Enron PDF
Enron PDF
The role of a director, as described by Agatha Christie in her novel The Seven Dials, is hopefully no longer appropriate:
of something
or other, declares
one
character. Ve~ good business for me nothing to do except go down into the Ci~ once or twice a year to one of those hotel places Cannon Street or Liverpool Street and sit around a table where they have some veq nice new blotting paper. Then Coote or some clever Johnny but fortunately makes a speech simply
1.
On December
largest
throughout the world. Thousands of Enron employees lost not only their jobs but a significant part of their retirement savings; Enron shareholders saw the value thousands creditors of their investments around plummet; and hundreds, if not
of businesses in bankruptcy
the world,
were turned
2.
for directors, managers, board committees, mangers, pension funds, the accounting
investment profession,
politicians
The manner in which business leaders conduct their business affairs is now under much closer scrutiny: with corporate governance the forefront questioned of this scrutiny. far more frequently Remuneration and closely; policies practices at
in a nutshell,
3.
Subcommittee Affairs,
United
entitled The Role of the Board of Directors in Enrons Collapse; Board was found to have failed in its duties in the following areas: 8
s
The report was scathing in its findings of the role of the Board of Enron; in particular in the way it failed to execute its fiduciary duties.
4.
has shown that it was not merely an individual or group of individuals that destroyed the 7th largest corporation in the United States. This was
the same as was the case with Nick Leeson and Barings Bank. Both cases clearly illustrate the dangers of weak systems and controls, acceptance by directors of what was being fed to them by management; by the apparent success and profitability of the entities. both masked
5.
Accountants
company failed by not giving enough real power to their risk committees and internal controls.
6.
For each of these groups, the thing they failed at was not something of a secondary nature to them; it was the prime reason for their existence.
7.
Independence
probing of management.
they have to understand the business, the risks it faces and the extent of the power granted to and the responsibility imposed on them.
8.
Audit
committees
need
to proactively
monitor
management
and
decisions taken to ensure that a realistic picture is presented to the users of the financial statements.
9.
Corporate
governance
world, it is the life-blood of the corporate world, carrying away waste, providing the antibodies to fight disease, carrying life giving oxygen to the cells.
10.
Co~orate work
governance
isthecheck risks
as expected, fostered.
are managed
environment
11.
The implications
of the collapse of Enron (and other large corporate have led to massive revisions of, inter alia, of auditors, the role of audit committees, the
entities such as Worldcom) the role and independence role and independence analysts
of non-executive banks.
and investment
Almost
questioning compensation
business ethics, including the -implications of the excessive paid to CEOS and executives in many cases. In the USA Act, passed in mid-2002, for businesses conducting will have a number of business there. In certain in other countries;
Part 2- Introduction
12.
The aim of this case study is to examine the Enron collapse looking specifically alia, point at corporate out: why governance issues. This case study will, inter of directors is critical to
the independence
transparent
for companies to avoid disasters such as Enron; why the audit committee should be a working committee non-executive directors. comprising a majority of independent
13.
all these
findings
and recommendations
of corporate governance, namely: discipline, transparency, accountability, responsibility, fairness and social
14.
This case study will also identify some of the global impacts of the breach of corporate governance at Enron. This case study is not the
definitive
case study
of Enron
but rather
an insight
to corporate
15.
Before we examine
the corporate
governance
it
Background
16,
As a company that was generally considered to be the largest natural gas and electricity trader in the world, and one that sparked international for having had the Midas touch, any indications faltered were quickly dispelled. In just awe
15 years,
employing
17.
How had Enron managed to become such a large player? Some factors that set the scene in which Enron operated arez:
s
limited
the viability
of
Need to compete with, and seek the same inflated valuations, the highflying Internet and tech companies.
as
an
Insufficient
incomeh-evenue growth created the need for ever more practices. the longest
aggressive accounting/business
s
The US economy was during the 1990s experiencing bull market in its history.
18.
In the process
merger, Enron incurred massive debt and as the result of deregulation, longer had exclusive business rights to its pipelines. strategy.
Enron would buy gas from a network of suppliers and sell it to a network of consumers, contractually guaranteeing supply and price.
19.
of strategic
acquisitions,
Enron into
the largest wholesale buyer and seller of natural gas and electricity in the
world. Revenue grew from $2 billion to $7 billion and the number of employees in this division grew to 2000 from 200. Using the same with the gas bank, Enron was
ready to create a market for anything that anyone was willing to trade including weather derivatives.
20.
Enron Online,
created
trading web site and was one of Enrons most progressive Firstly, Enron were the counterpart the platform. regarding This allowed them to every transaction to receive valuable
information
products prices in real time. Secondly, given that Enron was either a buyer or a seller in every transaction, credit risk management and Enrons community environment. credit rating was the cornerstone the confidence that Enron provided was crucial
21.
Early in 2001, Enron had plans for greater earnings for the year after two consecutive quarters of earnings increases; however the company faced
3 The Rise and Fall of Enron - C William Thomas, Journal of Accountancy April 2002.
10
business. It was hoped that Enrons strong second quarter earnings report could help offset the liquidity risks it had thus far faced. Liquidity risk fears appeared to have been offset by the fact that Enron was a worldclass company with a worldwide network and a market capitalization of
$36 billion and assets of over USD 65 billion of which $7.3 billion were current assets and reportedly $288 million in cash4.
22.
Enron earned more than 90% of its revenue from a business wholesale services, Enrons euphemism
it called
annual report described that activity as follows: Enron builds wholesale businesses ownership, through the creation of networks access to third-party involving selective asset
contractual
activities. The statement, as one market commentator characteristic of Enron k discussion of its finances
something written in German, translated to Chinese and back to English by wa~)of Polish.
4 Financial Services Board strateg]c planning workshop 5 February 2002 Enron Case Study s Forbes - Enron the Incredible (http: //www. forbes.coti2002/0 l/l5/Ol 15enron.html)
11
23.
In fact, 97 percent of Enrons profits came from the companys wholesale services division, which included its trading unit. In addition to its of
concentration
softening demand, dropping market prices for energy and the belief that the California energy crisis had peaked.
Revenue
24.
Most of the attention paid to Enrons finances has focused on its balance sheet - in particular independent how it hid debt by allocating it to supposedly
private partnerships.
increase in revenue: between 1996 and 2000, Enron reported an increase in sales from $13.3 billion to $100.8 billion. To put Enrons 57/0 fiveyear sales growth rate in perspective, during that same period, Cisco
25.
sales between
revenue again. Had it done so, it would have become the second-largest
bForbes
corporation
Exxon Mobil (2000 revenue: $206 billion) for the number-one way of comparison,
converted at an average rate of R8.60 to the US Dollar, was $110 billion. It is highly unlikely that a relatively obscure energy-trading company
would after a fairly short period of time be the worlds largest company by revenue. Yet this did not seem to generate a lot of questions from the market.
26.
Enron was able to book such large revenues by exploiting an accounting loophole. This loophole occurred because the Financial Accounting
Standards Board (FASB) could not decide how energy contracts should be accounted for. Enron booked revenue from huge energy-derivative
contracts at their gross value, not their net value as is done with other securities transactions.
27.
But beyond the trading of energy futures contracts back and forth with huge notational values, Enrons sales grew because it was a market
13
with a seller, take delivery of the contract for one fleeting moment and book the entire sale as revenue to Enron.
28.
Forbes believes
when observing revenue generated per employee. As of 2000, Enron had 19,000 employees and per employee, Enron claims it generated $5.3
million per employee in revenues. This figure is more than triple that of Goldman Sachs, which generated $1.7 million per employee. and women of Enron made the monopolists employee: $61 0,256) look like slackers. at Microsoft They The men
(revenue per of
Citigroup ($469,748 per employee) and IBM ($283,333) to shame. Once again these signs failed to arouse the suspicions of the market.
14
The end
29.
Enron filed for the largest bankruptcy 2001. Enron lost, according broadband,
to Newsweeks
billion on the electricity plant in India. The collapse destroyed the awe surrounding Enron to reveal the crippling debt that Enron had managed
30.
Billions of US dollars had been consistently concealed in annual balance sheets, which overstated Enrons income by as much as $600 million
during the last five years. Over the period of the next two months, the companys $40 billion. assets plummeted As mentioned, to $24.7 billion, down by more than
15
anal ysts report stated that the company had burned through $5 billion in cash in 50 days leading to the December bankruptc y9.
31.
Since December 2001, when Enron filed for Chapter 11 protection in the USA, it has been subject to several investigations surrounding its
accounting and disclosure policies. Untangling the collapse of Enron has been hindered by its secretive culture. But while rivals ascribe Enrons downfall to arrogance in the face of investors concerns, those who have known the company from its inception also cite lack of internal control.
32.
partnerships.
In order to hide their debt, Enron engaged in what has been termed aggressive independent accounting. Enron created partnerships with nominally
used to obscure debt exposure and allegedly to cover losses at Enrons broadband Andrew entity. These companies had been set up by and headed by Fastow, the former chief financial officer and were backed,
9 The Rise and Fall of Enron - C William Thomas, Journal of Accountancy April 2002
16
33.
regarded
their partners
accounting.
Companies
34.
As
the
company
was
being
liquidated,
shareholders
saw
their
investments
out Enrons employees savings in pension funds, part of which were converted into equities through the purchase of Enron stock.
35.
Management shareholders
to align management
interests
with
without causing undue strain on the balance sheet. Jeffrey has the following
comment on share options, There are cases where you can use equity to impact your income statement, the most egregious, or the one thats used by every corporation in the world is executive stock options ... what you to reduce compensation expense and
excessive salaries as was the case at Enron without impacting the income
17
statement. This allows the share price to grow, which benefits no~only the shareholder, but the director who has share options.
36.
structure its deals. Andersen, on whom the general public relied on for accurate information clearly failed in their job. They earned more in to Enron, than they did
2001 providing
37.
Enrons law firm, Vinson & Elkins (V & E), investigated irregularities. They asked few real questions, failed
alleged
partnerships.0
their report one day before Enron restated its financial 2001 to reflect consolidation of the special purpose
on November entities
it had
in losses and a
10Forbes (I\ ww .forbcs.tom) 11The Rise and Fall of Enron C William Thomas Journal of Accountancy April 2002.
..... . . . ..
---
18
38.
Another group that has let the public down are the anal ysts who work for stock brokerage beginning houses. Even when the problems of Enron were who
to be highlighted
by newspapers,
out of 17 analysts
followed Enron, 16 had strong buy or buy recommendations had hold. These are so-called experts who are knowledgeable firm and the industry and they failed in their duty 12.
39.
Conversations
numbers. Asked to compare how Enron or Dynegy booked revenue with other businesses, most analysts said that Enron was a trading business
and that revenue was not important. Asked to compare the energy traders to securities firms, who are also engaged in trading, one stumbled for an answer and finally said, You know, thats a really good question.
19
40.
Decreasing investor confidence (negative). Retreat to simplicity negative). Increased call for corporate transparency Review of banldanalyst and (positive). relationships & easy-to-understand models (positive and
auditorlconsultant
(positive and negative). Return to fiscal conservatism and practices (positive andnegative).
Call for increased regulation and scrutiny (positive and negative). Political fallout and manoeuvring on all levels (negative).
41.
According
to a range of companies,
the
collapse of Enron, so far a political, legal, accounting as detailed economy. above, is now imposing widespread
42.
of their more
in company
even
Some employees
20
company recklessly
under
employee
retirement
law,
claiming
the
company prevented
endangered
their retirement
43.
Shareholders
even if they can prove they were defrauded. Proving securities fraud is normally extremely tougher. difficult and proving fraud against auditors is even cannot bring securities is involved fraud lawsuits against
Shareholders
Enron, because
the company
in bankruptcy
proceedings,
freezes suits against it. In any case, shareholders behind secured creditors; little, if
anything, is likely to be left for them. Investors are therefore largely left with only Enrons directors and its auditors to sue. Even if they prevail, and can tap combined insurance coverage estimated million dollars, this will do little to recoup their losses. at several hundred
44.
The insurance industrys losses are estimated at around $2 billion. These losses are expected to be manageable insurers and reinsurers. if they are well diversified among
45.
Consequently,
of the 1990s bloated CEO bonuses, large debt build-ups by companies, and bad corporate practices. The danger is that many practices that are above-board and are, if anything, merely innovative, will get caught in by nothing negative
the crossfire. Knee-jerk regulatory changes, often motivated more than political posturing, can also have unintended
consequences
22
Part
4-
Corporate Governance
Ba~kqound
to co~orategovernance at Enron
46.
The Financial
demise emerged, industry insiders saw similarities with a trading scandal that Enron faced in the late 1980s - in Kenneth Lays early years as
chairman and chief executive. The affair led the company to incur a loss of .$142m, a substantial 1987]q. amount, as it reported just $6m in revenues in
47.
The trading case, which was settled in 1990 when two former senior Enron executives pleaded guilty to fraud charges, received scant
attention at the time because Enron was a much smaller company. The case revealed loose controls that allowed Louis Borget, head of its oil contracts trading subsidiary, and Thomas Mastroeni, the units vice-
president and treasurer, to operate a trading scheme that eventually cost Enron $ 142m in petroleum trade losses between October 1985 and
October 1987. The two men defrauded Enron by setting up four phony offshore shell corporations to arrange sham oil trading contracts with
3 Financial Serwces Board strategic planning workshop 5 February 2002 Enron Case Study
23
financial records. Perhaps more troubling, in the light of recent events, is that no explanation reports. to shareholders appeared in subsequent annual
48.
The oil-traders
balances system in place. Expert opinion was that Enrons actual track record over the years, with regard to both trading incidents business development, suggested a consistent difficulty and new
in managing
49.
While certainly extreme and clearly over the line, it appears unlikely the Enron cover-up began as a widespread conspiracy to commit fraud.
strategy
and a short-term
totally out of hand. A widening circle of basically good people appear to have gotten swept up in the pressure to behave in a manner mandated by the frenzy of greed that characterized time. U.S. business practices at the
24
50.
Despite the trading scandal it suffered in the late 1980s, Enron did not seem to have done much to strengthen its corporate governance mitigate firther and to
reporting practices, there were insufficient controls over employees thus allowing company. many executives to enrich themselves at the expense of the
51.
Following Exchange
investors, which included many employees, Chinese wall between the partnership
Lay was forced to admit that several of which helped to shift debt from the with the records of Enron peers saw a pattern of
vehicles,
balance sheet, should have been consolidated for accounting purposes. Many industry
emerging.
52.
Forbes 14in a recent article wrote, What do an abandoned dog and a derelict automobile corporation?
child, a stray
have no owners. No matter how many segments of society are moved by their plight, how many volunteer agencies work in their behalf, or how many laws and regulations substitute for the responsible are enhanced for their benefit, there is no is the appropriate
53.
In May
2002,
five
directors
of Enron
swore
before
the
Senate
subcommittee
Whether true or false, there is an element of truth about their testimony; corporate directors are not really directing companies. unconscionable negligence, but it is more fundamentally This may seem a result of the
14Forbes.tom:
.-
..-.
dont govern because all essential governance meets. In the US, state law mandates
directors
mean maximum share price. So as long as the share price remains high, directors feel confident. Yet it was precisely the hyperinflation of the
54.
When the stock is rising and shareholders incentive executives for the board ..and investment
of Enrons own code of conduct to permit the conflicts ..inherent off-books corporations Enron, but not many.~ ...A few analysts recommended
(to)...stay out of
55.
theory tells us that the board performs three roles: control the functioning a link of the corporation the and its management), and its external
(being
between
corporation
stakeholders),
the future). Of these three roles, control is the most basic and traditional role that provides the raison detre for a board.
15Interview with Kn-k Hanson, Executive Director of the Markkula Center for Applied Ethics, in Nikkei Newspaper
27
Findings of the Permanent Subcommittee on Investigations (the PSI) of the Committee on Governmental Affairs, United States Senate
56.
In a report (the PSI Report) compiled by the PSI entitled The Role of the Board of Directors in Enrons Collapse; the Board was found to
have failed in its duties in the following areas: a) Fiduciary failure, b) High-risk accounting, c) Inappropriate conflicts of interest, activity,
57.
Finding:
to safeguard
Enron largest
shareholders
of the seventh
in the United States, b~ allowing Enron to engage in inappropriate off-the-books conflict activities, of interest transactions, executive
accounting, undisclosed
and excessive
.-....
28
compensation, questionable
The practices
Board
witnessed
numerous
indications
of
by Enron management
chose to ignore them to the detriment of Enron shareholders, and business associates.
58.
During interviews
indicated
that they
were as surprised as everyone at the demise of the company. There were, however, more than a dozen incidents over the years that should have raised Board concerns. Examples of these incidents are the following:
s
Board members were advised in February was using accounting practices that
were
acceptable practice. E L.JM, an unconsolidated associate, produced over $2 billion funds gross revenues
jumped from $40 billion in 1999 to $100 billion in 2000. Although these figures are striking, no Board member questioned them.
s
In April 2001, the Board was advised that 64 per cent of assets were troubled or performing below expectations. They were on Enrons
29
Sherron Watkins wrote to Ken Lay and warned him that the market perceptions extremely resignation operations. surrounding negative. Jeff Skillings abrupt departure would be
59.
Although
authorised
or allowed
questionable
Enron strategies,
Enrons high-
risk accounting practices. for example, were not hidden from the Board. The Board knew of them and took no action to prevent Enron from using them.
60.
all thirteen
Enron Board
members
strongly
refuted that the Board had failed in its oversight duties. They contended that they had reasonably management, Andersen, relied on assurances provided by Enron to
provide reasonable oversight of company operations. During the hearing, all five Board witnesses explicitly rejected any share of responsibility Enrons collapse. for
30
61.
The failure of any Enron Board member to accept any degree of personal responsibility for Enrons collapse is a telling indicator of the Boards
failure to recognize its fiduciary obligations to set the companys overall strategic direction, oversee management, and ensure responsible
financial reporting.
b)
High-risk
accounting
62.
Finding: The Enron Board of Direc~ors knowingly allowed Enron s use of High-risk accounting practices.
63.
high-risk accounting practices. Outside experts concluded that the Board, after having being told that the accounting practices being followed were high-risk, should have asked a lot of questions. Furthermore, of high-risk activities by the auditors is a giant red flag. being told
31
64.
There
are
several
instances
where
Andersen
advised
the
Audit that
Committee couldbe
in accounting
transactions
deemed high-risk.
65.
legal team stated that one document provided was intended to advise the Audit Committee backing, Enrons use of the identified
to the Audit
accounting
invited accounting scrutiny and ran therisk be found to be in non-compliance principles. In addition, Andersens
with generally
legal counsel indicated that the firm that Enrons use ofhi,ghly purpose entities and
special
complex overlapping transactions, ran the risk that, ifone element failed, the entire structure might fail and cause the company to fall into
noncompliance.
66.
On February 7, 1999, Andersen informed the Audit Committee members that Enron was engaged in accounting practices that push limits or
were at the edge of acceptable practice. In the discussion that followed, Andersen did not advocate any change in company practice, and no
Board member objected to Enrons actions, requested a second opinion of Enrons accounting practices, or demanded a more prudent approach.
32
67.
In addition Enrons
on
high-risk
practices,
documents
demonstrate
68.
When confronted by evidence of Enrons high-risk accounting, Board members interviewed by the Subcommittee pointed
Enrons auditor, Andersen, had given the company a clean audit opinion each year. None recalled any occasion on which Andersen had expressed any objection to a particular transaction or accounting practice at Enron, despite evidence indicating that, internally at Andersen, Enrons accounting were commonplace. concerns about
object does not preclude a finding that the Enron Board, with Andersens concurrence, knowingly allowed Enron to use high-risk accounting and
failed in its fiduciary duty to ensure the company engaged in responsible financial reporting.
33
c)
Inappropriate
conjlicts
of interests
69.
Finding:
Despite
clear
conjlicts
of interest,
Board of
Enron s equity
an unprecedented
arrangement
Officerto
establish and operate the LJA4private business with Enron and profited
which transacted
at Enron s
expense. The Board exercised inadequate and compensation controls and failed
70.
The Board waived the companys code of conduct and allowed its CFO, Andrew Fastow to establish and operate off-the-books to transact business with Enron. This arrangement conflict of interest transactions entities designed
as well as accounting
disclosure problems, due to the dual role of Fastow as a senior officer at Enron and an equity holder and general manager Nevertheless, approved with little debate or independent of the new entities.
34
71.
The Enron Board approved code of conduct waivers for Fastow knowing that the LJM partnerships were designed to transact business primarily
with Enron, and controls would be needed to ensure the LJM transactions and Fastows however, fairness compensation were fair to Enron. The Board failed, the
were effective,
to monitor
Fastows
LJM-related realized
compensation.
partnerships
72.
Board members said they had not been troubled due to the
73.
74.
was also
relied on Skilling to
review Fastows LJM-related income and asked no questions. In October 2000, after LJM 1 had been operating Finance Committee multiple, for more than one year and the in
35
Committee
to conduct
a one-time
review of
75.
2000
the
Chairman
of the requested
Compensation
Committee
compensation
from
compensation
officer but was fobbed off and the matter dropped. It was
only after an article in the Wall Street Journal in October 2001 stating the Fastow had received compensation from the LJM transactions exceeding that
$7 million, was the matter pursued further. It was then ascertained the compensation million.
76.
A number of Board members claimed that the Board had been misled or misinformed regarding key aspects of the LJM partnerships. it did have should have triggered However,
the information
detailed information
and, ultimately, a change in course. But the Board transactions to go forward with few questions flowed from the initial While the Board was
that followed
the final decision on whether to allow Fastow to form, manage and profit
36
from the LJM partnerships rested with the Board itself. The Board cannot shift the responsibility matter. for that decision to any other participant in the
d)
Extensive
undisclosed
off-the-book
activity9
77.
Finding:
allowed Enron to
condition appear better than it was, and failed to ensure adequate public disclosure of material off-the-books liabilities that contributed to
Enron s collapse.
78.
dollar, off-the-books
and received
Board approval
establish new special purpose entities, issue prefen-ed Enron shares, and pledge Enron stock as the collateral needed for the deals to go forward. In the end, the Board knowingly allowed Enron to move at least $27
37
79.
During
their interviews,
expressed
concern on the
company balance sheet; the remaining Board members expressed little or no concern.
80.
Accounting
Enrons off-the-book
of extent. Although it is sometimes appropriate to have some items offbalance sheet, they should not be to the same extent as Enrons.
81.
The Boards lack of knowledge of certain aspects of certain transactions (the Raptor transactions), transactions. however, does not justify its handling of these a lack of diligence and independent
At best, it demonstrates
inquiry by the Board into a key Enron liability. It does not excuse or explain the Boards approval of these transactions based upon what they
did know nor does it excuse the Boards failure to ensure adequate public disclosure of Enrons ongoing liability for the transactions.
82.
The Enron Board failed in its fiduciary duty to ensure adequate public disclosure of Enrons off-the-books public disclosures regarding assets and liabilities. with Enrons initial
its dealings
its unconsolidated
38
affiliates nearly
impossible
and difficult
83.
In October 2000, the Finance Committee reviewed a chart showing that $27 billion out of $60 billion of Enrons assets, or almost 50 percent, were held off Enrons books in unconsolidated member objected course. to this corporate affiliates. No Board
84.
Board members, Mr. Blake, stated during his interview that transferring assets off a companys books is not immoral as long as disclosed. But here, too, the Enron Board failed in its fiduciary duty to ensure adequate public disclosure of Enrons off-the-books assets and liabilities.
39
e)
Excessive
compensation20
85.
Finding:
The
Enron
Board
of
Directors
approved
excessive
compensation
plans, and failed to monitor or halt abuse by Board Chairman and Chief Executive Officer Kenneth Lay of a company--nanced, multi-million
86.
On more than
one occasion, it paid tens of millions of dollars to a single executive as a bonus for work on a single deal. Stock options were distributed in large numbers to executives. One executive, Lou Pai, accumulated enough
stock options that, when he exercised them and sold the underlying stock in 2000, he left the company Kenneth Lay alone accumulated stock. In 2000, Lays total with more than $265 million in cash. more than 6.5 million options on Enron compensation exceeded $140 million,
including
$123 million
from exercising
a portion
-- . .... ..
.-
40
traded corporations
paid CEOS in the country. 87. The Enron Board, through its Compensation informed apparently member of the companys approved said during lavish executive Committee, was not only plans, it
compensation
philosophy achievement;
provide extraordinary
claimed that the company was forced to provide lavish compensation attract the best and brightest employees.
88.
Committee
appeared to have exercised little, if any, plans, instead and deferring to the
compensation
suggested
by management their
consultants.
During
interviews,
executives huge stock option awards, they might be creating incentives for Enron executives to improperly manipulate company earnings to
increase the company stock price and cash in their options. One Board member admitted, however, that Enron was a culture driven by
compensation.
the Board and cheated the company, that he only can assume they did it for the money.
41
j)
Lack of independence21
89.
Finding:
of the Enron
Board
of Directors
was
ties between the company and certain Board to ensure the independence of the
also failed
allowing Andersen
to provide
90.
Expert witnesses
and objectivity of
the Enron Board. These financial ties, which affected a majority of the outside Board members, included the following: Since 1996, Enron paid a monthly retainer of $6,000 to Lord John Wakeham for consulting services, in addition to his
Board compensation.
consulting work alone. Since 1991, Enron paid Board member John A. Urquhart for consulting services, in addition to his Board compensation. In
42
2000,
Enronpaid
alone. Enron Board member Herbert Winokur Board of the National Tank Company. also served on the In 1997, 1998, 1999,
and 2000, the National Tank Company recorded revenues of $1,035,00, $643,793, $535,682, $370,294 from sales to Enron subsidiaries of oil field equipment and services. In the five years prior to 2002, Enron and Kenneth Lay
donated nearly $600,000 to the M.D. Anderson Cancer Center in Texas. In 1993, the Enron Foundation pledged $1.5 million to the Cancer LeMaistre Center. Two Enron Board members, Dr. of
the Cancer Center. Since 1996, Enron and Belco Oil and Gas engaged in hedging arrangements worth tens of millions of dollars. In 1997, Belco
bought Enron affiliate Coda Energy. Enron Board member Robert Belfer is former Chairman of the Board and CEO of Belco. Since 1996, Enron and the Lay Foundation donated more than $50,000 to the George Mason University Center Board in Virginia. member The Mercatus Gramm. Centre and its Mercatus employs Enron Gramm
Dr. Wendy
(In addition,
43
was exempt from regulation by the CFTC. Shortly after that decision, she quit the commission She is presently and joined Enrons board. Studies Program at
Director of Regulatory
George Mason University.) Charls Walker, member more a noted tax lobbyist, was an Enron Board Enron paid and for
from 1985 until 1999. In 1993-1994, than $70,000 that to two partly firms owned
Walker/Free by Walker,
Walker/Potter government
were
was in addition to Walkerss Board compensation. also, for more than ten years of up to $50,000 ending annually a non-profit in 2001,
contributor
91.
The Enron Board and its Audit Committee inadequate oversight to ensure the independence
were criticised
for
and objectivity of
44
Enron Board members told the PSI staff that they had been unaware of any tensions between Andersen and Enron and unaware of the many concerns Andersen had with Enrons accounting practices.
The Board members observed that they had given Andersen regular opportunities communicate company outside the presence of Enron management to
officials
raised objections to company proposals. They expressed shock and dismay that Andersen had never conveyed its many concerns about Enrons accounting and transactions to the Enron Board.
s
The
interviewed
Board
members
indicated
considered
concerns about Enron accounting practices out of an unwillingness to upset Enron management or endanger its fees.
92.
For many years, Lay was both the Chairman and CEO. For a brief while the two positions were separated, when Skilling functioned as the CEO.
When Skilling resigned in August 2001, Lay again took on both roles.
. ... .. . ..
45
His claim that he did not know too much of the details of the accounting falsification that was going on is, at best, disingenuous.
93.
On the eve of January 23, 2002, Lay resigned as Chairman and CEO of the Enron resignation the Corporation, under pressure from outside creditors. The
came after a string of revelations that raised questions about of Enrons top executives, including Lay himself.
conduct
Disclosures
by Congressional
investigators
create and oversee some of the financial arrangements Enrons collapse. Investigations the following transactions,
s
Lay had used his shares to repay a loan extended by Enron to him. The value of the loan was not disclosed, and neither was the timing of the transaction, so it could not be determined what value the
Lay was a big seller of Enron stock. Even as he was selling his own shares of Enron stock in September reassuring encouraging employees that the company and October, would he was and
rebound
them to buy.
c Financial Services Board strategic planning workshop 5 February 2002 Enron Case Study
46
In early 2001, Lay sold Enron shares on almost every business day. He acquired these shares by exercising stock options and made a
Enron executives
made $1.1 billion by selling 17.3 million shares from 1999 tomid2001. Insider trading investigations continue.
Audit Committee22
94.
The charter
of the Enron
Audit
Committee
explicitly
required
the
Enrons internal controls and the quality of its financial reporting, review Enrons financial statements.
95.
The
Audit
Committee communicating
had
very
limited
contact personnel
with
Andersen,
essentially
with Andersen
only at Board
Chairman for more than ten years was the PSI with
Despite his long tenure on the Audit Committee, that Jaedicke had rarely
concluded outside
Andersen
or Board meeting.
47
Audit Committee
members
had ever
contacted anyone from Andersen regarding Enron outside of an official Enron Committee or Board meeting. None had ever telephoned Andersen directly.
96.
Materials indicate
produced
Audit regularly
Committee briefed
Committee regularly
Enrons the
accounting Audit
practices, that
Committee
accounting practices that, due to their novel design, application without judgments high established precedent, or significant reliance
on subjective a
by management of risk of
personnel,
degree
non-compliance
accepted
accounting principles.
97.
Committee
formally
reviewed
Andersens
independence
and Committee
been any sign of a problem. The evidence suggests, however, that the Audit Committee did not probe the independence issue, nor did it initiate that would have Enron accounting
Andersen
48
98.
The Audit Committee members indicated that they had thought Andersen and Enron had a good working relationship, and taken great comfort in
knowing that Andersen was more than Enrons outside auditor, but also provided Enron with extensive internal auditing and consulting services, combining Jaedicke its roles maintained into what Enron called an integrated benefit audit. for basis
to Enron
on a day-to-day
and to help the company design its most complex transactions start. Although one Board member, Lord Wakeham, indicated
had been concerned that this high level of involvement might be too close to Enron management,
meant Andersen
concern that Andersen might be auditing its own work, or that Andersen auditors might be reluctant to criticize Andersen consultants for the LJM
or Raptor structures that Andersen had been paid millions of dollars to help design.
99.
was charged by the Board with perfoi-ming an This task was apparently
49
100, On paper, the Audit Committee transactions reviews in February superficial with
were
entirely
management
representations, inquiry
no supporting
documentation second
Committees
transactions
non-residents Enron
committee
hampers
its functioning.
of the
102. CFO Magazine notes 25 In the wake of the Enron scandal, shareholders are tightening the screws on audit committees. Now all they have to do is find executives who are willing to serve on the things. Companies
..
.... .
50
experience, argue institutional investor Bert Denton, rather than wooing former senators. At the very least, corporate stakeholders, the next year meticulously will spend
...-. . . . ----
.. .
51
Education of Directors
103. The PSI report states: The board was denied important information
that
might have led it to action, but the Board also did not fully appreciate the significance of some of the specific information that came before it.2b if they did not have
Here is another acknowledgement sufficient information, that Enron partnerships directors operated
of responsibility;
they should have gone seeking it. Reports suggest about 3,500 Special Purpose Entities, that is,
that shifted debt and losses off Enrons balance sheet. If the what was being reported to them, it was the right
themselves
26William Powers, Jr., ,Member of the Enron Board of Directors and Chairman of the Special Investigation Comm(ttee, 1 February 2002
..----.
52
Part
5-
Post Enron
in place;
we just have to j7gure out how to runs a stop sign, you don t
When someone
change the law, you enforce it. - Bob Williamson, CFO, vFinance Inc.
105. 2001 will go down in the history books as the one that almost brought Corporate America to its knees with the collapse of Enron and several others.
companies
described above in the corporate governance section. When the company performance is satisfactory, the tendency is to overlook these drawbacks.
In Enrons case too many of their faults came together at the same time, causing the company to implode.
recognised that there was an immediate and greater direction in the running of a company. Also, in the professions had to be more
53
108. As a result,
the Sarbanes-Oxley
was
of major
corporate and accounting scandals involving some of the most prominent companies in the United States. Sarbanes-Oxley establishes new
standards for corporate accountability wrongdoing. responsibilities white-collar Exchange The legislation
contains 11 titles, ranging from additional to tougher criminal penalties for and
such as securities
Commission
(SEC) is required
109. Although
Sarbanes-Oxley
beyond
the US borders,
with the SEC, will not be we need to take heed of some in our market
of the key lessons and adapt some of the best practices when applicable27.
PricewaterhouseCoopers
54
110. In terms of additional more expeditious other disclosures: a) Quarterly information respects,
disclosures,
the Sarbanes-Oxley
requires new or
disclosures and directs the SEC to issue rules requiring 28 CEO/CFO certification of periodic reports that the
contained in the report fairly presents, in all material and results of operations of the
The CEO and CFO must certify that based on their knowledge, there are no materially that the report false statements fairly presents or material the issuers omissions financial
therein; condition,
and maintaining
the controls within the last 90 days, and that they have presented their conclusions about the effectiveness of the controls in the and
or employees
role in
28Summary Of Sarbanes-Oxley
55
any material
each periodic report include: has the senior finance code of ethics been adopted, who is the Audit Committee financial expert and
what non-audit services the auditors provided? d) Any changes to the senior finance code of ethics need to be
reported [$ 406(b)]. e) Section 16(a) requires that stock transaction reports be provided Internet posting by
within two days and with next-business-day issuer and the SEC. f) An annual management the responsibility
of management
internal control structure and procedures for financial reporting, and assess the internal control structure and procedures g) [$ 404(a)( 1)].
h)
governance other
provisions. areas
affecting several
particular, compensation
provisions
director
56
i)
or executive
officers.
and executive
[$ 402(a)].
renew any existing loans. j) New crimes and enhanced penalties. The Act establishes new
the maximum
penalties
profession
been a selfimpact on
regulated profession.
The Sarbanes-Oxley
the auditing firms and the way they do business29: a) The auditors must also attest to and report on the annual
management
whether this document is to be included in the report or otherwise made publicly available [tj 404(b)]. b) Auditing firms will report directly to the Audit Committee, which is directly responsible for the appointment and compensation of
work [$ 301].
Summary Of Sarbanes-Oxley
57
In selecting cannot
auditors,
Committees
Accounting
Officer of the issuer was employed by the auditing firm during the previous year on the audit of that issuer also should note that lead audit partners now
and participated
[$ 206]. Committees
must rotate every 5 years [$ 203]. c) Restrictions on non-audit services. Registered public accounting
firms cannot perform a list of specified non-audit services for their audit clients, subject to a case-by-case 201(a), auditors (b)]. Any non-audit must services exemption by the SEC [~$ that are still allowed Committee by and
be pre-approved
by the Audit
112. Post-Enron,
it is clear that the pursuit of profits must stay within ethical may not enrich themselves codes of ethics like
bounds, and that executives and shareholders by extorting the public or employees.
Toothless
Enrons are no help. Ethical concerns must grow teeth which means biting into reform of corporate governance. While most proposals for
reform today merely tinker at the margins, some get to the heart of the matter such as the ones mentioned below:~
58
Ensure auditors really audit by making them fully independent. Bar law-breaking companies from government contracts.
9
s
Create a broad duty of loyalty in law to the public good. Today a corporate duty of loyalty is due only to shareholders, not to other stakeholders, and Enron behaved accordingly.
Such piracy against the public good would be outlawed under a state Code for Corporate Citizenship, proposed by Robert
Hinkley, formerly a partner with Skadden, Arps. His change to the law of directors duties would leave the current duty to shareholders in place, but amend it to say shareholder gain the
may not be pursued at the expense of the community, employees, or the environment.
s
directors: Employees.
If Sherron Watkins had been on the Enron board, the whole scandal might have been averted.
8
should directors
be encouraged
to enforce
sanctions
against
in monitoring
of delinquent
public scrutiny.
59
of a new corporate
Enron debacle include: Financial literacy and an inquiring mind are more important than ever, particularly on the Audit Committee. Board Membership requires more responsibility than ever before
and should not be seen as a retirement hobby. Directors need to be actively involved in understanding a
companys business - its operation, finances & management. Directors cannot simply rely upon the word of management,
auditors, and outside professionals. Directors must be independent and able to represent the interests of shareholders Directors as they relate to other stakeholders. performance pressures
with the need to sustain and expand value over the long term.
and
60
members
meaning or any
be an affiliated
and that they cannot accept any consulting, fees from the issuer (other than in
member
who is a financial expert. While the Act does not require that any member be a financial expert, as noted above, it directs the SEC to issue rules requiring each issuer to disclose whether any member of the Audit Committee 407(a)].
s
Audit
Committees
must
establish
procedures received
of complaints accounting
internal
controls,
anonymous questionable
submission accounting
employees
31Summary Of Sarbanes-Oxley
. .... .-
61
Audit Committees
are authorized
to engage independent
counsel funding
and other advisers, and issuers must provide appropriate for such advisers (as well as for auditors) [$ 301].
115. The time of turning a blind eye or saying that you as a director did not know what was going on has passed. As in England, acomply environment is being developed in the post Enron environment. or explain
..-
62
Part 6- Conclusion
116. Hindsight is the only exact science and looking at Enron its easy to ask, how could that have happened? know instances In all honesty - too easily. We all
number of reasons but we dont speak out for fear of rocking the boat.
has shown that it was not merely an individual or group of individuals that destroyed the 7th largest corporation in the United States. This was the same as was the case with Nick Leeson and Barings Bank. Both cases clearly illustrate the dangers of weak systems and controls, acceptance by directors of what was being fed to them by management, by the apparent success and profitability of the entities. both masked
118. Accountants
company failed by not giving enough real power to their risk committees and internal controls.
119. For each of these groups, the thing they failed at was not something of a secondary nature to them; it was the prime reason for their existence.
63
120. Independence
probing of management.
they have to understand the business, the risks it faces andthe the power granted to and the responsibility imposed on them.
121. Audit
committees
need
to
proactively
monitor
management
and
decisions taken to ensure that a realistic picture is presented to the users of the financial statements.
world, it is the life-blood of the corporate world, carrying away waste, providing the antibodies to fight disease, carrying life giving oxygen to the cells.
is the check and balance as it ensures that controls risks are managed and a comply or explain
environment