Question

Question # 1 How was Enron able to outwit and literally fool so many investors?

Question # 2 What eventually happened to this entire company?

Question # 3 What does “Mark to Market” actually mean in accounting terms?

Question # 4 The accounting firm Arthur Anderson was the chief auditor for Enron, what happened to that firm?

Question # 5 Can this debacle happen once again in corporate America?

Question # 6 Exactly what did you learn from completing this entire assignment about greed and the naivety of the investing public?

Answer 1

• Enron was formed in 1985 following a merger between Houston Natural Gas Company and Omaha-based InterNorth Incorporated. Following the merger, Kenneth Lay, who had been the chief executive officer (CEO) of Houston Natural Gas, became Enron's CEO and chairman. Lay quickly rebranded Enron into an energy trader and supplier. Deregulation of the energy markets allowed companies to place bets on future prices, and Enron was poised to take advantage. In 1990, Lay created the Enron Finance Corporation and appointed Jeffrey Skilling, whose work as a McKinsey & Company consultant had impressed Lay, to head the new corporation. Skilling was then one of the youngest partners at McKinsey.

Skilling joined Enron at an auspicious time. The era's minimal regulatory environment allowed Enron to flourish. At the end of the 1990s, the dot-com bubble was in full swing, and the Nasdaq hit 5,000. Revolutionary internet stocks were being valued at preposterous levels and, consequently, most investors and regulators simply accepted spiking share prices as the new normal.

• One of Skilling's early contributions was to transition Enron's accounting from a traditional historical cost accounting method to mark-to-market (MTM) accounting method, for which the company received official SEC approval in 1992. MTM is a measure of the fair value of accounts that can change over time, such as assets and liabilities. Mark-to-market aims to provide a realistic appraisal of an institution's or company's current financial situation, and it is a legitimate and widely used practice. However, in some cases, the method can be manipulated, since MTM is not based on "actual" cost but on "fair value," which is harder to pin down. Some believe MTM was the beginning of the end for Enron as it essentially permitted the organization to log estimated profits as actual profits.

In Enron's case, the company would build an asset, such as a power plant, and immediately claim the projected profit on its books, even though the company had not made one dime from the asset. If the revenue from the power plant was less than the projected amount, instead of taking the loss, the company would then transfer the asset to an off-the-books corporation where the loss would go unreported. This type of accounting enabled Enron to write off unprofitable activities without hurting its bottom line.

The mark-to-market practice led to schemes that were designed to hide the losses and make the company appear more profitable than it really was. To cope with the mounting liabilities, Andrew Fastow, a rising star who was promoted to chief financial officer in 1998, developed a deliberate plan to show that the company was in sound financial shape despite the fact that many of its subsidiaries were losing money.

Andrew Fastow, a major player in the Enron scandal was Enron's accounting firm Arthur Andersen LLP and partner David B. Duncan, who oversaw Enron's accounts. As one of the five largest accounting firms in the United States at the time, Andersen had a reputation for high standards and quality risk management.

However, despite Enron's poor accounting practices, Arthur Andersen offered its stamp of approval, signing off on the corporate reports for years. By April 2001, many analysts started to question Enron's earnings and the company's transparency.

Arthur Andersen was one of the first casualties of Enron's prolific demise. In June 2002, the firm was found guilty of obstructing justice for shredding Enron's financial documents to conceal them from the SEC. The conviction was overturned later, on appeal; however, the firm was deeply disgraced by the scandal and dwindled into a holding company. A group of former partners bought the name in 2014, creating a firm named Andersen Global.

Learning:

people often display rational ignorance in that, unlike Chicago Man, they often choose to make decisions based on much less than full information. They willingly “satisfice” rather than optimize their decision making outcomes.

people tend to be subject to the confirmation bias in that they seek out and process information in such a way as to confirm preexisting beliefs rather than in a more optimally neutral manner