About the Author: Michael W. Peregrine is a partner in the Chicago office of the international law firm McDermott Will & Emery.
Thursday, December 2 marks the 20th anniversary of Enron’s bankruptcy, a date that will remain in American financial infamy.
At the time, it was the largest bankruptcy in U.S. history and the first in a series of financial disasters that threatened to destabilize the economy. Investments have evaporated; jobs have been lost; reputations have been destroyed; a famous accounting firm has collapsed; people went to jail. The perceived failures of Enron’s board of directors and executives have been the main driver of the Sarbanes-Oxley Act and the corporate responsibility movement.
As such, Enron remains one of the most significant developments in corporate governance and finance history. This is an evolution with which the new generation of business leaders, those who have entered the boardroom since then, may not be fully familiar with. But to them, their colleagues, their advisors and their investors, Enron still matters.
The Enron saga began with its founding as an electricity and natural gas pipeline company that, through mergers and diversification, evolved into a commerce and data management company based on the energy, engaged in various forms of very complex transactions. Among these were a series of unusual and complicated limited liability transactions in which certain members of Enron’s financial management team had lucrative financial interests and which allowed the company to shift certain liabilities from its financial statements.
As the company’s stock price peaked in August 2000, some executives of Enron began to sell their shares, allegedly on the basis of inside information about undisclosed losses. At the same time, many investment advisers continued to recommend Enron shares to their clients. In March 2001, a series of media reports began to question the sustainability of Enron’s share price, including a important article in Fortune who identified potential financial reporting issues.
Over the following months, the company’s stock price collapsed; several years of its financial statements have been restated; its CEO has resigned; a failed rescue merger; his credit has been degraded; and the Securities and Exchange Commission has opened an investigation into the company’s related party relationships. On December 2, she declared bankruptcy. Multiple regulatory investigations followed, several criminal convictions were obtained, and Sarbanes-Oxley was eventually enacted to address perceived abuses resulting from Enron and several similar accounting scandals.
The shocking costs of Enron’s collapse were widely distributed among a number of interests: the company’s shareholders, most of whom lost most of their investments; employees, many of whom are based in Houston, who have lost their jobs; financial analysts who have been misled by Enron’s financial data; executives sentenced to prison terms; and Enron’s auditor, the venerable Arthur Andersen, who collapsed following an obstruction of justice conviction (ultimately overturned by the United States Supreme Court).
The abuses which provoked the catastrophe were manifold. They understood a complex business model that made external oversight difficult. Complex financial statements confused shareholders and analysts. There were also very aggressive revenue recognition and “mark-to-market” accounting practices, speculative special purpose entities and the management conflicts they presented, a governance structure that lacked the necessary expertise. to properly oversee the business and its financial practices; and an overly aggressive corporate culture that places little value on ethics and compliance.
These abuses were “in the foreground” for the drafters of the Sarbanes-Oxley Act subsequently enacted. Legislative responses to various transgressions can be found throughout the law, including its treatment of oversight of the accounting profession, auditor independence, credibility of the board audit committee, integrity of financial statements, ethics of financial officers, whistleblower protection and record keeping. The Enron abuses have also resulted in substantial improvements in governance principles and the professional ethics of lawyers.
But despite their impact and influence, no combination of legislation, law enforcement, professional regulation and best practices can assure a company or board that the “smartest people in the room.” Do not resurface in any company, at any time. It’s human nature. Some people will “push the envelope (business)” all the time; most in the best interests of the business, but some not so much.
These past abuses are interesting lessons for today’s business leaders, many of whom did not hold similar positions 20 years ago. These current leaders probably don’t have the near-visceral reaction to the word “Enron” that older, and perhaps now retired, leaders retain. There’s a reason “Enron” is a mega-scandal metaphor.
The more business leaders know about the Enron saga, the more likely they are to support financial statement integrity and effective corporate governance. Executives who understand how financial data can and has been manipulated are more likely to insist on its accuracy. Executives who understand the rationale for a company’s governance policies are more likely to follow them than reject them. Executives who know of Enron’s board failures are more likely to recognize indicators of similar conduct within their own board.
To them, their businesses and their stakeholders, Enron still matters.
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