#2: ENRON CORPORATION
The story of the Enron Corporation has become one of infamy, and the ultimate example of how fraudulent and corrupt business practices can ruin even the most powerful of organisations. Prior to their well-reported scandal, Enron had dominated the energy market in the US and afar, securing revenues of $101bn during 2000. Yet just a year later, Enron were filing for bankruptcy. In this article, we take a look at the history of Enron, and the reasons behind their extraordinary collapse. Read on for more.
The Enron Corporation was founded in 1985, following a merger between Houston Natural Gas and InterNorth. At the time, both companies had been relatively small players in the energy market, but, following a major restructure, the combination allowed Enron to thrive, becoming one of the most powerful corporations in the United States. Enron traded in areas such as electricity, communications, broadband and natural gas.
The 1990s proved hugely successful for Enron. Substantial investments in overseas energy assets, together with the introduction of hedge funds, allowed Enron to increase its profitability considerably. Some acts in Congress also benefited Enron, who reacted smartly to such legislation changes. Internet and broadband services were becoming more popular after the advent of the internet, and Enron even expanded abroad – operating in around 20 nations. These different areas all added up for Enron, who were seen as a forward-thinking firm, winning Fortune’s ‘Most Innovative Company’ award five years running.
But, as most know, things would go terribly wrong for Enron in 2001. Part of the success and rapid rise of Enron was due to a consistently strong share price. This share price had been calculated based upon assets and accounts. Yet Enron’s accounts were fraudulent. They were being constantly inflated, with debts and losses moved into offshore accounts and subsequently left out of statements. Accounting loopholes were used wherever possible, with these practices helping to make Enron appear very profitable – when in actual fact, Enron were losing money.
These accounting practices would be likened to a ‘Ponzi scheme’ in later years. These practices were illegal, and allowed Enron to mislead their auditor, while hiding funds. Their auditor – Arthur Andersen – were far from innocent. Arthur Andersen’s employees engaged in an effort to destroy thousands of Enron documents. Their practices would also result in their business collapsing – one of the highest-profile victims of the Enron scandal. Many had little sympathy, with Arthur Andersen being complicit in the scandal.
To explain it simply, an example of how Enron would inflate their accounts is as follows: Enron would create an asset, such as a power plant. Now, instead of following legal practices, which would involve accounting for no income – because it has only just been created, Enron would immediately claim a projected profit from the asset – valuing assets at a current market value. When this process is repeated on thousands of assets, numbers quickly spiral out of control. Many other practices were used too.
Around 2000, many started to speculate as to whether or not Enron’s accounts were a fair representation of what was actually happening. An article in Fortune magazine cast doubt on Enron stock – which many were buying, before selling on for a large profit. Many senior figures within Enron were partaking in such actions too – making millions of dollars. The Fortune article questioned the ‘erratic’ cash flow of Enron, and queried the merits of purchasing Enron stock. Enron’s shares at their peak traded at $90.75.
The doubts started to creep in, and Enron’s share price did indeed drop. Struggles in broadband communications – previously a lucrative area – resulted in further share price drops. Panic set in, and Dynegy – a smaller firm – attempted to buy out Enron, but the rescue attempt failed. Enron wrote off $1.2bn in value from their company following alterations to financial statements, with Enron admitting they inflated its income. A probe from the Securities and Exchange Commission (SEC) was also launched into Enron – further affecting investor confidence.
Eventually, the share price hit just $0.26, when Enron filed for bankruptcy. This was at the time the largest corporate bankruptcy in American history (surpassed by WorldCom a year later). The company sold many of its assets prior to the bankruptcy – though many were worth mere pennies by the end. It took until 2006 for Enron to sell off its final asset. Full investigations were launched, resulting in lawsuits, along with prison sentences for some executives from Enron. Shareholders and customers received very little – despite losing billions in pensions and stock prices.
So what exactly went wrong? Accountancy practices were the main downfall of Enron. Their practices inflated income, and gave consumers an untrue account of what was really happening at Enron. With the company protected by its auditor, Enron continued to benefit from their high share price. But once investor confidence dropped, the floodgates opened, and Enron went from billions in revenue to a quick collapse. The collapse has affected many, many people.
There is no doubting the legacy left behind by the Enron Corporation. If you type ‘scandal’ into Google, Enron isn’t far from the first result. This has become a famous case study, and resulted in accountancy regulations being tightened up. The effect of the collapse still effects people to this day, and has served as a constant reminder to businesses of the importance of employing legal accountancy practices. Enron is gone, but certainly not forgotten.