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

Jeff Skilling was convicted of fraud

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.

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.

Recommended

Don’t listen to the doom-mongers – the future is bright
Economy

Don’t listen to the doom-mongers – the future is bright

With volatile markets, raging inflation and industrial unrest, it may feel like things are bad and likely to get worse. But the end of the world is no…
15 Aug 2022
How to harness the power of best ideas in your portfolio
Investment strategy

How to harness the power of best ideas in your portfolio

Fund managers’ top picks beat the market, but the rest of their portfolios often add little value, says Chris Sholto Heaton.
13 Aug 2022
Why the market is wrong about private equity
Investment trusts

Why the market is wrong about private equity

When it comes to listed private-equity trusts, investors are overly sceptical, with many funds trading at heavy discounts to their net asset values. B…
9 Aug 2022
Fear of missing out – what should investors do now?
Investment strategy

Fear of missing out – what should investors do now?

Markets have rallied from their mid-June lows. But if you missed out, as most investors did, what should you do now? Max King explains.
8 Aug 2022

Most Popular

Are UK house prices set to fall? It’s not so simple
House prices

Are UK house prices set to fall? It’s not so simple

Figures suggest UK house prices are starting to slide, but we shouldn’t take these numbers at face value, explains Rupert Hargreaves.
11 Aug 2022
Is gold cheap relative to equities?
Gold price

Is gold cheap relative to equities?

Dominic Frisby looks at the Dow-gold ratio and explains why gold is starting to appear inexpensive compared to equities.
12 Aug 2022
The energy price cap keeps rising - here is what you can do about it
Personal finance

The energy price cap keeps rising - here is what you can do about it

The energy price cap could hit £5,000 next year, even higher than expected, predicts energy consultancy Auxilione. Saloni Sardana explains what you ca…
12 Aug 2022