Enron scandal

A presentation from the Audit Perspective covering in detail the Enron Scandal, the parties involved, what should have been done, etc.

1. Presentation on the “Enron Scandal” Presented by - Anushka Gupta B.Com(Hons.) 3 rd Year

2. The Company Profile In 1985, Enron was born from the merger of Houstan Natural Gas and InterNorth. Kenneth Lay , the former chief executive officer of Houston Natural Gas, became CEO, and the next year won the post of chairman. Started trading futures in Gas Contracts. Soon got the control of over 25% of the all Gas business. Began trading in commodities like steel, coal, weather risk, etc.

3. Sequence of Events that followed

4. Partners in Crime Kenneth Lay- the Chairman Andrew Fastow - The CFO Jeffrey Skilling- The President and COO Arthur Anderson- The accounting Firm Masterminds: (left to right): founder Ken Lay; Jeff Skilling; Andy Fastow; and Lou Pai

5. Causes of the E nron Scandal Dubious Accounting Practices Enron’s misleading Accounts Mark to market accounting Special Purpose Entities Executive compensation Financial Audit Over-statement of Profits

6. On an annualized basis between 1995 and 2000 : Enron's assets grew 38%, revenues grew more than 60%, and earnings grew 12%.

7. Enron Operating Performance 1985 - 2000

8. Enron’s Accounting Fraud Diagram Enron Profit Understated Forecasted Future Price C O M P A R E Mark To Market Method Seller Buyer Overstated Debt Special Purpose Entity Debt & Failing Investment Sales Revenue Original Price paid for the contract

9. The Whistle Blower On Feb 14, 2002, Sherron Watkins, the Enron whistleblower, testifies before a Congressional panel against Skilling and Lay. Sherron Watkins is an Enron vice president. She wrote to Lay in the past expressing concerns about Enron's accounting practices.

10. The Down Fall

11. T he Rise and Fall of Enron ” “ The company’s success was based on artificially inflated profits, dubious accounting practices, and – some say – fraud.

12. Negative Cash Flows… Negative Cash Flows: 1 st three quarters in 1999, 2000 & 2001

13. T he True Picture Year Reported Income Revised Income True debt restated by True equity restated by 1997 $105m $77 m Up $771m Down $258m 1998 $733m $600m Up $561m Down $391m 1999 $893m $645m Up $685m Down $710m 2000 $979m $880m Up $628m Down $754m Reported and revised income, debt and shareholder equity 1997-2000 following special partnership revelations. Enron’s Accounts: The Company announced the restated figures

14. The Fraud Triangle Opportunities Weak Board of Directors Weak Internal Controls Incentives/Pressures Tight Debt Agreement Unrealistic Expectations Attitudes/Rationalizations Lack of a Code of Conduct Disregard for Financial Reporting

15. Role of Auditor The Internal Audit Department Should have ensured the compliance of SA 240, SA 520. Should maintain a tight internal control system established by the board members & directors Report directly to the CEO Direct consultation with the board director Submit a quarterly report to the board and the supervisory committee . Statutory Auditor Ensured compliance with SA 700 and SA 720. Independent from the company and the board Abides with accounting principles and rules Should hold neutral opinions

16. Enactment of Sarbanes Oxley Act In response to the Arthur Anderson, Enron, The Sarbanes Oxley Act seeks to Restore the public confidence in both public accounting and public traded securities. Assure the ethical business practices through heightened levels of executive awareness and accountability.

17. What is SOX ? US Law, Enacted in July 2002, By a bill sponsored by Mr. Paul Sarbanes & co-authored by Mr. Michael Oxley , under whose name the act was enacted, Consists of 11 chapters and 69 articles, Also Known as “Public Company accounting Reform and Investor Protection Act”.

18. How did SOX try to amend the situation? Sarbanes-Oxley provides for increased corporate governance and corporate accountability. Therefore, SOX is in place to be sure that fraud on the scale of Enron never takes place again. If a publicly-traded company is not in compliance with the SOX law, the penalties are stiff. Multi-million dollar fines can result and imprisonment of the CEO or CFO. Penalties are based on the section of SOX that the company is not in compliance with.

19. In summary, the Sarbanes-Oxley Act of 2002 is probably the best piece of legislation to protect investors in modern times. It is a shame that it took debacles like Enron and others to shake up Congress into writing this legislation as many innocent people, investors and employees, literally lost their life savings. Perhaps SOX will make sure that doesn't happen again.

20. What should have been done? 1. General Assembly Shareholders should be encouraged to attend GAs . Agenda items should be explained clearly GA Should be managed to allow shareholders to express their opinions . Voting on general assembly motions should be recorded accurately. 2. Board of Directors Should meet at least once every 3 months Non executive members may meet directors for consultation . Review internal regulations & procedures for their appropriateness & efficiency An internal audit committee formed from a number of non-executive members should be assigned to check internal controls & the company's working practices. Responsible for risk management in accordance with the company's activities, size, & market board should submit an annual report to shareholders including tasks assigned by law .

21. 3 . The Audit Committee Comprises of a minimum of three non-executive members. One member should be a finance & accounting expert Assess the efficiency of the financial manager & other financial staff review the financial statements before being presented to the board and give opinions and recommendations review the internal/external auditor’s plan and make suggestions. The committee should meet periodically, at least once every three months, with a specified agenda 4 . Disclosure of social policies At least once a year the company should disclose environmental, social, safety & health policies to shareholders, customers and employees. The policies disclosed should be clear & unambiguous, including the company's strategies for employee recruitment & training & social welfare programs within or outside the company. Relationships

22. 5 .Avoiding conflict of interests Each company should have clear and recognized regulations for the directors & staff regarding the prevention of conflict of interests Board members, directors and staff may not trade company stocks before the disclosure of the company's financial statements Draw up rules of professional code of conduct Impose an internal system for supervising the implementation of the code of conduct 6.Effective corporate governance 7.Disclosure and transparency 8. Audit Committee of the Board should have been more critical of the auditors and their work.

23. Steps to take to enhance your internal controls: Establishment of an audit committee to provide financial reporting and internal control expertise, along with oversight on such matters Establish a “ Whistle-Blower ” policy to provide the means and safeguards to those who identify fraudulent practices Assess the risk associated with the processes that make-up your organization ( ie ., sales/revenue, cash, accounts receivable, fixed assets, accounts payable, payroll, etc.) For high risk areas and processes ask yourself, “What Could Go Wrong” and address the answers to the question.

24. Conclusion The ENRON failure has not been the result of just questionable activities by ENRON’s executive management team. The cast of contributors to the failure and bankruptcy are both inside and outside the company. It’s the total system that resulted in failure that needs to be further understood and investigated.

25. In a nutshell, following shall be the approach

26. Thank You…