THE ENRON SCANDAL
A BOTCHED EXPANSION ATTEMPT
AN ACCOUNTING FRAUD.
Tanveer Mangat, Researcher
Enron served as the blueprint for companies, with 30,000 employees and $100 billion in yearly revenue at the start of 2001. But by year's end, the firm had earned the distinction of becoming the largest bankruptcy in history. How did the energy plant go from being named the most innovative firm by Fortune for six consecutive years to going bankrupt in a matter of months? Here is the progression of the story.
In 1985, the energy company Internorth and the utility company Houston Natural Gas merged to form Enron by Kenneth Lay. In the early 1990s, he helped to initiate the selling of electricity at market prices and, soon after, Congress approved legislation deregulating the sale of natural gas. The resulting markets made it possible for traders such as Enron to sell energy at higher prices. After producers and local governments decried the resultant price volatility and asked for increased regulation, strong lobbying on the part of Enron and others prevented such regulation.However, in the process of the merger, Enron had incurred massive debt and, as the result of deregulation, no longer had exclusive rights to its pipelines. In order to survive, the company had to come up with a new and innovative business strategy to generate profits and cash flow.
In order to increase profitability, Enron established its own trading subsidiary. In 1991, Jeffrey Skilling was named CEO of Enron Capital and Trade. He oversaw the corporation's adoption of mark-to-market accounting, that is the practice of valuing your assets based on predictions of their future prices, rather than on historical prices.In essence, it provided Enron the freedom to choose their own profits without being held responsible for the correctness of the assessments. These optimistic projections led to Enron's revenue statistics skyrocketing in the 1990s. As its stock price peaked at $90 a share and its directors outlined their prospects of even greater profits in the near future, Enron was rated the most innovative large company in America in Fortune's Most Admired Companies survey.
Enron was able to conceal losses behind inflated estimates of the worth of new assets, as the corporation invested hundreds of millions more in projects both domestically and abroad. It created a special economic vehicle to hide the massive debt from its external stakeholders. The special purpose vehicle was utilized to conceal the realities of accounting rather than focus on the operating results.The corporation transferred some portion of assets that had rising marketable value to the special economic vehicle, and in return, it took cash or notes. The special purpose vehicle then utilized such stock to hedge an asset present on its balance sheet of Enron. It ensured that a special purpose vehicle reduced the counterparty risk.
Enron's assets were severely harmed by the burst of the dot com bubble in 2000 since they had now expanded into markets like video on demand and high-speed broadband networks. By early 2001, major suspicions were being raised about Enron's financial statements as investors grew more wary and distrustful of the company's complex business model. In February, Lay resigned as CEO and was succeeded by Skilling. In the months that followed, the price of Enron's stock dropped by half to $40. In August 2001, Skilling resigned from his new post as Lay took over again, amid numerous speculations regarding the company's accounting methods. Lay started selling his shares in Enron worth millions of dollars when analysts began lowering the company's stock rating.
Due to $1 billion in charges from its underperforming assets, Enron reported its first quarterly loss in four years in October, and the SEC formally opened an investigation into its financial statements. Over 20,000 of the business's employees' 401k pension plans were locked for 30 days due to a change of administrator during November, at the same time that the company disclosed that it had inflated its revenues by $591 million between 1997 and 2000. Enron and Dynegy had agreed to merge, but the deal was abandoned because of worries that Enron's off-balance-sheet debts were still not transparent. The company's stock price dropped to an all-time low of $.26 per share on November 30th, from $80 in February. Enron requested bankruptcy protection two days later on 2nd of December, marking less than a year since it became the seventh biggest corporation in the United States. .
Thousands of employees lost their jobs and their life savings, and shareholders eventually sued banks like JP Morgan Chase and Citigroup for conducting deals with Enron, later winning $7.2 billion that was shared amongst the 1.5 million victims. Many Enron executives were indicted on a variety of charges and were later sentenced to prison. Notably, in 2006 both Skilling and Lay were convicted on various charges of conspiracy and fraud. Skilling was initially sentenced to more than 24 years but ultimately served only 12. Lay, who was facing more than 45 years in prison, died before he was sentenced. Not exempt from punishment were Enron's auditors, Arthur Anderson, who were one of the 5 big accounting firms, and also had their reputation dragged through the mud for their compliance in the fraud. They were found guilty of destroying documents that were of relevance to the SEC, which was cause to void their auditing license and leave the firm with no choice but to close. Hence their absence from the big 4 that we know today, although their consultancy branch does still operate as Accenture.
The fiasco saw the United Sates senate impose much tighter regulations to prevent a repeat in the future namely the Sarbanes-Oxley Act of 2002, which created a board to oversee audit reports for public companies and strict controls on what services auditors could provide. Along with the requirement for executives to sign off on all financial reports, meaning they could no longer plead ignorance for their firm's wrongdoings. Undoubtedly the effects of the Enron Scandal are still felt in the finance industry today.