About the author: Michael W. Peregrine is a partner in the Chicago office of international law firm McDermott Will & Emery.
Thursday, Dec. 2 marks the 20th anniversary of Enron’s bankruptcy, a date that shall live in American financial infamy.
At the time it was the largest bankruptcy in U.S. history and the first in a series of financial catastrophes that threatened to destabilize the economy. Investments evaporated; jobs were lost; reputations were destroyed; a famous accounting firm collapsed; people went to jail. The perceived failures of Enron’s board and executives served as a primary impetus for the Sarbanes-Oxley Act and the corporate responsibility movement.
As such, Enron remains one of the most consequential corporate governance and finance developments in history. It’s a development with which the new generation of corporate leaders—the ones who have entered the boardroom since then—may not be fully familiar. But to them, their colleagues, their advisors, and their investors, Enron still matters.
The Enron saga began with its creation as an electricity and natural gas pipeline company that, through mergers and diversification, transformed into an energy-based trading and data management enterprise engaged in various forms of highly complex transactions. Among these were a series of unusual and complicated limited-liability, related-party transactions in which some members of Enron’s financial management team held lucrative financial interests, and which allowed the company to transfer certain liabilities off its financial statements.
As the company’s stock price reached its highest levels in August 2000, some Enron executives began to sell their stock, allegedly on the basis of inside information regarding undisclosed losses. At the same time many investment advisors still continued to recommend Enron stock to their clients. By March 2001, a series of media reports began to question the sustainability of Enron’s stock price, including a prominent article in Fortune that identified potential financial reporting problems.
Over the next several months, the company’s stock price collapsed; multiple years of its financial statements were restated; its CEO resigned; a bailout merger failed; its credit was downgraded; and the Securities and Exchange Commission began an investigation of the company’s dealings with related parties. On Dec. 2 it declared bankruptcy. Multiple regulatory investigations followed, several criminal convictions were obtained, and Sarbanes-Oxley was ultimately enacted to curb the perceived abuses arising from Enron and several similar accounting scandals.
The shocking costs of Enron’s collapse were spread broadly among a number of interests: the company’s shareholders, most of whom lost the bulk of their investments; the employees, many based in Houston, who lost their jobs; the investment analysts who were misled by the Enron financials; the executives who received prison sentences; and Enron’s auditor, the venerable Arthur Andersen, which collapsed following an obstruction-of-justice conviction (ultimately reversed by the U.S. Supreme Court).
The abuses that prompted the catastrophe were multifold. They included an intricate business model that made external monitoring difficult. Complex financial statements confused stockholders and analysts alike. There were also highly 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 expertise necessary to properly monitor the business and its financial practices, and an overly aggressive corporate culture that placed little value on ethics and compliance.
These abuses were “front and center” to the drafters of the subsequently enacted Sarbanes-Oxley Act. Legislative responses to the various transgressions can be found throughout the act, including its treatment of oversight of the accounting profession, auditor independence, the credibility of the board’s audit committee, the integrity of financial statements, the ethics of financial officers, whistleblower protections, and preservation of documents. The Enron abuses also prompted substantial enhancements to governance principles and to the professional ethics of attorneys.
But their impact and influence notwithstanding, no combination of legislation, law enforcement, professional regulation, and best practices can provide assurances to any company or board of directors that the “smartest people in the room” won’t resurface in any business, at any time. It’s human nature. Some people will be “pushing the edge of the (business) envelope” all the time; most in the best interests of the company but some, not so much.
These past abuses are worthwhile lessons for today’s corporate leaders, many of whom weren’t serving in similar positions 20 years ago. These current leaders likely lack the near-visceral reaction to the word “Enron” that more senior, and perhaps now retired, leaders retain. There’s a reason why “Enron” is a metaphor for mega-scandal.
The more familiar that corporate leaders are with the Enron saga, the more likely they are to support the integrity of financial statements and effective corporate governance. Leaders who understand how financials can and have been manipulated are more likely to insist on their accuracy. Leaders who understand the rationale for a company’s governance policies are more likely to follow than dismiss them. Leaders who are familiar with the failures of the Enron board are more likely to recognize indicators of similar conduct on their own board.
For them, their companies, and their stakeholders, Enron still matters.
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