MBAF 698 – Futures and Options
August 8, 2013
Enron: Could it Happen Again?
The name Enron along with other names such as MCI/Worldcom has come to stand for the ultimate in corporate corruption and lack of oversight. They are icons of an era in which selfish greed was the norm and CEO's lost sight of simple ethics and sound decision making. Financial innovations continue to create new challenges both ethically and fundamentally and with an evermore interlinked and global economy, the effect of corporate missteps can have disastrous implications across the globe. While most corporations play by the rules, undoubtedly more scandals will occur. What happened at Enron? Could it happen again or are there limits in place to prevent similar occurrences in the future? History is full of lessons and the story of Enron has its share. Some lessons it seems have been learned. Enron is directly responsible to the Sarbanes-Oxley legislation, which attempts to prevent similar scandals. But people are the critical determinant in all scandals of this nature and like all scandals, we begin our study with the people at the center of the Enron scandal.
The Enron story begins and ends with one person. Ken Lay was the first of a triumvirate of major contributors to the Enron fraud. While he was not singularly responsible, he put wheels in motion and set the tone for the eventual ethical lapses. Without him, Enron quite possibly would still be a small time regional player. Lay received his Ph.D from The University of Houston in Economics and went on to hold multiple government jobs including a stint as the Assistant Deputy of the Interior during the Nixon Administration. While a pure coincidence, It is ironic that one of the 21st century's icons of corporate corruption served in the administration of one of the 20th century's icons of government corruption. After leaving the Department of the Interior in 1974, he began working in the Oil and Gas industry. During this period, he lobbied aggressively for deregulation of the industry. He also fostered connections and relationships with many politicians including both George Bush Sr. and George W. Bush. In 1984 he was hired as the CEO of Houston Natural Gas. Houston Natural Gas merged with InterNorth in 1985 and in 1986 the company changed its name to Enron. In 1987, it was discovered that 2 executives from Valhalla Oil were gambling beyond their limits in trading and transferring profits from futures trading revenues to their own personal accounts. Both were recalled to Houston and questioned by the Enron board. After they admitted to the transgressions, the Board of Directors asked Ken Lay how he wanted to handle the situation. His answer: do nothing. His justification: They were making money for the company and good money at that. Instead, they were sent back to work at Valhalla and their limits increased. His management (or mismanagement) of that situation would prove to be a bellwether of future decisions.
In 1990 Ken Lay hired Jeff Skilling as President of Enron. Jeff Skilling had graduated form Harvard's Business School with an MBA and had impressed Lay as a consultant when he had helped Enron establish a Natural Gas Forwards market. Skilling agreed on the condition that Enron utilize Mark to Market accounting practices. Mark to Market would allow Enron to book potential future profits of deals immediately once the deals were signed. Lay agreed and Arthur Anderson, Enron's accounting firm signed off on it. In addition, the SEC approved it. Skilling immediately changed Enron's business model. Rather than trading actual energy assets, Enron began to trade in financial derivatives with Energy products as the underlying assets.
The third person in the triumvirate was Andy Fastow, the CFO. Fastow received his B.A. in Economics from Tufts University and went onto get an MBA at Northwestern. After earning his MBA, he went on to work for the Continental