Enron Corporation was created in 1985 from union of two gas companies from Texas and Nebraska. It became the first company owning all networks of American gas lines. In early days, the company was dealing with gas only, but gradually it comprised electricity. In times it also spread out its activity into the trade area.
The corporation successfully came into the market of the power futures and derivative securities. In the 1990s the government control over the US power industry was canceled, after which California faced disconnecting. A single network of the electricity market was created instead. In 2001 Enron became the largest player at the electricity market, having 22 thousand employees in 40 countries of the world.
When the electricity prices started to grow at the peak of consumption, its cost was from $30 up to $1000 per megawatt-hour in California. According to experts, the government control abolition made everything depend on traders.
But on November 3, 2001, Enron, the seventh largest corporation on Fortune’s version with the incomes of more than $100 billion, was given the required protection from creditors, according to the chapter 11 of the US federal law about bankruptcy.
The reduction of company’s debt rating to the level of junk bonds caused the necessity of immediate amortization of debt obligations of $3,9 billion. Increasing distrust of creditors and investors towards Enron, together with the debt reaching colossal sizes, determined the refusal of banks to give additional cash to the company. The cost of company’s share, which equaled to $90,56 in August 2000, decreased up to 26 cents by November, 30, which was equal to price of a standard post stamp.
In fact, Enron had never been a producer; the company was a dealer, just a trader, whose revenue resulted from vast speculations. Enron was an international corporation and was controlling about 25% of European market due to Washington’s political lobbying. The company also obtained the markets of the third world countries (Kuwait, Argentina, Panama, India, Philippines, etc.) by means of the great influence of the White House.
Thousands of legal entities (about 3000 subdivisions and partnerships) were created, which meant 1 company per each 6th employee of Enron. Over 30% of these partnerships were registered as off-shores, which actually allowed averting taxes and excessive attention of regulative authorities. Enron’s executives didn’t conceal the factual functions of the created subdivisions. For instance, 692 subsidiaries were registered at the same legal address on the Cayman Islands. Though shell companies used for doubtful operations typically have solid names, Enron’s top-management cynically called the off-shores by the names of most popular science fiction characters of “Star Trek”¯ show. At the same time, all the off-shore companies were absolutely legal and had the submission of proper reports in the USA tax authorities. Moreover, the off-shore activity of Enron was agreed by the board, by lawyers and external auditors (Arthur Andersen Company).
In general, Enron owned options for 47 million corporate shares by the end of 2000, while the average strike price was about $30 and the exchange price reached $83. Thus, the possible revenue of options’ owners made about $2,5 billion. If Enron’s balance included these obligations, the company’s income would actually be reduced to zero. During 1999-2001, 29 members of Enron’s board realized their options and received $1,1 billion profit, being fully aware of the real state of the corporation.
According to financial reports of Enron, the gross income increased from $13,3 billion in 1996 to $100,8 billion in 2000. Thus, the average annual growth rate made 57%, and the gross income per employee made $5,3 million. This was possible only due to accounting methods used in Enron. During last 5 years over 90% of profit was obtained from trade operations, but the point is that Enron calculated transactions by their nominal gross cost, not by their added or net cost.
Enron’s President Jeffry Skilling claimed that for succeeding, Enron should dispose of hard assets tying the cash, which could be more effectively applied in trade operations. Thus, Enron became a huge trading platform, dealing with everything – from electric power supply to publicity space and computer chips – through the subdivision of EnronOnline, the central link of corporation acknowledged the most financially successful Internet project. The real economy turned into the victim of virtual finances.
Although the plan developed by Enron’s managers seems extremely complicated, it was rather simple. First, electric power transactions conducted through subsidiaries, allowed swelling the prime price and the electricity selling price. Second, secret debts were assigned to off-shores. It actually increased Enron’s financial indexes considerably and the cost of its shares. This allowed the stuff of Enron to receive multimillion premiums. For instance, Andrew Fastow, Enron’s main financial administrator, obtained over $30 million from the off-shore activity, and his assistant Michael Cooper got $10 million. Realizing that the collapse was inevitable, Kenneth Lay sold his Enron shares for $20 million, continuing to convince shareholders that the company’s state was brilliant.
This could be the beginning of the end for many companies related to Enron’s activities, as this was for Arthur Andersen Corporation, one of the world’s 5 greatest accounting companies. Annually, Arthur Andersen Corporation received over $25 million from Enron as hush money, which could actually be considered bribes. In fact, Enron overstated accounts, and Arthur Andersen employees were aware that the company could vanish within 1 year.
The U.S. Justice Department accused the chief auditor of the Arthur Andersen of hiding and destruction of Enron’s documents. The AA management appointed David Duncan, who was responsible for Enron case to stand trial. He, in turn, saw the way to his own salvation in collaboration with prosecutors, refusing to rely on his colleagues and bosses in the company, who seemed to have framed up Duncan, trying to cast the blame on him. Making Duncan a scapegoat in the Enron case, executives of Arthur Andersen tried to peacefully deal with the Ministry of Justice, prevent the judicial process and somehow normalize the situation inside the company.
Since the collapse of Enron, more than 100 corporate clients refused from the services of the Arthur Andersen, which led to a significant reduction in corporate income in the United States. Management of the company announced a reduction of 7000 jobs – more than a quarter of all personnel of the firm. In addition, most foreign subsidiaries of the company were planning to break away from their U.S. office.
CEO of Arthur Andersen Joseph F. Berardino, who devoted more than 30 years to the company, soon announced his resignation from the post. His reputation had successfully withstood several attacks, such as, for example, detection of defects in accounting inspection of one the largest home appliance producers Sunbeam Corp. and the company Waste Management Inc. collecting and utilizing recyclable materials. The Arthur Andersen even had to pay $7 million on the out-of-court settlement with the Securities Commission the United States to avert the suspicion of indulging the accounting fraud of Waste Management Inc. But the scandal around the energy giant Enron, ended the career of Berardino.
In general, the Enron scandal is very symbolic. It is only not understandable whether this was a verdict to the outrageous 1990s with their roulette economy and financial pyramids, or the symbol of virtual future coming, in which everything is just visibility: politicians as public defenders, auditors emulating financial inspections, authorities simulating control, reports hiding real losses, analysts ensuring investors that their advice is objective.
Enron bankruptcy revealed grave problems, associated with the American system of the financial accounting of public companies (Generally accepted accounting principles, GAAP). All the world public corporations form their accounting basing on this system and its European analogue IAS (International Accounting Standards). Currently, the effectiveness of the system designed to provide investors, creditors and partners with reliable information is doubtful. It is possible to assume that the standards of information opening, especially in off-balance operations and transactions, should be strengthened in other countries. One of the employees dismissed from Enron said that it was not the result of activity of individual swindlers, but the problem of the system in general.