“Investors have virtually given up on ENE (down 63% ytd), & its prospects as a long list of extremely neg stories have swirled around about the co and its financial cond; the co’s limited transparency to its sources of earnings, its cash flow and financials in gen. has worked against percep as mgmt has declined to be more specific in refuting even outrageous claims that have assumed a life of their own. We see major catalysts in Q3 reporting and disclosure and more in coming months as credibility is partially restored. We are strongly reiterating our RL rating, and our conviction in the high and sustained growth prosp at ENE, even as we are cutting our 02 est. to $2.15 and growth expect. and our price tgt to $48.”
October 3, 2001 Goldman Sachs Analyst Report: Enron Corporation
It started innocently. In February 2001, Fortune asked, “Is Enron Overpriced?” Eight months later, the company crumbled under revelations of bad investments, dubious accounting practices and abdication of corporate responsibility.
Enron was made possible by the deregulation of the natural gas industry in the late 1970s and early 1980s. It thrived on innovation, developing complex financial instruments for gas transactions. Driven by former McKinsey consultant Jeffrey Skilling, the company was a market-maker and a leader in the contracting of buying, selling and delivering natural gas. This trading increasingly drove profits and shaped corporate culture. Enron also expanded into power plants, electricity, water supply, broadband communications and Internet video, many of which failed, costing billions. Revenues, however, grew from $13.3 billion in 1996 to $100.8 billion in 2000. (37)
How did Enron grow despite major losses? In the early 1990s, the company implemented “mark-to-market” accounting for its outstanding gas contracts. This pegged the book value of the contract to market prices, requiring adjustments as prices rose and fell, and leaving room for manipulation. Special purpose entities, side ventures and partnerships used to remove assets or debt obligations from corporate books, and called “SPEs,” also buoyed Enron on paper. In 1999, for example, Andrew Fastow, Enron Chief Financial Officer, used a SPE to acquire equity in a company outside of Enron. Enron booked the sale as earnings. Arthur Andersen, more concerned about profits from consulting services than auditing responsibilities, abetted Enron’s dubious practices. As an investigator later put it, Enron essentially believed that “saying the right words, turning around three times and throwing salt over your shoulder could somehow transform something without economic substance into something with economic substance.”
By 2000, Enron’s precarious financial structure verged on collapse. One employee worried to Kenneth Lay, Enron Chief Executive Officer, that “we will implode in a wave of accounting scandals.” Another warned that “the house of cards are falling.” Nevertheless, Enron reported “increasingly strong business prospects” and entered 2001 as the seventh-largest company in the nation. In the fall, public confidence wavered and the share price plummeted. Many considered this an aberration. One analyst remained “convinced that the great bulk of the negative stories being told about Enron are false or without substantial merit.”
Two weeks later Enron announced a $1 billion write-off, and the Wall Street Journal spotlighted the shadowy finances of SPEs. Even as Lay insisted the company would endure, evidence to the contrary mounted. SEC and internal investigations began. Andersen accountants identified hundreds of millions of dollars left off of Enron’s balance sheet. Enron conceded that financial statements from 1997 to 2001 could “not be relied upon” and restated profits by nearly $600 million. (38) A last-ditch merger fell through and on December 2 Enron filed for bankruptcy, taking with it thousands of jobs and billions from investors. Standard accounting procedures and fiscal reporting conventions had been abused at great cost to the public.
(37) Loren Fox. Enron: The Rise and Fall (Hoboken, N.J.: John Wiley & Sons, Inc., 2003), 11, 25-27, 35-39, 221. McLean, Bethany and Elkind, Peter. The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (Penguin Books, 2004), 33-37, 257, 260, 279-282.
(38) Wall Street Journal, “Enron Jolt: Investments, Assets Generate Big Loss,” October 17, 2001. Forbes, “Enron Says ‘Oops’,” November 9, 2001.
Bill McLucas served at the SEC for 21 years, the last 9 as director of the Division of Enforcement. He started as a staff attorney in 1977 and became branch chief under Stanley Sporkin. He then rose through the ranks in the Enforcement Division as assistant director, associate director, and became director of the Division in 1989. In his oral history interview, he discusses what it was like to serve under directors Sporkin and Fedders, and for five SEC Chairmen as division director, and how the SEC’s enforcement program evolved over his time at the SEC, and since his departure from the agency in 1998. Mr. McLucas was a founding trustee of the SEC Historical Society.
