Enron's Scandal

Enron's Scandal

Enron is an energy and power company based in Houston, Texas that deals with the energy trade on an international and domestic basis. The company was founded in 1985 by Kenneth Lay when Houston natural gas merged with Internorth. Ken Lay helped to initiate the selling of electricity at market prices and, soon after according to (Enron: The Smartest Guys in the Room) President Bush senior helped Ken Lay in giving government subsidy to Enron international and promoted Ken Lay as deregulating ambassador at large. The resulting markets made it possible for traders to sell energy at higher prices, allowing them to prosper.

In 1992, Enron was considered to be the largest merchant of natural gas in North America. The gas trading business became the second largest contributor to Enron's net income, with earnings before interest and taxes of $122 million. In 1999 the creation of the online trading enabled the company to further develop and extend its abilities to negotiate and manage its trading business.

Enron's accounting use to be straightforward in listing the actual revenues received from selling energy. But however when Louis Borget and Thomas Mastroeni two oil traders were gambling beyond their means and threatened to bankrupt the company, Mike Muckleroy, oil and gas executive bluffed the Market and saved the company. After Borget and Mastroeni were fired for having to threaten the company, Lay hired Jeffrey Skilling to join the company. When Skilling joined the company, he demanded that the trading business adopt the Mark-to-Market accounting system. Arthur Anderson their auditor signed off on it and Securities and Exchange Commission (SEC) approved it. Enron became the first nonfinancial company to use the Mark-to-Market method. This method requires a long-term contract deal to be signed and then income was estimated as the present value of net future cash flows. Often these contracts and their related costs were very difficult to measure. Due to the large discrepancies of attempting to match profits and cash, investors were typically given false or misleading reports. Income from projects could be recorded, which increased financial earnings, but later on when projects could not be included, Enron had to figure out away to include new and additional income from more projects to develop additional growth just to satisfy investors.

Later on in the company as times were becoming hard for Enron to bring in income, Enron figured out away for their financial statements to be nontransparent, which is meant for the statement not to be so clearly detailed with its operations and finances with shareholders and analyst. Its complex business representation required that the company use accounting limitations to manage earnings and modify the balance sheet to portray a favorable interpretation of their performance. According to (Enron: The Smartest Guys in the Room) the Enron scandal grew out of a steady accumulation of habits, and values to actions that began years before and finally spiraled out of control. According to Bodurtha J. N. (2003) from the late 1997 until the day it collapse, their primary motivations were that the accounting and financial transactions seem to have been to keep reported income and cash flow up, assets values extravagant, and liabilities off the book (p.2).

All of these scandals later led the company to file for bankruptcy. Majority of these actions were perpetuated by the direct actions of Kenneth Lay, Jeffrey Skilling, Andrew Fastow and other executives. Fastow's jobs were to create off-balance sheet, complex financing structures and to do deals so confusing that few people can understand them. Fastow created 100 special companies to perform a system called "The Black Magic." It helped Enron's dept disappear, but to investors it looked like cash was coming in. When in reality, Enron was hiding their debt into Fastow's companies where investors couldn't see it.

Enron made it a habit of booking costs of cancelled projects as assets, with no justifications of an official letter stating that the project was cancelled. This method was known as "The Snowball" and although it was initially dictated that Snowballs stay under $90 million, it was later extended to $200 million.

As times got worse for Enron, Skilling announced he was resigning his position as CEO after only six months on August 14. According to The New York Times (2001) the company, having little cash to run its business, let alone to satisfy its enormous debts, Enron finally caved in. At the end of the day trading stock price fell to $.61 and Enron was estimated to have about $23 billion in liabilities, both debt outstanding and guaranteed loans. Citigroup and JP Morgan chase in particular appeared to have significant amounts to lose with Enron's