10 Kasım 2012 Cumartesi

The Most Famous Fraud Cases: Enron

In this article and the following articles we will try to concentrate on the famous fraud cases that had happened and affected the whole globe. In each case we will start with the history of the company, afterwards we will explain the fraud event and at last we will try to find out what the company should have done in order to prevent that kind of a big burden.

There are several fraud cases from the world. The following events are the famous examples to these cases:[1]
·         ENRON: December 2001, Enron has accepted that they have inflated their financial statements.
·         TYCO: June 2002, former CEO of Tyco who was Dennis Kozlowski, accused of stealing money from the company.
·         ANDERSEN: June 2002, Arthur Andersen was accused of deceiving the jurisdiction system about Enron case.
·         WORLDCOM: June 2002, the second biggest telecommunication company of USA was accused of a fraud in financial statements.
·         XEROX: June 2002, the financial statements were inflated.
·         GE: June 2002, inspection has started on the financial statements of GE after they are blamed to make fraud on the financial statements.

Since we want to go into more detail, we will use the following three cases with the plan that has been shown in the beginning of the section:
·         Enron
·         Tyco
·         Parmalat

Enron Case

Enron was an energy company that was based in Houston, Texas, that had dealt with the energy trade on an international and domestic basis. It was formed in 1985 when Houston Natural Gas merged with Inter North.[2] The time line of this company until 2000 is also stated below:[3]
·         1986 : The company has chosen the name Enron after rejecting Interon.
·         1987 : Enron discovered that oil traders in New York have overextended the company's accounts by almost USD 1 billion. The company ultimately worked this loss down to USD 142 million. This leads to Enron developing a myriad of services to help to reduce the risk of price swings for everything from gas to advertising space.
·         1988 : Enron opened its first overseas offices in England to take advantage of the country's privatization of its power industry. The company's major strategy shift - to pursue unregulated markets in addition to its regulated pipeline business - was revealed to executives in a gathering that became known as the "Come to Jesus" meeting.
·         1989 : Enron launched its Gas Bank, a program under which buyers of natural gas can lock in long-term supplies at fixed prices. The company also began to offer financing for oil and gas producers.
·         1992 : Enron acquired Transportadora de Gas del Sur, Enron's first pipeline presence in South America and the start of a push to expand on the continent.
·         1993 : Enron's Teesside power plant in England began operation as one of the first big successes for the company's international strategy.
·         1994 : Enron made its first electricity trade which would turn out to be one of the company's biggest profit centers in the next few years.
·         1995 : Enron Europe established a trading center in London, marking the company's entry into European wholesale markets. At that time, Europe was considered as one of the company's prime growth markets.
·         1996 : Construction began on the first phase of the Dabhol power plant in India.
·         1997 : To expand its electricity business, Enron bought Portland General Electric Corp., the utility serving the Portland, Ore., area. In 2001, Enron agreed to sell Portland General Electric to Northwest Natural Gas Co. for about USD 1.9 billion. Enron Energy Services was formed to provide energy management services to commercial and industrial customers.
·         1998 : Enron acquired Wessex Water in the United Kingdom, which has formed the basis for its water subsidiary Azurix.
·         1999 : Enron formed its broadband services unit. The first phase of the Dabhol project began operations. One-third of Azurix was sold to the public in an initial public offering. After an early rise, shares fell sharply as the year went on and the problems facing the company became apparent.

As a result, starting from a small energy and pipe line company in 1980’s, the company has reached to a revenue amount of USD 100 billion in 2000. The total assets have reached to USD 65 billion and employee size to 19,000.[4]

After explaining the history of Enron, we will try to give information about what has happened to Enron that lead to bankruptcy. From the history of Enron, we understood that the company has grown step by step and reached to a very big level at the end of 1990’s.

However, after that time the following happenings have taken place:[5]
·         Summer 1999 – California electricity market deregulated (initially electricity prices fall)
·         March 2000 – NASDAQ peaks above 5,000
·         Summer 2000 – California electricity blackouts happened.
·         December 2000 – Enron blocks government oversight of: Enron Online.

With paying attention to the above happenings, in order to sustain the growth rate of late 1990’s, Enron began to borrow money to invest in new projects. However, since this debt would make their earnings look less impressive, Enron began to create partnerships that would allow it to keep debt off of its books.

One partnership created by Enron which was Chewco Investments allowed Enron to keep USD 600 million in debt off of the books which was showed to the government and to people who own Enron stock. When this debt did not show up in Enron's reports, it made Enron seem much more successful than it actually was. In addition, Enron attracted big investors by promising them that they would receive secret information about the company that was not being given to the government or the public. This secrecy violated laws intended to ensure that all investors have full access to accurate information about publicly traded companies.[6]

When we come to the bank loans, we can say that Enron had used big amount of loans, most of them without security. The debts of Enron to the banks have reached to the following points:[7]
·         JP Morgan Chase: This bank announced that the total loss from Enron had reached to USD 456 Million at the beginning of 2002.
·         Citigroup: This bank announced USD 228 million in the same period of time.
·         Bank of America: The loan amount was USD 200-300 Million.

In 2001, the auditor announced that most of the debts that were explained above were put to the subsidiaries and these must have been factored in Enron’s financial reports. After this announcement, it is understood that the fiscal year has ended with USD 1 billion losses. This was enquired by the justice system and SEC later but the bankruptcy couldn’t be prevented.[8]

When we look at stock exchange, we have seen that the stock price started to fall from year 2000 and the investors were indifferent to sell or to hold the stock at those time period. However, after 2001, the momentum in the fall start to grow and the price of the stock almost halved in one year. To indicate how big the loss is, we can compare October 2000 figure which is USD 90 per share (USD 70 billion) and they are at the 7th level in Fortune 500 list of US companies with February 2005 figure which is only USD 0.04 per share (USD 31 million).[9]

As a result, the following events took place:[10]
·         November 13, 2001: Dynegy offered to buy Enron for USD 9 billion (USD 10 a share).
·         November 29, 2001: Dynegy called off merger
·         December 2, 2001: Enron filed for bankruptcy
·         August 2002: Michael Kopper pleaded guilty to conspiracy
·         January 2004: Andrew Fastow who was the CFO, pleaded guilty to tax fraud
·         February 2004: Skilling (former CEO) who had previously resigned unexpectedly in 2001, charged with fraud

This bankruptcy has resulted with the second biggest bankruptcy that has happened ever.

The Largest Bancruptcies Ever

Arthur Andersen which was the auditor and accountant of Enron, has enrolled into a big fraud in Enron case. When we look at the situation from Arthur Andersen point of view, we may find out the following issues:[11]
·         Enron was Andersen’s second largest client.
·         They had been providing both external and internal audits.
·         Arthur Andersen was paid USD 52 million in 2000, the majority of this money was for non-audit related consulting services.
·         They failed to spot many of Enron’s losses.
·         They should have assessed Enron management’s internal controls on derivatives trading which was expressed approval of internal controls during 1998 through 2000.
·         They kept a whole floor of auditors assigned at Enron around one year.
·         CFOs and controllers were former Andersen executives.

Arthur Andersen which was a very famous audit and accounting company (one of the 5 big audit companies) has accused of document destruction and they went out of the business. They were also accused of participating the fraud in Enron by not paying attention to the inflated financial reports.

On June 15, 2002, Andersen was convicted of obstruction of justice for shredding documents related to its audit of Enron, resulting in the Enron scandal. Nancy Temple (Andersen Legal Dept.) and David Duncan (Lead Partner for the Enron account) were cited as the responsible managers in this scandal as they had given the order to shred relevant documents. Since the U.S. Securities and Exchange Commission does not allow convicted felons to audit public companies, the firm agreed to surrender its licenses and its right to practice before the SEC on August 31, 2002. This effectively ended the company's operations.[12]

After all of these statements we can state what should have previously done in order to prevent the big burden on Enron in the following:
·         If the auditor company had been audited carefully by a superior council or by any supreme regulation board,
·         If the legal regulations that are used in the relations of auditor and the auditee had been previously stated well,
·         If the banks had used their expertise units for determining the operational scope of the company,
·         If the auditor company had previously informed and forced Enron about not transferring the debts to other subsidiaries,
·         If the auditor company had understood that it might affect their reputability in the whole globe,
·         If the rating agencies and the regulatory institutions had previously analyzed Enron case by making consolidated reports including the subsidiaries,
·         If the regulation centers had put rules about the former CEO or responsible people of Auditor companies to work on the companies which are audited by the same corporation,
·         If not only an auditor company but also a different governmental organization had participated in the audit,

This big fuss would have never happened.

[1] Akşam Gazetesi, “Skandallara Torpilsiz Kelepce”, http://www.aksam.com.tr/arsiv/aksam/2002/08/04/ekonomi/ekonomi1.html
[2] SecuritiesFraudFYI, “History of Enron”,http://www.securitiesfraudfyi.com/enron_fraud.html
[3] Chron Houston News, “Enron Time Line”, http://www.chron.com/disp/story.mpl/special/enron/1127125.html
[4] D.Yener Özel, “Enerji Devi Enron’un Çöküşü ve Etkileri”, http://www.ekodialog.com/Makaleler/enron_enerji_devi_cokusu.html
[5] East California University, “Worldwide Accounting Fraud”, http://personal.ecu.edu/ruppn/enron.ppt
[6] PBS, “What happened to Enron?”, http://www.pbs.org/newshour/extra/features/jan-june02/enron_past.html
[7] Özel, Ibid.
[8] Özel, Ibid.
[9] East California University, Ibid.
[10] East California University, Ibid.
[11] TAFE, “How  do accountants become involved in the fraud”,  http://business.tafe.vu.edu.au/dsweb/Get/Document-126829/9
[12] Wikipedia, “Arthur Andersen”,http://en.wikipedia.org/wiki/Arthur_Andersen

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