In laymans terms, how did they hide the poor health of the company from regulators and tbe public, why did the house of cards eventually collapse? And why couldn’t every company be doing the same or similar houdini tactics then and now?
In: Economics
First of all they didn’t one hundred percent hide the flaws in their system, lots of people reviewed Enron’s financials and realized that the company was heading towards insolvency. The major stock analysts and credit rating agencies didn’t take those analysts seriously so Enron stock continued to be highly valued and their debt highly rated right up until the end.
As for how they Enron hid things, they used accounting tricks, many of which were actually perfectly legal at the time. One of the big things Enron did was they created separate legal entities called special purpose entities, and used those entities to hide debt. According to accounting rules at the time, separate legal entities did not have to be included in a company’s financial statements if that entity had at least 3% independent ownership i.e. Enron could own 97% of the entity but still leave it off their books. What Enron did that was determined later to be illegal was they had their own executives purchase 3% of the SPE. So the vice president of finance might own 3% of half a dozen of these entities and Enron considered that independent ownership so they left those entities off their books. And once they had entities that weren’t on their books they could do tricks like selling things to that entity for above market price and recognize that as Enron profits, even though they were selling things to themselves.
The last part of the picture that failed was their auditor, Arthur Anderson. Auditors are supposed to be independent outside accountants that review a company’s financials to verify that they are reasonably accurate. Arthur Anderson cut a lot of corners and didn’t do their full due diligence in reviewing Enron’s financials. This was in part due to the fact that Arthur Anderson wasn’t fully independent; many Arthur Anderson personnel went right from auditing Enron to getting a job at Enron, so they had an incentive to make Enron happy. However it should be pointed out that accounting regulations and oversight in the auditing world was very lax before the Enron scandal. Ultimately despite all of the shitty things Arthur Anderson did, the only definitely illegal thing they did was that a few managers ordered their office to shred documents during the SEC investigation.
Since Enron accounting rules have changed a lot and now there is an oversight board for auditors that helps ensure auditors don’t screw up like Arthur Anderson did.
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