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Which Segment of Its Operations Got Enron Into Difficulties?

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Which segment of its operations got Enron into difficulties? The fall of Eron has understandably generated significant interest in the professional literature as well as in the popular press. The activities and events underlying Enron’s collapse are manifold, but several stand out as particularly noteworthy. One is the use of special purpose entities (SPEs). Although SPEs often serve legitimate economic purposes and are still in use today, Enron used several of them to hide debt and to overstate equity and earnings. Accounting standards required that third parties own at least 3 percent of the assets in SPEs. This rule was violated. Enron also represented that the SPEs helped it to hedge downside risk. This turned out not to be the case, because the SPEs used Enron’s stock and financial guarantees to carry out the hedges. While Arthur Andersen, Enron’s outside auditor, initially raised objections, the accounting firm ultimately softened its position. Andrew Fastow, Enron’s former CFO, became a partner in several SPEs and profited personally, which poses serious questions as to whether he breached his fiduciary duty to Enron stockholders.

A second procedure Enron used was mark-to-market accounting, in which a firm that signs a long-term contract can, under certain circumstances, recognize as current revenue the present value of the expected stream of future inflows and expense the present value of expected future costs. While such a process is appropriate in some situations, Enron used mark-to-market accounting to book future revenues as current revenue even when serious questions existed as to whether the long-term revenues would in fact materialize.

As the price of Enron stock declined, some Enron executives exercised their stock options and sold their shares, in some cases out of public view through loan repayment plans, while at the same time encouraging employees to hold and even to buy the stock. Many employees who tried to sell the stock in their 401(k) plans were barred from doing so and lost not only their jobs but most or all of the asset value of the retirement plans.

3. Did Enron’s directors understand how profits were being made in this segment? Why or why not? No. Enron’s directors did not know how the profits were being made because they were kept in the dark about everything until it went public.

5. Ken Lay was the chair of the board and the CEO for much of the time. How did this probably contribute to the lack of proper governance?

Ken Lay was in charge of Enron and all of its activities. He knowingly allowed things to happen. This led to the sever lack of governance because he was allowing the wheeling and dealing to go on without thinking ethically about the consequences.

6. What aspects of the Enron governance system failed to work properly, and why?

Enron’s board supported a disclosure that only gave a slight insight to the company’s earnings to the public and investors. The Board failed to exercise prudent judgment, failed to challenge management when necessary, and, as a result, failed to adequately protect the interests of the shareholders.

9. Identify conflicts of interests in:
• SPE activities
• Arthur Andersen’s activities
• Executive activities

The conflict with the SPE was that Enron was keeping their losses off of the end of year reports to offset other dealings that were not profitable. If true numbers had been reported losses would have been seen and not covered up. Enron created ways to use the SPE’s that had never been used. The original purpose was sound and creative, but Fastow and Kopper got involved. As a CEO or CFO you are supposed to act in the interest of the company you work for, therefore the conflict of interest comes about when as a CEO or CFO you contract with a company that you own or are a partner in. Arthur Andersens activities As accountants the conflict of interest came about when they acted as both auditor and financial advisors or advisors on accounting procedures and government policies regarding accounting principles. Executive activities The conflict of interest here would be the same as with the SPEs. Executives having an interest in, or being owners or CEOs of the SPEs. I also think a conflict of interest occurs when Executives are also members of the board of directors because they can use their influence as the company executive to get others on the board to agree to or over look the decisions they have made when those decisions should be investigated and questioned.

Worldcom Questions
1. Describe the mechanisms that WorldCom’s management used to transfer profit from other time periods to inflate the current period.

WorldCom Scandals Melissa Krol Instead of reporting line costs as expenses WorldCom offset these expenses by transferring capital or charging them against capital accounts, in other words they recharacterized these expenses as capital assets. They also created reserves or provisions for future operating expenses which were later reduced or released adding to the company’s profits.

3. How should WorldCom’s board of directors have prevented the manipulations that management used?

The manipulations of management may have been prevented if the board had better internal control procedures, such as having telephone communication taped or monitored. The board could have also requested more communication with auditors and possibly periodically looking at what new accounts showed on the balance sheet and asking why these accounts had to be implemented.

4. Bernie Ebbers was not an accountant, so he needed the cooperation of accountants to make his manipulations work. Why did WorldCom’s accountants go along?

WorldComs accountant went along most likely to keep their jobs. They may have also went along with Ebbers to profit from stock options and to maintain collateral requirements for personal loans.

5. Why would a board of directors approve giving its Chair and CEO loans of over $408 million?

In the case of Bernard Ebbers, the loan was to be used to buy WorldCom stock or for margin calls as the price of stock fell. Instead he used it to purchase a ranch, build a new home, and for other personal things. Personally I see no reasons why a board of directors would loan its chair and CEO that kind of money unless they were assured that it would be used in the best interest of the company.

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