Bob Jensen's Enron Quiz
Bob Jensen at Trinity University
Bob Jensen's threads on the Enron, Worldcom, and Andersen meltdowns can be found at http://www.trinity.edu/rjensen/FraudEnron.htm
Long-time subscribers to the AECM may remember my quips (years ago) about
Michael Kopper ---
These inspired AECMers to write their own quips about Enron and about accounting
in general.
You can read some of these AECM originals at
http://www.trinity.edu/rjensen/FraudEnron.htm#Humor
Bob Jensen's Enron Updates are at http://www.trinity.edu/rjensen/FraudEnron.htm#EnronUpdates
A person can be a professional thief only
if he is recognized and received as such by other professional thieves.
Professional theft is a group way of life.
Edwin
Sutherland
There will always be white collar crime as long as it
pays big even when you get caught.
Bob Jensen --- http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
Enron's Timeline From Beginning to End --- http://www.trinity.edu/rjensen/FraudEnron.htm#EnronTimeline
Memorable quotations about Enron, Worldcom, and Andersen --- http://www.trinity.edu/rjensen/FraudEnron.htm#Quotations
Special Report on the Fall of Enron --- http://www.chron.com/news/specials/enron/
Frontline (from PBS) videos on accounting and finance regulation and scandals in the U.S. --- http://www.pbs.org/wgbh/pages/frontline/shows/regulation/view/ Note that one of the Frontline videos in about the Enron scandal --- http://www.pbs.org/wgbh/pages/frontline/shows/regulation/view/
Enron Declared Bankruptcy in 2001
History of the Rise and Fall of Enron ---
http://www.trinity.edu/rjensen/FraudEnron.htm
Bob Jensen's Enron Quiz ---
http://www.trinity.edu/rjensen/FraudEnronQuiz.htm
And don't forget about the Enron home video starring some of the
real players (including Jeff Skilling) before they got caught ---
http://www.trinity.edu/rjensen/FraudEnron.htm#HFV
From Wikipedia --- http://en.wikipedia.org/wiki/Enron
Enron Creditors Recovery Corporation (formerly Enron Corporation) (former NYSE ticker symbol: ENE) was an American energy company based in Houston, Texas. Before its bankruptcy in late 2001, Enron employed around 22,000 people (McLean & Elkind, 2003) and was one of the world's leading electricity, natural gas, pulp and paper, and communications companies, with claimed revenues of $111 billion in 2000. Fortune named Enron "America's Most Innovative Company" for six consecutive years. At the end of 2001 it was revealed that its reported financial condition was sustained mostly by institutionalized, systematic, and creatively planned accounting fraud (see: Enron scandal). Enron has since become a popular symbol of willful corporate fraud and corruption.
Enron filed for bankruptcy protection in the Southern District of New York in late 2001 and selected Weil, Gotshal & Manges as their bankruptcy counsel. Enron still exists as an asset-less shell corporation, emerging from bankruptcy in November of 2004 after one of the biggest and most complex bankruptcy cases in U.S. history. On September 7, 2006, Enron sold Prisma Energy International Inc., its last remaining business, to Ashmore Energy International Ltd. Following the scandal, lawsuits against Enron's directors were notable because the directors settled the suits by paying very significant sums of money personally. The scandal also caused the dissolution of the Arthur Andersen accounting firm, affecting the wider business world.
Infectious Greed: How Deceit and Risk Corrupted the Financial Markets (Henry Holt and Company, 2003, Page 297, ISBN 0-8050-7510-0)
A close analysis of the dealings at Enron leads to three key conclusions, each counter to the prevailing wisdom about the company. First, Enron was, in reality, a derivatives-trading firm, not an energy firm, and it took much more risk than anyone realized. By the end, Enron was even more volatile than a highly leveraged Wall Street investment bank, although few investors realized it.
Second, Enron's core business of derivatives trading was actually highly profitable, so profitable, in fact, that Enron almost certainly would have survived if key parties had understood the details of its business. Instead, in late 2001, Enron was hoist with its own petard, collapsing --- not because it wasn't making money --- but because institutional investors and credit-rating agencies abandoned the company when they learned that Enron's executives had been using derivatives to hide the risky nature of their business.
March 31, 2008 message from rock musician larry@mightymoonmen.com
I just found your Enron links and stories from 2002...brings up bad memories
I wrote a song based loosely on Jeff skilling ... "Medicine Man"
You can listen to the song and read the lyrics --- www.mightymoonmen.com
thanx
Bob Jensen's Enron Quiz Questions
What is the main temptation of white collar criminals?
Why do
auditors often lose professionalism?
Click Here for Answer
Who are the two richest Enron executives to emerge unscathed by
Enron's scandal?
Click Here for Answer
What are some of the main lessons learned from the Enron
scandal?
Click Here for Answer
How many facts at the height of Enron's success can your
recite? For example what were its 1999 sales, profits, and cash on hand
(at least as reported in Enron's somewhat fictional 1999 financial
statements)? How big were the subsequent earnings and debt
restatements? Who held the most stock? What was CEO Ken Lay's
salary before other benefits? How many employees did Enron have on the payroll
in 1999?
Click Here for Answers
When was Enron formed and who founded it?
Click Here for Answer
When Enron's name became Enron, a consulting firm was
paid over $1 million to recommend a name that turned into a laughing
stock. What was that absurd name that became an embarrassing joke?
Click Here for Answer
Who were the leading executives and Board of Director members
and what did they eventually earn from their stock sales until paying fines or
being forced to return money to Enron?
Click Here for Answer
What executive committed suicide by gunshot after Enron
imploded?
Click Here for Answer
What are some of the leading books that have been written about
Enron?
Click Here for Answer
What set Andy Fastow and Michael Kopper apart from most of the
other Enron executives prior to the illegal self declarations of bonuses from
a secret bank account set up just before Enron declared bankruptcy?
Who were the phony versus the real female whistleblowers at Enron?
Click Here for Answers
How did energy deregulation became a tangled mess?
What was the main source of the idea that Enron (before it was
named Enron) should extend into the energy trading line of business in
addition to its gas transmission line of business? Who did this person
work for at the time (it wasn't Enron)?
Click Here for Answer
In the simplest of terms, what is a special purpose entity (SPE)
and why is it allowed by the SEC to remain off the accounting books (the FASB
mainly went along with the SEC rule on these entities)? Discuss the pros
and cons of allowing SPEs to be unconsolidated in the books of the primary
investor.
Click Here for Answer
What was the first SPE formed by Enron that was approved by the
Board of Directors? What did Andy Fastow promise the Board, a promise
that he violated in the worst of possible terms?
Click Here for Answer
The first SPE was set up to hedge Enron's investment
appreciation in Rhythms NetConnection. A contractual obligation
prevented sale of the investment at a time when its high value was
volatile. Andy Fastow proposed an SPE designed to hedge against a fall
in the value of the Rhythms investment. What type of derivative
financial instrument was proposed to carry out this hedge? Explain how
the hedge would've worked optimally.
Click Here for Answer
What is most unusual and actually unethical about the way
Enron's SPEs were managed? How were these related party dealings
disclosed and yet obscured in the infamous Footnote 16 of Enron's Year 2000
Annual Report?
What did Professors Hartgraves and Benston conclude with respect to
accounting fraud and failings of both Enron and the external auditors
(Andersen) after a detailed analysis of the Powers Report commissioned by
the former Chairman of the Board of Directors at Enron?
Click Here for Answers
Frank Partnoy presented the best testimony before the U.S.
Senate about Enron's misuse of derivative financial instruments after Enron
imploded and was being investigated. Summarize Partnoy's major
conclusions about these hedging activities and their accounting.
Click Here for Answer
In round numbers, what is the amount Andy Fastow ultimately
admitted to skimming from over 3,000 SPEs he set up in Enron? What is
the best estimate of the actual amount he stole from his company?
Click Here for Answer
Was Andy Fastow considered a financial genius by financial
experts within Enron? Elaborate.
Click Here for Answer
Enron's auditing firm was Arthur Andersen (or just
Andersen). In the early 1990s, who was the managing partner on the Enron
audit from the Houston Office? What was Enron earning in audit billings
to Enron per year? What were the consulting fees per year paid to the
Andersen's Houston office?
Click Here for Answer
David Duncan became Andersen's managing partner of the Enron
audit in what year? Was Duncan a great accountant? What were his
credentials when Andersen made him the managing partner on the Enron
audit?
Click Here for Answer
At one point in 1999 Duncan privately agreed with his Andersen
colleague Carl Bass that Enron should take an added $______ charge to
earnings, but that these were not material. How much was this charge? Why do you really think Duncan did not want to force Enron to
make this charge?
Click Here for Answers
A WSJ reporter was the first to uncover Enron's secret "Related Party
Transactions." What reporter was this and what are those transactions
that he/she investigated?
Click Here for Answer
What is Chewco and why did it ultimately lead to a major split
between Enron and Andersen?
Click Here for Answer
Virtually all of Enron's executives benefited from massive
fraud just prior to the declaration of bankruptcy by Enron in December of
2001. What was this fraud?
Click Here for Answer
What Time Magazine's Woman of the Year was noted for a very foul
mouth?
Hint: She's best known for her whistle blowing memo. She was an
undervalued accounting executive without much to do. She finally took the
trouble on her own to unravel the exceeding complexity of one of Andy Fastow's
most complex SPEs that "had no skin."
Click Here for Answer
Did Rebecca Mark have a high level position in Enron?
Was
she competent?
What famous accounting ratio could she just not
comprehend?
Click Here for Answer
Aside from Andy Fastow's suggested use of SPEs for off-book
transactions, who was the main instigator of accounting irregularities for
items on the books of Enron?
What were some of the most typical
types of accounting irregularities?
Also mention some of Fastow's
accounting irregularities.
Click Here for Answer
Who is Jay Cooke and what does he have, if anything, to do
with the Enron scandal?
Click Here for Answer
What was the total of Jeff Skilling's stock sales and how much was he
eventually fined in 2006?
What are Ken Lay's secret recipes for looting
$184,494.426 from the corporation you manage?
What was Ken Lay's defense?
Answers to these questions can be found at
http://www.trinity.edu/rjensen/FraudEnron.htm#SecretRecipes
This includes Ken Lay's speech on December 13, 2005 ---
http://www.trinity.edu/rjensen/FraudEnron.htm#KenLayDefense
Will Phil and Wendy Gramm forever go unpunished in the
Enron scandal?
Click Here for Answer
Was Enron really a loser or did outside forces bring it down?
Click Here for Answer
Bob Jensen's Enron Updates are at
http://www.trinity.edu/rjensen/FraudEnron.htm#EnronUpdates
Bob Jensen's Enron Quiz Answers
What is the main temptation of white collar criminals?
Why do auditors often lose professionalism?
Jane Bryant Quinn
once said something to the effect that, when corporate executives and bankers
see billions of loose dollars swirling above there heads, it's just too
tempting to hold up both hands and pocket a few millions. I tell my
students that it's possible to buy an "A" grade in my courses but none of them
can possibly afford it. The point is that, being human, most of us are
vulnerable to some temptations in a weak moment. Fortunately, none of
you reading this have oak barrels of highly-aged whiskey in your cellars, the
world's most beautiful women/men lined up outside your bedroom door, and
billions of loose dollars swirling about like autumn leaves in a
tornado. Most corporate criminals that regret their actions later
confess that the temptations went beyond what they could resist.
What amazes me in this era, however, is how they want to steal more and
more after they already have $100 million stashed. Why do they want more
than they could possibly need?
See Bob Jensen's "Rotten to the
Core" document at
http://www.trinity.edu/rjensen/FraudRotten.htm
The exact
quotation from Jane Bryant Quinn at http://www.trinity.edu/rjensen/FraudRotten.htm#MutualFunds
Question
So who are usually the master chefs cooking the accounting books and what is
their main reason?
Answer: The executives wanting fat bonuses
Question:
What is the typical ploy?
Answer
Get the fat bonus and then issue revised financial statements. Who ever heard of executives having to give back the cash bonuses received after the financial statements are revised?
Example
Besides Enron, look at big fat Fannie Mae
Investigators have uncovered new evidence that
senior executives of Fannie Mae, the nation's largest buyer of home
mortgages, manipulated its accounting in the 1990's to meet earnings
projections so that top executives could receive more than $25 million in
bonuses. In a 2,600-page report that was made public today, former Senator
Warren Rudman and a team of lawyers and investigators concluded after an
18-month investigation that Fannie Mae's accounting practices "in virtually
all of the areas that we reviewed were not consistent with" generally
accepted accounting principles.
Stephen Labaton and Eric Dash, "Report on Fannie Mae Cites
Manipulation to Secure Bonuses," The New York Times, February 23, 2006 ---
Click Here
Report protects the fannies of
Fannie's Board of Directors: But executives are hit hard
They said the report criticizes Timothy Howard, the
company's former chief financial officer, and Leanne G. Spencer, the former
controller, for their roles in setting accounting policies. They added that
the report focuses less criticism on Franklin D. Raines, the former chief
executive, but says the company's management didn't keep the board
adequately informed about accounting problems. (See
related article)
James R. Hagerty, "Fannie Report On Accounting Shields Board,"
February 23, 2006; Page A2 ---
http://online.wsj.com/article/SB114066161292580888.html?mod=todays_us_page_one
Jensen Comment
Fannie Mae fired the KPMG auditing firm and is now spending over $140
million just to restate past financial statements. Most of the troubles
center on FAS 133 rules for reporting derivative financial instrument
hedges.
For a running account on Fanny Mae's accounting problems with FAS 133 see http://www.trinity.edu/rjensen/caseans/000index.htm
Examples of Book Cooking
Enron Corp. dipped into reserve accounts to
illegally pad earnings in 2000 and improperly delayed reporting large losses
in a retail energy operation the following year, former accountants
testified yesterday. The testimony began the fifth week in the criminal
conspiracy-and-fraud trial of former Enron Chairman Kenneth Lay and former
President Jeffrey Skilling. The testimony provided new support for the
Justice Department's accusations that the two top executives manipulated
results at the company. Wesley Colwell, former accounting chief of Enron's
wholesale energy unit, alleged he shifted a total of $14 million in July
2000 to create a two-cents-a-share boost to the company's second-quarter
results. He testified that an Enron finance executive told him that month
that Mr. Skilling was looking to "beat the Street" estimate of its
second-quarter earnings. Mr. Colwell, who is testifying under a cooperation
agreement with the government, paid a $500,000 fine to settle allegations by
the Securities and Exchange Commission that he manipulated earnings. His
agreement with the Justice Department requires that he testify to avoid
criminal prosecution. Three previous government witnesses, all former Enron
executives, pleaded guilty to crimes related to the energy giant. Mr.
Colwell, who is testifying under a cooperation agreement with the
government, paid a $500,000 fine to settle allegations by the Securities and
Exchange Commission that he manipulated earnings. His agreement with the
Justice Department requires that he testify to avoid criminal prosecution.
Three previous government witnesses, all former Enron executives, pleaded
guilty to crimes related to the energy giant.
Gary McWilliams and John R. Emshwiller, "Accountant Says Enron Dipped Into
Reserves to Pad Earnings," The Wall Street Journal, February 28,
2006; Page C3 ---
http://online.wsj.com/article/SB114105814931084345.html?mod=todays_us_money_and_investing
"Testimony Links Skilling, Lay To Alleged Effort to Hide Losses," by John
R. Emshwiller and Gary McWilliams, The Wall Street Journal, March 1,
2006; Page C2 ---
http://online.wsj.com/article/SB114114167255385382.html?mod=todays_us_money_and_investing
The former head of Enron Corp.'s retail-energy unit tied former President Jeffrey Skilling and former Chairman Kenneth Lay in testimony to an alleged effort to improperly hide hundreds of millions of dollars of losses in the division.
The testimony yesterday by David Delainey, who headed Enron Energy Services, or EES, was some of the most specific yet linking Messrs. Lay and Skilling to alleged wrongdoing. The former Enron president and chairman are in the fifth week of their federal fraud and conspiracy trial. Mr. Delainey has pleaded guilty to one count of insider trading and agreed to pay nearly $8 million in penalties. Like four previous witnesses, he is testifying for the government as part of a cooperation agreement.
Mr. Delainey took over the retail unit in early 2001 after having headed the company's profitable wholesale-energy trading operation. While Enron at the time was publicly portraying the retail unit as profitable and growing, Mr. Delainey contended yesterday that he found a problem-ridden unit burdened by hundreds of millions of dollars of losses. He said another senior executive had told him the unit's financial problems "could potentially bankrupt Enron."
At a March 29, 2001, meeting led by Mr. Skilling, Mr. Delainey testified, a decision was made to hide some of the big EES losses. Mr. Delainey said he argued the action, which involved moving some retail operations to the profitable wholesale unit, "lacked integrity" and shouldn't be done.
Continued in article
Bob Jensen's other Enron updates are at http://www.trinity.edu/rjensen/FraudEnron.htm#EnronUpdates
When trapped white collar criminals often cop a plea for some type of deal and then sit it out in Club Fed for a few months (e.g., Martha Stewart) or a few years (e.g., Andy Fastow) and then emerge to enjoy their stashed millions. In Andy Fastow's case it took slightly over two years for Enron's December 2001 collapse until Andy Fastow, in the face of overwhelming evidence, confessed on January 14, 2004.
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The following is from Kurt Eichenwald's, Conspiracy of Fools (Broadway Books, 2005, pp. 671-672) --- http://www.bookreporter.com/reviews2/0767911784.asp
Why white collar crime pays for Chief Enron Accountant: The Causey of It All --- At Long Last Of all the Enron accounting executives (Fastow was the CFO who knew epsilon about accounting) I wanted Rick Causey sent up river. Causey was the Chief Accounting Officer who worked out most of the accounting fraud and was the closest conspirator with David Duncan, Andersen's manager of the less-than-independent audit. Causey mysteriously was not called on to testify in the trials of Lay and Skilling, purportedly because he was "not a rat." It appears that he was a bit more of a rat than previously reported. "Ex-Enron Officer Given 5½ Years in Prison," The New York Times, November 16, 2006 --- http://www.nytimes.com/2006/11/16/business/16enron.html
Bob Jensen's threads on Rick Causey are at http://www.trinity.edu/rjensen/FraudEnronQuiz.htm "Ex-Enron Accountant Pleads Guilty to Fraud," Kristen Hays, Yahoo News, December 28, 2005 --- http://news.yahoo.com/s/ap/20051228/ap_on_bi_ge/enron_causey
Jensen Comment January 3, 2005 reply from Scott Bonacker [aecm@BONACKER.US]
Question Enron's E-mail (Email) messages are now part of the public record --- http://www.trinity.edu/rjensen/FraudEnron.htm#Email "10 Enron Players: Where They Landed After the Fall," The New York Times, January 29, 2006 --- http://www.nytimes.com/2006/01/29/business/businessspecial3/29profiles.html Bob Jensen's threads on how white collar crime pays even if you get caught --- http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays Bob Jensen's threads on the Enron/Andersen frauds --- http://www.trinity.edu/rjensen/FraudEnron.htm |
Many big-time white collar criminals have enough stashed to make
their crimes worthwhile even in the unlikely event that they get caught --- http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
Ed Ketz sums it up pessimistically at http://accounting.smartpros.com/x50181.xml
Accounting frauds are here to stay. When the prophet said "the heart is deceitful above all things," he included the hearts of corporate managers. Whatever one's religious beliefs, one has to admit that the empirical evidence in the world of corporate accounting confirms Jeremiah's insight. Managers don't employ accounting; they bend, twist, and distort it to display the set of numbers that helps them look good. Who cares about truth?
Continued in article
Enron Investors and Their Lawyers Aiming at Deep Investment Banking
Pockets
Andersen Coughs Up $72.5 More Millions for Enron's Investors
Lawyers representing Enron investors have
already won settlements for $7.3 billion of the $40 billion shareholders
claim they lost in Enron’s 2001 collapse. On Nov. 1, the latest settlement —
an agreement by Arthur Andersen, Enron’s former accounting firm, to pay
$72.5 million — was disclosed. But it is far from clear whether the
testimony of Mr. Fastow, a convicted felon who masterminded some of the
fraudulent transactions that hid the company’s poor financial health, will
be enough to push the seven banks that have not settled to the negotiating
table.
Lexei Barrionuevo, "Fastow Gets His Moment in the Sun," The New York
Times, November 10, 2006 ---
Click Here
Jensen Comment
The investment bankers, including Merrill Lynch, in the high rolling days of
Enron succumbed to CFO Andy Fastow's extortion threats of taking Enron's
business away if these investment bankers did not play ball his (corrupt)
way. Now it's ironic how he's returning to make the banks restore millions
to investors he destroyed.
Update on October 2007
Then how come Merrill Lynch is on the verge of escaping the wrath of investors because of its involvement in some of Enron's corporate and accounting frauds?
The Securities and Exchange Commission lays out the facts in various documents such as Litigation Release No. 20159 and Accounting and Auditing Enforcement Release No. 2619, and in the related Complaint in the U.S. District Court.
"The Accounting Cycle: The Merrill Lynch-Enron-Government Conspiracy," by: J. Edward Ketz, SmartPros, October 2007 --- http://accounting.smartpros.com/x59129.xmlIn a 2004 trial, a jury found these four Merrill executives guilty of participating in a fraudulent scheme. The former Merrill managers appealed the verdicts, and amazingly the Fifth Circuit tossed them out. The appellate court held that those bankers provided "honest services" and that they did not personally profit from the deal.
That argument assumes that getaway drivers supply honest services to bank robbers; after all, an oral agreement to repurchase the investment at 22 percent return is a strong signal that something is amiss with the transaction. The argument also shows a lack of understanding how managers profit in the real world. Investment bankers advance their careers by bringing in business that generates income for the bank; Merrill Lynch's executives did that with the Enron barge transaction, thereby promoting their careers, their promotions, and their salaries and bonuses, even if in an indirect fashion.
Why do auditors often lose professionalism?
For auditors the problem is more complicated, especially for those in charge of major local-office audits or those in charge of their entire firms of tens of thousands of employees around the world. Think of David Duncan who had the honor as a relatively young man to take charge of Andersen's audit of the huge Enron Corporation in 1997. David was not a shareholder in Enron and, unlike Andy Fastow, did not have greedy hands in the air while Enron's billions were swirling over his head.
David Duncan was torn apart by classical auditor conflicting responsibilities. On one side he had a huge responsibility to see that Enron abided by Generally Accepted Accounting Principles (GAAP) intended for fairness of information released to the investing public. He also was responsible for maintaining both internal and external public perceptions of Andersen's professionalism. On the other side he inherited hundreds of Andersen's Houston Office auditors and consultants working on Enron, some of whom were my former students. David Duncan was responsible for meeting the huge monthly payroll of his audit and consulting teams. Enron was a problematic client because there were higher than usual threats about taking Enron's business elsewhere if Andersen became too problematic in Enron's eyes. I might add that financial institutions like Citibank and Merrill Lynch faced similar problems of losing enormous cash flows from Enron if they did not overlook some of Andy Fastow's financial misdeeds.
Hundreds upon hundreds of Andersen's Houston Office
professionals would've been fired if David Duncan lost Enron as a
client. And these people were much closer to Duncan than unknown faces
in the investing public. David Duncan violated GAAP responsibilities in
favor of keeping Enron as a client. Not all Andersen auditors would've
done the same. Carl Bass, who worked at a high level on the Enron
audit, most certainly paid more homage to GAAP than David
Duncan. But the buck stopped at Duncan's desk, and this is why
Duncan forced Bass off the Enron audit.
What is discouraging is how the
CEOs at both Enron and Andersen preferred to remain in the dark about
accounting irregularities instigated by executives beneath themselves.
Ken Lay at Enron preferred not to hear about accounting book cooking that
helped to keep Enron share prices soaring. Several succeeding CEOs
at Andersen resisted putting in quality controls on large audits around the
world --- even when there were signs of bad auditing dating back to audit
failures such as Waste Management. Art Wyatt, a former high-level
executive partner with Andersen, captured the sentiment in his paper entitled
"ACCOUNTING PROFESSIONALISM --- THEY JUST DON'T GET IT" --- http://aaahq.org/AM2003/WyattSpeech.pdf
I attribute
many audit failures in every large large CPA firm to
the growth in size of the clients themselves. The U.S. auditing process
is flawed in design by having CPA auditors both responsible to the public and
beholding to fees paid to them by clients being audited. The potential
for conflict of interest is self evident since huge clients can destroy local
offices of large CPA firms by changing auditors.
The problem was not
so huge years ago when firms had many small clients and could afford to lose a
client in favor of standing on principles of professional
responsibility. The problem is huge today because local offices of these
firms often have a single enormous client like Enron, Exxon, Fannie Mae, or
General Electric upon which the future of the entire office resides.
Enron was paying Andersen's Houston office $1 million per week for auditing
and consulting services. Imagine any single local office losing cash
flow of $1 million per week!
Many theorists claim that the U.S.
auditing model is so flawed that auditing should be put in the hands of
the government. My response is that this would be even worse given the track
record as U.S. government being the source of the biggest frauds in world
history.
No auditing system will ever be perfect. All we
can do is struggle to constantly make our profession better and increasingly
ethical. We do have some help from the tort lawyers nipping at our heels
(actually our heads). You can read more about the Future of Auditing at
http://www.trinity.edu/rjensen/FraudConclusion.htm#FutureOfAuditing
The day Arthur Andersen loses the public's trust is
the day we are out of business.
Steve Samek, Country Managing
Partner, United States, on Andersen's Independence and Ethical Standards
CD-Rom, 1999.
When the Securities and Exchange Commission found
evidence in e-mail messages that a senior partner at Andersen had participated
in the fraud at Waste Management, Andersen did not fire him. Instead, it put
him to work revising the firm's document-retention policy. Unsurprisingly, the
new policy emphasized the need to destroy documents and did not specify that
should stop if an S.E.C. investigation was threatened. It was that policy
David Duncan, the Andersen partner in charge of Enron audits, claimed to be
following when he shredded Andersen's reputation.
Floyd Norris,
"Will Big Four Audit Firms Survive in a World of Unlimited Liability?," The
New York Times, September 10, 2004
Kurt Eichenwald, Conspiracy of Fools (Broadway Books,
2005, pp. 666-667) --- http://www.bookreporter.com/reviews2/0767911784.asp
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Andersen sought to settle but fumbled. The government demanded an admission of criminal liability, and at one point the two sides seemed close to a deal. But in the end Andersen balked, and the government walked away from the negotiating table. By that time a top prosecutor on the Enron Task Force, Andrew Weissmann, had secured a secret weapon: David Duncan. After mulling the matter for months, Duncan acknowledged that he must have destroyed documents with the knowledge that he would be keeping them away from the SEC. He agreed to plead guilty to one count of obstruction, and to serve as the chief witness against his former employer. The Andersen indictment for obstruction of justice ended
the company's last hope of survival. Clients fled in droves,
unwilling to allow a firm charged with a crime to serve as their
financial watchdog. Around the globe, Andersen partners jumped to
competing firms. By the time of Andersen's conviction in June,
only a small shell of the once great firm remained, and it announced
that it would cease auditing public
companies. |
"Last of 15 Enron Defendants Sentenced: Former Broadband Chief Gets Lesser Prison Term After Aiding Prosecutors," by Carrie Johnson, The Washington Post, June 19, 2007 --- Click Here
The former chief of Enron's Internet business unit was sentenced to 27 months in prison yesterday, closing what could be the final chapter in the Houston energy trader's downfall.
Kenneth D. Rice, 48, is the 15th and final Enron official to face punishment for his role in the company's bankruptcy more than five years ago. Under federal guidelines, he must serve nearly two years, or 85 percent, of the sentence handed down by U.S. District Judge Vanessa D. Gilmore yesterday in a Houston courtroom.
Kenneth D. Rice, shown with daughter Kirsten Rice, got a 27-month sentence. His testimony helped win the conviction of Enron's top two executives. (By F. Carter Smith -- Bloomberg News)
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"What got me here is, I lied over about a two-year period, on a number of occasions, to the investing community," Rice said yesterday, according to Bloomberg News. "I wasn't raised that way, and I'm ashamed of that."
Rice told the jury in last year's criminal trial of Enron's two top executives that he and others misrepresented the financial health of Enron Broadband Services, a highly touted division that posted billions of dollars in losses. His testimony helped prosecutors win the conviction of former chief executive Jeffrey K. Skilling, who is serving a prison term of 24 1/3 years. Company founder Kenneth L. Lay died in July 2006 before he could be sentenced.
Rice faced as much as a decade in prison and agreed to forfeit cash, sports cars and jewelry worth $14.7 million under the terms of his 2004 plea agreement. Between February 2000 and June 2001, Rice sold $53 million worth of Enron stock, some at a time when he later said he had access to secret information about its high debt burdens.
Once among Skilling's closest confidants and companions on off-road adventure tours, Rice ultimately turned against him. Rice was known within Enron's gleaming office towers as a risk taker who collected motorcycles and fast cars, including a Ferrari and a Shelby he turned over to the government as part of his plea deal.
Federal prosecutors Ben Campbell and Jonathan E. Lopez argued that Rice should receive a reduced prison term in exchange for his testimony against his former colleagues.
"Mr. Skilling would simply say . . . 'this is the number, this is what the number is going to be,' " Rice told jurors in February 2006 about the process of generating financial projections.
See the Future of Auditing at http://www.trinity.edu/rjensen/FraudConclusion.htm#FutureOfAuditing
Who are the two richest Enron executives to emerge unscathed
by Enron's scandal?
If you care to
know what Enron officials (the Cast of Characters) received in stock sales,
you can see a listing at http://www.trinity.edu/rjensen/FraudEnron.htm#StockSales
Lou Pai
First
there's the soap opera of Lou Pai, his strip tease dancers, his Colorado ranch
bigger than Rhode Island, and the mountain he named after himself.
An obscure and incompetent trading executive named Lou Pai is the biggest Enron stock sale winner (over $270 million) but that was sheer luck because he was sued for divorce by his wife while Enron's share prices were still soaring. Lou had an addiction for strippers to a point where he brought dancers back to Enron HQ to prove that he really was a wealthy executive.
He didn't particularly want to sell his Enron
stock at that time, but when he got a strip tease dancer pregnant Lou's wife
demanded a cash settlement in the divorce. That turned out to be the
luckiest timing in her or his life. I don't know how much the
dancer got in the end, but she did marry Lou immediately after his
divorce.
Rich Kinder
A former head of Enron's accounting area,
Rich Kinder, left the company in 1998 long before the scandal broke in
2001. He since has become a billionaire in his own newly formed company
Kinder Morgan. Little of his vast wealth arose from ill-gotten gains
from Enron. However, Enron's accounting books got cooked early on under
his watch while Andersen's auditors turned a blind eye.
And a lesser executive named Lou Pai cashed in his stock early on due to the luck of being divorced by his wife. The fortuitous timing of the sale back when Enron's stock was soaring could not be attributed to insider trading by investigators. He's the luckiest sinner (I literally mean sinner) on the planet.
Enron's Infamous Home Video of Rich Kinder's Retirement
Party
The video shot at Rich Kinder's retirement party at Enron features CEO Jeff
Skilling proposing Hypothetical Future Value (HPV)
accounting with in retrospect is too true to be funny during the subsequent
melt down of Enron.The people in this video are playing themselves and you
can actually see CEO Jeff Skilling, Chief Accounting Officer Richard Causey,
and others proposing cooking the books. You can download my rendering of a
Windows Media Player version of the video from
http://www.cs.trinity.edu/~rjensen/video/windowsmedia/enron3.wmv
You may have to turn the audio up full blast in
Windows Media Player to hear the music and dialog.
Let me add a bit more about Rich Kinder that appears as follows
at http://www.fool.com/news/foth/2003/foth030131.htm
| Once upon a time, a company named Enron Liquids Pipeline, L.P.,
owned and operated the pipelines that shipped the fuel Enron sold to
itself, while pretending to provide an energy marketplace. Even in
Enron's heyday, fuel eventually transferred across those pipelines and
went to customers to heat homes, cook food, and power automobiles and
factories.
Despite Enron's fraud and deceit, the pipeline company still exists today as Kinder Morgan Energy Partners (NYSE: KMP). The name changed when owners Rich Kinder and Bill Morgan bought it from Enron in 1996. This, of course, was well before the big E's ultimate undoing. And though Kinder was an Enron executive until joining Morgan, the companies' corporate governance practices were far afield from one another. To wit, Kinder Morgan still exists as a public company, while its more famous cousin does not. In fact, it has a history of growth in earnings, operational cash flow, and cash distributions. It also has decent prospects for continued growth and a solid business model that make its current, longer-term 11% profit-growth projections seem achievable. While fuel prices are volatile -- rising and falling in response to everything from the weather to Middle East tensions -- Kinder Morgan isn't in the fuel business; it's in the fuel distribution business. Big difference. It makes money based on the amount of fuel that passes through its pipelines. The price of that fuel, while a concern to the buyers and sellers at each end of the pipeline, is of no concern whatsoever to Kinder Morgan. The company has four distinct units: natural gas pipeline, products (liquid petroleum) pipelines, carbon dioxide pipelines, and terminals (coal and other dry materials). Diversification protects it from being slammed by relative price swings among differing energy sources. A price hike in coal that causes more people to shift from electric to natural gas heat, for example, would likely shift revenues from Kinder Morgan's terminals unit to its natural gas pipelines unit. The biggest risk for the company would be a wholesale decrease in energy usage across its portfolio of transport offerings. It has happened, but there's a greater tendency to cycle among fuel stocks. Kinder Morgan is the largest pipeline company in the U.S., and the business offers significant barriers for new entrants that help protect it from competition. Pipeline construction costs are significant, as are right-of-way acquisitions (ROWs), and the latter of the two is a decreasing resource. Once ROWs are granted, alternate sites have declining value and increasing cost of acquisition. Pipeline construction also requires political capital, particularly if the construction comes close to populated areas. Pipelines have statutory minimal maintenance standards to protect against catastrophes, regardless of the revenue generated by the pipeline. In other words, the ramp up of a new pipeline or a new pipeline company can get expensive in a hurry, before the pipeline has generated the first penny of revenue. Kinder Morgan's infrastructure is already in place, and it has sufficient volume through its pipelines to cover the maintenance charges. Why would a new competitor try to compete against that? The huge infrastructure costs required for pipelines also act as financial leverage for the company. A substantial part of Kinder Morgan's costs are static and must be paid regardless of business levels. Once those costs are covered, however, the incremental margins in the company's businesses become incredibly high. As more goods travel across the company's pipelines, a large fraction of that additional revenue travels straight to the bottom line. In the company's second quarter of 2002, for example, it had an 87% boost in its natural gas pipelines' operating income. Half of that income growth came from internal growth, such as higher pipeline utilization. The other half came through acquisitions. In the past, the partnership has benefited from acquiring assets from its affiliated company, Kinder Morgan Inc. (NYSE: KMI). There's also a third financial component company that's also publicly traded, Kinder Morgan Management (NYSE: KMR). Future acquisitions will need to take place in a more competitive environment, however. The field of possible acquisitions that would make substantial difference to Kinder Morgan's bottom line has narrowed as the company has grown. Were Kinder Morgan a smaller company, the tougher acquisition climate would look like a difficult obstacle to overcome. Since it leads the industry, however, the company can negotiate competitive deals from a position of strength. Kinder Morgan carries some Enron baggage due to its shared heritage and similar core business model -- both being pipeline companies at their bases. However, upon closer look, Kinder Morgan bears little resemblance to the Enron that collapsed. As Enron's fraud fed on itself, its reported profits grew much faster than the money it paid to its shareholders. As a limited partnership, Kinder Morgan has an extremely high distribution payment, and thus any attempt to fraudulently boost profits would ultimately be self-defeating. Higher reported profits would inevitably lead to higher cash payments to its partners, and if these reported profits were fraudulent, the company would quickly knife through its available cash. The Master Limited Partnership structure taken on by Kinder Morgan requires federal tax liabilities to pass through to the partners, who then pay tax on them. As such, to attract investors, the partnership must pay out high dividends (currently Kinder Morgan's yield sits at 6.8%). This eliminates the double taxation on dividends, but not without risk. Most public companies have limited liability protection; investors cannot lose more than they invest. In this type of partnership, however, there are two classes of partners: general and limited. The general partner has unlimited liability and can lose even unrelated assets, while the limited partners have standard limited liability protections. In Kinder Morgan's case, the general partner is owned by Kinder Morgan Inc., so owners of Kinder Morgan Energy units are protected from unlimited risk. Continued in article
|
How did Enron really lose so much money?
What are some of
the main lessons learned from the Enron scandal?
What major problems
remain?
Accounting Standard Setters Are Making Some Dangerous Mistakes in the Wake of
Enron
From a short seller who made a fortune at the expense of Enron shareholders
From an investor who is not in favor of "principles-based standards" relative to
"rule-based standards"
"Short-Lived Lessons From an Enron Short," by Jim Chanos, The Wall Street Journal, May 30, 2006; Page A14 --- http://online.wsj.com/article/SB114894232503965715.html?mod=todays_us_opinion
The convictions of Ken Lay and Jeff Skilling are less than a week old, and yet conclusions are already being drawn about whether "corporate wrongdoing" is a thing of the past. As someone with more than a passing interest in the Enron story -- I was, to quote Ken Lay's bizarre testimony, one of the "short-sellers that were organized and working together and conspiring together" against Enron -- I feel a need to examine what lessons those of us who slog it out daily in the corporate trenches might gain from Enron's spectacular collapse. I propose to offer the top 10 lessons from Enron that executives, investors and lawyers will soon forget:
1. The Enron scandal shows a need for a standards-based accounting system, rather than a rules-based one.
Wait a minute, you must be saying -- in the wake of Enron, don't we need more accounting rules to cover every possible situation, not some mushy "standards"-based guidelines?
No. It is precisely our "check-the-box" accounting rules that get written for every type of transaction that helped create the financial monster that was Enron. By having armies of clever bankers and lawyers pretzel-twist uneconomic deals into profit sources that conformed to GAAP ("Generally Accepted Accounting Principles," or "Good As Actual Profits" as it's sometimes known), dishonest management teams always hide behind the disclaimer that their accounting has been blessed by their auditors. The problem is, I can think of no major financial fraud in the 25 years I've been on Wall Street that did not have audited financials that conformed to GAAP! Yet reasonable independent auditors and audit committees, using the "standard" of economic common sense, would have unmasked most of the financial chicanery that became apparent at these companies only after their collapse.
2. Mark-to-Market accounting was not the problem at Enron, Mark-to-Model was.
Many casual observers of the Enron saga have pointed to the shortcomings of the Mark-to-Market (MTM) method of accounting that Enron used for its trading assets (i.e., the act of recording the price or value of a security, portfolio or account to reflect its current market value rather than its book value). But MTM is entirely appropriate -- and necessary -- for trading assets held at financial firms. How else would one handle valuation for assets that trade on verifiable exchanges and/or electronic networks?
In Enron's case, however, non-exchange traded assets and illiquid private deals were treated similarly, with today's "prices" derived by computer models that estimated future prices and volatility. The "estimates" in these models were helpfully provided by . . . Enron itself! As any capable financial economist will point out, today's market prices offer only a starting point for estimating future prices and volatility, which are, by definition, unknowable. In an MTM system with no independent source of current prices, when one feeds the "unknowables" of future prices and volatility, and the "probable" of time, into a computer, a "certain" current price is calculated! Neat, huh?
3. Off-balance-sheet deals and entities are "off" the balance sheet for a reason.
One would think that this concept would be pretty obvious, given the LJM, Jedi, Chewco, Deathstar, Jabba the Hut (OK, I made that last one up) monikers used to describe off-balance-sheet entities at Enron. One would be wrong. Yet it is my experience, pre- and post-Enron, that such accounting is used by companies to hide things they don't want investors to see. Pre-Enron saw silliness such as the Coca-Cola/Coca-Cola Enterprises "two-step," while today one can ponder the off-balance-sheet "land banking" that exists at the publicly traded U.S. homebuilders. If a company is determined to keep a significant aspect of its business off its books, investors should simply ask why.
4. Wall Street analysts don't "do" complex.
Isn't that what securities analysts are for, you might ask? Silly reader . . . analysis is for kids! Literally. At most large Wall Street firms, the tedious job of constructing financial models and answering client accounting queries is handled by the junior analyst on the team. It still shocks me today that when meeting with a team of "sell-side" Wall Street analysts from a firm to discuss a particular company, the senior analyst invariably concedes the answer to a complex financial question to a junior analyst working for him.
In a post-Eliot Spitzer world, how can this be? Simple. Senior analysts still spend most of their time on the road making client presentations. That is, of course, if they aren't playing golf with the CEO or organizing the menu at the next investor conference in Las Vegas. The recent attempts by certain companies to discourage hard-hitting independent research will only serve to maintain the chasm between those that "do the numbers" and those with, hopefully, the experience to know what the numbers mean.
5. The rating agency system breaks down when most needed. Rely on it at your own peril.
Time and again, when confronted with negative financial "surprises" by corporate issuers during the last decade, the "independent" ratings agencies fell down on the job. This kept slow-on-the-uptake investors dancing on the decks of numerous financial Titanics, while those heeding other signals (such as the burgeoning market for credit-default derivatives) prepared to man the lifeboats.
Whether it was the hubris of not wanting to precipitate a run on the bank (as if it wasn't happening already!), or the incompetence of one ratings agency analyst admitting to not having read the company's SEC filings, the shortcomings of an analyst-based ratings agency system became apparent in the Enron fiasco. Market-based price-discovery agents, such as short sellers in the equity market and purchasers of credit-default insurance in the bond/derivative markets, supplanted the Big Three ratings agencies as accurate predictors of Enron's financial distress.
6. Beware of, and question, unexpected executive resignations.
This lesson should seem obvious, but cognitive dissonance assures that it isn't. When Jeff Skilling resigned abruptly after six months as Enron's CEO, alarm bells should have been going off on Wall Street, as they were in Houston. But mindful of the still-bountiful fees Enron promised the Street, virtually every analyst covering Enron told his/her clients "all was well"! Didn't anyone find it disconcerting that despite claiming (the still undisclosed) "personal reasons" for his resignation, Mr. Skilling admitted on the front page of this newspaper the next day that if Enron's stock price had stayed up, "I don't think that I would have felt the pressure to leave"?
By asking the right questions, investors in August 2001 (with Enron's stock still at $40) might have been able to deduce that Enron's stock was not just a barometer of its financial health, but was also an actual component (through the investor-guarantee mechanism in the Fastow partnerships) of its health, as this newspaper's reporters would so convincingly point out two months later. Mr. Skilling hid the road map to Enron's future collapse on the front page of The Wall Street Journal, but few noticed.
7. Whistleblowers aren't whistleblowers if they blow their whistles inside the company walls.
Someone should inform Time magazine's Person-of-the-Year Department that writing a "cover-your-behind" memo to your boss about financial irregularities within the firm is not "whistleblowing." Having the guts to risk your job and reputation, by bringing evidence of those irregularities to the proper financial authorities, is. Enough said.
8. Special investigations by corporate boards are almost always a waste of time/money, and often prove highly misleading.
As a corollary to Lesson No. 7, when questions are raised internally about possible financial improprieties, corporate boards often hire counsel to conduct investigations on their behalf. This is done foremost for their own protection ("We investigated once we knew!"), and only incidentally to uncover unpleasant facts that such boards, charged with oversight as a duty, should've known about already. Many boards, in a wonderful example of willful blindness, simply don't want to know. In fact, one well-regarded Washington law firm forensic accounting SWAT team, headed by a former SEC enforcement director, managed to not find much wrong at either Enron or Tyco, despite abundant internal documents at their disposal. Such incompetence is highly rewarded in future corporate assignments. Rely on these reports at your own risk.
9. Character cannot be compartmentalized.
This lesson may be the most important of all. Investors and outside advisors often seem preoccupied with analyzing the formal propriety of specific corporate transactions, and the associated financial accounting. Questionable deals and disclosures are analyzed discretely, and not as part of any disturbing pattern of dubious corporate policies. Yet one had only to read the history of Ken Lay's involvement in the Valhalla energy-trading scandal at Enron in 1987 to detect a harbinger of scandals yet to come. That bad guys have a pattern of dishonest behavior should seem obvious, but it's not.
And, finally, 10: Friends do not let (possibly guilty) friends take the stand in criminal trials.
Let's face it, the Enron trials of Lay and Skilling had it all; greed, arrogance, an incompetent defense strategy (oh, how I wish short sellers had the power that Enron's defense team claimed we have!) and, of course, larger-than-life corporate villains. One would assume the high profile nature of the trial itself might underscore this observer's list of lessons learned from Enron's spectacular collapse. But thankfully, I'm pretty confident that they will be forgotten soon.
Mr. Chanos is managing partner of Kynikos Associates.
Bob Jensen's Enron Updates are at http://www.trinity.edu/rjensen/FraudEnron.htm#EnronUpdates
Bob Jensen's threads on the Enron/Andersen scandals are at http://www.trinity.edu/rjensen/FraudEnron.htm
Main Lessons Learned from Enron
Enron lost a lot of money on various ventures (especially most of its huge international ventures) that were dreamed up by young and inexperienced cowboy-type executives hired more for their supposed creativity than for experience and understanding of how to make sustained profits in business ventures.
However, the main reason Enron went under is that it departed from its fundamental lines of business and became good (at times) and very bad (at other times) in trades of derivative financial instruments that can be used (for hedging) and abused (for speculation). The executives in this line of business ran the operation poorly and sometimes illegally. For a time they got away with covering up their mistakes with creative accounting.
| Testimony of Frank Partnoy Professor of Law, University of San Diego
School of Law Hearings before the United States Senate Committee on
Governmental Affairs, January 24, 2002 --- http://www.senate.gov/~gov_affairs/012402partnoy.htm How did
Enron lose so much money?
|
On July 14, 2006, Greg Wilson inquired about what the implications of poor auditing are to investors and clients?
July 14, 2006 reply from Bob Jensen
Empirical evidence suggests that when an auditing firm begins to get a reputation for incompetence and/or lack of independence its clients’ cost of capital rises. This in fact was the case for the Arthur Andersen firm even before it imploded. The firm’s reputation for bad audits and lack of independence from Andersen Consulting, especially after the Waste Management auditing scandal, was becoming so well known that some of its major clients had already changed to another auditing firm in order to lower their cost of capital.
Bob Jensen
Bob Jensen's threads on fraudulent and incompetent auditing are at http://www.trinity.edu/rjensen/FraudConclusion.htm#IncompetentAudits
Bob Jensen's threads on accounting and auditing theory are at
http://www.trinity.edu/rjensen//theory/00overview/theory01.htm
Bob Jensen's threads on the Andersen/Enron/Worldcom scandals are at http://www.trinity.edu/rjensen//theory/00overview/theory01.htm
July 14, 2006 reply from Ed Scribner [escribne@NMSU.EDU]
I think the conventional wisdom is that poor audits reduce the ability of information to reduce uncertainty, so investors charge companies for this in the form of lower security prices.
In a footnote on p. 276 of the Watts and Zimmerman "Market for Excuses" paper in the April 79 Accounting Review, WZ asserted the following:
***
Share prices are unbiased estimates of the extent to which the auditor monitors management and reduces agency costs... . The larger the reduction in agency costs effected by an auditor (net of the auditor's fees), the higher the value of the corporation's shares and bonds and, ceteris paribus, the greater the demand for that auditor's services. If the market observes the auditor failing to monitor management, it will adjust downwards the share price of all firms who engage this auditor... .
***Sometime in the 1980s, Mike Kennelley tested this assertion on the then-recent SEC censure of Peat Marwick. (I think his article appeared in the Journal of Accounting and Economics, but I can't find it at the moment.) The Watts/Zimmerman footnote suggests a negative effect on all of Peat Marwick's client stock prices, but Mike, as I recall, found a small positive effect.
Because agency theory seems to permit arguing any side of any argument, a possible explanation was that the market interpreted this adverse publicity as a wakeup call for Peat Marwick, causing it to clean up its act so that its audits would be impeccable.
A couple of other examples of the empirical research:
(1) Journal of Empirical Legal Studies Volume 1 Page 263 - July 2004 doi:10.1111/j.1740-1461.2004.00008.x Volume 1 Issue 2
Was Arthur Andersen Different? An Empirical Examination of Major Accounting Firm Audits of Large Clients Theodore Eisenberg1 and Jonathan R. Macey2
Enron and other corporate financial scandals focused attention on the accounting industry in general and on Arthur Andersen in particular. Part of the policy response to Enron, the criminal prosecution of Andersen eliminated one of the few major audit firms capable of auditing many large public corporations. This article explores whether Andersen's performance, as measured by frequency of financial restatements, measurably differed from that of other large auditors. Financial restatements trigger significant negative market reactions and their frequency can be viewed as a measure of accounting performance. We analyze the financial restatement activity of approximately 1,000 large public firms from 1997 through 2001. After controlling for client size, region, time, and industry, we find no evidence that Andersen's performance significantly differed from that of other large accounting firms.
... Hiring an auditor, at least in theory, allows the client company to "rent" the reputation of the accounting firm, which rents its reputation for care, honesty, and integrity to its clients.
... From the perspective of audit firms' clients, good audits are good investments because they reduce the cost of capital and increase shareholder wealth. Good audits also increase management's credibility among the investment community. In theory, the capital markets audit the auditors.
------------------------------------
(2) Journal of Accounting Research Volume 40 Page 1221 - September 2002 doi:10.1111/1475-679X.00087 Volume 40 Issue 4Corporate Financial Reporting and the Market for Independent Auditing: Contemporary Research Shredded Reputation: The Cost of Audit Failure Paul K. Chaney & Kirk L. Philipich In this article we investigate the impact of the Enron audit failure on auditor reputation. Specifically, we examine Arthur Andersen's clients' stock market impact surrounding various dates on which Andersen's audit procedures and independence were under severe scrutiny. On the three days following Andersen's admission that a significant number of documents had been shredded, we find that Andersen's other clients experienced a statistically negative market reaction, suggesting that investors downgraded the quality of the audits performed by Andersen. We also find that audits performed by Andersen's Houston office suffered a more severe decline in abnormal returns on this date. We are not able to show that Andersen's independence was questioned by the amount of non-audit fees charged to its clients.
Ed Scribner
New Mexico State University, USA
Top Enron Executives are now convicted felons
"Lay, Skilling Are Convicted of Fraud: Jurors Reject Defense Claim That Enron Was Clean; Question of Credibility Two 'Very Controlling People'," by John R. Emshwiller, Gary McWilliams, and Ann Davis, The Wall Street Journal, May 26, 2006; Page A1 --- http://www.trinity.edu/rjensen/FraudEnron.htm#EnronUpdates
The convictions of former Enron Corp. chairman Kenneth Lay and former president Jeffrey Skilling decimated their high-stakes argument that Enron was a law-abiding company done in by newspaper reports, short-sellers and market panic. The jury's decision cemented the once-highflying energy company's legacy as one of the most egregious corporate offenders of the 1990s.
The verdicts yesterday against both men on numerous federal fraud and conspiracy charges cap a string of prosecutions in which hundreds of senior corporate executives at numerous companies have been held accountable for wrongdoing on their watches.
Once viewed as one of the biggest business success stories of the 1990s, Enron collapsed in 2001, the first of a string of corporate scandals. Its fall marked a dramatic end to the stock-market boom and the beginning of a wave of corporate and regulatory reforms, including the 2002 Sarbanes-Oxley law.
Juror Kathy Harrison, an elementary-school teacher, said after the verdicts that she hoped executives at other companies would realize that "those in charge have responsibility. There's too much hurt here. If something good can come out, companies can be aware that they must be conscientious." (Read more reactions to the verdicts.)
After delivering their verdicts, the Enron jurors said they had focused partly on the credibility of the two former executives. In a risky legal strategy, both men had argued that no crimes were committed at Enron, apart from a few largely irrelevant ones involving former Chief Financial Officer Andrew Fastow. Messrs. Lay and Skilling both testified during the trial, and both faced withering cross-examinations by prosecutors.
Judge Sim Lake read the string of guilty verdicts in a packed courtroom. Both defendants stood calmly as family members gasped and some began to sob.
Mr. Skilling, 52 years old, was convicted on 19 of 28 counts of conspiracy, fraud and insider trading. He was acquitted on nine counts of insider trading. Mr. Lay, 64, was convicted on all six conspiracy and fraud counts he faced. After reading the jury verdicts, Judge Lake also found Mr. Lay guilty of all four counts in a separate banking-fraud case heard by the judge while the jury was deliberating.
After the verdicts were announced, Mr. Lay joined more than a dozen friends and family members in a circle in one corner of the courtroom to pray. One of Mr. Lay's supporters, Rev. Bill Lawson, could be heard invoking the story of Jesus, "who was convicted and even executed," he said.
"We'll all come through this stronger," said Mr. Lay, occasionally tugging at the hand of his wife, Linda, who had sat through the entire four-month trial. Later, Mr. Lawson said he advised Mr. Lay "to hang in there and trust God."
In a telephone interview last night, Mr. Skilling said that when he was pronounced guilty on the first count of conspiracy, "that floored me. God, there was no conspiracy." He said that the relatively short jury deliberations had raised his hopes. But "we were just on a tilted football field," he said, referring to going on trial in Enron's headquarters city.
The convictions came despite Messrs. Lay and Skilling putting on one of the most expensive criminal defenses ever, spending an estimated $60 million. Both men remain free pending sentencing, which is set for Sept. 11. Each faces many years in prison.
Attorneys for both men said they would appeal the verdicts, which came on the sixth day of jury deliberations that many observers had expected to stretch for weeks. The verdict "doesn't change our view of what happened at Enron, or of Jeff Skilling's innocence," said a clearly upset Daniel Petrocelli, Mr. Skilling's lead lawyer. "We told our story and the jury disagreed with it."
At a press conference after the verdicts, several jurors said that government witnesses, many of them former Enron executives testifying as part of plea bargains, had convinced them that illegal activities had occurred at Enron, and that the defendants were responsible.
Defense lawyers had decided to put both Mr. Skilling and Mr. Lay on the stand. "I wanted badly to believe what they were saying," said juror Wendy Vaughan, a small-business owner. But "there were places in their testimony where I felt their character was questioned," she said.
"Both men said they had their hands firmly on the wheel" of the company, said another juror, elementary-school principal Freddy Delgado. For the two executives to later claim they didn't know about wrongdoing, said Mr. Delgado, was "not the right thing."
Continued in article
What are some of the main lessons learned from the
Enron scandal?
I especially like "Suggestions for Reform" listed
at http://www.citizenworks.org/corp/reforms.php
A pretty good summary of lessons learned is provided at http://www.law.northwestern.edu/professionaled/documents/Ruder_Lessons_Enron.pdf
"Enron’s Lasting Influence," AccountingWeb, January 10,
2006 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=101647
With the former Enron executives finally coming to trial, we are reminded again of the long shadow cast by the implosion of the company that helped enact the Sarbanes-Oxley (SOX) Act of 2002. Section 404 has added teeth to SOX, making regulation more expensive and staff intensive and the Public Company Accounting Oversight Board (PCAOB) has been created to aid in the governance and enforcement of the accounting industry. Audit committees have attained more important positions in corporate structures and are more attuned to avoid the conflicts of being both auditor and consultant for the same company. At the same time, with the collapse of Arthur Andersen, the consolidation of the Big Five to the Big Four now have four accounting firms doing the work for more than 90 percent of publicly traded companies, according to the New York Times.
“We certainly have seen some improvements in governance, but we’ve also seen some areas of no improvement, and some areas where things have gone backwards,” said Lynn E. Turner, speaking to the New York Times. Turner is the former chief accountant at the Securities and Exchange Commission (SEC) and now managing director of research at Glass, Lewis & Company.
The outright accounting scandals of WorldCom, Tyco, and Adelphia have now morphed into companies making financial restatements. Glass, Lewis & Company reports that earnings restatements numbered 1,031 through the end of October 2005, compared with 650 for 2004 and 270 in 2001, according to the New York Times. John C. Coffee, speaking in the Los Angeles Times, said the restatements were not necessarily evidence of fraud but shows the tighter focus of accountants.
Also, more than 1,250 public companies, out of around 15,000 in total, reported material weaknesses in their internal corporate controls in October 2005. Some 232 other companies reported less serious, but significant deficiencies in their internal controls, according to the New York Times.
In contrast, a new study shows that the number of securities class-action suites has come down 17 percent in 2005. The 176 filed in 2005 is the lowest since 1997, according to Cornerstone Research and Stanford Law School. 1998 saw 239 suites, the highest number in recent years, according to the Los Angeles Times.
Christopher Cox, chairman of the SEC, said in a late December interview with the New York Times, that he agreed that more should be done, disclosing his intention to lead a commission effort to rewrite rules forcing companies to provide more financial details concerning executive pay.
Tighter accounting and disclosure rules enacted to enhance the transparency of financial information have lead to an industry-lead backlash. Cox said to the New York Times that it “would be a mistake” to retract major provisions of SOX.
“The shocks were so big that no director could miss the lesson and if they did miss somehow, the significant changes in the law made it absolutely certain that they are now more focused,” Cox added. “With just a few years of Sarbanes-Oxley under their belts, most companies are begrudgingly admitting that the exercise is producing benefits.”
SOX has sincere proponents though, institutional and pension investor groups being the most vocal. Alan G. Hevesi, New York comptroller of one of the nation’s largest institutional investors, has been leading the effort to increase corporate accountability. Speaking with the New York Times, Hevesi said, “We’ve had some successes in corporate governance reform. In other words – such as giving a greater voice to shareholders to elect independent directors and curbing excessive executive compensation – we haven’t been as successful. I worry about whether the necessary reforms have really been institutionalized.”
Executives say that restatements are healthy signs of change according to the New York Times although, “The general impression of the public is that accounting rules are black and white. They are often anything but that, and in many instances the changes in earnings came after new interpretations by the chief accountant of the S.E.C.," said Steve Odland, Office Depot’s CEO and head of a corporate governance task force at the Business Roundtable.
Accounting scandals are more often settled with the SEC or actions filed by the agency now. For example, AcAfee, the Internet security company, has agreed to settle charges made by the SEC that they inflated revenues by some $622 million between 1998 and 2000. Their penalty will be $50 million. The settlement is awaiting court approval.
The SEC filed a civil lawsuit against six former executives then employed by an unnamed transfer-agent unit of Putnam Investments last week. They allegedly defrauded mutual funds and clients out of some $4 million in 2001. Also the judge has ruled that SEC testimony will be allowed into the trials of former Enron executives Jeffrey Skilling and Kenneth Lay.
Bob Jensen's threads on reforms are at http://www.trinity.edu/rjensen/FraudProposedReforms.htm
Bob Jensen's threads on the Enron/Andersen scandals are at http://www.trinity.edu/rjensen/FraudEnron.htm
What major problems remain?
Some of the remaining problems are mentioned at
http://www.s-ox.com/news/detail.cfm?articleID=225
Frank Partnoy thinks problems will remain as long as the over-the -counter (OTC) markets in derivatives continue to operate in a nearly unregulated market where insiders can exploit investors. For a review of his books on this, and a summary of worldwide derivatives frauds in general, go to http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
How many facts at the height of Enron's success can your
recite? For example what were its 1999 sales, profits, and cash on hand
(at least as reported in Enron's somewhat fictional 1999 financial
statements? How big were the subsequent earnings and debt restatements?
Who held the most stock? What was CEO Ken Lay's salary before other
benefits? How many employees did Enron have on the payroll in 1999?
Sales in 1999: $40,112,000,000
Net Income: $893,000,000
Cash on hand at end of 1999: $288,000,000
In 2001 Enron had
slightly over 10,000 full-time employees, about half of which worked out at
its headquarters in Houston. Some writers place this number at 20,000
but I've never been able to confirm such a high number.
When Enron declared bankruptcy in December 2001 it was the seventh largest corporation in the United States and once dreamed of world domination in the energy market --- http://news.bbc.co.uk/2/hi/business/3400201.stm
There were subsequent restatements after accounting fraud was
detected. You can read about the impacts of these restatements at http://www.law.northwestern.edu/professionaled/documents/Ruder_Lessons_Enron.pdf
| 1997 earnings of $105 million were reduced by $28 million, 1998 earnings of $703 million were reduced by $133 million, 1999 earnings of $893 million were reduced by $153 million, 2000 earnings of $979 million were reduced by $91 million. Reported debt was increased by over $500 million for each of the years 1997 through 2000, as follows: 1997 - $711 million 1998 - $561 million 1999 - $685 million 2000 - $628 million The announced restatements of earnings, increased debt, and reduction of shareholder equity caused third parties in the trading community to lose confidence in Enron and to cease trading with the company. The result was a collapse of Enron’s ability to trade in the energy markets. Some have described this loss of confidence as the equivalent of a run on the bank. Others have described Enron’s collapse as due to market reaction to the disclosures regarding Enron’s earnings and balance sheet. In any event, Enron’s stock collapsed and the company filed for bankruptcy in mid-December of 2001. |
You can read the following at http://www.corpwatch.org/article.php?id=457
| Top Individual Stock Holders
BELFER, ROBERT A., 1.18% (PRX 03-21-2000) Common Stock RUBEN, LAWRENCE, JR., ET AL, 1.43% (PRX 03-21-2000) Common
Stock Chairman and CEO Kenneth L. Lay US Political Connections As of June 2000, Enron had contributed $10,265 to Sen. Slade Gorton 's Campaign (Center for Responsive Politics) As of January 2000, Enron had contributed $99,750 to George W. Bush's Presidential Campaign - the 11th largest contributor to Bush's campaign (Center for Responsive Politics) Kenneth Lay contributed a total of more than $100,000 to Bush's gubernatorial campaigns of 1994 and 1998, this made Lay's Bush top 21st individual donor (Associated Press, April 7, 2000) Kenneth Lay and his wife, Linda contributed $76,000 to the Republican National State Elections Committee since 1997 (Associated Press, April 7, 2000) Enron's total lobbying expenditures for 1998 were $1,600,000. Of this, $200,000 was lobbying expenditures for Enron Wind Corp. (Center for Responsive Politics) Enron hired former members of Pres. George Bush's Cabinet, Secretary of State James Baker and Commerce Secretary Robert Mosbacher in 1993 to help develop overseas projects. Mosbacher had served on the board of Enron in the 1980's (The New York Times, February 23, 1993) New Jersey State Attorney General is accusing Enron of violating state laws that prohibit some energy providers from making donations to politicians (Megawatt Daily, March 27, 2000) Foreign Political Involvement In order to get approval from the British Government to purchase one of Britain's largest public water utilities, Enron funneled "Labour almost pounds 30,000 in the last two years" (The Independent (London), September 11, 1998) Shortly after his father won the US Presidency in 1988, George W. Bush called the Argentine Minister of Public Works, Rodolfo Torragno to pressure him to accept Enron's "laughable" bid for a large pipeline project. (Mother Jones, March 1, 2000; The Nation, November 21, 1994) There were accusations in Panama that Enron was using it's influence with Energy Minister Luis Carlos Valenzuela to force the state oil company to sign a "sweetheart deal" with Enron to export natural gas to Central American (Latin America Energy Alert, December 8, 1999; The Nation, May 22, 2000) "Gas giant Enron Corp.'s plan to develop Mozambique's Pande natural gas field appears to have been saved from cancellation last month by a blunt threat from the U.S. National Security Council to cut off future U.S. aid to the country." (The Oil Daily, December 1, 1995) Enron beat out South Africa's state petroleum company, Sasal to build the pipeline in 1995 and recently sold the gas and oil rights to Sasal. Enron and Native Peoples in the United States Manager of Enron's American Indian Affairs is Roger Fragua. In 1997, Confederated Tribes of Warms Springs, Oregon, expressed their wish to gain control over the three Portland General Electric Co. hydropower dams on the Tribes' land in order to restore abandoned fish ladders. Enron owned PGE and "intended to keep the license". (Engineering News-Record, August 4, 1997) In early 2000, Enron Corp.'s Portland General Electric Co. agreed to sell stakes in its hydroelectric system over four decades to the Tribes, (Houston Chronicle, February 2, 2000). At the same time, Enron is in the process of selling it's interests in PGE to Sierra Pacific Resources. (Inside F.E.R.C.'s Gas Market Report, March 17, 2000) Activists challenging Enron's wind farm on the Columbia River Gorge "maintain that Enron has been unresponsive to tribal and environmental concerns, refusing to reply to repeated invitations to visit the site or meet with elders." (Indian Country Today (Lakota Times) April 12, 2000) In testimony to the US Congress in 1999, Enron's manager of American Indian Affairs stated, "We seek Tribal partners that are motivated in seeking "for-profit" energy projects that are culturally, environmentally and economically sound Enron has a long history of responsibly working with many American Indian Tribes...". (Federal Document Clearing House Congressional Testimony, July 1, 1999) Kenneth L. Lay, CEO and Chairman of Enron, received the American Spirit Award from the Council of Energy Resource Tribes in 1988. The award is "given to a corporate executive who has supported CERT and its efforts to enhance higher education opportunities for American Indian students in the fields of science, engineering and business". (Coal, March 1988) Enron and the Environment In 1996, Enron received the Corporate Conscience Award for Environmental Stewardship sponsored by the Council on Economic Priorities. (PR Newswire, June4, 1996) Patagonia, Inc, an outdoor clothing and equipment company committed to environmentally friendly business decisions, purchases all of its electricity from Enron Wind, the first company in California to do so. (The Energy Report, July 13, 1998) Enron's pipeline project with Florida Gas Transmission Co, was found in violation 109 times regarding wetlands destruction and improper land clearing and damaging waterways in 1994. It paid $575,400 in fines. (Oregonian, August 6, 1996 and Southeast Energy Power Report, December 16, 1994) Enron and Dutch Shell's pipeline in Bolivia ruptured on January, 2000, and spilled 29,000 barrels of crude petroleum. This contaminated "hundreds of acres of organic farmland, killing fish and birds in the Andes' lake Poopo, and destroying the livelihood of a 5,000 year old native tribe, Uru Morato". Enron and it's Bolivian partner, Transredes has spent $ 10-mil so far on the oil spill, and clean-up has not yet been completed, a spokesman for Enron Corp, which owns 50% of Transredes, said late Mar 21. (Friends of the Poopo and the Uru Morato, Vermont, USA and Platt's Oilgram News, March 23, 2000) Enron, Shell and Transredes are building a 390 mile pipeline in Bolivia that has "brought serious environmental and social problems " to local communities living along its path. They have so far experienced, "pollution of local water resources, degradation of local roads, soil and air pollution". (A World Class Disaster: The Case of the Bolivia-Cuiaba Pipeline, A Report on the Failures of Enron International to Comply with Bolivian Environmental Laws and OPIC Loan Conditions in the Construction of the Lateral Ipias-Cuiaba Gas Pipeline, December 8, 1999) Activist have been pressuring the US Overseas Private Investment Corporation to pull it's support of the Cuiaba Pipeline Project, however, Enron has stated that it will proceed with the project, whether or not it gets OPIC funding. (Financial Times (London) July 15, 1999) International Violations Enron's activities with their Dabhol Power project in India has been documented by Human Rights Watch as violating the human rights of locals protesting the project, the largest power plant in the world. "The Dabhol Power Corporation and it's parent company, Enron, are complicit in these human rights violations. Enron's local entity, the Dabhol Power Corp. benefited directly from an official policy of suppressing dissent through misuse of the law, harassment of anti-Enron protest leaders and prominent environmental activists, and police practices ranging from arbitrary to brutal". (The Enron Corporation: Corporate Complicity in Human Rights Violations, Jan 1999, Human Rights Watch) Enron's water division, Azurix Corp, is the city water supply company for the community of Bahia Blanca in Buenos Aires. In April, 2000, the water supply was laced with toxic bacteria that caused skin irritation and possible neurological damage. (Reuters, April 25, 2000) The World Bank is objecting to the terms of a power purchase agreement between Enron and the state of Lagos (Nigeria) in December of 1999. The terms are too favorable to Enron: they acquired a long-term right to sell power to Lagos without competitive bidding; can charge a high price for the fuel used by its power plant; cannot be penalized for the poor performance of its plants; does not fully bear the completion risks for the plants under its control; benefits from generous arrangements for payment security; and would receive excessive contract termination payments. (EIU Views Wire, May 25, 2000) Enron Wind 13000 Jameson Rd. Telephone: 661-823-6700 In 1999, Enron Wind agreed to relocate a proposed wind farm away from endangered California Condor flight patterns after The National Audubon Society and Tejan Ranch began a public campaign targeting Enron Wind after the California Energy Commission approved development of the project. (Global Power Report, November 12, 1999) Enron's Board of Directors (Proxy, March 23, 2000) NORMAN P. BLAKE, JR., 58 Director since 1993 Mr. Blake is the Chief Executive Officer and Secretary General of the United States Olympic Committee. Mr. Blake served as Chairman, President and Chief Executive Officer of the Promus Hotel Corporation from December, 1998 until November, 1999 wh |