Enron why it collapsed

On November 30 the stock closed at an astonishing 26 cents a share. The company filed for bankruptcy protection on December 2. Unquestionably, the Enron implosion has wreaked more havoc on the accounting profession than any other case in U. Critics in the media, Congress and elsewhere are calling into question not only the adequacy of U. The general public still questions how CPA firms can maintain audit independence while at the same time engaging in consulting work, often for fees that dwarf those of the audit.

The scandal threatens to undermine confidence in financial markets in the United States and abroad. In a characteristic move, the SEC and the public accounting profession have been among the first to respond to the Enron crisis.

The CEOs of the Big Five accounting firms made a joint statement on December 4 committing to develop improved guidance on disclosure of related party transactions, SPEs and market risks for derivatives including energy contracts for the reporting period.

In addition, the Big Five called for modernization of the financial reporting system in the United States to make it more timely and relevant, including more nonfinancial information on entity performance. They also vowed to streamline the accounting standard-setting process to make it more responsive to the rapid changes that occur in a technology-driven economy.

It has announced the imminent issuance of an exposure draft on a new audit standard on fraud the third in five years , providing more specific guidance than currently found in SAS no.

The Institute has also promised a revised standard on reviews of quarterly financial statements, as well as the issuance, in the second quarter of , of an exposure draft of a standard to improve the audit process.

In late December the AICPA issued a tool kit for auditors to use in identifying and auditing related party transactions. While it breaks no new ground, the tool kit provides, in one place, an overview of the accounting and auditing literature, SEC requirements and best practice guidance concerning related party transactions.

It also includes checklists and other tools for auditors to use in gathering evidence and disclosing related party transactions.

The new system would be managed by a board, a majority of which would be public members, enhancing the peer review process for the largest firms and requiring more rigorous and continuous monitoring.

The staff of the new board would administer the reviews. In protest, the Public Oversight Board informed Pitt that it would terminate its existence in March , leaving the future peer review process in a state of uncertainty.

The AICPA has also approved a resolution to support prohibitions that would prevent audit firms from performing systems design and implementation as well as internal audit outsourcing for public audit clients. While asserting that it does not believe prohibition of these services will make audits more effective or prevent financial failures, the board has stated it feels the move is necessary to restore public confidence in the profession.

These prohibitions were at the center of the controversy last year between the profession and the SEC under the direction of former Chairman Arthur Levitt. Big Five CPA firms and the AICPA lobbied heavily and prevailed in that controversy, winning the right to retain these services and being required only to disclose their fees.

The impact of Enron is now being felt at the highest levels of government as legislators engage in endless debate and accusation, quarreling over the influence of money in politics. Congressional investigations are expected to continue well into and beyond. Lay, Skilling and Fastow still have much to explain. Attorney General John Ashcroft, as well as his entire Houston office, disqualified themselves from the investigation because of either political, economic or family ties.

It appears that is shaping up to be a year of unprecedented changes for a profession that is already coping with an identity crisis. Arthur Andersen LLP, after settling two other massive lawsuits earlier in , is preparing for a storm of litigation as well as a possible criminal investigation in the wake of the Enron collapse.

Indeed, they are using the case to raise doubts about the credibility of the audit process for all Big Five firms who do such work.

So far, Andersen has acknowledged its role in the fiasco, while defending its accounting and auditing practices. He committed the firm to full cooperation in the investigations as well as to a leadership role in potential solutions. Enron dismissed Andersen as its auditor on January 17, , citing document destruction and lack of guidance on accounting policy issues as the reasons. Andersen countered with the contention that in its mind the relationship had terminated on December 2, , the day the firm filed for Chapter 11 bankruptcy protection.

Andersen is now under formal investigation by the SEC as well as various committees of both the U. Senate and House of Representatives of the U. Several provisions of Sarbanes-Oxley were designed to boost the power of independent directors and the audit committee of the board to exercise effective oversight of management and the accounting process.

Under Sarbanes-Oxley, the board's audit committee must have a majority of independent directors not affiliated with management or the corporation and is responsible for hiring, firing, overseeing, and paying the firm's outside auditor. In , the New York Stock Exchange and the Nasdaq adopted rules requiring listed corporations to have a majority of independent directors not affiliated with management or the corporation on their boards.

In , the SEC is considering a rule that would facilitate the nomination of directors by shareholders. Securities analysts employed by investment banks provide research and make "buy," "sell," or "hold" recommendations. These recommendations are widely circulated and are relied upon by many public investors. Analyst support was crucial to Enron because it required constant infusions of funds from the financial markets.

The Sarbanes-Oxley Act directs the SEC to establish rules addressing analysts' conflicts of interest; these were issued in One part of the fallout from Enron's demise involves its relations with banks. Prominent banking companies, notably Citigroup and J. Morgan Chase, were involved in both the investment banking securities and the commercial banking lending and deposit businesses with Enron.

Several aspects of Enron's relations with its bankers have raised several questions. Morgan Chase and Citigroup, represent protective self-dealing? Part of Enron's core energy business involved dealing in derivative contracts based on the prices of oil, gas, electricity and other variables.

For example, Enron sold long-term contracts to buy or sell energy at fixed prices. These contracts allow the buyers to avoid, or hedge, the risks that increases or drops in energy prices posed to their businesses. Since the markets in which Enron traded are largely unregulated, with no reporting requirements, little information is available about the extent or profitability of Enron's derivatives activities, beyond what is contained in the company's own financial statements.

While trading in derivatives is an extremely high-risk activity, no evidence has yet emerged that indicates that speculative losses were a factor in Enron's collapse. Since the Enron failure, several energy derivatives dealers have admitted to making "wash trades," which lack economic substance but give the appearance of greater market volume than actually exists, and facilitate deceptive accounting if the fictitious trades are reported as real revenue.

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Enron's Energy Origins. Enron Hailed for Its Innovation. Blockbuster Video's Role. The Wall Street Darling Crumbles. Arthur Andersen and Enron. Criminal Charges. New Regulations After Scandal. The Bottom Line. Key Takeaways Enron's leadership fooled regulators with fake holdings and off-the-books accounting practices.

Enron used special purpose vehicles SPVs , or special purposes entities SPEs , to hide its mountains of debt and toxic assets from investors and creditors. Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate.

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Investopedia does not include all offers available in the marketplace. Related Articles. Just a few months earlier in , this brash Texan energy giant had been exposed for hiding huge losses, and declared bankruptcy.

You could have heard a pin drop as former Enron executive and whistleblower Sherron Watkins recounted to Senators how she uncovered the accounting scandal. Later, she told me blowing the whistle had been like telling the Titanic captain "we've hit an iceberg, sound the alarm, come up with a plan" but the response was "icebergs don't matter, we're unsinkable".

This story was supposed to be a game-changer. US Senators, regulators and business leaders told me that it was a watershed moment for global business, that rules would be re-written and corporate culture changed forever.

Twenty years after Enron's demise, I wonder what has actually changed. One of the key checks on the way businesses operate is the external audit by accountants who inspect the books. In Enron's case, that was the firm of Arthur Andersen. Speaking today, Sherron Watkins says that "Enron was able to push Andersen around".

Andersen had won lucrative, non-audit consulting work from Enron, and would not want to jeopardise the relationship by raising the red flag. Andersen collapsed in , its reputation destroyed by the Enron story. The US quickly passed the Sarbanes Oxley Act which meant auditors of publicly traded companies are barred from providing most consulting services to audit clients.