Read the Case Study below carefully and, answer the questions that follow:

How Cooking the Books Works

Case Study: ENERGY COMPANY

Once the seventh largest company in America, Energy Company was formed in 1985 when Inter North acquired Houston Natural Gas. The company branched into many non-energyrelated fields over the next several years, including such areas as internet bandwidth, risk management, and weather derivatives (a type of weather insurance for seasonal businesses). Although their core business remained in the transmission and distribution of power, their phenomenal growth was occurring through their other interests Fortune Magazine selected Energy Company as "America's most innovative company" for six straight years from 1996 to 2001. Then came the investigations into their complex network of offshore partnerships and accounting practices

The Energy Company fraud case is extremely complex. Some say Energy Company's demise is rooted in the fact that in 1992, Jeff Skilling, then president of Energy Company's trading operations, convinced federal regulators to permit Energy Company to use an accounting method known as "mark to market. This was a technique that was previously only used by brokerage and trading companies. With mark to market accounting, the price or value of a security is recorded on a daily basis to calculate profits and losses. Using this method allowed Energy Company to count projected earnings from long-term energy contracts as current income. This was money that might not be collected for many years. It is thought that this technique was used to inflate revenue numbers by manipulating projections for future revenue

Use of this technique (as well as some of Energy Company's other questionable practices) made it difficult to see how Energy Company was really making money. The numbers were on the books, so the stock prices remained high, but Energy Company wasn't paying high taxes. Robert Hermann, the company's general tax counsel at the time, was told by Skilling that their accounting method allowed Energy Company to make money and grow without bringing in a lot of taxable cash.

Energy Company had been buying any new venture that looked promising as a new profit centre. Their acquisitions were growing exponentially. Energy Company had also been forming off balance sheet entities (LJM, LJM2, and others) to move debt off the balance sheet and transfer risk for their other business ventures. These SPES were also established to keep Energy Company's credit rating high, which was very important in their fields of business. Because the executives believed Energy Company's long term stock values would remain high, they looked for ways to use the company's stock to hedge its investments in these other entities. They did this through a complex arrangement of special purpose entities they called the Raptors. The Raptors were established to cover their losses if the stocks in their start-up businesses fell.

When the telecom industry suffered its first dowriturn, Energy Company suffered as well. Business analysts began trying to unravel the source of Energy Company's money. The Raptors would collapse if Energy Company stock fell below a certain point, because they were ultimately backed only by Energy Company stock. Accounting rules required an independent investor in order for a hedge to work, but Energy Company used one of their SPES.

The deals were so complex that no one could really determine what was legal and what wasn't. Eventually, the house of cards began falling. When Energy Company's stock began to decline, the Raptors began to decline as well. On August 14, 2001, Energy Company's CEO, Jeff Skilling, resigned due to "family issues. This shocked both the industry and Energy Company employees. Energy Company chairman Ken Lay stepped in as CEO.

On August 15, Sherron Watkins, an Energy Company VP, wrote an anonymous letter to Ken Lay that suggested Skilling had left because of accounting improprieties and other illegal actions. She questioned Energy Company's accounting methods and specifically cited the

Raptor transactions. Later that same month, Chung Wu, a UBS PaineWebber broker in Houstori, sent an e-mail to 73 investment clients saying Energy Company was in trouble and advising them to consider selling their shares.

Sherron Watkins then met with Ken Lay in person, adding more details to her charges. She noted that the SPEs had been controlled by Energy Company's CFO, Fastow, and that he and other Energy Company employees had made their money and left only Energy Company at risk for the support of the Raptors. (The Raptor deals were written such that Energy Company was required to support them with its own stock, When Energy Company's stock fell below a certain point, the Raptors losses would begin to appear on Energy Company's financial statements On October 16 Energy Company announced a third quarter loss of $618 million. During 2001, Energy Company's stock fell from $86 to 30 cents. On October 22, the SEC began an investigation into Energy Company's accounting procedures and partnerships In November Energy Company officials admitted to overstating company earnings by $57 million since 1997 Energy Company or the crooked E. filed for bankruptcy in December of 2001.

Energy Company is a classic example of a company whose ethical pronouncements were

"decoupled" from the rest of its operations (Weaver, Trevino, & Cochran 1999). The key values of the company were respect, integrity, communications, and excellence. Energy Company also had an extensive code of ethics. Unfortunately, these values and policies had little impact on how Lay, Skilling, and their underlings did business. By the time of its collapse in 2001, the company had been manipulating its books and misleading investors for several years.

Due to the actions of the Energy company executives, the Energy Company went bankrupt. The loss sustained by investors exceeded $70 billion. Furthermore, these actions cost both trustees and employees upwards of $2 billion; this total is considered to be a result of misappropriated investments, pension funds, stock options, and savings plans as a result of the government regulation and the limited liability status of the Energy company, only a small amount of the money lost was ever returned.

QUESTIONS

1. Leadership at Energy Company undermined the foundational values of the Energy

Company Code of Ethics Explain

2. Discuss the role of whistleblowing and state who in this case was the whistleblower

3. A Code of Ethics (also Explain any four possible causes that led to the collapse of

Energy Company under it is top leadership

4. Explain how the top is known as a Code of Conduct) is a formal document that establishes behavioral expectations for the company and the people who work there. Discuss the role of code of ethics in an organization