Enron, once lauded as the most innovative firm for six years, plummeted from a $60 billion market value to bankruptcy in just three months.
In the spring of 1996, a 25-year-old young man stepped into his boss's office with trepidation, his heartbeat so nervous that it reached his throat. In 30 seconds, he will know his year-end bonus. Because of his good performance, even though he was a new employee, the company had high expectations, and the year-end bonus was as high as US$5 million. This young man is Andy.
This story comes from Enron, a company that was named the most innovative company in the United States for six consecutive years. However, in just three months, the market value fell from US$60 billion to the edge of bankruptcy. Andy is the leader of a wolfish team led by three elites. How did he lead an originally healthy natural gas company to the point of no return and become the most notorious financial fraud company in the world?
Let’s start with Enron Chairman Kenneth Lay. He has a nickname, "Ken Lao". On April 15, 1942, Kenneth Lay was born in a small town in Missouri. His family was not wealthy when he was a child, but he succeeded with his IQ, EQ, and dual quotient. At the age of 28, he received a doctorate in economics from the University of Houston, and at the age of 29, he obtained a mid-level military rank. He worked as a financial analyst for the Navy at the Pentagon. He became the vice chairman of the Federal Energy Commission at the age of 30. He began to enter politics at the age of 32 and became the chairman of the Florida Electric Transportation Company at the age of 39.
In 1985, Ken Sr. brokered the merger of Houston Gas Company and InnerNote to form Enron. Ken Sr. replaced the original CEO in just three months and became Enron's chairman and CEO. This shows that Ken is influential not only in politics but also in business. His relationship with former US President George W. Bush is even more eye-catching. Enron's early success was inseparable from Ken's wisdom and political connections.
Enron's management was not known for fraud in the early days of the business, and in its financial reports from 1985 to 1989, the company's performance showed normal growth. However, it was discovered internally that two traders had gained profits through profit fraud and high-leverage speculation. Usually, this kind of illegal behavior would lead to expulsion, but they got the acquiescence of senior management and even received rewards. This incident revealed the ambition of Mr. Ken and unhealthy trends within the company.
In 1990, Mr. Ken recruited his first strongman, Jeffrey Skinling, also known as Jack. This Harvard Business School MBA graduate became the leader of Enron Financial Company, responsible for the trading of natural gas commodities. By establishing a forward trading market for natural gas, Enron quickly developed into a market maker, and Skinling also began to implement the management philosophy of the Wolf Team.
Skinlin's Wolf team aims to be efficient and profit-seeking. Through a clear reward and punishment mechanism, 10% to 15% of employees are fired every year, and high rewards are given at the same time. This incentive system allowed Enron employees to earn higher wages than their peers, creating huge revenue for the company. And Skinling became Enron's CEO.
Under Skinling, Enron's market-making business flourished, expanding from natural gas to electricity, plastics, steel, and other fields. The annual yield growth can reach 45%, causing Enron's stock to soar, with a market value of more than 60 billion US dollars, making it the seventh largest company in the United States. Skinling successfully built a team of wolves who were hardworking and capable and used any means to make money for the company, and Enron's employees also thrived because of the rise in the company's stock.
But behind this success lies the darkness of financial fraud. In the late 1990s, Enron used various means to fabricate income, cover up huge liabilities, and deceive investors and auditors. The fraud eventually led to the company's bankruptcy, and Enron became synonymous with financial scandals.
From 1996 to 2001, Enron was named the most innovative company in the United States by Fortune magazine for six consecutive years. On the surface, it was a very successful company with huge profits and considerable returns for investors. All this is just the tip of the iceberg, but the operations behind Enron are quite complex. When searching for the truth about Enron, we need to go under the water and see what this company really was like.
In 1990, Jack joined Enron and quickly recruited another master, Andrew Fisher, also known as Elite No. 3, commonly known as Xiao An. Xiaoan is an MBA graduate from Northwestern University, proficient in finance and accounting, and soon became the CFO of Enron. The reason why Enron is so prosperous is because of Xiaoan's financial methods.
In 1991, Enron's Big Three team was initially formed and began to adopt a new accounting method called "mark-to-market" or "market-to-market adjustment." This method is fine in theory, but it is not very suitable for industrial companies. Enron's mark-to-market approach relied on the future value of contracts, which could be calculated based on a specific model. In 1992, the SEC (Securities Regulatory Commission) approved Enron's use of market value valuation, providing them with a powerful tool to modify their books.
On this basis, the Enron team began large-scale operations, especially Xiaoan's transfer of Enron's liabilities and losses to these companies by establishing some special purpose entities (SPEs). By mortgaging Enron stock, Xiao An obtained funds, which he then used to purchase Enron's assets, converting liabilities into equity and thereby increasing profits. Although complex, this approach did make Enron's financial position look healthier.
This financial method has a fatal flaw: it can increase profits in the short term, but in the long term, expired contracts and liabilities still need to be paid off. The Enron team found that when stock prices plummeted, their operations became unsustainable. To maintain high stock prices, they engage in a variety of peripheral efforts, including lobbying for political connections, shaping media images, and influencing analysts and auditing firms.
In 2000, in order to solve financial problems, the Enron team discovered opportunities in the California electricity market. By manipulating market prices, they monopolized the California electricity market and were able to cause blackouts when needed, causing electricity prices to soar and profit. That pushed Enron's trading unit's revenue to an eye-popping $48.4 billion in the first quarter of 2001, giving the company some breathing room.
Of course, all this success also laid the foundation for destruction. Enron's financial fraud was eventually exposed, raising questions from the public and investors.
On December 2, 2001, Enron officially applied for bankruptcy protection with the bankruptcy court. The assets listed in the bankruptcy list reached US$49.8 billion, making it the largest bankrupt company in U.S. history.
Wolf King Jack announced his resignation as CEO on August 14, 2001, trying to get out before Enron went bankrupt. The stock price plummeted, the market lost confidence, and the capital chain was broken. Enron eventually declared bankruptcy, and 20,000 employees lost their jobs.
Faced with the crisis of bankruptcy, Enron began to blame each other. The executives tried to shift the blame to Xiao An, but Xiao An chose to come forward as a tainted witness to expose the Wolves' crimes. In 2006, Xiao An was sentenced to ten years in prison but was released early in 2011. Since then, he has been committed to the cause of financial anti-fraud.
In 2001, Ken Lao of the Wolves died of a heart attack before facing a maximum sentence of 45 years in prison. Jack was sentenced to 24 years and 4 months in prison. In 2013, his sentence was reduced by 10 years, and he was released from prison in 2019. After being released from prison, Jack tried to rebuild his natural gas company.
Arthur Andersen's accounting license was revoked for deleting documents, resulting in 85,000 employees losing their jobs. The former auditing giant also collapsed in the scandal. The whole incident reveals how the Wolves fell into a trap of their own making and why the Big Five accounting firms became blind in the face of short-term gain. This is a huge scam. If someone had exposed any link earlier, this disaster might have been avoided.
Disclaimer: This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by EBC or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.