One of the biggest scandals in the financial world was the accounting fraud in which the once-giant Enron Corporation was involved, before its closure in 2001. The fraud made it to history books as one of the largest due to the size of the company and the billions in assets involved in it.
While the intricacies of Enron’s infamous fraud are well-known by the people directly or indirectly involved, that doesn’t lessen the curiosity that the case still brings up in the general public forum for how long it lasted, and how complicated it was.
So what happened to Enron? How did such a large and formerly prestigious corporation fall from grace in a matter of hours? What about the legal aspects of the case? Keep watching to find out!
The Infamous Day
The date 16 October 2001 is one that many people will never forget, as it marked the day when Enron Corporation, once called ‘the golden child of Wall Street’, fell from grace. Nevertheless, it took the company a long while to get there, and before that very few outsiders had noticed that something wasn’t quite right with the company.
To explain the infamous Enron fraud, it’s necessary to go back to 1992, when the company developed and implemented a new accounting system called MTM, or mark-to-market. This accounting strategy allowed Enron to adjust the balance sheets from their historical to their current one according to the market. This system was developed by businessman Jeff Skilling, who worked at the energy division of the consulting company McKinsey & Company before being hired as an Enron partner by the company’s Chief Executive Officer (CEO) Kenneth Lay in 1990.
According to the International Banker website, the MTM system risks that companies can inflate their numbers, as contracts and assets could be written on books for their future instead of their current value, whether or not the deal matches its expectations. Despite the risks of inflated numbers, the Securities and Exchange Commission approved the usage of MTM in Enron.
How Everything Went Down
Given the inflation of numbers and the increasing difficulties of Enron and Jeff Skilling to explain where the money on the books came from, the company began establishing Special Purpose Entities. These served as a protection to Enron’s assets, and saved the company from suffering from risks associated with loans and malpractices, meaning that Enron’s business failures were attributed to the special purpose entities, while cutting any link to the main company.
Another of the famous techniques with which Enron purposefully inflated its numbers was through its’ branch Enron Broadband Services. In 2020, this unit made a deal with the entertainment giant Blockbuster, to provide movie services on demand, estimating their future earnings at $110 million at the time. Though the service could possibly have matched these grand expectations due to the novelty of the service at the time, the deal fell through when movie production companies opposed it.
Nonetheless, that didn’t stop Enron from not only promoting the service, but also selling shares of the unit based on the deal’s value. It’s also reported that several financial and technical difficulties got in the way of Enron Broadband Services becoming a reality, including that the internet-providing services were still too early in their development stages.
Omens Of A Downfall
By 2001, Enron Corporation’s financial and accounting information had been kept almost in secrecy due to the complexity of its books. Shortly before the scandal broke late that year, CEO Kenneth Lay told The New York Times that the complexity of Enron’s books was due to the nature of the company’s operations and the tax tactics implemented.
Nonetheless, that report by The New York Times also brought clarity to the concerns that financial analysts had over Enron at the time. One of them told the journal that it was ‘disconcerting’ how difficult it was to determine the profits of Enron, but Lay dismissed the concerns, claiming that there was a good amount of information to satisfy analysts.
Months before that incident, the journalist Bethany McLean posted a Fortune article in which she put in doubt the nature of Enron’s financial stability. According to her, the company painted itself in ‘grandiose terms’, yet the commercialization of gas and energy wasn’t a field complicated enough to explain why it was so difficult to explain how the company made its money.
Some months later, confidence in Enron’s operations decreased, alongside the market value of its shares, which had hit an historical high that year.
The Downfall
Despite the early efforts to calm shareholders’ concerns, in October 2001 Enron announced that a restatement was necessary to correct their accounting records of past years. This meant that several accounting violations had occurred in the company from 1997 to 2000, resulting in a 23% decrease in previously estimated profits during those three years.
Seeing the company’s once-golden image fall with the loss of $613 million – which had been inflated – Enron’s shares historically plummeted from over $20 to lower than $6 in hours. This downfall was prompted by the revelation that the US Securities and Exchange Commission was investigating the company’s transactions.
By November of that year, Enron’s shares were worth less than $1, and the company filed for bankruptcy, stating its lack of cash to further operate. What followed was a series of trials and years-long sentences, with Jeffrey Skilling given a fine of $45 million and a 24-year sentence. For his part, Kenneth Lay was found guilty of conspiracy and fraud but didn’t go to jail as he died from a heart attack before his sentence was announced.
All in all, the Enron fraud has been one of the most gruesome cases of accounting malice and cruel business malpractices. While this case was eventually surpassed in magnitude by inflation in other fraudulent corporate downfalls, the victims of Enron have surely never forgotten these terrible days.
