Enron and Arthur Andersen: The Case of the Crooked E and the Fallen A 31
PART I ENRON AND ANDERSEN – A UNIQUE AND INNOVATIVE
COMPANY WITH A PRESTIGIOUS AUDITOR
Enron was a leading energy commodities and service company with revenue of US $101
billion in 2000. It employed about 21,000 people, mostly at its headquarters in Houston, Texas.
Enron began in 1985 with the merger of two companies, Houston Natural Gas and InterNorth, which
sold and transported natural gas. After the merger, Enron was applauded for being innovative in
opening new markets. To create new markets, Enron acted as a bank for commodities, buying a
commodity from suppliers and selling it to buyers. For example, it would contract to sell natural gas
for future delivery at a fixed price. Then if it wanted to hedge the transaction, it would contract again
to buy natural gas at the same future date. These types of future contracts are among those called
derivatives. To deal with the buyers and sellers who were central to a “trading partners” strategy,
sound credit and liquidity were essential. Enron had to deliver cash when buy transactions were
settled financially. Therefore, it became important for Enron to generate cash flow and report cash
flow internally. Throughout its existence, Enron relied crucially on borrowed cash for its day-to-day
operations.
With past success, bull markets, debt, inexperienced employees, and diverse businesses,
Enron raced to become anything and everything. Its businesses were foreign and domestic, low-tech
and high-tech, commercial and residential, wholesale and retail, and regulated and unregulated. It
is unlikely that any company could have developed the expertise required. So, it is not surprising that
weaknesses emerged.
As Enron grew, it began to trade commodities about which its employees knew little. Its
commodity banking expanded from natural gas into electricity, Internet broadband, weather futures,
and other goods and services. As Enron’s trading grew, its assets shifted from fixed assets such as
pipelines, to intangibles, especially contractual rights to commodities, a form of derivatives. Often
budgetary and other basic controls were abandoned. Enron did not have a unified strategy. As a
result, its aggressive dealmakers transformed Enron from an operating company to an investment
fund. Enron’s management and its auditors were not prepared for this transformation and unable to
recognize the risks. For many top executives, business was not about selling goods and services; it
was about managing earnings, managing reported cash flow, and managing the numbers.
Andersen was among the most prestigious international accounting firms in the world.
Accounting students in the US often viewed it as the most glamorous and desirable employer.
Andersen marketed itself as having fewer offices than its competitors because it operated with larger
offices to serve prominent clients. Although Andersen’s client base was diversified, it often had
“high flying” companies such as Enron and WorldCom as clients. Enron was Andersen’s second
largest client, and the largest client in Andersen’s Houston office. Players in Enron and in Andersen
are presented in Exhibit 3 and the downfall is described in Exhibit 4.
PART II GOVERNMENT, LEGAL, AND ACCOUNTING ENVIRONMENT OF THE U.S.
Government and Legal System
Separation of Powers
The separation of powers between the federal government and the states is one of the most
fundamental aspects of government in the US. The Constitution of the US grants to the federal
government only those powers that the states have explicitly ceded to it; all other powers remain by