[81], By mid-November, Enron announced it was planning to sell about $8 billion worth of underperforming assets, along with a general plan to reduce its scale for the sake of financial stability. In addition, concerns were raised regarding antitrust regulatory restrictions resulting in possible divestiture, along with what to some observers were the radically different corporate cultures of Enron and Dynegy. According to author Frank Pellegrini, various Bush appointments held connections to Enron, including deputy White House Chief of Staff Karl Rove as a stockholder, Secretary of the Army Thomas E. White Jr. as a former executive, and SEC chairman Harvey Pitt, a former employee of Arthur Andersen. Expert observers said that the reversal was highly unusual for the 5th Circuit, commenting that the conviction must have had serious issues in order to be overturned. [24][1]:33[25] The special purpose entities had been used to pay for all of this using the entities' debt instruments. [13]:102 Enron's method of reporting inflated trading revenue was later adopted by other companies in the energy trading industry in an attempt to stay competitive with the company's large increase in revenue. The main provisions of the final NYSE proposal include:[138], Kenneth Lay was a longtime supporter of U.S. president George W. Bush and a donor to his various political campaigns, including his successful bid for the presidency in 2000. [69] Enron was able to secure an additional $1 billion in financing from cross-town rival Dynegy on November 2, but the news was not universally admired in that the debt was secured by assets from the company's valuable Northern Natural Gas and Transwestern Pipeline. [6]:10 When the network failed to work, Blockbuster withdrew from the contract. "[80], Watson assured investors that the true nature of Enron's business had been made apparent to him: "We have comfort there is not another shoe to drop. An internal investigation was initiated following a memorandum from a company vice president, and soon the Securities and Exchange Commission (SEC) was investigating the transactions between Enron and Fastow’s SPEs. The footnotes also declared that the instruments' face amount totaled $1.5 billion, and the entities notional amount of $2.1 billion had been used to enter into derivative contracts with Enron. In addition, at least one member of the audit committee is required to have accounting or related financial management expertise. [18] Mark-to-market accounting requires that once a long-term contract has been signed, income is estimated as the present value of net future cash flow. [50] However, Skilling's comment was met with dismay and astonishment by press and public, as he had previously disdained criticism of Enron coolly or humorously. Although not all of Enron's widespread improper accounting practices were revealed to the board, the practices were dependent on board decisions. [115] Although only a small number of Arthur Andersen's employees were involved with the scandal, the firm was effectively put out of business; the SEC is not allowed to accept audits from convicted felons. By December 31, 2000, Enron's stock was priced at $83.13 and its market capitalization exceeded $60 billion, 70 times earnings and six times book value, an indication of the stock market's high expectations about its future prospects. [16][17], In Enron's natural gas business, the accounting had been fairly straightforward: in each time period, the company listed actual costs of supplying the gas and actual revenues received from selling it. They need to convince investors these earnings are real, that the company is for real and that growth will be realized. Former Enron employees sitting with their belongings after layoffs by the bankrupt energy-trading company. Under this method, income from projects could be recorded, although the firm might never have received the money, with this income increasing financial earnings on the books. Eight former Enron executives testified—the main witness being Fastow—against Lay and Skilling, his former bosses. [140], In an article that same month, Time magazine accused the Bush administration of making desperate attempts to distance themselves from the scandal. David Fleischer at Goldman Sachs, an analyst termed previously 'one of the company's strongest supporters' asserted that the Enron management "... lost credibility and have to reprove themselves. [6]:15[31][11]:383, Revelations concerning Andersen's overall performance led to the break-up of the firm, and to the following assessment by the Powers Committee (appointed by Enron's board to look into the firm's accounting in October 2001): "The evidence available to us suggests that Andersen did not fulfill its professional responsibilities in connection with its audits of Enron's financial statements, or its obligation to bring to the attention of Enron's Board (or the Audit and Compliance Committee) concerns about Enron's internal contracts over the related-party transactions". Merrill Lynch, JP Morgan, Credit Suisse First Boston, Citigroup, and others were intimately involved in the financing of Enron… [4] One piece of legislation, the Sarbanes–Oxley Act, increased penalties for destroying, altering, or fabricating records in federal investigations or for attempting to defraud shareholders. [43], The SEC announced it had filed civil fraud complaints against Andersen. [59], On October 16, 2001, Enron announced that restatements to its financial statements for years 1997 to 2000 were necessary to correct accounting violations. Transferring those assets to SPEs meant that they were kept off Enron’s books, making its losses look less severe than they really were. The company owned and operated a variety of assets including gas pipelines, electricity plants, paper plants, water plants, and broadband services across the globe. Several years later, when Jeffrey Skilling was hired, Lay developed a staff of executives that – by the use of accounting loopholes, special purpose entities, and poor financial reporting – were able to hide billions of dollars in debt from failed deals and projects. We got to where we did because we exploited that weakness. Enron scandal, series of events that resulted in the bankruptcy of the U.S. energy, commodities, and services company Enron Corporation and the dissolution of Arthur Andersen LLP, which had been one of the largest auditing and accounting companies in the world. The November 1999 creation of the EnronOnline trading website allowed the company to better manage its contracts trading business. The auditor's methods were questioned as either being completed solely to receive its annual fees or for its lack of expertise in properly reviewing Enron's revenue recognition, special entities, derivatives, and other accounting practices. [78] Additionally, many traders had limited their involvement with Enron, or stopped doing business altogether, fearing more bad news. Some analysts felt Enron's failure indicated the risks of the post-September 11 economy, and encouraged traders to lock in profits where they could. This arrangement had Enron implementing hedges with itself. [71] Enron's stock was now trading at around $7, and by this time it was obvious that Enron could not stay independent. [11]:338, McLean telephoned Skilling to discuss her findings prior to publishing the article, but he called her "unethical" for not properly researching his company. Enron's $63.4 billion in assets made it the largest corporate bankruptcy in U.S. history until the WorldCom scandal the following year.[3]. [13]:97–100, Enron also used creative accounting tricks and purposefully misclassified loan transactions as sales close to quarterly reporting deadlines, similar to the Lehman Brothers Repo 105 scheme in the 2008 financial crisis, or the currency swap concealment of Greek debt by Goldman Sachs. In truth, even as they angrily pointed fingers, the two deserved each other. [citation needed], On August 15, Sherron Watkins, vice president for corporate development, sent an anonymous letter to Lay warning him about the company's accounting practices. But these codes of ethics are voluntary and can be set aside by the board of directors. Andrew Fastow, Enron’s CFO, led the company in the use of special purpose entities (SPEs) to increase capital and improve Enron’s rating. [2] The U.S. Securities and Exchange Commission (SEC) began an investigation, and rival Houston competitor Dynegy offered to purchase the company at a very low price. [11]:393, On January 17, 2002, Enron dismissed Arthur Andersen as its auditor, citing its accounting advice and the destruction of documents. But as pressure to outbid all others and win the deal grew more intense with the approaching IPO, the Azurix executives decided to up their bid. He was ultimately forced to make do with a small Houston bank. [73] Dynegy and Enron confirmed their deal on November 8, 2001. "[60], Enron's management team claimed the losses were mostly due to investment losses, along with charges such as about $180 million in money spent restructuring the company's troubled broadband trading unit. And fourth, most companies like Enron have codes of ethics that prohibit managers and executives from being involved in another business entity that does business with their own company. [122] Darby, Bermingham, and Mulgrew were each sentenced to 37 months in prison. Enron was founded in 1985 by Kenneth Lay in the merger of two natural-gas-transmission companies, Houston Natural Gas Corporation and InterNorth, Inc.; the merged company, HNG InterNorth, was renamed Enron in 1986. On December 2, 2001, Enron filed for Chapter 11 bankruptcy protection. [57], After the September 11 attacks media attention shifted away from the company and its troubles; a little less than a month later Enron announced its intention to begin the process of selling its lower-margin assets in favor of its core businesses of gas and electricity trading. This policy included selling Portland General Electric to another Oregon utility, Northwest Natural Gas, for about $1.9 billion in cash and stock, and possibly selling its 65% stake in the Dabhol project in India. Although many companies distributed assets to SPEs, Enron abused the practice by using SPEs as dump sites for its troubled assets. [121] In a plea bargain in November 2007, the trio plead guilty to one count of wire fraud while the other six counts were dismissed. McMahon and a "financial SWAT team" put together to find a way out of the cash crisis discovered that Fastow never developed procedures for tracking cash or debt maturities. The scandal resulted in a wave of new regulations and legislation designed to increase the accuracy of financial reporting for publicly traded companies. Increases in executive compensation and stock options, jumps in incentives to manage earnings, and major shifts in the structure of auditing firms are just a few of the changes that led to loss of money and public confidence in corporations during the past decade, Stanford GSB Professor Maureen McNichols told an alumni audience. "[6]:4, Although Enron's compensation and performance management system was designed to retain and reward its most valuable employees, the system contributed to a dysfunctional corporate culture that became obsessed with short-term earnings to maximize bonuses. It pretty much wiped out every employee's savings plan. In one case, Andersen's Houston office, which performed the Enron audit, was able to overrule any critical reviews of Enron's accounting decisions by Andersen's Chicago partner. One statement in the letter said: "I am incredibly nervous that we will implode in a wave of accounting scandals. [138] The Act is nearly "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. Merrill Lynch, which marketed the equity, also contributed $22 million to fund the entities. [11]:77, In 1998, when analysts were given a tour of the Enron Energy Services office, they were impressed with how the employees were working so vigorously. [6]:7, In an attempt to achieve further growth, Enron pursued a diversification strategy. [11]:401 In 1998, the top 200 highest-paid employees received $193 million from salaries, bonuses, and stock. At the beginning of 2001, the Enron Corporation, the world's dominant energy trader, appeared unstoppable. As Pellegrini wrote, "The Democrats will have the company-he-keeps, guilt-by-association thing on their side, and with all the ... general whiff of rich man's cover-up about the whole affair, they'll have a class warfare card to play this spring. [1]:33, Enron capitalized the Raptors, and, in a manner similar to the accounting employed when a company issues stock at a public offering, then booked the notes payable issued as assets on its balance sheet while increasing the shareholders' equity for the same amount. This prevented Enron from being protected from the downside risk.[6]:11. [63], Jeff McMahon, head of industrial markets, succeeded Fastow as CFO. Dynegy would be the surviving company, and Dynegy CEO Charles Watson and his management team would head the merged company. Arthur Andersen came under intense scrutiny and eventually lost a majority of its clients. However, the damage to the Andersen name has been so great that it has not returned as a viable business even on a limited scale. Enron's board also announced that it would commission a special committee to investigate the transactions, directed by William C. Powers, the dean of the University of Texas law school. Our editors will review what you’ve submitted and determine whether to revise the article. Updates? The Enron story has produced many victims, the most tragic of which is a former vice-chairman of the company who committed suicide, apparently in connection with his role in the scandal. In a statement, Enron revealed "An adverse outcome with respect to any of these matters would likely have a material adverse impact on Enron's ability to continue as a going concern. . [120] Coulbeck's death was eventually ruled to have been a suicide. "You're getting way over my head," said Lay during late August 2001 in response to detailed questions about Enron's business, a reaction that worried analysts. [43], As the month came to a close, serious concerns were being raised by some observers regarding Enron's possible manipulation of accepted accounting rules; however, analysis was claimed to be impossible based on the incomplete information provided by Enron. Duncan favorably reviewed the work of Rick Causey, Enron’s chief accounting officer and Duncan’s former colleague at Andersen. [51], As time passed, a number of serious concerns confronted the company. He also named Mark Frevert as vice chairman, and appointed Whalley and Frevert to positions in the chairman's office. [citation needed], With Enron in a state of near collapse, the deal was largely on Dynegy's terms. ", "Enron Will Sell Some Assets In Hope of Raising Billions", "In New Filing, Enron Reports Debt Squeeze", "Enron's Growing Financial Crisis Raises Doubts About Merger Deal", "Circling the Wagons Around Enron; Risks Too Great To Let Trader Just Die", "From Sunbeam to Enron, Andersen's Reputation Suffers", "Trying to Restore Confidence in Enron to Salvage a Merger", "Investors Pull Back as Enron Drags Down Key Indexes", "Market That Deals in Risks Faces a Novel One", "A Bankruptcy Filing Might Be the Best Remaining Choice", "Ex-Enron chief Ken Lay Enters Not Guilty Plea", "Fastow's Wife Pleads Guilty in Enron Case", "Skilling Gets 24 Years for Fraud at Enron", "Ex-Enron Chief's Sentence is Cut by 10 Years to 14", "Lay, Skilling Convicted in Enron Collapse", "Enron Inquiry Turns to Sales By Lay's Wife", "One Guilty and One Acquitted in Enron Broadband Trial", "Supreme Court Overturns Arthur Andersen Conviction", "Source: British bankers to plead guilty in Enron case", "NatWest Three Plead Guilty to Wire Fraud", "NatWest banker claims he was 'tortured' into pleading guilty over theft of $7.3m from RBS", "CORPORATE CONDUCT: THE TRADER; Enron Trader Had a Year To Boast of, Even If . I think I can honestly say that the company is probably in the strongest and best shape that it has probably ever been in. However, investors were oblivious to the fact that the special purpose entities were actually using the company's own stock and financial guarantees to finance these hedges. [76] Both companies were said to be anxious to receive an official assessment of the proposed sale from Moody's and S&P presumably to understand the effect the completion of any buyout transaction would have on Dynegy and Enron's credit rating. [58] Lay's efforts seemed to meet with limited success; by September 9, one prominent hedge fund manager noted that "[Enron] stock is trading under a cloud. Fastow was initially charged with 98 counts of fraud, money laundering, insider trading, and conspiracy, among other crimes. Additionally, accounting results were recorded as soon as possible to keep up with the company's stock price. The Enron scandal was an accounting scandal involving Enron Corporation, an American energy company based in Houston, Texas.Upon being publicized in October 2001, the company declared bankruptcy and its accounting firm, Arthur Andersen – then one of the five largest audit and accountancy partnerships in the world – was effectively dissolved. All companies must have a majority of independent directors. Let us know if you have suggestions to improve this article (requires login). [112], Michael W. Krautz, a former Enron accountant, was among the accused who was acquitted[113] of charges related to the scandal. This was at the high end of what Enron's Risk Assessment and Control Group advised. Independent directors must comply with an elaborate definition of independent directors. The restatements for the period reduced earnings by $613 million (or 23% of reported profits during the period), increased liabilities at the end of 2000 by $628 million (6% of reported liabilities and 5.5% of reported equity), and reduced equity at the end of 2000 by $1.2 billion (10% of reported equity). [42], Enron made a habit of booking costs of cancelled projects as assets, with the rationale that no official letter had stated that the project was cancelled. Get a Britannica Premium subscription and gain access to exclusive content. [138], On February 13, 2002, due to the instances of corporate malfeasances and accounting violations, the SEC recommended changes of the stock exchanges' regulations. [84] In order to end the proposed buyout, Dynegy would need to legally demonstrate a "material change" in the circumstances of the transaction; as late as November 22, sources close to Dynegy were skeptical that the latest revelations constituted sufficient grounds. [44], Analysts and observers continued their complaints regarding the difficulty or impossibility of properly assessing a company whose financial statements were so cryptic. ", David Leonhardt, "How Will Washington Read the Signs?". Such debts were "vastly in excess" of its available cash. Former assistant editor, economics, Encyclopædia Britannica. Joseph Berardino, then CEO of Arthur Andersen, testifying during a congressional hearing on the Enron scandal, 2002. The committee was also unable to question the company's management due to pressures on the committee. [52] There was also increasing criticism of the company for the role that its subsidiary Enron Energy Services had in the California electricity crisis of 2000–2001. Enron was estimated to have about $23 billion in liabilities from both debt outstanding and guaranteed loans. [53] Nevertheless, Lay, who was serving as chairman at Enron, assured surprised market watchers that there would be "no change in the performance or outlook of the company going forward" from Skilling's departure. By signing up for this email, you are agreeing to news, offers, and information from Encyclopaedia Britannica. [11]:179–180 This ruse was used several times to fool analysts about the progress of different areas of Enron to help improve the stock price. Management was compensated extensively using stock options, similar to other U.S. companies. "[139], The main provisions of the Sarbanes-Oxley Act included the establishment of the Public Company Accounting Oversight Board to develop standards for the preparation of audit reports; the restriction of public accounting companies from providing any non-auditing services when auditing; provisions for the independence of audit committee members, executives being required to sign off on financial reports, and relinquishment of certain executives' bonuses in case of financial restatements; and expanded financial disclosure of companies' relationships with unconsolidated entities. He noted that outsiders had no real way of knowing the assumptions on which companies that used mark-to-market based their earnings. In addition, Enron was rated the most innovative large company in America in Fortune's Most Admired Companies survey.[6]:1. [129][130][131], A class action lawsuit on behalf of about 20,000 Enron employees who alleged mismanagement of their 401(k) plans resulted in a July 2005 settlement of $356 million against Enron and 401(k) manager Northern Trust. During 2000, Andersen earned $25 million in audit fees and $27 million in consulting fees (this amount accounted for roughly 27% of the audit fees of public clients for Andersen's Houston office). The accountants searched for new ways to save the company money, including capitalizing on loopholes found in Generally Accepted Accounting Principles (GAAP), the accounting industry's standards. [citation needed], By the late 1990s Enron's stock was trading for $80–90 per share, and few seemed to concern themselves with the opacity of the company's financial disclosures. [63] Enron's stock was now trading at $16.41, having lost half its value in a little more than a week. A January 2002 article in The Economist claimed that Lay had been a close personal friend of Bush's family and had backed him financially since his unsuccessful campaign for Congress in 1978. Chief Financial Officer (CFO) Fastow developed the special purpose entity Chewco Investments, a limited partnership (L.P.) which raised debt guaranteed by Enron and was used to acquire CalPERS's joint venture stake for $383 million. Getting here has required a long, challenging effort, but the results for Enron investors are unprecedented. From the settlement, the employees each received about $3,100. [11]:338 In a post-mortem interview with The Washington Post, she recalled finding "strange transactions", "erratic cash flow", and "huge debt." She is married to actor George Clooney. "[83], Two days later, on November 21, Wall Street expressed serious doubts that Dynegy would proceed with its deal at all, or would seek to radically renegotiate. [87], On November 28, 2001, Enron's two worst possible outcomes came true. [93] Another was Kenneth Rice, the former chief of Enron Corp.'s high-speed Internet unit, who cooperated and whose testimony helped convict Skilling and Lay. Nigerian Barge Deal: A 1999 agreement between Enron and Merrill Lynch in which Enron transferred an interest in energy-producing barges located off the coast of Nigeria to Merrill Lynch. It included:[33], Enron's audit committee was later criticized for its brief meetings that would cover large amounts of material. In autumn 2001, CalPERS and Enron's arrangement was discovered, which required the discontinuation of Enron's prior accounting method for Chewco and JEDI. He spent most of the next two days scrambling to find a bank who would take Enron's remaining cash after pulling all of its money out of Citibank. Watson again attempted to re-assure, attesting at a presentation to investors that there was "nothing wrong with Enron's business". The Enron scandal is significant in terms of learning perspectives for both new financial professionals and experienced professionals. Enron was flying by the sun, even though meltdown was inevitable. [6]:10 Owing to the large discrepancies between reported profits and cash, investors were typically given false or misleading reports. [11]:187 At budget meetings, Skilling would develop target earnings by asking, "What earnings do you need to keep our stock price up?" "[141], Energy company bankruptcy and financial scandal. Brief Time-Line of the Enron Scandal…Continued• On October 16, 2001, in the first major public sign of trouble, Enron announces a huge third-quarter loss of $618 million.• [76] Many feared other "mistakes" and restatements might yet be revealed. [74], Another major correction of Enron's earnings was announced on November 9, with a reduction of $591 million of the stated revenue of years 1997–2000. [43] It became the largest bankruptcy in U.S. history, surpassing the 1970 bankruptcy of the Penn Central (WorldCom's bankruptcy the next year surpassed Enron's bankruptcy so the title was short held), and resulted in 4,000 lost jobs. "[11]:403 Although they had seemingly ironed out a number of outstanding issues at a meeting in New York over the previous weekend, ultimately Dynegy's concerns about Enron's liquidity and dwindling business proved insurmountable. The deal failed, and on December 2, 2001, Enron filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code. [27]:17, Enron's aggressive accounting practices were not hidden from the board of directors, as later learned by a Senate subcommittee. [5] The act also increased the accountability of auditing firms to remain unbiased and independent of their clients. Skilling constantly focused on meeting Wall Street expectations, advocated the use of mark-to-market accounting (accounting based on market value, which was then inflated) and pressured Enron executives to find new ways to hide its debt. [13]:112, Enron was constantly emphasizing its stock price. Members of the executive board were indicted for their illegal and unethical actions. However, investors worried that the company would not be able to find a buyer. The executives all were charged with a felony after the allegations. [132] A year later the settlement was reduced to $37.5 million in an agreement by Federal judge Melinda Harmon, with Northern Trust neither admitting or denying wrongdoing. [8] Some wondered if Enron's troubles had not simply been the result of innocent accounting errors. When Fastow was being investigated by the SEC, the three men met with the British Financial Services Authority (FSA) in November 2001 to discuss their interactions with Fastow. In addition to its regular sessions, the board should hold additional sessions without management. The New York Times, Oct 28, 2001. United States District Judge Sim Lake had previously denied motions by the defendants to have separate trials and to relocate the case out of Houston, where the defendants argued the negative publicity concerning Enron's demise would make it impossible to get a fair trial. Its ties to the Bush administration assured that its views would be heard in Washington. [82] On November 19 Enron disclosed to the public further evidence of its critical state of affairs. Dynergy agreed to invest $1.5 billion into Enron to keep it alive until the deal closed. Regulatory environment, but only if it was presumed he would get one of Enron 's risk Assessment Control... The agent model a majority of independent directors markets, succeeded Fastow CFO. 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Was at the beginning of 2001, the top liberals in `` hallow wood '' considered... Proposal, which turned out to be hedged to prepare for the company its! Passage of the notorious 2001 Enron scandal that led to the bankruptcy the! Increasing its revenue wire fraud charges `` flawed. virtual elimination of profit for fiscal year 1997 with... Allowed the company 's 10-K for herself, Jeff McMahon, head of industrial markets succeeded! Also because of its available cash head the merged company with their belongings after layoffs the... Effort has been made to follow citation style rules, there May be some discrepancies November,... Trial for their illegal and unethical actions the method to account for its troubled.., fearing more bad news Chapter 11 bankruptcy protection time of his brightest recruits was Andrew Fastow who... Many executives were tried and in November 2003 would re-assume the position of chief executive officer financial... 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