My take on Enron

Since I am a CPA and I see the effects of Enron every day, I thought I would post my somewhat unique thoughts on the scandal and the sentences handed down yesterday to Ken Lay and Jeff Skilling. Fair warning though - this is my take on what happened so some of my facts may be a bit off. Also, this could take a while so you may want to brace yourself.

I graduated college with my degree in Accounting right before Enron fell. While I was in school we studied Enron as an ideal business model and an example of a company that was a huge success. Right around the time I started my job as an auditor for a public accounting firm, Enron decided that they would need to restate their financial statements. Once word of this leaked, the true state of the company’s financial situation came to light and the stock price tanked leaving Enron’s employees’ retirement plans in the dust, and my chosen profession would change forever.

I guess I should explain the reason why Enron needed to restate their statements in case some of you are unsure. If you’ve been following the trials you’ve probably heard of the phrase “off-balance sheet partnerships.” If a partnership meets certain requirements, only the company’s income or loss is presented on the statements at the company’s percentage of ownership. One of those requirements is whether or not the company essentially has control over the partnership. Enron did not have a majority ownership and claimed they had no control over the partnerships, therefore they did not show any of the partnerships’ assets or liabilities on their balance sheet.

The problem with this was that the majority owners of the partnerships were officers and employees of Enron, including Andrew Fastow, the CFO of the company. In actuality, Enron didn’t meet the requirement that they did not have control of the partnership and Arthur Andersen failed to recognize that.

This brings up another issue – auditor independence. Our code of ethics tells us that auditors are to remain completely independent of those companies we audit. We cannot and close family members cannot be employed by the company or invest in the company. We must maintain a sense of professional and personal separation from the company. Arthur Andersen maintained a full-time office at Enron headquarters. The partner assigned to Enron had been the partner on that client for many years and was personal friends with many of Enron’s upper managers. It’s difficult to maintain independence when you basically work with and play with the employees of the company you are auditing. You also hate to lose a client that you make millions of dollars on. AA was asked to look past the partnerships and they did.

Here is my understanding of how Enron misstated their financial statements. While off-balance sheet partnerships can be a good thing if used properly, Enron used these partnerships in an unethical way. The partnerships would obtain bank loans with Enron as a guarantor of the loan. Enron would then sell some of its assets to the partnerships and record the gain on the sales as income. The partnerships would then depreciate the assets over its determined life instead of recording the money they spent on the assets as an expense. So what would happen is all of this income would hit Enron’s books boosting their bottom line while the only expense flowing through from the partnerships would be a fractional depreciation expense. The capital assets and the liabilities for the bank loans would be sitting on the partnerships’ books and wouldn’t be shown on Enron at all. If the auditors at AA would have looked closer at these partnerships they would have seen what was going on, and since Enron had control over the partnerships the balance sheet activity should have been shown on the statements. AA was negligent in their fiduciary duty to the stockholders of the company and eventually the firm collapsed.

Now, here’s where the fraud comes in. Upper management knew what was going on with the sales of the assets to the partnerships. They were manufacturing income and intentionally boosting their bottom line so the stock price would go up. Then they were lying to their employees and shareholders about the true status of the company. Fraud, fraud, fraud.

The insider trading charges stem from the fact that upper management dumped their stocks at a high price because they knew word would leak of what was really going on. Then instead of informing their shareholders of what they knew, they froze sales of the stock so the employees’ investments in their companies couldn’t be sold until after the stock price plunged. Entire retirement plans of employees who had devoted years of their lives to a company they believed in were gone in a matter of days because the employees failed to diversify their portfolios and invested entirely in their company’s stock.

So what do I think of the sentences handed down to Lay and Skilling? I think the jury definitely got it right. I hope when they are sentenced that they get the maximum allowed by law. I think that it’s despicable that they were more concerned about padding their pockets than the employees who gave their blood, sweat and tears to that company. But I really think that every penny that these people have should be divided up between the employees who lost their jobs and their futures.

The whole thing is just so sad.