Read the Enron Case and answer the questions that follow it. Kenneth Lay, former

Question

Read the Enron Case and answer the questions that follow it.

Kenneth Lay, former chairman and chief executive officer (CEO) of Enron Corp., claimed to be a moral and ethical leader and exhorted Enron’s officers and employees to be highly ethical in their decisions and actions. In addition, the Enron Code of Ethics specified that “An employee shall not conduct himself or herself in a manner which directly or indirectly would be detrimental to the best interests of the Company or in a manner which would bring to the employee financial gain separately derived as a direct consequence of his or her employment with the Company.” Enron’s ethics code was based on the values of respect, integrity, communication, and excellence. Given this code of conduct and Ken Lay’s professed commitment to business ethics, one wonders how Enron could have collapsed so dramatically? The answer to this question seems to be rooted in a combination of the failure of top leadership, a corporate culture that supported unethical behavior, and the complicity of the investment banking community.

The failure of Enron’s top leadership was evident in the activities of Andrew Fastow, Jeff Skilling, and Ken Lay, all of whom faced multiple counts of criminal activity with respect to their decisions and actions at Enron. Included among these criminal charges were money laundering, wire fraud, securities fraud, conspiracy, making false statements on financial reports, and insider trading. Some of the activities that led to these criminal charges were: (a) concealing how extensively Enronwas involved in trading in order to support a high market valuation of Enron’s stock; (b) setting up and operating related party transactions, called LJM partnerships, to do business with Enron; (c) exempting Fastow from the company’s ethics code regarding the private partnerships he set up; and (d) covering up the nature and extent of Enron’s problems through deceptive accounting practices and deliberate misinformation.

Enron has been described as having a culture of arrogance that led people to believe that they could handle increasingly greater risk without encountering any danger. “Enron’s unspoken message was, ‘Make the numbers, make the numbers, make the numbers ¾ if you steal, if you cheat, just don’t get caught. If you do, beg for a second chance, and you’ll get one.’ ” Enron’s culture of arrogance can be characterized by an emphasis on decentralization with inadequate financial and operational controls, a very rigorous and threatening employee performance evaluation process, and a compensation plan that encouraged people to inflate the value of contracts and to use non-standard accounting practices.

“One of the most sordid aspects of the Enron scandal is the complicity of so many highly regarded Wall Street firms” in enabling Enron’s fraud as well as in being partners to it. This complicity occurred primarily through the use of prepays and related party transactions. Prepays occurred when Enron booked loans as operating cash flow, and regularly secured new prepays to pay off existing ones as well as to support rapidly expanding investments in new businesses. Related party transactions were used by Andrew Fastow to sell an underperforming asset to the investment bankers, usually at the end of a quarter, and then and then to have the bankers sell it back to the company at a profit once the quarter was over and the “earnings” had been booked.” Such transactions were basically smoke and mirrors, reflecting a relationship between the partnerships and the banks wherein “Enron could practically pluck earnings out of thin air.”

A follow-up of Enron’s major officers speaks to the cover-up and false testimony they paid to their ethics code and announced values.  A grand jury indicted Lay on July 7, 2004 on 11 counts of securities fraud and related charges. He was found guilty of 10 counts against him on May 25, 2006.  A judge dismissed the last count since each count carried a 5 to 10 year maximum prison sentence.  Had he not died of a heart attack on July 5, 2006, he could have served between 20 to 30 years in prison. Skilling is still serving a 24-plus year prison sentence, after he was convicted on 19 counts-- “one count of conspiracy to commit securities fraud and wire fraud, 12 counts of securities fraud, five counts of making false statements to accountants, and one count of insider trading.”  Recently, it was questionable whether or not he would be temporarily released after his son’s suicide attempt.  Fastow was sentenced on conspiracy to commit securities fraud and sentenced from 10 to 6 years after he testified against Ken Lay, Jeff Skilling, and others. His release date is scheduled on December 2011.

What led to the eventual collapse of Enron under Lay and Skilling?

How did the top leadership at Enron undermine the foundational values of the Enron Code of Ethics?

In retrospect: given Kenneth Lay’s and Jeff Skilling’s operating beliefs and the Enron Code of Ethics, what expectations regarding ethical decision and actions should Enron’s employees reasonably have had?

How did Enron’s corporate culture promote unethical decisions and actions?

How did the investment banking community contribute to the ethical collapse of Enron?

If the Sarbanes-Oxley law had been in effect, do you believe the Enron debacle would have occurred? Explain.

Could another Enron occur now? Why or why not? Explain.

Explanation / Answer

1.

All the fraud activities conducted by Lay and Skilling and bad corporate culture led to the Eventual collapse of Enron. Both were aware of the Enron Code of Ethics but they did not follow it. Kenneth Lay former CEO was indicted on 11 criminal counts of fraud and making misleading statements. Jeff Skilling was indicted on 35 counts of wire fraud, securities fraud, conspiracy, making false statement on financial reports, and insider trading. Hence both were responsible for collapse of Enron.

2.

Enron numerous executives such as former CEO, former chief financial officer and treasurer who forced company to the bankruptcy were found guilty after the bankruptcy. They were engaged in money laundering, fraud and conspiracy. In this manner Enron’s leadership undermine the company’s expressed Enron Code of Ethics i.e. respect, integrity, communication and excellence.

3.

The Enron’s employees must had thought that senior management executive and top level management are not concerned about the business ethics since they themselves were doing unethical things such as frauds, money laundering etc. The employees then automatically get the sense of freedom for doing unethical activities. Therefore there must be no value for Enron Code of Ethics in the eyes of the Enron’s employees.

4.

The employees believed that they could deal with extra risk without any danger until they don’t get caught. Even if they got caught then also they could ask for second chance. The corporate culture took very less efforts to promote the code of ethics. Instead the company gave more emphasis on decentralization and there were inadequate operational and financial controls. They inflate the contracts and hided the losses.

5.

Enron was engaged with highly reputed firms such as Citigroup, J. P. Morgan and Merrill Lynch and used prepays. Prepays were basically loans that Enron booked as operating cash flow. Enron secured new prepays to pay off existing one and to support rapidly expanding investments in new business.

6.

These days, all the company tried to hide their debts and show high profits in other to sustain and to avoid them from the bankruptcy. Therefore, another Enron could occur. Talking about bad corporate culture and fraud that Enron chief Executive officer had conducted, another Enron could not occur.

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