Enrol collapse

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Order Code RS21135
February 4, 2002

CRS Report for Congress
Received through the CRS Web

The Enron Collapse:
An Overview of Financial Issues
Mark Jickling, Coordinator
Specialist in Public Finance
Government and Finance Division

Summary
Only months before Enron Corp.’s bankruptcy filing in December 2001, the firm was widely regarded as one of the most innovative, fastest growing, and best managed businesses in the United States. With the swift collapse, shareholders, including thousands of Enron workers who held company stock in their 401(k) retirement accounts, lost tens of billions of dollars. Investigations of wrongdoing may take years to conclude, but Enron’s failure already raises financial oversight issues with wider applications. Why didn’t the watchdogs bark? This report briefly examines the accounting system that failed to provide a clear picture of the firm’s true condition, the independent auditors and board members who were unwilling to challenge Enron’s management, the Wall Street stock analysts and bond raters who missed the trouble ahead, the rules governing employer stock in company pension plans, and the unregulated energy derivatives trading that was the core of Enron’s business. The report will be updated regularly as further reliable information about Enron’s downfall – which is now extremely limited – becomes available.

Other contributors to this report include Bob Lyke, Patrick Purcell, and Gary Shorter.

Formed in 1985 from a merger of Houston Natural Gas and Internorth, Enron Corp. was the first nationwide natural gas pipeline network. Over time, the firm’s business focus shifted from the regulated transportation of natural gas to unregulated energy trading markets. The guiding principle seems to have been that there was more money to be made in buying and selling financial contracts linked to the value of energy assets (and to other economic variables) than in actual ownership of physical assets. Until late 2001, nearly all observers – including professional Wall Street analysts – regarded this transformation as an outstanding success. Enron’s reported annual revenues grew from under $10 billion in the early 1990s to $101 billion in 2000, ranking it seventh on the Fortune 500.

The unraveling began in August 2001, when CEO Jeffrey Skilling resigned for undisclosed reasons. On October 16, Enron reported its first quarterly loss in 4 years, Congressional Research Service ˜ The Library of Congress

CRS-2
taking a charge against earnings of $1 billion for poorly performing businesses. The reported third quarter loss was $618 million, versus a $292 million profit a year earlier. On November 8, the company announced in a Securities and Exchange Commission (SEC) filing that it was restating its earnings since 1997 – reducing them by $586 million. The coup-de-grace came on November 28, when the major bond rating agencies downgraded Enron’s debt to below-investment-grade, or junk bond status. The company filed for Chapter 11 bankruptcy on December 2, 2001.

Several committees in the House and Senate have held or plan to hold hearings related to Enron’s fall. The Justice Department is conducting a criminal investigation. The challenge for financial oversight, however, does not depend on findings of wrongdoing. Even if no one at Enron did anything improper, the swift and unanticipated collapse of such a large corporation suggests basic problems with the U.S. system of securities regulation, which is based on the full and accurate disclosure of all financial information that market participants need to make informed investment decisions. The overarching financial issue raised by Enron is whether the quality of information available about public corporations needs to be improved. Several aspects of this central issue are briefly sketched below, with references to CRS products that discuss the issues in more detail.

Auditing Issues
Federal securities law requires that the accounting...
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