If you said to me, “Jon, what’s
the biggest ethical crisis in the world of money and finance that you can think
of?” I’d probably ignore your question. Realistically, though, one scandal
comes to the forefront of my mind and probably would do the same for many of your parents – Enron. However, like me, you probably didn’t really know
many details about the Enron scandal until this blog post.
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| Enron Logo | Courtesy of LogoMaker |
In 1985, Enron formed from
acquisitions within the natural gas industry. Initially focusing on energy,
Enron quickly expanded into a variety of other fields, including internet,
weather insurance, and risk management, quickly earning them the distinction of
“America’s Most Innovative Company” from Forbes magazine every year from 1996
to 2001.
Many had huge faith in Enron’s
potential and saw themselves swimming in piles of money by investing in the up
and coming company. In 1992, unbeknownst to most, Jeff Skilling, former CEO of
Enron, received permission from regulators to use an accounting method known as
“mark to market”. This method of recording assets can be fairly confusing, but
the Journal of Accountancy describes it as a practice in which “companies
[that] have outstanding energy-related or other derivative contracts (either
assets or liabilities) on their balance sheets at the end of a particular
quarter…must adjust them to fair market value, booking unrealized gains or
losses”. Simply put, companies record assets and liabilities that haven’t
really been capitalized yet on their current balance sheet. For Enron, many of
the long-term contracts they held were difficult to value; therefore, “it is
possible [read: true] that valuation estimates might have considerably
overstated earnings” for Enron balance sheets.
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| Courtesy of Aftab Khan |
Clearly, this practice dupes
investors into believing that Enron is doing much better than it actually is.
Projecting very optimistic returns overstated Enron’s actual value, keeping its
stock price high without actually generating much taxable revenue. Using this strange
accounting system, Enron opened the door for Andrew Fastow’s devious plan to
use special purpose entities.
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| Andrew Fastow | Courtesy of NBC |
Fastow, CFO of Enron as of 1998,
developed a unique plan to hide the losses that Enron was recording in various
other business entities to keep its own books clean and solvent. This not only
allowed Enron to maintain a high stock price but also preserved a high credit
rating for a firm that clearly did not deserve any sort of credit considering
the questionable nature of its practices. Once Enron crashed, Fastow was
charged with nearly 80 counts of fraud, the majority of which were connected to
this practice of disguising Enron’s financial state through other minor
companies that earned him tens of millions and kept Enron in the clear.
In early 2000, Enron first began
to show signs of cracking. The telecom industry hit a rough patch, and Enron
suffered heavily as people began trying to figure out how Enron really worked.
Amid this turbulence, Jeff Skilling resigned as CEO, and Chairman Ken Lay stepped
(back) in as CEO. Following this leadership change, Sherron Watkins, a VP at
Enron, contacted Lay and explained that Skilling probably left because of
accounting issues.
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| Kenneth Lay | Courtesy of Biography.com |
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| Courtesy of Startup Juncture |
Enron’s collapse left many
individuals in a poor state of affairs. Enron’s chief accounting firm and
auditor, Andersen, was convicted of obstruction of justice for shredding Enron
files immediately following the bankruptcy declaration. Andrew Fastow, former
CFO and mastermind of the debt-hiding system, accepted a plea bargain in early
2004 in which he testified against other former Enron executives in exchange
for a punishment reduction to ten years of jail time and nearly $30 million in
damages.
Many Enron executives pleaded the
Fifth Amendment during the investigation, but Skilling refrained. Instead,
Skilling insisted that he had absolutely no knowledge of the scandal, a
difficult notion to swallow from the former CEO. He was sentenced to 24 years
of jail time. Lay was one of the many to remain silent and was found guilty
on ten counts of conspiracy and fraud. Before he could be sentenced, Lay
suffered a fatal heart attack in July of 2006.
In hindsight, the regulation that
allowed Enron to engage in such risky financial manipulation was clearly
insufficient. Following the fallout, Congress passed the Sarbanes-Oxley Act of
2002 to heighten regulation and stiffen the penalties for financial
manipulation. The Financial Accounting Standards Board also enhanced its level of involvement in
an attempt to prevent such conduct again. Enron’s fall, a devastating collapse
that impacted thousands of people, was a solemn reminder of the power that
profit-hungry executives wield. It reminds us that we must be careful and
scrutinous of those who have such awesome power; it reminds us of the importance of the ethics of money.
