What was Enron?
Enron was an energy-trading and utilities company based in Houston, Texas, that perpetrated one of the biggest accounting frauds in history. Enron's executives employed accounting practices that falsely inflated the company's revenues and, for a time, made it the seventh-largest corporation in the United States. Once the fraud came to light, the company quickly unraveled, and it filed for Chapter 11 bankruptcy on Dec. 2, 2001.
Enron's $63 billion bankruptcy was the biggest on record at the time.
Enron shares traded as high as $90.56 before the fraud was discovered, but plummeted to around $0.25 in the sell-off after it was revealed. The former Wall Street darling quickly became a symbol of modern corporate crime. 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.
- Enron executives used fraudulent accounting practices to inflate the company's revenues and hide debt in its subsidiaries.
- The Securities and Exchange Commission, credit rating agencies, and investment banks were accused of negligence—and, in some cases, outright deception—that enabled the fraud.
- As a result of Enron, Congress passed the Sarbanes-Oxley Act to hold corporate executives more accountable for their company's financial statements.
Enron's Energy Origins
Enron was an energy company formed in 1985 following a merger between Houston Natural Gas Company and Omaha-based InterNorth Incorporated. After the merger, Kenneth Lay, who had been the chief executive officer (CEO) of Houston Natural Gas, became Enron's CEO and chairman. Lay quickly rebranded Enron into an energy trader and supplier. Deregulation of the energy markets allowed companies to place bets on future prices, and Enron was poised to take advantage. In 1990, Lay created the Enron Finance Corporation and appointed Jeffrey Skilling, whose work as a McKinsey & Company consultant had impressed Lay, to head the new corporation. Skilling was then one of the youngest partners at McKinsey.
Skilling joined Enron at an auspicious time. The era's minimal regulatory environment allowed Enron to flourish. At the end of the 1990s, the dot-com bubble was in full swing, and the Nasdaq hit 5,000. Revolutionary internet stocks were being valued at preposterous levels and, consequently, most investors and regulators simply accepted spiking share prices as the new normal.
What Happened to Enron
The Enron bankruptcy, at $63 billion in assets, was the largest on record at the time. The company's collapse shook the financial markets and nearly crippled the energy industry. While high-level executives at the company concocted the fraudulent accounting schemes, financial and legal experts maintained that they would never have gotten away with it without outside assistance. The Securities and Exchange Commission (SEC), credit rating agencies, and investment banks were all accused of having a role in enabling Enron's fraud.
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. The Senate's investigation 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. Meanwhile, the investment banks—through manipulation or outright deception—had helped Enron receive positive reports from stock analysts, which promoted its shares and brought 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.
The Legacy of Enron
In the wake of the Enron scandal, the term "Enronomics" came to describe creative and often fraudulent accounting techniques that involve a parent company making artificial, paper-only transactions with its subsidiaries to hide losses the parent company has suffered through other business activities. Parent company Enron had hidden its debt by transferring it (on paper) to wholly owned subsidiaries—many of which were named after Star Wars characters—but it 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 was "Enroned," slang 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 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."
As a result of Enron, lawmakers put several new protective measures in place. One was the Sarbanes-Oxley Act of 2002, which serves to enhance corporate transparency and criminalize financial manipulation. The rules of the Financial Accounting Standards Board (FASB) were also strengthened to curtail the use of questionable accounting practices, and corporate boards were required to take on more responsibility as management watchdogs.