Case Assignment 2

You will complete a Case Assignments from Business Ethics: Ethical Decision Making and Cases. You will answer the questions at the end of the case in 4–5 pages (double spaced), not including the title or reference pages. The Case Assignments must be written in current APA format. In addition to the Ferrell textbook, utilize outside sources on the case questions. All sources must be of a scholarly nature; the sources must be either textbooks or journal articles from peer-reviewed journals. At least 5 references are required in addition to the course textbooks and the Bible. As this is a paper that requires research, it must be written in third person.Case Assignment 2 can also be found in the Ferrell textbook. The case is Case 9, “Enron: Questionable Accounting Leads to Collapse.” The paper must have at least 3 Level 1 headings that correspond to the following case points:How did the corporate culture of Enron contribute to its bankruptcy?In what ways did Enron’s bankers, auditors, and attorneys contribute to Enron’s demise?What role did the company’s Chief Financial Officer play in creating the problems that led to Enron’s financial problems?I have attached the case from the textbook below.Here are the questions at the end of the case:How did the corporate culture of Enron contribute to its bankruptcy?Did Enron’s bankers, auditors, and attorneys contribute to Enron’s demise? If so, how?What role did the company’s chief financial officer play in creating the problems that led to Enron’s financial problems?
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Introduction
Once upon a time, there was a gleaming office tower in Houston,
Texas. In front of that gleaming tower was a giant “E,” slowly
revolving, flashing in the hot Texas sun. But in 2001, the Enron
Corporation, which once ranked among the top Fortune 500
companies, would collapse under a mountain of debt that had
been concealed through a complex scheme of off-balance-sheet
partnerships. Forced to declare bankruptcy, the energy firm laid
off 4,000 employees; thousands more lost their retirement
savings, which had been invested in Enron stock. The company’s
shareholders lost tens of billions of dollars after the stock price
plummeted. The scandal surrounding Enron’s demise
engendered a global loss of confidence in corporate integrity
that continues to plague markets today, and eventually it
triggered tough new scrutiny of financial reporting practices. In
an attempt to understand what went wrong, this case will
examine the history, culture, and major players in the Enron
scandal.
Enron’s History
The Enron Corporation was created out of the merger of two
major gas pipeline companies in 1985. Through its subsidiaries
and numerous affiliates, the company provided goods and
services related to natural gas, electricity, and communications
for its wholesale and retail customers. Enron transported
natural gas through pipelines to customers all over the United
States. It generated, transmitted, and distributed electricity to
the northwestern United States, and marketed natural gas,
electricity, and other commodities globally. It was also involved
in the development, construction, and operation of power
plants, pipelines, and other energy-related projects all over the
world, including the delivery and management of energy to
retail customers in both the industrial and commercial business
sectors.
Throughout the 1990s, Chairman Ken Lay, CEO Jeffrey Skilling,
and CFO Andrew Fastow transformed Enron from an old-style
electricity and gas company into a $150 billion energy company
and Wall Street favorite that traded power contracts in the
investment markets. From 1998 to 2000 alone, Enron’s
revenues grew from about $31 billion to more than $100 billion,
making it the seventh-largest company in the Fortune 500.
Enron’s wholesale energy income represented about 93 percent
of 2000 revenues, with another 4 percent derived from natural
gas and electricity. The remaining 3 percent came from
broadband services and exploration. However, a bankruptcy
examiner later reported that although Enron had claimed a net
income of $979 million in that year, it had really earned just $42
million. Moreover, the examiner found that despite Enron’s
claim of $3 billion in cash flow in 2000, the company actually
had a cash flow of negative $154 million.
Enron’s Corporate Culture
When describing the corporate culture of Enron, people like to
use the word “arrogant,” perhaps justifiably. A large banner in
the lobby at corporate headquarters proclaimed Enron “The
World’s Leading Company,” and Enron executives believed that
competitors had no chance against it. Jeffrey Skilling even went
so far as to tell utility executives at a conference that he was
going to “eat their lunch.” This overwhelming aura of pride was
based on a deep-seated belief that Enron’s employees could
handle increased risk without danger. Enron’s corporate culture
reportedly encouraged flouting the rules in pursuit of profit.
And Enron’s executive compensation plans seemed less
concerned with generating profits for shareholders than with
enriching officer wealth.
Skilling appears to be the executive who created the system
whereby Enron’s employees were rated every six months, with
those ranked in the bottom 20 percent forced out. This “rank
and yank” system helped create a fierce environment in which
employees competed against rivals not only outside the
company but also at the next desk. The “rank and yank” system
is still used at other companies. Delivering bad news could
result in the “death” of the messenger, so problems in the
trading operation, for example, were covered up rather than
being communicated to management.
Ken Lay once said that he felt that one of the great successes at
Enron was the creation of a corporate culture in which people
could reach their full potential. He said that he wanted it to be a
highly moral and ethical culture and that he tried to ensure that
people honored the values of respect, integrity, and excellence.
On his desk was an Enron paperweight with the slogan “Vision
and Values.” Despite such good intentions, however, ethical
behavior was not put into practice. Instead, integrity was
pushed aside at Enron, particularly by top managers. Some
employees at the company believed that nearly anything could
be turned into a financial product and, with the aid of complex
statistical modeling, traded for profit. Short on assets and
heavily reliant on intellectual capital, Enron’s corporate culture
rewarded innovation and punished employees deemed weak.
Enron’s Accounting Problems
Enron’s bankruptcy in 2001 was the largest in U.S. corporate history at
the time. The bankruptcy filing came after a series of revelations that
the giant energy trader had been using partnerships, called “specialpurpose entities” or SPEs, to conceal losses. In a meeting with Enron’s
lawyers in August 2001, the company’s then-CFO Fastow stated that
Enron had established the SPEs to move assets and debt off its balance
sheet and to increase cash flow by showing that funds were flowing
through its books when it sold assets. Although these practices
produced a very favorable financial picture, outside observers believed
they constituted fraudulent financial reporting because they did not
accurately represent the company’s true financial condition. Most of the
SPEs were entities in name only, and Enron funded them with its own
stock and maintained control over them. When one of these
partnerships was unable to meet its obligations, Enron covered the debt
with its own stock. This arrangement worked as long as Enron’s stock
price was high, but when the stock price fell, cash was needed to meet
the shortfall.
After Enron restated its financial statements for fiscal year 2000 and the
first nine months of 2001, its cash flow from operations went from a
positive $127 million in 2000 to a negative $753 million in 2001. With
its stock price falling, Enron faced a critical cash shortage. In October
2001, after it was forced to cover some large shortfalls for its
partnerships, Enron’s stockholder equity fell by $1.2 billion. Already
shaken by questions about lack of disclosure in Enron’s financial
statements and by reports that executives had profited personally from
the partnership deals, investor confidence collapsed, taking Enron’s
stock price with it.
For a time, it appeared that Dynegy might save the day by providing
$1.5 billion in cash, secured by Enron’s premier pipeline Northern
Natural Gas, and then purchasing Enron for about $10 billion. However,
when Standard & Poor’s downgraded Enron’s debt to below investment
grade on November 28, 2001, some $4 billion in off-balance-sheet debt
came due, and Enron did not have the resources to pay. Dynegy
terminated the deal. On December 2, 2001, Enron filed for bankruptcy.
Enron now faced 22,000 claims totaling about $400 billion.
The Whistle-Blower
Assigned to work directly with Andrew Fastow in June 2001,
Enron vice president Sherron Watkins, an eight-year Enron
veteran, was given the task of finding some assets to sell off.
With the high-tech bubble bursting and Enron’s stock price
slipping, Watkins was troubled to find unclear, off-the-books
arrangements backed only by Enron’s deflating stock. No one
seemed to be able to explain to her what was going on. Knowing
she faced difficult consequences if she confronted then-CEO
Jeffrey Skilling, she began looking for another job, planning to
confront Skilling just as she left for a new position. Skilling,
however, suddenly quit on August 14, saying he wanted to
spend more time with his family. Chair Ken Lay stepped back in
as CEO and began inviting employees to express their concerns
and put them into a box for later collection. Watkins prepared
an anonymous memo and placed it into the box. When Lay held
a companywide meeting shortly thereafter and did not mention
her memo, however, she arranged a personal meeting with him.
On August 22, 2001, Watkins handed Lay a seven-page letter
she had prepared outlining her concerns. She told him that
Enron would “implode in a wave of accounting scandals” if
nothing was done. Lay arranged to have Enron’s law firm,
Vinson & Elkins, and accounting firm Arthur Andersen look into
the questionable deals, although Watkins advised against having
a third party investigate that might be compromised by its own
involvement in Enron’s conduct. Lay maintained that both the
law firm and accounting firm did not find merit in Watkins’s
accusations. Near the end of September, Lay sold some $1.5
million of personal stock options, while telling Enron employees
that the company had never been stronger. By the middle of
October, Enron was reporting a third-quarter loss of $618
million and a $1.2 billion write-off tied to the partnerships
about which Watkins had warned Lay.
For her trouble, Watkins had her computer hard drive
confiscated and was moved from her plush executive office suite
on the top floor of the Houston headquarters tower to a sparse
office on a lower level. Her new metal desk was no longer filled
with the high-level projects that had once taken her all over the
world on Enron business. Instead, now a vice president in name
only, she faced meaningless “make work” projects. It is
important to note that Watkins stayed in the company after
warning Lay about the risks and did not become a public
whistle-blower during this time. In February 2002, she testified
before Congress about Enron’s partnerships and resigned from
Enron in November of that year.
The Chief Financial Officer
In 2002, the U.S. Justice Department indicted CFO Andrew
Fastow—who had won the “CFO of the Year” award two years
earlier from CFO Magazine—on 98 counts for his alleged efforts
to inflate Enron’s profits. The charges included fraud, money
laundering, conspiracy, and one count of obstruction of justice.
Fastow faced up to 140 years in jail and millions of dollars in
fines if convicted on all counts. Federal officials attempted to
recover all of the money Fastow had earned illegally, and seized
some $37 million.
Federal prosecutors argued that Enron’s case was not about
exotic accounting practices but about fraud and theft. They
contended that Fastow was the brain behind the partnerships
used to conceal some $1 billion in Enron debt and that this debt
led directly to Enron’s bankruptcy. The federal complaints
alleged that Fastow had defrauded Enron and its shareholders
through off-balance-sheet partnerships that made Enron appear
to be more profitable than it actually was. They also alleged that
Fastow made about $30 million both by using these
partnerships to get kickbacks that were disguised as gifts from
family members, and by taking income himself that should have
gone to other entities.
Fastow initially denied any wrongdoing and maintained that he
was hired to arrange the off-balance-sheet financing and that
Enron’s board of directors, chair, and CEO had directed and
praised his work. He also claimed that both lawyers and
accountants had reviewed his work and approved what was
being done, and that “at no time did he do anything he believed
was a crime.” Skilling, COO from 1997 to 2000 before becoming
CEO, had reportedly championed Fastow’s rise at Enron and
supported his efforts to keep up Enron’s stock prices.
Fastow eventually pleaded guilty to two counts of conspiracy,
admitting to orchestrating myriad schemes to hide Enron debt
and inflate profits while enriching himself with millions. He
surrendered nearly $30 million in cash and property, and
agreed to serve up to 10 years in prison once prosecutors no
longer needed his cooperation. He was a key government
witness against Lay and Skilling. His wife Lea Fastow, former
assistant treasurer, quit Enron in 1997 and pleaded guilty to a
felony tax crime, admitting to helping hide ill-gotten gains from
her husband’s schemes from the government. She later
withdrew her plea, and then pleaded guilty to a newly filed
misdemeanor tax crime. In 2005, she was released from a yearlong prison sentence, and then had a year of supervised release.
In the end, Fastow received a lighter sentence than he otherwise
might have because of his willingness to cooperate with
investigators. In 2006, Fastow gave an eight-and-a-half-day
deposition in his role as government witness. He helped to
illuminate how Enron had managed to get away with what it
did, including detailing how many major banks were complicit
in helping Enron manipulate its financials to help it look better
to investors. In exchange for his deposition, Fastow’s sentence
was lowered to six years from ten. Fastow has also stated that
Enron did not have to go out of business if there had been better
financial decisions made at the end.
The case against Fastow had been largely based on information
provided by Michael Kopper, the company’s managing director
and a key player in the establishment and operation of several
of the off-balance-sheet partnerships and the first Enron
executive to plead guilty to a crime. Kopper, a chief aide to
Fastow, pleaded guilty to money laundering and wire fraud. He
faced up to 15 years in prison and agreed to surrender $12
million earned from illegal dealings with the partnerships.
However, Kopper only had to serve three years and one month
of jail time because of the crucial role he played in providing
prosecutors with information. After his high-powered days at
Enron, Kopper’s next job was as a salaried grant writer for
Legacy, a Houston-based clinic that provides services to HIVpositive and other chronically ill patients.
Today Andy Fastow has been released from prison and works as
a document-review clerk at a law firm. He also speaks about
business ethics at many different forums, including Leeds
Business School at the University of Colorado, the University of
New Mexico, the University of Texas at Austin, and the
Association of Certified Fraud Examiners global conference.
During his speaking engagements, Fastow has emphasized that
a major problem companies encounter in business ethics is not
using principles and overly relying on rules. He claims that laws
and regulations technically allowed the risky transactions he
made at Enron. He also cited General Motors, IBM, and the
nation of Greece as more recent examples of companies (or
nations) that faced hardship and/or bankruptcy because they
took actions that were highly risky but technically allowable by
law.
The main idea that Fastow tries to communicate in his lectures
is that it is not enough to simply obey rules and regulations. It is
also easy to rationalize questionable behaviors. Fastow claims
that ethical decisions are rarely black-and-white, and
sometimes unethical decisions seem more or less unethical
depending upon the situation. For instance, he used Apple’s tax
evasion as an example of an action that seemed less unethical
because it was less pronounced than what often occurs in other
cases. There are always murky areas where regulations can be
exploited. Instead, businesspeople must be able to recognize
when issues are going too far and stop them before they
snowball into an Enron-esque crisis. Fastow recommends that
the best way to deal with questionable situations is to construct
and examine a worst-case scenario analysis and look at the risks
of questionable deals with more scrutiny.
The Chief Executive Officer
Former CEO Jeffrey Skilling, generally perceived as Enron’s
mastermind, was the most difficult to prosecute. At the time of
the trial, he was so confident that he waived his right to avoid
self-incrimination and testified before Congress, saying, “I was
not aware of any inappropriate financial arrangements.”
However, Jeffrey McMahon, who took over as Enron’s president
and COO in February 2002, told a congressional subcommittee
that he had informed Skilling about the company’s off-balancesheet partnerships in 2000, when he was Enron’s treasurer.
McMahon said that Skilling had told him that “he would remedy
the situation.”
Calling the Enron collapse a “run on the bank” and a “liquidity
crisis,” Skilling said that he did not understand how Enron had
gone bankrupt so quickly. He also said that the off-balance-sheet
partnerships were Fastow’s creation. However, the judge dealt a
blow to Lay and Skilling when he instructed the jury that it
could find the defendants guilty of consciously avoiding
knowing about wrongdoing at the company.
Many former Enron employees refused to testify because they
were not guaranteed that their testimony would not be used
against them in future trials, and therefore questions about the
company’s accounting fraud remain. Skilling was found guilty of
honest services fraud and sentenced to 24 years in prison,
which he has been serving in Colorado. He maintains his
innocence and has appealed his conviction. After his release
from prison, Andy Fastow was quoted as saying that the
bankruptcy of Enron was not Skilling’s fault. In 2008, a panel of
judges from the Fifth Circuit Court of Appeals in New Orleans
rejected his request to overturn the convictions of fraud,
conspiracy, misrepresentation, and insider trading. However,
the judges did grant Skilling one concession. The three-judge
panel determined that the original judge had applied flawed
sentencing guidelines in determining Skilling’s sentence. The
Court ordered that Skilling be resentenced. The matter was
taken to the Supreme Court.
In June 2010, the U.S. Supreme Court ruled that the honest
services law could not be used to convict Skilling because the
honest services law applies to bribes and kickbacks, not to
conduct that is ambiguous or vague. The Supreme Court’s
decision did not suggest that there had been no misconduct,
only that Skilling’s conduct was not in violation of a criminal
fraud law. The court’s decision did not overturn the conviction
and sent the case back to a lower court for evaluation.
The Chair
Ken Lay became chair and CEO of the company that was to
become Enron in 1986. A decade later, Lay promoted Jeffrey
Skilling to president and chief operating officer, and then, as
expected, Lay stepped down as CEO in 2001 to make way for
Skilling. Lay remained as chair of the board. When Skilling
resigned later that year, Lay resumed the role of CEO.
Lay, who held a doctorate in economics from the University of
Houston, contended that he knew little of what was going on,
even though he had participated in the board meetings that
allowed the off-balance-sheet partnerships to be created. Lay
said he believed the transactions were legal because attorneys
and accountants had approved them. Only months before the
bankruptcy in 2001, he reassured employees and investors that
all was well at Enron, based on strong wholesale sales and
physical volume delivered through the marketing channel. He
had already been informed that there were problems with some
of the investments that could eventually cost Enron hundreds of
millions of dollars. In 2002, on the advice of his attorney, Lay
invoked his Fifth Amendment right not to answer questions that
could be incriminating.
Lay was expected to be charged with insider trading, and
prosecutors investigated why he had begun selling about $80
million of his own stock beginning in late 2000, even as he
encouraged employees to buy more shares of the company. It
appears that Lay drew down his $4 million Enron credit line
repeatedly and then repaid the company with Enron shares.
These …
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