Why Did Enron Fail?

Why Did Enron Fail? Enron emerged as a major American corporation in 1985 following a merger between Houston Natural Gas and InterNorth. The company would only last 16 years. By the end of 2001, Enron filed for bankruptcy—the largest in U.S. history at the time. Most people know Enron as an energy company—natural gas and electricity—but it also had departments devoted to communications and paper.

Eventually, Enron would become the center of a massive fraud investigation that contributed to Congress passing the Sarbanes-Oxley Act of 2002 (also known as SOX).

The act established laws designed to protect investors by improving the accuracy and reliability of information released by corporations. Among other things, the act establishes:

• Requirements for disclosing period reports.
• Assessing internal controls.
• Improper influence of executives on audits.
• Criminal penalties for retaliating against whistleblowers.
• Criminal penalties for misrepresenting company performance.
• The right for investors to take civil action against corporations.

The Enron scandal has become an essential example of how corporations can attempt to mislead investors and authorities when laws do not regulate their activities properly.

In the end, Enron failed because it fabricated, altered, and destroyed records to defraud stockholders. When a federal investigation uncovered these misdeeds, the company lost all support from its shareholders and clients. It quickly went from a company that did billions of dollars in business per year to one with whom no one wanted to associate.

What Went Wrong At Enron?

Things started going wrong at Enron almost from the very beginning.

Company executives and staff members hid billions of dollars in debt through creative accounting, loopholes, and outright lies.

Leadership within the company was aware of these practices and encouraged accountants and executives to continue filing misleading documents that misrepresented the company’s revenues, debts, and profits.

For years, Enron’s fraudulent tactics benefitted the company. At one point, its stock price reached as high as $90.75 per share. Before the end of 2001, the company shares had fallen to a mere 26 cents.

Enron’s success, however, relied on years of fooling investors and authorities. Once investigators discovered that Enron was keeping financial records off the official books, the company’s value plummeted practically overnight. It took less than a month for one of the country’s largest multinational corporations to fall apart.

Why Did Enron Fail?

The short version of why Enron failed is that it got caught breaking the law and misleading shareholders. The longer version is much more complicated.

Enron didn’t fail just because investors and partners severed ties to the company. It was forced to go into bankruptcy and develop a strategy for repaying its debts. At first, calculations showed that Enron owed its debtors about $18.7 billion. Within one day, the estimate was adjusted to about $23 billion.

Additionally, investors in Enron sued the company. They had, after all, lost billions of dollars because of Enron’s fraud. Unfortunately, it took years for courts to reach a conclusion that would repay investors and shareholders.

In 2008, the court awarded $7.2 billion to be divided among 1.5 million investors who had purchased stock between September 9, 1997 and December 2, 2001—representing the period of fraudulent activity as best as investigators could determine.

What Was Enron Guilty Of?

Enron and some of its executives were charged with committing several crimes, including:

• Wire fraud
• Mail fraud
• Securities fraud
• Money laundering
• Conspiracy

Enron’s accounting firm, Arthur Anderson, helped the company commit these crimes. It also destroyed documents that showed some of Enron’s crimes. Arthur Anderson was found guilty of obstruction of justice for destroying evidence.

To get a true sense of Enron’s crimes, though, you need to look at the charges and court decisions for key individuals involved in the scandal.

Kenneth Lay

Kenneth Law left his CEO position shortly before Jeffrey Skilling (below) took the job. Lay was found guilty of 11 counts of wire fraud, securities fraud, and making false and misleading statements.

Jeffrey Skilling

Jeffrey Skilling, Enron’s CEO, was found guilty on 12 counts of securities fraud, five counts of making false statements to auditors, one count of conspiracy, and one count of insider trading. He had only been the CEO for about six months.

Andrew Fastow

Andrew Fastow, the CFO of Enron, stands out as the person who received the most indictments. He was found guilty of committing securities fraud, wire fraud, mail fraud, and money laundering. In all, he was indicted on 78 counts.

Michael Kopper

Michael Kopper pleaded guilty of financial wrongdoing.

J. Clifford Baxter

J. Clifford Baxter was a former Vice Chairperson of Enron. He was accused of securities fraud by died by apparent suicide before his trial reached a conclusion.

Timothy Belden

Timothy Belden pleaded guilty to one count of wire fraud.

Related Charges

In addition to charges against Enron executives, three employees of National Westminster Bank—Gary Steven Emigree, David John Birmingham, and Robert Hugh Darby—were charged with wire fraud. The charges claimed that they had defrauded National Westminster Bank to benefit themselves and Enron executives.

Who Is Responsible For Enron’s Failure?

Many people share responsibility for Enron’s failure and crimes. The bulk of the blame, however, must fall on two men Kenneth Lay and Jeffry Skilling. The two CEOs fostered an environment of deception, encouraging other executives and accountants to falsify earnings and increase the company’s supposed profits.

Skilling should perhaps take more blame than Lay since he adopted an accounting method called “mark-to-market.” Mark-to-market accounting anticipates future profits without considering any of historical costs. The approach inflates the appearance of profits that do not exist. He also pushed an outrageous investment strategy for the company and claimed that it didn’t need any assets.

What Did Enron Do That Was Unethical?

Enron did a lot of unethical things to boost its appearance. Some of its worst actions include:

• Misrepresenting profits, earnings, and debts to falsely increase its value and stock price.
• Participate in a conspiracy that helped the company make money from the California energy crisis.
• Lie to adjusters about their accounting practices.

Throughout this, Enron’s executives maintained their innocence, lying to reporters, government officials, and courts about their activities. Prosecutors had enough evidence that their arguments made lies and obfuscation obvious.

Did Anyone From Enron Go To Jail?

It doesn’t seem that many executives spend significant time in jail for committing financial crimes. The Enron crimes were so egregious, though, that some people spent time behind bars.

Skilling received the harshest sentence. In 2006, a judge sentenced him to 24 years and four months in prison. The Justice Department later reached a deal with Skilling that reduced his sentence by 10 years.

Chief Account Officer Rick Causey initially pleaded not guilty but later changed his position and was sentenced to seven years in prison.

Kenneth Rice, a chief at Enron Corp., received a 27-month sentence after cooperating with prosecutors.

Kenneth Lay never spent time in jail because he died of heart problems three months before his sentence was scheduled to begin.

How Did Enron Get Caught?

Several things probably contributed to Enron getting caught. It seems that the SEC did not start investigating the company until Enron changed its pension plan, a move that prevented employees from selling their shares as stock prices plummeted.

The SEC opened its public investigation a few days after Enron made this change to its pension plan.

After the SEC got involved, evidence mounted quickly and at least one Enron executive testified before the House of Representatives.

Who Was The Enron Whistleblower?

Sherron Watkins, who was Enron’s Vice President of Corporate Development, originally reported her concerns about irregular accounting to Lay. She had worked at Arthur Andersen as an auditor and spent nearly a decade at Enron when she reported her suspicions.

Time magazine listed her as one of three “Persons of the Year” in 2002. The other two, Cynthia Cooper and Coleen Rowley, were also whistleblowers.

How Could Enron Have Been Prevented?

Several things could have potentially made it harder for Enron’s executives and accountants to commit their crimes. It’s unlikely that any rule would have absolutely prevented the scandal from happening, though. Everyone involved, after all, knew that they were committing crimes. As criminals, they probably would have done anything necessary to avoid the law for as long as possible.

Two things stand out as preventative measures: auditor independence and separation between government and business.

Independent auditors might have discovered Enron’s “creative” accounting much earlier if they had the freedom to review every financial document generated by the company. (Of course, Enron may have simply hidden the documents or not created them). Greater independence would make it possible for auditors to access a greater depth of information without requesting authorization.

Enron also had close ties to the federal government, which may have helped executives avoid prosecution for some time. Kenneth Lay donated heavily to George W. Bush’s presidential campaign. After winning the election, President Bush even considered Lay to serve as the country’s Secretary of Energy.

Could Enron Happen Again?

Something similar to the Enron scandal could happen today. It would only require conspiracy between the executives of a powerful company, knowledgeable people unwilling to act as whistleblowers, and an SEC that does not pursue suspicions or take litigation seriously.

A few changes could help prevent crimes, though. For instance, the SEC could require companies—at least those that trade on public exchanges—to change auditing firms periodically. That would prevent companies and auditors from conspiring with each other.

Under the Trump Administration, the SEC weakened auditor independence. The SEC should strengthen independence, making it more likely that they would report suspicious activities and giving them greater access to business documents.

The Public Company Accounting Oversight Board (PCAOB) also needs some changes to help prevent Enron-like crimes. PCAOB should operate much more transparently than it does. At present, many charges from the PCAOB do not become public.

It’s impossible to eliminate financial crimes, but more transparency and better regulations could make it much more difficult for companies to commit similar crimes.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.