen served as Enron's sole internal sole internal auditor auditor throughout the energy giant's throughout the energy giant's sixteen years, also performing sixteen years, also performing internal audits and consulting internal audits and consulting services.services.

In 2002 the firm voluntarily In 2002 the firm voluntarily surrendered its licenses to practice as surrendered its licenses to practice as Certified Public Accountants in the U.S. Certified Public Accountants in the U.S. pending the result of prosecution by pending the result of prosecution by the Department of Justice over the the Department of Justice over the firm's handling of the auditing of firm's handling of the auditing of EnronEnron

Jury InstructionsJury Instructions 2005-ended operation2005-ended operation

White Collar Crimes that the White Collar Crimes that the SEC investigates and SEC investigates and prosecutesprosecutes Insider tradingInsider trading

Tipping off investors/friends/family of Tipping off investors/friends/family of confidential financial info motivating them confidential financial info motivating them to either buy or sell a stockto either buy or sell a stock

Securities fraudSecurities fraud providing false or misleading information providing false or misleading information

about financial statements to motivate about financial statements to motivate people to buy or sell stockpeople to buy or sell stock

ConspiracyConspiracy A secret plan by a group to do something A secret plan by a group to do something

unlawful or harmful unlawful or harmful Money LaunderingMoney Laundering

Changing the source of incomeChanging the source of income

Lead PlaintiffsLead Plaintiffs

1. The University of California1. The University of California 155,000 employees retirement funds tied to 155,000 employees retirement funds tied to

Enron stockEnron stock Purchased over 2 million shares at inflated Purchased over 2 million shares at inflated

pricesprices Suffered damages of over $144 millionSuffered damages of over $144 million

2. Washington State Investment Board2. Washington State Investment Board Manages and invests state’s retirement fundsManages and invests state’s retirement funds Purchased debt securities at inflated pricesPurchased debt securities at inflated prices

Lead PlaintiffsLead Plaintiffs3. San Francisco City and County Employees‘3. San Francisco City and County Employees‘

Retirement SystemRetirement System Provides benefits for retired employeesProvides benefits for retired employees Purchased equity securities at inflated pricesPurchased equity securities at inflated prices

4. Teamsters Nos.175 & 505 Pension Trust 4. Teamsters Nos.175 & 505 Pension Trust FundFund

Oversees retirement savingsOversees retirement savings Purchased debt securities at inflated pricesPurchased debt securities at inflated prices

5. Hawaii Laborers Pension Plan5. Hawaii Laborers Pension Plan Administers retirement savingsAdministers retirement savings Purchased debt securities at inflated pricesPurchased debt securities at inflated prices

DefendantsDefendants

1. Enron1. Enron Kenneth Lay, Jeffrey Skilling, Andrew Fastow, and Kenneth Lay, Jeffrey Skilling, Andrew Fastow, and

various other Executivesvarious other Executives Accused of illegal insider trading

2. “Andersen”2. “Andersen” consisted of Arthur Andersen LLP and Andersen consisted of Arthur Andersen LLP and Andersen

Worldwide S.C.Worldwide S.C.

3. Law Firms 3. Law Firms Vinsin & Elkins, Kirkland & EllisVinsin & Elkins, Kirkland & Ellis

4. Investment Banks4. Investment Banks J.P. Morgan & ChaseJ.P. Morgan & Chase, CitiGroup, , CitiGroup, Bank of America, etc.Bank of America, etc.

The Verdicts…The Verdicts…

http://www.youtube.com/watch?v=di2XVJljadA&NR=1&feature=fvwp

What happened to Kenneth What happened to Kenneth Lay?Lay? On July 7, 2004, Lay was indicted and On July 7, 2004, Lay was indicted and

found guilty by a grand jury on 11 found guilty by a grand jury on 11 counts of conspiracy, securities fraud counts of conspiracy, securities fraud and related charges. and related charges.

Lay could have faced 20 to 30 years Lay could have faced 20 to 30 years in prison. in prison.

However, he died while vacationing However, he died while vacationing in Snowmass, Colorado on July 5, in Snowmass, Colorado on July 5, 2006, about three and a half months 2006, about three and a half months before his scheduled October 23 before his scheduled October 23 sentencing.sentencing.

What happened to Jeffery What happened to Jeffery Skilling?Skilling?

Skilling was indicted on 35 counts of Skilling was indicted on 35 counts of fraud, insider trading, and other fraud, insider trading, and other crimes related to the collapse of crimes related to the collapse of Enron. Enron.

pleaded not guilty to all charges. pleaded not guilty to all charges. About a month after quitting Enron, About a month after quitting Enron,

Skilling sold almost $60 million of his Skilling sold almost $60 million of his stake in the company stake in the company leading to the prosecutors' allegation that leading to the prosecutors' allegation that

he sold those shares with he sold those shares with inside inside informationinformation of Enron's impending of Enron's impending bankruptcy. bankruptcy.

On October 23, 2006, Skilling was On October 23, 2006, Skilling was sentenced to 24 years and 4 months sentenced to 24 years and 4 months in prison, and fined $45 million.in prison, and fined $45 million.

What happened to Andrew What happened to Andrew Fastow?Fastow?

Despite entering into a plea Despite entering into a plea agreement to serve 10 years in agreement to serve 10 years in prison, on 26 September 2006, prison, on 26 September 2006, Fastow was sentenced to six years, Fastow was sentenced to six years, followed by two years of probation. followed by two years of probation.

DeregulationDeregulation

Commodity exchange: an organized market where future delivery contracts for graded commodities (as grains, cotton, sugar, coffee, wool) are bought and sold.

federal deregulation of commodity exchanges has removed accountability and transparency from the energy sector, allowing corporations to manipulate price and supply of electricity and natural gas through the exercise of significant market power

Enron developed mutually beneficial relationships with federal regulators and lawmakers to support policies that significantly curtailed government oversight of their operations. 

Enron's business model was built entirely on the premise that it could make more money speculating on electricity contracts than it could by actually producing electricity at a power plant. Central to Enron's strategy of turning electricity into a speculative commodity was removing government oversight of its trading practices and exploiting market deficiencies to allow it to manipulate prices and supply. 

Dr. Wendy Gramm, in her capacity as chairwoman of the Commodity Futures Trading Commission (CFTC), exempted Enron's trading of futures contracts in response to a request for such an action by Enron in 1992. At the time, Enron was a significant source of campaign financing for Wendy Gramm's husband, U.S. Senator Phil Gramm. 

President Bush's presidential campaign received significant financial support from Enron ($1.14 million). 

Commodity Futures Act of 2000

DerivatesDerivates

Derivatives are used for two main purposes: to speculate and to hedge investments. Let’s look at a hedging example. Since the weather is difficult–if not impossible–to predict, orange growers in Florida rely on derivatives to hedge their exposure to bad weather that could destroy an entire season’s crop. Think of it as an insurance policy: farmers purchase derivatives that allow them to benefit if the weather damages or destroys their crop. If the weather is good, and the result is a bumper crop, then the farmer is only out the cost of purchasing the derivative.Most of the money Enron had came from derivates

Sarbanes-Oxley ActSarbanes-Oxley Act

The Sarbanes-Oxley Act of 2002The Sarbanes-Oxley Act of 2002 commonly called SOXcommonly called SOX is a United States federal law signed is a United States federal law signed

on July 30, 2002 in response to a on July 30, 2002 in response to a number of major number of major corporate and corporate and accounting scandals, primarily accounting scandals, primarily led by Enron/Andersenled by Enron/Andersen

SOX