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Enron Corp. is a company that reached dramatic heights, only to face a dizzying
collapse. The story ends with the bankruptcy of one of America's largest
corporations. Enron's collapse affected the lives of thousands of employees and
shook Wall Street to its core. At Enron's peak, its shares were worth $90.75, but
after the company declared bankruptcy on December 2, 2001, they plummeted to
$0.67 by January 2002. To this day, many wonder how such a powerful business
disintegrated almost overnight and how it managed to fool the regulators with
fake, off-the-books corporations for so long.

Enron Named America's Most Innovative Company

Enron was formed in 1985 following a merger between Houston Natural Gas Co.
and Omaha-based InterNorth Inc. Following the merger, Kenneth Lay, who had
been the chief executive officer (CEO) of Houston Natural Gas, became Enron's
CEO and chairman, and quickly rebranded Enron into an energy trader and
supplier. Deregulation of the energy markets allowed companies to place bets on
future prices, and Enron was poised to take advantage.

The era's regulatory environment also allowed Enron to flourish. At the end of the
1990s, the dot-com bubble was in full swing, and the Nasdaq hit 5,000.
Revolutionary internet stocks were being valued at preposterous levels and
consequently, most investors and regulators simply accepted spiking share prices
as the new normal.

Enron participated by creating Enron Online (EOL), an electronic trading website

that focused on commodities in Oct. 1999. Enron was the counterparty to every
transaction on EOL; it was either the buyer or the seller. To entice participants
and trading partners, Enron offered up its reputation, credit, and expertise in the
energy sector. Enron was praised for its expansions and ambitious projects and
named "America's Most Innovative Company" by Fortune for six consecutive
years between 1996 and 2001.
By mid-2000, EOL was executing nearly $350 billion in trades. At the outset of
the bursting of the dot-com bubble, Enron decided to build high-speed broadband
telecom networks. Hundreds of millions of dollars were spent on this project, but
the company ended up realizing almost no return.

When the recession began to hit in 2000, Enron had significant exposure to the
most volatile parts of the market. As a result, many trusting investors and
creditors found themselves on the losing end of a vanishing market cap.

The Collapse of a Wall Street Darling

By the fall of 2000, Enron was starting to crumble under its own weight. CEO
Jeffrey Skilling had a way of hiding the financial losses of the trading business
and other operations of the company; it was called mark-to-market accounting.
This is a technique used when trading securities where you measure the value of
a security based on its current market value, instead of its book value. This can
work well for securities, but it can be disastrous for other businesses.

In Enron's case, the company would build an asset, such as a power plant, and
immediately claim the projected profit on its books, even though it hadn't made
one dime from it. If the revenue from the power plant were less than the projected
amount, instead of taking the loss, the company would then transfer these assets
to an off-the-books corporation, where the loss would go unreported. This type of
accounting enabled Enron to write off losses without hurting the company's
bottom line.

The mark-to-market practice led to schemes that were designed to hide the
losses and make the company appear to be more profitable than it really was. To
cope with the mounting losses, Andrew Fastow, a rising star who was promoted
to CFO in 1998, came up with a devious plan to make the company appear to be
in great shape, despite the fact that many of its subsidiaries were losing money.
How Did Enron Use SPVs to Hide its Debt?
Fastow and others at Enron orchestrated a scheme to use off-balance-
sheet special purpose vehicles (SPVs), also know as special purposes entities
(SPEs) to hide mountains of debt and toxic assets from investors and creditors.
The primary aim of these SPVs was to hide accounting realities, rather than
operating results.

The standard Enron-to-SPV transaction occurred when Enron transferred some

of its rapidly rising stock to the SPV in exchange for cash or a note. The SPV
would subsequently use the stock to hedge an asset listed on Enron's balance
sheet. In turn, Enron would guarantee the SPV's value to reduce apparent
counterparty risk.

Enron believed that its stock price would keep appreciating a belief similar to
that embodied by Long-Term Capital Management before its collapse. Eventually,
Enron's stock declined. The values of the SPVs also fell, forcing Enron's
guarantees to take effect. One major difference between Enron's use of SPVs
and standard debt securitization is that its SPVs were capitalized entirely with
Enron stock. This directly compromised the ability of the SPVs to hedge if
Enron's share prices fell. Just as dangerous and culpable was the second
significant difference: Enron's failure to disclose conflicts of interest. Enron
disclosed the SPVs to the investing publicalthough it's certainly likely that few
understood even that much but it failed to adequately disclose the non-arm's
length deals between the company and the SPVs.

Arthur Andersen and Enron: Risky Business

In addition to Andrew Fastow, a major player in the Enron scandal was Enron's
accounting firm Arthur Andersen LLP and its partner David B. Duncan, who
oversaw Enron's accounts. As one of the five largest accounting firms in the
United States at the time, it had a reputation for high standards and quality risk
management.

However, despite Enron's poor practices, Arthur Andersen offered its stamp of
approval, which was enough for investors and regulators alike, for a while. This
game couldn't go on forever, however, and by April 2001, many analysts started
to question the transparency of Enron's earnings, and Andersen and Eron were
ultimately prosecuted for their reckless behavior.

The Shock Felt Around Wall Street

By the summer of 2001, Enron was in a free fall. CEO Ken Lay had retired in
February, turning over the position to Skilling, and that August, Jeff Skilling
resigned as CEO for "personal reasons." Around the same time, analysts began
to downgrade their rating for Enron's stock, and the stock descended to a 52-
week low of $39.95. By Oct.16, the company reported its first quarterly loss and
closed its "Raptor" SPE, so that it would not have to distribute 58 million shares of
stock, which would further reduce earnings. This action caught the attention of
the SEC.

A few days later, Enron changed pension plan administrators, essentially

forbidding employees from selling their shares, for at least 30 days. Shortly after,
the SEC announced it was investigating Enron and the SPVs created by Fastow.
Fastow was fired from the company that day. Also, the company restated
earnings going back to 1997. Enron had losses of $591 million and had $628
million in debt by the end of 2000. The final blow was dealt when Dynegy
(NYSE: DYN), a company that had previously announced would merge with the
Enron, backed out of its offer on Nov. 28. By Dec. 2, 2001, Enron had filed for
bankruptcy.

Enron Gets a New Name

Once Enron's Plan of Reorganization was approved by the U.S. Bankruptcy
Court, the new board of directors changed Enron's name to Enron Creditors
Recovery Corp. (ECRC). The company's new sole mission was "to reorganize
and liquidate certain of the operations and assets of the 'pre-bankruptcy' Enron
for the benefit of creditors." The company paid its creditors more than 21.7 billion
from 2004-2011. Its last payout was in May 2011.

Enron Execs and Accountants Prosecuted

Once the fraud was discovered, two of the preeminent institutions in U.S.
business, Arthur Andersen LLP, and Enron Corp. found themselves facing federal
prosecution. Arthur Andersen was one of the first casualties of Enron's prolific
demise. In June 2002, the firm was found guilty of obstructing justice for
shredding Enron's financial documents to conceal them from the SEC. The
conviction was overturned later, on appeal; however, despite the appeal, like
Enron, the firm was deeply disgraced by the scandal.

Several of Enron's execs were charged with a slew of charges, including

conspiracy, insider trading, and securities fraud. Enron's founder and former CEO
Kenneth Lay was convicted of six counts of fraud and conspiracy and four counts
of bank fraud. Prior to sentencing, though, he died of a heart attack in Colorado.

Enron's former star CFO Andrew Fastow plead guilty to two counts of wire
fraud and securities fraud for facilitating Enron's corrupt business practices. He
ultimately cut a deal for cooperating with federal authorities and served a four-
year sentence, which ended in 2011.

Ultimately, though, former Enron CEO Jeffrey Skilling received the harshest
sentence of anyone involved in the Enron scandal. In 2006, Skilling was
convicted of conspiracy, fraud, and insider trading. Skilling originally received a
24-year sentence, but in 2013 his sentence was reduced by ten years. As a part
of the new deal, Skilling was required to give $42 million to the victims of the
Enron fraud and to cease challenging his conviction. Skilling remains in prison
and is scheduled for release on Feb. 21, 2028.

New Regulations As a Result of the Enron Scandal

Enron's collapse and the financial havoc it wreaked on its shareholders and
employees led to new regulations and legislation to promote the accuracy of
financial reporting for publicly-held companies. In July of 2002, then-President
George W. Bush signed into law the Sarbanes-Oxley Act. The Act heightened the
consequences for destroying, altering or fabricating financial records, and for
trying to defraud shareholders. (For more on the 2002 Act, read: How The
Sarbanes-Oxley Act Era Affected IPOs.)
The Enron scandal resulted in other new compliance measures. Additionally,
the Financial Accounting Standards Board (FASB) substantially raised its levels
of ethical conduct. Moreover, company's boards of directors became more
independent, monitoring the audit companies and quickly replacing bad
managers. These new measures are important mechanisms to spot and close
the loopholes that companies have used, as a way to avoid accountability.

The Bottom Line

At the time, Enron's collapse was the biggest corporate bankruptcy to ever hit the
financial world. Since then, WorldCom, Lehman Brothers, and Washington
Mutual have surpassed Enron as the largest corporate bankruptcies. The Enron
scandal drew attention to accounting and corporate fraud, as its shareholders lost
$74 billion in the four years leading up to its bankruptcy, and its employees lost
billions in pension benefits. As one researcher states, the Sarbanes-Oxley Act is
a "mirror image of Enron: the company's perceived corporate governance failings
are matched virtually point for point in the principal provisions of the Act." (Deakin
and Konzelmann, 2003). Increased regulation and oversight have been enacted
to help prevent corporate scandals of Enron's magnitude.

Featur

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Correction Appended

Enron, the champion of energy deregulation that grew into one of the nation's
10 largest companies, collapsed yesterday, after a rival backed out of a deal to
buy it and many big trading partners stopped doing business with it.
 Enron, based in Houston, was widely expected to seek bankruptcy protection.
With $62 billion in assets as of Sept. 30, it would be the biggest American
company ever to go bankrupt, dwarfing the filing by Texaco in 1987. Late in
the day, though, Enron's chief financial officer, Jeff McMahon, said that the
company was still talking to banks about a restructuring and considering
other options.

Talks with its would-be rescuer Dynegy, also of Houston, about salvaging the
deal ended in acrimony.

Dynegy, which had agreed on Nov. 9 to buy Enron but had second thoughts
as Enron disclosed more financial problems and investors pummeled its
stock, accused Enron of misrepresenting the health of its business. Enron,
meanwhile, was weighing whether to sue Dynegy for breaching the terms of
the deal, a person close to Enron said.

Enron's swift collapse left the prospects of 21,000 employees in doubt and
wiped out what was left of the holdings of stock investors, including some big
mutual funds, as shares that sold for $90 in August 2000 crashed to close
yesterday at 61 cents. It roiled the Treasury market and tarnished the
standing of the big New York banks that both advised on the deal and poured
their own cash into the company. And it left in tatters the reputation of
Enron's chief executive, Kenneth L. Lay, a confidant and campaign backer of
President George W. Bush. [Page C1.]

Continue reading the main story

The Treasury Department, the Federal Reserve and the Federal Energy
Regulatory Commission said they had monitored Enron's impact on the
financial and energy markets yesterday; officials who would comment said
they saw no dangerous ripple effect.

''The markets are functioning normally,'' said Peter Bakstansky, a spokesman

for the Federal Reserve Bank of New York.

From a pipeline company in the 1980's, Enron grew into the world's largest
energy trader, using the Internet to buy and sell natural gas and electric
power supplies for utilities and industrial power users and helping them
hedge against fluctuations in power prices.

But Enron was undone by shaky accounting, too much borrowed money and
an unwillingness to provide information to investors who grew to doubt its
financial reports.

Five weeks ago, the company disclosed that, to fuel its growth, it had shifted
billions of dollars in debt off its balance sheet and into an array of complex
partnerships. The Securities and Exchange Commission began an
investigation, and Enron restated five years of earnings, wiping out nearly
$600 million in profit.
Enron was teetering close to insolvency before Dynegy, a smaller cross-town
rival, agreed to acquire it for $9 billion plus the assumption of $13 billion in
debt, with additional financing from ChevronTexaco, a major Dynegy
shareholder.

But Enron subsequently disclosed even more debts, and its financial plight
continued to worsen. Energy-trading companies reduced dealings with the
firm; doubting its creditworthiness, some forced Enron to pay higher prices
for natural gas and other products or required it to post large cash deposits to
back trades.

For four days, Enron and Dynegy worked to salvage the deal. But yesterday
morning, Dynegy pulled out. ''We knew when to say no, and this morning, we
said no,'' said Chuck Watson, Dynegy's chairman.

In an interview, Mr. Watson said Enron's energy-trading business had

deteriorated. He also cited ''surprises'' in the quarterly report to the S.E.C.
that Enron filed on Nov. 19, including the disclosures that a credit downgrade
meant Enron had to pay or refinance a $690 million obligation and that
Enron had less cash on hand than Dynegy had expected. ''Confidence and
credibility, which is what this business is all about, deteriorated after that,'' he
said.

Mr. Watson said he called Mr. Lay yesterday after a meeting of Dynegy's
board to call off the deal. By then, S.& P. had downgraded Enron's debt to
junk status, accelerating up to $3.9 billion in debt payments.

But last night, Mr. McMahon, Enron's chief financial officer, took strong issue
with the notion that Dynegy could have been surprised by Enron's financial
report.

''I believe Dynegy was aware of everything that was encapsulated in that,'' Mr.
McMahon said, explaining that Dynegy had been given advance copies of the
filing.

The companies even disagreed about whether they had reached agreement on
a renegotiated deal that would have cut Dynegy's purchase price and pumped
hundreds of millions dollars more into Enron.

''There was never a global settlement that all parties agreed to,'' Mr. Watson
said.

Mr. McMahon had a very different view. ''It's fair to say that we thought we
had a deal several times,'' he said, ''and the goal posts definitely kept moving
on us.''

As for Enron's future, Mr. McMahon said: ''We are looking at every option
under the sun, as you can imagine.'' Those options include the Chapter 11
filing for bankruptcy reorganization that analysts and competitors widely
expected. He said that a Chapter 7 filing -- in short, the liquidation of the
company -- ''is not an option we are pursuing.''

An executive close to Enron said it had not yet done the advance work needed
to seek protection in bankruptcy court. ''It's a last resort, but not a last-
minute kind of thing,'' this executive said. ''If you go in and file for Chapter 11
like this without having everything done, it's like walking in a bank lobby and
throwing a dozen eggs on the floor.''

A bankruptcy filing would give the company some breathing room to deal
with creditors' claims, but it would be complicated, and many creditors --
including stockholders -- would be likely to come away empty handed. Enron
has relatively few hard assets, and those it has -- including an extensive
network of natural gas pipelines -- are already pledged to lenders.

In any case, by the end of the day Enron was a shadow of the colossus that
politicians blamed for California's energy crisis and analysts promoted as an
innovator that epitomized the free-market swashbuckling that the Internet
could unleash.

Yesterday morning, Enron shut down its Internet-based trading platform,

EnronOnline, its screens going blank. Other major energy traders announced
that they would trade with Enron only in cash -- effectively meaning that
virtually all trading with the company had stopped, they said.

Late yesterday, Mr. McMahon said that Enron was doing some trading by
phone, but he declined to say how much or whether EnronOnline would be
reopened today.

Yesterday, shares of Enron, which peaked last summer at $90, fell to 61 cents,
down 85 percent for the day; Dynegy shares fell $4.08, or 10 percent, to close
at $36.81.

Other big energy traders, like the El Paso Corporation, Reliant Energy,
Mirant and Aquila, also fell. But Enron's gradual decline over the last month
gave many energy companies time to reduce their exposure to Enron, and
many operate rival trading operations that would benefit from its collapse.

Yesterday morning, as news leaked out of Dynegy's plans to cancel the deal
and S.& P. announced its downgrade of Enron's credit, prices for natural gas
futures traded on the New York Mercantile Exchange soared more than 10
percent. But they quickly reversed, plunging about 15 percent from the highs
reached before noon. Traders said volume fell off sharply as word of Enron's
problems spread.

Mr. McMahon said Enron was working with J. P. Morgan Chase and
Citigroup, its lead banks, to restructure the company's debts. ''We are
optimistic we can get a restructuring,'' he said. Earlier in the day, Enron said
that it had begun a ''temporary suspension of all payments other than those
necessary to maintain core operations,'' but Mr. McMahon declined to
comment on what bills Enron was paying.

The two banks had hoped that by helping arrange Enron's rescue they could
prove the merits of their strategy of providing both loans and advice in the
merger business. Now, not only have the banks lost bragging rights for
pulling off a difficult deal, as well as millions in fees, they are also left holding
hundreds of millions in loans to Enron, analysts said.

Dynegy may come out better. Under terms of the initial merger deal, the $1.5
billion it injected into Enron earlier in the month gave it preferred stock in
Enron's Northern Natural Gas pipeline that can be converted into ownership
of the pipeline. Dynegy said yesterday that it would exercise its option to
acquire the pipeline. Enron said it was reviewing the ''assertion'' by Dynegy
that it could claim the pipeline.

The person close to Enron said that Dynegy might have been seeking control
of the pipeline all along. ''You've got to wonder if they ever wanted to go
through with this agreement from the get-go,'' he said of Dynegy. ''Certainly,
this was a way to take probably the world's largest energy player out of the
market.''

Mr. Watson said that Enron had never leveled that charge at Dynegy in the
course of their talks.

Enron executives believed they had successfully revised the deal with Dynegy
on Monday afternoon.

Mr. Lay was in a private plane preparing to fly out of Teterboro Airport in
suburban New Jersey. He had just signed new merger documents and was
hoping to announce a deal on Tuesday in Houston, executives close to the
talks said.

But Mr. Watson, who had just returned from a trip, had become deeply
involved in the talks earlier that day and kept raising the ante, one executive
close to Enron said. ''All the parties were flipping out because Chuck was
changing the terms by the hour,'' this executive said.

As Mr. Lay's plane was taxiing for takeoff, the executives said, a call came in
from Mr. Watson asking to change the terms once again. That, they said, was
when it became clear that the deal might unravel.

In the end, Enron's uncertain finances and evidence that its customers were
fleeing sealed Dynegy's decision. ''Sometimes,'' Mr. Watson said, ''a
company's best deals are the very ones they did not do.''
 Correction: November 30, 2001, Friday Because of an editing error, a
front-page article yesterday about the collapse of the Enron Corporation
misstated the size of its work force and the Wednesday closing price for the
stock of its former merger suitor, Dynegy. Enron has 21,000 employees, not
13,000. Dynegy shares closed at $36.81, not $35.97. At one point the article
misspelled the surname of the White House press secretary, who was quoted
on President Bush's reaction to Enron's troubles. He is Ari Fleischer, not
Fleisher.

Before its collapse, Enron marketed electricity and natural gas, delivered energy and
other physical commodities, and provided financial and risk management services to
customers around the world.

Facts:
Most of the top executives were tried for fraud after it was revealed in November 2001
that Enron's earnings had been overstated by several hundred million dollars.

Enron was once ranked the sixth-largest energy company in the world.

Enron shares were worth $90.75 at their peak in August 2000 and dropped to $0.67 in
January 2002.

Top Enron executives sold their company stock prior to the company's downfall.

Lower-level employees were prevented from selling their stock due to 401k restrictions and
many subsequently lost their life savings.

Enron paid the top 140 executives $680 million in 2001. Kenneth Lay received $67.4 million
and Jeffrey Skilling received $41.8 million.

Timeline:
July 1985 - Enron is formed by the merger of Houston Natural Gas and Omaha-based
InterNorth.

2000 - Enron reaches No. 7 on the Fortune 500 list.

August 14, 2001 - Jeffrey Skilling resigns as CEO, and Kenneth Lay becomes CEO again
(He had been CEO from 1985-2000).

August 15, 2001 - Sherron Watkins sends a memo to Kenneth Lay about accounting
issues.

October 16, 2001 - Enron announces a third-quarter loss of $618 million.

October 31, 2001 - The SEC opens a formal investigation into Enron's transactions.
November 9, 2001 - Enron and Dynegy announce the $7.8 billion merger agreement. It
would form Dynegy Corp, in which Dynegy would own 64% and Enron 36%.

November 28, 2001 - Dynegy announces it has terminated merger talks with Enron.

December 2, 2001 - Enron files for Chapter 11 protection, becoming the largest bankruptcy
in U.S. history at that time and leaving thousands of workers with worthless stock in their
pensions.

January 9, 2002 - U.S. Department of Justice opens a criminal investigation into Enron's
collapse.

January 11, 2002 - The SEC widens its investigation to include Enron's chief auditor, Arthur
Andersen, due to reports of document shredding.

January 15, 2002 - The NYSE suspends trading of Enron shares.

January 17, 2002 - Enron ends its partnership with Arthur Andersen.

January 23, 2002 - Kenneth Lay resigns as chairman of the board and CEO.

January 25, 2002 - Former Enron vice chairman J. Clifford Baxter commits suicide in
Sugarland, Texas.

January 30, 2002 - Enron appoints Stephen Cooper as its interim CEO.

February 4, 2002 - Kenneth Lay resigns from Enron's board of directors.

February 7, 2002 - Andrew Fastow, Michael Kopper, Richard Buy and Richard Causey all
invoke their Fifth Amendment rights before the House Energy and Commerce Committee.

February 12, 2002 - Kenneth Lay invokes his Fifth Amendment right before the Senate
Commerce Committee.

February 14, 2002 - Whistleblower Sherron Watkins testifies before the House of
Representatives.

February 26, 2002 - Jeffrey Skilling, Sherron Watkins and Jeffrey McMahon testify before
the U.S. Senate Commerce Committee.

March 14, 2002 - U.S. Justice Department indicts accounting firm Arthur Andersen for
obstruction of justice in the Enron case.

April 2002 - Enron rises to No. 5 on the Fortune 500 list despite its bankruptcy filing.
Fortune bases its rankings only on the first nine months of revenue in 2001, which total
$138.7 billion.
June 15, 2002 - Arthur Andersen found guilty of obstructing justice.

August 21, 2002 - Former Enron executive Michael Kopper pleads guilty to conspiracy to
commit wire fraud and money laundering conspiracy.

October 2, 2002 - Andrew Fastow is charged with securities fraud, wire fraud, mail fraud,
money laundering and conspiracy.

May 1, 2003 - Andrew Fastow, his wife, and seven others are charged in a superseding
indictment for actions relating to the firm's financial scandals.

January 8, 2004 - Judge David Hittner says he will accept Lea Fastow's plea deal in
exchange for a guilty plea that could reduce her prison time.

January 14, 2004 - Andrew and Lea Fastow each plead guilty, as part of a plea agreement.

January 22, 2004 - Richard Causey pleads not guilty to five counts of securities fraud and
one count of conspiracy to commit securities fraud.

February 19, 2004 - Former Enron CEO Jeffrey Skilling is indicted on fraud and conspiracy
charges and pleads not guilty.

May 6, 2004 - Lea Fastow pleads guilty to a single count of filing a false tax return and
receives a 12-month sentence.

May 19, 2004 - The former Enron vice president responsible for investor relations, Paula
Rieker, pleads guilty to insider trading.

July 7, 2004 - Lay is indicted on 11 counts - one count of conspiracy to commit security and
wire fraud, two counts of wire fraud for misleading statements at employee meetings, four
counts of securities fraud for false statements in presentations to securities analysts, one
count of bank fraud and three counts of making false statements to banks.

July 8, 2004 - Lay pleads not guilty to all 11 charges and is released on $500,000
unsecured bond.

November 3, 2004 - The first criminal trial ends with the acquittal of former accountant
Sheila Kahanek.

November 17, 2004 - Enron comes out of bankruptcy after selling its interest in three
natural gas pipelines to CCE Holdings for $2 billion.

May 31, 2005 - The U.S. Supreme Court overturns Arthur Andersen's obstruction of justice
conviction.
December 28, 2005 - Richard Causey pleads guilty to securities fraud for his role in
the Enron scandal. He will serve only seven years in exchange for cooperating with
prosecutors seeking convictions of his former bosses, Lay and Skilling.

March 28, 2006 - The judge dismisses three counts against Skilling (two charges of
securities fraud and one charge of lying to auditors) and one count of securities fraud
against Lay.

May 25, 2006 - The jury in the Enron case finds former CEO Jeffrey Skilling and founder
Kenneth Lay guilty of conspiracy and fraud. Lay is convicted of all six counts against him
and Skilling is found guilty on 19 counts of conspiracy, fraud, false statements and insider
trading. Skilling is found not guilty on nine counts of insider trading. Judge Simeon T. Lake
announces four guilty verdicts in the separate bench trial of Lay on separate counts of
conspiracy and fraud.

July 5, 2006 - Ken Lay dies in Aspen, Colorado, from a heart attack brought on by severe
coronary artery disease.

September 26, 2006 - Andrew Fastow is sentenced to six years in prison, four years less
than his plea agreement stipulated in January 2004.

October 17, 2006 - Judge Lake erases Lay's fraud and conspiracy convictions. This is a
long-standing legal practice of the U.S. federal courts if the defendant dies before he/she
has a chance for an appeal to be heard.

October 23, 2006 - Jeffrey Skilling is sentenced to 24 years and four months in prison.

November 7, 2006 - Fastow reports to the Oakdale, Louisiana, federal detention center to
begin serving his six-year sentence.

November 15, 2006 - Former COO Richard Causey is sentenced to five years and six
months in prison for one count of securities fraud.

November 16, 2006 - Jeffrey Skilling appeals his convictions to the 5th Circuit Court of
Appeals.

December 13, 2006 - Skilling reports to prison in Waseca, Minnesota, after a judge refuses
to allow him to remain free pending appeal.

January 3, 2007 - Richard Causey reports to the Bastrop Federal Correctional Institution to
begin serving his five and a half year sentence.

January 6, 2009 - The U.S. Court of Appeals affirms Skilling's conviction but sends his
case back for resentencing.
June 24, 2010 - The U.S. Supreme Court rules that Skilling was incorrectly prosecuted
under a law concerning "honest-services fraud." The court then nullifies Skilling's conviction
on that charge.

April 6, 2011 - The Fifth U.S. Circuit Court of Appeals confirms Skilling's criminal
conviction.

May 16, 2011 - Andrew Fastow is transferred from a federal prison in Louisiana to a halfway
house in Houston. He is later allowed to move to his home to complete his sentence.

May 17, 2011 - Richard Causey begins serving the rest of his five and a half year sentence
in home confinement.

December 17, 2011 - Fastow's home confinement ends and he begins two years of
probation.

April 16, 2012 - The U.S. Supreme Court turns aside Jeffrey Skilling's second appeal. A few
weeks later, Skilling's attorney files a motion requesting a new trial in Houston federal court
citing newly discovered evidence.

June 21, 2013 - A federal judge reduces Skilling's sentence by more than 10 years. As part
of the resentencing deal brokered between prosecutors and the defense, Skilling agrees to
stop challenging his conviction and forfeit roughly $42 million that will be distributed among
the victims of the Enron fraud.

November 18, 2015 - A federal judge issues a ruling that bars Skilling from ever acting as
an officer or director of a publicly traded company again, settling a long-running civil suit by
the U.S. Securities Exchange Commission.

February 1, 2017
New revenue recognition working drafts issued for insurance, software

February 1, 2017
AICPA urges changes to employee benefit reporting proposal

February 1, 2017
FASB proposal would improve hedge accounting, AICPA committee says

December 2, 2016
U.S. anti-money laundering regulations well-developed, analysis finds
December 1, 2016
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o Internal Control over Financial Reporting

If youre like most, youve been astonished, disillusioned and angered as you learned of the meteoric rise
and fall of Enron Corp. Remember the companys television commercial of not so long ago, ending with
the reverberating phrase, Ask why, why, why? That question is now on everyones lips. The Enron case
is a dream for academics who conduct research and teach. For those currently or formerly involved with
the company, such as creditors, auditors, the SEC and accounting regulators, its a nightmare that will
continue for a long time.

Formal investigations of Enron are now under way, headed by the companys board, the SEC, the Justice
Department and Congress. The exact causes and details of the disaster may not be known for months.
The purpose of this article is to summarize preliminary observations about the collapse, as well as
changes in financial reporting, auditing and corporate governance that are being proposed in response by
Big Five accounting firms, the AICPA and the SEC.

IN A WAY IT'S SIMPLE, IN A WAY IT'S NOT

On the surface, the motives and attitudes behind decisions and events leading to Enrons eventual
downfall appear simple enough: individual and collective greed born in an atmosphere of market euphoria
and corporate arrogance. Hardly anyonethe company, its employees, analysts or individual investors
wanted to believe the company was too good to be true. So, for a while, hardly anyone did. Many kept on
buying the stock, the corporate mantra and the dream. In the meantime, the company made many high-
risk deals, some of which were outside the companys typical asset risk control process. Many went sour
in the early months of 2001 as Enrons stock price and debt rating imploded because of loss of investor
and creditor trust. Methods the company used to disclose (or creatively obscure) its complicated financial
dealings were erroneous and, in the view of some, downright deceptive. The companys lack of
transparency in reporting its financial affairs, followed by financial restatements disclosing billions of
dollars of omitted liabilities and losses, contributed to its demise. The whole affair happened under the
watchful eye of Arthur Andersen LLP, which kept a whole floor of auditors assigned at Enron year-round.

THE BEGINNING PRESAGES THE END

In 1985, after federal deregulation of natural gas pipelines, Enron was born from the merger of Houston
Natural Gas and InterNorth, a Nebraska pipeline company. In the process of the merger, Enron incurred
massive debt and, as the result of deregulation, no longer had exclusive rights to its pipelines. In order to
survive, the company had to come up with a new and innovative business strategy to generate profits and
cash flow. Kenneth Lay, CEO, hired McKinsey & Co. to assist in developing Enrons business strategy. It
assigned a young consultant named Jeffrey Skilling to the engagement. Skilling, who had a background in
banking and asset and liability management, proposed a revolutionary solution to Enrons credit, cash
and profit woes in the gas pipeline business: create a gas bank in which Enron would buy gas from a
network of suppliers and sell it to a network of consumers, contractually guaranteeing both the supply and
the price, charging fees for the transactions and assuming the associated risks. Thanks to the young
consultant, the company created both a new product and a new paradigm for the industrythe energy
derivative.

Lay was so impressed with Skillings genius that he created a new division in 1990 called Enron Finance
Corp. and hired Skilling to run it. Under Skillings leadership, Enron Finance Corp. soon dominated the
market for natural gas contracts, with more contacts, more access to supplies and more customers than
any of its competitors. With its market power, Enron could predict future prices with great accuracy,
thereby guaranteeing superior profits.

THE BEST, THE BRIGHTEST AND THE DREADED PRC

Skilling began to change the corporate culture of Enron to match the companys transformed image as a
trading business. He set out on a quest to hire the best and brightest traders, recruiting associates from
the top MBA schools in the country and competing with the largest and most prestigious investment banks
for talent. In exchange for grueling schedules, Enron pampered its associates with a long list of corporate
perks, including concierge services and a company gym. Skilling rewarded production with merit-based
bonuses that had no cap, permitting traders to eat what they killed.

One of Skillings earliest hires in 1990 was Andrew Fastow, a 29-year-old Kellogg MBA who had been
working on leveraged buyouts and other complicated deals at Continental Illinois Bank in Chicago.
Fastow became Skillings protg in the same way Skilling had become Lays. Fastow moved swiftly
through the ranks and was promoted to chief financial officer in 1998. As Skilling oversaw the building of
the companys vast trading operation, Fastow oversaw its financing by ever more complicated means.

As Enrons reputation with the outside world grew, the internal culture apparently began to take a darker
tone. Skilling instituted the performance review committee (PRC), which became known as the harshest
employee-ranking system in the country. It was known as the 360-degree review based on the values of
Enronrespect, integrity, communication and excellence (RICE). However, associates came to feel that
the only real performance measure was the amount of profits they could produce. In order to achieve top
ratings, everyone in the organization became instantly motivated to do deals and post earnings.
Employees were regularly rated on a scale of 1 to 5, with 5s usually being fired within six months. The
lower an employees PRC score, the closer he or she got to Skilling, and the higher the score, the closer
he or she got to being shown the door. Skillings division was known for replacing up to 15% of its
workforce every year. Fierce internal competition prevailed and immediate gratification was prized above
long-term potential. Paranoia flourished and trading contracts began to contain highly restrictive
confidentiality clauses. Secrecy became the order of the day for many of the companys trading contracts,
as well as its disclosures.

HOW HIGH THEY FLY

Coincidentally, but not inconsequentially, the U.S. economy during the 1990s was experiencing the
longest bull market in its history. Enrons corporate leadership, Lay excluded, comprised mostly young
people who had never experienced an extended bear market. New investment opportunities were
opening up everywhere, including markets in energy futures. Wall Street demanded double-digit growth
from practically every venture, and Enron was determined to deliver.
In 1996 Skilling became Enrons chief operating officer. He convinced Lay the gas bank model could be
applied to the market for electric energy as well. Skilling and Lay traveled widely across the country,
selling the concept to the heads of power companies and to energy regulators. The company became a
major political player in the United States, lobbying for deregulation of electric utilities. In 1997 Enron
acquired electric utility company Portland General Electric Corp. for about $2 billion. By the end of that
year, Skilling had developed the division by then known as Enron Capital and Trade Resources into the
nations largest wholesale buyer and seller of natural gas and electricity. Revenue grew to $7 billion from
$2 billion, and the number of employees in the division skyrocketed to more than 2,000 from 200. Using
the same concept that had been so successful with the gas bank, they were ready to create a market for
anything that anyone was willing to trade: futures contracts in coal, paper, steel, water and even weather.

Perhaps Enrons most exciting development in the eyes of the financial world was the creation of Enron
Online (EOL) in October 1999. EOL, an electronic commodities trading Web site, was significant for at
least two reasons. First, Enron was a counterparty to every transaction conducted on the platform.
Traders received extremely valuable information regarding the long and short parties to each trade as
well as the products prices in real-time. Second, given that Enron was either a buyer or a seller in every
transaction, credit risk management was crucial and Enrons credit was the cornerstone that gave the
energy community the confidence that EOL provided a safe transaction environment. EOL became an
overnight success, handling $335 billion in online commodity trades in 2000.

The world of technology opened up the Internet, and the IPO market for technology and broadband
communications companies started to take off. In January 2000 Enron announced an ambitious plan to
build a high-speed broadband telecommunications network and to trade network capacity, or bandwidth,
in the same way it traded electricity or natural gas. In July of that year Enron and Blockbuster announced
a deal to provide video on demand to customers throughout the world via high-speed Internet lines. As
Enron poured hundreds of millions into broadband with very little return, Wall Street rewarded the strategy
with as much as $40 on the stock pricea factor that would have to be discounted later when the
broadband bubble burst. In August 2000 Enrons stock hit an all-time high of $90.56, and the company
was being touted by Fortune and other business publications as one of the most admired and innovative
companies in the world.

THE ROLE OF MARK-TO-MARKET ACCOUNTING

Enron incorporated mark-to-market accounting for the energy trading business in the mid-1990s and
used it on an unprecedented scale for its trading transactions. Under mark-to-market rules, whenever
companies have outstanding energy-related or other derivative contracts (either assets or liabilities) on
their balance sheets at the end of a particular quarter, they must adjust them to fair market value, booking
unrealized gains or losses to the income statement of the period. A difficulty with application of these rules
in accounting for long-term futures contracts in commodities such as gas is that there are often no quoted
prices upon which to base valuations. Companies having these types of derivative instruments are free to
develop and use discretionary valuation models based on their own assumptions and methods.

The Financial Accounting Standards Boards (FASB) emerging issues task force has debated the subject
of how to value and disclose energy-related contracts for several years. It has been able to conclude only
that a one-size-fits-all approach will not work and that to require companies to disclose all of the
assumptions and estimates underlying earnings would produce disclosures that were so voluminous they
would be of little value. For a company such as Enron, under continuous pressure to beat earnings
estimates, it is possible that valuation estimates might have considerably overstated earnings.
Furthermore, unrealized trading gains accounted for slightly more than half of the companys $1.41 billion
reported pretax profit for 2000 and about one-third of its reported pretax profit for 1999.
CAPITALISM AT WORK

In the latter part of the 1990s, companies such as Dynegy, Duke Energy, El Paso and Williams began
following Enrons lead. Enrons competitive advantage, as well as its huge profit margins, had begun to
erode by the end of 2000. Each new market entrants successes squeezed Enrons profit margins further.
It ran with increasing leverage, thus becoming more like a hedge fund than a trading company.
Meanwhile, energy prices began to fall in the first quarter of 2001 and the world economy headed into a
recession, thus dampening energy market volatility and reducing the opportunity for the large, rapid
trading gains that had formerly made Enron so profitable. Deals, especially in the finance division, were
done at a rapid pace without much regard to whether they aligned with the strategic goals of the company
or whether they complied with the companys risk management policies. As one knowledgeable Enron
employee put it: Good deal vs. bad deal? Didnt matter. If it had a positive net present value (NPV) it
could get done. Sometimes positive NPV didnt even matter in the name of strategic significance. Enrons
foundations were developing cracks and Skillings house of paper built on the stilts of trust had begun to
crumble.

RELATED PARTIES AND COMPLEX SPECIAL PURPOSE ENTITIES

In order to satisfy Moodys and Standard & Poors credit rating agencies, Enron had to make sure the
companys leverage ratios were within acceptable ranges. Fastow continually lobbied the ratings
agencies to raise Enrons credit rating, apparently to no avail. That notwithstanding, there were other
ways to lower the companys debt ratio. Reducing hard assets while earning increasing paper profits
served to increase Enrons return on assets (ROA) and reduce its debt-to-total-assets ratio, making the
company more attractive to credit rating agencies and investors.

Enron, like many other companies, used special purpose entities (SPEs) to access capital or hedge risk.
By using SPEs such as limited partnerships with outside parties, a company is permitted to increase
leverage and ROA without having to report debt on its balance sheet. The company contributes hard
assets and related debt to an SPE in exchange for an interest. The SPE then borrows large sums of
money from a financial institution to purchase assets or conduct other business without the debt or assets
showing up on the companys financial statements. The company can also sell leveraged assets to the
SPE and book a profit. To avoid classification of the SPE as a subsidiary (thereby forcing the entity to
include the SPEs financial position and results of operations in its financial statements), FASB guidelines
require that only 3% of the SPE be owned by an outside investor.

Under Fastows leadership, Enron took the use of SPEs to new heights of complexity and sophistication,
capitalizing them with not only a variety of hard assets and liabilities, but also extremely complex
derivative financial instruments, its own restricted stock, rights to acquire its stock and related liabilities.
As its financial dealings became more complicated, the company apparently also used SPEs to park
troubled assets that were falling in value, such as certain overseas energy facilities, the broadband
operation or stock in companies that had been spun off to the public. Transferring these assets to SPEs
meant their losses would be kept off Enrons books. To compensate partnership investors for downside
risk, Enron promised issuance of additional shares of its stock. As the value of the assets in these
partnerships fell, Enron began to incur larger and larger obligations to issue its own stock later down the
road. Compounding the problem toward the end was the precipitous fall in the value of Enron stock.
Enron conducted business through thousands of SPEs. The most controversial of them were LJM
Cayman LP and LJM2 Co-Investment LP, run by Fastow himself. From 1999 through July 2001, these
entities paid Fastow more than $30 million in management fees, far more than his Enron salary,
supposedly with the approval of top management and Enrons board of directors. In turn, the LJM
partnerships invested in another group of SPEs, known as the Raptor vehicles, which were designed in
part to hedge an Enron investment in a bankrupt broadband company, Rhythm NetConnections. As part
of the capitalization of the Raptor entities, Enron issued common stock in exchange for a note receivable
of $1.2 billion. Enron increased notes receivable and shareholders equity to reflect this transaction, which
appears to violate generally accepted accounting principles. Additionally, Enron failed to consolidate the
LJM and Raptor SPEs into their financial statements when subsequent information revealed they should
have been consolidated.

OBSCURE DISCLOSURES REVEALED

A very confusing footnote in Enrons 2000 financial statements described the above transactions. Douglas
Carmichael, the Wollman Distinguished Professor of Accounting at Baruch College in New York City, told
the Wall Street Journal in November of 2001 that most people would be hard pressed to understand the
effects of these disclosures on the financial statements, casting doubt on both the quality of the
companys earnings as well as the business purpose of the transaction. By April 2001 other skeptics
arrived on the scene. A number of analysts questioned the lack of transparency of Enrons disclosures.
One analyst was quoted as saying, The notes just dont make sense, and we read notes for a living.
Skilling was very quick to reply with arrogant comments and, in one case, even called an analyst a
derogatory name. What Skilling and Fastow apparently underestimated was that, because of such
actions, the market was beginning to perceive the company with greater and greater skepticism, thus
eroding its trust and the companys reputation.

IT ALL COMES TUMBLING DOWN

In February 2001 Lay announced his retirement and named Skilling president and CEO of Enron. In
February Skilling held the companys annual conference with analysts, bragging that the stock (then
valued around $80) should be trading at around $126 per share.

In March Enron and Blockbuster announced the cancellation of their video-on-demand deal. By that time
the stock had fallen to the mid-$60s. Throughout the spring and summer, risky deals Enron had made in
underperforming investments of various kinds began to unravel, causing it to suffer a huge cash shortfall.
Senior management, which had been voting with its feet since August 2000, selling Enron stock in the bull
market, continued to exit, collectively hundreds of millions of dollars richer for the experience. On August
14, just six months after being named CEO, Skilling himself resigned, citing personal reasons. The stock
price slipped below $40 that week and, except for a brief recovery in early October after the sale of
Portland General, continued its slide to below $30 a share.

Also in August, in an internal memorandum to Lay, a company vice-president, Sherron Watkins, described
her reservations about the lack of disclosure of the substance of the related party transactions with the
SPEs run by Fastow. She concluded the memo by stating her fear that the company might implode under
a series of accounting scandals. Lay notified the companys attorneys, Vinson & Elkins, as well as the
audit partner at Enrons auditing firm, Arthur Andersen LLP, so the matter could be investigated further.
The proverbial ship of Enron had struck the iceberg that would eventually sink it.

On October 16 Enron announced its first quarterly loss in more than four years after taking charges of $1
billion on poorly performing businesses. The company terminated the Raptor hedging arrangements
which, if they had continued, would have resulted in its issuing 58 million Enron shares to offset the
companys private equity losses, severely diluting earnings. It also disclosed the reversal of the $1.2
billion entry to assets and equities it had made as a result of dealings with these arrangements. It was this
disclosure that got the SECs attention.

On October 17 the company announced it had changed plan administrators for its employees 401(k)
pension plan, thus by law locking their investments for a period of 30 days and preventing workers from
selling their Enron stock. The company contends this decision had in fact been made months earlier.
However true that might be, the timing of the decision certainly has raised suspicions.

On October 22 Enron announced the SEC was looking into the related party transactions between Enron
and the partnerships owned by Fastow, who was fired two days later. On November 8 Enron announced a
restatement of its financial statements back to 1997 to reflect consolidation of the SPEs it had omitted, as
well as to book Andersens recommended adjustments from those years, which the company had
previously deemed immaterial. This restatement resulted in another $591 million in losses over the four
years as well as an additional $628 million in liabilities as of the end of 2000. The equity markets
immediately reacted to the restatement, driving the stock price to less than $10 a share. One analysts
report stated the company had burned through $5 billion in cash in 50 days.

A merger agreement with smaller cross-town competitor Dynegy was announced on November 9, but
rescinded by Dynegy on November 28 on the basis of Enrons lack of full disclosure of its off-balance-
sheet debt, downgrading Enrons rating to junk status. On November 30 the stock closed at an
astonishing 26 cents a share. The company filed for bankruptcy protection on December 2.

THE AFTERMATH

Unquestionably, the Enron implosion has wreaked more havoc on the accounting profession than any
other case in U.S. history. Critics in the media, Congress and elsewhere are calling into question not only
the adequacy of U.S. disclosure practices but also the integrity of the independent audit process. The
general public still questions how CPA firms can maintain audit independence while at the same time
engaging in consulting work, often for fees that dwarf those of the audit. Companies that deal in special
purpose entities and complex financial instruments similar to Enrons have suffered significant declines in
their stock prices. The scandal threatens to undermine confidence in financial markets in the United
States and abroad.

In a characteristic move, the SEC and the public accounting profession have been among the first to
respond to the Enron crisis. Unfortunately, and sadly reminiscent of financial disasters in the 1970s and
1980s, this response will likely be viewed by investors, creditors, lawmakers and employees of Enron as
too little, too late.

In an op-ed piece for the Wall Street Journal on December 11, SEC Chairman Harvey Pitt called the
current outdated reporting and financial disclosure system the financial perfect storm. He stated that
under the current quarterly and annual reporting system, information is often stale on arrival and
mandated financial disclosures are often arcane and impenetrable. To reassure investors and restore
confidence in financial reporting, Pitt called for a joint response from the public and private sectors that
included, among other things,

A system of current disclosures, supplementing and updating quarterly and annual information
with disclosure of material information on a real-time basis.

Public company disclosure of significant current trend and evaluative data in addition to
historical information.

Identification of most critical accounting principles by all public companies in their annual
reports.

More timely and responsive accounting standard setting on the part of the private sector.
 An environment of cooperation between the SEC and registrants that encourages public
companies and their auditors to seek advice on disclosure issues in advance.

An effective and transparent system of self-regulation for the accounting profession, subject to
SECs rigorous, but nonduplicative, oversight.

More proactive oversight by audit committees who understand financial accounting principles as
well as how they are applied.

The CEOs of the Big Five accounting firms made a joint statement on December 4 committing to develop
improved guidance on disclosure of related party transactions, SPEs and market risks for derivatives
including energy contracts for the 2001 reporting period. In addition, the Big Five called for modernization
of the financial reporting system in the United States to make it more timely and relevant, including more
nonfinancial information on entity performance. They also vowed to streamline the accounting standard-
setting process to make it more responsive to the rapid changes that occur in a technology-driven
economy.

Since the Enron debacle, the AICPA has been engaged in significant damage control measures to restore
confidence in the profession, displaying the banner Enron: The AICPA, the Profession, and the Public
Interest on its Web site. It has announced the imminent issuance of an exposure draft on a new audit
standard on fraud (the third in five years), providing more specific guidance than currently found in SAS
no. 82, Consideration of Fraud in a Financial Statement Audit. The Institute has also promised a revised
standard on reviews of quarterly financial statements, as well as the issuance, in the second quarter of
2002, of an exposure draft of a standard to improve the audit process. These standards had already been
on the drawing board as part of the AICPAs response to the report of the Blue Ribbon Panel on Audit
Effectiveness, issued in 2000.

In late December the AICPA issued a tool kit for auditors to use in identifying and auditing related party
transactions. While it breaks no new ground, the tool kit provides, in one place, an overview of the
accounting and auditing literature, SEC requirements and best practice guidance concerning related party
transactions. It also includes checklists and other tools for auditors to use in gathering evidence and
disclosing related party transactions.

In January the AICPA board of directors announced that it would cooperate fully with the SECs proposal
for new rules for the peer review and disciplinary process for CPA firms of SEC registrants. The new
system would be managed by a board, a majority of which would be public members, enhancing the peer
review process for the largest firms and requiring more rigorous and continuous monitoring. The staff of
the new board would administer the reviews. In protest, the Public Oversight Board informed Pitt that it
would terminate its existence in March 2002, leaving the future peer review process in a state of
uncertainty. The SEC and the AICPA are now engaged in talks with the POB to reassure the board it will
continue to be a vital part of the peer review process in the future.

The AICPA has also approved a resolution to support prohibitions that would prevent audit firms from
performing systems design and implementation as well as internal audit outsourcing for public audit
clients. While asserting that it does not believe prohibition of these services will make audits more
effective or prevent financial failures, the board has stated it feels the move is necessary to restore public
confidence in the profession. These prohibitions were at the center of the controversy last year between
the profession and the SEC under the direction of former Chairman Arthur Levitt. Big Five CPA firms and
the AICPA lobbied heavily and prevailed in that controversy, winning the right to retain these services and
being required only to disclose their fees.
The impact of Enron is now being felt at the highest levels of government as legislators engage in endless
debate and accusation, quarreling over the influence of money in politics. The GAO has requested that
the White House disclose documents concerning appointments to President George W. Bushs Task
Force on Energy, chaired by Vice-President Dick Cheney, former CEO of Halliburton. The White House
has refused, and the GAO has filed suit, the first of its kind in history. Congressional investigations are
expected to continue well into 2002 and beyond. Lawmakers are expected to investigate not only
disclosure practices at Enron, but for all public companies, concerning SPEs, related party transactions
and use of mark-to-market accounting.

Kenneth Lay resigned as Enrons CEO, under pressure from creditor groups. Lay, Skilling and Fastow still
have much to explain. In addition, Enrons board of directors, and especially the audit committee, will be
in the hot seat and rightfully so.

The Justice Department opened a criminal investigation and formed a national task force made up of
federal prosecutors in Houston, San Francisco, New York and several other cities to investigate the
possibility of fraud in the companys dealings. Interestingly, to illustrate how far-reaching Enrons ties are
to government and political sources at all levels, U.S. Attorney General John Ashcroft, as well as his
entire Houston office, disqualified themselves from the investigation because of either political, economic
or family ties.

It appears that 2002 is shaping up to be a year of unprecedented changes for a profession that is already
coping with an identity crisis.

WHERE WERE THE AUDITORS?

Arthur Andersen LLP, after settling two other massive lawsuits earlier in 2001, is preparing for a storm of
litigation as well as a possible criminal investigation in the wake of the Enron collapse. Enron was the
firms second-largest client. Andersen, who had the job not only of Enrons external but also its internal
audits for the years in question, kept a staff on permanent assignment at Enrons offices. Many of Enrons
internal accountants, CFOs and controllers were former Andersen executives. Because of these
relationships, as well as Andersens extensive concurrent consulting practice, members of Congress, the
press and others are calling Andersens audit independence into question. Indeed, they are using the
case to raise doubts about the credibility of the audit process for all Big Five firms who do such work.

So far, Andersen has acknowledged its role in the fiasco, while defending its accounting and auditing
practices. In a Wall Street Journal editorial on December 4, as well as in testimony before Congress the
following week, Joseph Berardino, CEO, was forthright in his views. He committed the firm to full
cooperation in the investigations as well as to a leadership role in potential solutions.

Enron dismissed Andersen as its auditor on January 17, 2002, citing document destruction and lack of
guidance on accounting policy issues as the reasons. Andersen countered with the contention that in its
mind the relationship had terminated on December 2, 2001, the day the firm filed for Chapter 11
bankruptcy protection.

The fact that Andersen is no longer officially associated with Enron will, unfortunately, have little impact on
forces now in place that may, in the eyes of some, determine the firms very future. Andersen is now
under formal investigation by the SEC as well as various committees of both the U.S. Senate and House
of Representatives of the U.S. Congress. To make matters worse for it, and to the astonishment of many,
Andersen admitted it destroyed perhaps thousands of documents and electronic files related to the
engagement, in accordance with firm policy, supposedly before the SEC issued a subpoena for them.
The firms lawyers issued an internal memorandum on October 12 reminding employees of the firms
document retention and destruction policies. The firm fired David B. Duncan, partner in charge of the
Enron engagement, placed four other partners on leave and replaced the entire management team of the
Houston office. Duncan invoked his Fifth Amendment rights against self-incrimination at a congressional
hearing in January. Several other Andersen partners testified that Duncan and his staff acted in violation
of firm policy. However, in view of the timing of the October 12 memorandum, Congress and the press are
questioning whether the decision to shred documents extended farther up the chain of command.
Andersen has suspended its firm policy for retention of records and asked former U.S. Senator John
Danforth to conduct a comprehensive review of the firms records management policy and to recommend
improvements.

In a move to bolster its image, Andersen also has retained former Federal Reserve Chairman Paul
Volcker to lead an outside board that will advise it in making fundamental change in its audit process.
Other members of the board include P. Roy Vagelos, former chairman and CEO of Merck & Co., and
Charles A. Bowsher, current chairman of the Public Oversight Board, which disbanded in March. Volcker
also named a seven-member advisory panel made up of prominent corporate and accounting executives
that will review proposed reforms to the firms audit process.

Hindsight is so clear that it sometimes belies the complexity of the problem. Although fraud has not yet
been proven to be a factor in Enrons misstatements, some of the classic risk factors associated with
management fraud outlined in SAS no. 82 are evident in the Enron case. Those include management
characteristics, industry conditions and operating characteristics of the company. Although written five
years ago, the list almost looks as if it was excerpted from Enrons case:

Unduly aggressive earnings targets and management bonus compensation based on those
targets.

Excessive interest by management in maintaining stock price or earnings trend through the use of
unusually aggressive accounting practices.

Management setting unduly aggressive financial targets and expectations for operating
personnel.

Inability to generate sufficient cash flow from operations while reporting earnings and earnings
growth.

Assets, liabilities, revenues or expenses based on significant estimates that involve unusually
subjective judgments such asreliability of financial instruments.

Significant related party transactions.

These factors are common threads in the tapestry that is described of the environment leading to fraud.
They were incorporated into SAS no. 82 on the basis of research into fraud cases of the 1970s and 1980s
in the hope that auditors would learn from the past. Andersen will have to explain when and how it
identified these factors, as well as how it responded and how it communicated with Enrons board about
them.

More important, Andersen will have to explain why it delayed notifying the SEC after learning of the
internal Enron memo warning of problems. In addition, it will have to explain why the Houston office
destroyed the thousands of documents related to the Enron audits for 1997 through 2000. Only time will
tell, but it appears the firm is in serious trouble. In the end, and also characteristic of cases like this, the
chief parties likely to benefit from this process are the attorneys.

THE HUMAN FACTOR

The Enron story has produced many victims, the most tragic of which is a former vice-chairman of the
company who committed suicide, apparently in connection with his role in the scandal. Another 4,500
individuals have seen their careers ended abruptly by the reckless acts of a few. Enrons core values of
respect, integrity, communication and excellence stand in satirical contrast to allegations now being made
public. Personally, I had referred several of our best and brightest accounting, finance and MBA
graduates to Enron, hoping they could gain valuable experience from seeing things done right. These
included a very bright training consultant who had lost her job in 2000 with a Houston consulting firm as a
result of a reduction in force. She has lost her second job in 18 months through no fault of her own. Other
former students still hanging on at Enron face an uncertain future as the company fights for survival.

The old saying goes, Lessons learned hard are learned best. Some former Enron employees are
embittered by the way they have been treated by the company that was once the best in the business.
Others disagree. In the words of one of my former students who is still hanging on: Just for the record,
my time and experience at Enron have been nothing short of fantastic. I could not have asked for a better
place to be or better people to work with. Please, though, remember this: Never take customer and
employee confidence for granted. That confidence is easy to lose and toughto impossibleto regain.

C. WILLIAM THOMAS, CPA, Ph.D., is the J.E. Bush Professor of Accounting in the Hankamer School of
Business at Baylor University in Waco. Mr. Thomas can be reached at Bill_Thomas@baylor.edu . This
article originally appeared in the March/April 2002 issue of Todays CPA, published by the Texas Society
of CPAs.

- See more at:

http://www.journalofaccountancy.com/issues/2002/apr/theriseandfallofenron.html#sthash.5n
RS5BKL.dpuf

Comptronix Dismisses Chief In

Bogus-Earnings Scandal
By KURT EICHENWALD
Published: December 12, 1992

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REPRINTS

The Comptronix Corporation dismissed its chairman and chief executive yesterday and said
it expected to sue him for routinely and illegally inflating the company's profits for more
than three years.

The electronics parts manufacturer also announced that its accountant, KPMG Peat
Marwick, was resigning and that the board expected to appoint new auditors soon. Arthur
Andersen & Company is working with a special committee of the board to track down
fraudulent entries in Comptronix's accounting.

The executive who was dismissed yesterday, William J. Hebding, and two other top
executives -- Allen L. Shifflet, president and chief operating officer, and J. Paul Medlin,
treasurer and controller -- were suspended last month after they admitted falsifying the
books, the company said. Helping Investigation

In a statement, Comptronix's directors said that although all three executives had lied to the
board about the extent of the illegal activities, the company was reserving decision about
taking action against Mr. Shifflet and Mr. Medlin. Both are cooperating in a company
inquiry.

The company said it had received requests from the three for indemnification against
potential litigation. While the directors have not formally considered the request, people
close to the company said it was virtually impossible that it would be granted.

After announcing the scandal on Nov. 25, Comptronix, based in Guntersville, Ala., was hit
with regulatory investigations and investor lawsuits. The stock, which was at $22 a share
before the announcement, closed at $6.875 in over-the-counter trading yesterday, down 25
cents. Details of Plan
In its statement yesterday, Comptronix detailed the complex plan it said had allowed the
three executives to juggle the books for years. But despite its sophistication, the plan had a
big flaw, raising questions about how the company's accountants were misled for so long.

"The accountants say this is going to be one for the textbooks," said Joelle Frank, a
spokeswoman for Comptronix.

According to the company, beginning in 1989, the executives made false additions to
inventory at the end of each month. As that change wound through the Comptronix
financial statement, it had the effect of falsely increasing profits the same amount.

Accountants measure the cost of a company's sales by measuring the decline in inventory in
the month. By increasing the amount of inventory at the end of each month, the executives
made it appear that the cost of sales was lower than it actually was. Those lower costs, in
turn, plumped up gross profit margins, and those bogus figures were brought down to the
bottom line as pure -- albeit fictitious -- pretax profits.

Continuing month to month, this first stage would be undetected for only so long. After all,
each month more and more fictitious inventory would be added. If the number was not
somehow decreased, eventually the fake figures would so outpace the space for inventory
that even warehouse workers would know something was amiss. A 2-Step Remedy

So the fraudulent inventory numbers were juggled onto another line of the books. By the
time the executives were done, the company says, the fraudulent inventory had been
transformed into fraudulent equipment. The executives, sitting down with pens to create a
paper trail that backed up every stage of the transactions, would first record a fake sale out
of the fictitious inventory levels, in turn recording on the books a false account receivable,
which is a statement of money owed but not yet paid.

Then the executives would create a fake order to purchase equipment from a supplier. A
check for the amount of the fictitious purchase was then written by the company.

It was here that the plan became sloppy. To pay for the bogus equipment, checks were
written to the supposed suppliers. The executives then fraudulently endorsed the checks and
deposited them back into company accounts as payments for the nonexistent sales of
merchandise in inventory. The checks would have shown that circuitous route, and if the
auditors had noticed them, they might have halted the plan early.
Photo: William J. Hebding was dismissed yesterday as chairman and chief executive of
Comptronix. (Comptronix Corporation)