Great frauds in history: the collapse of Enron

Enron was energy company that was expanding aggressively, says Matthew Partridge. And the management was fiddling the finances.

935-skilling-634

Enron was an energy company formed as part of a merger between two gas companies, InterNorth and HNG, in 1985. From 1987 onward it began aggressively expanding into newly deregulated energy markets across the US and the world, through both new ventures and mergers.

It also became involved in energy futures markets (which allow firms and investors to both hedge against and speculate on movements in energy prices) and attempted to become an important player in the telecommunications market.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

How did this work out?

Although legitimate, Enron's businesses were unprofitable.To hide this, the management fiddled the finances.It treated the total amount of money traded on its energy exchanges as revenue, for example (the standard practice is to count only profits and trading commissions).It counted expected future profits from its deals as current profits. And to hide losses and mounting debts, it set up a complicated structure of off-balance-sheet "special purpose vehicles" to borrow money against Enron's stock.

What happened next?

While Enron's stock was rising, its creditors were willing to lend more money. But the bear market that accompanied the bursting of the technology bubble caused its share price to decline.

Advertisement
Advertisement - Article continues below

At this time The Wall Street Journal ran a critical article about Enron's accounting, causing other analysts to start to ask questions. With creditors now demanding repayment, and its credit lines drying up, Enron's executives were forced to admit that they had overstated earnings between 1996 and 2000, which made the problems even worse. After rival Dynergy abandoned its planned bid for Enron, the company filed for bankruptcy in December 2001.

Lessons for investors

CEOs Jeffrey Skilling (pictured) and Ken Lay were convicted of fraud and CFO Andrew Fastow (along with 12 other Enron executives) also pleaded guilty. Shareholders were wiped out, although the banks that facilitated Enron's deceptive deals paid some later shareholders around $7 a share (less than 10% of the peak value).

The Enron debacle shows it is a good idea to avoid firms that structure their finances in overly complicated or opaque ways. Insider selling is also a big red flag Enron's executives dumped their shares at the same time as encouraging their employees to use their savings to buy them.

Advertisement

Recommended

Visit/516944/why-wall-street-has-got-it-wrong-again
Economy

Why Wall Street has got the US economy wrong again

The hiring slowdown does not signal recession for the US economy. Growth is just moving down a gear, says Brian Pellegrini.
25 Oct 2019
Visit/investments/investment-strategy/600830/great-frauds-in-history-john-g-bennett-jrs-ponzi-scheme
Investment strategy

Great frauds in history: John G. Bennett Jr’s Ponzi scheme

John G. Bennett Jr's classic Ponzi scheme cost his investors $135m and ended him ten years in jail.
18 Feb 2020
Visit/economy/us-economy/600841/apples-coronavirus-warning-wont-be-the-last-but-will-markets-care
US Economy

Apple’s coronavirus warning won’t be the last – but will markets care?

If one of the world's biggest companies is feeling the pain from the coronavirus, then presumably others are too, says John Stepek. That can only lead…
18 Feb 2020
Visit/investments/investment-strategy/600834/the-trouble-with-world-stockmarket-indices-and-how-to-fix
Investment strategy

The trouble with "World" stockmarket indices and how to fix them

Indices such as the MSCI World or the FTSE World are not an accurate reflection of the global economy
17 Feb 2020

Most Popular

Visit/investments/stocks-and-shares/600863/sirius-minerals-anglo-american-takeover
Stocks and shares

Do you own shares in Sirius Minerals? Here’s what you need to do now

Mining giant Anglo American has proposed a cash takeover of Yorkshire-based minnow Sirius Minerals. Unhappy shareholders must decide whether to accept…
20 Feb 2020
Visit/investments/commodities/gold/600874/gold-is-at-its-highest-level-in-years-heres-how-to-invest
Gold

Gold is at its highest level in years – here’s how to invest

Gold's rise at a time when the dollar is unnervingly strong isn't unheard of – but it is curious. John Stepek explains what's going on, and what it me…
21 Feb 2020
Visit/investments/stocks-and-shares/share-tips/600843/share-tips-of-the-week
Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
21 Feb 2020
Visit/investments/stockmarkets/european-stockmarkets/600725/is-2020-the-year-for-european-small-cap
Sponsored

Is 2020 the year for European small-cap stocks?

SPONSORED CONTENT - Ollie Beckett, manager of the TR European Growth Trust, on why he believes European small-cap stocks are performing well.
12 Feb 2019