dinsdag 7 december 2010

The downfall of Andersen

The motto of the accounting firm Arthur Andersen, “Think straight, talk straight.” , doesn’t sound as right anymore as it used to when Enron was just another prosperous enterprise. Years later, when Andersen found out that Enron’s financial situation was about to be made public, a memo was sent to the personnel which instructed them to destroy all audit material regarding Enron.

In 2002 Andersen was convicted of obstruction of justice although there is no exact rule on how long these documents should be hold on to and it couldn’t be proved that evidence was still being destroyed while Enron was under investigation, which is illegal. Andersen lost its Certified Public Accountant licence and was officially put out of business. Three years later the Supreme Court of the United States reversed the earlier conviction because of a communication mistake regarding the jury instructions. But the damage was already done and because Andersen’s reputation was severely damaged, nobody wanted its name on an audit and so it hasn’t returned as a viable business. I guess there is such a thing as bad publicity after all.

source: http://www.time.com/time/business/article/0,8599,193520,00.html

Enron, a numbers game

While most of the previous blogs focused on how Enron executives had hidden their debts through various methods, especially paying attention to the balance sheet, Enron’s main goal actually was to keep their share prices rising. Although the world believed their 57% five-year sales growth rate and their revenue rise from $13.3 billion to $100.8 billion between 1996 and 2000, Enron executives knew that those numbers weren’t exactly truthful.

Because the FASB, also known as the Financial Accounting Standards Board couldn’t agree on how energy contracts should be booked, they left companies such as Enron the choice whether to book the revenues at their gross or at their net value. Enron used this accounting loophole to its advantage and booked the energy contracts at their full value instead of the commission or profit they got, which explains how their revenue per employee can be at least three times higher when being compared to companies with similar sales or at least eight times higher if you look at companies with a similar number of employees. Sometimes people need to be reminded that there’s a good reason why people say “If it’s too good to be true, then it probably is!”

source: http://www.forbes.com/2002/01/15/0115enron.html

The rise and fall of Enron: a brief history

In my last blog entry I will talk about the rise and fall of Enron. In our blogs we focused on the fraud case, but to understand everything we should know something about the history.

It all started back in 1985 when Houston Natural Gas -where Ken Lay was CEO- and Omaha–Based Internorth merged. At that time Enron was only an interstate pipeline company. In 1999 they extended their horizons by launching Enron online, the company’s website where it was possible to trade commodities. That was a masterstroke, the company grew rapidly. In 2000, they were already 7th largest company on the Fortune 500. But what goes up must come down. In 2001 the drawback became clear. Enron was hiding their debt as a result of setting up a complex web of subsidiary companies.

The consequences are well-known. There’s no doubt that Enron is one of the biggest frauds in corporate history. Justice should learn from this case and revise their legislation on accounting thoroughly.

The California Energy Crisis (2)

After Enron’s bankruptcy, a confidential memo surfaced in which Enron’s own lawyers admit that the company abused the rules, by manipulating the energy market. Also, the memo reveals the names of the strategies Enron used to exploit the California electricity market: ‘Wheel Out’, ‘Get Shorty’, ‘Fat Boy’, ‘Death Star’...

The ‘Death Star’ memo for instance literally states that “Enron gets paid for moving energy to relieve congestion without actually moving energy or relieving congestion". During his appeal, Skilling’s answer to all the questions concerning these memos would be: “The rules weren’t quite clear...”

Still, the question remains: Why did the traders act so unethical? The documentary draws a parallel with the well-known Milgram experiment. As Milgram found out, people lost their sense of morality when a supervisor says that behaving inhumanly -in this case giving higher electric shocks- is permitted.

It’s obvious that Skilling could be seen as the man who’s telling people below him that it’s okay to put up the power. Consequently, the traders kept manipulating the electricity market without asking ‘why?’ enough. Or, as a former Enron trader said in the documentary: “I just didn’t want confirmed what I suspected might be true, that what I was doing was in fact unethical, if not worse.”

Based on
and the documentary 'Enron: The Smartest Guys In The Room'

Insights into the Enron scandal

Curt Launer, managing director at Credit Suisse First Boston, presented a presentation about the Enron scandal. According to him, there were three main reasons for this scandal: innovation, compensation and investment attraction.

In the early nineties, Enron innovated a lot which led to buying large amounts of capital. The company grew and saw their shares rising.

To benefit their executives, Enron had a compensation system which included a stock option plan. This was an incentive to keep the stock price getting higher and higher. When the debts rose, Enron used creative accounting to maintain their price and to stay attractive for the investors. Of course this went wrong after a while, I have explained this in other blogs.

The Enron scandal is a good lesson for other companies. Companies should have high ethical standards so that these things can’t happen again and they should stay to their core business instead of entering other markets.

The California Energy Crisis (1)

Back in December 2001, California suffered from two rolling blackouts, which means that there was not enough electricity for America’s largest state. Accordingly, electricity prices shot through the roof, in some cases by a factor of ten.
How could this possibly happen and more important, who was responsible for this energy crisis?

It all started with the deregulation of the electricity market in California a few years earlier. Thanks to the complicated and hard-to-follow new rules, a few smart guys inside Enron, such as Tim Belden, found plenty of loopholes to exploit the California energy system.

Basically, the Enron energy traders followed two massively effective strategies to make money out of ‘those poor grandmothers in California’ (sic). First, the traders created artificial electricity shortages by shutting down power plants. In energy shortage, they exported power out of the state. When prices soared again, the traders brought it back in.

However, the real money was made by arbitrage, essentially by betting that electricity prices would go up. As a result, the Enron traders made billions of dollars for the company, while the State of California was being plundered. The whole California electrical system, built a hundred years ago by Edison, was all of a sudden turned into a casino...

Based on the documentary 'Enron: The Smartest Guys In The Room'

maandag 6 december 2010

Sarbanes-Oxley Act

The Sox does not only refer to an Amercian baseball team, but also to the Sarbanes-Oxley Act, a United States federal law enacted approximately one year after the Enron scandal was revealed and it was meant to avoid other accounting scandals and to restore public confidence in the nation’s capital markets. This wide-ranging legislation directly caused the creation of the Public Company Accounting Oversight Board in order to protect the investors by controlling the auditors of public companies.

But a lot of people, including myself, doubt the effectiveness of the PCAOB and SOX, especially regarding increased regulation, professional conflicts, increased compliance costs, corporate federalism, and lack of clarity.

Though, we shouldn’t be too hard on this government intervention because it managed to increase the confidence of investors in the markets by requiring full disclosure, accuracy and transparency. So it seems the Sarbanes-Oxley Act deserves the benefit of the doubt, at least for now.


zondag 5 december 2010

Threat to Bush in Enron inquiry

In my previous blogs, I dealt with the appeal by Jeffrey Skilling, the former CEO of Enron. In this blog, I will talk about the disputed role of the ex-president George W. Bush and his administration.

Apparently Ken Lay contacted the treasury secretary by the end of October 2001 to propose a bail-out for Enron. This means that the White House probably knew about the problems of the firm before the implosion. It is also a common knowledge that Enron was the greatest financier to Bush’s campaign. And Ken Lay was known to be an old friend of Bush, who called him ‘Kenny Boy’.  It also emerged that former vice-president Dick Cheney met Ken Lay several times in April 2001, Cheney refused to reveal the details of those meetings. Bush and his administration anticipated on the criminal inquiry by the justice department by announcing they were going to review pension rights and corporate disclosure.

The US Congress wanted to take the White House to court for the first time in history but this didn’t worked out. Bush was too powerful, as president he had the power to nominate the judge, of course he chose someone in favor of him. Eventually Bush and his administration weren’t found guilty.  

Enron: The smartest guys in the room

When people are confronted with the Enron scandal, they spontaneously think of numbers and complicated transactions. But in reality, the story of Enron is more like a human tragedy. It’s a story about humans and their flaws, such as arrogance, intolerance, and greed.

The documentary 'Enron: The Smartest Guys In The Room' gives us a profound insight into the different backgrounds of the three protagonists in the Enron saga: Lay, Skilling and Fastow.

First of all, there's Kenneth ‘Ken’ Lay, son of a Baptist preacher, who tries to leave his poor childhood behind and has the ambition to make huge wealth for himself. The deregulation of the energy market became his first mission. He succeeded and founded Enron back in 1985, which he would leave in 2001 with 300 million dollars cashed in over the years.

Next, we meet Jeffrey ‘Jeff’ Skilling, a nerdy financial whizz-kid, who has a very Darwinian view of how the world works. When he applied for Harvard Business School, a professor posed him the question “Are you smart?”. His response was: “I’m fucking smart”. Skilling was the self-declared genius who came up with the idea that energy could be traded like stocks and bonds.

Finally, there's Andy Fastow, the clever guy who developed a bunch of dummy accounts to essentially keep up the profits. Andy is an eloquent speaker, a man who uses his charm and salesmanship to convince companies to invest in his fake accounting constructions.

Despite all these skills, the story of Enron ended like a Greek drama. Lay, Skilling, Fastow and other smart guys thought that they were changing the world. Eventually, they all became victims of their own hubris.

Based on the documentary 'Enron: The Smartest Guys In The Room'

dinsdag 30 november 2010

How Enron let down its employees

In my first two blogs I wrote about how and why Enron collapsed. In this blog I will talk about a consequence that is often forgotten but had an enormous impact on many lifes: thousands of people lost their job and had worthless Enron stocks.

All the former employees are telling the same story: Enron was a wonderful company to work for. You could earn lots of money, and you could enjoy luxury for free, provided by the company. Enron arranged theatre tickets, taxis if you had to work late, there were fridges full of drinks etc.

In the US, Enron matched the pension contributions with Enron stock. In the UK they matched around 10% of the salaries with shares.

When Enron collapsed, all these stocks lost all their value. During the downfall of stock prices, Enron forced their employees not to sell. This was disastrous for all those employees who had a lot of their money in stocks. Many people lost a lot of their pension savings and of their saving money. This is another dark side of the Enron story.


zaterdag 27 november 2010

The Cult of Personality

The writer of this article says the Enron executives, all members of a certain cult, didn't mean to practically bankrupt the state of California, but that they just didn't care about the impact of their shareholder value-driven competition on their surroundings.

In this kind of cult you can only find the exceptionally smart with financial success as their primary focus, whose membership can only be garanteed by continuous performance. Enron executives thought they were smarter than the other players on the market and made them believe in their continuous growth fairy tale, making a lot of money in the process, realising that somebody else would have to clean up their mess later on.

And when they succeeded in bringing in millions of dollars for their company, they convinced themselves not to be another ordinary criminal, but rather a hard-working businessman who doesn't mind the tough competition because competition eventually pays off for all of us, doesn't it?

woensdag 24 november 2010

What caused Enron to collapse?

Enron collapsed because of their creative accounting practices. It didn’t collapse because it was so big, but because people thought Enron was much bigger than it actually was.

Enron had many subsidiary companies around the world which made it possible for them to hide big losses. The transactions between Enron and the subsidiaries masked Enron’s real financial state. Losses were hidden, assets were stated.

This way, Enron could borrow much money from other Wall Street firms without any problems. When the fraud was finally found, accounting firm Arthur Anderson lost their liability to the public and was forced out of the market. Enron’s stocks lost all their value.

Of course this wasn’t an accident. The focus was the appearance of the value to rise stock prices, the focus was not creating real value. This was part of Enron’s management culture. It’s a good example of the dark side of American capitalism.


maandag 22 november 2010

Skilling Decision: No Get Out Of Jail Free Card

In this blog, I will continue on my previous subject of the appeal by Jeffrey Skilling. On June 24th Ruth Bader Ginsberg, a Supreme Court justice, didn’t deviate from the Supreme Court doctrine, which says: Don’t overrule Congress if you can avoid it. Therefore he examined the essence of the statute and came to the conclusion that the legal concept of honest services can only be used if there is a bribe.

This is important for future defendants in white-collar criminal cases but it won’t help Skilling to get out of jail. Skilling was convicted of 19 felony counts, of which only one on the basis of the statute of honest services.

Fortunately the Court didn’t overturn the convictions against Skilling but they instructed the lower courts to hold a new trial. That new trial started November 1st and it will take a few months. It is Skillings last chance at freedom. 

woensdag 17 november 2010

“The rich get richer, the poor get poorer”

The city of Houston, and its people, suffered a lot from the Enron scandal. The story of the Enron collapse and its consequences is a story about two different groups, causing two different reactions.

On the one hand, there’s a massive group of -relatively- poor, hard-working employees, who lost a lot of money, pension and savings. They do have plenty of negative feelings, such as anger and frustration, about the Enron scandal and are mostly in a struggle to survive financially.

On the other hand, there are certain former Enron executives, who caught some midnight bonuses just after Enron got bankrupt. Ken Lay for instance, former Enron chief, stayed
-relatively- wealthy in the years after the bankruptcy, and still believes he’s innocent.

Homo homini lupus. A man is a wolf to his fellow man. The story of Enron is one of greed and moral decline. The idea of corporate governance is a modest step forward, although I do believe that there will always be people in charge with too much ambition and greed inside them. Therefore, I think this could happen again... but not on such a gigantic scale anymore.

Based on http://news.bbc.co.uk/2/hi/americas/4652322.stm

donderdag 11 november 2010

Inside the Enron Scandal

Until late 2001, Enron was the world’s biggest energy trading company. It posted one billion dollar profit in 2001.

Now it’s clear these profits were false and those figures were wildly inflated by the aggressive accounting techniques. This made it possible for the Enron executives to make millions by selling Enron shares.

I keep on wondering how it’s possible such a big fraud can happen but apparently it’s possible. The Enron board ‘failed’ to spot the wrong figures. So did accountants Arthur Andersen.

Many big Wall Street firms invested also in Enron’s obscure subsidiary companies, although they knew it was to improve Enron’s balance sheet. Enron spent $250 million on fees to these firms in 2001…

If there were analysts that wrote bad reports about Enron, their investment houses came under big pressure as they could be cut out of the lucrative Enron business.

All this kept going until 28 November 2001, when Enron imploded.

Based on http://news.bbc.co.uk/2/hi/programmes/the_money_programme/1909153.stm

zaterdag 6 november 2010

Supreme court to hear appeal by Enron's Skilling

In 2006 Jeffrey Skilling, former Enron Chief Executive, was convicted of 19 felony counts and has been sentenced to 24 years prison because one of the biggest fraud cases of the last decade. 
In October 2009 Skilling and his lawyer applied to review his case on the grounds that a legal concept known as the “honest services” wasn’t used in the right way. “Honest services” is the duty to be honest that business leaders or politicians have towards shareholders or the public. The problem is that this law is poorly defined. 
Peter Henning, an expert in white collar crime, said: "The lower courts have diverged on their interpretation of honest services." He is going to use this case and put parameters on it to give the courts some help how they can deal with this legal concept. He also said that it’s unlikely that the Supreme Court, which will deal with Skilling’s appeal, will drop all convictions. But there’s a chance that there will be a fresh trial if the judges can redefine the honest services concept.