Enrons Fall

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Enrons Fall
Kenneth Lay – CEO
Auditors – Arthur Anderson
Jeffrey Skilling – Consultant, Hired as a young consultant, as due to deregulation, Enron incurred massive debts. Jeffrey skilling was hired to come up with innovative new ideas. His revolutionary idea for Enron was to ‘create a gas bank in which Enron would buy gas from a network of suppliers and sell to a network of consumers, contractually guaranteeing both the supply and the price, charging fees for the transactions and assuming the associated risks’ Lay impressed with Skillings brilliance, created a separate division for him to run, Enron Finance Corp. Due to their market dominance, Enron could predict the future prices with great accuracy and where therefore able to generate superior profits.

Skiling in 1996 became the chief operating officer, and sold the idea that the ‘gas bank’ concept could be incorporated into the electric industry. Soon after Enron acquired Portland General Electric Corp.

With profits skyrocketing, ‘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’

Skilling hired Andrew Fastow in 1990, who became his protégé. Working his way up swiftly, became the financial chief officer in 1998.

PRC – Performance Review committee, ranked from 1-5, 1 meaning you got closer to skilling, 5 meaning you usually got fired within 6 months. Everyone then became instantly motivated to work harder to generate more profits

As the internet and technology market was growing vastly, In 2000 Enron and blockbuster announced a deal to provide high speed internet just electricity and gas flowed to consumers. They would provide the service of movies on demand to any household. INVESTING hundreds of millions of pounds with very little return the deal became insignificant

Mark to Market accounting – “Whenever companies have an outstanding energy-related or other derivative contracts on their balance sheet at the end of a particular quarter, they must adjust them to fair market value, booking unrealised gains and losses to the income statement of the period.”

“Unrealised trading gains accounted for slightly more than half of the company’s $1.41 billion reported pretax profit for 2000 and about one-third of its reported pretax profit for 1999.”

Due to each new market entrants following in Enrons footsteps, Enrons profit margin was squeezed further and therefore reverted to running the company with increasing leverage “thus becoming more like a hedge fund than a trading company”

Strategic goals were ignored and deals carried out eventually totally disregarded the company’s risk management policies”

With leverage increasing outside of the legal bounds and Fastows attempts to lobby the rating agencies at the credit rating company to no avail, Fastow would soon find other means to lower their debt ratio.

Fastow would “reduce hard assets while earnings increasing paper profits served to increase Enron’s return on assets and reduce its debt-to-total-asset ratio, making the company more attractive to credit rating agencies and investors”

SPE – Special Purpose Entities, typically used by companies to isolate the firm from financial risk. Commonly used to hide debt, hide ownership, and obscure relationships between different entities which are in fact related to each other. A company will transfer assets to the SPE for management or use the SPE to finance a large project thereby achieving a narrow set of goals without putting the entire firm at risk.

By using SPE, Enron were able to hide their debt elsewhere while showing profits in their own financial reports and also able to leverage more as the more SPE, the more a company is permitted to leverage.

Enron would ‘park’ troubled assets into various SPE, and in exchange offer large issuance of stock and shares down the line. “as the value of the assets in these...
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