Enron Corporation and its Way to Bankruptcy
How it works
In the 1990s, Enron was a well-respected and one of the most innovative companies in the world. The company sought to forsake old industry and embraced the world of freewheeling e-commerce. Though the company continued to engage in operating gas lines and building power plants, they excelled in their trading model, which was unique to those in existence. Despite the company’s involvement in purchasing electricity futures and trading in gas, it saw a new opportunity in other avenues. Through its innovative marketing and business strategies, Enron created new market niches through offering broadcast times for advertisers, internet bandwidth and weather futures.
The creation of the company was in 1985; and during this time, it went to become a global leader in the provision of communications and electricity. In addition, Enron engaged in the processing of pulp to paper before it officially went belly up in 2001. Before the scandal and the company’s demise, Enron’s annual revenues saw an increase of $100 billion in 2000 from $9 billion in 1995. However, in 2001 it was discovered that the company was only able to offer these financial records through malpractices in accounting. The entire organization was riddled with fraudulent practices. Thomas (2002) posited that Enron lost Shareholders’ money amounting to $11 billion when their stock price plunged from $90 per share to $1 per share. When the company revised its financial statement, it was discovered that it had incurred losses of $586 million in the prior five years. It is after this revelation that Enron officially announced bankruptcy on December 2, 2001.
How it works
There is a great lesson pertaining to the internet boom in that there is many difficulties in analyzing and understanding new types of commerce. The Enron case unearthed a problem that has been perpetuated by Wall Street; more money is made by investment banks through underwriting and merger fees than the money they make from brokering.
Overview of Corporation
Enron was based in Houston, Texas; it was a major energy company that was previously recognized by Forbes as one of the top companies in corporate strategies and management. After the Enron Scandal got much publicity in 2001, the company finally went bankrupt. Arthur Andersen was responsible for auditing Enron’s finances being one of the most established auditing companies of the time. Enron’s bankruptcy went on to become the biggest audit failure in America (Farrar 2008).
The founder of the company was Kenneth Lay; the company was a result of amalgamation. Inter-North was one of the companies that merged with Houston Natural Gas. Several years later, Jeffery Skilling was offered a position as the company’s Chief Executive Officer. On being hired, Skilling used accounting loopholes to create the Executive staff. Through his ineptitude/schemes, he employed poor financial reporting and special purpose entities. It is through a combination of these tactics and more that the company was able to hide their debt that spanned into the billions. Much of this loss was attributed to failed projects and deals. The Chief Financial Officer of Enron, Andrew Fastow actively misled the board of directors and went as far as to pressure Arthur Andersen to be indifferent to the issues.
A lawsuit worth $40 billion was filed in 2001 by the shareholders after the company’s stock value deteriorated from $90 a share to $1 per share. While this transpired, the SEC (Securities and Exchange Commission) opened an investigation against them. This presented an opportunity for Dynegy, which was its Houston competitor, to present an offer to purchase Enron at a very low rate. Under the Bankruptcy Code, Enron finally filed for bankruptcy on December 2, 2001.
Enron’s executives got indicted and some of them received a jail sentence for a variety of charges. Arthur Andersen’s license to audit was revoked when they were found to have destroyed documents pertinent to the SEC investigation. The United States Supreme Court later overturned the earlier ruling but by this time the company had lost all customer faith and operations had already seized. Despite that the company lost billions in stock prices and pensions, its shareholders and employees got returns in lawsuits. Enron’s scandal paved way for new legislation and regulation (Prebble 2016). The SarbanesOxley Act introduced stern penalties for companies caught fabricating, destroying, or altering documents that pertain to federal investigations.
The executive staff of Enron was as follows:
- Owner: Kenneth Lay
- Chief Executive Officer: Jeffery Skilling
- Chief Financial Officer: Andrew Fastow
Before the company’s bankruptcy, Enron’s shareholders incurred a loss of $70 billion in the previous four years prior to bankruptcy. Much of this loss was attributed to copious instances of fraud ($40 to $45 billion). At the time, Enron owed $67 billion to creditors. For this reason, employees and shareholders had to settle for limited severance from Enron. Enron had to liquidate all its assets including pipelines, logo signs, photographs, and art in order to cover the creditors’ debt.
Over 20,000 former employees of Enron got a compensation of $85 million after winning a lawsuit in 2004. This sum was a reduction from their original $2 billion in pensions. Each employee received roughly $3,100 after the exercise. The shareholders received a compensation of $4.2 billion the following year from several banks. Moreover, the shareholders won a settlement of $7.2 billion, from a lawsuit of $40 billion. This sum was shared among the main plaintiffs: UC (University of California) and one and a half million persons.
Failure in Enron
The failure of Enron was a “team effort as instances of corruption and fraud were found throughout its organization’s structure.
Auditing and Accounting Issues
It is a requirement by the federal securities law that all public traded companies be reviewed by independent auditors. For this reason, Enron employed the services of Arthur Andersen as the consulting audit company. This auditing company was inclusive in Enron’s financial scandal. Not only did Andersen ignore the improper accounting of Enron, but they actively devised complicated financial structures that aided in the deception.
A proper audit certification authenticates a business’ financial statement to have complied with GAAP (general accepted accounting principles). This was not the case for Enron as it was discovered that the company violated the set of accounting standards and requirements. The company was found guilty of misappropriating investor funds in complex money schemes and poor accounting. The Enron scandal facilitated the enactment of the Sarbanes-Oxley Act of 2002 by Congress, which promised severe consequences for those caught in accounting malpractice.
It is a popular culture for companies to sponsor their employees’ retirement plan. Enron’s Employees made contributions from a portion of their salary to this effect. 62% of the employees’ contributions towards their 401(k) was in form of Enron’s Stock as of December 31, 2000. There were many employees who held substantial Enron stock pertaining to their retirement accounts. In 2002, Enron’s stock became worthless, a contrast from the $80 per share price in January 2001. Many employees saw their retirement accounts lose money and this led to debate about the current laws regarding retirement plans and how to govern the aforementioned.
Corporate Governance Issues
Enron’s executive branch and its board of directors became subjects of scrutiny when the company was hit by scandal. The management was found guilty of selling stock worth billions of dollars while they hid critical financial problems from the public’s eye. The Sarbanes-Oxley offers provisions to act as reminders to CEOs the duties and responsibilities they have to shareholders and their organizations. Mandatory reporting of all stock trade that is handled by corporate insiders must be made within hours of activity and not weeks or months. The CEO must ratify the accuracy of the financial statements and fraud involved will be met with increased criminal penalties (Sterling 2002).
Securities Analyst Issues
Research and recommendations for “buying” “selling” and “holding are done by securities analysts who work for investment banks. These recommendations are widely utilized and depended upon by many stakeholders in the industry. Enron’s required the support of these analysts as it needed funding that only could be provided by the financial markets. By November 29, 2001, the value of the company’s stock was labeled “junk bond by 9 of 11 major firm analysts. Two analysts promoted the sale of stock raising the question of objectivity and integrity of investment banks. The SEC through the Sarbanes-Oxley Act offers guidelines for mitigating conflicts of interest.
The practices in banking were a key involvement in the demise of Enron. Banking institutions, for example, JPMorgan Chase and Citigroup were engaged in securities and commercial banking financed Enron. Both banking companies suffered as a result of this involvement with Enron and its collapse. The Glass-Steagall Act made sure that these two services offered by banks were separated in 1933. This had been law until it was replaced by Gramm-Leach-Bliley Act, which recombined them. Questions of objectivity of the financial holding companies who offer both commercial banking and investment came up. Would the bank have a conflict of interest when their investment is compromised? This is one of the debates that arose.
Enron was able to hide fraud for years due to the preexisting environmental conditions in accounting. The field has been culpable for many financial malpractices. Many managers employ dubious schemes in “managing funds either for personal gains or for maintaining their employment. Such practices require the intervention of federal organizations to offer protection to all stakeholders involved.
The SEC and GAAP
The general accepted accounting principles provides a scheme through which the standards and rules of financial reporting must comply (Du et al 2005). However, there are no universal standards set as the rules and regulations vary geographically and for a specific industry. The SEC is responsible for ensuring that all public traded companies follow the guidelines set by GAAP.
Lessons and Implications
Enron’s problems were primarily caused by the organization’s architecture. The company had minimal mechanisms for monitoring the company’s management activities and this opened the door for fraud. Eventually, the company collapsed due to failure in regards to its system of corporate governance. For this reason, companies need a well-organized structural architecture with clear professional responsibilities. All management activities should be reviewed by higher levels of governance where long-term goals can be set.
Corporations have been known for their malpractices that end up costing shareholders and employees their rightful compensation. Despite the laws provided to ensure that there is transparency and fair play, it is difficult for individuals to protect themselves against such occurrences thereby making government policies the last line of defense. Companies should be held to the prevalent standards of commerce in order to curb this behavior. By following through on persecuting such individuals, this will reduce such cases.