What was Enron
Enron was a U.S. energy-trading and utilities company that perpetuated one of the biggest accounting frauds in history. Enron's executives employed accounting practices that falsely inflated the company's revenues, which, at the height of the scandal, made the firm become the seventh-largest corporation in the United States. Once the fraud came to light, the company quickly unraveled and filed for Chapter 11 bankruptcy on Dec. 2, 2001.
Enron shares traded as high as $90.56 before the fraud was discovered but plummeted to below $0.30 in the sell-off after the fraud was revealed. Shareholders received company payouts as compensation for their losses, but former company executives also settled to pay shareholders out of their own pockets. Enron was one of the first big-name accounting scandals, but it was soon followed by the uncovering of frauds at other companies such as WorldCom and Tyco International. What was once a Wall Street darling has now become a symbol of modern corporate crime.
Why Enron Collapsed
BREAKING DOWN Enron
The Enron bankruptcy, at $63 billion in assets, was the largest on record at the time. Its collapse shook the markets and nearly crippled the energy industry. While those responsible for the scandal were the senior executives, who concocted the accounting schemes, financial and legal experts determined that none of it would have been possible without help. As a result of negligent oversight by the Securities and Exchange Commission (SEC), the credit rating agencies and the investment banks, Enron was enabled by failed oversight, manipulation, and deceptive practices of these organizations.
Initially, much of the finger pointing was directed at the SEC, which the U.S. Senate found complicit for its systemic and catastrophic failure of oversight. It was determined that, had the SEC reviewed any of Enron’s post-1997 annual reports, it would have seen the red flags and possibly prevented the enormous losses suffered by employees and investors. The credit rating agencies were found to be equally complicit in their failure to conduct proper due diligence before issuing an investment grade rating on Enron’s bonds just before its bankruptcy filing. However, it was the investment banks, through their manipulation or outright deception, that allowed Enron to continue to receive positive research analysis, promoting its stock and bringing billions of dollars of investment into the company. It was a quid pro quo in which Enron paid the investment banks millions of dollars for their services in return for their backing.
In light of the Enron scandal, the term "Enronomics" was coined to describe a creative and often fraudulent accounting technique that involves a parent company making artificial paper-only transactions with its subsidiaries to hide losses the parent company has incurred through business activities.
Transferring debt in this way creates an artificial distance between the debt and the company that incurred it. Parent company Enron continued to hide debt by transferring it (on paper) to wholly-owned subsidiaries—many of which were named after Star Wars characters—but still recognized revenue from the subsidiaries, giving the impression that Enron was performing much better than it was.
Another term inspired by Enron's demise is "Enroned," a slang term for having been negatively affected by senior management's inappropriate actions or decisions. Being "Enroned" can happen to any stakeholder, such as employees, shareholders or even suppliers. For example, if someone has lost their job because their employer was shut down due to illegal activities that they had nothing to do with, they have been "Enroned."
Can Enron Happen Again?
As a result of the Enron catastrophe, certain protective measures have been put in place. The Enron scandal gave us the Sarbanes-Oxley Act of 2002, which serves to enhance transparency and criminalize financial manipulation. Further, as a result of Enron's wrongdoings, the Financial Accounting Standards Board (FASB) standards were strengthened to curtail the use of questionable accounting practices, and more accountability was imposed upon corporate boards in their role as management watchdogs.