Enron Corporation Essay

Enron Corporation began as a small natural gas distributor and, over the course of 15 years, grew to become the seventh largest company in the United States. Soon after the federal deregulation of natural gas pipelines in 1985, Enron was born by the merging of Houston Natural Gas and InterNorth, a Nebraska pipeline company. Initially, Enron was merely involved in the distribution of gas, but it later became a market maker in facilitating the buying and changeing of futures of natural gas, electricity, broadband, and other products. However, Enrons continuous growth eventually came to an end as a involved pecuniary statement, role player, and multiple scandals sent Enron through a downward spiral to bankruptcy.During the 1980s, several major national energy corporations began lobbying Washington to deregulate the energy trade. Their exact was that the extra competition resulting from a deregulated market would benefit both businesses and consumers. Consequently, the national g overnment began to lift controls on who was allowed to produce energy and how it was marketed and sold. However, as competition in the energy market increased, gas and energy prices began to fluctuate greatly. Over time, Enron incurred massive debts and no longer had exclusive rights to its pipelines. It needed some new and innovative business strategies.Kenneth Lay, chairman and CEO, hired the consulting firm McKinsey & Company to assist in developing a new plan to help Enron get back on its feet. Jeffrey Skilling, a young McKinsey consultant who had a background in banking and asset and liability management, was assigned to work with Enron. He recommended that Enron create a gas bank to buy and remove gas. Skilling, who later became chief executive at Enron, recognized that Enron could capitalize on the fluctuating gas prices by acting as an intermediary and creating a futures market for buyers and sellers of gas it would buy and sell gas to be used tomorrow at a st fit price tod ay.Although brilliantly successful in theory, Skillings gas bank idea faced a major problem. The natural gas producers who agreed to supply Enrons gas bank desperately needed cash and required cash as payment for their products. Enron also had insufficient cash levels. Therefore, management decided to team up with banks and other financial institutions, establishing partnerships that would provide the cash needed to complete the transactions with Enrons suppliers. Under the direction of Andrew Fastow, a newly hired financial genius, Enron also created several special-purpose entities (SPEs), which served as the vehicles through which money was funneled from the banks to the gas suppliers, thus keeping these transactions off Enrons books. As Enrons business became more(prenominal) and more complicated, its vulnerability to fraud and eventual disaster also grew. Initially, the newly formed partnerships and SPEs worked to Enrons advantage. Yet in the end, it was the creation of these SPEs that culminated in Enrons death.Within just a a few(prenominal) years of instituting its gas bank and the complicated financing system, Enron grew rapidly, controlling a large part of the U.S. energy market. At one point, it controlled as much as a quarter of all of the nations gas business. It also began expanding to create markets for other types of products, including electricity, crude oil, coal, plastics, weather derivatives, and broadband. In addition, Enron go along to expand its traffic business and, with the introduction of Enron Online in the late 1990s, it became one of the largest trading companies on Wall Street, at one time generating 90% of its income through trades. Enron soon had more contracts than any of its competitors and, with market dominance, could predict future prices with great accuracy, thereby guaranteeing superior profits.To continue enhanced growth and dominance, Enron began hiring the best and brightest traders. However, Enron was just as qui ck in firing its employees as it was in hiring new ones. Management created the Performance Review Committee (PRC), which became known as the harshest employee ranking system in the country. Its method of evaluating employee surgical process was nicknamed rank and yank by Enron employees. Every 6 months, employees were ranked on a scale of 15. Those ranked in the lowest category (1) were today yanked (fired) from their nonplus and replaced by new recruits. Surprisingly, during each employee review, management required that at least 15% of all the employees ranked were given a 1 and indeed yanked from their position and income. The employees ranked with a 2 or 3 were also given notice that they were liable to be released in the near future. These ruthless capital punishment reviews created fierce internal competition amidst fellow employees who faced a strict ultimatum perform or be replaced. Furthermore, it created a work environment where employees were futile to express opi nions or valid concerns for fear of a low ranking score by their superiors.With so much pressure to succeed and maintain its position as the global energy market leader, Enron began to jeopardize its integrity by committing fraud. The SPEs, which originally were used for good business purposes, were now used illegally to handle bad investments, poorly performing assets, and debt to manipulate cash flows and eventually, to report more than $1 billion of preposterous income. The following are examples of how specific SPEs were used fraudulently.Chewco In 1993, Enron and the California Public Employees Retirement System (CalPERS) formed a 50/50 partnership called Joint Energy Development Investments Limited (JEDI). In 1997, Enrons Andrew Fastow established the Chewco SPE, which was designed to repurchase CalPERSs fate of equity in JEDI at a large profit. However, Chewco crossed the bounds of legality in devil ways.First, it stone-broke the 3% equity rule, which allowed corporation s such as Enron to not consolidate if outsiders contributed even 3% of the capital, but the other 97% could come from the company. When Chewco bought out JEDI, however, fractional of the $11.4 million that bought the 3% equity involved cash collateral provided by Enronmeaning that only 1.5% was owned by outsiders. Therefore, the debts and losses incurred at Chewco were not listed where they belonged, on Enrons financial reports, but remained only on Chewcos separate financial records.Second, because Fastow was an Enron officer, he was, therefore, unauthorized to personally run Chewco without direct approval from Enrons board of directors and public disclosure with the SEC. In an effort to secretly bypass these restrictions, Fastow appointed one of his subordinates, Michael Kopper, to run Chewco, under Fastows close supervision and influence. Fastow continually applied pressure to Kopper to prevent Enron from getting the best possible deals from Chewco and, therefore, giving Michae l Kopper huge profits.Chewco was eventually forced to consolidate its financial statements with Enron. By doing so, however, it caused large losses on Enrons balance sheet and other financial statements. The Chewco SPE accounted for 80% (approximately $400 million) of all of Enrons SPE restatements. Moreover, Chewco set the stage for Andrew Fastow as he continued to expand his personal profiting SPE empire.LJM 1 and 2 The LJM SPEs (LJM1 and LJM2) were two organizations sponsored by Enron that also participated heavily in fraudulent deal making. LJM1 and its successor, LJM2, were similar to the Chewco SPE in that they also broke the two important rules set forth by the SEC. First, although less than 3% of the SPE equity was owned by outside investors, LJMs books were kept separate from Enrons. An delusion in judgment by Arthur Andersen allowed LJMs financial statements to go unconsolidated. Furthermore, Andrew Fastow (at that time CFO at Enron) was appointed to personally oversee al l operations at LJM. Without the governing controls in place, fraud became inevitable.LJM1 was first created by Fastow as a result of a deal Enron made with a high-speed Internet service provider called Rhythms NetConnections. In March 1998, Enron purchased $10 million worth of shares in Rhythms and agreed to hold the shares until the end of 1999, when it was authorized to sell those shares. Rhythms released its first IPO in April 1999 and Enrons share of Rhythms stock immediately jumped to a net worth of $300 million.Fearing that the value of the stock might drop again before they could sell it, Enron searched for an investor from whom it would purchase a put option (i.e., insurance against a falling stock price). However, because Enron had such a large share and because Rhythms was such a unstable company, Enron could not find an investor at the price Enron was seeking. So, with the approval of the board of directors and a waiver of Enrons code of conduct, Fastow created LJM1, w hich used Enron stock as its capital to sell the Rhythms stock put options to Enron. In effect, Enron was insuring itself against a plummeting Rhythms stock price. However, because Enron was basically insuring itself and paying Fastow and his subordinates millions of dollars to run the deal, Enron really had no insurance. With all of its actions independent of Enrons financial records, LJM1 was able to provide a hedge against a profitable investment.LJM2 was the sequel to LJM1 and is infamous for its meshing in its four major deals known as the Raptors. The Raptors were deals made between Enron and LJM2, which enabled Enron to hide losses from Enrons unprofitable investments. In total, the LJM2 hid approximately $1.1 billion worth of losses from Enrons balance sheet.LJM1 and LJM2 were used by Enron to alter its veritable financial statements and by Fastow for personal profits. Enrons books took a hard hit when LJM finally consolidated its financial statements, a $100 million SPE r estatement. In the end, Fastow pocketed millions of dollars from his involvement with the LJM SPEs.Through complicated accounting schemes, Enron was able to fool the public for a time into thinking that its profits were continually growing. The energy giant cooked its books by conceal significant liabilities and losses from bad investments and poor assets, by not recognizing declines in the value of its aging assets, by reporting more than $1 billion of false income, and by manipulating its cash flows, often during fourth quarters. However, as soon as the public became aware of Enrons fraudulent acts, both investors and the company suffered. As investor faith in Enron dropped because of its fraudulent deal making, so did Enrons stock price. In just 1 year, Enron stock plummeted from a high of about $95 per share to below $1 per share. The decrease in equity made it impossible for Enron to cover its expenses and liabilities and it was forced to declare bankruptcy on December 2, 200 1. Enron had been reduced from a company claiming almost $62 billion worth of assets to nearly nothing.