Enron was formed in 1985 as an energy trader and supplier company with a merger between Houston Natura Gas Company and InterNorth Incorporated. Kenneth Lay, the CEO of Houston Natural Gas, became the CEO of Enron. This is a story of how a $70 billion US company went bankrupt in days and their stock fell steeply from all time high of $90.75 US to a meager $0.26 US. Imagine losing 98.8% of your wealth just in days.
Kenneth Lay took the advantage of deregulations of the energy markets that allowed the companies to place bets on the future prices. Thus, it created the Enron Finance Corporation in 1990 and hired Jeffrey Skilling, who was one of the partners at McKinsey. He’s the most important link in the story as he created the Mark to Marketing (MTM) Accounting technique that made the company worth billion of dollars on papers which actually worth nothing and this might surprise you that this accounting technique was actually approved by Securities and Exchange Commission (SEC). You might be wondering what this MTM technique actually is. In simple terms it means booking the potential profits in the books as soon as a deal is signed, even when no single penny is received. Suppose, Enron would build a power plant that will generate revenue of $5 million US over next 5 years, they will immediately record this revenue in the books. And if it makes loses it will transfer it to another shell or off the books company. Thus, making it more financially sound and profitable and the rising stock prices.
It’s very clear that the company wasn’t making any profits but just pouring them in books and soon the situation started becoming clearer. The business model of the company was so complex that even analysts couldn’t figure out what’s wrong in the company. Company’s cash flows weren’t matching to the its revenue. So, in 1999 it decided to start on demand video service and broadband services (like Netflix now-a-days) which was a huge flow as the technology wasn’t adequate. But still they added $55 million US dollars to their books. Furthermore, in 2001, this evil business minded company crossed its limit and robbed approximately $30 billion US from the people of California by entering into electricity business. It created a huge demand by cutting supply of electricity and making intentional blackouts. Though, this could be regulated by the government, Enron has huge political influence in California and nothing happened until the new Governor was appointed.
Andrew Fastow, the Chief Financial Officer (CFO) of the company also participated equally with CEO and other management in the fraudulent activities of the company. Andrew created shell companies to write-off losses and Special Purpose Entities (SEPs) in which different investors buys the company’s assets to make it look productive and they were rewarded by company’s shares. This surged the stock price further. And when analysts questioned the transparency of the company by April 2001, Andrew closed its Raptor SPE and kept their employees from selling shares for 30 days to avoid suspicions.
The company’s CEO resigned during this time and after investigation by SEC the company’s fraudulent business model was exposed. This multi-billion-dollar company was actually $591 million in losses and $628 million in debt. More than 20,000 people lost their jobs and health insurance. Management was put behind the bars for years, paid heavy compensations ordered to pay back their creditors. On 2 December, 2001 this company declared bankruptcy and thus lead to the biggest scam and bankruptcy in the history of Us.
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