A scandal of epic proportions: ENRON.
The mother of all financial scandals. The biggest, most disgusting, greed driven, humanity despising financial scandal the world has witnessed in modern times. Enron, the number one electricity trader. The company able to make or break electricity prices. A company so full of itself, so rotten from its way it conducted business to the way it treated its staff, Enron, the company that would destroy you for a dollar. And dear oh dear, Enron did destroy, not just people's lives, they destroyed themselves and one of the biggest consultancy firms, the predecessor of what is now known as accenture.
The Enron scandal costs lives, literally. A suicide, thousands losing their jobs and pensions, and numerous individuals sentenced to year-long prison sentences. Oh, yes, and let us not forget the famous quote “Asshole”. Truly spoken by no other than the CEO of the company. Not internally, but publicly insulting an analyst who questioned the company's finances.
Who or rather what was Enron?
Alright, what exactly was Enron? Enron was founded in 1985 by Kenneth Lay, the son of a pastor who reportedly chased riches from a very young age. With a PhD in economics, he was well equipped to construct an energy trading house. Unfortunately, his smarts weren't the only thing that was above average, his greed was similarly developed.
On top of his intellect, Ken Lay enjoyed the company of some influential people, among them the Bush family. He called both George Bush senior and junior his friends and incidentally the two also assisted Lay in gaining a number of contrast. In fact, he was even assumed to become United States Secretary of the Treasury under George W. Bush. Something that never came to fruition as the company was on its last legs. Lay, who shaped Enron out of Houston Natural Gas, the company he bought in 1985 while being its executive. A proponent of energy deregulation, he lobbied consistently in Washington, donating millions to Republicans and Democrats for ever more deregulation.
Enter into the picture the second in command, Jeffrey Skilling. A former McKinsey consultant, who worked with Enron, was hired by Lay in 1990 as both CEO and Chairman of Enron's financial arm. Seven years later, in 1997, he moved up the ranks and became COO of Enron, to be followed by his appointment as CEO in 2001 by which time Lay took up the position as Chairman of Enron.
The third major player involved in the wrongdoings was Andrew Fastow, Enron's CFO. A former banker, he joined Enron in 1990 and promoted to CFO in 1998.
Enron started out as an energy and gas company before pivoting and also becoming a market maker for energy and gas prices. In addition Enron started investing in geographical areas that other companies would not even have considered as viable investments. One such example was a power plant in India, a project named Dabhol Power Company. After a newly elected government reassessed the contract, it deemed it too costly. Enron was left with a massive project but no customer leading to great losses for the company. This was only one of many mishaps. Most important, however, Enron, rather than reporting the losses, hid them in a complicated web of lies, shady deals, and shell companies.
These decisions were the beginning of the end. The downfall and number of bad decisions was accelerated by one of the most brutal and inexplicable corporate cultures. Skilling and Lay introduced a performance system where colleagues had to vote on the worst fifteen percent of employees, their peers. These fifteen percent were subsequently laid off. Imagine a culture where survival of the baddest and most scrupulous is encouraged by management. If you get to watch the documentary Enron: The Smartest Guys in the Room, you'll here traders talking about willing to kill colleagues and customers if it earns them a bigger bonus. In fact, many traders at Enron did just that, put people's lives at risk to make a buck.
How did Enron pull of their fraud?
In fact there are a number of different scandals embedded in the umbrella Enron scandal. One is the enormous corporate scandal, the other, as in Martha Stewart's case, insider trading.
Let's start with the corporate scandal that not only brought down Enron, but with it one of the oldest accounting firms, Arthur Andersen Consulting, now known as accenture and Andersen Tax. Enron not only used one but multiple methods to disguise their faltering business. One fraudulent method was to book fake profits. Among the many bad deals that Enron made, one involved barges off the coast of Nigeria. With losses at Enron accumulating, management decided to sell the Nigerian barges to Merril Lynch enabling them book book pre-tax profits of $ 12 million. What looked good on paper was in fact a big scam. These apparent profits were in reality non-existent, as shortly after Enron bought the barges back. Multiple people including former Merril Lynch executives were sentenced to year-long prison sentences following the revelation after the collapse of Enron.
An even more complex method was adopted by Andrew Fastow, who set up a highly complex web of shell companies to move around money and to absorb losses that should have appeared on Enron's balance sheet. To make matters worse and to show the arrogance and disgust management had for those “inferior onlookers”, they used names such as Mr. M. Yass, apparently a Lebanese business man and speculator who regularly received money transfers from Enron – supposedly to wire corporate monies to personal offshore accounts – Jedi, Raptor, LJM (Lea, Jeffrey, Matthew – Fastow's wife and two sons) for their accounts and shell companies. LJM was probably one of his biggest tricks yet, as its sole reason for existence was to buy badly performing assets from Enron and thus make Enron substantially more profitable. Most astonishing, however, is the fact that Fastow tried to sell this financial vehicle to major banks such as Merril Lynch as a great investment opportunity. Unbelievably, he succeeded and raised $ 415 for LJM 1 and LJM 2. After the initial creation of LJM 1, Fastow followed up and created a second so-called partnership LJM 2 that enabled Enron to raise money from investors and take liabilities of its books.
These tricks made Enron look good on paper. Officially Enron's profits were steadily rising. In reality, however, the company was losing money. The deception of employees, investors, analysts, and the media was only possible as they shuffled money from one side of the business to another and making up imaginary profits.
The insider trading scandals at Enron involved many of the executives. In fact, Enron executives engaged in pump and dump schemes, talking up the share price to investors and even their own employees, only to sell the shares following its rise. They didn't stop there. Shortly before the collapse of Enron, insiders sold shares worth $ 1 billion. Among these was Skilling who sold $ 60 worth, Andrew Fastow who sold $ 30 million in shares and sidelined another $ 30 million, and Kenneth Lay who sold $ 100 million in 2001, of which $ 20 million were sold in the space of three weeks following the realization that Enron was going to go bust. Worse still, he sold the shares back to his own company.
When the company went under, it wasn't merely a small player, it was once of the biggest companies in the US that went from a $ 70 billion market cap to zero.
Who was involved in the Enron scandal?
Alright, this question is difficult to address with a simple answer. Different from the Madoff, Ponzi, or Martha Stewart cases, the variety of parties involved in the Enron scandal is mind-blowing. Big names such as Deutsche Bank, Merril Lynch, the now defunct Dresdner Bank, Citibank, to name only a few. Let us not forget a century-old auditing house, Andersen.
In fact, four Merril Lynch executives were convicted of fraud in the infamous Nigerian Barge case, three California Enron traders pled guilty to overwhelming evidence of wire fraud, there was a total of fifteen guilty pleas, and numerous convictions with former top managers spending years in prison.
The main culprits, Kenneth Lay, Andrew Fastow, and Jeffrey Skilling were fighting for their freedom in court. Kenneth Lay, however, died before a court was able to sentence him to a prison sentence. The two others, Fastow and Skilling were respectively sentenced to six years and 24 years and four months in prison. Skilling's sentence was later reduced to fourteen years of which he spent almost thirteen years in prison in addition to paying $ 42 million in restitution to Enron's victims.
Despite the terrible performance of Enron, 144 former senior managers received $ 744 million in bonuses only one year before the bankruptcy. The greatest beneficiary was chairman Kenneth Lay who collected $ 150 million.
Victims of the Enron scandals
Cliff Baxter, Jeffrey Skilling's supposedly best friend, committed suicide. He shot himself in his car after being subpoenaed leaving nothing more than a suicide note for his wife that stated that he regretted who he had become.
It is very sad when people become victims of their environment and who may have taken a very different paths had it not been for their surroundings.
But there were many more who had not been responsible for the massive fraud and still suffered. Among them were 20,000 employees who lost both their jobs and medical insurance. Ever more shocking the fact that whilst top executives received bonuses totaling $ 55 million, the average severance pay for regular employees was a mere $ 4,500.
Who else was among the victims? Again the employees who also lost $ 1.2 billion in retirement funds. Many had invest in Enron shares through their 401ks. This number is topped by the losses retirees had to face. Pension funds lost $ 2 billion leaving many retirees out of pocket. Put this in contrast to the money Enron executives earned from selling their shares prior to the collapse, these numbers look even more outrageous. Enron's top executives earned $ 116 million through the sale of their shares.
There was another group of victims that may not necessarily spring to mind immediately when thinking about the collapse of one of the biggest companies. In the process leading up to the collapse of Enron, one group fell victim to the power of Enron's executives, analysts. Analysts who were critical of the company and did not give a 'buy' or even better a 'strong buy' rating were either attacked by Enron's management – something unusual – or lost their jobs. One of those analysts who lost their jobs worked for one of the banks that were indeed involved in the scandal, Merril Lynch. Following his dismissal, Fastow, the infamous Enron COO, rewarded the bank with two $ 50 million contracts.
* Image source: ENRON Annual Report 2000