Financial Disasters: The Enron Scandal

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The Enron scandal was a financial scandal that was revealed in late 2001. After a series of discoveries involving irregular accounting procedures which could be turned in as fraud, went on throughout the 1990s, involving Enron and its accounting firm Arthur Andersen. Enron stood at the verge of falling into the largest bankruptcy in history by mid-November 2001. An attempt by a smaller energy company, Dynegy, was not feasible. Enron filed for bankruptcy on December 2, 2001. As the scandal was shown, Enron shares dropped from over $90.00 to just pennies. As Enron had been considered a blue chip stock, this was event came as a surprise to all and was an overall disaster in the financial world. Enron's downfall happened soon after it was revealed that the majority of its profits and revenues were the result of deals with special purpose entities (limited partnerships which it controlled). The result was that many of Enron's debts and the losses that it suffered were not reported in its financial statements. In the early 1990s the Congress of the United States of America passed legislation deregulating the sale of electricity. It had done the same for natural gas some years earlier. The resulting energy markets made it possible for companies like Enron to thrive, while the resultant price volatility was often bemoaned by producers and local governments.[2] Strong lobbying on the part of Enron and others, however, kept the system in place.[3][4] By the late 1990s Enron's stock was trading for $80-90 per share, and few seemed to concern themselves with the opacity of the company's financial disclosures. In mid July 2001, Enron reported earnings of $50.1 billion, almost triple year-to-date, beating analysts' estimates by 3 cents a share.[5] Despite this, Enron's profit margin had stayed at a modest average of about 2.1%, and its share price had dropped by over 30% since the same quarter of 2000.[6] However, concerns were mounting. Enron had recently faced several serious operational challenges, namely logistical difficulties in running a new broadband communications trading unit, constructing the Dabhol Power project, a large power plant in India, and criticism of the company for the role it allegedly had played in the power crisis of California in 2000-2001. By the end of August of 2001, his company's stock still falling, Lay named Greg Whalley, 39, president and chief operating officer of Enron Wholesale Services and Mark Frevert, 46, who was previously Mr. Whalley's superior at Enron Wholesale, to positions in the chairman's office. Some observers suggested that Enron's investors were in significant need of reassurance, not least because the company's business was difficult to understand (even "indecipherable"[14]) and difficult to properly express in a financial statement.[15] "[I]t's really hard for analysts to determine where [Enron] are making money in a given quarter and where they are losing money," said one analyst.[16] Lay accepted that Enron's business was very complex, but asserted that analysts would "never get all the information they want" to satisfy their curiosity. He also explained that the complexity of the business was due largely to tax strategies and position-hedging.[17]

Lay's efforts seemed to meet with limited success; by September 9, 2001, one prominent hedge fund manager noted that "[Enron] stock is trading under a cloud."[18] The sudden departure of Skilling combined with the opacity of Enron's accounting books made proper assessment difficult for Wall Street. In addition, the company admitted to repeatedly using "related-party transactions," which some feared could be too-easily used to transfer losses that might otherwise appear on Enron's own balance sheet. A particularly troubling aspect of this technique is that several of the "related-party" entities were or had been controlled by Enron's CFO, Andrew Fastow.[19] Then, a few days later, on October 17, 2001, Enron announced that its...
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