Enron scandal

Enron Corporation
Public
Traded asNYSE: ENE
IndustryEnergy
FateBankruptcy
Predecessor
Successor
FoundedOmaha, Nebraska, U.S. (1985 (1985))
FounderKenneth Lay
DefunctDecember 2001 (2001-12)
Headquarters,
United States
Key people
Kenneth Lay, Founder, Chairman and CEO
Jeffrey Skilling, former President, and COO
Andrew Fastow, former CFO
Rebecca Mark-Jusbasche, former Vice Chairman, Chairman and CEO of Enron International
Stephen F. Cooper, Interim CEO and CRO
Divisionsenron.com

The Enron scandal, publicized in October 2001, eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas, and the de facto dissolution of Arthur Andersen, which was one of the five largest audit and accountancy partnerships in the world. In addition to being the largest bankruptcy reorganization in American history at that time, Enron was cited as the biggest audit failure.[1]:61

Enron was formed in 1985 by Kenneth Lay after merging Houston Natural Gas and InterNorth. Several years later, when Jeffrey Skilling was hired, he developed a staff of executives that – by the use of accounting loopholes, special purpose entities, and poor financial reporting – were able to hide billions of dollars in debt from failed deals and projects. Chief Financial Officer Andrew Fastow and other executives not only misled Enron's Board of Directors and Audit Committee on high-risk accounting practices, but also pressured Arthur Andersen to ignore the issues.

Enron shareholders filed a $40 billion lawsuit after the company's stock price, which achieved a high of US$90.75 per share in mid-2000, plummeted to less than $1 by the end of November 2001.[2] The U.S. Securities and Exchange Commission (SEC) began an investigation, and rival Houston competitor Dynegy offered to purchase the company at a very low price. The deal failed, and on December 2, 2001, Enron filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code. Enron's $63.4 billion in assets made it the largest corporate bankruptcy in U.S. history until WorldCom's bankruptcy the next year.[3]

Many executives at Enron were indicted for a variety of charges and some were later sentenced to prison. Andersen was found guilty of illegally destroying documents relevant to the SEC investigation, which voided its license to audit public companies and effectively closed the firm. By the time the ruling was overturned at the U.S. Supreme Court, the company had lost the majority of its customers and had ceased operating. Enron employees and shareholders received limited returns in lawsuits, despite losing billions in pensions and stock prices.

As a consequence of the scandal, new regulations and legislation were enacted to expand the accuracy of financial reporting for public companies.[4] One piece of legislation, the Sarbanes–Oxley Act, increased penalties for destroying, altering, or fabricating records in federal investigations or for attempting to defraud shareholders.[5] The act also increased the accountability of auditing firms to remain unbiased and independent of their clients.[4]

Rise of Enron

Kenneth Lay in a July 2004 mugshot

In 1985, Kenneth Lay merged the natural gas pipeline companies of Houston Natural Gas and InterNorth to form Enron.[6]:3 In the early 1990s, he helped to initiate the selling of electricity at market prices, and soon after, Congress approved legislation deregulating the sale of natural gas. The resulting markets made it possible for traders such as Enron to sell energy at higher prices, thereby significantly increasing its revenue.[7] After producers and local governments decried the resultant price volatility and asked for increased regulation, strong lobbying on the part of Enron and others prevented such regulation.[7][8]

As Enron became the largest seller of natural gas in North America by 1992, its trading of gas contracts earned $122 million (before interest and taxes), the second largest contributor to the company's net income. The November 1999 creation of the EnronOnline trading website allowed the company to better manage its contracts trading business.[6]:7

In an attempt to achieve further growth, Enron pursued a diversification strategy. The company owned and operated a variety of assets including gas pipelines, electricity plants, pulp and paper plants, water plants, and broadband services across the globe. The corporation also gained additional revenue by trading contracts for the same array of products and services with which it was involved.[6]:5 This included setting up power generation plants in developing countries and emerging markets including The Philippines (Subic Bay), Indonesia and India (Dabhol).[9]

Enron's stock increased from the start of the 1990s until year-end 1998 by 311%, only modestly higher than the average rate of growth in the Standard & Poor 500 index.[6]:1 However, the stock increased by 56% in 1999 and a further 87% in 2000, compared to a 20% increase and a 10% decrease for the index during the same years. By December 31, 2000, Enron's stock was priced at $83.13 and its market capitalization exceeded $60 billion, 70 times earnings and six times book value, an indication of the stock market's high expectations about its future prospects. In addition, Enron was rated the most innovative large company in America in Fortune's Most Admired Companies survey.[6]:1

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