Enron Scandal: The Downfall of a Wall Street Darling (2023)

The Story of Enron Corp. shows a company that reached dramatic heights only to experience a precipitous crash. The collapse of the predestined company hit thousands of employees and shook Wall Street to the core. At Enron's heyday, its shares were worth $90.75; Just before they filed for bankruptcy on December 2, 2001, they were trading at $0.26.

To this day, many wonder how such a powerful company—then one of the largest corporations in the United States—disintegrated almost overnight. It's also difficult to understand how his leadership managed to fool regulators for so long with false claims and unofficial accounting.

Main Conclusions

  • Enron's leadership duped regulators with false claims and unofficial accounting practices.
  • Enron used special purpose vehicles (SPVs) or special purpose entities (SPEs) to hide its mountains of debt and toxic assets from investors and creditors.
  • Enron's stock price rose from $90.75 at its peak to $0.26 at the bankruptcy.
  • The company paid its creditors more than $21.7 billion from 2004 to 2011.


Why Enron collapsed

Enron Scandal: The Downfall of a Wall Street Darling (1)

Enron Energy origins

Enron was formed in 1985 from the merger of Houston Natural Gas Co. and InterNorth Inc., headquartered in Omaha, Neb.Chief Executive Officer (CEO)of Houston Natural Gas, became CEO and Chairman of Enron. Lay quickly rebranded Enron as an energy trader and supplier. The deregulation of energy markets allowed companies to bet on future prices, and Enron was poised to take advantage. In 1990, Lay founded Enron Finance Corp. and appointed Jeffrey Skilling, whose work as a consultant to McKinsey & Co. impressed Lay to lead the new company. Skilling was one of McKinsey's youngest partners at the time.

Skilling came to Enron at an opportune time. The minimal regulatory environment at the time allowed Enron to thrive. In the late 1990s, the dot-com bubble was in full swing and the Nasdaq hit 5,000.Revolutionary internet stocks were valued at absurd levels, and as a result, most investors and regulators simply accepted rising stock prices as the new normal.


One of Skilling's first contributions was the conversion of Enron's bookkeeping from traditional bookkeeping tohistorical costsAccounting method for aMark-to-Market (MTM)Accounting method by which the company received official US certificates.Securities and Exchange Commission (SEC)Approval 1992.MTM is a measure of the fair value of accounts that may change over time, such as B. Assets and Liabilities. The MTM aims to provide a realistic assessment of an institution's or company's current financial situation, which is a legitimate and common practice. However, in some cases the method can be manipulated as the MTM is not based on the 'true' cost but on the more difficult to define 'fair value'.Some believe the MTM was the beginning of the end for Enron, as it essentially allowed the organization to book estimated profits as actual profits.

Enron is praised for its innovation

Enron launched EnronOnline (EOL) in October 1999, an e-commerce site focused on merchandise. Enron was the counterparty to all EOL transactions; was buyer or seller. To attract attendees and business partners, Enron offered its reputation, recognition, and expertise in the energy industry.Praised for its expansion and ambitious projects, Enron was named "America's Most Innovative Company" by the US National CouncilFortunafor six consecutive years: 1996–2001.

Papel make blockbusters

One of the many ignorant players in the Enron scandal was Blockbuster, the formerly major video store chain. In July 2000, Enron Broadband Services and Blockbuster partnered to enter the growing video-on-demand (VOD) market. The VOD market was a reasonable choice, but Enron began releasing expected earnings based on expected VOD market growth, which drove the numbers up a lot.

In mid-2000, EOL had a nearly $350 billion business. As the dot-com bubble began to burst, Enron decided to build high-speed, broadband telecommunications networks. Hundreds of millions of dollars were spent on this project, but the company ended up with almost no return.

When the recession hit in 2000, Enron had significant exposure to the most volatile parts of the market. As a result, many unsuspecting investors and creditors found themselves on the losing side of a dying economy.market capitalization.

Wall Street Darling desmorona

In the fall of 2000, Enron began to collapse under its own weight. Skilling hid the financial losses of the trading business and other corporate activities with the MTM bill.This technique measures the value of a security based on its current market value rather than its book value. This can work well when trading stocks, but can be disastrous for real trading.

In Enron's case, the company would build an asset like a power plant and immediately claim the projected profit on its books even though the company didn't make a penny from the asset. If the mill's earnings were less than the projected amount, the company would transfer the asset to an unregistered company rather than absorb the loss where the loss would go unreported. This type of accounting allowed Enron to shut down unprofitable activities without affecting the bottom line.

The MTM practice led to plans aimed at hiding losses and making the company appear more profitable than it actually was. To cope with the growing responsibilities, Andrew Fastow, a rising star, was promotedChief Financial Officer (CFO)In 1998, he devised a conscious plan to show that the company was in good financial shape, even though many of its subsidiaries were making losses.

How did Enron hide its debt?

Fastow and others at Enron orchestrated a scheme to be usedout of balance Special Purpose Vehicles (SPVs), also known as Special Purpose Entities (SPEs)to hide Enron's mountains of debt and toxic assets from investors and creditors.The primary purpose of these SPVs was to hide accounting reality, not operating results.

The standard transaction from Enron to SPV would be as follows: Enron would transfer to SPV in exchange for a portion of its rapidly growing inventoryBoxor a note. SPV would then use the inventory to hedge the asset listed on Enron's balance sheet. In return, Enron would guarantee the value of the SPV to reduce apparent counterparty risk.

Enron Scandal: The Downfall of a Wall Street Darling (2)

Although their purpose was to obscure accounting reality, SPVs were not illegal. But they differed from standard debt securitization in several key -- and potentially catastrophic -- ways. A big difference was that the SPVs wereCapital lettercomplete with Enron bearings. This directly impacted the SPV's ability to hedge if Enron's share price fell. Equally dangerous was the second significant difference: Enron's failure to disclose conflicts of interest. Although Enron disclosed the existence of the SPVs to the investing public - although it is likely that few people understood them - it has not adequately disclosed the independent arrangements between the company and the SPVs.

Enron management believed the stock price would continue to riseto appreciate- a belief similar to that of embodiedLong-term capital management, a large hedge fund, before its collapse in 1998.Ultimately, Enron stock fell. SPV values ​​also fell, bringing Enron's guarantees into effect.

Jim Chanos Short-Trade bei Enron

Jim Chanos of Kynikos Associates is a well known oneshort seller. At an SEC-chaired roundtable on hedge funds in May 2003, Chanos said his interest in Enron and other energy trading companies was "sparked" in October 2000 after a.Wall Street JournalThe article pointed out that many of these companies use the "sales profit" accounting method for their long-term energy businesses. According to Chanos, his experience with companies using this accounting method was that management was too tempted to make overly aggressive assumptions about the future, and that "income" could effectively be created out of thin air if management were willing to push the boundaries to be exceeded under very favorable assumptions.

Chanos also noted that Enron's cost of capital was closer to 9% and probably over 7%.Capital leases-- a widely used profitability metric -- it claimed to have, meaning it wasn't making any money, although it reported profits to its shareholders. Chanos said this discrepancy between Enron's cost of capital and itsCapital leasesbecame the cornerstone of his bearish view of Enron, and his firm began selling Enron common stock to its customers in November 2000. This short trade made hundreds of millions in profits for Chanos and his company Kynikos when Enron went bankrupt.

Arthur Andersen and Enron

Aside from Fastow, a major player in the Enron scandal was Enron's accounting firm Arthur Andersen LLP and his partner David B. Duncan, who oversaw Enron's accounts. As one of the top five accounting firms in the United States, Andersen was known for high standards and quality risk management at the time.

Yet despite Enron's poor accounting practices, Arthur Andersen has lent his seal of approval by signing off on company reports for years.In April 2001, many analysts began questioning Enron's earningstransparency.

The shock in Wall Street

In the summer of 2001, Enron was in freefall. Lay retired in February, handing over the job as CEO to Skilling. In August 2001, Skilling resigned as CEO for personal reasons. Around the same time, analysts began lowering their ratings on Enron stock, and the stock fell to $39.95, a 52-week low. On Oct. 16, the company reported its first quarterly loss and closed its Raptor I SPV. This action caught the attention of the SEC.

A few days later, Enron changed the manager of the pension plan, essentially barring employees from selling their stock for at least 30 days. Shortly thereafter, the SEC announced that it was investigating Enron and the SPVs founded by Fastow. Fastow was fired from the company that day. In addition, the company confirmed earnings since 1997. Enron had a loss of $591 million and $690 million in debt at the end of 2000. The final blow was dealt when Dynegy, a company that previously announced it would merge with Enron, pulled out of the bid on 11/28. On December 2, 2001, Enron filed for bankruptcy.

$74 billion

The amount shareholders lost in the four years prior to Enron's bankruptcy.


After the Enron Reorganization Plan was approved by the United States Bankruptcy Court, the newThe board of directorschanged the name from Enron to Enron Creditors Recovery Corp. (ECRC). The company's unique new mission was to "reorganize and liquidate some of Enron's pre-bankruptcy operations and assets for the benefit of creditors."The company paid its creditors over $21.7 billion from 2004 to 2011. The last payment was made in May 2011.

Enron Scandal: The Downfall of a Wall Street Darling (3)

criminal charges

Arthur Andersen was one of the first victims of Enron's infamous downfall. In June 2002, the company was found guilty of obstruction of justice for destroying Enron financial documents to hide them from the SEC.The conviction was later overturned on appeal; However, the company was deeply disgraced by the scandal and transformed into a holding company.A group of former partners bought the name in 2014 and formed a company called Andersen Global.

Several Enron executives have been accused of conspiracy, insider trading, and securities fraud. Lay, founder and former CEO of Enron, was convicted on six counts of fraud and conspiracy and four counts of bank fraud. Before his sentencing, he died of a heart attack in Colorado.

Fastow, Enron's former star CFO, pleaded guilty to two countselectronic fraudetitle fraudfor facilitating Enron's corrupt business practices. He eventually decided to cooperate with federal authorities and served more than five years in prison. In 2011 he got out of prison.

Skilling, the former CEO of Enron, ended up receiving the harshest sentence of anyone implicated in the scandal. In 2006, Skilling was convicted of conspiracy, fraud and insider trading. Skilling originally received a sentence of 17.5 years in prison, but this was reduced to 14 years in 2013. As part of the new settlement, Skilling was required to give $42 million to victims of the Enron fraud and no longer contest his conviction.Skilling was originally scheduled for release on February 21, 2028, but was released earlier on February 22, 2019.

New regulations after the scandal

The collapse of Enron and the financial devastation it inflicted on its shareholders and employees led to new regulations and laws promoting accurate financial reporting for public companies. In July 2002, then-President George W. Bush signed the law into lawLei Sarbanes-Oxley. The law increased the consequences of destroying, altering or falsifying financial statements and attempting to defraud shareholders.

As two researchers have noted, the Sarbanes-Oxley Act is a “mirror of Enron: the company's perceived corporate governance failures are compared virtually point by point in key provisions of the law” (Deakin and Konzelmann, 2003).

The Enron scandal led to other new compliance measures. additionallyFinancial Accounting Standards Board (FASB)raised his ethical behavior significantly. In addition, corporate boards have become more independent, overseeing audit firms and rapidly replacing weak managers. These new measures are important mechanisms to uncover and close loopholes that companies have used to evade accountability.

What exactly is the Enron scandal?

Enron was reputedly one of the most innovative and fastest-growing companies in the United States in the 1990s. However, the entire edifice was based on massive accounting and corporate fraud that eventually came to light and resulted in Enron's bankruptcy declaration in December 2001, the largest corporate bankruptcy in the world at this time.

Why were Enron's top executives later derided as the "smartest guys in the room"?

The phrase "smartest guys in the room" is a sarcastic nod to Enron's top executives -- including former chairman Kenneth Lay, CEO Jeffrey Skilling, and CFO Andrew Fastow -- whose arrogance in committing massive fraud at Enron eventually led to his downfall led.Enron: the smartest guys in the roomIt was also the title of a book by Bethany McLean and Peter Elkind that was published in 2003 and later became an award-winning documentary of the same name. Co-author McLean was among the first to be skeptical of Enron's inflated claims when she wrote an article entitled "Is Enron Overpriced?" In theFortunain March 2001.

Who is Sheron Watkins?

Sherron Watkins, Enron's vice president, wrote a letter to Lay in August 2001 warning that the company could implode in a wave of accounting scandals; A few months later, Enron collapsed. Watkins role aswhistleblowerby exposing Enron's corporate misconduct led to its being recognized as one of the threeTempo"People of the Year" 2002.

Does Enron still exist?

Enron no longer exists. In 2006 he sold his last company, Prisma Energy.

What role did Enron play in California's 2000-01 energy crisis?

In December 2000, legislation was passed deregulating energy commodity trading in California and allowing Enron to conduct an unregulated energy auction.called EnronOnline, which quickly gained control of a large chunk of the state's power and natural gas markets. After the law was passed, California suffered an acute power shortage that caused up to 38 continuous power outages through June 2001, compared to just one in the six months before the law.

Subsequent investigations by state and federal agencies concluded that power producers and electricity traders were intentionally withholding power to create artificial bottlenecks and increase electricity costs. Because Enron was a key player in this market manipulation, its energy traders were able to sell energy at multiples of normal peak energy prices. Enron's new unregulated power auction resulted in revenue from its wholesale services business quadrupling to $48.4 billion in the first quarter (Q1) of 2001 compared to the same period last year.


At that time, Enron's collapse was the biggestcorporate bankruptcynever reached the financial world (it has since been overtaken by bankruptciesfrom other former giants, includingLehman Brothers, Washington Mutual,WorldComand General Motors). Enron's scandal drew attention to accounting and corporate fraud as its shareholders lost $74 billion and its employees lost billions in pension benefits in the four years leading up to its bankruptcy.

Greater regulation and oversight were enacted to prevent corporate scandals on the scale of Enron. However, some companies are still recovering from the damage Enron caused. More recently, in March 2017, a judge awarded a Toronto-based investment firm the right to sue Skilling (former CEO of Enron), Credit Suisse Group AG, Deutsche Bank AG and Bank of America's Merrill Lynch unit for losses suffered sue for buying Enron stock. .


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