In the mist of all of these mergers, acquasitions and take overs, Enron had certain core competencies. They believed they had to be the best, so they had to have the best resources and capabilities. They believed they had to have the best staff (human resourses), so they used a recruitment process designed to hire individuals who were smart, hard working and intensively loyal. Enron used a rank and yank strategy to make sure people were doing what they had to do and that they were still the best at doing it every six months.
Some other values that Enron had listed in their website, www. enron. com, were communication, respect, integrity and excellence. Enron had great trading capabilities. This allowed many firms, companies and industries to use Enron’s networks for different commodities to be transmitted and transferred through the networks. These networks for these different commodities allowed Enron to gain an Integrated cost leadership advantage into different markets within the US and around the world. Like Canada, Africa, Peru, India, etc. The central figure from Enron’s history is or was Kenneth L. Lay.
Kenneth L. Lay was the son of a Baptist minister from Missiouri. Lay trained as an economist at the Univ. of Missouri and the Univ. of Houston. In 1974, Lay took the first in a series of executive positions at various energy companies and in 1984 Lay became the CEO of Houston Natural Gas. Lay assumed the top job at Enron in 1986, shortly after the merger Both the price of gas and the electrical power industry were highly regulated and as a strong proponent of free markets, Lay felt that deregulation presented an opportunity for Enron.
But deregulation caused problems for both producers and users of energy, because with the fluctuation of prices sellers did not want to be forced to sell when prices were low and buyers did not want to be forced to buy when prices were high. To solve this problem, Enron came up with the idea of setting up a gas bank as an intermediary, to reduce market risk. The idea was that Enron would sign contracts with producers to buy their gas on a certain date at a certain price and other contracts with users to sell them gas on a certain date at a certain price.
All Enron required was that both parties pay a small premium to insure against risk, this would allow Enron to make money. Jeffrey Skilling was the man behind this idea. Jeffrey Skilling was a graduate of the Harvard Business School and was brought into Enron by Lay in the 1980’s to advice the Co. about deregulation. Skilling developed a series of other products, called energy derivatives, for Enron’s trading partners. Derivatives are financial contracts that can entail significant risks.
Derivatives, which come in many forms, allow investors to bet with other investors on changes in an underlying asset or index, such as stocks, interest rates, weather or electricity prices. In 1990 Skilling became CEO of Enron Gas Services (the gas bank). In 1996 he was promoted to the position of president and chief operating officer of Enron and in February 2001 to CEO of Enron. In the mid 1990’s Enron’s core gas services division began to slow down because of competition from buyers and sellers. Skilling planned to turn Enron’s profits.
His focus was to stick to commodities that were undergoing deregulation, had fragmented markets, maintained dedicated distribution channels and in which both buyers and sellers wanted flexibility. A focus strategy that Enron had was to reinvent itself as a high-tech clearinghouse in an ever-expanding roster of markets, so it did. The company moved into the residential electricity market in 1996, when Enron agreed to acquire Portland General, an Oregon utility whose transmission lines would give the company access to California’s $20-billion market, as well as access to 650,000 customers in Oregon.
In 1998 Enron acquired Wessex Water in the United Kingdom. In Jan. 2000 Enron formed Enron Broadband Services, Portland General provided the fiber optic network for this service, Enron spent about 1. 3 billion on this project. Another way Enron planned to turn it’s profits was by creating an online market by the name of clickpaper. com for creating contracts to deliver wood products and they also bought a newsprint co. to ensure a ready source of supply. Wall Street began to take notice, and Enron’s stock, which had languished, began to climb again.
It rose 55 percent in 1999, and leapt another 87 percent over 2000, giving them a 32% above average return Enron’s Downfall Enron lost money when it entered a huge deal to build a power plant in India, by that time earnings had grown annually in the early 1990s by between 16 and 20 percent for Enron. The figure then shrank to 11 percent for 1995, then to only 1 percent in 1996, giving them a 10% below average return. Like I had mentioned before, Skilling and Lay’s goals or focus strategy were very much directed towards deregulation and reducing government oversight.
Their strategy was to make political contributions to political campaigns so the company spent or better said, lost millions on advertising and lobbying for the causes. Enron was the largest contributor to congressional campaigns. In 1993 Enron contributed $260,000 in gifts to then Senator, Phill Gramm, who was also the chair of the powerful banking committee. From 1994 to 2000 Enron contributed $5 million to the House and Senate candidates. In 2000 they contributed another $2. 4 million in political contributions and $2. 1 million in lobbying for deregulation in 2000.
And who knows how many other amounts they contributed towards promoting deregulation and to reduce gov’t oversight. Enron also began going into debt in the 1990’s because Enron wanted to enter into such a varied market of commodities like, water, steel and broadband. This required Enron to buy significant hard assets for an estimate of $10 billion in up front capital investments, another hard hit. These capital investments were not expected to generate significant earnings or cash flow in the short term. This put pressure on Enron’s balance sheet Enron’s Corruption
How did Enron try to get out of it’s debt problem? Enron created special purpose entities (SPE’s). These SPE’s were created with the intention of lifting debt off their books. The SPE as like a trust, to establish this trust, the company must sell the SPE an asset any of the ones listed on its balance sheet will do. In this case, it sells its receivable balance and therefore must remove it from the balance sheet. The SPE pays the company for the receivables with the money it collects from these new investors and the company gets to beef up the cash section of its balance sheet.
Under the General Accounting Principles an SPE can be excluded from it’s financial statement if one, an independent party had to exercise control of the SPE and two, this party had to own at least three percent of the SPE’s assets. So SPE’s provide clever and legitimate ways for companies to more efficiently raise debt, but they also make it tougher for investors to decipher a company’s actual debt exposure. Enron created three SPE’s. The key figure in the transactions involving the SPE’s was Andrew S. Fastow. Fastow entered Enron Finance in 1990 and was considered a financial whiz. He became very close with Skilling and became CFO in 1998.
The first SPE created was Chewco in 1997. Chewco’s transactions were not reported and it should have been included in the financial statements because the SPE did not have the required three percent outside ownership to be considered independent of Enron per the Accounting rules. The second SPE was the LJM Parnerships (LJM1 and LJM2). Fastow served as a partner and invested 1 million of his own money. Enron transferred various assets and liabilities to the LJM Partnerships. The LJM transactions generated earnings of $229 million for Enron and they reported a total pre-tax earning of $570 million for that period.
In 1999 and 2000 the Raptors partnerships (Talon, Timberwolf, Bobcat and Porcupine) were created. Enron conducted various transaction with and among the Raptors and between the Raptors and the LJM’s that generated $1. 1 billion in earnings for the firm. Most of the SPE’s transactions were made to accomplish favorable financial statement results. All the money that Enron contributed to political parties was all for a purpose. The Commodities Futures Trading Commission (CFTC) is a federal agency that regulates futures contracts traded in an exchange.
From 1988 to 1993 the CFTC was chaired by Wendy Gramm, the wife of Phil Gramm (for which Enron contributed $260,000 to his campaign). In 1992 Enron petitioned the CFTC to exempt energy derivatives and swaps. In Jan. 1993, days before Clinton took office, Wendy approved the exemption. In 1996 Enron hired the former director of the investment management division at the SEC (Securities and Exchange Commission) as a lobbyist to take the companie’s case. The SEC granted Enron their petition in 1997, the same year that was the last year that the SEC conducted a thorough examination of Enron’s annual reports.
Under the Commodity Futures Modernization Act passed by Congress in 2000, Enron received a special exemption that allowed the co. to operate an unregulated energy trading subsidiary. These three exemptions gave Enron exactly what they wanted which was to reduce government oversight over their operations. Enron created partnerships with several banks, the main ones were jp morgan chase and citigroup. These financial institutions collaborated with the now-bankrupt energy company in its financial sleight of hand, the deals that enabled Enron to inflate its profits, conceal its burgeoning debts and push its stock price higher and higher.
Together and individually, the banks and brokerages raised at least $6 billion for Enron through the debt or stock issues sold to unsuspecting investors from 1996 through 2001. Another $4 billion or more was channeled into Enron’s “partnerships” like Jedi, Chewco and LJM1 and LJM2. These deals were often hurriedly arranged at year’s end to paper over the company’s true condition and keep the fraud from collapsing. The banks “earned” hundreds of millions, billions altogether, in securities commissions and consulting fees as well as from the inflated interest rates they charged Enron on disguised loans.
The banks’ stockbrokers maintained “strong buy” recommendations even as Enron began to sink. Citigroup and JP Morgan Chase also extended off-balance-sheet loans to Enron by disguising them as gas trades. Two examples were Yosemite and Mahonia the special-purpose entities used as middlemen in the transactions. How did Enron manipulate revenue? One was using Mark to Market Accounting (MTM), which is an approved accounting principle by the Financial Accounting Standards Board (FASB). MTM allowed companies to book as current earnings their expected future revenue from certain assets.
This allowed Enron to count projected profits from many deals in the year they were made. In 2000 MTM gains accounted for over half of Enron’s reported pre-tax earnings, LJM’s $570 million pre-tax earnings in 1999. . Enron also used “Sham Swaps”, to manipulate revenue. Sham swaps were when two firms exchanged assets to book a sale and avoid recording a loss. Prudency accounts, where profits were split into two categories. One was were profits made were added to the company’s current financial statement and the other was were profits were added to a reserve fund.
These prudency accounts were considered “slush funds”. These funds could be used to smooth out profits and losses over time. Derivatives allowed Enron to inflate the value of its assets and transactions while understating their risks and obscuring their real nature. Enron could engage in its complex trading strategy without fear of regulatory intervention because the government explicitly exempted much derivatives trading from oversight, granted by Wendy Gramm. Enron had become a full blown OTC (over the counter) derivatives trading firm.
Enron’s derivatives-related assets soared to $21 billion in 2000 from $3. 1 billion the year before, according to the company’s 2000 annual report. This enormous growth, apparently related to its Internet trading system, Enron Online, made it the fifth-largest commodity derivatives dealer in the U. S. . In June 2000 Enron sold LJM2 a dark fiber ( a type of bandwidth Enron traded as part of it’s broadband business) for $100 million, but is was actually valued at $33 million. The sale was made at an inflated price, allowing Enron to record a $67 million profit on the trade.
LJM2 was persuaded to buy at the inflated price because Enron entered into a “make whole” derivatives contract with LJM2 (the same contract they used with Raptor). The investor bought securities in LJM2 because if the drak fiber declined in price, which it will definitely do because of it’s inflated value, Enron would make the investor whole. As the value of the dark fiber fell during 2000, Enron was able to record a gain on it’s sale and avoid recording any losses on assets held by LJM2.
