Enron Corporation’s December 2, 2001, Chapter 11 reorganization filing was the largest bankruptcy in history, until it was exceeded in 2002 by WorldCom. Enron, headquartered in Houston, Texas, had grown quickly into a superficially giant and well-regarded company. It rapidly collapsed following the sudden disclosure of massive financial misdealing, which revealed the company to be a shell rather than a real business. During 2001, Enron stock fell to about $0.30—an unprecedented collapse for a blue-chip stock.
The Enron scandal helped propel passage of the McCain-Feingold Bipartisan Campaign Reform Act of 2002 (March). While Enron was neither the biggest nor the most important source of political funds, it had been active in making political contributions and attempting to influence legislators. Part of the Enron scandal involved political connections to President George W. Bush (former governor of Texas) and Vice President Dick Cheney (formerly CEO of a Texasheadquartered company). In May 2005, a U.S. appeals court dismissed a related lawsuit against the vice president on the grounds that an administration must be free to seek confidential information (including Enron) concerning energy policy.
Enron, quickly followed by WorldCom, helped propel the Sarbanes-Oxley Act of 2002 (July), the most significant change in U.S. securities laws since the early 1930s. As shocking as the sudden bankruptcy of a blue-chip company was, the subsequent revelations were worse: The traditional U.S. corporate governance watchdogs—attorneys, auditors, and directors—had either aided and abetted the responsible executives or been grossly negligent in the supervision of those executives. The United States and several other countries were rocked by multiple revelations of corporate scandals that ultimately also included analysts; auditors; banks; brokerages; mutual, hedge, and currency trading funds; and the New York Stock Exchange.
Enron was not the first or the last or the largest of the corporate scandals in recent years. Nevertheless, Enron became, above all other companies, the emblem for management fraud, director negligence, and adviser misconduct. Enron is easily the most widely studied and best documented of the recent corporate frauds. Enron was a prolonged media event.
The high education levels and intelligence of Chairman Kenneth L. Lay (Ph.D. in economics), CEO Jeffrey K. Skilling (Harvard MBA and top 5% Baker Scholar), and CFO Andrew Fastow (Northwestern MBA) raised serious questions about business school treatment of ethics and law. In January 2005, the documentary movie Enron: The Smartest Guys in the Room, based on Bethany McLean and Peter Elkind’s 2003 bestseller of the same name, premiered at the Sundance Film Festival in Utah. Spring 2005 releases took place in Austin and then Houston. The theme of the book and the movie is that smart guys can outsmart themselves as well as everyone else.
The most astonishing aspect of the Enron scandal was that a significant number of executives had engaged in improper actions despite the company having in place the key elements and best practices of a comprehensive ethics program. There was a detailed 64-page “Code of Ethics” with an introductory letter from Chairman Ken Lay and a “Statement of Human Rights Principles” together with a sign-off procedure on the code for each employee, an internal reporting and compliance system, visible posting of corporate values (banners in the headquarters building, signs in the parking garage, and so forth), and an employeetraining video—Vision and Values—discussing ethics and integrity. Enron issued a 2000 annual report on corporate responsibility. The “Code of Ethics,” like other Enron paraphernalia, was later auctioned on eBay. The Smithsonian Institution reportedly obtained a copy of the code for its permanent collection.
The publicized “values” of Enron were respect, integrity, communication, and excellence. The real “ethical” climate at Enron was a combination of arrogance (or hubris), corruption, greed, and ruthlessness. The gap between words and deeds at Enron was dramatic. This gap suggests that it is not particular corporate governance devices that matter most but the probity and integrity of individuals in relationship to the ethical climate within a company.
The executives were arrogant in attitude and conduct. The company strategy was one of revolutionizing trading by breaking traditional rules. The “vision” at Enron was to become the world’s leading energy company—in reality, by any means necessary. There were rumors of sexual misconduct by executives. Expensive vehicles and power-oriented photogenic poses were commonplace.
The weight of evidence suggests that the lure of wealth had suborned the corporate governance watchdogs. It turned out that the directors must have been asleep at the switch or mesmerized by the rising stock price. It turned out that the external attorneys and auditors could not afford to lose such a successful client. Enron executives did not hesitate to bully the external safeguards, such as analysts, when and if necessary. A corruption machine was at work, whether intentionally or inadvertently.
In the 1987 film Wall Street, the character named Gordon Gekko announces that greed is good. Enron—whose logo became known as “the Crooked E”—epitomized that slogan. Greed is a morally disturbing paradox at the heart of the market economy. Bernard Mandeville, in the Fable of the Bees, or Private Vices, Publick Benefits (1714), argued that individual vices and not individual virtues produce public benefits by encouraging commercial enterprise. An economic actor engages in selfish calculation of interest or advantage. This consequentialist perspective emphasizes outcomes over intentions or means. The Enron executives carried this perspective to its logical extreme. Adam Smith’s telling criticism in The Wealth of Nations of the East India Company’s personnel suggests that he would hardly be surprised.
The company culture embodied ruthlessness toward outsiders and insiders alike. Skilling emphasized a process of creative destruction within the company. The rank and yank system of employee evaluation by peer review, reportedly installed by CEO Skilling, annually dismissed the bottom 20% of the employees—and perhaps corruptly rather than objectively. It has been reported that traders were afraid to go to the bathroom because someone else might steal information from their trading screen. In such a culture, no one would report bad news. In such a culture, individual achievement was everything and teamwork was nothing. Enron culture emphasized bonuses, hardball, take no prisoners, and tacit disregard for ethics and laws.
Ken Lay, then CEO of Houston Natural Gas, formed Enron in 1985 by merger with InterNorth. Lay had worked in federal energy positions and then in several energy companies. He was an advocate of free trade in energy markets and had experience in political influence peddling. Enron was originally involved in transmission and distribution of electricity and natural gas in the United States. It also built and operated power plants and gas pipelines, and similar industrial infrastructure facilities, globally. Allegedly, bribes and political pressure tainted contracts around the world—most notoriously a $30 billion contract with the Maharashtra State Electricity Board in India.
Jeff Skilling was a senior partner at McKinsey & Co. and in the later 1980s worked in that capacity with Enron. Skilling joined Enron in 1990 as chairman and CEO of Enron Capital & Trade Resources. In 1996, he became president and COO of Enron. The company morphed into an energy trading and communications company that grew to some 21,000 employees, and its stock price rose to about $85. Enron grew to the seventh largest publicly listed company in the United States. Strategy emphasized bold innovation in trading of power and broadband commodities and risk management derivatives—including highly exotic weather derivatives. Trading business involved mark-to-market accounting in which revenues were booked, and bonuses awarded, on the basis of effectively Enrononly estimates of the value of contracts. Fortune magazine named Enron “America’s Most Innovative Company” for five consecutive years (1996–2000). Enron made Fortune’s “100 Best Companies to Work for in America” list in 2000. The company’s wealth was reflected in an opulent office building in downtown Houston. Business school cases on Enron’s business practices and culture were circulated for teaching purposes. Skilling served briefly as CEO of Enron from February to August 2001. Then, he abruptly resigned from Enron and Lay took over as CEO.
Following the bankruptcy filing, there were multiple investigations, including one commissioned by the Enron board of directors and directed by William C. Powers Jr., dean of the University of Texas at Austin’s law school. The U.S. Department of Justice announced (January 9, 2002) a criminal investigation of Enron, and various congressional hearings began (January 24, 2002). The hearings also revealed the role of Sherron Watkins, a certified public accountant, who had warned Lay about Fastow’s offshore devices after Skilling suddenly resigned. Watkins’s experience helped propel into law the whistle-blower protection elements of the Sarbanes-Oxley Act. The investigations emphasized two key matters, revealing how Enron had been built as an empty house of cards.
Enron was deeply involved in manipulating the California energy crisis. John Forney, a former energy trader, was indicted in December 2002 on 11 counts of conspiracy and wire fraud and pled guilty. Tape recordings revealed Enron traders on the phone asking California power plant managers to get a little creative in shutting down plants for repairs. Forney was a Star Wars fan. His “Death Star” strategy involved shuffling energy around the California power grid to generate state payments relieving congestion. Death Star deliberately created congestion. He named other devices JEDI (Joint Energy Development Investments) and Chewco (after the character of Chewbacca).
The other key revelation concerned CFO Andrew Fastow’s creative use and alleged partial ownership of offshore special purpose entities (SPEs) or limited partnerships. These devices separated debt from revenues and kept mark-to-market losses off Enron’s books temporarily. Fastow had been a CFO Magazine award for excellence winner. Fastow was indicted (November 1, 2002) on 78 counts, including fraud, money laundering, and conspiracy. He and his wife, Lea Fastow, former assistant treasurer of Enron, accepted a plea agreement (January 14, 2004) in exchange for testifying against other Enron defendants. Mr. Fastow received a 10-year prison sentence and a loss of $23.8 million; Mrs. Fastow received (for income tax evasion charges in concealing Mr. Fastow’s gains) a 5-month prison sentence and 1 year of supervised release, including 5 months of house arrest. The Enron board had waived conflict of interest rules in its own Code of Conduct to permit Fastow to oversee some of these SPEs. Most important were the “Raptors” (after Jurassic Park creatures) or “LJM1” and “LJM2,” named for Fastow’s wife and two children. It was alleged that Fastow had engaged in unauthorized self-dealing and benefited directly from these supervised devices.
The Enron bankruptcy resulted in the criminal conviction for obstruction of justice and, thus, forced auditing license surrender of its auditor Arthur Andersen, which collapsed. The audit partner assigned to Enron, David Duncan, pled guilty to ordering large-scale destruction of work documents. Some 28,000 Arthur Andersen employees had to find other employment. On May 31, 2005, the U.S. Supreme Court unanimously overturned the firm’s conviction on grounds that the trial judge’s jury instructions were too vague and broad. Federal prosecutors decided in November 2005 not to retry the case. Duncan was allowed to withdraw his guilty plea, although other charges could be filed against him.
As of July 2005, there had been 16 guilty pleas and six convictions (one thrown out) in the Enron cases. Former Merrill Lynch bankers and Enron executives were convicted in the Nigerian barge trial. (One executive was found innocent.) Nonexistent barges (to be built) were flipped between Enron and Merrill Lynch to generate paper profits and bonuses. In July 2005, three former executives of Enron Broadband Services (EBS) were acquitted of some charges; the jury deadlocked on other charges against them and two other defendants. The charges had argued intentional overpromotion of EBS’s value. The judge dismissed the remaining charges against all defendants. In November 2005, a special grand jury issued three streamlined indictments against the five codefendants. Skilling was indicted in February 2004 and Lay in July 2004, both on multiple counts. Both pled not guilty; their trials had not commenced as of November 2005. The prosecution wanted to try with Lay and Skilling the former chief accounting officer of Enron Rick Causey. He had pled not guilty to more than 30 charges of fraud. He was indicted in January 2004.
Enron’s bankruptcy had serious effects for many individuals and organizations. The Houston Astros paid Enron $5 million to rename Enron Field as Astros Field, subsequently changed to Minute Maid Park. Playboy (August 2002) featured a pictorial “The Women of Enron.” David Tonsall, former Enron employee, became rapper “N Run” (i.e., Enron and “never run”) on a December 2003 CD Corporate America.
Shareowners lost virtually everything. Several employees lost their jobs and their life savings that they had invested in Enron stock. Like former Arthur Andersen employees, former Enron employees may have damaged résumés. The Enron bankruptcy reorganization was a lengthy affair under a new management and bankruptcy examiner. The state of California is attempting recovery of monies from various parties. Eventually, shareowners and employees may begin partial financial recoveries from various parties, including banks and insurance companies. As of November 2005, Citigroup had settled for $2 billion, J. P. Morgan Chase for $2.2 billion, and the Canadian Imperial Bank of Commerce for $2.4 billion. These figures represent the largest securities class-action settlement on record, and there are still a number of other prominent defendant banks remaining. The U.S. bankruptcy court finalized a settlement in May 2005 of about $3,500 on average for more than 20,000 current and former employees (about $69 million total). Civil lawsuits are still proceeding against Lay, Skilling, Enron, and others. The directors of Enron (and WorldCom) personally paid damages.
Adelphia Communications; Arthur Andersen; Campaign Finance Laws; Global Crossing; Grasso, Richard; Mandeville, Bernard; Parmalat; Royal Ahold Company; Sarbanes-Oxley Act of 2002; Scandals, Corporate; Tyco International; Whistle-Blowing; WorldCom
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