Enron Scandal Explained

Enron was formed in 1985 by merging Houston Natural Gas Company and InterNorth Incorporated. Kenneth Lay became Enron’s CEO and chairman. Following the merger, Enron was branded as an energy trader and supplier. In 1990, Lay appointed Jeffrey Skilling to head the company. Enron, at one point valued 70 billion dollars, used to be the seventh largest corporation in the US. At Enron’s peak, its shares were priced at 90.75 dollars; in 2001 just prior to declaring bankruptcy, they were trading at 0.26.  Many people wonder how such a powerful business disintegrated almost overnight.

In 2000, Enron started crumbling under its own weight. Instead of making changes or coming clean, the company used mark to market accounting to hide its losses. Under this method, a company can record its assets on a company’s balance sheet at their fair market value instead of the book value. Profits could also listed as projections rather than their actual numbers.

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For example, Enron would build a powerplant and record the projected profit immediately on its books even if the profit had not yet been made. But if the plant’s revenues were less than what was predicted in the books, Enron would transfer it to an off the record corporation. The loss went unreported. The company used special purpose entities (SPEs) also known as special purpose vehicles (SPVs) to hide its losses. The existence of SPEs was hidden from the investors although they were capitalized entirely from Enron stock. SPEs would borrow on behalf of Enron and would cut all ties with the SPE when it went bankrupt.

By the April of 2001, analysts started having suspicions about the company. Questions were being raised whether the company was profitable. Soon, the Securities and Exchange Commission of the US government started investigating. It discovered that Enron was 591 million dollars in losses and 628 million dollars in debt. Enron had completely collapsed. Shareholders lost 74 billions in the four years leading to the bankruptcy of the company and many lost their jobs.

Several of the company executives faced criminal charges. The havoc created by this scandal led to new rules in the legislation to promote accuracy in financial reporting. In July 2002, the Sarbanese-Oxley Act was signed into law by President George Bush.

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