The fall of Enron, then ranked as the seventh-largest company in the United States, affected thousands of employees and shook Wall Street to its core
On 2 December 2001, 20 years ago energy giant Enron — then the seventh-largest company in the United States — filed for bankruptcy, sending shock waves across the investing world, resulting in historic layoffs and ravaging retirement savings accounts.
The collapse of Enron, which held more than $60 billion in assets, still holds interest and generates much debate on improving accounting standards and practices.
So, what was all the hullabaloo about and why is it still spoken of today?
Rise of Enron
In the year 1985, Enron was formed by merging Houston Natural Gas Company and Omaha-based InterNorth Incorporated. Kenneth Lay, who had been the chief executive officer (CEO) of Houston Natural Gas, became Enron’s CEO and chair and quickly rebranded the firm as an energy trader and supplier.
With the help of Jeffrey Skilling, Enron soon dominated the market for natural-gas contracts, and the company started to generate huge profits on its trades.
Skilling also changed the culture of the company and emphasised more on aggressive trading. One of his brightest recruits was Andrew Fastow, who quickly rose through the ranks to become Enron’s chief financial officer. Fastow oversaw the financing of the company through investments in increasingly complex instruments.
However, as they say what goes up, must come down and the same happened to Enron. By the fall of 2000, Enron was starting to crumble under its own weight. Facing increased competition in the energy-trading business, the company’s profits began to shrink rapidly.
In an attempt to hide the losses, the company created an array of related business entities and used accounting gimmicks to conceal massive business losses and large amounts of debt. They adopted the dubious tactic of ‘mark-to-market accounting’, in which the company wrote unrealised future gains from some trading contracts into current income statements, thus giving the illusion of higher current profits.
Those tactics eventually stopped working, and in October 2001, Enron revealed a huge quarterly loss of $638 million. Shortly thereafter, the Securities and Exchange Commission (SEC) began investigating the transactions and the company’s deals.
Investigations revealed a horror story of accounting frauds in which Arthur Andersen, then one of the world’s preeminent accounting firms, ultimately disclosed that its employees had destroyed Enron documents that could have been used to prosecute the company.
Enron went into a deep dive; the company’s stock which had risen to a high of $90 per share in mid-2000 plummeted to less than $12 by the beginning of November 2001.
On 7 November 2001, utility rival Dynegy voted to acquire the company at a very low price of about $8 billion in stock. However, days later, Dynegy terminated its merger talks, causing Enron’s stock to drop to under $1 per share. Eventually, left with no option, Enron filed for bankruptcy on 2 December 2001.
The day they filed for bankruptcy thousands of employees were told to pack their belongings and given 30 minutes to vacate the building.
Trial and legislation
Arthur Andersen was one of the first casualties of Enron’s notorious 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.
Enron’s founder and former CEO Kenneth was convicted on six counts of fraud and conspiracy and four counts of bank fraud. Prior to sentencing, he died of a heart attack in Colorado.
Enron’s former star CFO Andrew Fastow pled 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.
Former Enron CEO Jeffrey Skilling was convicted of 19 of 28 counts of securities fraud and wire fraud and acquitted on the remaining nine, including charges of insider trading. He was sentenced to 24 years and 4 months in prison. In 2013 the United States Department of Justice reached a deal with Skilling, which resulted in 10 years being cut from his sentence.
Lessons from Enron
Enron’s collapse was a financial disaster for thousands of people, and its indirect impact hurt millions more.
However, it also led to the passage of the Sarbanes-Oxley Act in 2002. This legislation imposed harsh penalties for destroying, altering, or fabricating financial records. The act also prohibited auditing firms from doing any concurrent consulting business for the same clients.
With inputs from agencies