Trading Fraud Early on at Enron Story The first sign of fraud at Enron goes back to a trading division called Enron Oil in January 1987. David Woyek, the head of Enron’s internal audit department, received a call from Apple Bank in New York. He was told that wire transfers amounting to about $5 million had been flowing in from a bank in the Channel Islands, and over $2 million went into an account of Tom Masteroeni, treasurer of Enron Oil. The Apple Bank account could not be found anywhere on Enron’s books. Masteroeni admitted that he had diverted funds to his account, but insisted that it was a profit-sharing tactic and that he always intended to repay the money. After a preliminary investigation, Woyek’s deputy, John Beard wrote on his working papers “misstatement of records, deliberate manipulation of records, impact on financials for the year ending 123186.” (McLean and Elkin 2003) Louis Borget, CEO of Enron Oil, explained that the Apple account was used to move profits from one quarter to another for Enron management. From 1985, the oil trader had been doing deals with companies Isla, Southwest, Petropol and other entities that allowed Enron Oil to generate the loss on one contract then have the loss canceled out by a second contract to generate a gain of the same amount. Borget described Enron Oil as “the swing entry to meet objectives each month.” Woyek wrote in a memo the process was a creation of “fictitious losses.” (McLean and Elkin 2003). The management of Enron Oil was not even reprimanded. Instead, Borget received a thank you note saying, “keep making millions for us.” The internal auditors continued their investigation. They consulted directories of trading organizations, but could not find Isla, Southwest, or Petropol. They discovered other irregularities in the Apple account amounting to hundreds of thousands of dollars. Before they completed their fieldwork, management told them to stop and let the work be done by Enron’s outside auditor, Arthur Andersen. Andersen presented their findings to the Enron audit committee of the board of directors some months later. They told the board that they “were unable to verify ownership or any other details” regarding Enron Oil’s supposed trading partners. They also found that Enron Oil was supposed to have strict controls on trading – their open position was never supposed to exceed 8 million barrels, and when the losses reached $4 million, the traders were required to liquidate their position. Andersen could not test the controls because Borget and Masteroeni destroyed daily position reports. But even so, Andersen would not give an opinion on these unusual transactions or whether the profit shifting had a material impact on the financial statements. Andersen claimed that it was beyond their professional competence and that they would rely on Enron itself to make that determination. Andersen got a letter from Rich Kidder, Enron CEO, and another Enron lawyer saying, “the unusual transactions would not have a material effect on the financial statements. and that no disclosure of these transactions is necessary.” In October 1997, it was discovered that the management at Enron Oil had been losing on their trades and they were $1.5 billion short. Enron fired Borget and Masteroeni and brought in traders who were able to reduce the position to an $85 million charge which Enron announced for the third quarter of 1987. (Bryce 2002)

 Discussion Questions

■ Was Andersen fulfilling its responsibility to consider fraud and risk

■ Whose responsibility is it to determine the materiality of fraud on the financial statements: Enron management or Andersen?