Enron: The Smartest Scandal of the World

This story is about how a prominent company with a remarkable share value got bankrupt within 24 hours.

This has been the greatest, the smartest, the destructive, and the complex scandal of any corporation that ever existed in America.

Keep in mind that this Blog is going to touch only the highlights of the whole scandal. To know everything in detail you should read the book, “The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron”.

Get Book

One of the must-read books for Entrepreneurs. This book covers in detail everything you would ever want to know about this scandal.

More specifically this book will tell you some most important Business Lessons like Money-Making, Ethics, Greed, Corporates Truth, and much more.

Do read it!

So, let’s dive into the scandal.

In case you want to watch a video on Enron Scandal, check out below.

Two giants Houston Natural Gas Company and InterNorth Incorporated merged together to give birth to Enron, in 1985. The initial names of the company were HNG/InterNorth Inc. & Enteron.

Kenneth Lay or Ken Lay in short was the Chief Executive Officer (CEO) of this merger was. Ken’s father was a Baptist Priest. His family was poor. As a child, he always wanted to make money to keep poverty away from doors. This money-making attitude of Ken resulted in the Scandal. You’ll know-how.

Formation of Enron

Enron started as an energy supplier, mainly dealing with natural gas. This energy supply was a regulated sector, where the government was the controller of each & every act. As a result, Ken felt that the scope to make money was limited.

This regulation resulted in a shift in the company led by Ken. Enron was now an energy trader & supplier, the main focus on online trading. This step was taken by Ken as Energy Trading was unregulated where market forces (demand & supply) would decide prices.

Enron launched Enron Online where just like other commodities (securities), energy can be traded online. That’s how Enron introduced Energy Trading to the world.

In 1997, two traders in the company were shifting money to fake accounts. They used to manipulate earnings & gamble trades beyond the capacity. This was affecting the whole online trading market, delivering money as a by-product of the company. This offense was observed & reported by auditors to Ken. Rather than taking strict actions against them, Ken appreciated them through a letter. Above all, he asked them to make gazillions for the company. As a result, this whole is often called Valhalla Scandal and this was the beginning of the later, Enron Scandal.

After some time the two traders were convicted of fraud & sent to prison. Ken in his statement said that he wasn’t aware of this gamble & secured himself.

Now, Ken was worried not for the fact that he knew about the traders. Instead of the money, as his moneymakers were exposed.

Here comes the most important architect of this whole scam, Jefferey Skilling.

Ken hired Jeff as the Chief Finance Officer (CFO) for Enron, who later served as CEO. On the other hand, Ken became the Chairman. Ken knew about Jeff’s intelligence. He was impressed with his previous work & thought that Jeff could be the one who can help him make gazillions.

Jeff introduced Mark-to-Market (MTM) Accounting in the company. MTM empowers business firms to record revenue of the deals in books irrespective of whether they have been received or not.

For Example

If the company used to sign a deal of $10 lakh for 5 years which will deliver revenue of let’s say $3 lakh in the future then the company would record this revenue in the books of accounts ignoring the fact whether the deal may collapse before the period or the money actually received from the deal.

Once MTM Accounting was approved by the Securities & Exchange Commission (SEC), Enron celebrated. Both, Ken and Jeff knew that the door to make millions was open now.

The Enron Scandal Beginning

The Company with Andy Fastow the then CFO used to manipulate the figures in accounts using MTM. They used to reflect whatever they wanted to. They used Special Purpose Entities (SPEs) to hide the mountain of debt (loan) & other toxic assets from the investors & creditors. Further, Enron used to act as a buyer for its own shares behind the back of some fake entities. It used to transfer money to other accounts that were owned by the company itself in unique names. The Company’s worth was astounding on paper. Due to which its stock price was always rising & hence the company became The Darling of Wall Street.

Jeff believed that greed & competition motivates human nature. To active the same instincts among the company employees, he introduced a grading system for employees. Employees used to be graded at a scale of one to five. One being the best & five being the worst. All those with grade five were fired from Enron. One unbelievable fact was that employees weren’t aware of Enron’s dark side.

One of the mysterious men of Enron was Lou Pai. He was the CEO of Enron Energy Services & Enron Xcelerator for some time. He was only interested in money & strippers. Moreover, he left Enron in 2001 with $215 million before the company’s fraud started being noticed by the world.

In addition to Ken, Jeff, Andy the other major confederate was Arthur Anderson with his accounting firm. Arthur’s accounting firm Arthur Anderson LLP was among the five largest accounting firms of America at the time. They used to audit Enron’s accounts. Despite the faulty accounting practices of Enron, Arthur gave a green signal to them in exchange for a weekly payment of $1 million.

The beautiful but illusionary picture of Enron was increasing its stock price at a great pace. Every investor used to invest in Enron.

The first person skeptical of Enron was John Olson, an analyst. He couldn’t believe that a company can grow so rapidly that too in the energy sector. His gut feeling objected that Enron was indulged in some kind of illegal activity. Olson’s action made Enron’s top executives cautious. They made Oslon lost his job at Merrill Lynch, rewarding Lynch with 2 investment banking jobs worth $50 million each.

Wiping Olson from their way, executives were now diversifying & expanding Enron into electric plants, broadband services, etc. Enron invested in Electricity Plant in developing countries like India, Philippines & Indonesia. They ignored the fact that the poverty rate was high in these countries & nobody could afford electricity. This mistake cost a lot of millions to Enron. Other businesses like broadband services were also not successful. Despite the losses, they recorded profits in books.

In early 2001, Fortune Magazine mentioned Enron at the first in the list of Top 100 Companies to Work for in the world.

Soon after this, a reporter at Fortune asked Jeff Skilling, “How exactly Enron make money?”

Jeff replied that he couldn’t answer as he wasn’t an accountant. He sent a few accountants & Andy Fastow to meet the reporter & answer her questions.

At the end of the conversation, Andrew said to the reporter, “I don’t care what you write for Enron but don’t make us look bad.”

In order to recover losses, Enron merged with Pacific Gas & Electric Company to get access to California’s electricity. Enron traders were again manipulating the market by rolling frequent blackouts. They used to moved electricity out of state & move it back in again, once demand leads to high prices. This way Enron executives filled their pockets with money. The government didn’t intervene in this issue as at that time George Bush, the good friend of Ken was the president.

Jeff was a prodigy. In 2001, he saw something dangerous with the company’s numbers. His gut feeling was saying that Enron is gonna boom. On 14 th August 2001, Jeff Skilling resigned as the CEO of Enron claiming some personal issues as the reason. Ken Lay took back the charge of Enron CEO.

Scandal Gained visibility

After Jeff’s resignation, Sharon Watkins who worked under CFO Andy informed Ken about the staggering amount of corruption & offenses that she had found within the company. By 16 October 2001, Enron reported its first-ever loss. This Loss made all stakeholders, especially investors & employees in trouble. The stock price of Enron also falls from $90.75 to $39.95. The market was also closed at the time & was opened when each stock worth $9. Enron’s top executives didn’t allow their employees to sell and avoid investing in Enron stocks. Although they secured themselves by selling their own stocks.

Soon after on 31st October 2001, the investigation by the Securities & Exchange Commission (SEC) began. The SPEs developed by Andy was investigated & loopholes came into the light. SEC started inquiring with Ken & Jeff taking the company’s middle-level executives into the discussion. Cross questioning started unveiling all the curtains of faults. Every crack was very much visible now.

On 2nd December 2001, Enron became bankrupt its stock price at $0.26. The irony is that still, the company was at the fifth position of Fortune Magazine list of Top 100 Companies to Work for.

Enron Scandal Results

The Day Enron Scandal came into the picture various cracks were very much visible.

  • 29,000 Employees losing their jobs
  • Arthur Anderson LLP, one of the greatest accounting firms collapsed
  • Andy convicted of wire fraud
  • Ken Lay was found guilty of 10 counts of securities fraud & 45 years of prison in contrast before sentencing, he died of a heart attack
  • Jeff Skilling was convicted of 19 counts of security & a wire fraud with 24 years of prison and $180 million in fines
  • 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 Financial Accounting Standards Board (FASB) substantially raised its levels of ethical conduct.

Final Words

Jeff Skilling has come back from prison. He has started to reconnect with his connections & Lou Pai is helping him. Above all, he has started something once again in the energy sector.

This could be Enron 2.0.

Again, to understand the Scandal better I’ll recommend you to read the book written on it, The Smartest Guys in the Room. That’ll help you to understand even the minutes of the Enron Scandal Case Study.

That’s all for this blog.

I hope you enjoyed it. We’ll meet in the next blog.

What’s Your take on this Blog? Comment below👇 It’ll take just 2 minutes of your time.

Till then…

Happy Reading!!

Any Feedback, Suggestions, or Questions are welcome 🙂

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Hey 😄 I am Dhruv Singla. I create YouTube Videos and write Blogs. The sole aim of this is to help all of us. Check out ‘BeingDhruv’ on YouTube.

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Dhruv Singla

Dhruv Singla

Hey 😄 I am Dhruv Singla. I create YouTube Videos and write Blogs. The sole aim of this is to help all of us. Check out ‘BeingDhruv’ on YouTube.

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