Why enron went bust

Institutions like Janus, Fidelity, and Alliance Capital piled in. Of course, earnings growth isn't the entire explanation for Wall Street's attitude. There were also the enormous investment-banking fees Enron generated.

Nor was asking questions easy. Wall Streeters find it hard to admit that they don't understand something. And Skilling was notoriously short with those who didn't immediately concur with the Enron world-view. Although it's hard to pinpoint the exact moment the tide began to turn against Enron, it's not hard to find the person who first said that the emperor had no clothes. In early , Jim Chanos, who runs Kynikos Associates, a highly regarded firm that specializes in short-selling, said publicly what now seems obvious: No one could explain how Enron actually made money.

Chanos also pointed out that while Enron's business seemed to resemble nothing so much as a hedge fund--"a giant hedge fund sitting on top of a pipeline," in the memorable words of Doug Millett, Kynikos' chief operating officer--it simply didn't make very much money.

Not only was Enron surprisingly unprofitable, but its cash flow from operations seemed to bear little relationship to reported earnings. Because much of Enron's business was booked on a "mark to market" basis, in which a company estimates the fair value of a contract and runs quarterly fluctuations through the income statement, reported earnings didn't correspond to the actual cash coming in the door. That isn't necessarily bad--as long as the cash shows up at some point. Skilling and Fastow had a simple explanation for Enron's low returns.

The "distorting factor," in Fastow's words, was Enron's huge investments in international pipelines and plants reaching from India to Brazil. Skilling told analysts that Enron was shedding those underperforming old-line assets as quickly as it could and that the returns in Enron's newer businesses were much, much higher.

It's undeniable that Enron did make a number of big, bad bets on overseas projects--in fact, India and Brazil are two good examples. But in truth, no one on the outside and few people inside Enron can independently measure how profitable--or more to the point, how consistently profitable--Enron's trading operations really were.

A former employee says that Skilling and his circle refused to detail the return on capital that the trading business generated, instead pointing to reported earnings, just as Fastow did.

By the late s much of Enron's asset portfolio had been lumped in with its trading operations for reporting purposes. Chanos noted that Enron was selling those assets and booking them as recurring revenue. In addition, Enron took equity stakes in all kinds of companies and included results from those investments in the figures it reported. Chanos was also the first person to pay attention to the infamous partnerships.

In poring over Enron documents, he took note of an odd and opaque mention of transactions that Enron and other "Entities" had done with a "Related Party" that was run by "a senior officer of Enron. These, we now know, refer to the LJM partnerships. When it came to the "Related Party" transactions, Enron didn't even pretend to be willing to answer questions. Back in February, Fastow who at the time didn't admit his involvement said that the details were "confidential" because Enron "didn't want information to get into the market.

But perhaps that didn't matter, because the partnerships were supported with Enron stock--which, you remember, wasn't supposed to decline in value. And then came what should have been the clearest signal yet of serious problems: Jeff Skilling's shocking announcement that he was leaving the company.

Though Skilling never gave a plausible reason for his departure, Enron dismissed any suggestion that his departure was related to possible problems with the company. Now, however, there are those who speculate that Skilling knew the falling stock price would wreak havoc on the partnerships--and cause their exposure.

What's astonishing is that even in the face of this dramatic--and largely inexplicable--event, people were still willing to take Enron at its word. Ken Lay, who stepped back into his former role as CEO, retained immense credibility on Wall Street and with Enron's older employees, who gave him a standing ovation at a meeting announcing his return.

He said there were no "accounting issues, trading issues, or reserve issues" at Enron, and people believed him. Lay promised to restore Enron's credibility by improving its disclosure practices, which he finally admitted had been less than adequate. Did Lay have any idea of what he was talking about? Or was he as clueless as Enron's shareholders? This directly compromised the ability of the SPVs to hedge if Enron's share prices fell. Just as dangerous as the second 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 The values of the SPVs also fell, forcing Enron's guarantees to take effect. 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 the summer of , Enron was in freefall. By Oct. 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. Fastow was fired from the company that day. Also, the company restated earnings going back to By Dec. Once Enron's Plan of Reorganization was approved by the U. 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.

Its last payout was in May Arthur Andersen was one of the first casualties of Enron's notorious demise. In June , the firm was found guilty of obstructing justice for shredding Enron's financial documents to conceal them from the SEC.

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 In , Skilling was convicted of conspiracy, fraud, and insider trading. Enron's collapse and the financial havoc it wreaked on its shareholders and employees led to new regulations and legislation to promote the accuracy of financial reporting for publicly held companies.

In July , 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. As one researcher states, the Sarbanes-Oxley Act is a "mirror image of Enron: the company's perceived corporate governance failings are matched virtually point for point in the principal provisions of the act. The Enron scandal resulted in other new compliance measures.

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.

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.

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. Joint Committee on Taxation. The response from Enron was anything but standard. Skilling quickly became frustrated, said that the line of inquiry was "unethical," and hung up the phone.

Now, in the wake of Enron's stunning collapse, it looks as if the company's critics didn't throw enough rocks. The world is clamoring for those "explicit answers," but Skilling, long gone from Enron--and avoiding the press on the advice of his lawyers--is in no position to provide them. As for "completely and accurately," many would argue that the men running Enron never understood either concept. They didn't have to lie. All they had to do was to obfuscate it with sheer complexity--although they probably lied too.

Until recently Enron would kick and scream at the notion that its business or financial statements were complicated; its attitude, expressed with barely concealed disdain, was that anyone who couldn't understand its business just didn't "get it. Bulls, including David Fleischer of Goldman Sachs, admitted that they had to take the company's word on its numbers--but it wasn't a problem, you see, because Enron delivered what the Street most cared about: smoothly growing earnings.

Of course, now that it's clear that those earnings weren't what they appeared, the new cliche is that Enron's business was incredibly complicated--perhaps even too complicated for founder Ken Lay to understand something Lay has implied since retaking the CEO title from Skilling last summer.

Which leads to a basic question: Why were so many people willing to believe in something that so few actually understood? Of course, since the Enron collapse, there are other basic questions as well--questions for which there are still no adequate answers. Even today, with creditors wrangling over Enron's skeletal remains while the company tries desperately to find a backer willing to keep its trading operations in business, outsiders still don't know what went wrong. Neither do Enron's employees, many of whom expressed complete shock as their world cratered.

Was Enron's ultimate collapse caused by a crisis of confidence in an otherwise solid company? Or were the sleazy financial dealings that precipitated that crisis--including mysterious off-balance-sheet partnerships run by Enron executives--the company's method of covering up even deeper issues in an effort to keep the stock price rising?

And then there's the question that's been swirling around the business community and in Enron's hometown of Houston: Given the extent to which financial chicanery appears to have take place, is someone going to jail? If you believe the old saying that "those whom the gods would destroy they first make proud," perhaps this saga isn't so surprising. There was the company's powerful belief that older, stodgier competitors had no chance against the sleek, modern Enron juggernaut. A few years ago at a conference of utility executives, "Skilling told all the folks he was going to eat their lunch," recalls Southern Co.

To be sure, for a long time it seemed as though Enron had much to be arrogant about. The company, which Ken Lay helped create in from the merger of two gas pipelines, really was a pioneer in trading natural gas and electricity. It really did build new markets for the trading of, say, weather futures.

Led by Skilling, who had joined the company in from consulting firm McKinsey he succeeded Lay as CEO in February , Enron operated under the belief that it could commoditize and monetize anything, from electrons to advertising space.

And in early , just as broadband was becoming a buzzword worth billions in market value, Enron announced plans to trade that too. But that culture had a negative side beyond the inbred arrogance. Greed was evident, even in the early days. Compensation plans often seemed oriented toward enriching executives rather than generating profits for shareholders. For instance, in Enron's energy services division, which managed the energy needs of large companies like Eli Lilly, executives were compensated based on a market valuation formula that relied on internal estimates.

As a result, says one former executive, there was pressure to, in effect, inflate the value of the contracts--even though it had no impact on the actual cash that was generated. Because Enron believed it was leading a revolution, it encouraged flouting the rules. There was constant gossip that this rule breaking extended to executives' personal lives--rumors of sexual high jinks in the executive ranks ran rampant.

Enron also developed a reputation for ruthlessness, both external and internal. Thus, employees attempted to crush not just outsiders but each other. One thing we can learn from the Enron story is the lack of business ethics in the business world.

I personally feel that Enron should be made an example of. We already proved, as a society, that we will not question the integrity of something as long as we are profiting from it.

Someone needs to watch big businesses and keep them in check, because we wont. Your email address will not be published. Skip to content How will the Enron saga resolve? Lublin, Joann S. Tuesday, February 26,