ENRON

THE CLAIM

That Enron systematically misrepresented its financial condition using accounting structures designed to hide debt, that its auditor knew and signed anyway, and that the auditor then destroyed evidence.

THE THEORY, AS ITS PROPONENTS TELL IT

Everything in this file is proven, and it is included because it is the corporate equivalent of a confessed conspiracy: convictions, a destroyed firm, and a statute named after it.

Enron used mark-to-market accounting to book the entire projected profit of long-term contracts immediately, before any money arrived. When the projections did not materialise, the shortfall had to go somewhere.

It went into special purpose entities, partnerships nominally independent but controlled by Enron executives, notably those run by CFO Andrew Fastow. Debt and underperforming assets were moved into these entities so they did not appear on the balance sheet, while Enron guaranteed them with its own stock, which made the whole structure dependent on the share price it was propping up.

Arthur Andersen was both auditor and consultant, earning substantial fees for the latter, and signed the accounts. When the investigation began, Andersen personnel destroyed a large volume of Enron documents. The firm was convicted of obstruction in 2002 and effectively ceased operating, with 85,000 jobs lost. The Supreme Court overturned the conviction in 2005 on jury instruction grounds, by which time the firm no longer existed.

WHAT IS KNOWN

Jeffrey Skilling and Kenneth Lay were convicted of fraud and conspiracy in 2006. Lay died before sentencing; Skilling served twelve years after a sentence reduction. Fastow cooperated and served six.

Employees lost pensions heavily invested in company stock while executives sold shares, which is documented in trading records.

The Sarbanes-Oxley Act of 2002 was a direct consequence, imposing executive certification of accounts, auditor independence rules and internal control requirements.

Enron's California energy trading, in which traders discussed manipulating supply on recorded phone lines, is separately documented and contributed to the state's 2000 to 2001 electricity crisis.

EVIDENCE FOR

• Criminal convictions of the chief executive and chairman for fraud and conspiracy.
• The special purpose entity structures themselves, documented in the bankruptcy examiner's reports.
• Recorded trader calls discussing manipulation of California electricity supply.
• Document destruction by the auditor, which produced a conviction even though it was later overturned on instruction grounds.

EVIDENCE AGAINST (THE SIMPLIFIED VERSION)

• Much of the accounting was technically permitted at the time, which is the actual scandal: the rules allowed it.
• The Andersen conviction was overturned, and the firm's destruction preceded any final adjudication of guilt.
• Not every executive was culpable, and the collapse destroyed the livelihoods of thousands who had no part in it.

ASSESSMENT

Confirmed at the highest standard and included as the corporate benchmark. When this archive grades a corporate file, this is the standard it is grading against: convictions of the two most senior officers, a bankruptcy examiner's forensic reconstruction, an auditor destroyed, and a federal statute enacted in response. Note the uncomfortable part. Much of what Enron did was permitted when it did it, which means the honest lesson is not that criminals broke the rules but that the rules were the opportunity.

WHAT WOULD CHANGE THE GRADE

• CONFIRMED at the highest standard: fraud and conspiracy convictions of the chief executive and the chairman, a bankruptcy examiner's forensic reconstruction of the special purpose entities, and recorded trader calls discussing manipulation of California electricity supply.
• The auditor was convicted of obstruction for destroying documents. The Supreme Court overturned that conviction in 2005 on jury instruction grounds, by which point the firm had already ceased to exist.
• The uncomfortable finding: much of the accounting was technically permitted when it was done. The rules were the opportunity, which is why Sarbanes-Oxley had to rewrite them.

FURTHER READING

• Enron scandal · Wikipedia
• Neal Batson, Enron bankruptcy examiner reports (2002 to 2003)
• Bethany McLean and Peter Elkind, The Smartest Guys in the Room (2003)