Founded in 1985 when Houston Natural Gas and InterNorth merged, Enron was a force to be reckoned with. The company employed around 20,000 people and was one of the world’s major electricity, natural gas, communication, and pulp and paper companies.
Revenues of nearly $101 billion helped secure the company’s place in the market, and Fortune named Enron “America’s Most Innovative Company” six years in a row.
Unfortunately, all of this success wasn’t well-founded. On Dec. 2, 2001, Enron filed bankruptcy. This was the result of discovering in October of that year that accounting fraud had been responsible for the financial situation the company was in. What came next has been dubbed the Enron scandal.
The Enron Scandal
Founded by Kenneth Lay in 1985, Enron started off on the wrong foot, but it was several years later, when Jeffery Skilling was hired, that things really began to crumble.
As CEO, he hired a team of executives who began to hide billions of dollars in debt from failed deals and projects using accounting loopholes, special purpose entities, and poor financial reporting, thanks to their relationship with accounting firm Arthur Andersen LLP.
So what exactly took place?
It all started when Enron was questioned about how it was making the money it claimed to be making. When claiming revenue, the company reported under a “merchant model,” meaning Enron reported the entire value of each of its trades, mentioned before, as revenue.
The way Enron should have been reporting is under the “agent model,” where the agent only provides a service to the customer but doesn’t take the same risks for buying and selling.
According to reports at the time, between 1996 and 2000, Enron’s revenues increased by more than 750 percent. That meant the company grew 65 percent per year—unprecedented growth in any industry, but especially the energy industry, which only typically saw a respectable increase of 2 to 3 percent.
By September of 2001, Enron reported $138.7 billion in revenue.
A special-purpose entity is a legal entity created to fulfill narrow, specific, or temporary objectives. While using a special-purpose entity is acceptable, Enron used them to hide losses and fabricate earnings. More notably, the company used the entities to hide debt.
Notable examples of special-purpose entities that Enron employed were JEDI, Chewco, Whitewing, and LJM.
Enron used a variety of practices to make its books, as well as its operation, seem more efficient than it really was. In one instance, analysts were given a tour of the Enron Energy Services office. Skilling pulled employees from other departments and instructed them to “pretend to work hard.”
Of course, they did, and the analysts were fooled into thinking the office was larger than it was. This trickery led analysts to believe Enron was more efficient that it seemed. That reportedly had the effect of raising stock price.
Time Magazine has reported in depth on Enron’s blunders leading up to its downfall. The aftermath has led the way for corporate responsibility and operation today.
What Happened Afterward
The short story about the outcome is that Enron was caught. Executives Kenneth Lay and Jeffery Skilling were tried and convicted, along with other executives at Enron and Arthur Anderson LLP. Skilling was convicted of a total of twenty-nine criminal counts, including a conspiracy to hide the failing health of the company by selling optimism to Wall Street and the public.
Lay was convicted on all six counts of conspiracy, securities, and wire fraud against him in the corporate trial and all four in the separate personal banking trial.
After the convictions and official release of Enron’s misdeeds, Enron’s stock price plummeted to less than $1 by the end of November 2001, and shareholders filed a $40 billion lawsuit against the company. The scandal also caused Enron to file for bankruptcy on December 2, 2001, effectively ending its run.
The Good News
While the scandal was a headache from start to finish, we did get some good out of it. Thanks to Enron and its fraud, America saw passage of the Sarbanes-Oxley Act on July 30, 2002. This act created the Public Company Accounting Oversight Board to develop standards companies should follow in their accounting and financial practices.
Further regulations were also set. On February 13, 2002, the SEC recommended changes of the stock exchange’s regulations. In June 2002, the New York Stock Exchange announced a new governance proposal, which was approved by the SEC in November 2003.
While Enron’s scheme was among the biggest scandals in the corporate world, large corporations and entities are still using faulty practices to ensure their financial stability. Unfortunately, regulations set by the government aren’t enough to stop them. It’s up to the people to push best practices and, in the end, help our economy.