Enron Bankruptcy: An accounting fraud

Enron Formed after Merger Enron was formed in 1985 following a merger between Houston Natural Gas and Omahabased InterNorth. Kenneth Lay, who had been the chief executive officer (CEO) of Houston Natural Gas, became Enron's CEO and chairman, and quickly rebranded Enron into an energy trader and supplier. Deregulation of the energy markets allowed companies to place bets on future prices, and Enron was poised to take advantage. Enron Named America's Most Innovative Company By 1993, Enron had set up a number of limited liability special purpose entities that allowed Enron to hide its liabilities while growing its stock price. Analysts were already criticizing Enron for "swimming in debt," but the company continued to grow developing a large network of natural gas pipelines, and eventually moving into the pulp and paper and water sectors. Enron was named "America's Most Innovative Company" by Fortune for six consecutive years between 1996 and 2001. Misleading Financial Accounts Creative accounting allowed Enron to appear more powerful on paper than it really was.Special purpose entities subsidiaries that have a single purpose and that did not need to be included in Enron's balance sheet were used to hide risky investment activities and financial losses. Forensic accounting later determined that many of Enron's recorded assetsand profits were inflated, and in some cases, completely fraudulent and nonexistent. Some of the company's debts and losses were recorded in offshore entities, remaining absent from Enron's financial statements. During the late 1990s and into the early 2000s, more and more special purpose vehicles were created that allowed the company to keep debts off the books and inflate assets. These entities, along with other accounting loopholes and poor financial reporting, let Enron ultimately hide billions in debt from special deals and projects. (For more on corporate disclosure, read The Importance of Corporate Transparency.) Sell-Off In August of 2001, shortly after the company achieved $100 billion in revenues, then-CEO Jeff Skilling unexpectedly resigned, prompting Wall Street to question the health of the company. Kenneth Lay once again took the helm, and both Lay and Skilling, in addition to other Enron executives, began selling large amounts of Enron stock as prices continued to drop from a high of about $90.00 per share earlier in the year, to less than a dollar. The U.S. Securities and Exchange Commission (SEC) opened an investigation. (For more on the structure of the commission, check out Policing The Securities Market: An Overview Of The SEC.) Dec. 2, 2001 Less than a week after a white knight takeover bid from Dynegy was called off, Enron filed for bankruptcy protection. The company had more than $38 billion in outstanding debts. In the following months, the U.S. Justice Department initiated a criminal investigation into Enron's bankruptcy. Several Enron executives and Enron's auditor firm, Arthur Andersen,

have since been indicted for a variety of charges including obstruction of justice for shredding documents and conspiracy to commit wire and securities fraud, and some have been sentenced to prison. New Regulations 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 of 2002, President Bush signed into law the Sarbanes-Oxley Act, intended to "enhance corporate responsibility, enhance financial disclosures and combat corporate and accounting fraud." (For more on the 2002 Act, read How The Sarbanes-Oxley Act Era Affected IPOs.) The Act heightened the consequences for destroying, altering or fabricating financial records, and for trying to defraud shareholders. Enron Creditors Recovery Corp. 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 Corp (ECRC) to reflect its sole mission: "to reorganize and liquidate certain of the operations and assets of the 'pre-bankruptcy' Enron for the benefit of creditors." The board wishes to "obtain the highest value from the company's remaining assets and distribute the proceeds to the company's creditors." After ECRC has finalized "outstanding litigation and monetized all of assets, it will make a final distribution to creditors," and the company "will cease to exist." Conclusion At the time of Enron's collapse, it was the biggest corporate bankruptcy ever to hit the financial world. Since then WorldCom, Lehman Brothers and Washington Mutual have surpassed Enron as the largest corporate bankruptcies. 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. The Sarbanes-Oxley Act has been called a "mirror image of Enron: the company's perceivedcorporate governance failings are matched virtually point for point in the principal provisions of the Act." Increased regulation and oversight have been enacted to help prevent or eliminate corporate scandals of Enron's magnitude