Enron 

Corporation
The story of Enron Corporation depicts a company that reached dramatic heights
only to face a dizzying fall. The fated company's collapse affected thousands of
employees and shook Wall Street to its core. At Enron's peak, its shares were worth
$90.75; just prior to declaring bankruptcy on Dec. 2, 2001, they were trading at
$0.26. To this day, many wonder how such a powerful business, at the time one of
the largest companies in the United States, disintegrated almost overnight. Also
difficult to understand, is how its leadership managed to fool regulators for so long
with fake holdings and off-the-books accounting. 
Enron's Energy Origins
Enron was formed in 1985 following a merger between Houston Natural Gas
Company and Omaha-based InterNorth Incorporated. Following the merger, Kenneth
Lay, who had been the chief executive officer (CEO) of Houston Natural Gas,
became Enron's CEO and chairman. Enron was rebranded into an energy trader and
supplier. Deregulation of the energy markets allowed companies to place bets on
future prices, and Enron was ready to take advantage. In 1990, Lay (Enron's CEO &
Chairman) 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.
Mark-to-Market
One of Skilling's early contributions was to transition Enron's accounting from a
traditional historical cost accounting method to mark-to-market (MTM) accounting
method, for which the company received official SEC approval in 1992. MTM is a
measure of the fair value of accounts that can change over time, such as assets and
liabilities. Mark-to-market aims to provide a realistic appraisal of an institution's or
company's current financial situation, and it is a legitimate and widely used
practice. However, in some cases, the method can be manipulated, since MTM is not
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based on "actual" cost but on "fair value," which is harder to pin down. Some believe
MTM was the beginning of the end for Enron as it essentially permitted the
organization to record estimated profits as actual profits.
Enron Hailed for Its Innovation
Enron created Enron Online (EOL) in Oct. 1999, an electronic trading website that
focused on commodities. Enron was the counterparty to every transaction on EOL; it
was either the buyer or the seller. To attract participants and trading partners, Enron
offered its reputation, credit, and expertise in the energy sector. Enron was
appreciated its expansions and ambitious projects, and it was named "America's Most
Innovative Company" by Fortune for six consecutive years between 1996 and 2001.
Blockbuster Video's Role
One of the many unwitting players in the Enron scandal was Blockbuster, the former
juggernaut video rental chain. In July 2000, Enron Broadband Services and
Blockbuster entered a partnership to enter the growing video on demand (VOD)
market. The VOD market was a sensible pick, but Enron started recording expected
earnings based on the expected growth of the VOD market, which vastly inflated the
numbers.
By mid-2000, EOL (Enron Online) was executing nearly $350 billion in trades.
When the dotcom bubble began to burst, Enron decided to build high-speed
broadband telecom networks. Hundreds of millions of dollars were spent on this
project, but the company ended up realizing almost no return.
When the recession hit in 2000, Enron had significant exposure to the most volatile
parts of the market. As a result, many trusting investors and creditors found
themselves on the losing end of a vanishing market cap.
The Wall Street Darling Crumbles
By the fall of 2000, Enron was starting to crumble (collapse) under its own weight.
CEO Jeffrey Skilling hid the financial losses of the trading business and other
operations of the company using mark-to-market accounting. This technique
measures the value of a security based on its current market value instead of its book

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value. This can work well when trading securities, but it can be disastrous for actual
businesses.
In Enron's case, the company would build an asset, such as a power plant, and
immediately claim the projected profit on its books, even though the company had
not made one cent from the asset. If the revenue from the power plant was less than
the projected amount, instead of taking the loss, the company would then transfer the
asset to an off-the-books corporation where the loss would go unreported. This type
of accounting enabled Enron to write off unprofitable activities without hurting its
bottom line (net income).
The mark-to-market practice led to schemes that were designed to hide the losses and
make the company appear more profitable than it really was. To cope with the
mounting liabilities, Andrew Fastow, a rising star who was promoted to chief
financial officer in 1998, developed a deliberate plan to show that the company was
in sound financial shape despite the fact that many of its subsidiaries were losing
money.
How Did Enron Hide Its Debt?
Fastow and others at Enron orchestrated a scheme to use off-balance-sheet special
purpose vehicles (SPVs), also known as special purpose entities (SPEs), to hide its
mountains of debt and toxic assets from investors and creditors. The primary aim of
these SPVs was to hide accounting realities rather than operating results.
The standard Enron-to-SPV transaction would be the following: Enron would transfer
some of its rapidly rising stock to the SPV in exchange for cash or a note. The SPV
would subsequently use the stock to hedge an asset listed on Enron's balance sheet. In
turn, Enron would guarantee the SPV's value to reduce apparent counterparty risk.
Although their aim was to hide accounting realities, the SPVs were not illegal. But
they were different from standard debt securitization in several significant—and
potentially disastrous—ways. One major difference was that the SPVs
were capitalized entirely with Enron stock. This directly compromised the ability of
the SPVs to hedge if Enron's share prices fell. Just as dangerous as the second

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significant difference: Enron's failure to disclose conflicts of interest. Enron disclosed

the SPVs' existence to the investing public—although it's certainly likely that few
people understood them—it failed to adequately disclose the non-arm's-length deals
between the company and the SPVs.
Enron believed that their stock price would continue to appreciate—a belief similar to
that embodied by Long-Term Capital Management, a large hedge fund, before its
collapse in 1998. Eventually, Enron's stock declined. The values of the SPVs also
fell, forcing Enron's guarantees to take effect. 
Arthur Andersen and Enron
In addition to Andrew Fastow, a major player in the Enron scandal was Enron's
accounting firm Arthur Andersen LLP and partner David B. Duncan, who oversaw
Enron's accounts. As one of the five largest accounting firms in the United States at
the time, Andersen had a reputation for high standards and quality risk management.
However, despite Enron's poor accounting practices, Arthur Andersen offered its
stamp of approval, signing off on the corporate reports for years. By April 2001,
many analysts started to question Enron's earnings and the company's transparency.
The Shock Felt Around Wall Street
By the summer of 2001, Enron was in freefall. CEO Kenneth Lay had retired in
February, turning over the position to Jeffrey Skilling. In August 2001, Skilling
resigned as CEO citing personal reasons. Around the same time, analysts began to
downgrade their rating for Enron's stock, and the stock descended to a 52-week low
of $39.95. By Oct. 16, the company reported its first quarterly loss and closed its
"Raptor" SPV. This action caught the attention of the SEC.
A few days later, Enron changed pension plan administrators, essentially forbidding
employees from selling their shares for at least 30 days. Shortly after, the SEC
announced it was investigating Enron and the SPVs created by Fastow. Fastow was
fired from the company that day. Also, the company restated earnings going back to
1997. Enron had losses of $591 million and had $690 million in debt by the end of
2000. The final blow was dealt when Dynegy (NYSE: DYN), a company that had

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previously announced it would merge with Enron, backed out of the deal on Nov. 28.
By Dec. 2, 2001, Enron had filed for bankruptcy.

Bankruptcy
Once Enron's Plan of Reorganization was approved by the U.S. Bankruptcy
Court, the new board of directors changed Enron's name to Enron Creditors Recovery
Corporation (ECRC). The company's new sole mission was "to reorganize and
liquidate certain of the operations and assets of the 'pre-bankruptcy' Enron for the
benefit of creditors." The company paid its creditors more than $21.7 billion from
2004 to 2011. Its last payout was in May 2011.
Criminal Charges
Arthur Andersen (audit firm) was one of the first casualties of Enron's failure. In June
2002, the firm was found guilty of obstructing justice for shredding Enron's financial
documents to conceal them from the SEC. The conviction was overturned later, on
appeal; however, the firm was deeply disgraced by the scandal and dwindled into a
holding company. A group of former partners bought the name in 2014, creating a
firm named Andersen Global.
Several of Enron's executives were charged with conspiracy, insider trading,
and securities fraud. Enron's founder and former CEO Kenneth Lay were convicted
on six counts of fraud and conspiracy and four counts of bank fraud. Prior to
sentencing, he died of a heart attack in Colorado.
Enron's former star CFO Andrew Fastow pled guilty to two counts of wire fraud and
securities fraud for facilitating Enron's corrupt business practices. He ultimately cut a
deal for cooperating with federal authorities and served more than five years in
prison. He was released from prison in 2011.
Ultimately, former Enron CEO Jeffrey Skilling received the harshest sentence of
anyone involved in the Enron scandal. In 2006, Skilling was convicted of conspiracy,
fraud, and insider trading. Skilling originally received a 17½-year sentence, but in

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2013 it was reduced by 14 years. As a part of the new deal, Skilling was required to
give $42 million to the victims of the Enron fraud and to cease challenging his
conviction. Skilling was originally scheduled for release on Feb. 21, 2028, but he was
instead released early on Feb. 22, 2019.

New Regulations after Scandal

Enron's collapse and the financial disorder and confusion that damaged its
shareholders and employees led to new regulations and legislation to promote the
accuracy of financial reporting for publicly held companies. In July 2002, President
George W. Bush signed into law the Sarbanes-Oxley Act. The Act heightened the
consequences for destroying, altering, or fabricating financial statements and for
trying to defraud shareholders.
The Enron scandal resulted in other new compliance measures. Additionally,
the Financial Accounting Standards Board (FASB) substantially raised its levels of
ethical conduct. Moreover, company boards of directors became more independent,
monitoring the audit companies, and quickly replacing poor managers. These new
measures are important mechanisms to spot and close loopholes that companies have
used to avoid accountability.
The Bottom Line
At the time, Enron's collapse was the biggest corporate bankruptcy to ever hit the
financial world (since then, the failures of WorldCom, Lehman Brothers, and
Washington Mutual have surpassed it). The Enron scandal drew attention to
accounting and corporate fraud as its shareholders lost $74 billion in the four years
leading up to its bankruptcy, and its employees lost billions in pension benefits.
Increased regulation and oversight have been enacted to help prevent corporate
scandals of Enron's magnitude. However, some companies are still reeling from the
damage caused by Enron. Most recently, in March 2017, a judge granted a Toronto-
based investment firm the right to sue former Enron CEO Jeffrey Skilling, Credit

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Suisse Group AG, Deutsche Bank AG, and Bank of America's Merrill Lynch unit
over losses incurred by purchasing Enron shares.

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