"Enron – lessons from corporate hell."

The worst year in living memory – 2021? Really?  What about 2001?

There was 9/11;the attack on the Indian Parliament; an earthquake in Bhuj; then there was a corporate collapse that was to shake Wall Street to its foundations with the fall of one of its darlings, Kenneth Lay.

It was an ill wind that blew no auditors any good. In 2021, there are the big four auditing firms; in.2001 it was the big five. Arthur Anderson did not survive the corporate collapse of Enron and its 29,000 employees amid chaos on Wall Street and embarrassment for President George W Bush who trusted in the company.

Twenty years on from the wiping out of America’s seventh largest listed entity hold lessons? Does it really matter?

I spoke to a Governance expert ,Zubair Wadee. He is an ex-PWC Partner, and a member of the International Integrated Reporting Committee He has deep experience in both creating and applying Governance standards. Could Enron happen again?

“Today, there is still massive room for improvement when it comes to the implementation and reporting of governance practices,” he says. So, maybe, yes? Or was Enron a victim of fraud too complex for governance?

Let’s examine the background to the Enron collapse: 

• The illusion– created by Jeff Skilling (COO) and Ken Lay (founder & CEO; arguably, the Elon Musk and Steve Jobs of their day. Their mind-blowing projections, outrageous predictions and gambler attitudes convinced every Wall Street analyst to hold a buy rating on the Enron stock. Few were skeptical, even when the numbers were too good to be true.Some of the adventurist ideas were: online movie streaming in partnership with Blockbuster – at the time Netflix was still mailing DVDs – and trading weather futures.

• The trick-market to market accounting. After SEC approval Enron was essentially allowed to record ‘projected future profits’ immediately. For example, recording projected future profits of online streaming in the current year’s financial statements.
• The cover up – the key to keeping Enron’s ship afloat, hiding the debt off the balance sheet. Then CFO Andrew Fastow created partnerships between himself, Enron and third parties. With unusual names like Raptor and JEDI. Fastow hid the debt using complex financial instruments.

Essentially the debt was hedgedaway, however, the hedge was protected by Enron’s own stock. Meaning the higher the share price, the stronger Enron’s balance sheet appeared.It worked perfectly as Enron stock consistently outperformed the stock market.

But in 2001, Skilling unexpectedly resigned and Enron’s came crashing down ultimately resulting in bankruptcy on December 2, 2001.

This story may seem like ancient history, but,over the past 5 years, there has been an uptick in business scandals: Steinhoff, Wirecard andArchegos Capital to name but a few.

These businesses do not compare to the size of Enron, but perhaps they arealso warning signs.

When talking to Wadee, he shares his experience, but maintains hisconfidentiality and other key auditingprinciples.

“That is what is required from auditors at this time, absolute trust. You are only as good as your word.”

The Enron scandal was impossible without the negligence and compliance of Arthur Anderson. It is unfair to group all auditors in this basket. Yet, it is a reminder of the importance of auditors in society.

Arthur Anderson did sign off on the shady partnerships, there was a lack of independence between the auditor’s and the board.

Locally, and internationally, standards determining an auditor’s independence have increased to prevent this from occurring again.

Yet, new regulations do not allow auditors to prevent all catastrophes, it comes down to the companies themselves.

“Companies are part of, not apart, from society. They are integral part of society,” says Wadee.

The buck should stop at the top.

“The board has the responsibility to act in the best interests of the company and not in the best interests of shareholders.”

Enron’s board, led with their own individual shareholder interests, profiting handsomely off the biggest fraud case in history.

Fiduciary duty requires the board to act reasonably for the sustainability and long-term success of the company and not short-term benefits of shareholders.

Looking back, it is easy to think Lay was talking crazy ideas, but at the time investors were hooked.

To prevent a similar collapse, the lessons are to diversify investments and to remember if something is too good to be true then it usually is.

But how does better governance prevent fraud?

It starts with understanding why governance is applied; it is not just a tick box exercise.

“Tell us how you bring theseprinciples alive,” says Wadee.

If the board understands their role, there should be the necessary processes in place to prevent fraud. If not, individual directors should apply pressure protecting the long-term interests of the company.

Enron may have failed 20 years ago, but the lessons learned allow investors, directors and businesses today to pass and survive.