December 2, 2011 • Electricity, Energy Generation, Natural Gas, Perspectives

A decade later: Ripples from Enron

by Dominic Barbato

The infamous (and now defunct) Enron logo.

It is difficult to believe 10 years have passed since Enron filed for bankruptcy on Sunday, Dec. 2, 2001. The company was America’s darling. Like the Titanic, Enron was thought to be unsinkable. It seemed to do no wrong; it was a company that could not fail. At the height of its power in 2001, Enron ranked seventh on the Fortune 500 with revenues topping $100 billion, a status earning it the moniker of “America’s Most Innovative Company” six consecutive years by Fortune magazine. The company’s business model was heralded to be a paradigm shift in business, a poster child for the new economy and modern markets, a firm that relied more on the development of intellectual capital and technology than on the creation of brick-and-mortar, physical assets.

Everything about Enron was larger than life, a characteristic that pervaded all aspects of the company, including its collapse, which is recognized as one of the largest and most complex bankruptcies in our country’s history. Ten years later, Enron exists only as Enron Creditors Recovery Corp., the new name for the company after the U.S. Bankruptcy Court approved its Plan of Reorganization. It’s a mere shadow of its former grandeur, to be certain. Perhaps no one summed it up better than Cliff Baxter, Enron’s chief dealmaker, who stated, “…where there was once great pride, now it is gone.”

My first exposure to Enron was after its collapse during a managerial accounting class I took my senior year of college. The events leading to the bankruptcy intrigued me greatly and laid the foundation for a burgeoning interest in the field of corporate and organizational ethics. As a result, I thought a discussion of just a few ways in which Enron and its bankruptcy have affected the energy industry seemed fitting on the 10-year anniversary of its collapse.

For what it is worth, Enron was not all bad. The company, and specifically its Chairman (Ken Lay) and CEO (Jeff Skilling), were enthusiastic proponents for natural gas and electric power deregulation here in the United States. While the merits of deregulation may be debatable at times, the invisible hand, free-market principles behind deregulation are core tenets of contemporary, capitalist economics. Regardless of one’s position on the topic, deregulation has dramatically altered the daily operations of the energy markets in the U.S. (and around the world) throughout all levels of the industry. Prior to deregulation, vertically integrated, regulated utility companies dictated the price and terms governing an end-user’s purchase of energy commodities. Now, end-users have access to an increased array of options that allow them to customize energy management programs to meet specific needs. New businesses were birthed because of deregulation, including firms like Summit that help companies navigate market complexities and drive energy cost reductions through procurement strategies.

Ironically, and in stark contrast to the previous paragraph, the Enron collapse was a key driver of the Sarbanes-Oxley Act of 2002 (SarbOx or SOX), which significantly increased the internal control and financial reporting requirements of companies to comply with governmental accounting regulations. SOX legislation is complicated and often requires considerable resources on the part of companies to ensure compliance. Energy companies are not immune, as most operate in highly complex environments where a variety of factors can affect financial reports. In order to meet the financial accountability requirements mandated by SOX, many companies were required to create or bolster internal control mechanisms on matters that could impact financial statements.

Enron was also an ardent supporter of the “fair-value” accounting treatment known as mark-to-market (MTM), which allowed the company to book expected future profits years in advance of actually seeing any benefit (or loss). The practice of mark-to-market is now formally regulated by the Financial Accounting Standards Board via the Statement of Financial Accounting Standards No. 157 (FAS157), which was issued in 2006 and requires companies to report the fair value of assets and liabilities. In Enron’s case, those assets or liabilities were energy futures or derivatives contracts, but often, Enron’s long-term contracts had no fair-market value due to illiquidity in the market. As a result, Enron estimated the “hypothetical future value” (HFV) of those assets as it saw fit, thereby creating and recording profits where none actually existed. While Enron is not necessarily responsible for the creation of FAS157, the company’s bankruptcy has generated a greater degree of scrutiny and consternation among companies using fair-value accounting treatment. At times, energy professionals witness this anxiety while working with companies that seek such accounting treatment on energy derivatives or products, as the memory of Enron looms as a reminder of what could go wrong.

There are many other ways Enron’s failure continues to ripple through our business environment today, and it goes without saying the bankruptcy was a wake-up call for corporations and investors worldwide. On the 10-year anniversary of Enron’s collapse, I hope we all take a moment to remember that “those who cannot learn from history are doomed to repeat it” and reflect on the lessons the Enron story presents.

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