Courses
Courses for Kids
Free study material
Offline Centres
More
Store Icon
Store

Enron Scandal Case Study

Reviewed by:
ffImage
hightlight icon
highlight icon
highlight icon
share icon
copy icon
SearchIcon

Enron Scandal Summary

The Enron scandal is one of the most renowned scandals in History. It refers to the certain events that lead to the bankruptcy of American commodities, energy, and services. The Enron scandal occurred in October 2001, when it was declared that the American seventh-largest company was involved in corporate corruption and accounting fraud. The Enron scandal eventually led to the bankruptcy of Enron together with the dissolution of the auditing company Arthur Andersen. Enron shares lost $74 billion which resulted in the bankruptcy. The employees of the company lost their jobs and billions in pension benefits. The CEO of the company Jeffrey Skilling was sentenced to 24 years, and the former CEO Kenneth Lay died before serving time. This article represents the Enron case summary and how it affected the various parties involved.  


(Image will be Updated soon)


Enron Company Founding And Its Rise

The Enron company was established in 1985 by Kenneth Ley in the merger of two natural gas transmission companies, Houston Natural Gas Corporation and the merged company InterNorth, Inc. HNG InterNorth was renamed as Enron in 1986. After the U.S. Congress adopted a series of laws to deregulate the sale of natural gas in early 1990, the company lost its exclusive right to operate its pipelines. 


With the help of Jeffrey Skilling who was initially a consultant and later became a Chief operating officer, the company transformed itself into a trader of energy derivative contracts, playing the role of intermediary between natural gas producer and customer. The trades enable the producers to mitigate the rise of energy price fluctuations by fixing the selling price of their product through a contract negotiated by Enron for a fee. The Enron company under the guidance of Jeffrey Skilling soon dominated the market for the natural gas contracts and the company started to generate huge profit on its trades.


The culture of the company was gradually changed by the Skilling to emphasize aggressive trading of the company.  He hired the top rankers from MBA programs around the world that created an intense competition with the company in which the main focus was generally on closing as many cash generating trades as possible in the short duration of time. One of his best recruits was named Andrew Fastow. Due to his excellent work in the company, he soon became the chief financial officer. Andrew Fastow administered the financing of the company through investment in complex instruments whereas Skilling administered the trading operations of the business.


In 1990, the bull market helped Enron to nourish its ambition and contributed to the immense growth. There were an appreciable amount of deals everywhere and the company was prepared to create a market for anything that anyone was willing to trade. It started trading derivatives of the contract for a wide range of commodities including electricity, coal, copper, gold, and even for the weather. The company's online trading division named as Enron Online, was launched during the dot com boom and it started executing online trades worth about 2.5 billions a day by 2001. Enron also invested in accelerating the broadband internet connection to facilitate high speed trading.

The Fall of Enron Company

Enron employed the Mark to Mark accounting procedure for which Enron received official US Security and Exchange Commission approval in 1992. The accounting method enables companies to value their financial situations on the basis of their fair values of the assets which may change as the market conditions change. Enron used the accounting method to increase the estimated profits of the company and to mislead investors.  To hide its large debt, Enron used special purpose vehicles to borrow money on Enron's behalf. By 2001, Enron had used several SPVs to hide its debt.


Investors' confidence in the company had started declining by the end of 2001. Jeffrey Skilling who became the CEO  of the company after Kenneth Lay retired in February. Due to "personal reasons" Jeffrey Skilling resigned in August. Analysts began to downgrade Enron's stock rating. On October 16, the company's first quarterly loss was reported. Shortly thereafter, the US Securities and Exchange Commission (SEC)  declared it was opening an investigation into Enron and its SPVs. The Enron company earnings were restated and it was declared that the company had $628 million in debt and $591 million in losses. After Dynegy, a company that had previously stated plans to merge with Enron, canceled the deal, and Enron filed for bankruptcy.

Enron Cases Legal Action And Legislation

Many Enron executives were impeached on several charges and were later sentenced to prison. In 2006 both Skilling and Lay were imprisoned on various charges of conspiracy and fraud. Skilling was initially sentenced to more than 24 years but eventually served only 12. Lay, who was facing more than 45 years in prison, died before he was sentenced. Also, Andrew Fastow (CEO of Enron Corporation) pleaded guilty and was sentenced to six years in prison.


Arthur Andersen also came under intense investigation. On June 15, 2002, he was found guilty of minimizing evidence and lost his license to be involved in public accounting. Clients longing to assure investors that their financial statements could meet the highest accounting standards neglected Andersen for its competitors. The clients were soon observed following the Andersen employees and entire offices. Also, thousands of employees were released. 


Also, several lawsuits were filed against both Enron and Andersen by the shareholders of the company. Although a number of suits were successful, most investors were not able to recover money, and employees received only a fraction of their money. The scandal resulted in the introduction of  new regulations and legislation. These were designed to increase the accuracy of financial reporting for publicly traded companies. The most important regulation was the Sarbanes-Oxley Act (2002). This imposed harsh penalties for destroying, altering, or formulating financial records of the company. The act also restricted auditing firms from doing any side by side advisory business for the same clients.


FAQs on Enron Scandal Case Study

1. What exactly did the Enron company do?

Enron was an energy company that began to trade immensely in the energy derivatives market. The company disguised massive trading losses, which resulted in one of the largest accounting scandals and bankruptcy in recent history. 

2. Why Is The Enron Scam Significant to study?

The Enron scandal is significant with respect to the learning perspective for both financial and experienced professionals. The Enroll case tells why strong corporate governance plays a key role in the success of any business. Also, it tells how carefully an accountant should select and apply accounting policies as any misuse can have a drastic impact on the financial condition of the business.  Due to the bankruptcy of Enron, many employees lost their jobs and pension benefits. The Enron case was so immense that the shareholders of the business lost an estimated value of $74 billion. The Enron scam should be taken as learning as understanding it properly helps us to know why rules and compliance are necessary for business to grow.

3. What were the main causes of the Enron scandal?

The main cause of the Enron scandal are:

  • Creation of special purpose vehicles for disguising financial losses and heap of financial debt.

  • Mark to market accounting method is an excellent accounting method to value its securities, but such an accounting concept became a disaster when applied to the actual business. 

  • Failure of corporate governance in Enron corporation.

4. What investors should learn from the Enron mistakes to improve their personal investing strategies?

  • Investors should not invest in what they can’t understand.

  • Investors should avoid investing in the companies that employ fancy derivatives.

  • Investors should beware of excessive leverage.

  • Investors should understand and assess counterparty risk.

  • Investors should understand the importance of management integrity.