The Downfall of Enron
Enron was an American energy and commodity based in Texas. For its in lifetime in the later 20th century and early 21st century, it witnessed massive growth year on year and had reached an all time high of $90.75 however this changed in the crisis around Enron leading to the stock price plummeting almost overnight to under a dollar and soon later the firm was filing for bankruptcy. It was revealed that they had been concealing their debt and loans under SPV taking advantage of the mark for marketing(MFM) accounting technique which allowed them to log deceivingly large growth in their quarterly earning. This lead to large reform in the way accounts and quarterly earning were submitted legislating the importance of not concealing losses and loans and the directors of Enron lead on to face jail sentences as a result of their actions.
The way they did this was they taking advantage of Special Purpose Vehicles(SPVs) which are financial entities that a parent firm will create as a subsidiary for more risky ventures or to restructure their business and by doing so it can protect the parent company from the financial risk of their venture. Enron then took advantage of this to disguise their losses. They for example, would build a new plant for $x million and then immediately mark their profits in their books although no cash flow had been received to support this. These profits were mere cash projections from Enron and if the profits weren’t met, Enron would transfer the asset to one of their SPVs and mark the loss on the books for the SPV rather than Enron. By doing so, this meant they never had to log any losses on the accounts of Enron allowing them publish profitable quarterly earnings although they were misleading. This concealed their millions of debt.
The standard Enron-to-SPV transaction would be the following: Enron would transfer some of its rapidly rising stock to the SPV in exchange for cash or a note. The SPV would subsequently use the stock to hedge an asset listed on Enron’s balance sheet. In turn, Enron would guarantee the SPV’s value to reduce apparent counter-party risk.
Their accounting firm that published their reports also were one of the top five firms for accounting at the time raising concerns on how the firm could sign their stamp of approval on the accounts and the techniques they must have been aware Enron were conducting.
Leading the crisis, shareholder lost $74 billion. The Sarbanes Oxley Act was also created to heighten the consequences of altering, manipulating or fabricating financial statements as a way to defraud shareholders.