The Twisted Tale Of The Crooked E.
On 2nd December
2001, America’s 7th largest corporation filed for Chapter 11
bankruptcy protection. And it broke Wall Street’s heart. This was a company
that had been the blue-eyed boy of the stock markets for the better part of a
decade, a global giant that had literally risen from nothing and had gone on to
become a titan and bellwether of its industry, much to the utter delight of
Wall Street. And the bourses had long placed the company on a pedestal. It was
a juggernaut that could literally do no wrong, a company that was governed by
some of the most brilliant, celebrated and capable men that America Inc. had
ever known. The entity in question had taken the oil-and-gas and energy sectors
by storm and it had single-handedly managed to revolutionize the
once-lacklustre industries.
It had taken over 15 years for
America’s most innovative corporation to grow to a size of $70 billion. All it
took for the company to go bankrupt was 24 days. And did it go down quietly?
Not quite. What you are about to read is the intriguing tale of how one of
America’s most storied companies disintegrated in the wake of a full-blown
scandal. It was America’s largest corporate bankruptcy at that time and the
biggest accounting scandal that the world had ever seen. This is the story of
how Enron went from dust to boom to bust. This is the twisted tale of the
crooked E.
The Rise Of Enron.
In the mid 1980s, the oilfields of
Texas witnessed a pair of large energy companies, Houston Natural Gas (HNG) and
InterNorth, merge under the chairmanship of Ken Lay to form Enron, which set up
its global headquarters at Houston. In those years, the US energy market was
still highly regulated and Enron, foreseeing the benefits of a free energy
market, set out to convince the American Government to deregulate the energy
sector. Uncle Sam’s doling out of billions of dollars in subsidies to Enron
pushed the deregulation forward. Furthermore, the fact that Enron had funded
the first political campaign of George Bush (as Texan Governor) and that Lay
was a close friend of George Bush Sr. ensured a ruling in Enron’s favour. The
USA deregulated its energy markets, much to Enron’s delight, and energy prices
began to float in tandem with the international market rates.
With the dynamics of the market now
operating in Enron’s favour, the company began to grow its business in leaps
and bounds. Besides oil and gas, it diversified into utilities, power and pulp.
But rather than being a mere energy major, Enron wanted to control the market.
Enron wanted to call the shots and go where no company had ever gone before.
Under the helm of Jeff Skilling, it set up an online trading platform, on which
oil, gas and electricity could be traded like commodities. Enron would later
broaden the scope of its platform (billed EnronOnline) to include futures and
derivatives, broadband, weather patterns, movies (in an unsuccessful joint
venture with Blockbuster) and credit payments. It was a first for the entire
industry and Enron was regarded as the pioneer.
Houston, We Have A Problem.
With Enron moving away from being a
traditional energy and utilities company, it began to embrace the magic of an
online marketplace. What that meant was that Enron’s traders were now running
the show. Scruples took a back seat as Enron’s traders began drawing down the
company’s reserves and making colossal bets on energy prices. While most of the
losses were hidden away in offshore subsidiaries, the profits were brought to
the forefront. During Enron’s early years, the traders were raking in money
like there was no tomorrow. Or so it seemed.
When Enron started losing money, it
did so in a big way at that but those losses weren’t reported to Wall Street.
In what was later called the Valhalla Oil Scandal, Enron lost billions of
dollars when it bet the wrong way on oil prices. Enron’s traders ought to have
come clean and good accounting sense, coupled with prudence, dictated that the
losses should have been written off. Instead, Enron chose to bluff the markets.
The losses were buried abroad and Enron’s traders pocketed millions of dollars
when the company’s stock price surged. Soon, Lay began to rely entirely on his
traders to prop up the company’s numbers. Not surprisingly, the inmates were
slowly taking over the asylum.
Breaking Bad.
Enron’s novel idea of an online
marketplace stemmed from Jeff Skilling, the company’s CEO. He was always in
search of the next big idea that would make Enron money and take the markets by
storm. EnronOnline, as a matter of fact, was his brainchild. Skilling was
backed in able capacity by Andy Fastow, Enron’s CFO. Fastow was the architect
of Enron’s network of special purpose entities (SPEs), which had bizarre names
such as LJM, JEDI, Chewco, Raptor and Whitewing (Fastow was known to be a fan
of the Star Wars and Jurassic Park series of films). The SPEs, which were
little more than offshore shell companies, were used to siphon away the debt
and losses, so that Enron’s balance sheet was as clean as Lay and Skilling
wanted it to be.
While deregulation had freed up
energy prices, Enron did all it could to ensure that energy prices rose and in
turn, boost its bottomline. Even though a fine line does separate business and
ethics, Enron had no hesitation in stepping over that line. In the state of
California, Enron began shutting down its power plants, curbed output and
manipulated power grids to ensure that the demand for power would outstrip its
supply. When that happened, prices went through the roof and Enron made hay
while the sun shone. Enron even acquired Portland General Electric to gain a
foothold in other American states and repeat its devious gameplan. Ultimately,
in the Californian power crisis that was even linked to the gubernatorial campaign
of Arnold Schwarzenegger (apparently, Arnie and Lay were buddies), the state of
California lost around $40 billion due to Enron’s monkey business.
Nevertheless, Enron had made its fortune and the company had had its fun in the
warm California sun.
The Fox Of Wall Street.
Wall Street loved
Enron. It was as simple as that. With each passing quarter, Enron’s topline and
bottomline both grew, far outstripping analysts’ projections. Even as Enron
managed to fly high quarter after quarter, some brokerages began to doubt the
veracity of the company’s financials. After all, peers like ExxonMobil, Chevron
and Dynegy were reporting fluctuating numbers at best. Was Enron everything
that it claimed to be?
Enron, as the world would later
discover, was largely a house of smoke and mirrors. While most of its
international subsidiaries were bleeding, its oil business was one of the few
arms that were spurting cash. Portland General Electric, the utilities company
that Enron had acquired, was another money spinner. A large chunk of Enron’s
other subsidiaries, however, were deep in the red. Enron had even established
an international water utilities subsidiary called Azurix, which ratcheted up
millions of dollars in losses. Enron, in typical fashion, chose to bury those
losses under its vast network of international subsidiaries and SPEs. When it
came to accounting jugglery, window dressing and cooking its books, Enron
succeeded in pulling out all the stops. It made use of an accounting technique
called mark-to-market accounting (MTM accounting), which allows a company to
book all anticipated future profits from a project upfront and stagger the
expenses over the lifetime of the project. Enron used MTM accounting to book
all the profits from its global projects even before they were commissioned.
When its plants came on steam, Enron would then suppress the expenses and
losses under its matrix of shell companies. Enron used MTM accounting on its
American, British, Mexican, Venezuelan, Nigerian, Chinese and Argentinean
subsidiaries. After all, MTM accounting ensured that Enron’s profits would be
anything it wanted them to be.
The Desi Angle.
If Enron had been
frolicking around in countries like Venezuela, Argentina and the Dominican
Republic, could India stay off the scope of its radar for long? Of course not!
In the 1990s, India was a country that was starving for power and Enron,
sensing its chance to make a quick buck, announced huge investment plans for
India. Enron’s glamour doll and chief of Azurix, Rebecca Mark, spearheaded
Enron’s Indian sojourn and became a media sensation overnight. Enron zeroed in
on the state of Maharashtra and started building a colossal power plant at
Dabhol, from which it intended to supply power to the Maharashtra State Electricity
Board (MSEB). But Enron had forgotten to consider one important fact. Its power
tariffs were so high that the MSEB couldn’t afford to buy power at such
exorbitant rates. Furthermore, large-scale protests by Bal Thackeray’s party,
the Shiv Sena (the entire Dabhol saga was captured in the Amitabh Bachchan -
Abhishek Bachchan - Aishwarya Rai Bachchan starrer, Sarkar Raj), made life
difficult for Enron. Lay decided that he had had enough, considering that the
plant was economically unviable anyway. Enron jettisoned its Indian venture,
mothballed its plant and wrote off a staggering one billion dollars in losses.
And of course, even before its plant at Dabhol had been conceived, Enron had
conveniently used MTM accounting to record anticipated future profits of
nothing less than a few billion dollars.
Beam Me Up.
With Enron reporting Street-beating
numbers, via MTM accounting and its international subsidiaries, Wall Street
rewarded the company by pushing its stock higher and higher. Retail investors began
to invest their savings into the company’s stock, even as financial
institutions snapped up large chunks of the Enron. Most Wall Street firms had
outperform ratings on the company and those that didn’t were ridiculed and even
shunned when it came to bids for fund-raising by Enron’s overseas subsidiaries.
Ironically, no one could accurately pinpoint the sources of Enron’s burgeoning
profits. When the company declared its results, Wall Street would take its top
brass’ word for its numbers. Enron was essentially an arcane black box.
When the stock markets boomed,
Enron’s scrip virtually had a one way ride and it was going nowhere but up. The
stock appreciated by 50% and then 90% in the years leading up to the
twenty-first century, even as Lay and Skilling egged Wall Street firms and
other investors on into believing in the Enron story and investing in the
company. Enron’s scrip, riding a wave of greed and euphoria, hit an all-time
high of $90, trading at a pricey earnings multiple of over 60 times. Soon
enough, price targets on the Enron scrip in the range of $120 to $150 were
doing the rounds of Wall Street. At Enron, Wall Street’s perception of the
company had assumed greater importance than the company’s underlying business.
The stock price had become the be all and end all, as far as the company was
concerned. And with good reason too. What the outside world didn’t know then
was that Enron’s top management was pushing the stock price higher and then
cashing in on their stock options (a move that was called ‘Pump ‘N Dump’), thus
pulling millions of dollars out of Enron. And what Wall Street failed to
realize was that all of Enron’s debt that was hidden away in the SPEs was
backed by the company’s stock. Enron, in essence, was nothing more than a ticking
time bomb.
The Crooked E Crumbles.
When the dotcom bubble burst, Wall
Street collapsed and Enron’s stock went into a freefall, along with the market.
What followed was the unravelling of Enron’s carefully-wound ball of string.
With its stock falling, margin calls from lenders descended upon the company.
Fastow had used Enron’s stock to back the company’s $30 billion debt, in the
hope that Enron’s stock would go nowhere but up. But now, it was moving
entirely in the opposite direction. Most of the company’s businesses were
struggling with ballooning losses and the consolidated entity was on the verge
of a meltdown.
When news of Enron’s SPEs, hidden
debt and suppressed losses came to light, Lay fired Fastow and squarely blamed
him for all of Enron’s wrongdoings. A few months later, Skilling decided to
abandon ship, even as Enron’s scrip fell to new lows. With his trusty henchmen
now gone, Lay took over as CEO but as the months passed by, more and more of
the company’s past sins were revealed to the world. In a bid to save his own
skin, Lay tried to assuage Wall Street’s fears and reassure investors that
Enron’s business was stable and that the fall in the stock price was only an
aberration. But the markets weren’t buying it and they decided to call Lay’s
bluff. It was only now that Wall Street began to realize that the emperor had
no clothes.
As Enron came under the scrutiny of
the Securities and Exchange Commission (SEC) and allegations of fraud began to
surface, Wall Street lost faith in Enron and sent its stock crashing. Enron’s
scrip soon became a penny stock. As Enron’s losses began to pile up, the
company began hiving off its subsidiaries to raise cash and Lay desperately
tried to court its rival, Dynegy, for a possible merger. However, Dynegy
baulked at the deal at the very last minute and walked away from the table. For
Enron however, it proved to be the final nail in the coffin.
On 2nd December 2001, Enron filed
for Chapter 11 bankruptcy protection and the trio of Lay, Skilling and Fastow
were sentenced to multi-year terms of imprisonment for accounting fraud,
insider trading and rigging the company’s stock price (Ken Lay later kicked the
bucket in prison). Multi-billion dollar lawsuits were filed against Enron. As
the world slowly came to terms with the ramifications of the accounting scandal
and fraud at Enron, public outcry increased and corporate governance was called
into question all over America Inc. In 2002, in the aftermath of the Enron
scandal, amidst all the outrage, the Sarbanes-Oxley Act was passed to ensure
stringent standards of financial accounting and corporate governance. But as
far as the bourses were concerned, the fall of Enron had meant only one thing.
Wall Street had lost its eternal darling.
If I Fall, You’re Going Down With Me.
If Enron had indulged in accounting
fraud to such a large extent, then what were its auditors doing? Well, to put
it simply, Arthur Andersen, Enron’s auditors, were in cahoots with Enron. And
with Enron paying them a substantial fee every year, they couldn’t afford to
offend Lay or Skilling. Despite Enron’s excessive use of MTM accounting,
artificially bloated revenues, hidden debts, buried losses and a labyrinth of
international subsidiaries and SPEs, Arthur Andersen would sign off on Enron’s
annual accounts with nary a qualification.
In fact, even when Enron was
sinking, Arthur Andersen never raised any objections to the company’s
financials, until it was too late. By then, however, Arthur Andersen’s fate was
sealed. When Enron filed for bankruptcy, Arthur Andersen shredded huge volumes
of documents and records that would have proved to be the smoking gun. But as
far as the audit major was concerned, it was all she wrote. Arthur Andersen,
once a part of the ‘Big Five’ audit firms, had its license stripped away from
it and criminal charges pressed against it by the SEC. Even though a part of
the firm was later resurrected as Accenture, there’s no denying the fact that
Arthur Andersen’s role in the Enron accounting scandal was significant. And
when Enron went down, it dragged Arthur Andersen down with it into a bottomless
pit of doom.
Ask Why, Asshole.
At the end of the day,
Enron turned out to be a wake-up call for America Inc. at large. It was a
classic case of a global giant with political and investor support turning out
to be nothing more than a house of cards. When Enron went down, it erased
billions of dollars’ worth of shareholder value, debt and employee pensions.
Enron was a company that had had the audacity of publicly declaring its intent
to do away with ExxonMobil, a giant of its industry. In fact, both Enron and
its top echelon were so revered that Wall Street was gullible enough to believe
anything and everything that the company claimed. Enron was held as a company
that was the embodiment of innovation, new ideas and an obsession of being
better than everything else that existed around it. Lay had even announced his
vision of transforming Enron from the world’s leading energy company into the
world’s largest company. Ultimately, when Enron crumbled, it went down as a
victim of its own greed, hubris and hype.
Today, Enron’s dual-tower,
glass-and-steel headquarters still stand on the Houston skyline, a
spine-chilling reminder that behind Wall Street’s façade and the smokescreen,
all is not as it appears. In its heyday, Enron was often billed as
an immortal company by Wall Street and everyone was completely mesmerized and
taken in by the illusion that Enron managed to portray. Those who doubted Enron
were ostracized and viewed as outcasts. The energy giant was so revered that it
could afford to shun the outside world’s standards. Enron largely operated
according to its own whims and fancies. In fact, a few years before Enron
collapsed, in the midst of an investor conference call, a fund manager
questioned Skilling as to why Enron, being a financial services major, never
bothered to publish a cash flow statement or a balance sheet with its quarterly
numbers. And Skilling, much to the bewilderment of everyone listening in,
responded by calling the fund manager an asshole. This incident led to Enron’s
traders coining the infamous ‘Ask Why, Asshole’, a humorous take on Enron’s
tagline. ‘Ask Why’, in case you’re wondering, was Enron’s corporate tagline.
And the ‘Crooked E’ comes from the shape of the company’s logo (a slanting E),
designed by Paul Rand.
Indeed, as far as the crooked E’s
accounting shenanigans were concerned, the cruel irony is that if someone had
merely bothered to do the tagline’s bidding, America’s most notorious
accounting scandal might have been stopped dead in its tracks. It might be a
bit too late to speculate now but maybe, just maybe, Enron would have never
gone crooked in the first place, if only someone had deigned to ask why.
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