The biggest fraud ever in history of business! Why a company from $101 Billion filed bankruptcy in just 1 year?

Case Study on Enron Corporation, one of the America’s Most Innovative Company reached dramatic heights only to face a big fall. How one of the largest companies in US fall into pieces overnight?

A brief introduction about Enron:

Enron corporation was an American Energy, Commodities and Service Company based in Huston, Texas. Founded in 1985 following a merger between Huston Natural Gas & InterNorth.

Huston Natural gas corporation was gas pipeline company acquired by InterNorth, a Nebraska pipelined company.

The combination would create a giant energy corporation with the nation’s second largest natural gas pipeline system, stretching from Canada to the Texas Panhandle and from California to Florida.

Following the merger, Kenneth Lay, Who had been the chief executive officer ( CEO ) of Huston Natural Gas, became Enron’s CEO and chairman.

The Valhalla Scandal : How Two Employees Made Millions?

In 1987, two top executives Louis Borget ( President of Enron Oil Trading ) & Tom Mastroeni ( The treasurer ) plead guilty to charges of fraud and filing false tax returns. Louis Borget and Mastroeni had been called to answer charges of opening undisclosed bank accounts to conduct unauthorised transactions.

Laid had already heard a bit about the controversy. He again skimmed an Internal audit. The essence of the matter concerned on account opened by Enron oil trading (EOT) at the Eastern Savings Bank. They were the authorised signatory on the account but had failed to report its existence to Enron Houston Headquarter.

Millions of dollars from Enron Oil Trades(EOT) had found their way into this account. More worrisome, some $2 Million had then been transferred into Mastroeni’s personal account at the same bank.

Borget and Mastroeni had Enron Oil Trading(EOT) engaging in unauthorised and fictitious trading, skimming money for personal game.

1990, The turning point

Enron launches plan to expand US gas natural abroad. Kenneth Lay and Rich kinder hire Jeff Skilling from McKinsey & Company to become of Enron gas services.

Enron gas eventually morphs into Enron Capital & Trade Resources (ECT). Here Jeff skilling hires Andrew Fastow from the banking industry as an account director. He was well acquainted with the burgeoning deregulated energy market that Skilling wanted to exploit.

1991–2000, Why their financials were showing Continuous Profit?

Enron adopts Mark to Market Accounting for which the company received official SEC Approval. An accounting method of the fair value of an asset or liability based on the current market price, or the price for similar Assets and liabilities, or based on another objectively assessed fair values.

In simple words Transactions or Deals were recorded in the books on the day of transaction, no matter whether the deal is done or not.

Though its use is considered to be one of the reasons for the Enron’s scandal and eventually bankruptcy of the company as well the closure of the accounting firm Arthur Anderson ( the firm behind Enron’s accounting ).

Enron invested heavily in overseas assets, specifically energy. Another major shift was the gradual transition of focus from a producer of energy to a company that acted more like an investment firm and sometimes a hedge fund.

In 1993, Fastow begin establishing numerous limited liability special purpose entity a common business practice in the energy industry. However this allowed Enron to transfer liability so that It would not appear in its accounts, allowing it to maintain a robust and generally increasing stock price and thus keeping its critical investment grade credit ratings.

Enron became Americas most Innovative Company

In 1999 Enron created Enron Online (EOL), an electronic trading website that focused on commodities. To tempt participants and trading partners, Enron offered its reputation, credit and expertise in energy sector. Enron was praised for its expansion and ambitious projects, and it was named “Americas Most Innovative Company” for six consecutive years (1996–2001) by Fortune.

In 2000, How the stock price took a Flight?

In January 2000, Kenneth lay and Jeffrey Skilling announced to analyst that they were going to open trading for their own “high speed fibre optic network that form the back support for internet traffic”. After the announcement, investors quickly bought Enron stock. Leading to $40 stock prices rising from $40 per share in January to $70 per share in March, peaking at $90 in the summer of 2000.

Enron executive started selling their stocks. With total of $924 Million of stocks sold by high level Enron employees between 2000 and 2001. When dot-com bubble began to burst, Enron decided to build high speed broadband telecom network. Enron purchased the in-active dark fibres to fulfil increase in the need of internet. Enron accounting would use estimates to determine how much of dark fibre would be worth when “lit” and apply those estimates to current income, adding exaggerated revenue to their accounts. Since transactions were not yet made and it was not known if the cable would ever be active.

How the brightening sun moved to eclipse?

In Feb 2001 Lay announced his retirement and named Skilling president and CEO of Enron. By the second quarter of 2001, Enron broadband services was reporting losses. On March 12, 2001 , a proposed 20 year deal between Enron and Blockbuster Inc. to stream movies on demand over Enron’s connections was cancelled, with Enron’s shares dropping from $80 per share in mid-February to below $60 the week deal was cancelled.

On August 14 , just six months after being named CEO, skilling himself resigned, citing “Personal reasons”. The stock price slipped below $40 that week and, except for a brief recovery in early October after the sale of Portland General, continued its slides below $30 a share.

By October 16, the company reported its first quarterly loss in more than 4 year after taking charges of $1billion on poorly performing businesses. The company terminated the “Raptor” SPV so that they would not have to distribute $58 Million shares of stocks, which would further reduce earnings. It also disclosed the reversal of the $1.2 billion entry to assets and equities it had made as a result of dealigns with these arrangements. It was the disclosure that got SEC’s attention.

On October 22, Enron announced the SEC was looking into the related party transactions between Enron and the partnership owned by Fastow, who was fired two days later. On November 8 Enron announced a restatement of its financial statements back to 1997 to reflect consolidation of the SPEs it had omitted, as well as the book Andersen’s recommended adjustments from those years, which the company had previously “deemed immaterial.” The restatement resulted in another $591 million in losses over the four years as well as an additional $628 million liabilities as the end of 2000. The equity markets immediately reacted to the restatement, driving the stock price to less than $10 a share. One analyst’s reported stated the company had burned through $50 billion in cash in 50days.

On November 30 the stock closed at an astonishing 26 cents a share. The company filed for bankruptcy protection on December 2.

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