Case Study: Enron
At the beginning of 2001, the Enron Corporation, the world's dominant energy trader, appeared unstoppable. The company's decade-long effort to persuade lawmakers to deregulate electricity markets had succeeded from California to New York. Its ties to the Bush administration assured that its views would be heard in Washington. Its sales, profits and stock were soaring.
— A. Berenson and R. A. Oppel Jr. The New York Times, Oct 28, 2001
Company Background
Enron was founded in 1985 through the merger of two natural gas pipeline companies — Houston Natural Gas and InterNorth.
Enron’s stock rose from the start of the 1990s until year-end 2000 by 554% percent. The stock was priced at USD83.13 and its market capitalisation exceeded USD60 billion. Revenues of the company were USD101 billion. Additionally, Enron was rated the most innovative large company in Fortune’s Most Admired Companies survey for five years, from 1996 to 2000.
Fraud
The dates 9th September 1997 to 2nd December 2001 are now etched in to securities class action folklore as the period during which the most complex and high profile securities frauds ever took place. The estimated loss to investors was USD25 billion.
In Enron’s original natural gas business, the accounting had been fairly straightforward: in each time period, the company listed actual costs of supplying the gas versus the actual revenues received.
However, Enron’s trading business adopted mark-to-market accounting, which meant that once a long-term contract was signed, income was estimated as the present value of net future cash flows, even though in some cases there were serious questions about the viability of these contracts and their associated costs.
An example of this is in July 2000, Enron signed a 20 year agreement with Blockbuster Video to introduce entertainment on-demand to multiple U.S. cities by year-end. Enron would store the entertainment, and encode and stream the entertainment over its global broadband network. Pilot projects were created to stream movies to a few dozen apartments from servers set up in the basement. Based on these pilot projects, Enron went ahead and recognised estimated profits of more than USD110 million from the Blockbuster deal, even though there were serious questions about demand for the service.
Enron’s downfall was quantified when it was discovered that a considerable amount of its profits resulted from complex deals with so-called special-purpose vehicles (SPVs). The result of these complex deals was that Enron did not have to report many of the company’s losses in its financial statements.
These SPVs were used to fund or manage risks associated with specific assets. SPVs are technically shell firms created by a sponsor, but funded by independent equity investors and debt financing. For financial accounting purposes, a series of rules are used to determine whether a SPV is a separate entity from the sponsor. In total, Enron had used hundreds of these by 2001, including Chewco Investments LP, Joint Energy Development Investments (JEDI), Yosemite Trust and Osprey Trust (aka Whitewing).
Timeline
At the start of the class period Enron’s share price was around USD28 per share. By mid 2000 this had risen to a record high of nearly USD90 per share. The share price of Enron stock was inflated by hiding the actual losses from share holders through the SPVs and by issuing positive statements through various press releases (Enron Stock Issuance Price Trigger).
For example, Enron announced in a press release dated July, 2000 “Strong Q2 00 income. Business is booming – gaining momentum. Profits are ahead of expectations, never in better shape, very excited about the future”. Within the next eight weeks insiders had sold nearly 1.3 million shares totalling USD108 million, some months later the share price had crashed to only USD0.03 per share. Overall 28 Enron Directors made over USD1.2 billion from insider trading.
Our graphic charts the dramatic rise in the Enron share price versus the peer index. All major insider trading periods are represented together with various information on how many shares were traded along with the consideration received. The graphic also includes a chronology of the major events that impacted the Enron share price.
Conclusion
On the 25th May 2006 a Jury found Kenneth Lay (Founder and Chairman) and Jeffrey Skilling (CEO) guilty of fraud and conspiracy charges. Kenneth Lay passed away from a heart attack on the 5th July 2006; his conviction was vacated on the 17th October 2006. Jeffrey Skilling was sentenced to 24 years and 4 months imprisonment on the 23rd October 2006 for his part in the Enron collapse.
In total, 34 individuals were prosecuted through the U.S courts. 18 pleaded guilty and received a combined total of over 84 years imprisonment, there were 4 jury convictions, 2 were acquitted, 3 individuals had their convictions overturned, 2 had the cases dropped against them and the final 5 are awaiting retrial.
Judge Melinda Harmon of the U.S. District Court for the Southern District of Texas gave final approval to the proposed distribution of more than USD7.2 billion on Monday 8th September 2008. This was distributed to eligible shareholders on the 19th December 2008.
