Enron

The fall of the colossal entity called Enron has forever changed the level of trust that the American public holds for large corporations. The wake of devastation caused by this and other recent corporate financial scandals has brought about a web of new reforms and regulations such as the Sarbanes-Oxley Act, which was signed into law on July 30th, 2002. We are forced to ask ourselves if it will happen again. This essay will examine the collapse of Enron and detail the main causes behind this embarrassing stain of American history.

Whenever someone hears the word "Enron" today, they usually think of the transgressions committed by the top-level executives who successfully managed to destroy the company's reputation and achievements. Actually, the company has been in business for more than 20 years and was once well known for being one of the premier American energy corporations [1]. The key to its inevitable downfall was greed. A group of Enron management made the decision to put their own personal desires for wealth and power ahead of the company, its employees, and the thousands of investors who trusted in the stocks they held. How did they do it?

The problems began in 1999 when Enron created two non-consolidated special purpose entities, or SPEs [2]. The investment companies were formed by Enron's CFO Andrew Fastow with the approval of the board of directors [3]. A major conflict of interest lied in the fact that Mr. Fastow became managing director of these companies while holding onto his title of Enron CFO [3]. Enron used the SPEs to help reduce visible losses and spread the overall risk by using them as separate investment entities [2]. These entities dumped millions of dollars into various investment deals and outside projects [3]. The entire operation was complex to say the least.

According to the Powers Report submitted in February of 2002, stock was given to the SPEs in exchange for cash and IOUs. This would serve to guarantee the SPE's value [2]. The SPE, in exchange, would use the stock to hedge the value of various investments on Enron's balance reports [2]. Enron stock prices had been consistently on the rise and, counting on this trend to continue, the false assumption was made that they would never have to pay on any of the guarantees [2]. These complicated financial maneuvers generated huge sums of money for Enron. Several people were getting rich from these dealings, especially Mr. Fastow. They were given enormous amounts of compensation to continue promoting the use of the SPEs [2].

One example of these transactions took place in June of 2000. The SPE known as LJM2 purchased fiber-optic cable for $30 million in cash and $70 million in IOUs [3]. LJM2 sold part of the fiber to other companies for $40 million and paid Enron a 20 million dollar agency fee for helping to market the product [3]. LJM2 then sold the remaining fiber for $113 million to a company owned by Enron and used some of the money from that sale to pay off their remaining debt [3]. When it was all over, LJM2 was 2.4 million dollars richer, and Enron's credit risk had been reduced by $9 million [3]. Unfortunately for Enron and its investors, the money party was short lived.

When Enron's stock values began to fall, the value of the SPEs fell with it, triggering the previous guarantees. This caused the value of the Enron stock to fall even faster [2]. As stocks and investment prices fell exponentially, the SPEs ran out of sufficient capitol to perform their hedge [2]. A SPE must maintain a minimum of three percent independent equity to be considered "independent" [2]. Once this three percent barrier had been breached, the SPE's debt was transferred onto Enron's balance sheets, further damaging Enron's credit holdings [2].