Mark ở vũ trụ khácVIMark học AI
Mark ở vũ trụ khác · Another Universe Anatomy of a Business Failure #5 · Energy · Finance

Enron

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Enron Corp. · Houston, Texas · filed for bankruptcy on 2 December 2001

What happenedAmerica's seventh largest public company went bankrupt within months
Damagefour years of profits restated, employees lost retirement savings, Andersen fell with it
Root causeprofits came from private vehicles that few people could explain
Main sourcesPowers Report (2/2002), US Senate report (7/2002), SEC, US Department of Justice

Source: US Senate, Senate Print 107-70 (8 July 2002), summary ("seventh largest"); notice of the US Bankruptcy Court, Southern District of New York, case 01-16034 (2 December 2001); Enron, Form 8-K of 8 November 2001 (restated 1997–2000 profits).

Recap in 1 minute

Essence

America's 7th largestReported revenue of $100.8 billion in 2000, 2.5 times the year before.
Profits from private vehiclesThe SEC called the Raptors "sham hedges" that let Enron avoid writing down earnings by over $1 billion.
A CFO on both sides of the tableAndrew Fastow was Enron's CFO and ran the LJM funds that traded with Enron, earning more than $30 million.
The warnings arrivedThe auditor said the accounting was "pushing limits" in 2/1999. An employee wrote to the chairman in 8/2001.
Not a few people22 people convicted. The board, the auditor and banks were all named.

Source: US Senate, Senate Print 107-70 (2002); Enron, Form 10-K for 2000 (revenue $100,789 million, 1999: $40,112 million); SEC, Litigation Release 18776 (Raptors); Powers Report (2/2002) via CNN Money, 2 Feb 2002 (Fastow over $30 million, secondary source); Bloomberg, 28 July 2002, citing the Senate exhibits (2/1999, secondary source); Sherron Watkins's testimony to the House (2/2002); FBI Houston (2016, 22 convictions); SEC press release 2003-87 (banks).

Part 1

The question of the case

Fortune named it "America's most innovative company" six years in a row. Why was it bankrupt a few months later? Because a large part of its profit came from deals where almost nobody outside, and very few people inside, could explain where the real money came from.

Source: Enron press release, 6 Feb 2001 (Fortune, sixth year in a row); bankruptcy court notice, case 01-16034 (2 Dec 2001).

1992Book profit firstThe SEC did not object to Enron recording gas contracts at market value: future profit goes on the books at signing.
→
1999–2001Private vehiclesChewco, LJM, the Raptors: entities that dressed up the accounts, run or set up by the CFO himself.
→
10–12/2001ExposedA quarterly loss, four years of profits restated, a bankruptcy filing.

Source: SEC no-objection letter of 30 Jan 1992, per Cato Institute, Regulation (2003) (secondary source); Powers Report (2002); Enron press release of 16 Oct 2001 and Form 8-K of 8 Nov 2001.

Part 2

What happened

To the top and down again in about 15 months. Dates come from Enron's SEC filings, court records and testimony to Congress.

Enron's share price. About $90.75 in August 2000. $30.72 on 16 October 2001, the day of the third-quarter loss. $11.69 on 19 November 2001. $0.26 at the close on 30 November 2001. On 2 December 2001 Enron filed for bankruptcy. 045$90 ~$90.75 · 8/2000 $30.72 · 16/10/2001 $11.69 · 19/11 8/200010/2001$0.26 · 30/11 time axis roughly to scale · only 4 sourced points joined, not a daily price line
Almost all its value gone in 15 months, most of it in the last 6 weeks. Not a one-day crash, but a chain of bad news from October 2001 on.Source: $90.75 and $0.26 per History.com (secondary source; another source gives a $90.10 peak); $30.72 and $11.69 per the Congressional Record of 19 Dec 2001 (Rep. Ken Bentsen citing employees' figures).
30/1/1992 · Allowed to book profit up frontThe SEC sends a no-objection letter on Enron Gas Services using mark-to-market accounting for gas contracts.
28/6/1999 and 10/1999 · The board approves LJMCFO Andrew Fastow may run the LJM1 fund, then LJM2, funds that will buy and sell assets with Enron itself.
2000 · The peakReported revenue of $100.8 billion (1999: $40.1 billion). In February 2001 Fortune names it "most innovative" for the sixth year running.
14/8/2001 · The CEO quits, a letter is sentJeffrey Skilling resigns suddenly. The same day Sherron Watkins sends an anonymous letter to chairman Ken Lay; on 22/8 she meets Lay.
16/10/2001 · Third-quarter loss$1.01 billion after-tax charges, a net loss of $618 million.
8/11/2001 · "Don't rely on the old reports"Enron restates 1997–2000 profits and says the financial statements for those years should no longer be relied on.
2/12/2001 · BankruptcyChapter 11 filing in the Southern District of New York. About $63 billion in assets, the largest in the US at the time.
2002 · InvestigationsPowers Report (2/2002), Senate (7/2002). Andersen convicted of obstruction of justice (6/2002), reversed by the Supreme Court in 2005.
2004–2013 · The courtsFastow pleads guilty (1/2004). Lay and Skilling convicted (5/2006). Lay dies before sentencing. Skilling gets 24 years 4 months, resentenced to 14 years (2013).

Source: SEC letter 30 Jan 1992 (per Cato Institute 2003, secondary source); Enron's LJM timeline quoted in University of Chicago course materials (picker.uchicago.edu, Class6) and the Powers Report; Enron, Form 10-K for 2000; Enron press release 6 Feb 2001; Watkins's testimony to the House (2/2002); Enron press release 16 Oct 2001; Form 8-K 8 Nov 2001; bankruptcy court notice case 01-16034; $63 billion and "largest at the time" per Oil & Gas Journal (secondary source); Arthur Andersen LLP v. United States, 544 U.S. 696 (2005); DOJ press releases of 25 May 2006, 26 Sep 2006 and 21 Jun 2013.

Part 1

What happened

$100.8bn revenue6 years "most innovative"$618m lossbankrupt 2/12/2001
Part 2

Why

profit booked firstprivate vehiclesboth sides of the tablegatekeepersmyths
Part 3

Work lesson

explain it in 2 sentencesprofit or cashwarnings get an answer
Part 3

Why: four layers of causes

Strategy layer: book the profit today, the cash comes over years

mark-to-market accountingSEC 1992 · Powers 2002
Illustration, not real figures. A multi-year contract is signed today. Under mark-to-market accounting, the company estimates the value of the whole contract and books the profit in the year of signing. The cash arrives bit by bit over the years. If the estimate is wrong, the company must write it down later, or find a way to hide it. books the whole estimated profit, booked in year 1 cash arrives over many years year 1year 2year 3year 4year 5year 6 The gap between the two rows is where to ask: "has this profit turned into cash yet?" illustrates the idea, not drawn from any real Enron contract
This method is legal, but it rests on estimates. Critics later argued that allowing market-value accounting where no active market existed to check against was a big loophole.Source: SEC no-objection letter of 30 Jan 1992 to Enron Gas Services, per Cato Institute, Regulation 26(3), 2003 (secondary source) and University of Illinois research on Enron's prepay deals (academic); the figure is Mark's illustration.

Structure layer: private vehicles, and one man on both sides of the table

special purpose entities · related-party dealsPowers 2002 · SEC LR 18776
Enron sells assets to, or signs hedges with, the LJM funds and the Raptors. These were run by CFO Andrew Fastow, or capitalised with Enron's own stock. Enron books gains or avoids booking losses. Fastow earns more than $30 million. When Enron's share price fell in 2001, the Raptors could no longer carry the load and the losses came back to Enron. Enron books gains,avoids losses LJM1, LJM2 fundsrun by Fastow Raptorscapital = Enron stock sells assets "hedges" CFO> $30 million 2001: the share price falls, losses return to Enron
The simplest question nobody was made to answer: who is on the other side of the table? The Powers Report concluded that many of the most significant transactions were designed to achieve favourable financial statement results, not bona fide economic objectives or to transfer risk. The SEC called the Raptors "sham hedges" that let Enron avoid writing down earnings by over $1 billion.Source: Powers Report (2/2002), quoted via CNN Money, 2 Feb 2002 (secondary source; Fastow over $30 million); SEC, Litigation Release 18776 (Raptors as "sham hedges", over $1 billion).
On 8 November 2001 Enron announced it would restate: net income reduced by about $96 million in 1997, $113 million in 1998, $250 million in 1999 and $132 million in 2000. Four years combined: $591 million. 1997−$96 million 1998−$113 million 1999−$250 million 2000−$132 million 1997–2000 combined: about −$591 million net income (Mark's sum)
Four years of profit rewritten. Most of it came from bringing Chewco and an LJM1-related entity back onto the consolidated books. Some documents give other figures (28, 133, 248, 99 million); this article uses the numbers Enron filed with the SEC.Source: Enron, Form 8-K of 8 Nov 2001, exhibit 99.1; the total is Mark's sum.

Organisation layer: the board heard the warning, then approved anyway

board oversightSenate 2002 · Powers 2002
In February 1999, auditor Andersen told the Audit Committee that Enron's accounting was pushing limits. In June 1999, the board let the CFO run LJM1. In October 1999, it approved LJM2. The US Senate concluded that the board knowingly allowed high-risk accounting. 7/2/1999Andersen:"pushing limits" 28/6/1999LJM1 approvedCFO as partner 10/1999LJM2 approveda bigger fund 7/2002Senate:"knowingly allowed" Nobody was fooled at this level. The information was on the table; nobody pushed the hard question to the end.
A dispute about words, not about what happened. The press often wrote that the board "waived the code of ethics" for Fastow. Former director Herbert Winokur objected: the board used a provision allowing the CEO to make a determination, it did not "waive" anything. Whatever it is called, the board is where it was approved.Source: US Senate, Senate Print 107-70 (8 July 2002), findings 1–3 and the exhibit of Andersen's presentation of 7 Feb 1999; the words "pushing limits" per Bloomberg, 28 July 2002 (secondary source); Herbert Winokur's written testimony to the Senate (5/2002); LJM timeline in the Powers Report.

Gatekeeper layer: auditors, banks, lawyers

gatekeepersSEC 2003 · Supreme Court 2005

Auditor Arthur Andersen

Signed off accounts that later had to be restated. Staff destroyed Enron documents from 10/2001; the firm was convicted of obstruction of justice in 2002. In 2005 the Supreme Court reversed 9–0 because the jury instructions were wrong.

Banks

The SEC made J.P. Morgan Chase pay $135 million and Citigroup $101 million for the Enron-related part, for helping deals that dressed up the accounts.

Lawyers

After receiving Watkins's letter, Ken Lay handed the questions to the company's own outside law firm, Vinson & Elkins.

Source: Arthur Andersen LLP v. United States, 544 U.S. 696 (31 May 2005); SEC press release 2003-87 (28 July 2003); Sherron Watkins's testimony to the House (2/2002), per CNN (secondary source).

Part 4

Fact check: what is true and what is myth

14 things often said about Enron, checked against Enron's SEC filings, the Powers Report, the Senate report and court records. Tap each line for the reason.

Who was named in the official record: Enron leaders convicted, 22 people in all; the board found by the Senate to have failed its fiduciary duty; auditor Andersen convicted then reversed; two banks paid settlements to the SEC. 22people convictedCEO, COO, CFO,chief accountant… The board"fiduciaryfailure" Andersenconvicted 2002reversed 2005 2 banks$236 millionfor Enron victims "A few bad people" does not explain why it took a whole system to keep it running for years.
The main myth is false. William Powers, who chaired the investigation, told Congress the consequences were "the result of failures at many levels and by many people": a flawed idea, self-enrichment by employees, inadequately designed controls, inattentive oversight.Source: FBI Houston (2016); US Senate, Senate Print 107-70, finding 1; Arthur Andersen LLP v. United States (2005); SEC press release 2003-87 (135 + 101 = $236 million); Powers's testimony to the House, 2/2002, PBS NewsHour transcript (secondary source).
SOLIDEnron's top leaders were convicted

25 May 2006: the jury convicted Lay on all 6 counts and Skilling on 19 of 28 (acquitted on 9 insider trading counts). Lay was also convicted on 4 more counts by the judge in a separate bench trial. Fastow pleaded guilty on 14 Jan 2004 and got 6 years in prison (DOJ press releases of 25 May 2006 and 26 Sep 2006).

SOLIDThe CFO made more than $30 million from funds dealing with Enron itself

The Powers Report and Enron's disclosures in late 2001 put Fastow's take from LJM at more than $30 million (per CNN Money, 2 Feb 2002, secondary source; the original page could not be checked because the network was blocked).

SOLIDSomeone inside raised the alarm

Sherron Watkins sent an anonymous letter to Ken Lay on 14 Aug 2001 (many reports say 15 Aug; her testimony says 14 Aug), then met Lay on 22 Aug 2001. The letter feared the company would "implode in a wave of accounting scandals".

SOLIDEmployees lost retirement money because the plan was heavy in Enron stock

The US Department of Labor sued Lay, Skilling, former outside directors and the plan committee in 2003; 2004 settlements returned at least $66.5 million to the 401(k) and ESOP plans. At the end of 2000 about 62% of the 401(k) plan's assets were Enron stock (CNN citing Reuters, secondary source).

CAUTION"Skilling served 24 years"

The original sentence was 292 months (24 years 4 months, 23 Oct 2006). The appeals court upheld the convictions but vacated the sentence; in 2013 he was resentenced to 168 months (14 years), with about $42 million going to victims (DOJ, 21 Jun 2013).

CAUTION"The largest bankruptcy in US history"

True when filed (12/2001), with about $63 billion in assets. WorldCom overtook it the following year (Oil & Gas Journal, secondary source). Some reports use "$63 billion" for both assets and debts.

CAUTION"70% of Enron's profits were made up"

The figure appears in press accounts of Powers's testimony (for July 2000 to October 2001). This article could not find the sentence in the original documents, so it is not used as fact.

FALSE"Enron fell because of a few bad people"

Powers: "failures at many levels and by many people". The Senate: the board "knowingly allowed" high-risk accounting. The FBI: 22 people convicted. The SEC fined two banks. The auditor was prosecuted. The crooks were real, but the system around them let it run for years.

FALSE"The board was fooled and knew nothing"

Andersen told the Audit Committee on 7 Feb 1999 that the accounting was "pushing limits". The board itself let the CFO run LJM1 (6/1999) and LJM2 (10/1999). The Senate concluded the board "knowingly allowed" it. Some directors dispute details, for example the word "waived" for the ethics code.

FALSE"Ken Lay went to prison"

Lay died on 5 Jul 2006, before sentencing. On 17 Oct 2006 the judge vacated the conviction and dismissed the indictment under the "abatement" rule: a defendant who dies before exhausting appeals (NBC News, Jurist, secondary sources).

FALSE"Enron was a shell with no real business"

Enron had gas pipelines, power plants and a real energy trading arm (Form 10-K for 2000). The problem was dressed-up profit and hidden debt, not that the whole company was fake.

FALSE"Mark-to-market accounting was illegal"

The SEC did not object to it from 30 Jan 1992 (secondary source). The wrong lay in inflated estimates and deals built to avoid booking losses.

FALSE"Watkins blew the whistle to regulators"

She wrote to the company's chairman, internally. The letter reached the public when Congress released it in early 2002. The press called her a "whistleblower", but what she did was warn upward.

FALSE"Andersen was convicted of accounting fraud, and it stuck"

The charge was obstruction of justice (destroying documents), not accounting fraud. On 31 May 2005 the Supreme Court reversed 9–0 because of faulty jury instructions (544 U.S. 696).

Source: the sources noted in each line; full list in Part 8.

Part 5

Assessment

Scores are Mark's assessment based on the sources in Part 8, not figures from a study.

Avoidable
5/5
Warnings came early
5/5
Transparent investigation
4/5
Lessons kept
3/5
Done right after the collapse
  • The board set up an independent committee and published its report
  • The Senate, the SEC and the Justice Department made their records public
  • Bank settlement money went to victims
Done wrong
  • Years of warnings without stopping
  • The warning letter was handed to the company's usual law firm to review
  • Lay died before a final judgment and Andersen's conviction was reversed: many questions never got a final answer in court

Not a few bad people. A system where everyone was rewarded when the numbers looked good, and nobody was made to explain where the numbers came from.

More: what changed in law after Enron

In 2002 the US passed the Sarbanes-Oxley Act. One of its provisions (section 308(a), "Fair Fund") is what the SEC used to send $236 million of the two banks' settlement money to Enron victims.

But laws only patch the holes already seen. The "great profits, nobody can explain where the money is" failure returns later in this series: Lehman Brothers (2008) and FTX (2022).

Source for "More": SEC press release 2003-87 (Sarbanes-Oxley section 308(a), $236 million); the rest is Mark's comment.

Part 6

Work lesson: be able to explain where the money comes from

Use it for any number that makes you happy: revenue from a new channel, a project with a "surprise profit", a metric that suddenly jumps on the dashboard.

Four steps: explain the number in two sentences to a newcomer; separate booked profit from cash received; nobody sits on both sides of the table; warnings get an answer by a deadline. 1 · explain in 2 linesto a newcomerif you can't, it's a risk 2 · profit or cashhas the cash arrived?two columns side by side 3 · one person, one sidenot both sidesdeclare conflicts 4 · warnings, deadlinewho answers, by whenreviewer is independent "It's complicated, hard to explain" is a signal, not an answer.
Each step patches one of Enron's failures. Profit booked before the cash, private funds run by the CFO himself, an auditor's warning in 1999 and a letter in 2001 that stopped nobody.Source: the failures come from the Powers Report (2002), Senate Print 107-70 (2002) and Watkins's testimony (2002); the steps are Mark's proposal.
The two-sentence testFor every large revenue line: "who pays this, and why do they pay". Explain it to a new colleague. If you can't, mark it red.
Two columns: booked and collectedEvery report puts "profit on the books" next to "cash received". A growing gap is a question, not an achievement.
Nobody on both sides of the tableWhoever approves a contract must not benefit from the other side. If there is a conflict, declare it and let someone else approve.
Warnings with an answer deadlineWhoever raises a concern gets a written answer by a clear deadline, from someone not involved in what is being questioned.
Check your own team: 5 questions for the next meeting
  1. What is your team's best number this month? Who can explain in two sentences where it comes from?
  2. How much of it has turned into cash (or a real result), and how much is still an estimate?
  3. Is there a contract, supplier or partner where the approver has a personal connection? Has it been declared?
  4. The last time someone said "this number looks odd", did they get an answer, and from whom?
  5. If an outsider asked "how are you making so much", would you want them to see the books?
The tragic consequences were the result of failures at many levels and by many people.William Powers, testimony to the US House, 2/2002, per the PBS NewsHour transcript.
Part 7

Further reading

The Powers Report (2002)Report of the special investigative committee set up by Enron's own board. The opening summary takes 20 minutes.
US Senate, The Role of the Board of Directors in Enron's Collapse (2002)Short and clear, with meeting minutes in the exhibits. Read it to see what the board knew.
Bethany McLean and Peter Elkind, The Smartest Guys in the Room (2003)By two Fortune journalists (secondary source). The human story behind the numbers.
Anatomy of a Business Failure #6: Blockbuster (bankrupt 2010)When short-term metrics kill a long-term project.
Part 8

Sources

Primary documents first: Enron's SEC filings, investigation reports, congressional reports, court records. The network in the drafting session blocked sec.gov, govinfo.gov and justice.gov, so wording was checked through excerpts; where only the press confirms a point it is marked "secondary source".

  1. Special Investigative Committee of the Board of Directors of Enron Corp. (William C. Powers Jr., chair), Report of Investigation, 1 Feb 2002 (released 2 Feb 2002). Quoted via CNN Money, 2 Feb 2002 (secondary source).
  2. US House of Representatives, The Financial Collapse of Enron, Part 1, hearings 2/2002 (testimony of William Powers, Sherron Watkins), CHRG-107hhrg77985. govinfo.gov; PBS NewsHour transcript.
  3. US Senate, Permanent Subcommittee on Investigations, The Role of the Board of Directors in Enron's Collapse, Senate Print 107-70, 8 July 2002. govinfo.gov
  4. Enron Corp., Form 10-K for 2000. sec.gov/Archives
  5. Enron Corp., press release, 6 Feb 2001 (Fortune, "most innovative company in America" for the sixth year).
  6. Enron Corp., third-quarter 2001 earnings release, 16 Oct 2001. University of Chicago copy
  7. Enron Corp., Form 8-K of 8 Nov 2001 and exhibit 99.1. sec.gov/Archives
  8. US Bankruptcy Court, Southern District of New York, In re Enron Corp., case no. 01-16034, Chapter 11 petition of 2 Dec 2001.
  9. SEC, Litigation Release No. 18776 (Causey, Skilling, Lay). sec.gov
  10. SEC, press release 2003-87, 28 July 2003 (J.P. Morgan Chase, Citigroup). sec.gov
  11. US Department of Justice, press releases of 25 May 2006 (Lay, Skilling verdicts), 26 Sep 2006 (Fastow), 21 Jun 2013 (Skilling resentenced). justice.gov
  12. FBI Houston, 2016 press release on the ten-year anniversary of the Enron executives' convictions. fbi.gov
  13. US Supreme Court, Arthur Andersen LLP v. United States, 544 U.S. 696 (31 May 2005). law.cornell.edu
  14. US Department of Labor, press release of 12 May 2004 on the Enron retirement plan settlements (Chao v. Enron). dol.gov
  15. Congressional Record, 19 Dec 2001, E2336 (Rep. Ken Bentsen). congress.gov
  16. Secondary sources: CNN Money (2 Feb 2002; 26 Nov 2001); PBS NewsHour; Bloomberg (28 July 2002); History.com (share price); Oil & Gas Journal (bankruptcy size); NBC News, Jurist (Lay conviction vacated); Cato Institute, Regulation 26(3), 2003 (1992 SEC letter).