Enron Corporation's Fraud and the Meaning of Market to Market

The story of Enron Corporation depicts a company that reached dramatic heights only to face a dizzying fall. The fated company's collapse affected thousands of employees and shook Wall Street to its core. At Enron's peak, its shares were worth $90.75; just prior to declaring bankruptcy on Dec. 2, 2001, they were trading at $0.26.1 To this day, many wonder how such a powerful business, at the time one of the largest companies in the United States, disintegrated almost overnight. Also difficult to fathom is how its leadership managed to fool regulators for so long with fake holdings and off-the-books accounting.

Enron Fraud. It was one of the largest securities fraud scandals in history, and the investigation into the extent of the fraud committed by Enron is still ongoing. As a result, Enron was forced to file for bankruptcy in December 2001.

The root of Enron has to be the accounting tactics that enabled deception. But what did Enron do that was illegal? Accountants let Enron book more revenue than they actually earned; keep losses and debt off balance sheets. If these were disallowed, the money-losing state of Enron would have been apparent far sooner.

Enron's Energy Origins

Enron was formed in 1985 following a merger between Houston Natural Gas Company and Omaha-based InterNorth Incorporated. Following the merger, Kenneth Lay, who had been the chief executive officer (CEO) of Houston Natural Gas, became Enron's CEO and chairman. Lay quickly rebranded Enron into an energy trader and supplier. Deregulation of the energy markets allowed companies to place bets on future prices, and Enron was poised to take advantage. In 1990, Lay created the Enron Finance Corporation and appointed Jeffrey Skilling, whose work as a McKinsey & Company consultant had impressed Lay, to head the new corporation. Skilling was then one of the youngest partners at McKinsey

Skilling joined Enron at an auspicious time. The era's minimal regulatory environment allowed Enron to flourish. At the end of the 1990s, the dot-com bubble was in full swing, and the Nasdaq hit 5,000.4 Revolutionary internet stocks were being valued at preposterous levels and, consequently, most investors and regulators simply accepted spiking share prices as the new normal.

Mark-to-Market

One of Skilling's early contributions was to transition Enron's accounting from a traditional historical cost accounting method to mark-to-market (MTM) accounting method, for which the company received official SEC approval in 1992.5 MTM is a measure of the fair value of accounts that can change over time, such as assets and liabilities. Mark-to-market aims to provide a realistic appraisal of an institution's or company's current financial situation, and it is a legitimate and widely used practice. However, in some cases, the method can be manipulated, since MTM is not based on "actual" cost but on "fair value," which is harder to pin down.6 Some believe MTM was the beginning of the end for Enron as it essentially permitted the organization to log estimated profits as actual profits.

Enron Hailed for Its Innovation

Enron created Enron Online (EOL) in Oct. 1999, an electronic trading website that focused on commodities. Enron was the counterparty to every transaction on EOL; it was either the buyer or the seller. To entice participants and trading partners, Enron offered its reputation, credit, and expertise in the energy sector.7 8 Enron was praised for its expansions and ambitious projects, and it was named "America's Most Innovative Company" by Fortune for six consecutive years between 1996 and 2001.