Two decades before the sudden and dramatic collapse of cryptocurrency exchange FTX in November 2022, Enron was a Houston-based energy company that imploded as a result of various fraudulent accounting practices. The fraud came to light in October 2001, following a whistleblower letter from then-Enron Vice President Sherron Watkins to Chairman Ken Lay in August 2001. For years, Enron had used complicated off-balance sheet entities and special purpose vehicles to hide billions of dollars in losses from failed deals and projects.
As news of the fraud leaked out, Enron’s stock price fell to less than $1 at the time of its bankruptcy filing in December 2001 (see image below) from a onetime high of more than $90.
The bankruptcy threw thousands at Enron out of work, and, worse yet, emptied the company’s pension fund—costing more than 20,000 employees their life savings. At the time, Enron’s $63.4 billion in assets was the largest U.S. bankruptcy case in history (later superseded by the 2002 bankruptcy filing by WorldCom).
- Enron was once a massive energy conglomerate, involved in everything from energy production to water treatment and broadband trading. It filed for bankruptcy in 2001.
- Enron achieved its elevated status by engaging in many dubious accounting practices, using various off-balance sheet and third-party vehicles to remove debt from its balance sheet.
- Investors and business partners became increasingly alarmed because no one understood how Enron made money, leading to a U.S. Securities and Exchange Commission (SEC) investigation and an accounting overhaul.
- The Enron audits led to a restatement of debt and earnings dating back to 1997.
- As a result of the audits, Enron filed for bankruptcy with $63.4 billion in assets—at the time, the largest U.S. bankruptcy filing ever.
In addition to Enron’s own implosion, its accounting firm, Arthur Andersen (one of the Big Five accounting firms in the United States at that time), was found guilty of destroying documents and had its license to audit companies revoked, effectively putting the firm out of business. The Andersen mistakes led to an increase in diligence among auditors, which is known as the Andersen Effect.
The principal actors in the accounting fraud were Chairman/Chief Executive Officer (CEO) Ken Lay, CEO Jeff Skilling, and Chief Financial Officer (CFO) Andrew Fastow. Together they engaged in a series of accounting maneuvers to keep Enron’s massive debt off the company’s balance sheet and instead show ever-increasing revenue, pushing the value of their company stock ever higher, which is now known as Enronomics.
Before we can get into the fates of the main culprits, it is important to understand the business culture (at least in the C-suite) that prevailed during the periods where the accounting schemes were pursued. Their ultimate goal was to make Enron’s stock price move higher. That required the various accounting stratagems deployed by Enron, under the primary management of CFO Fastow and with the blessing of CEO Skilling and, later, CEO Lay.
Senior Enron management was obsessed with the company’s stock price, as many of them held substantial amounts of Enron stock as part of their compensation, and the company’s stock was frequently used as collateral for corporate loans.
One of the trademarks of Enron’s accounting schemes is perhaps best understood as “bullying.” Enron executives purposely presented false and misleading financial data to the banks they sought to engage with, cautioning that if the banks did not buy into a given plan, they would lose the chance of other business opportunities in the future. At the same time, they pressed hard against their auditors (Arthur Andersen) to accept the accounting of some of the dubious investments that Enron had made, all of which had the effect of keeping debt off the balance sheets and pumping up revenue.
Given the size of the $63.4 billion Enron bankruptcy at the end of 2001, and the subsequent larger WorldCom bankruptcy in 2002, Congress finally took notice and passed the Sarbanes-Oxley (nicknamed SOX) corporate governance legislation. The SOX law was designed to make it harder to mislead investors and regulators about corporate financial reporting. SOX also increased the penalties for document destruction, fraudulent reporting, and alteration of company documents in any investigation by regulators. SOX also required that accounting and auditing firms maintain greater independence from their clients.
Where Are They Now?
The Enron accounting scandal was the culmination of years of fabricating financial reports, using third-party entities, special purpose vehicles, and misleading the Enron board and investors. The principal agents behind the fraud were all tried and convicted, but there are other important personalities who were secondary actors. Below, we’ll run you through the fates of both the criminal actors and some of the other people who got caught up in the scandal.
Ken Lay, Chairman and CEO
Ken Lay was the CEO of Enron back in 1986. Over the years, as chairman of Enron, he built a team of highly aggressive business and financial executives who were willing to skirt financial reporting requirements by developing off-balance sheet entities to hide Enron’s massive debt load from investors and regulators.
Lay himself was very politically connected, and counted among his friends former President George W. Bush (who affectionately referred to Lay as “Kenny-Boy”). At the time of the collapse of Enron, Lay was both the chairman and CEO of Enron, having assumed the role of CEO following the abrupt departure of Jeff Skilling after only six months in the same position.
After being indicted by a grand jury on 11 counts of securities fraud, wire fraud, and making false and misleading statements, Lay was eventually convicted of six counts of conspiracy and fraud. In a separate bench trial, he was convicted of an additional four counts of fraud and making false statements. While waiting for his sentencing ruling in October 2006, Lay died of a heart attack on July 5, 2006. By virtue of his death, his guilty verdicts were vacated by the courts, and we’ll never know how long a sentence he might have received.
Jeff Skilling, COO and CEO
Jeff Skilling held multiple senior roles at Enron, most notably chief operating officer (COO) and CEO, in the run-up to the Enron scandal and bankruptcy. He was known as an aggressive executive with one eye focused on the business and the other on Enron’s stock price, which ultimately was what led him and other Enron executives to undertake the accounting fraud that sank Enron.
He was CEO for only six months as he watched the signs of the accounting scandal beginning to break out. Lay then stepped back in as CEO, in addition to being chairman. As the scandal began to unravel and Skilling made for the exits, he sold around $60 million of his Enron stock holdings, leading many to conclude that he knew the jig was up. Skilling publicly denied any knowledge of the accounting fraud that took place under his watch.
When the scandal completely unraveled and became a public spectacle, Skilling’s involvement could not be overlooked. He was indicted on 35 counts of fraud, insider trading, and other charges related to the Enron collapse. He was ultimately convicted of one count of fraud, one count of insider trading, five counts of making false statements to auditors, and 12 counts of securities fraud.
He was initially sentenced to 24 years in prison, which was subsequently reduced to 14 years on appeal. He was also ordered to repay $42 million to the fund seeking to compensate Enron employees and shareholders. Skilling finished out his sentence in a halfway house and was released in February 2019. In a separate proceeding, he was also prohibited from ever serving as a director or officer of a public company.
After his release from prison in 2019, Skilling sought to establish a company called Veld LLC, which was purportedly a trading platform to facilitate natural gas and other energy trading. In August 2021, Veld LLC became registered with the state of Texas, but on Aug. 30, 2022, the company became listed as inactive. Estimates of Skilling’s remaining net worth range from $500,000 to $1 million.
Andrew Fastow, CFO
Andrew Fastow was hired by Skilling in 1990 and later rose to become CFO of Enron in 1998. Given his background in asset-backed securities, he was arguably the brains behind the Enron fraud schemes. He set up dozens of off-balance-sheet deals and special purpose vehicles that helped hide debt from Enron’s balance sheet while simultaneously registering revenue, inflating Enron’s stock price in the process. Fastow was the listed owner of several Enron offshore entities that he concocted, earning him millions on the side.
In October 2002, Fastow was indicted on 78 counts of fraud, money laundering, and conspiracy. He negotiated a plea deal for a maximum 10-year prison term and the forfeiture of more than $29 million in assets, in exchange for cooperating in the trials of other Enron executives.
In September 2006, Fastow was sentenced to six years in prison and two years of probation. A judge subsequently felt that Fastow’s cooperation in other Enron cases warranted a reduction to five years in prison, leading to his release in 2011.
Following his prison time, Fastow took up work as a document review clerk at a Houston law firm, as well as making the rounds of the lecture circuit, ironically speaking about ethics and accounting integrity. His net worth was also placed at around $500,000.
Sherron Watkins, the Whistleblower
The beginning of the downfall of Enron came in August 2001 in the form of an anonymous note to CEO Lay about accounting irregularities in the company’s financial reports. Sherron Watkins, then a vice president of Corporate Development at Enron, sent the memo to alert Lay to what she believed were serious accounting irregularities that could lead to the collapse of Enron in accounting scandals. The secret memo did not become public until months after it was written, well after the scandal blew wide open and Enron had filed for bankruptcy in December 2001.
Watkins was criticized for not releasing the memo sooner while also being praised as one of three Persons of the Year 2002 by Time magazine. In 2004, she released a book about her life at Enron, and she later participated in the seminal film on Enron’s collapse: Enron: The Smartest Guys in the Room.
Watkins is currently active on the lecture circuit, covering topics such as corporate ethics and governance as well as the story of her personal experience at Enron. She has also built a consulting firm that focuses on corporate governance and business ethics.
Lou Pai, CEO of Enron Energy Services (EES)
Lou Pai was one of Skilling’s most trusted lieutenants, having been with Enron since 1987, shortly after the founding of the company in 1985. Skilling put him in charge of several of the company’s divisions, in roles such as CEO of Enron Energy Services from March 1997 to January 2001, and CEO of Enron Xcelerator, a venture capital arm of Enron, from February 2001 to June 2001. Pai suddenly resigned in June 2001, taking an estimated $250 million in stock proceeds with him.
Pai was not charged with any criminal wrongdoing in the Enron accounting scandal, and he invoked the Fifth Amendment in subsequent class action civil lawsuits against Enron. In the class action suit, he had to forfeit $6 million in an insurance policy payout to go to a fund set up to help those who were harmed by the Enron scandal. Much later, in 2008, Pai settled insider trading charges in an out-of-court agreement for $31.5 million, which included $30 million that also went to the Enron victims’ fund.
Following his departure from Enron, Pai was the founder and former chairman of Element Markets, a renewable energy consulting firm. He later joined as a partner in Midstream Capital Partners LLC, where several other ex-Enron employees worked.
Gray Davis, Governor of California
Gray Davis was the governor of California from 1999 to 2003. Just months after being reelected to a second term as governor, he was put to a recall vote in October 2003. He lost that vote in large part due to the California energy crisis, which resulted in millions of customers being intermittently shut off from the power grid. Enron had for years operated various schemes to inflate California’s energy prices, selling at high prices and buying at lower prices in an artificially created market that had just been deregulated.
Estimates are that Enron took away about $27 billion from California customers and the state with its various price-gouging schemes.
Following his ouster as governor, Davis worked as a lecturer at UCLA’s School of Public Affairs and as an attorney at Loeb & Loeb.
Richard Kinder, ex-COO and President
Richard Kinder started his career in energy as an attorney at Florida Gas Transmission, which ultimately became Enron after a series of mergers. He had been college friends with Ken Lay at the University of Missouri. He served as president and COO of Enron from 1990 to 1996, before the accounting charades began.
In December 1996, he left Enron to start a business with an old friend, William Morgan, another college classmate. Through a series of purchases of various pipeline companies, the two built a successful company in Kinder Morgan Inc., becoming the largest midstream (pipeline operator) energy company in the U.S. As of December 2022, he was listed on Forbes, with an estimated net worth of $7.2 billion. He currently serves as the founder and chairman of Kinder Morgan, stepping down from the CEO role in 2015.
How was Enron able to get away with its fraudulent accounting practices for so long?
Enron used extremely complicated off-balance sheet tools, such as special purpose vehicles and hedging strategies, to mislead both the Enron board and the financial analyst community. When financial analysts questioned some of Enron’s accounting techniques, Chief Executive Officer (CEO) Jeff Skilling and Chief Financial Officer (CFO) Andrew Fastow vouched for the financial results and accused the analysts of not being able to comprehend the numbers put forth. There was a fair amount of bullying involved with persistent analysts in which Enron’s willingness to do future business with the analyst’s firm was questioned.
What is an example of one of Enron’s creative accounting practices?
Enron used a special purpose vehicle known as Whitewing to hide some of Enron’s debts. Whitewing was used to buy Enron assets, such as stakes in power plants and pipelines, generating revenue using Enron stock as collateral. Enron changed the accounting treatment of Whitewing by removing it from Enron’s consolidated balance sheet. Although the Enron board signed off on the arrangement, the asset transfers were not true sales and should have been treated as loans, but the ultimate objective of keeping debt off of Enron’s balance sheet was satisfied.
How did Enron eventually get caught?
The most apparent answer is the Aug. 1, 2001, famous whistleblower memo sent by Enron Vice President Sherron Watkins to then-CEO Ken Lay, warning him of accounting irregularities that could cause the company to fail. Wall Street analysts had long been puzzling over Enron’s accounting practices, and as word of the memo slipped out, Enron’s ability to con and cajole industry analysts into believing Enron’s accounting lessened. Once backed into a corner, the ruse was up, and Enron filed for bankruptcy protection in December 2001.
The Bottom Line
To this day, Enron remains the poster child for accounting malfeasance. Not that the senior executives at the time minded much, as they were getting rich off of Enron stock, which was being propped up by those same accounting subterfuges. Hence the negative feedback loop of more accounting ruses leading to a higher stock price and more executive compensation, which required more accounting chicanery to keep the stock buoyed, and so on and so on.
The fallout from the Enron scandal shook the industry and its accountants, ultimately leading to the Sarbanes-Oxley law (SOX for short), which required more transparency in financial reporting and executives’ personal accountability for financial statements. While the Enron debacle destroyed the life savings of many Enron employees by collapsing the pension fund and the value of their stock (they were constantly urged to invest in Enron’s stock as a good investment and a sign of loyalty), subsequent legal reforms, such as SOX, could help prevent the next Enron.