Marketing A Study In Business Ethics Danna Nelson

Marketing A Study In Business Ethics Danna Nelson- Gresham High School

How is the Enron story relevant to current economic problems? Evaluate the collapse of Lehman Brothers (one of the largest investment banks in the world) and explain how it is similar to the Enron bankruptcy. Video: The Lehman Brothers Bankruptcy

What Was The Enron Company? l l l l An American energy company based in Houston, Texas One of the world’s leading electricity and natural gas companies Claimed revenues of $111 billion in 2001 The 7 th largest corporation in America, valued at almost $70 billion A global business with over 20, 000 employees Named America’s Most Innovative Company by Fortune magazine for six consecutive years Largest bankruptcy (at that time) in history

Enron Field Home of The Astros In 1999, Enron agreed to pay more than $100 million to name the new Houston Astros stadium Enron field.

Enron Field After Enron declared bankruptcy on December 2, 2001 the Astros decided to buy back the naming rights for their new stadium. It would later be named Minute Maid field.

Explain How Enron Went Bankrupt l l l It abandoned it’s key profit areas of natural gas and electricity in favor of high risk business ventures such as futures/commodity trading It developed a culture that valued growth and deal making with little regard for the negative consequences these deals would have on the future profitability of the company It engaged in accounting fraud using “mark-to-market accounting” and “special purpose entities” (SPEs) to hide losses and create profits where none existed It purchased or began unrelated businesses of which Enron’s executives had little understanding - resulting in financial losses (Example: The Broadband Division) It purchased businesses in other parts of the world without understanding the risks and complexities associated with that country (Example: The power plant in Dabhol, India)

The Fall of Enron Over a 16 -month period, Enron's stock price declined from a high of $90 to a low of under $1 before the giant energy-trading company declared bankruptcy.

One of the Enron towers in downtown Houston. 1500 Louisiana Street (also known as Enron Tower II / Enron Center South) www. bizjournals. com

The building has one of the most high-end trading facilities ever built. It includes four 53, 000 square-foot trading floors and two data center floors. Nearly 800, 000 square feet in the building is unfinished office space. An adjacent 1, 100 -car parking garage and an entire downtown block of land were included in the sale. www. bizjournals. com

The Enron Parking Garage along with the skybridge that connects the garage with Enron Center North and 1500 Louisiana Street. The 1100 Louisiana Building is on the far left. Just above the skybridge on the left is the rotating restaurant on top of the Hyatt Regency Hotel Houston.

Explain “Futures” Trading l l l Virtually any raw material (oil, natural gas, wheat, cattle) can be traded on the “futures” market These products have fluctuating prices Producers of these products and businesses that buy these products in bulk seek to reduce the risk of large changes in price by signing contracts (a “futures” contract) agreeing on a set price at a set time in the future (90 days, 6 months, 1 year)

Chicago Mercantile Exchange

Chicago Mercantile Exchange

Evaluate the Nature of “Futures” Trading l l l If electricity is currently selling at $95 per megawatt hour, but I believe the price will be higher in the future my business (which consumes vast amounts of electricity) might attempt to purchase a “future” contract to buy 100, 000 megawatt hours at $95, deliverable one year from now – this is a binding legal contract If I’m right and the cost of electricity rises to $100 per megawatt hour I’ve made a profit of $500, 000 If I’m wrong and the price drops to $90 per megawatt hour I’ve lost $500, 000 This is called commodity trading or futures trading Since the actual future price of a commodity is uncertain this is essentially a form of gambling – one company is betting that the price will go up in the future and the other company is betting that it will go down – someone has to lose – VERY risky!

Evaluate the Potential for Harm in “Futures” Trading l l Most economists agree that overspeculation in the housing market lead to the crash of the financial sector in 2008 and the great recession. In late 2008 the price of crude oil dropped significantly. Why? Video: Speculation and the Price of Oil

Evaluate the Potential for Harm in “Futures” Trading Deepen your understanding … How does the interaction of supply and demand impact the price of crude oil? Are there factors other than supply and demand that can influence the price of crude oil? Domain 3 b

Explain the Purpose of a Special Purpose Entity l An SPE is a corporation created by another corporation for a specific, temporary purpose l l Ethical Example: The Walt Disney Company might create several SPEs to purchase land in SW Missouri and NW Arkansas for a future theme park – by doing this the company can conceal its plans from competitors and prevent the price of land from increasing Unethical Example: The Enron Company wanted to sell a poor performing Polish Power Plant worth $14 million – Andy Fastow created an SPE (LJM) that purchased the power plant for $30 million – this allowed Enron to “book” $16 million in profits – LJM later sold the power plant back to Enron for $31. 9 million – Fastow and his partners would split the $1. 9 million handling fee

How Did An SPE Work? This allows Enron to book $30 million in profits before the end of the year Enron sells Polish Power plant to LJM 1 for $30 million LJM 1 Nat West Bank Citi Corp Bank (SPE) Andy Fastow Chase National Bank Each bank “invests” $9, 700, 000 in LJM 1 30 days later, LJM 1 sells the JEDI (SPE) Power Plant back to Enron for $31. 6 million After repaying the banks plus interest, Andy will “earn” over $1, 000 in “management fees” as director of the SPE – (he is also the CFO for Enron – CONFLICT) (but since the investment is guaranteed by Enron then its really just a loan to Enron) JEDI “invests” 900, 000 in LJM 1

Enron had as many as 500 SPE’s and thousands of partnerships

Special Purpose Entities Created by Andy Fastow l l l l JEDI – (Joint Energy Development Investments) A fund jointly owned by Enron and the California Public Employees Retirement System (Calpers) to invest in oil and gas properties. JEDI II – Also formed between Enron and Calpers. Chewco – An off-books partnership controlled by an Enron executive. Used to purchase Calper’s interest in JEDI to allow for the retirement system to invest in JEDI II LJM Cayman – (LJM = Lea, Jeffrey, & Matthew) Also known as LJM 1. In investment fund managed by CFO Andy Fastow. Used manly to protect against a decline in the price of Enron’s investment in a technology company. LJM 2 – A far larger investment fund, also managed by Enron’s CFO, Andy Fastow. Used primarily to sell unwanted Enron assets. The Raptors – A total of 4 off-books entities created to protect Enron from losses from certain investments. Braveheart – The code name for the deal involving the sale by Enron of a portion of its video-on-demand business, formed in a joint venture with Blockbuster.

“Mark to Market” Accounting l l l Allowed the Enron Corporation to “book” the profits on a deal on the day the deal closed Example: Enron agreed to build a power plant in England predicted that this power plant would generate $500 million in profits over the next 10 years – under “mark to market” accounting the $500 million would be booked as profit in the year the deal closed – cash doesn’t change hands, its all on paper AND there is no way to predict the real amount of profit that will be generated – in fact many of these mark to market deals actually LOST money Mark to market accounting is used in the sale of stocks – as soon as the deal closes the profit, or loss, on the sale of stock is booked – this makes sense for stocks

California Energy Crisis l l l High prices and rolling blackouts lasted from May 2000 to September 2001. Enron was accused of manipulating the energy market in order to drive up prices. This resulted in a $5. 7 billion increase in energy prices for consumers, and drained the state of California of more than $11 billion l Enron would shut down a power plant for “maintenance” in order to drive up the price of electricity. l Power would be sent out of California resulting in a shortage – then the power could be returned at a higher price.

Gray Davis Governor of California Due to the increase in electricity prices and the rolling blackouts the people of California were very dissatisfied with their political leadership. The Governor of California After his recall by the – Gray Davis -became only people … who the second governor to be replaced Gray Davis recalled in American history. as the Governor of California? ? ?

The Governator On October 7, 2003 Governor Gray Davis was removed from office with 55. 4% of the population voting Yes in favor of a recall. Schwarzenegger was elected Governor of California under the second question on the ballot with 48. 6% of the vote. Schwarzenegger was the first foreign-born governor in California history since Ireland -born Governor John G. Downey in 1862. In an ironic twist, many claim that actor Arnold Schwarzenegger became Governor in part because of the energy “crisis” that many blamed on Enron.

Enron: A Story About People “People perceive the Enron story to be about numbers and complicated financial transactions … but in reality it is a story about people. It is really a human tragedy. ” – Bethany Mc. Lean Quote from documentary The Smartest Guys in the Room Bethany Mc. Lean was the first journalist to question Enron's inflated stock price with her article in the March 5, 2001 issue of Fortune Magazine entitled, "Is Enron Overpriced? ". She would later co-author a book titled Enron: The Smartest Guys in the Room. Bethany Mc. Lean Senior Editor Fortune Magazine

The Enron Players Kenneth “Ken” Lay He was born to a poor family in Tyrone, Missouri. When he was a child he delivered newspapers and mowed lawns. His father, Omer, was a Baptist preacher and occasional tractor salesman. The family moved to Columbia, Missouri where Ken attended David H. Hickman High School and the University of Missouri where he studied economics. He served as president of the Zeta Phi chapter of his fraternity at the University of Missouri. He obtained a doctorate in economics at University of Houston in 1970 and went to work at Exxon Mobil Corporation. CEO and Chairman of the Board of Enron

Tyrone, Missouri Tyrone, MO Tyron is an unincorporated community so small it does not appear on maps.

Mr. Dorman takes a fieldtrip to Tyrone, MO!

The only business left in town.

The Enron Players Jeffrey “Jeff” Skilling was born in Pittsburgh, Pennsylvania, the second of four children. He grew up in New Jersey and Aurora, Illinois. After graduating from West Aurora High School (where he graduated number 16 in a class of 600), Skilling received his B. S. in applied science at Southern Methodist University in 1975. During his admissions interview for Harvard Business School, he was asked if he was smart, to which he famously replied, "I'm expletive smart. “ Skilling earned his M. B. A. from Harvard Business School and became a consultant at Mc. Kinsey & Company in the energy and chemical consulting practices. In 1991, he became the chairman of Enron Gas Services and in 2001 he was named CEO of Enron, receiving $132 million in a single year. Jeff Skilling President & CEO

The Enron Players Andrew “Andy” Fastow was born in Washington, DC, the middle child of three sons. His parents worked in merchandising for a drug store chain. He grew up in New Providence, New Jersey, where he was student council president and on the tennis team and in the school band. Fastow graduated from Tufts University in 1983 with a BA in economics. Fastow earned an MBA at Northwestern University and worked for Continental Illinois National Bank in Chicago. While at Continental Illinois, Fastow helped pioneer a system of raising capital by selling notes backed by risky loans. The practice spread across the industry "because it provides an obvious advantage for a bank, " noted the Chicago Tribune. "It moves assets off the bank's balance sheet while creating revenue. " Continental became the largest U. S. bank to fail during the Savings and Loan crisis. Based on his work at Continental, Fastow was hired in 1990 by Jeffrey Skilling at Enron. He rose to the position of Chief Financial Officer. Andy Fastow Chief Financial Officer

The Enron Players Rebecca Mark was head of the International division of Enron. Later, she served as CEO of Azuriz – the Enron division created to purchase public water utilities around the world. She was responsible for investing $900 million in a power plant in Dabhol, India that eventually had to shut down because the Indian government could not afford to pay for the power. Enron lost nearly all of its $900 million dollar investment. As head of Azurix she purchased British water utility Wessex Water, paying 30% more than the company was worth. Deregulation brought a rapid decrease in water prices, and the junk debt financing of the purchase was very costly. Enron eventually sold Wessex at a loss of $1. 1 billion She was frequently criticized for excessive personal spending. She often chartered a jet (at Enron’s expense) for travel between Houston and New York when commercial airlines offered numerous daily flights. She decorated her private office with expensive Rebecca Mark, CEO furnishing, including a limestone floor. She resigned from the company in 2000 under pressure from Enron International & Azurix both Skilling and Lay. She sold her stock for nearly $80 million dollars. She faces no legal consequences. It has been said of Rebecca Mark that being a bad business manager wasn’t illegal.

The Enron Players Lou Pai was born in Nanjing, China and came to the US at the age of 2. Pai obtained both his BS and MS from the University of Maryland in College Park, where his father was a math professor. A mathematics wiz, he was instrumental in getting Enron into the trading business. He was notorious for his misuse of his Enron expense account. He often charged large amounts of money spent at strip clubs to his Enron expense account. Pai also used Enron's corporate jet for personal travel. To meet his divorce settlement, he cashed out nearly $300 million in Enron stock before the collapse. His was the largest stock sale of any Enron employee. An attorney for Pai says sale of the stock was part of the divorce settlement, protecting him from insider trading charges, adding "He's the only guy who's ever been lucky to get divorced. " He has not been charged with any criminal wrongdoing in the Enron scandal and has exercised his 5 th Amendment right in regard to the subsequent Enron class action lawsuits. Accounts of the Enron scandal have frequently portrayed him as a mysterious figure; a former Enron employee, interviewed in the documentary film Enron: The Smartest Guys in the Room, referred to Pai as the "the invisible CEO“. Lou Pai Enron Executive

The Enron Players Amanda Martin She is a graduate of the University of Natal in South Africa (she speaks English with a South African accent) and the Louisiana State University Law School. She began working at Enron in 1991 as an in-house lawyer. In 1995 she became the first female managing director at Enron. She was named President of the North American Finance division in 1996. She received an anonymous letter in 1995 indicating that she was being paid nearly $100, 000 less than her male counterparts. After confronting Skilling she received a check for $300, 000 to compensate her for 3 years of underpayment. She was also the subject of much gossip due to a 3 year affair with her married boss, Ken Rice. The affair resulted in a lawsuit by another employee she demoted. The demoted employee claimed that Ken Rice refused to overturn Martin’s decision due to the improper relationship between the two. The case was settled out of court. After numerous complaints of favoritism, Skilling transferred Martin to the failing Azurix water division. Nothing happened to Ken Rice. Amanda Martin Longtime Enron Executive

The Enron Players Ken Rice was the ninth ex-Enron executive to receive a jail term after pleading guilty to crimes. He was also fined $50, 000, but allowed to remain free on bond until the Bureau of Prisons determined where he would be committed. Rice had faced up to 10 years in prison and a fine of up to $1 million. The plea agreement with prosecutors also required him to forfeit $13. 7 million in cash and property that included jewelry and a pair of exotic sports cars. Rice was charged in 2003 with selling 1. 2 million shares of Enron stock for more than $76 million while he knew Enron Broadband Services was failing. Ken Rice Chief of Enron’s Broadband Division

The Enron Players Cliff Baxter was an Enron executive who resigned in May 2001, about 7 months before the company declared bankruptcy. He sold a large quantity of Enron stock during the months before the company collapsed. Baxter disagreed with Jeff Skilling over questionable Enron business practices. It was said by whistleblower Sherron Watkins that he "complained mightily to Skilling and all who would listen about the inappropriateness of our transactions with LJM. " Before his death, he had agreed to testify before Congress in the Enron case. On January 25, 2002, Baxter was found dead in his black Mercedes-Benz with a gunshot wound through the right side of his head. While his death was ruled a suicide there has been some speculation that he was murdered to prevent his testimony against other executives. However, friends have said that he was deeply depressed over the company's collapse. Cliff Baxter Vice Chairman

The Death of Cliff Baxter l l l He slipped out of bed in the middle of the night, stuffing pillows under the covers so his sleeping wife wouldn’t notice he was gone – he was dressed in blue jogging slacks, a t-shirt, and moccasin slippers He stepped quietly through the house, taking care not to awaken his 16 year old son or 11 year old daughter Around 2: 20 AM he parked his new black Mercedes in a turnaround very near his home and used a. 357 Magnum handgun to fire a bullet into his right temple He was buried near his family’s home in Long Island, NY in a burial plot he had secretly purchased a few days earlier He left the following suicide note in his wife’s car

The Enron Board of Directors The Board of Directors are elected by the stockholders of the corporation to provide oversight for the company and give strategic guidance for the company. The Enron Board of Directors would settle lawsuits filed against them by paying large sums of their own money to the plaintiffs.

NAME POSITION AT ENRON J. Clifford Baxter Vice-Chairman Robert Belfer SHARES SOLD GROSS PROCEEDS 619, 898 $34, 734, 854 Member of Board of Directors 2, 065, 137 $111, 941, 200 Norman Blake Member of Board of Directors 21, 200 $1, 705, 328 Rick Buy Chief Risk Officer 140, 234 $10, 656, 595 Rick Causey Chief Accounting Officer 208, 940 $13, 386, 896 Ronnie Chan Board of Directors 8, 000 $337, 200 James Derrick General Counsel 230, 660 $12, 563, 928 John Duncan Board of Directors 35, 000 $2, 009, 700 Andy Fastow Chief Financial Officer 687, 445 $33, 675, 004 Joe Foy Board of Directors 38, 160 $1, 639, 590 Mark Frevert CEO Enron Europe 986, 898 $54, 831, 220 Wendy Gramm Member of Board of Directors 10, 328 $278, 892 Kevin annon Enron Broadband Services Unknown Ken Harrison Board of Directors 1, 011, 436 $75, 416, 636 Joe Hirko CEO, Enron Communications 473, 837 $35, 168, 721 Stan Horton CEO, Enron Transportation 830, 444 $47, 371, 361 Robert Jaedicke Member of Board of Directors 13, 360 $841, 438 Steve Kean Vice President, Chief of Staff 64, 932 $5, 166, 414 Mark Koenig Executive Vice President 129, 153 $9, 110, 466 Enron Executives & Their Stock Sales Ken Lay Chairman, Enron Corp. 4, 002, 259 $184, 494. 426 Charles Le. Maistre Member of Board of Directors 17, 344 $841, 768 Rebecca Mark Chief Executive Officer, Azurix 1, 895, 631 $82, 536, 737 Michael Mc. Connell Executive Vice President 32, 960 $2, 506, 311 Jeff Mc. Mahon Treasurer 39, 630 $2, 739, 226 Cindy Olson Executive Vice President 83, 183 $6, 505, 870 Lou Pai CEO, Enron Energy Services 3, 912, 205 $270, 276, 065 Ken Rice CEO, Enron Broadband Services 1, 234, 009 $76, 825, 145 Jeffrey Skilling Chief Executive Officer, Enron Corp. 1, 307, 678 $70, 687, 199 Joe Sutton Vice-Chairman 688, 996 $42, 231, 283 Greg Whalley Chief Operating Officer, Enron Corp. Unknown TOTALS 20, 788, 957 $1, 190, 479, 472

Frameworks 3. 1 Enron Whistle-Blower Sherron Watkins She alerted Ken Lay in a seven page letter in August 2001 to the accounting irregularities within the company. She warned Mr. Lay that Enron “might implode in a wave of accounting scandals. ” She testified before Congressional Committees that were investigating the bankruptcy of Enron. She wrote a book about her career at Enron and is currently a business consultant and professional speaker. A whistleblower is an employee or former employee, of a business who reports misconduct to people or agencies that have the power and presumed willingness to take corrective action. Generally the misconduct is a violation of law. Vice President for Corporate Development

Where Are They Now? Ken Lay l l Arrested in 2004 on 11 counts of securities fraud Convicted in May 2006 of conspiracy and fraud – he faced as much as 30 years in prison While out on bail pending his sentencing, he died of a heart attack in July 2006 at his vacation home near Aspen, Colorado Because of his death before sentencing his conviction was vacated by the courts

Where Are They Now? Jeff Skilling l l Arrested in 2004 on 35 counts of fraud and insider trading. Suffered a nervous breakdown on the streets of New York City in April 2004, during which he harassed several passersby and accused them of being undercover FBI agents. Convicted in 2006 and sentenced to 24 years in federal prison Currently serving his sentence at the low security federal prison in Waseca, Minnesota.

Where Are They Now? Jeff Skilling Sign welcoming visitors to Waseca, Minnesota – home to a low security federal prison Jeff Skilling saying farewell to his family as he surrenders to a federal prison in Minnesota

Where Are They Now? Andy Fastow l l Indicted in 2002 on 78 counts including fraud, money laundering, and conspiracy. Agreed to become an informant and cooperate with federal authorities in the prosecutions of other former Enron executives in order to receive a reduced sentence. Pled guilty in 2004 to two counts of wire and securities fraud and was sentenced to six years in prison. He was released from Federal prison on December 17, 2011. Andy Fastow is considered to be the worst offender in the Enron scandal.

Results of the Bankruptcy … l l l Over $60 billion dollars in market value disappeared in a matter of a few months Pension plans lost another $2 billion dollars resulting in the loss of retirement benefits and the elimination of retirement plans for many Caused the closure of the international accounting firm Arthur Anderson resulting in the loss of 85, 000 jobs

Over 20, 000 Enron Employees Would Lose Their Jobs

Books Written About Enron All of these books are available in the High School library – see Mrs. Nance!

Leonardo Di. Caprio To Star In Enron Scandal Movie l l Oscar-nominated Leonardo Di. Caprio is to star in a film about the collapse of energy giant Enron. Di. Caprio will play a new arrival at the Texas-based corporation who gradually uncovers the culture of greed and fraudulent accounting that drove Enron into bankruptcy. It is the second time the scandal has been brought to the big-screen following the documentary "Enron: The Smartest Guys in the Room", which was nominated for an Academy Award. The movie "Conspiracy of Fools", will be based on the book of the same name by New York Times reporter Kurt Eichenwald.

Enron Documentary l l l Enron: The Smartest Guys in the Room is a 2005 documentary film based on the best-selling 2003 book of the same name by Fortune reporters Bethany Mc. Lean and Peter Elkind, a study of one of the largest business scandals in American history. Interviews are conducted with former executives, stock analysts, reporters and the former Governor of California Gray Davis. The film was nominated for Best Documentary Feature at the 78 th Academy Awards.

Enron Documentary l l l We will watch the documentary Enron: The Smartest Guys in the Room in our Marketing class. We will watch an edited version of this “R” rated documentary in class. Some inappropriate language has been left in the movie resulting in a PG 13 rating. Video: Trailer - Enron The Smartest Guys in The Room