Enron Scandal: How a Genius Was Born

Enron, American’s fifth largest company by Fortune Magazine in 2002 filed the largest bankruptcy in American history back in 2001. The energy trading company filed for a loss of $74 billion and collapsed after a major accounting fraud scheme. A Wall Street Darling, Enron had gone from the most innovative company to the most scandalous one in less than a year due to corruption and management misconduct. Dated back in July 1985, Texas based Houston Natural Gas merged with Nebraska based InterNorth and Enron was thus formed.

Though it was a natural gas provider for the first few years, in 1989 Enron used Wall Street magic to convert energy supplies into financial instruments tradeable online. In 1994 the company stepped up the game and reported started trading electricity. By 1999, the company opened an Internet based trading system, Enron Online creating a nationwide energy trading network and no wonder in 2001 it was making online trades of $2.5 billion a day.

Amidst of all these sheer successes and over the top innovations, where did the company go wrong? Enron discovered if energy could be traded, so did anything I the virtual marketplace.

Be it advertising time, insurance or high speed data. Practically all of these tradeable things were converted to derivatives and sold to investors. Like any other investment, Enron flunked in few. Truth to be told, Enron as a company was incredible in inventing new businesses or opportunities but was equally incompetent in properly running or utilizing those. Be it some horrifying internal management audits or creatively hiding its failures or losses, Enron fooled the Wall Street, accountants, banks, associated partners or the press before hitting the major collapse.

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Enron’s balance sheet was a mystery to many accountants, because the company had the tendency to shuffle the debt into offshore partnerships often initiated by CFO Andrew Fastow. One instance could be Enron’s investment in Blockbuster to rent out movies online. Though the venture failed after few months, Enron set up a deal with a Canadian Bank to get loan worth $115 million in exchange of profit made out of the movie deal for the next 10 years.

So, though the movie venture failed, the Canadian loan was counted as profit for the company. Simultaneously, there was reports of false trading revenues. Traders used to serve as a middleman linking up buyers and sellers for a contract in future and report the entire sale as company revenue. The company also was involved in misusing its partnerships to conduct back and forth sale of contracts and reporting revenue from each. Things started to come into public eye when COO Jeffrey Skilling resigned in August 2001. Meanwhile Kenneth Lay resumed as CEO and got informed anonymously by a Vice President of the company about the malpractices. It came as major shock to the investors when the company reported loss of $638 million for the third quarter and reduction of shareholder equity by $1.2 billion due to the non-performing (fraudulent) partnerships. During that time Enron’s accountant, Andersen LLP was also found to be involved in covering up the mess created by the company. Securities and Exchange Commission started a full-fledged investigation regarding the matter in October. CFO Fastow was fired and CEO Lay attempted to make deal with Commerce Secretary Donald Evans to stop downgrading Enron bonds to non-investment grade status. But Evans did not make the deal.

The world could see the revised financial statements of Enron for the last 5 years in November and was overwhelmed to see it was actually at a loss of $586 million instead of making profits. As a result, the stock value fell to $1 per share and later delisted on January 2002. Even the deal made by Dynergy Inc. to buy the company for $8 billion in stock was out of the table due to Enron’s downgrade to junk bond status and financial mishaps right after it disclosed a restructure of $690 million obligation. The company filed for Chapter 11 bankruptcy and CEO Lay resigned meanwhile Department of Justice began a criminal investigation of the company. In January, the energy-trading business was taken over by European bank UBS Warburg. The management and top officials of Enron were summoned to testify in hearings related to the company. Executives including Kenneth Lay and Jeffrey Skilling were prosecuted for criminal charges of committing corporate fraud. Though key officials sold their stock quickly before the company collapse, other employees were encouraged to invest in company stock for their retirement savings and after the collapse they were unemployed with worthless stocks. Later they won a lawsuit settlement of $85 million.

Be it financial depredation or utter audacity and greed, devastation, the fall of Enron is more overwhelming than many other corporate scandal cases and trials that come across. Lay and Skilling were silent players of the accounting scam that Enron adopted for years to hide losses and produce forged profit reports. These enabled them to cash in the overvalued stock prices. If there were more competent and sincere about the business practices rather than committing malpractice the company would not have had this fate. But it is quite surprising how accountants, lawyers, bankers and credit agencies involved with Enron could have stopped getting involved but did not. Maybe this is why Skilling and Lay unreasonably thought that they were just utilizing the grey area of law because no one ever questioned the devious ways Enron tweaked its finances to the outside world.

On the flipside, a huge scandal involving the public company like Enron introduced the acute need for new compliance standards for public accounting and auditing. Years before Enron’s bankruptcy deregulation of oil and gas industry took place to allow more competition. But it also created more opportunities for companies like Enron to commit frauds and forgery. Due to the false representations of produced inflated earnings reports, many shareholders suffered from immense losses after the collapse. The overpriced stock of the company also instigated the illegal manipulation of the energy market. As a response to this massive corporate fraud, a new legislation called the Sarbanes-Oxley Act (SOX) came to light. The idea was to safeguard investors by assuring the accuracy of the financial statements and other documents disclosed by corporations. Moreover, in order to put a halt to mischievous partnerships between the corporations and their accounting/auditing partners, SOX also intervened in the way boards deal with the financial auditors. As per SOX, all companies must provide an annual report about the internal controls and their effectiveness. If I put my perspective about the scandal then I will say Enron scandal is the aftermath of how a genius was born, dazzled everyone with its innovations, took advantage of the weakness and loopholes of the systems, fooled everyone with fraudulent activities until it took the fall finally.