You have to understand that nobody really understood how Enron was making so much money, and that sounds a little crazy now that we look back. When asked, the company and management were often evasive, ambiguous, or just explained it in very, very complicated ways. And quite frankly, some people just accepted it and didn't push any further. And as I said, for many years they got away with this. After all, Enron was the darling of Wall Street. It was the it stock, that is of course until wasn't. The beginning of the end may have come when a smart reporter for Fortune magazine, Bethany McLean, wrote an article entitled, Is Enron Overpriced? In the article, McLean began to ask questions about valuation of Enron stock, and she actually asked a very simple, straightforward question. How exactly does Enron make money? She pointed out quote, strange transactions and quote, erratic cash flows that were in the company's filings and commented on the lack of transparency that Enron was providing to all research analysts. Then in October 2001, Enron had actually announced that it was restating three years of its financial statements to correct certain accounting violations. The restatements decreased previously reported earnings and increased liabilities. The next month, in November, it became public that the Securities and Exchange Commission was formally investigating certain accounting irregularities in Enron's financial statements. By December 2001, Enron filed for bankruptcy. After Enron's stock had dropped from over $50 in the summer before to well, about 0. Their credit rating was downgraded to just above junk status and they were unable to sell the company to anyone. The bankruptcy was the largest in United States history. Until the next year, of course, when the WorldCom declared bankruptcy also due to an accounting fraud. So what happened as a result? 20,000 Enron employees lost their jobs, and all or almost all of their retirement accounts because much of their retirement account was in Enron stock. Arthur Andersen, their accounting firm, was found guilty of obstruction of justice, and they went out of business. Several years later, the United States Supreme Court overturned that case, but it was too late. The company was out of business, and about 85,000 people lost their jobs. Andrew Fastow, who was the CFO of the company, was found guilty and sentenced to ten years in prison. His wife, the assistant treasurer, was also found guilty. Ken Lay, the chairman and CEO, was found guilty. He died before sentencing, but I'm certain he would have gotten a very, very stiff sentence. Jeff Skilling, who took over as the CEO, was also found guilty. He got 24 years and 4 months in prison. Rick Causey, the Chief Accounting Officer, was found guilty, seven years in prison. And ten others were also found guilty. Four Merrill Lynch employees were found guilty of aiding and abetting in one of the transactions. And the big result of Enron's bankruptcy was the passage of the Sarbanes-Oxley Act in July of 2002. So Sarbanes-Oxley was actually passed in direct response to this Enron scandal, and it contributed significantly to the change in the compliance landscape. It imposed new duties on public companies and accounting firms in order to prevent accounting fraud and to protect shareholders. The act closed problematic loopholes and accounting practices. It strengthened compliance monitoring and increased the requirements for corporate transparency in reporting to shareholders. For instance, managers and auditors must now establish internal controls and report on their effectiveness. In addition, senior management must certify the accuracy of financial statements. And the act also strengthened whistleblower protections for those who exposed fraud and it increased penalties for malfeasance. Finally, it authorized the creation of the Public Company Accounting Oversight Board, which supervises public company's audits. Though some criticize Sarbanes-Oxley Act for increasing corporate cost, I think it's generally viewed as having reduced corporate fraud and improved investor protections. So how could Enron have happened? How could this massive fraud have occurred? And also most importantly, how could other frauds occur in its wake? What compliance lessons can we learn from Enron? Well many people involved with the structures and transactions clearly knew they were wrong. Many people knew Enron was misstating debt and engaging in other accounting irregularities. Was it an illegal enterprise or just part of the culture of dishonesty? How were these actions allowed to start and continue when so many people knew about it?
