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The Enron Scandal
The Enron scandal comprises of a series of events that led to the fall and collapse of Enron Corporation in 2001. Enron Corporation was by then one of the largest energy companies in the United States. The company was founded in 1985 by Kenneth Lay. Enron was formed as a result of a merger between InterNorth and Houston Natural Gas, which were both relatively small regional companies. The Enron disaster led to the dissolution of their auditing company, and one of the five largest auditing companies in the world, Arthur Andersen LLP. By the time of its collapse, Enron was valued at $60 million in asset value (Edel Lemus 6). The company’s collapse was termed as the biggest corporate scandal in the United States.
The film ENRON: The Smartest Guys in the Room demonstrates the greed and unethical practices of Enron executives and other players such as the audit firm Arthur Andersen to manipulate the securities trading, inflate the balance sheet, and deceive shareholders. Enron’s traders are in cheers as they make millions of dollars out of the California energy crisis. Later the advice of these traders creates a shock on many investors as the collapse of the company. It all begins in 1985 with the merger of two local firms. The film is a fascinating exploration of corporate culture and fraudulent practices (ColdFusion).
Several years after the formation of Enron, Jeffrey Skilling was hired as the CEO. Jeffrey organized a staff of executives who used accounting loopholes, poor financial reporting, and special purpose entities to hide billions in debt from failed projects and financial deals (Alex et al.). In collaboration with other company executives, Chief Financial officer Andrew Fastow also misled the company’s board of directors and audit committee of high-risk accounting practices. The company’s accounting officers also pressured Arthur Andersen to ignore the high-risk accounting issues.
Enron experienced a successful stock price growth in the year before its collapse, which saw many investors bust its stock. And then, the worst and unexpected happened. The company’s stock price, which had hit a high of US$90 per share in mid-2000, plummeted to less than US$1, causing nearly US$11 billion in shareholder’s losses (Edel Lemus). The US Securities and Exchange Commission (SEC) launched an investigation into the affairs of the company, and Dynergy Inc. offered to buy Enron at a fire sale price. When the purchased deal went through, Enron filed for bankruptcy in 2001 under the US Bankruptcy Code. With an asset valuation of over $63.4 billion, bankruptcy became the largest corporate bankruptcy in US history by that time.
Most of the top-level executives at Enron were indicted for multiple charges, found guilty, and sentenced to prison. Arthur Andersen, who acted as auditors for Enron, was found guilty in a US District Court. However, the ruling was later overturned at the US Supreme Court, but by this time, Andersen had lost most of its customers and had been dissolved (Alex et al.). The courts awarded shareholders and employees limited returns despite having lost billions in stock prices and pensions. Enron’s scandal led to the enactment of new regulations and legislation to expand the reliability of financial reporting for public companies. For example, the Sarbanes-Oxley legislation expanded the consequences of fabricating, destroying, or altering records in federal investigations or attempting to defraud shareholders. The legislation also increased the independence of auditing firms.
The rise of Enron Corporation
In the early 1990s, Kenneth Lay helped to initiate the sale of natural electricity at market prices. Soon after this, the US Congress passed legislation that effected the deregulation of the sale of natural gas. The deregulation law’s impact was that companies like Enron were enabled to sell energy more than the market price, allowing them to thrive (Alex et al.). Most producers and local governments were opposed to the deregulation because it created high price volatility. However, lobbying from the beneficiaries such as Enron kept the free market in place.
By the year 1992, Enron stood as the largest natural gas merchant in North America. The gas trading venture also emerged as the highest Enron’s income generator. In November 2009, Enron launched the EnronOnline, an online trading model that enabled the company to develop and expand its capacity to manage and negotiate its trading operations. The company also diversified its venture to achieve further growth. By 2001, Enron operated in paper plants, gas pipelines, broadband assets, pulp, water plants, and electricity plants both locally and internationally. Enron also traded in financial markets for the line of services and products.
As a result of the exponential growth, Enron’s stock value rose by 311 percent from the beginning of the 1990s to the end of 1998. The stock also rose by 56 percent in 1999, and 87 percent in 2000. By 2001, Enron’s market capitalization was over $60 billion, seventy times its earning, and six times the book value (Hosseini 37454). The growth in the stock price was an indication of high prospects in its prospects. In addition to all the company’s positive, it was named the most innovative large company in the US in Fortune’s Most Admired Companies Survey.
Enron’s Downfall
Enron operated nontransparent financial practices that did not detail its finances and operations with shareholders and analysts. Enron also operated a complex business model that exploited accounting loopholes. The company had to use accounting limitations to manage earnings and manipulate the balance sheet to indicate a favorable state of its affairs. According to the movie, the Enron scandal was a culmination of values, habits, and actions that began several years before but erupted out of control. An evaluation of the company’s financial and accounting transactions indicates that the company intended to maintain reported cash flow and income high, inflate asset values, and keep liabilities out of the books (Hosseini 37453).
The combination of this management, accounting, and financial flaws led to the bankruptcy of the company. Most of the financial and accounting misdoings were conducted under the direct or indirect knowledge of Kenneth Lay, Jeffrey Skilling, Andrew Fastow, and other top executives (Boddy 3). Lay was the chairman of Enron in its last few years and oversaw Fastow and Skilling’s actions, although he claimed that he was not always directly involved in the skimming of these actions. Skilling focused on delivering stock market expectations, allowed the use of mark-to-market accounting to intentionally misrepresent the company’s status, and pressured other executives to apply unethical practices to hide the company’s debt (Alex et al.). The executives used such complex financial structures that very few understand them to date.
Conclusion
The Enron scandal led to the introduction of many changes if accounting reporting and audit firms’ independence. It showed how innocent investors could fall victim to poor corporate governance and the greed of a few individuals. Although the law took its cause and sentenced most of the responsible officials, the investors were never compensated for their losses in equal measure.
Works Cited
Alex Gibney, Matt Hauser, and John Mccullough. ENRON: THE SMARTEST GUYS IN THE ROOM. USA, 2005.
Boddy, C. R. “Enron Scandal.” Encyclopedia of Business and Professional Ethics (2017): 1-4.
ColdFusion. “Enron-The Biggest Fraud in history” YouTube Uploaded by ColdFusion, 30 Aug. 2019, https://www.youtube.com/watch?v=e5qC1YGRMKI&t=2s.
Company Man. “The Enron Scandal – A Simple Overview” YouTube Uploaded by Cold Man, 23 Aug. 2017, https://www.youtube.com/watch?v=hwollZoVmUc
Edel Lemus, M. I. B. A. “The financial collapse of the Enron corporation and its impact in the United States Capital Market.” Global Journal of Management And Business Research (2014).
Hosseini, Seied Beniamin. “The Lesson from Enron Case-Moral and Managerial Responsibilities.” Journal of Current Research 8.08 (2016): 37451-37460.
Luke, Milena. The Enron Scandal. Main Reasons for the Downfall of the Company. GRIN Verlag, 2018.