Enron employed shoddy and deceptive accounting practices to hide its financial losses (and occasionally its gains). The techniques of structured finance—complex financial transactions designed to hedge the risks involved in business activities—were used to enrich some of Enron's corporate officers and hide the firm's financial losses. Independent partnerships to which Enron sold assets were created, enabling Enron to convert loans and assets burdened with debt obligations into income, but the contracts with the partnerships contained guarantees and risky buy-back conditions that had potentially disastrous consequences for Enron. Enron also booked projected long-term income from trading contracts when those contracts were signed, but the income projections were often overly optimistic and inflated. In 2001, when one partnership deal was properly accounted for by Enron's outside auditor, Arthur Andersen, large quarterly losses resulted. Those losses and subsequent profit and debt restatements caused Enron's stock price to drop, triggering the unraveling of the partnership and resulting in a sudden and dramatic financial collapse that led to bankruptcy in Dec., 2001. The pensions of some 20,000 Enron employees were devastated in varying degrees as well; 62% of the company pension plan was in now worthless Enron stock.
Enron was also accused of manipulating the electricity markets during the California energy crisis of 2000–2001. There is evidence that its subsidiaries engaged in sham trading among themselves to drive up the price of electricity, and Enron traders arranged power supply deals with California that gave the appearance of creating power congestion, generating fraudulent fees when Enron then appeared to take steps relieve the nonexistent congestion. The large profits made during the crisis were partially hidden by manipulating Enron's financial reserves.
More than 30 people were charged with various crimes arising from Enron's business practices. More than 20 people, including its chairman, president, and chief financial officer, were ultimately convicted of or pleaded guilty to fraud, conspiracy, and other crimes, although the chairman, Kenneth L. Lay, had his conviction extinguished when he died in 2006 before being sentenced. The collapse also destroyed Arthur Andersen, Enron's accounting firm, which found itself accused of obstructing justice when it destroyed documents relating to the case in late 2001 after the Securities and Exchange Commission had begun investigating Enron. Arthur Andersen, which had been one of the top five accounting firms, quickly lost clients and partners when it came under SEC investigation for its role in Enron's collapse, and its federal criminal conviction for obstruction of justice in 2001 sealed the firm's fate. (The conviction was overturned in 2005 by the U.S. Supreme Court because of faulty instructions given by the judge to the jury.)
A number of financial institutions, including Citigroup and J. P. Morgan, paid hundreds of millions in fines and penalties for the roles they played in financing and setting up the independent partnerships that contributed to Enron's collapse. The firms also paid more than $7 billion to be used to repay creditors and investors, but Enron's creditors were owed more than $70 billion when the company collapsed.
See study by B. McLeon and P. Elkind (2003).
The Columbia Electronic Encyclopedia, 6th ed. Copyright © 2012, Columbia University Press. All rights reserved.
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