Enron Corporation Essay

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When Enron Corporation filed for bankruptcy under Chapter  11 protection on December  2, 2001, it was valued at over $60 billion, thus achieving the notoriety of being the largest U.S. corporate  failure at that time. The exemplar  of American  commercial  enterprise became a byword for corporate malfeasance.

Enron was brought  into being by Chief Executive Officer Kenneth  Lay in 1985 from an amalgamation of Houston Natural Gas (HNG), of which he was previously CEO, and InterNorth of Nebraska. The new corporation’s business was centered  on some 37,000 miles of natural  gas pipelines and supply contracts. Until the late 1980s, gas pipeline operators  were required  to be buyers and resellers of natural  gas as well as  transporters of  the  product.   Deregulation motivated Enron to remove the constraints  of entering into purchase contracts  and reduce their involvement to transportation and tolling. In 1988, a meeting of top executives was told by Lay and his vice chairman Richard Kinder that far from harming their business, deregulation should provide the impetus for reengineering their business.

By 1990, a review of their corporate  business strategy led to a reprofiling of the corporation. Some noncore businesses were sold off and the business was relabeled as an energy provider. In reality, this was a move from their previous conservative strategy of developing trading opportunities from a capital asset base to becoming an energy trading entity with capital assets.

This business  transformation  was led  by Jeffrey Skilling, who joined Enron in 1990 from the consultancy business of McKinsey and Co., where he had been senior partner of their energy business. He came with his strategy to turn  Enron into an “asset-light” organization, fueling expansion through financial trading.  From using their  “Gas Bank” to fulfill contractual obligations, their trading from 1992 might be better  considered  as derivative trading,  since Enron was more  involved in creating  energy and financial markets than selling either products or services.

From its foundation, Enron was saddled with substantial  debt  inherited  from  HNG  and  InterNorth. This was increased in 1988 to buy out some 16 percent of the shareholding held by Irwin Jacobs, a major investor in InterNorth, and later investors, who had threatened to  mount  a takeover  bid for the  young Enron. This raised their debt-to-capital ratio to some

75 percent, making the corporation a poor investment risk. Through refinancing, this ratio was reduced, but keeping debt and losses off their consolidated balance sheet eventually led to Enron’s collapse. This was not helped  by some of Enron’s less successful ventures, such as Azurix (water/utilities)  and Elektro Eletricidade e Servicios (Brazilian electricity utility).

Enron  also invested  in the  internet,  buying into RhythmsNetConnections, an independent internet service provider (ISP). While developing a means of hedging following their initial public offering (IPO), Andrew Fastow, who was promoted  to chief financial officer (CFO) in 1998, set up the first LJM entity. This was an investment vehicle formed by his family (their initials) that became an integral part of Enron’s SPEs (special purpose  entities).  Earlier SPEs, such as the Cactus Fund, were legitimately used to create trading liquidity in gas markets. The later SPEs, such as the Raptors and Talon partnerships,  became vehicles for “off balance sheet” accounting,  avoiding the consolidation of debt, risk, and losses.

Two other  Enron  ventures  also need to be mentioned,  since they contributed to a shift in Enron’s reputation with the  public and  investors.  First was the  trade  in  electricity  supplies  in  California.  By using their expertise to play the deregulated markets in 1997–98, as the largest power trader,  Enron  was able to make substantial profits during a crisis period, mostly at the expense of consumers.  It was reported that they generated profits of $1.5 billion before suddenly leaving the market.

The other  venture  was EnronOnline,  which  was launched in 2000 and where using their strong technical expertise, Enron was able to take advantage of the boom in dotcom  technology. The online market created  was primarily a tool for their  own business rather than as an open or third-party online marketplace. They were able to increase their trading capacity through  the  immediacy  of this internet  trading. However,  the  growth  in  liquidity  of their  trading, with the reduction in timescale, now meant that deals were smaller and standardized for simplicity and thus subject to a much decreased profit margin. Whether this influenced the change in trading practice or was a product  of practices that were already undergoing change is open to debate.

In February 2001 Jeffrey Skilling became chairman of Enron, a post he held for only six months  before resigning on August 14 and returning  the responsibility to Ken Lay. The following day, Lay received an anonymous  letter that later transpired  to have originated from Sherron  Watkins, who worked in Enron as an accountant for their  SPEs. She expressed  her concerns  for their  insubstantial  collateral  and  their tax implications.  Lay met  with Watkins  and subsequently took legal advice from Enron’s lawyers, Vinson and Elkins.

Enron’s  stock  value  continued   to  fall,  so  Lay made efforts to appease the financial community  by explaining  Enron’s income  and  disengaging  Fastow from their SPEs. However, he and several other Enron executives had been selling their stock since 1999 and continued  to do so while aware of the corporation’s serious financial problems.

On October  19, the Wall  Street Journal revealed that  Fastow  had  made  a profit  of over  $7 million from  his SPE activities. This prompted  the  Securities and  Exchange Commission  (SEC) to announce an investigation into these activities. Enron immediately replaced Fastow as CFO and appointed  Jeffrey McMahon  to replace him. Shortly thereafter,  Enron restated  its earnings  downward  by $0.5 billion and increased its debt by $2.6 billion.

Dynergy opened  a bid to buy Enron  on November  9, supported  by Chevron  Texaco,  though  they pulled out of the deal three weeks later following an announcement of a further $700 million loss. Enron’s credit rating crashed to the extent that on December 2 they filed for bankruptcy under Chapter 11 protection. On January 23, 2002, Lay resigned. A report  by William Powers following an inquiry by Enron’s Special Investigation  Committee  blamed  Lay, Skilling, and  accounting  firm Arthur  Andersen  for the  collapse. A subsequent  hearing found Arthur Andersen, Enron’s auditors, to be guilty of obstruction of justice for shredding  documents  while aware of a pending investigation by the SEC.

In May 2006, Lay and Skilling were found  guilty of fraud and conspiracy, although Lay died of a heart attack six weeks later and his conviction was quashed. Skilling was sentenced to 24 years in prison and Fastow to seven years, with lesser sentences handed out to  others.  Enron  stockholders  are  still working  to minimize their losses.

Bibliography:   

  1. Stephen Arbogast, Resisting Corporate Corruption:  Lessons in  Practical Ethics from  the  Enron Wreckage (Scrivener, 2008);
  2. Robert L. Bradley, Corporate Social Responsibility  and  Energy:  Lessons From  Enron (Institute  for Study of Economics  and  the  Environment, Lindenwood University, 2008);
  3. Kurt Eichenwald, Conspiracy of Fools: A True Story: Collapse of the Enron Corporation: Hearing Before the Committee on Commerce, Science, and Transportation (U.S. G.P.O., 2005);
  4. Gladwell, “Open Secrets: Enron and the Perils of Full Disclosure,” New Yorker (January 8, 2007);
  5. Helman and D. Fisher, “Crime Pays the Enron Trial Will Have One Happy Result: For the Market Value of the Prosecutors,” Forbes (v.177/13, June 19, 2006);
  6. John Kroger, Convictions: A Prosecutor’s Battles Against Mafia Killers, Drug Kingpins, and  Enron Thieves (Farrar, Straus,  and  Giroux,  2008);
  7. Bethany McLean  and  Peter Elkind, “Enron Diary,” Fortune (v.153/4, 2006);
  8. Powers, Jr., Report of Investigation by the Special Investigative Committee of the Board of Directors of Enron Corp. (February 1, 2002);
  9. Malcolm S. Salter, Innovation Corrupted: The Origins and Legacy of Enron’s Collapse (Harvard University Press, 2008).

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