The Rise and Fall of Enron
What is Enron?
Enron is the company that altered international finance forever. The company shook the corporate world. This company became the catalyst for many changes in federal and international law as well as other policies dealing with corporate accounting practices. Inquiries surrounding the rise and fall of Enron emerged because of the shifty techniques used to deceive investors and corporate watchdogs. How did this corporation pull the wool over so many people’s eyes? This essay will briefly describe the rise, fall, and international aftermath of the Enron Corporation.
Before delving into the gruesome details, let us go over the details of the Enron Corporation. In 1985 the Northern Natural Gas Company, became what will be known as the core of the Enron Corporation when the company purchased the smaller Houston Natural Gas Company. With the latest acquisition, Enron was formed. The new formed company originally dealt in the transmission and distribution of gas and electricity in the United States. In later years leading up to ultimate demise, the company dealt with multiple of other companies such as water sector, broadband, plastics, and steel. The company also became one of the world’s largest energy companies. Enron became the seventh largest corporation in the United States which interestingly enough also became the largest business scandal in United States’ history. At its epitome, its profits were $101 billion and employed over 20,000 individuals. The question arises, were these claims actual profits? This is where the accounting practices and techniques used by Enron come into question.
Let us briefly introduce the main players. We will focus on three main players. These men are Kenneth Lay, Andrew Fastow, and Jeffrey Skilling. Kenneth Lay is the Founder and former Chairman. Andrew Fastow is the Chief Financial Officer. Jeffrey Skilling is the former Chief Executive Officer, who “dreamed of creating a new business model that could change American capitalism forever”. (Swartz and Watkins, p. 40)
The Rise and Fall
The rise of Enron is beautiful. From 1985 forward, the company grew substantially. “Enron grew wealthy, it claimed, through its pioneering, marketing and promotion of power and communications bandwidth commodities and related derivatives as tradable financial instruments, including exotic items such as weather derivatives.”[1] (wikipedia.com) Enron gained prominence not only through its acquisition, but also through publicity of awards. It was named “America’s Most Innovative Company” by Fortune Magazine for six consecutive years, from 1996 to 2001, the year of the disclosures. Another award was also given by Fortune magazine. Ironically, this time it was Fortune’s year 2000 list of “100 Best Companies to Work for in America”.
The fall begins one day when Skilling explains to the risk management team of a plan to keep the money they made off investments in smaller businesses, specifically Rythms NetConnections. Rhythm NetConnections company value jumped over time to about $300 million. Enron could not sell the investment value earned. This plan would insure that Enron would keep the profits made by the sudden rise in the market. Andrew Fastow designed the plan.
“The plan was to create a private partnership in the Cayman Islands that would protect -- or hedge -- the Rhythms investment, locking in the gain. Ordinarily, Wall Street firms would provide such insurance, for a fee. But Rhythms was such a risky stock that no company would have touched the deal for a reasonable price. And Enron needed Rhythms: The gain would amount to 30 percent of its profit for the year.” (Behr and Witt)
This entity that Fastow creates is named LJM after his wife and kids. In the future LJM buys poor performing Enron assets. These poor performing assets became burdens on Enron and hurt its bottom-line. The profits were taking hits because of the lack of performance of these smaller companies. In effect, the LJM partnership became a device used to hide Enron’s debt.
“The whole thing was really just an accounting trick. The arrangement would pay Enron to cover any losses if the tech stock dropped. But Skilling proposed to bankroll the partnership with Enron stock. In essence, Enron was insuring itself. The risk was huge.”(Behr & Witt)
The accounting trick allowed Enron to embellish its profit record for its investors. This in effect raised stock prices due to the lack of information of the company’s business practices.
The demise started when these tricks and improper use of accounting began. From 1999 to 2000 the profits rose 50%. Profits in 1999 were around $50 billion, whereas in 2000 profits rose to $100 billion. This dollar amount would be impressive, but under just one year it raised some eyebrows. “Some people had nagging suspicions. But like the cowed townspeople in the children's story, few questioned the emperor's new clothes.” (Behr & Witt)
Indictments and Trial
Once the company’s fault was released to the public the slippery slope to bankruptcy was inevitable. Though everything was not disclosed to the public at first, as things were still kept secret, investigations started. Several top executives were charged with multiple counts of securities fraud, or other illegal business activities. Skilling was indicted with 28 counts of securities fraud and wire fraud, and Lay was indicted with six counts of securities and wire fraud.
The trial began January 30, 2006. Within five months, the jury reached its verdict. Lay and Skilling were found guilty. In the sentencing that took place October 23, 2006 Skilling was convicted of 19 of the 28 counts of securities fraud and wire fraud. However, the other nine he was acquitted. Lay on the other hand was convicted on all six counts of securities and wire fraud. However, Lay passed away 3 months before the sentencing occurred. Upon autopsy, Kenneth Lay died of a heart attack. The judge therefore vacated his conviction on October 17, 2006. Several other individuals were found guilty from other companies such as Merrill lynch.
There are certain aspects that the demise of this company has had on our society. It has been estimated that $60 billion was lost in investments. In the wake of the collapse, there have been numerous companies to follow Enron’s path. Investor awareness has risen. Companies are held more accountable for their accounting as well as there business practices. Congress suddenly pushed through legislation on accounting reform. The terms of the bill creates an oversight board. When violations occur in corporations, each accounting violation is punished, the “chief executives and financial officers must certify the accuracy of financial statements. White-collar criminals will face fines will face fines as high as $5 million and prison terms of up to 20 years.”(Behr & Witt)
Enron’s Global Influence: Europe
Wing and Mark
In the late 1980s, Margaret Thatcher was trying to deregulate the UK’s utility markets. This was fabulous for Enron’s big ideals, for they were trying to execute a plan to get their first big power plant online in the global market. Enron had to convince larger British power companies to support an ambitious young company to build such a massive power plant project. The plant would be “the world’s largest natural gas-fired power plant.” It would generate both electricity and steam. The massive plant would add 4% to the United Kingdom’s power grid. (Swartz, p. 37) Teesside would cost $1 billion to construct, which included contracts and other construction costs, but brought in more than $200 million profits for Enron. (Swartz, p. 37) The success of this power plant made Enron a power player in the global market.
The ambitious Teesside project for Enron was lead by a “Brilliant strategist” (Swartz & Watkins, p. 36) whose name is John Wing. Wing was responsible for Enron’s first big power plant in Texas City, Texas; it is no surprise that he had much bigger plans in store for this up and coming multifaceted company. As stated in the previous paragraph, the Teesside plant was a massive power plant that brought in a lot of revenue, but one of the big changes brought forth from this project was that Wing persuaded Lay to approve a “new way of compensating Enron executives on project development deals”. (Swartz & Watkins, p. 37) This new way allowed Wing to receive the compensation when the deal was closed, not before the plant went online.
Wing was a tough executive. He abused people, and treated individuals lower than they should have been treated. His protégé felt a lot of this pressure and abuse, but through this trial, she came out transform. His protégé was Rebecca Mark, a young woman who was in the right place at the right time, learning all the she could from examples in the corporate world as well as traditional education, earning her MBA from Harvard. Once John Wing left Enron, Rebecca Mark was promoted. Ken Lay did not promote her slightly, he gave her a CEO position of her own company, Enron Development Corporation. “Her mandate was to open energy markets for Enron around the world.” (Swartz & Watkins, p 40)
Now let us shift gears and explored other effects of this company. Though the huge energy giant was based in Houston, Texas, its scope of influence and power spread across the globe. Therefore, its collapse created an aftershock. Enron was not only in the energy market across the globe, but it was in numerous European sectors. This paper will discuss several areas of the world where Enron influenced and subsequently was affected by its collapse.
Pricewaterhousecooper, the accounting firm was named the administrator of European arm of Enron Thursday, November 29, 2001 in a move that is similar to the Chapter 11 bankruptcy in the United States. The same day as the firm taking over, Enron Europe stopped its wholesale electricity and was expected to cut jobs of its 5400.(Pfanner) Pricewaterhousecooper, also took over PX limited a company that was set up to operate and manage the 1875 MW Teesside power and gas station. Therefore Enron’s collapse did not greatly effect this power plants production in England.
The initial response would point fingers at the banks because of their continued support of a fraudulent company. Between the years 2000 and 2001 Milan Bank loaned Enron an estimated $20 million.(Fairlamb) The Royal Bank of Scotland reportedly gave the largest loan to Enron, which was between $500 and $800 million. (Fairlamb) “Deutsche Bank AG said its exposure was $100 million; Centrica PLC, a british trader, put its exposure at $43 million.” (Pfanner) All totaled the European banks have loaned $2 billion. (Fairlamb) Monetarily these companies are at fault for supporting Enron, but giving the circumstance that Enron was the company with whom you do not say no to because they control vast amount of the markets. “…Enron’s reach is so vast – it accounts for 20 percent of the energy trading in the United States and Europe…” (Pfanner)
At first, the concept of the fall of Enron in European minds was “the product of flawed U.S. accounting practices”. (Fairlamb) They shrugged it off as something that was solely in the United States. But as the investigations of this huge and spectacular collapse unfolded, corporate fraud not only in accounting but in the leadership was found. The European Union realized that its own companies were vulnerable to the same corporate fraud. The collapse of Enron pushed the European Union to reflect on its own management and regulation of its Capital Markets. “Getting regulation right is critical to successful economic management, and to our long-term growth prospects.” (Fairlamb)
Not only were the investigations pushing regulation of the markets in Europe, but the United States Congress legislated with the Sarbanes-Oxley Act, which was aimed at avoiding a repeat of corporate disasters, pushed it as well. The act which was passed in 2002 covers any company worldwide that is traded on the U.S. stock markets. “Foreign companies had less than a year to get in line with the Sarbanes-Oxley Act, which came into force in June 2005.” (Stamp)
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What firms must and must not do |
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(http://news.bbc.co.uk/1/hi/business/3849867.stm)
The Sarbanes-Oxley Act is having far-reaching impact on Europe. “Adecco, the Swiss recruitment company, is currently being investigated by the U.S. Securities and Exchange Commission after it revealed that it had discovered ‘material weaknesses’ in the internal controls of its North American subsidiary.” (Stamp) The cost of compliance has been costly to some of the companies. Many of the companies are not happy with the legislation. These companies see the rising costs as more significant than the benefits.
After the reflection on its own practices in its Capital Markets, the European Union as a whole started tightening corporate financial reporting and accounting standards. This regulation required all E.U. listed companies to apply International Accounting Standards. The next tightening was the enforcement of accounting standards, “to ensure harmonized application of I.A.S. within the E.U.” (Fairlamb)
However before the E.U began its centralized corporate governance, the United Kingdom developed corporate governance through certain reform effort. “In the early 1990s, the United Kingdom explored governance reforms on a ‘comply or explain’ basis through the adoption of the Cadbury Code,” which later became the Combined Code. (Philips & Saft)
The Combined Code is the Cadbury Code, which was published in 1990, and several other important contributions were added over the years to form a set of voluntary practices, which “governed” the companies that were traded on London Stock Exchange. “Companies must disclose whether they comply with its provisions and if not, why.” (Philips & Saft) The combined code has over the years influenced rules and regulations governing these publicly traded companies. Other E.U. states have adopted the same comply-or-explain methodology of compliance. With the collapse of Enron these methodologies along with new ideas were adopted to help prevent corporate fraud.
Enron International Today
On March 19, 2003, Enron’s Board of Directors voted to create a new entity that it would be able to transfer its 3 North American pipelines to, instead of selling its interests in the areas. The new company will be temporarily called “PipeCo”. (Palmer)
On May 9, 2003 Enron Corporation announced that it was creating a new entity that will be temporarily called “InternationalCo”. This company was determined a viable option to maximize value, which will be distributed to its creditors. As the press release says, “InternationalCo is expected to hold all or portion of Enron’s interests in its international electric and natural gas utilities and pipelines.” (Ambler)
Business Interests Expected to be Held by InternationalCo |
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*All or a portion of such interests are expected to be held in InternationalCo |
http://www.enron.com/corp/pressroom/icoassets.html
March 1, 2007, Enron Corporation legally changed its name to Enron Creditors Recovery Corporation. The name change was prompted because it better applies to the companies duties at this time.
Works Cited
Ambler, John. "Press Release: April 30, 2007." Enron.Com. 9 May 2003. 30 Apr. 2007 <http://www.enron.com/corp/pressroom/releases/2003/ene/docs/050903release.pdf>.
"Europe Escapes Enron Knock." BBC News. 30 Apr. 2007 <http://news.bbc.co.uk/1/hi/business/1685457.stm>.
"Enron." Wikipedia. Wikipedia. 31 Jan. 2007 <http://en.wikipedia.org/wiki/Enron>.
Fairlamb, David. "Aftershocks in Europe." Business Week Online. 17 Dec. 2001. 30 Apr. 2007 <http://www.businessweek.com/magazine/content/01_51/b3762008.htm>.
Fairlamb, David. "Eurotrashing Enron." Foreign Policy. Nov.-Dec. 2002. 1 May 2007 <http://www.foreignpolicy.com/Ning/archive/archive/133/BTL-eurotrashing-enron.pdf>.
Green, Scott, and Holly J. Gregory. "The Ripple Effect: International Corporations are Feeling the Effects of Governance Practices That are Evolving on a Global Scale and Adjusting the Way They Operate Accordingly." Find Articles. 2002. 1 May 2007 <http://findarticles.com/p/articles/mi_m4153/is_1_62/ai_n13821850>.
“Hidden Debts, Deals Scuttle Last Chance.” Behr, Peter and Witt, April. WashingtonPost.com. Washington Post. 31 Jan. 2007 <http://www.washingtonpost.com/wp-dyn/content/article/2005/06/10/AR2005061000707_5.html>.
“H.R. 3763.” 107th Congress. Findlaw.com. Sarbanes-Oxley. 31 Jan 2007 <http://fl1.findlaw.com/news.findlaw.com/hdocs/docs/gwbush/sarbanesoxley072302.pdf>.
"InternationalCo Assets." Enron.Com. 9 May 2003. 30 Apr. 2007 <http://www.enron.com/corp/pressroom/icoassets.html>.
Palmer, Mark. "Press Release: March 19, 2003." Enron.Com. 19 Mar. 2003. 30 Apr. 2007 <http://www.enron.com/corp/pressroom/releases/2003/ene/docs/031903releasepdf.pdf>.
Pfanner, Eric. "Wake of Enron's Demise Buffets Global Banks and Utilities." Herald Tribune. 1 Dec. 2001. 30 Apr. 2007 <http://www.iht.com/articles/2001/12/01/a9_0.php>.
Phillips, Donald W., and Mark D. Saft. "Enron and Its Ripple Effects." CUDenver. Apr. 2002. 1 May 2007 <http://www.cudenver.edu/NR/rdonlyres/ewfkbodnzklw7vkqgcjb74ni53vqq6khhpfcp3ps5tj2takkmlxvigapmymnh2cxevfaopvlqote4c5nl25twpg7dla/ENRON+and+its+ripple+effects.pdf>.
"PX Limited." PX Limited. 1 May 2007 <http://www.pxlimited.com/>.
Stamp, Gavin. "Europe Faces Enron Legacy." BBC News. 30 Apr. 2007 <http://news.bbc.co.uk/1/hi/business/3849867.stm>.
Swartz, Mimi, and Sherron Watkins. Power Failure. First ed. New York, London, Toronto, Sydney, Auckland: Doubleday, 2003. 30-109.
“Visionary's Dream Led to Risky Business.” Behr, Peter and Witt, April. WashingtonPost.com. Washington Post. 31 Jan. 2007 <http://www.washingtonpost.com/wp-dyn/content/article/2005/06/10/AR2005061000709.html>.
[1] Wikipedia.com is not used as a source. It is used for the specific wording of the sentence.
