About ENRON

Enron was a high-flying energy company that sought to transform itself into one of the
worlds biggest energy trader. At one time it was by stock market value the seventh
largest US Company, led by its dynamic, politically connected chairman Kenneth Lay.
Enron was formed from a merger in 1985 of Houston Natural Gas and InterNorth. The
Texan company was largely credited with creating market trading in energy, allowing
energy to be traded in the same way as other commodities such as oil.

Andersens role in Enron bankruptcy

With more than 21,000 employees in more than 40 countries its revenues were over $100
billion in 2000. Enron grew rapidly, containing three businesses - energy, wholesale and
global services. Enron marketed electricity and natural gas, delivered energy and other
physical commodities and provided financial and risk management services to customers
around the world. Enron's prominence came not only from the key role it played in world
energy markets but also because under President Bush, the US administration looked to
its chairman Kenneth Lay for advice on energy. By some estimates, it had many millions
of investors through the holdings of pension funds across the US.

In late 2001, Enron revealed it would incur losses of at least $1 billion and would restate
its financial results for 1997, 1998, 1999, 2000, and the first two quarters of 2001 to
correct errors that inflated Enron's net income by $591 million. On 8 November, Enron
took the highly unusual move of restating its profits for the past four years. It effectively
admitted that it had inflated its profits by concealing debts in the complicated partnership
arrangements.
Andersens role in Enron bankruptcy

Enrons share price collapsed when it emerged that the company had been concealing
losses by setting up shell companies. The impact of this restatement was enormous as
Enron's stock dropped 91%. Soon after, the attempted acquisition of Enron by Dynegy
Inc. fell through, Enron's debt was downgraded to junk bond status and its stock dropped
to just $0.26 per share. On December 2, 2001, Enron filed for Chapter 11 (bankruptcy).

Many executives benefited from the companys high share price by cashing in their stock
options. But employees who had put all their pension money in Enron shares lost
everything when the firm went bankrupt in December. The collapse of energy giant
Enron is the largest bankruptcy and one of the most shocking failures in United States
corporate history. In just a little over 15 years, Enron grew from a regulated natural gas
company into one of USs largest companies. It embraced new technologies, established
new methods of trading in energy and seemed to be a shining example of successful
corporate America. But in just three months time Enron had gone from being a company
claiming assets worth almost 62bn to bankruptcy. But the companys success was based
on artificially inflated profits, dubious accounting practices, and fraud. Its share price
collapsed from about $95 to below $1.

ENRON'S ACCOUNTS: THE TRUE PICTURE

Year

Reported
income

Revised
income

True debt

True equity

1997

$105
million

$77m

$771m

down
$258m

1998

$733m

$600m

$561m

down
$391m

Andersens role in Enron bankruptcy

1999

$893m

$645m

$685m

$710m

Reported and revised income, debt and shareholder equity 1997 - 2000
following special partnership revelations.

Some 25 further companies have declared Enron exposure, totaling an estimated $1bn.
Total global investment exposure at least $4bn.

INTERNATIONAL SHOCKWAVES:
Companies with substantial exposure to Enron
J P Morgan: $900m

Sumitomo Mitsui Corp: $210m

Citigroup: $800m

Nikko Cordial: $207m

Credit Lyonnais: $250m

Principal Financial Group: $171m

Bank of Tokyo-Mitsubishi: 248m

Abbey National: $164m

Chubb Corp: $220m

National Australia Bank: $104m

Canadian Imperial Bank: $215m

Duke Energy Corp: $100m

Source: Enron/Powers Special Report

Andersens role in Enron bankruptcy

About ARTHUR ANDERSEN

Arthur Andersen was one of the "Big 5" accounting firms (the other 4 are: Deloitte &
Touche, Ernst & Young, KPMG and PricewaterhouseCoopers). With 85000 employees
working in more than 84 countries, Arthur Andersen provided audit services to
companies all around the world.
Arthur Andersen an 89-year old company, once one of the world's top five accountants
had a proud tradition of integrity, which soured during the late 20th century. Eager to
make millions of dollars in consulting and auditing fees, the firm looked the other way as
clients such as Waste Management, Global Crossing, Worldcom and Enron cooked their
books. Starting with Waste Management in 1998, the accounting irregularities started
coming to light. Enron was the last straw. Arthur Andersen was convicted of obstruction
of justice in 2002. The firm filed for bankruptcy and soon ceased operations.
But, in June 2002, Andersen's US division was found guilty by federal prosecutors of
obstructing the course of justice. Pre-empting its official punishment, Andersen
voluntarily agreed to stop auditing public companies in the US. Many important clients
Andersens role in Enron bankruptcy

had already deserted the sinking ships, and its international businesses have been divided
up between its rivals. Earlier attempts to save itself through a merger ended in failure.
Almost a footnote to the 2001 bankruptcy of energy trading powerhouse Enron was the
demise of the firm's auditor, Arthur Andersen. The incident further damaged the
reputation of venerable Arthur Andersen, which in June 2001 settled allegations of fraud
stemming from its audit of Houston-based Waste Management and paid a $7 million fine
without admitting any wrongdoing. The previous year without admitting wrongdoing,
Andersen agreed to pay $110 million to settle a class action brought on behalf of
shareholders of another client, Sunbeam, which had misstated its financial results during
the 1990s.
Andersen has already lost much of its business, and two-thirds of its once 28,000 strong
US workforce. Following the conviction, multi-million dollar lawsuits brought by Enron
investors and shareholders demanding compensation are likely to follow, and could
bankrupt the firm. Arthur Andersen LLP was also sentenced to five years' probation and
fined $500,000 for obstruction of justice related to its handling of Enron Corp.
documents. That Enron's false accounting was not spotted sooner has prompted the
accounting industry to take a hard look at itself. Hundreds of US firms, which used socalled aggressive accounting methods to keep debts or one-off charges away from the
headline figures have been affected. Arthur Andersen, the former auditing giant has
collapsed after being found guilty of deliberately destroying evidence of its relationship
with Enron. A jury in the United States has found accountancy firm Arthur Andersen
guilty of obstructing justice by shredding documents relating to the failed energy giant
Enron.

Andersens role in Enron bankruptcy

How Andersen was in involved on the Enron

bankruptcy case?
Arthur Andersen's role in the Enron affair has brought the once prestigious accounting
firm to its knees. Arthur Andersen's job was to check that the companys accounts were a
fair reflection of what was really going on. As such, they were the first line of defense in
the case of any fraud or deception. When the scandal broke, as the government began to
investigate the companys affairs, Andersens chief auditor for Enron, David Duncan,
ordered the shredding of thousands of documents that might prove compromising.
Andersen dismissed Mr. Duncan, but insisted that the firm did not act improperly and
could not have detected the fraud. Enron paid Andersen $25 million for its audits and $27
million for "consulting" and other services. Arthur Andersen performed both external and
internal audit of Enron. Such was the extent of their partnership that Enron provided
work space for Andersons employees in their Houston office. Andersen's interpretation
Andersens role in Enron bankruptcy

of accounting rules allowed Enron to exclude losses at several partnerships from its
balance sheets.
Enron provided natural gas and electricity products to businesses worldwide by acting as
a middleman in the industrial market. Enron bought power from localized plants around
the world and sold it in long-term packages to businesses and facilities. As Enron grew,
so did its stock options. Enron managers and business partners sought to take advantage
of profitable investment opportunities. Enron wanted to recognize income immediately
from its long-term supply contracts rather than wait for the income to stream in as the
electricity or natural gas was delivered to customers. In order to show income on its
financial statements, Enron made deals with partners to sell the delivery contracts. Some
partners however were reluctant to accept all of the risk associated with the long-term
contracts. So Enron sometimes guaranteed the future cash flows for those partners. Enron
continued to recognize income on these transactions, arguing that generally accepted
accounting principles (GAAP) permitted it to do so.
Enron's accounting firm, Arthur Andersen, LLP, recognized that GAAP was not
completely clear on how to account for such transactions. The auditors agreed that
Enron's accounting was consistent with GAAP, but its financial reporting methods have
been questioned by the SEC, other accountants and by some within Enron itself. But
Enron got in over its head with such business deals and Arthur Anderson was no longer
able to support its actions. Andersen used off balance sheet special purpose entities
that make it possible for Enron to hide the true financial conditions of the company.
Through Enrons deal making and Andersens complex accounting the energy giant was
able to hide had swept tens of millions of dollars in debt off its books, making the
company's balance sheet look much better than it was in reality. Andersen mislead the
shareholders and investors by making the financial situation of Enron seem very sound
by hiding the real amount of debt from the balance sheets.
Andersens role in Enron bankruptcy

Andersen is also responsible of shredding Enron-related documents to thwart a Securities

and Exchange Commission accounting probe. When the Enron scandal broke as the
government began to investigate the companys affairs, Andersens chief auditor for
Enron, David Duncan, ordered the shredding of thousands of documents that might prove
compromising. Arthur Andersen employees were clearly instructed to illegally destroy
thousands of documents and computer records relating to Enron. Arthur Anderson is
accused of:
Ignoring or failing to thoroughly investigate shell companies created by
insiders who grotesquely enriched themselves while hiding Enrons mounting
debt in "off balance sheet companies."
Ignoring knowledgeable whistleblowers.
Altering documents.
Ignoring well-known accounting industry "red flags" that indicates whitecollar fraud is taking place.

The actions of one hundred or so employees at both Arthur Anderson and Enron have
destroyed the reputation and lives of tens of thousands of individuals who were never
involved or even aware of the situation.

The Future of the Auditing industry

The independent auditor is supposed to objectively review managements presentation of
accounting data to shareholders. In the course of conducting a financial audit, accounting
Andersens role in Enron bankruptcy

firms gain a great under-standing of their clients business. About two decades ago, the
major auditing firms discovered there was significant money to be made by adding
consulting businesses to their auditing work. This consulting work covers such things as
tax strategy development, advice on mergers and acquisitions, and suggestions for
restructuring and improving management information systems. Not only does non-audit
consulting work carry higher profit margins, but most clients have been enticed to spend
more on their consulting contracts than on their audits. The objectivity of auditors is
compromised when their challenging a problematic accounting method may result in
their losing valuable consulting business.
In Enrons case, Arthur Andersen was not willing to jeopardize $27 million in consulting
contracts by blowing the whistle on the accounting excesses discovered during the audit
process, for which it was paid a $25 million fee in 2000.

A study conducted by Business Week on more than 3,000 proxy statements from 2001
found that Nelson found that the more consulting services a company bought from one
of the Big Five auditors, the more likely its earnings met or beat Wall Street expectations.
Companies using their auditors as consultants tend to manage earnings maneuvers such
as moving debt off the books into partnerships and booking gains in pension funds as
income. Investors should be wary of the quality of a companys earnings if it hires its
auditor as a consultant.

With Enrons spectacular demise and Arthur Andersens bungled audit of the energy
company raising questions about the validity of independent auditors, the accounting
industry will have to replay a regulatory battle it fought and won a few years ago. In
2000, Arthur Levitt, who was then chairman of the Securities and Exchange Commission,
spotted a potential conflict of interest brewing in the accounting industry. The Big Five
Andersens role in Enron bankruptcy

10

accounting firms (Arthur Andersen, Deloitte & Touche, Ernst & Young, KPMG and
PricewaterhouseCoopers) had managed to increase their income by offering consulting
services to the same companies they audited. Levitt, concerned that the firms would
compromise their credibility when they had to audit their own services, proposed an SEC
rule that would bar accountants from also acting as consultants. But when the accounting
industry heard about the rule, Levitt became the target of what he later called an
intensive and venal lobbying campaign. The accounting industry got 46 members of
Congress to call or write personal letters to Levitt questioning the proposed rule. Some
lawmakers reportedly threatened to withdraw funding from the SEC. Withering under the
assault, the SEC eventually curtailed Levitts proposal.
Now, with both Congress and the FBI investigating Enrons close relationship with
Arthur Andersen, the SEC is tackling the issue again. Enrons critics say because Arthur
Andersen also provided $27 million worth of consulting services to Enron, the auditor
failed to properly review the companys financial statements, allowing Enron to overstate
its earnings by nearly $600 million. The SEC, now has proposed creating a watchdog
panel that would oversee the accounting industry. And California Senator Barbara Boxer
has pledged to introduce a bill that would prohibit accounting firms from also providing
consulting services to clients.
The accounting industry is scrambling to respond to the burgeoning federal regulation.
The industrys trade association, the American Institute of Certified Public Accountants,
which led the fight against the SECs proposed rule two years earlier, is meeting with the
SEC to discuss the watchdog panel. The group has also reportedly hired additional
lobbyists to help deal with legislation on Capitol Hill. If the battle with former SEC
chairman Arthur Levitt two years ago is any indication, the industry knows what its
doing. Andersen's downfall means the remaining Big Four accounting firms have to be
more scrupulous and more skeptical of clients, particularly if accounting practices are
questionable. No one had a clue that one of the Big Five would disappear this way. This
Andersens role in Enron bankruptcy

11

is a wake-up call to the other firms that they should be doing their work properly or they,
too, could go down.

Andersens role in Enron bankruptcy

12