Fall of Enron: My Take
By: Emerald Mclaniyi
Tags: Financial Market, Risk, Ethics, Finance, Risk Management

Introduction

The fall of Enron, the largest gas and energy contractor in the world was one that shook not just wall street but the entire world. It is a story of greed, bad investments, bankruptcy, and fraud. Their core values were built on respect, integrity, communication, and excellence (RICE) but these values were never seen nor evident in their mode of operation.

Enron started out as a physical supplier of natural gas and oil to become the largest contractor of this commodity. Gas and energy were initially successful but they got into various markets and commodities such as water, broadband, paper, etc. which they had little or no expertise.

The role financial instruments played in the downfall of Enron

Enron was a hedge-fund type of trading firm, that operated a wholesale spots market in derivatives trading and futures trading where bonds and options were sold. They operated in the commodities market but instead of selling goods, they were focused on buying and building project which was not profitable. They ran an online, free-market business model, but this free market strategy soon made debt prominent and accumulated faster due to the lack of cost control.

They employed a marked-to-market strategy that allowed them to project profit on a new venture, but they would claim these profits in their books even when they’ve not made any money yet, and if they ran into loss, they’ll manipulate standard accounting practice to inflate profit and hide debt. Enron was projecting profit on new ventures without first calculating the cost of these ventures. They used Special Purpose Entities (SPE) to borrow money and write off these debts in off-balance-sheets partnerships.

The broader markets effects resulting from the rise and fall of Enron

The rise and fall of Enron led to major changes in the broader markets as it exposed the loopholes in the regulations of financial markets. New regulations and legislation were implemented to promote accurate financial reporting for publicly held organizations. In July 2002, the then president of the United States of America, President George W. Bush, signed the Sarbanes-Oxley Act into law. This act raised the bar of the consequence of fabricating and manipulating documents and trying to defraud shareholders by withholding information or destroying records.

New compliance measures were created and the Financial Accounting Standard Board (FASB) raised the standard of ethical conduct. This helped cover the loopholes that were exposed by the Enron scandal which some organizations used to avoid accountability.

Recommendation of risk mitigation techniques that could have been applied to minimize Enron’s profile

The fall of Enron was due majorly to bad investment, wrong accounting practice, greed, and fraud. They engaged in spot trading which is an extremely bad idea in a commodities market where goods are extremely volatile. The following risk mitigation techniques if applied would have avoided or minimized bankruptcy to an extent.

· Avoidance: that this technique offers little or no reward, it is also the most expensive as this strategy prevents the organization from getting involved in any high-risk investment. This also means the organization might actually lose the opportunity of getting a high-risk premium as they applied a 100% risk aversion strategy.

· Risk sharing: though Enron tried to apply this strategy at a later time by trying to go into partnership with Dynergy Inc., going to a joint venture with company’s that had expertise in commodities which they didn’t. In an event of a loss, both ventures bear the cost and negative impact, which would have been a major loss for a single company.

· Transferring Risk: Enron tried employing this strategy by using SPE and off-balance sheet partnerships but there is a legit way of transferring risk from one party to another rather than erasing and manipulating records

REFERENCES

Enron Scandal: The Fall of The Wall Street Darling[online]. URL: https://www.investopedia.com/updates/enron-scandal-summary/ (September 22, 2020)

The Energy Journal: 2004; 25, 4; Earth, Atmospheric & Aquatic Science Database pg. 115–134

Holly Hubbard Preston. International Herald Tribune; Paris [Paris] (August 24, 2002) pg. 15