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Enron - The W1nners' Club

Enron Corp. was a US energy company that achieved stellar success which ended in a dramatic collapse. It was one of America’s largest corporations at the time and Enron’s implosion destroyed the lives of thousands of its employees whilst sending a catastrophic ripple effect through Wall Street. At the company’s peak, its shares were priced at $90.75, but after it went bankrupt on December 2, 2001, their value nosedived to a paltry $0.67 by January 2002.

Many still wonder how it came to be that such a powerful business could disintegrate seemingly overnight, and how it managed to fool the finance regulators with its false accounting for so long.

Enron was incorporated in 1985 after Houston Natural Gas Co. and InterNorth Inc. merged to form a single entity. Subsequent to the merger, Kenneth Lay who was CEO of Houston Natural Gas, then became Enron’s CEO and chairman and his principle move was to rebrand Enron into an energy supplier and trader. The deregulation of the energy markets allowed companies to place bets on future market prices so the stage was set for Enron to take full advantage of the situation.

By the turn of the millennium, the dot-com bubble was in full swing and internet stocks were being valued at ridiculously huge amounts so as a result, investors and regulators were used to witnessing spiked share prices.

Enron formed Enron Online (EOL) which was an electronic trading website that focused on commodities in October 1999. Enron was the counter-signatory to all transactions on EOL ie. it was always either the buyer or the seller. To entice people to trade, Enron used its reputation, credit lines and expertise in the energy sector as a draw. The company was lauded for its ambitious expansion and was at the time named “America’s Most Innovative Company” by Fortune magazine for six consecutive years between 1996 and 2001.

By mid-2000, EOL was transacting $350 billion in trades. As the dot-com bubble began to burst, Enron elected to build high-speed broadband telecoms networks. The company invested hundreds of millions of dollars in the project, but ultimately ended up realizing almost zero returns.

As the recession took hold in 2000, Enron’s exposure to some of the most volatile parts of the economy resulted in many investors and creditors losing a fortune as the company’s value rapidly disintegrated.

Hiding the losses


As Enron began to crumble under the weight of its apparent success, CEO Jeffrey Skilling hid the losses of the company’s trading business by way of a practice known as mark-to-market accounting. The technique involved measuring the value of a security based on its current market value, rather than its actual book value and while appropriate for securities, it can be disastrous if used for other types of businesses.

In the case of Enron, the company built assets such as a power plants and then immediately claimed the projected profits onto its books even though no money had yet been made. If the power plant’s revenues fell below the projected earnings figure, the company would transfer these assets to an off-the-books corporation where the loss would go unreported on Enron’s books. This accounting process enabled Enron to write off huge losses without it ever affecting the company’s bottom line.

The mark-to-market process led to the development of schemes that were designed to hide losses and make the company appear more profitable than it actually was. In an effort to cope with the ever-mounting losses, company CFO Andrew Fastow devised a devious plan to make the company appear as if it was in rude health despite the fact that a number of its subsidiaries were losing vast amounts of money.

Fastow and other executives at Enron concocted a scheme to use off-balance-sheet special purpose vehicles (SPVs), to hide the company’s huge mountains of debt and toxic assets from investors and creditors alike. The principle aim of these SPVs was as a device to aid an opaque accounting process, rather than serving to generate actual operating results.

A standard Enron-to-SPV transaction would involve Enron transferring some of its bullish stock to the SPV in exchange for cash. The SPV would then use the stock to hedge an asset listed on Enron’s balance sheet. Enron in turn would guarantee the SPV’s value to negate the risk.

The system remained workable as long as Enron’s stock price kept appreciating, but eventually Enron’s stock declined. The values of the SPVs also fell which forced Enron’s guarantees to kick in. The major difference between Enron using SPVs as opposed to standard debt securitization is that the SPVs were capitalized entirely with Enron stock. This therefore compromised the ability of the SPVs to hedge if Enron’s share prices fell. The second major difference was Enron’s failure to disclose its conflicts of interest. Enron disclosed the existence of its SPVs to the investing public—although it’s unclear to what extent their significance was genuinely understood and the company also failed to adequately disclose the non-arm’s length deals it had with the SPVs.

Enron’s accounting firm at the time was Arthur Andersen LLP. As one of the five largest accounting firms in the US, it had a reputation for high standards and quality risk management. Despite Enron’s poor practices however, Arthur Andersen offered a seal of approval of its practices, which was enough for investors and regulators to maintain confidence in the interim. By April 2001 however, some analysts had started to question the transparency of Enron’s accounting.

By the summer of 2001, Enron had gone into freefall. Company CEO Ken Lay had retired in February, handing the position over to Jeff Skilling who himself resigned as CEO for “personal reasons” in August. At about the same time, analysts began to downgrade Enron’s stock which had plummeted to a 52-week low of $39.95. By October, the company reported a quarterly loss and closed its “Raptor” SPV, so that it would not have to distribute 58 million shares of stock – an eventuality that would reduce earnings even further. It was at this point that the SEC got involved.

As Enron changed pension plan administrators, thus forbidding employees from selling their shares for at least 30 days, the SEC announced that it was investigating Enron and the SPVs created by Fastow. Fastow was sacked that day and the company restated its earnings going back to 1997. Enron had acquired losses of $591 million and had accrued $628 million in debt by the end of 2000. The nail in the coffin came when Dynegy, who had previously announced it would merge with Enron, backed out of its offer on November 28th.

By Dec. 2nd 2001, Enron had filed for bankruptcy.

Criminal charges


Several Enron executives were charged with an array of offences including conspiracy, insider trading, and securities fraud. Company founder and former CEO Kenneth Lay was convicted of six counts of fraud and conspiracy and four counts of bank fraud but he died of a heart attack prior to sentencing.

Former CFO Andrew Fastow pleaded guilty to two counts of wire fraud and securities fraud for facilitating Enron’s corrupt business practices. He served a four-year sentence, which ended in 2011.

Former CEO Jeffrey Skilling received the harshest sentence of all and was convicted of conspiracy, fraud, and insider trading. Skilling initially received a 24-year sentence, but in 2013 his term was reduced by ten years. Skilling remains in prison today and is scheduled for release on February 21st 2028.

It’s hard to imagine what drives business leaders to be so dishonest that not even the shareholders know how much money the company is making at any given point. Here at The W1nners’ Club, staff are only ever dishonest when it comes to pulling the odd sickie on a Monday morning after a weekend at a festival – even then, they usually get found out straight away!


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