THE ENRON SCANDAL

Business Law (Optional-1) Assignment

Submitted by

Ambujesh Upamanyu

SM0121006

4th Year, 7th Semester

Submitted to

Ms. Monmi Gohain

Faculty-in-Charge

National Law University and Judicial Academy, Assam

The Enron scandal, often regarded as a defining moment in corporate malfeasance, exposed
the depths of financial manipulation and unethical practices within one of America's largest
energy companies. Founded in 1985 through a merger, Enron rose to become a global leader
in energy, communications, and commodities. However, its dramatic collapse in December
2001 following revelations of widespread fraud marked a watershed moment for corporate
governance and financial regulation. This essay delves into Enron's rise, fraudulent practices,
exposure, and the aftermath, emphasizing its long-lasting implications on corporate oversight.

THE RISE OF ENRON

Enron's ascent began with its establishment in 1985, following a merger between Houston
Natural Gas and InterNorth, creating a dynamic force in the energy sector. Under the
leadership of Kenneth Lay and later Jeffrey Skilling, Enron transitioned from a traditional
energy company into a diversified conglomerate specializing in energy trading, electricity,
and broadband services. Through innovative strategies such as EnronOnline, a digital
platform for trading commodities, and aggressive international expansion, the company
gained a reputation for innovation and market leadership. By the late 1990s, Enron was
consistently ranked among America’s most admired companies. Its financial growth, driven
by high stock valuations and reported revenues that grew from $9 billion in 1995 to $101
billion in 2000, painted a picture of unprecedented success, masking underlying
vulnerabilities and questionable financial practices.1

FRAUDULENT PRACTICES

Enron's fraudulent practices were intricate and systematic, designed to sustain its meteoric
rise while masking its underlying financial instability. The company's executives relied on
unethical accounting methods and deceptive financial strategies to manipulate its public
image and maintain investor confidence.

Mark-to-Market Accounting

1
CNN Library, Enron Fast Facts, CNN (July 2, 2013),
https://edition.cnn.com/2013/07/02/us/enron-fast-facts/index.html.
At the core of Enron's fraudulent practices was its use of mark-to-market accounting, a
method typically applied in trading markets to value financial instruments at their current
market value. Enron exploited this technique by applying it to long-term energy contracts.
Instead of recording actual revenue over the life of a contract, Enron projected the total
estimated profits at the contract's inception and recorded them immediately as revenue. This
approach inflated the company's financial health on paper, even if the actual cash flows were
minimal or the contracts underperformed. Over time, these speculative projections created a
significant disconnect between reported earnings and Enron’s true financial performance.2

Special Purpose Entities (SPEs)

Another critical element of Enron's fraud was the creation of special purpose entities (SPEs).
These off-balance-sheet partnerships were used to hide the company's mounting debts and
losses while overstating its earnings. By transferring underperforming assets to these entities,
Enron effectively removed liabilities from its books, creating a misleading picture of
financial stability. CFO Andrew Fastow, who managed many of these SPEs, played a pivotal
role in orchestrating these deceptive transactions. Not only did Fastow exploit these entities
for Enron's benefit, but he also personally profited by funneling millions into his private
accounts through his control of these SPEs.3

Misleading Investors and Employees

Enron misled investors and employees by presenting an image of relentless growth and
financial success. Earnings were overstated, and the company regularly reported record
profits while concealing its losses. Senior executives, including Kenneth Lay and Jeffrey
Skilling, projected confidence in Enron's stock, urging employees and shareholders to invest
heavily. Meanwhile, these executives privately sold millions of dollars in Enron stock,
knowing the company's financial reality. This betrayal left many employees financially
devastated when the company collapsed, as their retirement savings, tied to Enron stock,
became worthless.

Internal Warnings Ignored

2
Mahatma Gandhi Central University, Material on The Enron Scandal (Apr. 3, 2020),
https://mgcub.ac.in/pdf/material/202004031459479da36eba96.pdf.
3
BBC News, Enron's Legacy: The Scandal that Changed Corporate America (July 19, 2021),
https://www.bbc.com/news/business-58026162.
Sherron Watkins, an Enron vice president, was among the few who recognized and attempted
to expose the company's fraudulent activities. In a detailed memo to Kenneth Lay, she
highlighted the severe risks associated with Enron’s accounting practices and the potential for
the company to "implode in a wave of accounting scandals." Instead of addressing these
concerns, Lay and other executives dismissed them, allowing the fraud to persist. Watkins
later became a key whistleblower, testifying before Congress and shedding light on the
company’s internal culture of deceit.4

The Role of Arthur Andersen

Enron's auditor, Arthur Andersen, was complicit in the fraud, failing to challenge the
company’s questionable accounting practices and even actively assisting in concealing
evidence. Andersen shredded key documents related to Enron's financial reports during
investigations, further obstructing justice. This complicity not only led to Enron’s downfall
but also to the eventual demise of Arthur Andersen itself, once a respected accounting firm.

THE UNRAVELING

“Enron’s downfall began in 2001 when the cracks in its financial structure became evident.
Jeffrey Skilling abruptly resigned as CEO in August, raising questions about the company’s
stability. Around this time, the market learned of significant financial losses in Enron’s
broadband division, coupled with troubling revelations of undisclosed liabilities linked to
SPEs. In October 2001, Enron announced a staggering $618 million quarterly loss and
disclosed that it had overstated earnings by nearly $600 million over four years. Credit rating
agencies responded by downgrading Enron's credit to junk status in November, triggering a
cascade of financial repercussions. Simultaneously, a proposed merger with Dynegy, intended
to stabilize Enron, fell through, signaling the inevitability of bankruptcy. The unraveling
exposed the fragile nature of a company that had relied heavily on deception and speculative
accounting.5”

BANKRUPTCY AND LEGAL FALLOUT

4
Federal Bureau of Investigation, Enron Code of Ethics,
https://www.fbi.gov/history/artifacts/enron-code-of-ethics.
5
Journal of Accountancy, The Rise and Fall of Enron (April 2002),
https://www.journalofaccountancy.com/issues/2002/apr/theriseandfallofenron.html.
“On December 2, 2001, Enron filed for bankruptcy, marking the largest corporate bankruptcy
in U.S. history at the time, with $63.4 billion in assets. This event sent shockwaves through
financial markets and led to the collapse of Arthur Andersen, one of the "Big Five"
accounting firms, after its involvement in shredding Enron-related documents came to light.
Legal repercussions were swift and severe. Kenneth Lay and Jeffrey Skilling faced multiple
charges of fraud and conspiracy, resulting in convictions; Skilling received a 24-year
sentence, later reduced to 14 years, while Lay passed away before sentencing.6 CFO Andrew
Fastow cooperated with prosecutors, serving a six-year sentence. The scandal also prompted
lawsuits against financial institutions that had facilitated Enron’s fraudulent practices,
resulting in billions of dollars in settlements. The fallout led to sweeping regulatory reforms,
most notably the Sarbanes-Oxley Act of 2002, which tightened corporate financial reporting
standards and strengthened mechanisms for accountability.7”

IMPACT AND REFORMS

The Enron scandal profoundly reshaped corporate governance, financial regulations, and
public trust in large corporations. It underscored systemic vulnerabilities in corporate
oversight mechanisms, leading to sweeping reforms and a more stringent regulatory
environment aimed at preventing similar scandals in the future.

The Sarbanes-Oxley Act (2002)

“The most significant legislative response to the Enron debacle was the enactment of the
Sarbanes-Oxley Act in 2002. This law introduced rigorous new standards for corporate
accountability, focusing on enhancing transparency in financial reporting and auditing
processes. One of its key provisions required chief executive officers (CEOs) and chief
financial officers (CFOs) to personally certify the accuracy of financial statements, holding
them directly accountable for any inaccuracies or fraudulent reporting. The act also mandated
the establishment of the Public Company Accounting Oversight Board (PCAOB) to oversee
the auditing of public companies, ensuring that auditors maintained independence from the
firms they reviewed. Penalties for fraudulent financial activity were significantly increased,
creating a powerful deterrent against corporate malfeasance. This legislation set a benchmark

6
Securities and Exchange Commission, SEC Charges Enron’s Former CEO and CFO with Fraud (June 4, 2004),
https://www.sec.gov/news/press/2004-94.htm.
7
International Banker, The Enron Scandal (2001), (July 12, 2019),
https://internationalbanker.com/history-of-financial-crises/the-enron-scandal-2001/.
for corporate governance worldwide, demonstrating the U.S. government's commitment to
addressing the systemic issues highlighted by Enron's collapse.8”

Increased Oversight

The Enron scandal brought to light the failures of various oversight entities, including
auditors, corporate boards, and credit rating agencies. Arthur Andersen, once a prestigious
accounting firm, faced dissolution after being implicated in the scandal for aiding Enron in
concealing its financial troubles. This highlighted the need for stronger oversight mechanisms
and stricter independence requirements for auditors to prevent conflicts of interest. Corporate
boards also faced increased scrutiny regarding their role in monitoring executive actions. The
scandal underscored the necessity for boards to include independent directors capable of
providing unbiased oversight. Similarly, credit rating agencies were criticized for their failure
to detect and disclose Enron’s financial instability, leading to calls for reforms to ensure
greater accountability and accuracy in their evaluations. These changes aimed to rebuild trust
in corporate governance by fostering a culture of accountability and transparency.9

Erosion of Public Trust

Perhaps one of the most enduring impacts of the Enron scandal was the significant erosion of
public trust in corporate America and financial markets. Investors, employees, and the
general public were deeply shaken by the revelations of widespread deceit and greed. Enron’s
collapse wiped out billions in shareholder value and left thousands of employees and retirees
with worthless pensions, intensifying public anger and disillusionment. The scandal became a
symbol of corporate corruption, prompting widespread skepticism of large corporations and
their commitment to ethical practices. To address these concerns, regulators and corporations
began emphasizing transparency, ethical leadership, and stakeholder accountability. Efforts to
rebuild trust included promoting corporate social responsibility initiatives and strengthening
whistleblower protections to encourage employees to report unethical practices without fear
of retaliation.10

8
Time, How the Enron Scandal Changed American Business Forever (Dec. 3, 2020),
https://time.com/6125253/enron-scandal-changed-american-business-forever/.
9
Santa Clara University, Lessons from the Enron Scandal, Markkula Center for Applied Ethics,
https://www.scu.edu/ethics/focus-areas/business-ethics/resources/lessons-from-the-enron-scandal/.
10
Colorado State University, More Than 20 Years After the Enron Scandal: What Have We Learned?, (Dec. 1,
2021), https://biz.source.colostate.edu/more-than-20-years-after-the-enron-scandal-what-have-we-learned/.
“In conclusion, the Enron scandal served as a wake-up call for governments, corporations,
and the public. The reforms it prompted, particularly the Sarbanes-Oxley Act, significantly
enhanced the regulatory framework for corporate governance. While these measures have
reduced the likelihood of similar scandals, the legacy of Enron continues to underscore the
importance of vigilance, transparency, and ethical leadership in maintaining public trust and
the integrity of financial markets.

CONCLUSION

The Enron scandal remains a stark reminder of the devastating consequences of corporate
misconduct. It catalyzed significant changes in financial regulation and corporate governance,
leaving a legacy that continues to shape business practices worldwide. While the company is
long gone, its story serves as a cautionary tale for corporations, regulators, and investors
alike, emphasizing the enduring importance of integrity and accountability in business.”