“Enron was the most important
corporate scandal of our lifetimes. It was one of the immediate causes of the
Sarbanes-Oxley Act, the governance reforms of the New York Stock Exchange and NASD,
and the most consequential reorientation of corporate behavior in living
memory,” claimed the securities law historian Joel Seligman. Indeed, the rapid rise to power and
precipitous downfall of Enron, a Houston-based energy corporation with assets
estimated at $111 billion at its height, represents the most notorious corporate
fraud and bankruptcy in United
States history. Nonetheless, government regulations on
so-called free market corporate business have emerged from the ruins of Enron,
and undoubtedly the corporate world has been duly warned about the consequences
of unethical business practices in the twenty-first century.
Enron was founded in 1985 in Omaha, Nebraska,
by the chief executive officer of Houston Natural Gas, Kenneth Lay. As a consequence of the deregulated energy
market in California, Enron rapidly acquired a
large share of the US
energy market and hired 21,000 employees at its apex. By 2000, Enron became the
world’s premier electricity, natural gas, and communications corporation with
assets (falsely) estimated at $111 billion in 2000. Furthermore, Enron was granted the title “America’s
Most Innovative Company” six consecutive times by Fortune magazine. Such positive
publicity bolstered Enron’s stock price and gave investors confidence in
Enron’s
financial stability. However, in
2001, after investigations into Enron’s specious financial statements, Enron
revealed that it had reported profits that were sustained by accounting fraud
and mark to market accounting. Since
Enron used mark to market accounting (the act of assigning an estimated future
value to a financial instrument based on current market prices), its financial
statements all reported positive economic profits, while in reality the
corporation faced enormous losses. The
company’s
executives repeatedly devised ways in which to conceal Enron’s debt,
such as storing debt in offshore accounts invisible to investors. Enron executives even arranged financial
transactions with leading investment banks in order to remove unprofitable
investments from Enron’s financial statements.
Enron’s
unstable financial status, which forced it to rely on accounting fraud to
maintain the stock price, also hindered company performance. Enron, for example, restricted the California energy supply
in order to raise the price of energy to generate revenue. California
congressman Phil Gramm, Enron’s second largest recipient of campaign contributions,
successfully passed a bill that deregulated California’s energy trading market. According to Bethany McLean, a reporter for Fortune, “Prior to the passage of the
deregulation law, there had been only one Stage 3 rolling blackout
. Following
the passage, California
experienced a total of 38 blackouts defined as Stage 3 rolling blackouts until
federal regulators intervened in June 2001. These blackouts occurred largely as
a result of the manipulation by traders and marketers. By withholding energy
and shutting down generators, frenzy appeared in the market and energy prices
climbed higher on the west coast.”
Clearly, Enron manipulated the supply of energy in California in order to raise the price of
energy to compensate for its debt from unprofitable transactions. In effect, Enron took advantage of the
deregulation of the energy industry and manipulated the energy market at the
expense of consumers.
Due
to the massive cash flows required to operate Enron and the lack of revenue
generated (because pipelines and power plants were shut down and plans for
construction were terminated), Enron drained itself of financial assets. As the scandal was unveiled, Enron shares
plummeted from $90.00 to $0.30. This
drop in stock price was devastating to investors who heavily invested in Enron
because it was a blue chip stock (a stock issued by a company with stable
earnings and few liabilities). In August
2000, Enron’s stock price hit its highest value of $90. At this point Enron
executives, who had inside information on future losses, began to sell their
stock. Meanwhile, the general public and Enron’s investors were encouraged to
buy the stock. However, Enron filed for bankruptcy on December 2, 2001 because of
its debt. More than 4,000 Enron
employees lost their jobs and their fringe benefits, such as insurance and
pensions. The charges held against Enron
executives included bank fraud, securities fraud, wire fraud, money laundering,
conspiracy, and insider trading.
What lessons can be gleaned from
Enron’s sudden collapse and the unethical business practices committed by it executives? The trial of Arthur Andersen, LLP, the
accounting firm that approved Enron’s falsified financial statements, revealed
that Arthur Andersen had been involved in several other accounting frauds, such
as the one at WorldCom. Like a row of
dominoes, accounting fraud and insider trading were exposed at several large
corporations. In response, the federal
government passed the Sarbanes-Oxley Act on July 30, 2002. The Sarbanes-Oxley Act makes the penalties
for accounting fraud more severe, mandates that companies report more
information to its investors, and requires that public companies maintain
financial internal control procedures and face auditing by government
agencies.
Undoubtedly, Enron has become a
symbol of corruption, greed, and corporate misconduct in the twenty-first
century. A valuable lesson, however, has
emerged from the ruins of Enron’s legacy: without government regulation, a
company with greedy executives at the helm will always seek to maximize profit,
and will sometimes resort to unethical business practices (such as insider
trading and accounting fraud) to maintain artificially high stock prices. Although the Darwinian view of business advocated
by Jeffrey Skilling, CEO of Enron and mastermind of the accounting fraud
scheme, resulted in millions of dollars in bonuses for Enron executives, this
view contributed directly to the collapse of Enron. Corporate America has been violently shaken
by the fallout of the Enron scandal, but the government will certainly regulate
business practices more strictly in the wake of a scandal of Enron’s magnitude.