Enron’s Story

On-the-Job Ethical Conflicts Four ethical conflicts confront leaders in business: Conflict of Interest - A leader achieves personal gain from a decision he/she makes) Loyalty versus truth - A leader must decide between loyalty to the company and truthfulness in business relationships Honesty and integrity – A leader must decide if he/she will be honest or lie; if he/she will take responsibility for decisions and actions or blame someone else? Whistleblowing – Does the leader tell others (media or government authorities) about the unethical behavior of the company or institution?

Broken Trust – The Story of Enron October 16, 2001 – earnings included unexpected after tax charge of $544M October 22 – stock fell 20% to $20.65 (SEC asked for disclosure of investment partners November 8 – stock price at $8.41 (Media scrutiny about overstatement of net income and understatement of debt November 28 – Stock trading at just over $1.00 December 2 – filed for bankruptcy

Broken Trust – The Story of Enron 72 Pairs of Relationships Board of Directors Senior Management Accountants Analysts Investment Bankers Lawyers Consultants Professional Associations Credit Raters

Broken Trust – The Story of Enron Board of Directors and Senior Management Aggressively promoted shares publicly while privately unloading their shares Engaging in multiple off-balance sheet partnerships primarily to manage reported earnings Executives became “outside parties” with ownership stakes in these partnerships Board accused of lax oversight

Broken Trust – The Story of Enron Accountants (Andersen) Failed to report Enron’s accounting irregularities Supposed to be investor’s representative, but they helped to conceal rather than report liabilities Lack of independence of auditor and firm – they also acted as Enron’s internal auditor Provided consulting services to Enron Auditors and consultants had office space at Enron and blended in with Enron employees Regulators asserted that Andersen shredded documents relevant to Enron case Civil class action lawsuit on behalf of shareholders Criminal suit concerning obstruction of justice

Broken Trust – The Story of Enron Analysts Lack of skepticism about Enron’s performance (Enron’s stock 70 times earnings) Acceptable in high growth industry, but Enron was in mature industry May of 22 sell-side analysts (supposed to be experts at discerning Enronian situations) rate Enron a “buy” Positive sentiment continued through stock slide to $0.75 per share Investment banking colleagues \earned fees from Enron ($50 M from 1986 to 2001)

Broken Trust – The Story of Enron Investment Bankers Channeled hundreds of millions of dollars in financing through partnerships – allowed Enron to borrow covertly Banks earned interest income and fees Helped Enron exploit accounting loopholes while, simultaneously, making it appear Enron had less debt – improves attractiveness of investment in Enron Partnerships produced income for owners, but failed to reduce Enron risk – returns from partnerships were tied to Enron’s stock price (Banks and execs in banks invested in Enron)

Broken Trust – The Story of Enron Lawyers Negligent Complicit in wrongdoing? No question of legalities associated with partnerships Internal and external counsel ties – Enron’s general counsel was previously employed by outside counsel (others, too) Vinson & Elkins relied on Andersen’s judgment when issues of irregularities were first brought to light – n outside audit

Broken Trust – The Story of Enron Consultants Jeffrey Skilling was a McKinsey partner before Enron appointment in 1990 McKinsey billings to Enron - $10M annually McKinsey consultants were “everywhere” Consultants advise on strategy – “advisees are responsible for their own actions” Consultants promoted Enron practices in books/ seminars, etc.

Broken Trust – The Story of Enron Credit Raters Late in identifying Enron’s credit risk Was Enron an example of credit rating abuse? Raters are paid by firms they are rating Raters sold risk management services and research to firms they rated

Broken Trust – The Story of Enron Professional Associations Irrelevant self-regulating monitors? Lobbyists for professions? Accounting association had fought attempts by SEC for more professional regulation prior to Enron Associations of Investment Management and Research (fund managers, investment professionals and security analysts) quickly established task force to study analyst objectivity American Bar Association – ok to break client confidentiality norm to prevent a client from committing a crime that would result in bodily harm, but not to protect assets National Association of Securities Dealers drafted new regulations for analysts and investment bankers

Broken Trust – The Story of Enron Core Dilemma – Managing Conflicts of Interest Three rationales for Enron collapse – bad luck – probability of all professions simultaneously missing telltale signs of collapse? Incompetence – professionals were among most prestigious in their profession conflict

Broken Trust – The Story of Enron Conflicting interests compromised independence of professionals from Enron’s management – most acute for accountants, credit raters, and analysts (lawyers and consultants also susceptible to management influence) Accommodating interests of management conflicted with professionals’ duties to clients accountants consulting and auditing responsibilities investment bankers’ financial services and research analyst responsibilities Consultants as management experts and role as consultants