Enron Scandal: where are we now and what are lessons learnt?
Those in the market will remember the downfall of Enron. It is one of the most impressive financial collapses in history and is still the subject of many stories. This year symbolises the 20th anniversary of this scandal marked by shady practices, deceits from its executives, inaccurate reportings and accounting malpractices. Let’s look back and examine how this downfall impacted the financial system and whether we learnt any lessons from this scandal. What happened 20 years back? Enron was founded in 1985 by Ken Lay and it soon grew to become one of the largest firms in the world. Its revenue surged from $5 billion a year to $200 billion and it had 20,000 employees globally. However, in 2001, it was found out that the firm had millions hidden debts and inflated profits and it filed for bankruptcy in December of the same year. The corporate darling, the ‘economy powerhouse… it was just all a mirage. As it turns out, its traders had been manipulating the electricity market and executives had been playing with their finances so much that when it crashed, it was forced to write off more than $1 billion of failed investments and disclose major losses in shareholder equity. As we say, “It was a total fiasco!”. Employees had just minutes to vacate the Enron building and they were seen carrying out cardboard boxes. Just like that, they had no job and their millions of dollars in retirement and pension funds were wiped out… All of this, during the festive month of December. Repercussions on the American financial sector Such a downfall has definitely had repercussions on the market, as was expected. First of all, the US stock market was stained with a huge black mark. At the time, most investors trusted the market. They could not even imagine that such a huge financial fraud could really happen when they purchased US listed stock. In fact, the US markets were seen as the gold standard when it came to transparency and compliance. Imagine what happens when you are at the top and suddenly, everyone discovers that you were a fraud. This was the sort of punch that the system received. Considering how such a huge fraud went unnoticed, it became obvious that the sector needed to be strengthened. The government introduced several sets of strict regulations for firms. Auditors, accountants and senior executives… all have to adhere to huge requirements for record keeping and other activities. Let’s not forget: more criminal penalties for securities laws violations. Moreover, everything was like a domino effect, which means more repercussions. All those rules and regulations meant that there was less choice for US stock investors and lower participation in stock ownership by individuals. People started thinking, “If a giant like Enron could collapse, what about us?”. A huge number of Americans stopped participating in the stock market and this still holds true even today. Those from lower classes are hesitant because they are afraid of losing their savings. Additionally, following all the rules, regulations and bureaucratic form-filling that were involved, it became difficult for companies to IPO. It cost a lot money to go public and fewer companies were able to meet all the requirements needed. Now, firms wait until they are far larger before going public. Even today, fewer companies are listed. What does this mean? The public market has fewer investing opportunities, in comparison to private ones and small investors are excluded from participating and gaining. What are some of the lessons learnt from this scandal? Despite all the complaints about the regulations and new rules, one thing cannot be denied: the US financial market has learnt its lesson and it is now a safer environment. Investing in equities is now more transparent. For instance, a year later, the Sarbanes-Oxley Act was introduced. This was described as “the most far-reaching reform of American business practices since the time of Franklin Delano Roosevelt”. What did it involve? The maximum prison term for fraud increased by four to reach 20 years. Chief executives and finance chiefs had to personally vouch for the truthfulness of financial statements and documents. The Public Company Accounting Oversight Board had to provide independent oversight of public accounting firms providing audit services. Standards for external auditor independence were established. Securities and Exchange Commission enjoyed more tools to try to restore confidence in the market. In summary, its aim was to create a more controlled environment based on cross-checking, reconciliations, data verification and accountability. With these processes in place, it might be difficult to conduct fraud. Additionally, since Enron’s board of directors was criticized and sanctioned, executives of other firms learnt their lessons. They became aware that the days during which everything was game to them were over and things had to be taken seriously now. The scandal, thus, acted as a form of governance lesson. Moreover, since then, there have been continuous calls for corporations to develop and commit to environmental, social and governance reforms that link corporate success to societal goods.
Enron Corporation scandal: lessons to be learnt from the havoc
This scandal is not something recent. However, the lessons it involves is something useful and relevant even in today’s time. The firm peaked in the industry and fell down and crashed! The crash was even bigger than its success and it affected the whole of Wall Street. Thousands of employees lost their jobs and the most shocking part is that one of the most powerful firms in the US just crumbled overnight. Enron Corporation: a high street darlingThe firm saw its beginnings in 1985 when the two natural gas companies Houston Natural Gas Company and InterNorth Incorporated. Following this, Kenneth Lay, the CEO of the former firm became Enron’s CEO and chair. The firm was rebranded into an energy trader and supplier and being very ambitious, he wanted to expand the firm’s capabilities beyond natural gas. As such, it made an aggressive move into electrical power. It invested into power plants and other electrical generation assets. However, Enron took another direction from other energy companies. Its executive tried to generate a profit from energy trading. How did it do so? Instead of producing and delivering natural energy to clients like conventional firms would, it used future contracts to deliver energy at specific times in the future, which allowed it to make money via the bias of those who wanted to speculate on price movements or to hedge against the risks of unexpected energy-price volatility. As such, Enron became more like a Wall Street investment company. In 1999, Enron created Enron Online (EOL). This was an electronic trading website that looked at commodities and the firm Enron became the counterparty to all transactions completed on EOL. The company managed to entice a lot of clients because of its reputation, credit and expertise in the energy sector. Following trades etc, it ended up creating completely new markets, such as contracts tied to weather events and internet bandwidth. However, these were only loosely connected to weather events and internet bandwidth capacity. Despite this, the firm was highly praised in the industry. By 2000, its stock grew at a very rate and Enron became one among the top 10 businesses in the country. It was applauded by many for its expansions and ambitious projects. Moreover, for six consecutive years, Fortune named the firm “America’s Most Innovative Company”. The fall of the Wall Street darling Nonetheless, by fall 2000, the firm started to crumble under its own weight and its success turned out to be a mirage. It turns out that the firm used accounting techniques to conceal the fact that it was undergoing huge business losses and it was in massive debt. For instance, it used mark-to-market accounting. This is a technique which measures the value of a security based on its current market value instead of its book value. While this is a strategy that can be efficient for trading securities, it is disastrous for businesses. Nonetheless, thanks to this, Enron appeared to be a success financially. Moreover, executives used off-balance-sheet special purpose vehicles to hide its debts and toxic assets from investors and creditors. However, with time, the techniques stopped working and by 2001, the firm revealed a huge quarterly loss and debts. It was then revealed that it had been consistently overstating its earnings for at least four years. After that, it had to file for bankruptcy and the authorities started paying attention to its operations. As everyone would have guessed, criminal charges against executives ensued. They were charged with conspiracy, insider trading and securities fraud and Wall Street’s darling experienced a fall from grace. In fact, the whole industry felt the impact of this fraud. It is estimated that shareholders lost $74 billion during the years leading up to the bankruptcy and the havoc that was caused led to new regulations and compliance measures being implemented. Lessons learnt from the debacles If there is one good that came out of this situation, it is that we could learn several lessons from this chaos. Learn about a firm well before investingAs mentioned before, Enron was quite different from other traditional energy companies and many of its investors did not understand its business model. Even experts in the sector could not understand some of the transactions. Moreover, the firm used a lot of fancy derivatives which were unnecessary. One of the dangers of the firm is that it relied too much on these speculations and derivative contracts. As such, as an investor, you must be careful when dealing with a firm. Some of the red flags that you must be on the lookout for is whether the company has a complicated business model or its financial derivatives are completely different from others. There is a lack of transparency or a false semblance and these may confuse you. Prioritise firms that are completely transparent in their operations and that offer help and support whenever you need it. For instance, Blue Azurite has a team of experts at your disposal. They are always available to answer your questions, clear your doubts and make sure that you are completely satisfied. Another important factor that comes into play when speaking about Enron its ethic-a moral code of conduct. All companies have a set of rules that they have to abide to and these are based on principles and values. Enron completely disregarded this structure of trust that support a firm and instead, it built a mirage of a reliable one. The fact that that this was possible and the charade kept going on for years says a lot about the jurisdiction in which the firm operates. It is only after the scandal that the US set up more rules and regulations to ensure that such a havoc does not happen again. But by then, it was too late. That is why it is important to choose firm in jurisdictions having well-established laws protecting investors and the likes. For instance, in Mauritius, in which Blue Azurite operates, there are several institutions regulating the activities of financial
