The Enron Scandal & Ethics
Few names in American business are so synonymous with scandal and corruption as that of Enron. Even those who don’t understand the basics of the story know one thing – Enron means bad business. Today, Enron’s a case study in ethics and the story of one of the biggest frauds in American history.
At its simplest, the Enron scandal is about fraud, the complexities of deregulation and a system that rewards companies for how they look on paper. Of course, it goes far deeper than that, because it’s also a story about how millions of people lost their savings by buying stock in a company that many deemed was too big to fail. It’s also about how the watchers at the gate, including accounting firms like Arthur Andersen, can be wilfully complicit in turning the other cheek to inflated numbers on balance books, because greed is a mighty motivator.
At its height, Enron was America’s seventh-largest company. Even now, people struggle to understand what Enron really did, since they didn’t have a straight product to sell, like, say, Apple. Enron essentially created the way energy is traded on public markets. There was no framework for this before Enron engineered one. What happened next was their hubris got in the way, because if they could trade something so intangible as energy, why not trade everything?
Turns out that wasn’t such a great plan, because failures began mounting. That’s where Jeff Skilling's accounting wiles came to the creative rescue – Enron invented partner companies through which they could offset or hide their losses, leaving the stock market’s darling looking great on paper. But, after a meteoric rise from Enron’s inception in 1985, the year 2001 finally brought scrutiny and skepticism. With the SEC and others poking holes in the veil of Enron’s lies, soon the whole facade was exposed and a cautionary tale for the ages was writ.
In the 1980s, Wall Street rejoiced as deregulation (especially surrounding energy) meant markets opened and became freer. This allowed for all kinds of new, innovative trading for those who saw the potential. By the 1990s, the "dot-com bubble" was growing wildly with share values commonly being padded to wow and woo investors.
If a company looked solid on paper, it performed well in the market, which was where Enron got its juice. It was CEO Jeff Skilling who decided to change Enron’s accounting approach from the traditional historical cost accounting method to the mark-to-market (MTM) method, and this changed everything, helping the company to reach its stratospheric heights of over $90 a share in August 2000 (and which would plunge to $0.26 a share by December 2001).
MTM accounting is legitimately used by many companies on a regular basis, but it’s easily misused by those looking for something to hide, like Enron. As Investopedia explains, “The method can be manipulated, since MTM is not based on 'actual' cost but on 'fair value,' which is harder to pin down. Some believe MTM was the beginning of the end for Enron as it essentially permitted the organization to log estimated profits as actual profits.” Basically, this method meant Enron could count projected long-term energy contract earnings as current income, thus cooking their books, which was one of the key Enron ethical issues.
When all was done and dusted, the estimated losses from the Enron scandal clocked in around $74 billion. Around 4,500 people lost their jobs, many receiving little in their settlements, most capping out to a max of $13,500.
Execs, however, scandalously cleaned out the coffers in 2000, paying themselves bonuses as the company's collapse loomed, leaving little to nothing for tens of thousands of investors who lost billions.
Several executives faced and were convicted of charges of wire fraud and securities fraud in the Enron scandal. The biggest names were Kenneth Lay, Jeffrey Skilling and Andrew Fastow.
- Kenneth Lay: In 1985, Enron was formed as a result of a merger between Houston Natural Gas Company and Omaha-based InterNorth Incorporated. Kenneth Lay transitioned from being the CEO of HNG to leading Enron. Lay was convicted for his role in engineering the massive fraud but died of a heart attack before sentencing.
- Jeffrey Skilling: CEO of subsidiary Enron Finance, Jeff Skilling abruptly resigned in August 2001, just as the cracks began to show in the parent company’s brazen schemes. He was arrested in 2004 and sentenced to 28 years in prison. In 2013, a series of negotiations led to his term being reduced to 14 years. He was released in February 2019 and began making immediate waves as reports emerged of the 65-year-old ex-con’s efforts to try to return to the energy sector.
- Andrew Fastow: After cooperating with authorities and providing evidence, former CFO Fastow was found guilty and sentenced to five years in prison in 2006. He was released in 2011.
Some may look at the jail time served by some Enron leaders as being the consequence of that scandal, but others lost their retirement savings and saw their entire lives transformed because they believed news headlines about Enron being America’s “most innovative company” and bought shares. Tens of billions of dollars were lost, lives altered, investor confidence shaken and laws changed, all because a few executives let their egos get in the room when doing the accounting. The question that comes up, even now, is to whom is a company responsible? The public, the investors, the employees, themselves?
Whatever the answer, eventually Enron failed them all. It often comes down to the premise that just because something is legal doesn’t mean it’s ethical. Sure, the MTM accounting method is used in responsible, pragmatic ways daily, by all kinds of ethical companies, but it was also used by the likes of Enron to dupe millions of investors out of their life savings. As that happened, the seeming on-paper successes allowed Enron’s execs to pay themselves ludicrous bonuses even as the end was drawing near. Kenneth Lay alone cashed in on over $152 million in bonuses in 2000, just as the farce was beginning its end.
The complexities of what was legal versus ethical is why Enron will remain a lesson in business classes for decades to come. And the scandal opened the door to new, critical laws, as Encyclopedia Britannica explains, “The most important of those measures, the Sarbanes-Oxley Act (2002), imposed harsh penalties for destroying, altering, or fabricating financial records. The act also prohibited auditing firms from doing any concurrent consulting business for the same clients.”
If the Enron scandal continues to fascinate you, you’re not alone. For a far deeper dive, check out the book "Enron: The Smartest Guys in the Room" by Fortune Magazine reporters Bethany McLean and Peter Elkind, or watch the fantastic documentary of the same name by director Alex Gibney.