The particular causes of Enron’s failure Essay

Custom Student Mr. Teacher ENG 1001-04 9 July 2016

The particular causes of Enron’s failure

The particular causes of Enron’s failure are complex. There are lots of issues that have to do with the Enron collapse. Enron is a company that was called as Houston Natural Gas and then Enteron. It becomes politically connected player in the new deregulated market of energy. At one time Enron appears to have been a successful and innovative enterprise, principally engaged in trading and dealing in energy-related contracts. At some point it expanded by making substantial investments in a variety of large-scale projects.

Although some of these were initially successful, others resulted in Enron incurring large economic losses. Then it appears to have embarked on covering up losses and manufacturing earnings. This succeeded for a time, but was ultimately unsustainable. These efforts allowed Enron to disguise the losses and not report debt for which it was contingently liable. They also apparently afforded certain Enron managers the opportunity of extracting personal gains at the expense of Enron’s stockholders.

Enron Company failed, lost money, had severe financial troubles, but it did not tell not only the government, but also its employees. Enron Company fooled the world by showing that it earned $500 million that it in fact did not earn. The following information is found so far about the company’s magic acts:

The key was “accounting alchemy,” which means miraculously turning lead into gold, losses into profits, making debts and bad investments, or anything they wanted to simply disappear. Enron played the all-in-the-family fantasy finance game, manipulating hundreds of subsidiary companies with names out of “Star Wars,” “Jurassic Park,” medieval Scotland. In the early ’90s, Enron made money, with, an oil partnership dubbed Jedi. One of its many subsidiaries, Raptor, which invested in Internet firms, was virtually minting money as its portfolio soared. And when Enron made a deal with Blockbuster Video to deliver movies on demand over the fiber optic cables it was installing across the country, Enron seemed to be making all the right connections.Soon Enron was America’s seventh largest company in terms of revenues. But from the beginning, something was kind of fantastic. It turns out, Enron got so big very soon, with “ledger domain.”

Enron recorded, as revenues, what on the stock market they simply refer to as volume. Enron booked its energy trading contracts at the full contract price. By the late ’90s, Enron had begun to lose money. But to keep its stock price and credibility as a trader from collapse, Enron needed to keep the game going. It started playing faster. Take Enron’s movies-on-demand deal with Blockbuster. That was a real partnership: To share profits 50/50 for 20 years. But before it could even go bad- which it did- Enron created a different company, code name: Project Braveheart. A Canadian bank invested $115 million in it, in return for the first decade of supposed future earnings from the Blockbuster deal. Plus, Enron guaranteed the bank its money back if Braveheart fell. Then, Enron recorded the bank’s $115 million money- back guaranteed investment as Enron’s profit.

Also another related party had invested in something called New Rhythms Net Connections. Unfortunately, New Rhythms had crashed. So Enron entered into something called a derivatives contract with its own subsidiary. The contract increased in value as New Rhythm’s stock price went down. So if the stock rose, Enron would report profits from the stock because it was an asset of the subsidiary. If the stock dropped, Enron would report the profits from the New Rhythms derivative contract, neglecting to report that the related party- the subsidiary- was losing exactly the same amount.

Enron borrowed money through related parties to hide its debts, sold off energy assets, then claimed the proceeds as pure profit, while never deducting the value of the asset it no longer had. It sold now a nearly worthless fiber optic cable to one of its related parties, claiming a profit of $53 million, and then, without explanation, reported that same transaction again the following quarter with an additional $14 million profit, thereby just beating expectations on Wall Street. It created so-called special purpose entities (SPEs) like the Chewco and JEDI partnerships to get assets like power plants off its books. Enron was able to do this because, under standard accounting, a company is allowed to spin off its assets — and related debts — to an SPE if an outside investor has put up capital worth at least three per cent of the SPE’s total value. These methods also stretched across the lumping of assets into its trading business and the booking as operating revenues the proceeds of the sale of fixed assets.

Originally, it appears that initially Enron was using Special Purpose Entities appropriately by placing nonenergy-related business into separate legal entities. What they did wrong was that they apparently tried to manufacture earnings by manipulating the capital structure of the Special Purpose Entities; hide their losses, did not have independent outside partners that prevented full disclosure and did not disclose the risks in their financial statements. Or to put it another way, they got greedy. Any system can be abused and misused. If management uses nonpublic SPEs as a way to hide debt and manipulate earnings, it will lead to Enron-type disasters.

Between 1996 and 2000, the energy trading outfit reported an increase in its sales from $13.3 billion to 100.8 billion. In one single accounting year, 1999-2000, Enron doubled its reported sales. Enron exploited a loophole in accounting rules that allowed it to book revenue from energy-derivative contracts at their gross-as against net value to claim this phenomenal increase in sales revenue. According to Enron’s 2000 annual report, it was in the business of building “wholesale businesses through the creation of networks involving selective asset ownership, contractual access to third-party assets and market making activities”. It seems to have used the term “wholesale businesses” to mean trading, plain and simple. From which it made more than 90 per cent of its revenue. To make matters worse, Enron bought and sold the same goods over and over again. And all this trading — a good amount of which was being carried on with purportedly independent partnerships which do not look very independent on examination — was being booked as revenue at full value.

The downside, of course was that it did not do anything for its profits because of the steady erosion in its trading margins from 5.3 per cent in 1998 to less than 1.7 per cent in the third quarter of the current year. To pump up the net worth, or shareholder’s equity of the company, Enron lower its liabilities by whisking some of them off the balance sheet entirely. There’s lots of debt. The question is whether all of it was showing up. Enron had arranged for complex off-balance sheet partnerships – which it owned – so subsume a large part of the debts so we don’t see it showing up on the balance sheet.In retrospect, it would seem that the company made frantic attempts to keep up its profits in spite of diminishing margins through various methods, including the setting up of several off-the-balance sheet entities represented as independent of Enron to which it sold assets or portfolios of assets.

The members who involved in this trail are Skilling (CEO) Richard Causey (Enron’s former chief accounting officer) and Ben Glisan (Former treasurer). The 42-count indictment unsealed Thursday accused Skilling and Richard Causey, Enron’s former chief accounting officer, of orchestrating efforts to mislead government regulators and investors about the company’s earnings. From at least 1999 through late 2001, defendants Jeffrey K. Skilling and Richard A. Causey and their co-conspirators engaged in a wide-ranging scheme to deceive the investing public, credit-rating agencies and others about the true performance of Enron’s business.

Skilling became the chief executive officer and president of Enron in February 2001 after heading the company’s North American operations. Six months after being appointed CEO, in August 2001, Skilling suddenly resigned for personal reasons, just five months before the company filed for bankruptcy. His abrupt departure spread rumors throughout the financial world, and a few weeks later Enron began to unravel as its loose accounting led to a restatement of earnings and a collapse that cost its shareholders some $1.2 billion in equity.

The charges also mention former treasurer Ben Glisan, who pleaded guilty to conspiracy and became the first former Enron executive put behind bars. Skilling has consistently insisted he did nothing wrong. In testimony before the House Energy and Commerce Committee two years ago, he blamed Enron’s demise on a liquidity crisis caused by a decline in confidence.

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