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.


Jeff Skilling was convicted of fraud
(Image credit: 2006 Getty Images)

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.

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.

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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.

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.

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri