Its a detailed presentation on Enron Scam

1. ask why.
ENRON
Smartest Guys in the Room
By Phoenix

2. Company’s Profile
• Enron is a USA based Company formed in 1985 by Kenneth
Lay from a merger of Houston Natural Gas Company and
InterNorth Inc., It was the first nationwide natural gas
pipeline network in Houston, Texas.
• Enron Corp ranked 7th on the Fortune 500 list of Companies.
• Enron employed approximately 22,000 employees.
• It was one of the world's leading electricity, natural
gas, pulp, paper, and communications companies, with
claimed revenues of nearly $101 billion in 2000.
• Enron was named "America's Most Innovative Company" for
six consecutive years.

3. Areas of Business
Enron
Enron Whole Enron Energy Enron’s
Sale Services Services Global Assets

4. Wholesale Services
• Enron Wholesale Services- encompasses Enron's global wholesale
businesses, and is divided into four business units.
Enron America Enron Europe
Enron Global Markets Enron Net Works
Energy Services
• Enron Energy Services (EES) was a business unit of Enron
Corporation.
• The purpose of EES was to provide gas, electricity, and energy
management directly to businesses and homes.

5. Global Assets
• Enron Transportation Services:
It oversees Enron's regulated, interstate natural gas pipelines.
• Enron had assets spread across :
Central America and the Caribbean
South America
Europe
Asia Pacific

6. Enron’s Products
Enron traded in more than 30 different products, which included
the following:
• Products traded on EnronOnline : Petrochemical, Plastics, Power, Pulp &
Paper, Steel, Weather Risk Management.
• Oil & LNG Transportation.
• Broadband.
• Principal Investments.
• Risk Management for Commodities.
• Energy transportation and upstream services.
• Capital and risk management services.
• Energy and commodities services, etc.

7. Kenneth Lay
• He was a son of Baptist Preacher.
• He was an American businessman.
• He was the CEO and Chairman of Enron from 1985 to 2002.
• He was one of the Crusaders of Deregulation in energy sector
specially oil, natural gas and electricity.
• He was America’s highest paid CEO’s with a compensation
package of $42.4 million in 1999.

8. Enron Oil Trading – The Vahalla Scandal
• Enron Oil Trading (EOT) was a unit of InterNorth Inc. formed
in 1984 which is located in Valhalla, Newyork.
• Louis Borget was hired to head the EOT and Tom Mastroeni
was another trader of EOT.
• Enron Oil Trading was a profitable unit.
• It generated profit $28 million in the year 1986.
• When Enron was incurring losses, EOT was reporting profits.

9. Enron Oil Trading – The Vahalla Scandal
• It was suspected that EOT is exceeding its oil trading limits, Oil
trading is like gambling where sometimes you win and
sometimes you loose, but Enron was always making profits
while the others incurred losses.
• Enron Traders made bets whether the price of Oil will rise or
fall. They started trading recklessly and destroyed daily
trading records.
• Internal Auditor of Enron were contacted by an officer at the
Eastern Savings Bank.
• He said there was some unusual transaction going on in which
Enron Bank Account was involved.

10. Enron Oil Trading – The Vahalla Scandal
• In further investigation it was found that there was a
diversion of company’s fund to the personal accounts and
various Offshore Accounts of Tom Mastroeni in the name of
“M. Yass” which stood for “MY ASS”.
• Ken Lay who was CEO during that time was made aware
about oil trading transactions.
• Ken Lay did not take any action against both the traders
Borget and Mastroeni because they were making profits for
the company.

11. Jeffrey Skilling
• He was a MBA graduate from Harvard Business School.
• He worked as a consultant for McKinsey and Company.
• He helped Enron in 1987 to create a Forward market in
natural gas.
• Skilling impressed Kenneth Lay in his capacity as a consultant
and was hired as a chairman and CEO of Enron Finance Corp.
• His only condition while joining the company was to adopt
Mark to Market accounting.
• He quit the company on August 14,2001.

12. Mark to Market Accounting
• Meaning of Mark to Market.
• Use of Mark to Market Accounting.
• Mark to Market in Enron.
• Arthur Anderson signed off and the SEC approved it.
• Mark to Market allowed Enron to book potential future
profits on the very day the deal was signed, no matter how
little cash actually came in the door.
• To the outside world Enron’s profit could be whatever Enron
said they were.

13. Lou Pai
• Lou Pai is a Chinese-American businessman.
• Made CEO of Enron Energy Services and Enron Xcelerator, a
venture capital division of Enron.
• He and his traders went to club and spent money on strippers
which was charged to Enron’s account.
• He left Enron with over $250 million but the divisions incurred a
total loss of $1 billion . He became the second largest land
owner in Colorado.

14. Investment in India
• Enron began to investigate opportunities in the Indian power sector
in 1992, when India first opened its power sector to private foreign
investors.
• By June 1992, Enron had selected Dabhol as the site for a
project, and, with General Electric, Enron entered a memorandum
of understanding with the Maharashtra State Electricity Board
(MSEB) to build the Dabhol project.

15. Dabhol Project - India
• But Enron had failed to see something basic, India couldn’t
afford to pay for the power Enron produced. Enron lost a
billion dollar on the project and paid out multimillion bonuses
to executives based imaginary profits which never arrived.

16. Special Purpose Entities
• What is a SPE?
• Rule for Consolidation of Accounts of SPE.
• Important SPE’s created by Enron:
1. BRAVEHEART
2. JEDI
3. CHEWCO
4. LJM 1 and LJM SWAP SUB L.P.
5. LJM 2
6. RAPTORS 1,2,3 AND 4

17. 1. BRAVEHEART
• Enron entered into a partnership with Blockbuster (A major
Video rental Company).
• Portland General Electric (PGE) – A subsidiary of Enron.
• nCube – Oracle founder Jim Ellison’s private technology
company.
• CIBC – Investment Banking division of Canadian Imperial
Bank of Commerce.
• Braveheart – An SPE owned by Enron and CIBC.
• Outcomes of the SPE.

18. 2. JEDI – Joint Energy Development Investments
• Enron entered into partnership with CALPERS.
• CALPERS – California State Retirement System.
• Named after the Star Wars movie Characters.
• ENRON to sell high risk assets to JEDI in return for IOU’s
backed by ENRON stock as collateral.
• Outcomes of the SPE.
CALPERS
50% INTEREST ENRON
50% INTEREST
$250 million IN
ENRON STOCK
JEDI

19. 3. CHEWCO
• Enron entered into a second partnership with CALPERS.
• CALPERS wanted to cash out from JEDI and invest in new
partnership.
• Enron formed a new partnership Chewco consisting of Enron
Executives and some outside investors.
• Chewco was named after another Star Wars character
Chewbacca.
• Legality of this SPE.
• Outcomes.

20. Chewco Chart
ENRON
CALPERS
Guarantee
$240 million
BARCLAY’S $1,25,000 WILLIAM DOBSON
CHEWCO &
BANK MICHAEL KOPPER
Loan given by Barclay’s
BIG RIVER for a cash reserve of
& $6.6 million (security)
JEDI
LITTLE RIVER given by JEDI.

21. Andrew Fastow – CFO ENRON
• An American businessmen who served as a Chief Financial
Officer of Enron Corporation.
• He was one of the key figures behind the complex web of off
Balance Sheet SPE’s which were used to conceal Enron’s
massive losses.
• His main job was to keep the stock prices up even though the
company had a $ 30 billion debt.
• He created hundreds of SPE’s designed to transfer Enron’s
Debt to an outside company and get it off the books of Enron
without giving up the control of the assets that stood behind
the debt.
•

22. Andy Fastow’s SPE strategy

23. 4. LJM1 and LJM Swap Sub L.P.
• LJM1 was created and controlled by Fastow and was named
for the initials of his wife and Children (Lea, Jeffrey and
Michael).
• LJM Swap Sub L.P. (AKA Swap Sub) is a SPE created in 1999.
• Enron’s investments in Rhythms NetConnections.
• Creation of Enron would help Andy earn $45 million for
himself.
Invests $10M for 5.4 million Shares
Enron Rhythms
Rhythms
goes public
Value of after
Listing.

24. 5. LJM2 Co-Investment L.P.
• In October 1999, Fastow created LJM2.
• It was the second version of the same idea.
• Fastow would act as a General Partner of a larger private
equity fund.
• It was funded with $200 million by 96 individual bankers.
• $25 million each was contributed by banks like:
a. J.P. Morgan Chase d. Citi Bank and
b. Credit Suisse e. Deutsche Bank.
c. Meryl Lynch

25. 6. Raptors
Raptors1 - Talon :
• LJM2 contributed $30 million in cash.
• Enron Contributed $1000 in cash, a promissory note for $50
million and Enron Stock and Stock Contracts worth $537 million.
• In Exchange Enron received Limited Interest in Talon and a
promissory not for $400 million.
• Enron agreed to pay $41 million as a premium for put option on
7.2 million shares of Enron Stock.
• This $41 million was immediately distributed to LJM2.

26. Talon

27. 6. Raptors
Ex: Of a Trade in Raptor 1:
Talon was used to hedge Enron’s investment in Avici Systems Inc.
an internet architecture firm. Enron owned a large share of
company’s stock and on September 15, 2000 it entered into a
total return swap with Talon on Avici stock. At that time it was
traded at $95.50 per share. However the swap agreement was
dated as of August 3rd. This was also the day on which Avici stock
traded at $162.50 per share, its all time high. By september 30
when Avici had dropped to $95 per share, Enron offset $75
million in losses as result of the swap.

28. 6.Raptors
Raptors 2 and 4: Timberwolf and Bobcat:
• Essentially structured like raptor 1.
• Outside partners contributed $30 million and received $41
million as premium for put options on Enron Stock.
Raptors 3 – Porcupine:
• Enron contributed shares in an Enron created company, The
New Power Company (TNPC) in exchange for a promissory
note for $259 million.
• Enron and Porcupine had entered into a total return swap of
$18 million shares of TNPC stock at $21 per share.
• Enron gained $370 million in this transaction.

29. Porcupine

30. Problems with Raptors
• The Raptors were designed to protect Enron’s financial
statements against losses from declines in the market value
of a variety of investments held in its “merchant portfolio”.
This depended on the credit worthiness of the Raptors. If that
became questionable, Enron would have to record credit
reserves, negating the positive effects of the hedges. For
Talon, Timberwolf, and Bobcat this required that the value of
Enron stock (their only asset) increase to offset the significant
losses they incurred on most of their derivative transactions
with Enron. Porcupine, however, had to rely on the value of
its TNPC stock, the same stock it was hedging.

31. CALIFORNIA ENERGY SCAM: Breakthrough
• Eyes on California to make the stock prices go up.
• Enron exploited the “DREGULATION” option in California to
manipulate electricity supply and charge high price for electricity.
• Drought, delays in approval of new power plants and market
manipulation decreased supply.
• 800% increase in wholesale prices.
• “Megawatt” laundering
• “Overscheduling”

32. Result of California Crisis
• Rolling blackouts.
• Artificial demand – supply gap was created.
• Electricity bills sky-rocketed.
• Widespread outrage.

33. Result of California Crisis

34. Sherron Watkins – The Whistleblower
• On August 13,2001 Jeff Skilling resigns and on August
15, 2001 Sherron Watkins, an Enron Vice President writes to
Lay expressing concerns about Enron’s accounting practices.
• On August 22, 2001 Sherron Watkins meets with Lay and
gives him a letter in which she says that Enron might be an
elaborate Hoax.
• On February 14, 2002 she testifies before congressional panel
against Skilling and Lay.

35. Outcomes of the Scams
• Enron's shareholders lost $74 billion in the four years before
the company's bankruptcy ($40 to $45 billion was attributed
to fraud).
• Enron’s more than 20,000 former Employees lost $2 billion in
pensions.
• Employees lost more than $1.2 billion in retirement funds.
• Enron’s top executives cashed in $116 million in stock.
• 20,000 employees lost there jobs and medical insurances.

36. Prosecutions
Andrew Fastow –
faced 98 counts, pleaded guilty to one charge of conspiracy to
commit wire fraud and one charge of conspiracy to commit
wire and securities fraud. Fastow has agreed to serve 6 years
in prison and forfeit $23.8 million, including homes in
Galveston and Vermont; and forfeit claims on another $6
million held by third parties.
Jeffrey Skilling –
Named in 35-count indictment, Skilling pleads not guilty to
wire fraud, securities fraud, conspiracy, insider trading and
making false statements on financial reports.

37. Prosecution
• On May 25, 2006 Skilling convicted on 19 of 28 counts of
conspiracy, fraud, insider trading, and false statements.
Skilling gets 24 years and 4 months of imprisonment and
forfeits $45 million.
Kenneth Lay –
Indicted on 11 criminal counts of fraud and making misleading
statements , Ken Lay, surrenders to the FBI. After pleading
not guilty.
On May 25,2006 Lay convicted on all six counts of conspiracy
and fraud, In July Lay dies before sentencing.

38. Arthur Anderson
• They where the Auditors of Enron Corporation.
• In 1991, they signed off on Mark to Market Accounting.
• They approved the SPE’s created by Andy Fastow.
• On Oct 23, 2001 where Lay assures the employees about the
companies wellbeing at same time just a few blocks
away, Arthur Anderson shredded 1 Ton of Enron Documents.
• On March 14, 2002 Arthur Anderson LLP indicted for
obstruction of Justice for destroying Tons of Enron
Documents.

39. Arthur Anderson
• On April 09, 2002 David Duncan, Enron’s Auditor pleads guilty
to obstruction.
• On August 31, 2002 the firm surrenders its license to practice
accounting.
• On Oct 16, 2002 sentenced to probation and a $500,000 fine
and banned from auditing public companies.
• On March 13, 2007 Arthur Anderson will pay $72.5 million to
investors who sued the firm for its involvement in Enron
Scandal.

40. Introduction to Sarbanes Oxley Act
• July 30, 2002 by President George W Bush.
• Corporate scandals, companies such as Enron, WorldCom and Tyco.
• Senator Paul Sarbanes and Representative Michael G Oxley, who
drafted the Sarbanes-Oxley Act of 2002.
• Objective: "To protect investors by improving the accuracy and
reliability of corporate disclosures made pursuant to the security
laws, and for other purposes."

41. An insight into the Act
• Corporate accountability
• It changes how corporate boards and executives must
interact with each other and with corporate auditors.
• It removes the defense of "I wasn't aware of financial issues”
• New financial reporting responsibilities,
• Adherence to new internal controls and procedures.

42. Who the Act applies to
• All public companies in the U.S.
• International companies that have registered equity or debt
securities with the Securities and Exchange Commission (SEC) and
• The accounting firms that provide auditing services to them.

43. Objectives of SOX Audit
• Data accuracy and safeguarding financial data.
• Assessment of the Internal Controls and its effectiveness.
• Auditing firm is required to attest to that assessment.

44. Disclosure Requirements
1. All material off-balance sheet transactions
2. Special purpose entities must be disclosed in annual and quarterly
financial reports.
3. If a company uses pro forma numbers earlier it must show what
the financial results would be, using GAAP
4. Legal insider trading must be reported within two business days.
5. Other material changes must be reported on a “rapid and current
basis.”
6. Any waiver of company’s ethical code, must be disclosed.

45. Consequences of Non Compliance
BEHAVIOUR SENTENCE
The alteration, destruction, concealment of any records with Fine and/or up to 10 years imprisonment.
the intent of obstructing a federal investigation.
Failure to maintain audit or review “work papers” for at least Fine and/or up to 5 years imprisonment.
five years.
Anyone who “knowingly executes, or attempts to execute, a Fine and/or up to 10 years imprisonment.
scheme” to defraud a purchaser of securities.
Any CEO or CFO who “recklessly” violates his or her Fine of up to $1,000,000 and/or up tp 10 years
certification of the company’s financial statements. imprisonment.
If “willfully” violates. Fine of up to $5 million and/or up to 20 years
imprisonment.
Two or more persons who conspire to commit any offense Fine and/or up to 10 years imprisonment.
against or to defraud the U.S. or its agencies.
Any person who “corruptly” alters, destroys, conceals, etc., Fine and/or up to 20 years imprisonment.
any records or documents with the intent of impairing the
integrity of the record or document for use in an official
proceeding.
Mail and wire fraud. Increase from 5 to 20 years imprisonment.
Violating applicable Employee Retirement Income Security Various lengths depending on violation
Act (ERISA) provisions.

46. Conclusion
• Enron was a massive failure, partly because of its size, partly
because of its complexity, partly because the controls to
protect the integrity of capital markets failed, and especially
because of the massive greed and collusion of key
participants. Management failed, auditors failed, analysts
failed, creditors/bankers failed, and regulators failed. The
intersection of multiple failures sent a signal of structural
problems. Suddenly, the consequence of deceptive financial
data resulting from structural failure in the capital markets
was not merely a hypothetical possibility. The speed with
which the system responded indicates the importance of
fairly presented financial information.
• .
•

47. Questions