{"id":465712,"date":"2021-05-08T04:31:51","date_gmt":"2021-05-08T08:31:51","guid":{"rendered":"https:\/\/financhill.com\/blog\/?p=465712"},"modified":"2021-05-02T21:55:58","modified_gmt":"2021-05-03T01:55:58","slug":"why-did-enron-fail","status":"publish","type":"post","link":"https:\/\/financhill.com\/blog\/investing\/why-did-enron-fail","title":{"rendered":"Why Did Enron Fail?"},"content":{"rendered":"<p><span style=\"color: #0e101a; background-color: transparent;\"><em>Why Did Enron Fail?<\/em> 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. <strong>By the end of 2001, Enron filed for bankruptcy\u2014the largest in U.S. history at the time.<\/strong> <\/span><span style=\"color: #0e101a; background-color: transparent;\">Most people know Enron as an energy company\u2014natural gas and electricity\u2014but it also had departments devoted to communications and paper.<\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Eventually, Enron would become the center of a massive fraud investigation that contributed to Congress passing the&nbsp;<\/span><a style=\"color: #4a6ee0; background-color: transparent;\" href=\"https:\/\/www.soxlaw.com\/\" target=\"_blank\" rel=\"noopener noreferrer\">Sarbanes-Oxley Act of 2002<\/a><span style=\"color: #0e101a; background-color: transparent;\">&nbsp;(also known as SOX). <\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">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:<\/span><\/p>\n<ul>\n<li><strong><span style=\"color: #0e101a; background-color: transparent;\">Requirements for disclosing period reports.<\/span><\/strong><\/li>\n<li><strong><span style=\"color: #0e101a; background-color: transparent;\">Assessing internal controls.<\/span><\/strong><\/li>\n<li><strong><span style=\"color: #0e101a; background-color: transparent;\">Improper influence of executives on audits.<\/span><\/strong><\/li>\n<li><strong><span style=\"color: #0e101a; background-color: transparent;\">Criminal penalties for retaliating against whistleblowers.<\/span><\/strong><\/li>\n<li><strong><span style=\"color: #0e101a; background-color: transparent;\">Criminal penalties for misrepresenting company performance.<\/span><\/strong><\/li>\n<li><strong><span style=\"color: #0e101a; background-color: transparent;\">The right for investors to take civil action against corporations.<\/span><\/strong><\/li>\n<\/ul>\n<p><span style=\"color: #0e101a; background-color: transparent;\">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.<\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">In the end, <strong>Enron failed because it fabricated, altered, and destroyed records to defraud stockholders<\/strong>. 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.<\/span><\/p>\n<h2><span style=\"color: #0e101a; background-color: transparent;\">What Went Wrong At Enron?<\/span><\/h2>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Things started going wrong at Enron almost from the very beginning. <\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\"><strong>Company executives and staff members hid billions of dollars in debt through creative accounting, loopholes, and outright lies<\/strong>. <\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Leadership within the company was aware of these practices and encouraged accountants and executives to continue filing misleading documents that misrepresented the company&#8217;s revenues, debts, and profits.<\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">For years, Enron&#8217;s fraudulent tactics benefitted the company. At one point, its stock price reached as high as $90.75 per share. <\/span><span style=\"color: #0e101a; background-color: transparent;\">Before the end of 2001, the company shares had fallen to a mere 26 cents. <\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Enron&#8217;s success, however, relied on years of fooling investors and authorities. <strong>Once investigators discovered that Enron was keeping financial records off the official books, the company&#8217;s value plummeted practically overnight.<\/strong> It took less than a month for one of the country&#8217;s largest multinational corporations to fall apart.<\/span><\/p>\n<h2><span style=\"color: #0e101a; background-color: transparent;\">Why Did Enron Fail?<\/span><\/h2>\n<p><span style=\"color: #0e101a; background-color: transparent;\"><strong>The short version of why Enron failed is that it got caught breaking the law and misleading shareholders.<\/strong> The longer version is much more complicated.<\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Enron didn&#8217;t fail just because investors and partners severed ties to the company. <strong>It was forced to go into bankruptcy and develop a strategy for repaying its debts.<\/strong> At first, calculations showed that&nbsp;Enron owed its debtors about $18.7 billion. Within one day, the estimate was adjusted to about $23 billion.<\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Additionally, investors in Enron sued the company. <\/span><span style=\"color: #0e101a; background-color: transparent;\">They had, after all, lost billions of dollars because of Enron&#8217;s fraud. <\/span><span style=\"color: #0e101a; background-color: transparent;\">Unfortunately, it took years for courts to reach a conclusion that would repay investors and shareholders. <\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">In 2008, <a href=\"http:\/\/www.cnn.com\/2008\/US\/09\/09\/enron.settlement\/\" target=\"_blank\" rel=\"noopener\">the court awarded $7.2 billion to be divided among 1.5 million investors<\/a> who had purchased stock between September 9, 1997 and December 2, 2001\u2014representing the period of fraudulent activity as best as investigators could determine.<\/span><\/p>\n<h2><span style=\"color: #0e101a; background-color: transparent;\">What Was Enron Guilty Of?<\/span><\/h2>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Enron and some of its executives were charged with committing several crimes, including:<\/span><\/p>\n<ul>\n<li><strong><span style=\"color: #0e101a; background-color: transparent;\">Wire fraud<\/span><\/strong><\/li>\n<li><strong><span style=\"color: #0e101a; background-color: transparent;\">Mail fraud<\/span><\/strong><\/li>\n<li><strong><span style=\"color: #0e101a; background-color: transparent;\">Securities fraud<\/span><\/strong><\/li>\n<li><strong><span style=\"color: #0e101a; background-color: transparent;\">Money laundering<\/span><\/strong><\/li>\n<li><strong><span style=\"color: #0e101a; background-color: transparent;\">Conspiracy<\/span><\/strong><\/li>\n<\/ul>\n<p><span style=\"color: #0e101a; background-color: transparent;\"><strong>Enron&#8217;s accounting firm, Arthur Anderson, helped the company commit these crimes<\/strong>. It also destroyed documents that showed some of Enron&#8217;s crimes. <a href=\"https:\/\/www.wsj.com\/articles\/SB1023469305374958120\" target=\"_blank\" rel=\"noopener\">Arthur Anderson was found guilty<\/a> of obstruction of justice for destroying evidence.<\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">To get a true sense of Enron&#8217;s crimes, though, you need to look at the charges and court decisions for key individuals involved in the scandal.<\/span><\/p>\n<h3><span style=\"color: #0e101a; background-color: transparent;\">Kenneth Lay<\/span><\/h3>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Kenneth Law left his CEO position shortly before Jeffrey Skilling (below) took the job. <strong>Lay was found guilty of 11 counts of wire fraud, securities fraud, and making false and misleading statements.<\/strong><\/span><\/p>\n<h3><span style=\"color: #0e101a; background-color: transparent;\">Jeffrey Skilling<\/span><\/h3>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Jeffrey Skilling, Enron&#8217;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.<\/span><\/p>\n<h3><span style=\"color: #0e101a; background-color: transparent;\">Andrew Fastow<\/span><\/h3>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Andrew Fastow, the CFO of Enron, stands out as the person who received the most indictments. <strong>He was found guilty of committing securities fraud, wire fraud, <a href=\"https:\/\/www.impactlaw.com\/criminal-law\/white-collar\/securities-fraud\/lawsuits\/enron\" target=\"_blank\" rel=\"noopener\">mail fraud, and money laundering<\/a>. In all, he was indicted on 78 counts.<\/strong><\/span><\/p>\n<h3><span style=\"color: #0e101a; background-color: transparent;\">Michael Kopper<\/span><\/h3>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Michael Kopper pleaded guilty of financial wrongdoing.<\/span><\/p>\n<h3><span style=\"color: #0e101a; background-color: transparent;\">J. Clifford Baxter<\/span><\/h3>\n<p><span style=\"color: #0e101a; background-color: transparent;\">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.<\/span><\/p>\n<h3><span style=\"color: #0e101a; background-color: transparent;\">Timothy Belden<\/span><\/h3>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Timothy Belden pleaded guilty to one count of wire fraud.<\/span><\/p>\n<h3><span style=\"color: #0e101a; background-color: transparent;\">Related Charges<\/span><\/h3>\n<p><span style=\"color: #0e101a; background-color: transparent;\">In addition to charges against Enron executives, three employees of National Westminster Bank\u2014Gary Steven Emigree, David John Birmingham, and Robert Hugh Darby\u2014were charged with wire fraud. The charges claimed that&nbsp;they had defrauded National Westminster Bank to benefit themselves and Enron executives.<\/span><\/p>\n<h2><span style=\"color: #0e101a; background-color: transparent;\">Who Is Responsible For Enron&#8217;s Failure?<\/span><\/h2>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Many people share responsibility for Enron&#8217;s failure and crimes. <strong>The bulk of the blame, however, must fall on two men Kenneth Lay and Jeffry Skilling.<\/strong> <\/span><span style=\"color: #0e101a; background-color: transparent;\">The two CEOs fostered an environment of deception, encouraging other executives and accountants to falsify earnings and increase the company&#8217;s supposed profits.<\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\"><strong>Skilling should perhaps take more blame than Lay<\/strong> since <a href=\"https:\/\/www.creditpulse.com\/accountingfinance\/lessons-enron\/enron-lesson-no-1-mark-market-fair-value-accounting\" target=\"_blank\" rel=\"noopener\">he adopted an accounting method called &#8220;mark-to-market.<\/a>&#8221; Mark-to-market accounting anticipates future profits without considering any of historical costs. The approach inflates the appearance of profits that do not exist. <strong>He also pushed an outrageous investment strategy for the company and claimed that it didn&#8217;t need any assets.<\/strong><\/span><\/p>\n<h2><span style=\"color: #0e101a; background-color: transparent;\">What Did Enron Do That Was Unethical?<\/span><\/h2>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Enron did a lot of unethical things to boost its appearance. Some of its worst actions include:<\/span><\/p>\n<ul>\n<li><strong><span style=\"color: #0e101a; background-color: transparent;\">Misrepresenting profits, earnings, and debts to falsely increase its value and stock price.<\/span><\/strong><\/li>\n<li><strong><span style=\"color: #0e101a; background-color: transparent;\">Participate in a conspiracy that helped the company make money from the California energy crisis.<\/span><\/strong><\/li>\n<li><strong><span style=\"color: #0e101a; background-color: transparent;\">Lie to adjusters about their accounting practices.<\/span><\/strong><\/li>\n<\/ul>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Throughout this, Enron&#8217;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.<\/span><\/p>\n<h2><span style=\"color: #0e101a; background-color: transparent;\">Did Anyone From Enron Go To Jail?<\/span><\/h2>\n<p><span style=\"color: #0e101a; background-color: transparent;\">It doesn&#8217;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.<\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\"><strong>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<\/strong>.<\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Chief Account Officer Rick Causey initially pleaded not guilty but later changed his position and was sentenced to seven years in prison.<\/span><\/p>\n<p><strong><span style=\"color: #0e101a; background-color: transparent;\">Kenneth Rice, a chief at Enron Corp., received a 27-month sentence after cooperating with prosecutors.<\/span><\/strong><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Kenneth Lay never spent time in jail because he died of heart problems three months before his sentence was scheduled to begin.<\/span><\/p>\n<h2><span style=\"color: #0e101a; background-color: transparent;\">How Did Enron Get Caught?<\/span><\/h2>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Several things probably contributed to Enron getting caught. <strong>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.<\/strong><\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">The SEC opened its public investigation a few days after Enron made this change to its pension plan.<\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">After the SEC got involved, evidence mounted quickly and at least one Enron executive testified before the House of Representatives.<\/span><\/p>\n<h2><span style=\"color: #0e101a; background-color: transparent;\">Who Was The Enron Whistleblower?<\/span><\/h2>\n<p><span style=\"color: #0e101a; background-color: transparent;\"><strong><a href=\"https:\/\/www.theguardian.com\/business\/2003\/jun\/21\/corporatefraud.enron\" target=\"_blank\" rel=\"noopener\">Sherron Watkins<\/a>, who was Enron&#8217;s Vice President of Corporate Development, originally reported her concerns about irregular accounting to Lay<\/strong>. She had worked at Arthur Andersen as an auditor and spent nearly a decade at Enron when she reported her suspicions.<\/span><\/p>\n<p><em style=\"color: #0e101a; background-color: transparent;\">Time&nbsp;<\/em><span style=\"color: #0e101a; background-color: transparent;\">magazine listed her as one of three &#8220;Persons of the Year&#8221; in 2002. The other two, Cynthia Cooper and Coleen Rowley, were also whistleblowers.<\/span><\/p>\n<h2><span style=\"color: #0e101a; background-color: transparent;\">How Could Enron Have Been Prevented?<\/span><\/h2>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Several things could have potentially made it harder for Enron&#8217;s executives and accountants to commit their crimes. It&#8217;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.<\/span><\/p>\n<p><strong><span style=\"color: #0e101a; background-color: transparent;\">Two things stand out as preventative measures: auditor independence and separation between government and business.<\/span><\/strong><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">Independent auditors might have discovered Enron&#8217;s &#8220;creative&#8221; 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.<\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\"><strong>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&#8217;s presidential campaign.<\/strong> After winning the election, President Bush even considered <a href=\"https:\/\/courses.lumenlearning.com\/boundless-ushistory\/chapter\/the-george-w-bush-administration\/\" target=\"_blank\" rel=\"noopener\">Lay to serve as the country&#8217;s Secretary of Energy<\/a>.<\/span><\/p>\n<h2><span style=\"color: #0e101a; background-color: transparent;\">Could Enron Happen Again?<\/span><\/h2>\n<p><span style=\"color: #0e101a; background-color: transparent;\">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.<\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">A few changes could help prevent crimes, though. For instance, <strong>the SEC could require companies\u2014at least those that trade on public exchanges\u2014to change auditing firms periodically.<\/strong> That would prevent companies and auditors from conspiring with each other.<\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">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.<\/span><\/p>\n<p><span style=\"color: #0e101a; background-color: transparent;\">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.<\/span><\/p>\n<p><strong><span style=\"color: #0e101a; background-color: transparent;\">It&#8217;s impossible to eliminate financial crimes, but more transparency and better regulations could make it much more difficult for companies to commit similar crimes.<\/span><\/strong><\/p>\n","protected":false},"excerpt":{"rendered":"<p>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\u2014the largest in U.S. history at the time. Most people know Enron as an energy company\u2014natural gas and [&hellip;]<\/p>\n","protected":false},"author":2,"featured_media":465714,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"content-type":"","jetpack_post_was_ever_published":false,"_jetpack_newsletter_access":"","_jetpack_dont_email_post_to_subs":false,"_jetpack_newsletter_tier_id":0,"_jetpack_memberships_contains_paywalled_content":false,"_jetpack_memberships_contains_paid_content":false,"footnotes":"","jetpack_publicize_message":"","jetpack_publicize_feature_enabled":true,"jetpack_social_post_already_shared":true,"jetpack_social_options":{"image_generator_settings":{"template":"highway","enabled":false},"version":2}},"categories":[22],"tags":[],"class_list":["post-465712","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-investing"],"jetpack_publicize_connections":[],"jetpack_featured_media_url":"https:\/\/financhill.com\/blog\/wp-content\/uploads\/2021\/05\/why-did-enron-fail.jpg","jetpack_sharing_enabled":true,"jetpack_shortlink":"https:\/\/wp.me\/p9czeV-1X9u","_links":{"self":[{"href":"https:\/\/financhill.com\/blog\/wp-json\/wp\/v2\/posts\/465712","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/financhill.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/financhill.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/financhill.com\/blog\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/financhill.com\/blog\/wp-json\/wp\/v2\/comments?post=465712"}],"version-history":[{"count":6,"href":"https:\/\/financhill.com\/blog\/wp-json\/wp\/v2\/posts\/465712\/revisions"}],"predecessor-version":[{"id":465719,"href":"https:\/\/financhill.com\/blog\/wp-json\/wp\/v2\/posts\/465712\/revisions\/465719"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/financhill.com\/blog\/wp-json\/wp\/v2\/media\/465714"}],"wp:attachment":[{"href":"https:\/\/financhill.com\/blog\/wp-json\/wp\/v2\/media?parent=465712"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/financhill.com\/blog\/wp-json\/wp\/v2\/categories?post=465712"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/financhill.com\/blog\/wp-json\/wp\/v2\/tags?post=465712"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}