An ENRON Scandal Summary
The ENRON Scandal is considered to be one of the most notorious within American
history; an ENRON scandalsummary of events is considered by many historians and
economists alike to have been an unofficial blueprint for a case study on White Collar
Crime – White Collar Crime is defined as non-violent, financially-based criminal activity
typically undertaken within a setting in which its participants retain advanced education
with regard to employment that is considered to be prestigious. The following took place
in the midst of the ENRON Scandal:
ENRON Scandal Summary: The Deregulation of ENRON
While the term regulation within a commercial and corporate setting typically applied to
the government’s ability to regulate and authorize commercial activity and behavior with
regard to individual businesses, the ENRON executives applied for – and were
subsequently granted – government deregulation. As a result of this declaration of
deregulation, ENRON executives were permitted to maintain agency over the earnings
reports that were released to investors and employees alike.
This agency allowed for ENRON’s earning reports to be extremely skewed in nature –
losses were not illustrated in their entirety, prompting more and more investments on
the part of investors wishing to partake in what seemed like a profitable company
ENRON Scandal Summary: Misrepresentation
By misrepresenting earnings reports while continuing to enjoy the revenue provided by
the investors not privy to the true financial condition of ENRON, the executives of ENRON
embezzled funds funneling in from investments while reporting fraudulent earnings to
those investors; this not only proliferated more investments from current stockholders,
but also attracted new investors desiring the enjoy the apparent financial gains enjoyed
by the ENRON corporation.
ENRON Scandal Summary: Fraudulent Energy Crisis
In the year 2000, subsequent to the discovery of the crimes listed in the above ENRON
Scandal Summary, ENRON had announced that there was a critical circumstance within
California with regard to the supply of Natural Gas. Due to the fact the ENRON was a then-
widely respected corporation, the general populace were not wary about the validity of
these statements.
However, upon retroactive review, many historians and economists suspect that the
ENRON executives manufactured this crisis in preparation of the discovery of the fraud
they had committed – although the executives of ENRON were enjoying the funds
rendered from investments, the corporation itself was approaching bankruptcy.
ENRON Scandal Summary: Embezzlement
An ENRON Scandal Summary of the acts of Embezzlement undertaken by ENRON
Executives may be defined as the criminal activity involving the unlawful and unethical
attainment of monies and funding by employees; typically, funds that are embezzled are
intended for company use in lieu of personal use. While the ENRON executives were
pocketing the investment funds from unsuspecting investors, those funds were being
stolen from the company, which resulted in the bankruptcy of the company.
ENRON Scandal Summary: Losses and Consequences
Due to the actions of the ENRON executives, the ENRON 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 ENRON
Corporation, only a small amount of the money lost was ever returned.
The Fall of a Wall Street Darling
The story of Enron Corp. is the story of a company that reached dramatic heights, only to
face a dizzying fall. Its collapse affected thousands of employees and shook Wall Street to its
core. At Enron's peak, its shares were worth $90.75; when it declared bankruptcy on
December 2, 2001, they were trading at $0.26. To this day, many wonder how such a
powerful business, at the time one of the largest companies in the U.S, disintegrated almost
overnight and how it managed to fool the regulators with fake holdings and off-the-books
accounting for so long.
Enron's Energy Origins
Enron was formed in 1985, following a merger between Houston Natural Gas Co. and
Omaha-based InterNorth Inc. Following the merger, Kenneth Lay, who had been the chief
executive officer (CEO) of Houston Natural Gas, became Enron's CEO and chairman and
quickly rebranded Enron into an energy trader and supplier. Deregulation of the energy
markets allowed companies to place bets on future prices, and Enron was poised to take
advantage. In 1990, Lay created the Enron Finance Corp. To head it, he appointed Jeffrey
Skilling, whose work as a McKinsey & Co consultant had impressed Lay. Skilling was at the
time one of the youngest partners at McKinsey.
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Why Enron Collapsed
Skilling joined Enron at an auspicious time. The era's regulatory environment allowed Enron
to flourish. At the end of the 1990s, the dot-com bubble was in full swing, and the Nasdaq hit
5,000. Revolutionary internet stocks were being valued at preposterous levels and
consequently, most investors and regulators simply accepted spiking share prices as the new
normal.
Mark-to-Market
One of Skilling's early contributions was to move Enron from a traditional historical cost
accounting method to a mark-to-market (MTM) accounting method, for which the company
got official SEC approval in 1992. MTM is a measure of the fair value of accounts that can
change over time, such as assets and liabilities. Mark-to-market aims to provide a realistic
appraisal of an institution's or company's current financial situation. It is a legitimate and
widely-used practice. However, in some cases it can be manipulated, since MTM is not based
on "actual" cost but on "fair value," which is harder to pin down. Some believe MTM was the
beginning of the end for Enron, as it essentially started logging estimated profits as actual
ones.
"America's Most Innovative Company"
Enron created Enron Online (EOL) in October 1999, an electronic trading website that
focused on commodities. Enron was the counterparty to every transaction on EOL; it was
either the buyer or the seller. To entice participants and trading partners, Enron offered up its
reputation, credit, and expertise in the energy sector. Enron was praised for its expansions
and ambitious projects, and named "America's Most Innovative Company" by Fortune for six
consecutive years between 1996 and 2001.
Blockbuster Video's Accidental Role
One of the many unwitting players in the Enron scandal was Blockbuster, the formerly
juggernaut video rental chain. In July 2000, Enron Broadband Services and Blockbuster
entered a partnership to enter the burgeoning VOD market. Probably a sensible sector to pick,
but Enron started logging expected earnings based on expected growth of the VOD market,
which vastly inflated the numbers.
By mid-2000, EOL was executing nearly $350 billion in trades. When the dot-com bubble
began to burst, Enron decided to build high-speed broadband telecom networks. Hundreds of
millions of dollars were spent on this project, but the company ended up realizing almost no
return.
When the recession hit in 2000, Enron had significant exposure to the most volatile parts of
the market. As a result, many trusting investors and creditors found themselves on the losing
end of a vanishing market cap.
The Collapse of a Wall Street Darling
By the fall of 2000, Enron was starting to crumble under its own weight. CEO Jeffrey
Skilling had a way of hiding the financial losses of the trading business and other operations
of the company; it was called mark-to-market accounting. This is a technique where you
measure the value of a security based on its current market value, instead of its book value.
This can work well when trading securities, but it can be disastrous for actual businesses.
In Enron's case, the company would build an asset, such as a power plant, and immediately
claim the projected profit on its books, even though it hadn't made one dime from it. If the
revenue from the power plant was less than the projected amount, instead of taking the loss,
the company would then transfer the asset to an off-the-books corporation, where the loss
would go unreported. This type of accounting enabled Enron to write off unprofitable
activities without hurting its bottom line.
The mark-to-market practice led to schemes that were designed to hide the losses and make
the company appear to be more profitable than it really was. To cope with the mounting
liabilities, Andrew Fastow, a rising star who was promoted to CFO in 1998, came up with a
deliberate plan to make the company appear to be in sound financial shape, despite the fact
that many of its subsidiaries were losing money.
How Did Enron Use SPVs to Hide its Debt?
Fastow and others at Enron orchestrated a scheme to use off-balance-sheet special purpose
vehicles (SPVs), also known as special purposes entities (SPEs) to hide its mountains of debt
and toxic assets from investors and creditors. The primary aim of these SPVs was to hide
accounting realities, rather than operating results.
The standard Enron-to-SPV transaction would go like this: Enron would transfer some of its
rapidly rising stock to the SPV in exchange for cash or a note. The SPV would subsequently
use the stock to hedge an asset listed on Enron's balance sheet. In turn, Enron would
guarantee the SPV's value to reduce apparent counterparty risk.
Although their aim was to hide accounting realities, the SPVs weren't illegal, as such. But
they were different from standard debt securitization in several significant – and potentially
disastrous – ways. One major difference was that the SPVs were capitalized entirely with
Enron stock. This directly compromised the ability of the SPVs to hedge if Enron's share
prices fell. Just as dangerous was the second significant difference: Enron's failure to disclose
conflicts of interest. Enron disclosed the SPVs' existence to the investing public—although
it's certainly likely that few people understood them—but it failed to adequately disclose
the non-arm's length deals between the company and the SPVs.
Enron believed that its stock price would keep appreciating — a belief similar to that
embodied by Long-Term Capital Management, a large hedge fund, before its collapse in
1998. Eventually, Enron's stock declined. The values of the SPVs also fell, forcing Enron's
guarantees to take effect.
Arthur Andersen and Enron: Risky Business
In addition to Andrew Fastow, a major player in the Enron scandal was Enron's accounting
firm Arthur Andersen LLP and partner David B. Duncan, who oversaw Enron's accounts. As
one of the five largest accounting firms in the United States at the time, Andersen had a
reputation for high standards and quality risk management.
However, despite Enron's poor accounting practices, Arthur Andersen offered its stamp of
approval, signing off on the corporate reports for years – which was enough for investors and
regulators alike. This game couldn't go on forever, however, and by April 2001, many
analysts started to question Enron's earnings and their transparency.
The Shock Felt Around Wall Street
By the summer of 2001, Enron was in a free fall. CEO Kenneth Lay had retired in February,
turning over the position to Jeffrey Skilling; that August, Skilling resigned as CEO for
"personal reasons." Around the same time, analysts began to downgrade their rating for
Enron's stock, and the stock descended to a 52-week low of $39.95. By Oct.16, the company
reported its first quarterly loss and closed its "Raptor" SPV so that it would not have to
distribute 58 million shares of stock, which would further reduce earnings. This action caught
the attention of the SEC.
A few days later, Enron changed pension plan administrators, essentially forbidding
employees from selling their shares, for at least 30 days. Shortly after, the SEC announced it
was investigating Enron and the SPVs created by Fastow. Fastow was fired from the
company that day. Also, the company restated earnings going back to 1997. Enron had losses
of $591 million and had $628 million in debt by the end of 2000. The final blow was dealt
when Dynegy (NYSE: DYN), a company that had previously announced would merge with
the Enron, backed out of the deal on Nov. 28. By Dec. 2, 2001, Enron had filed for
bankruptcy.
Bankruptcy
Once Enron's Plan of Reorganization was approved by the U.S. Bankruptcy Court, the new
board of directors changed Enron's name to Enron Creditors Recovery Corp. (ECRC). The
company's new sole mission was "to reorganize and liquidate certain of the operations and
assets of the 'pre-bankruptcy' Enron for the benefit of creditors." The company paid its
creditors more than $21.7 billion from 2004-2011. Its last payout was in May 2011.
Criminal Charges
Arthur Andersen was one of the first casualties of Enron's prolific demise. In June 2002, the
firm was found guilty of obstructing justice for shredding Enron's financial documents to
conceal them from the SEC. The conviction was overturned later, on appeal; however, the
firm was deeply disgraced by the scandal, and dwindled into a holding company. A group of
former partners bought the name in 2014, creating a firm named Andersen Global.
Several of Enron's execs were charged with a slew of charges, including conspiracy, insider
trading, and securities fraud. Enron's founder and former CEO Kenneth Lay was convicted on
six counts of fraud and conspiracy and four counts of bank fraud. Prior to sentencing, though,
he died of a heart attack in Colorado.
Enron's former star CFO Andrew Fastow plead guilty to two counts of wire fraud and
securities fraud for facilitating Enron's corrupt business practices. He ultimately cut a deal for
cooperating with federal authorities and served more than five years in prison. He was
released from prison in 2011.
Ultimately, though, former Enron CEO Jeffrey Skilling received the harshest sentence of
anyone involved in the Enron scandal. In 2006, Skilling was convicted of conspiracy, fraud,
and insider trading. Skilling originally received a 24-year sentence, but in 2013 it was
reduced by 10 years. As a part of the new deal, Skilling was required to give $42 million to
the victims of the Enron fraud and to cease challenging his conviction. Skilling remains in
prison and is scheduled for release on Feb. 21, 2028.
New Regulations As a Result of the Enron Scandal
Enron's collapse and the financial havoc it wreaked on its shareholders and employees led to
new regulations and legislation to promote the accuracy of financial reporting for publicly
held companies. In July 2002, President George W. Bush signed into law the Sarbanes-Oxley
Act. The Act heightened the consequences for destroying, altering or fabricating financial
statements, and for trying to defraud shareholders. (For more on the 2002 Act, read: How The
Sarbanes-Oxley Act Era Affected IPOs.)
The Enron scandal resulted in other new compliance measures. Additionally, the Financial
Accounting Standards Board (FASB) substantially raised its levels of ethical conduct.
Moreover, company's boards of directors became more independent, monitoring the audit
companies and quickly replacing bad managers. These new measures are important
mechanisms to spot and close the loopholes that companies have used as a way to avoid
accountability.
The Bottom Line
At the time, Enron's collapse was the biggest corporate bankruptcy to ever hit the financial
world (since then, the failures of WorldCom, Lehman Brothers, and Washington Mutual have
surpassed it). The Enron scandal drew attention to accounting and corporate fraud, as its
shareholders lost $74 billion in the four years leading up to its bankruptcy, and its employees
lost billions in pension benefits. As one researcher states, the Sarbanes-Oxley Act is a "mirror
image of Enron: the company's perceived corporate governance failings are matched virtually
point for point in the principal provisions of the Act." (Deakin and Konzelmann, 2003).
Increased regulation and oversight have been enacted to help prevent corporate scandals of
Enron's magnitude. However, some companies are still reeling from the damage caused by
Enron. Most recently, in March 2017, a judge granted a Toronto-based investment firm the
right to sue former Enron CEO Jeffrey Skilling, Credit Suisse Group AG, Deutsche Bank AG
and Bank of America's Merrill Lynch unit over losses incurred by purchasing Enron shares.
