Enron shares hit $90.75 on August 23, 2001. By December 2, they had corrected to $0.26 and the business had filed for Chapter 11. Twenty years after the culmination of Enron’s too-close-to-the-sun flight, it’s clear its fallout set the course for the evolution of compliance in the new millennium.
The infamous Enron scandal of 2001 didn’t create the corporate compliance movement. Its roots go back many years, even past the seminal 1996 decision in the Caremark derivative litigation, that established board oversight responsibility for compliance. But Enron, with the sheer breadth of its audacity, gave compliance the vitality that led to its near—institutionalization in the Sarbanes – Oxley Act.
From the archives: The late and not-so-great-after-all Enron… pic.twitter.com/MQt2NxiYWb
— Walter Deemer (@WalterDeemer) November 15, 2021
For that reason alone, “Enron” is a transcendent compliance development with which all board and compliance officers should be familiar, especially with the looming 20th anniversary of its bankruptcy on December 2. Enron is a metaphor for mega-scandal, and properly the subject of board education, particularly given the return of aggressive federal corporate fraud enforcement.
Enron Files for Chapter 11 – December 2, 2001
Enron was created through a 1985 merger between natural gas companies, and quickly evolved within a deregulated market into an energy trading and supplier enterprise. In this model it became highly recognized for its operational creativity and was named by Fortune “America’s Most Innovative Company” for six straight years between 1996 and 2001. Enron had developed a management team that was highly experienced, and both its board and its audit committee were composed of individuals with broad and diverse business, accounting and regulatory backgrounds.
By 2001 the company had become a highly diversified energy trading enterprise that pursued various forms of particularly complex transactions in the energy business. Among these were the soon-to-be notorious related party transactions in which Enron financial management executives held lucrative economic interests. (These were the so-called “Star Wars” joint ventures, with names such as “Jedi”, “Raptor” and “Chewco.”)
In the late 1990s the company experienced rapid growth, such that by March 2001 its stock was trading at 55 times earnings; its high point was $90.56 per share in 2000. However, that rapid growth attracted substantial scrutiny, including reports in the financial press that challenged the sustainability of its high stock value. Concerns also arose about the company’s exposure to the “dot-com” recession of 2000.
Additional questions focused on the complexity and opaqueness of the company’s financial statements, that made it difficult to accurately track its source of income. Indeed, there were indications that the company was using its mark-to-market accounting, together with off-balance sheet transactions, to disguise its true (weakening) financial condition.
Longtime leader Kenneth Lay resigned as CEO in February, 2001 and was replaced by senior executive Jeff Skilling. But by mid-summer one of the company’s divisions reported a massive, unexpected loss; Enron’s share price dropped to $39.95; Skilling resigned, and Lay returned to the CEO position. The now-famous Sherron Watkins whistleblower letter was sent (anonymously) to Lay on August 15. On October 16, the company announced its intention to restate its financial statements from 1997 to 2001. Huge losses and share price declines continued.
Enron would be the greatest meme stock of it we’re around today
— Kenny Lay (Parody) (@EnronChairman) November 16, 2021
On October 21 the SEC announced that it had commenced an investigation of the related party transactions. Chief Financial Officer Andrew Fastow was fired on October 25 after disclosing to the board that he had earned $30 million from those transactions. On October 29, Enron’s credit rating was lowered. The company admitted that it had been inflating its income for several years. A possible purchaser of Enron withdrew from negotiations on November 28, and the company filed for Chapter 11 bankruptcy protection on December 2 (with a share price of $0.26).
Following the collapse of the company, the casualties began to mount: a criminal investigation that led to individual criminal prosecutions and convictions; the obstruction of justice verdict against company, and for its external auditor (subsequently but belatedly overturned); the loss of scores of jobs and the collateral damage to the city of Houston; Mr. Lay’s sudden death. Ultimately in 2002, there was enactment of the Sarbanes-Oxley Act, which was intended to prevent future accounting, financial and governance failings as had occurred in Enron and other similar corporate scandals.
The Compliance Connection
Many elements of the Enron controversy led to major changes in corporate governance and financial and accounting controls. Yet many others contributed to an enhanced understanding of corporate compliance and the value of effective organizational compliance function. These included:
Organizational Culture: The sheer magnitude of malfeasance within the operational leadership of Enron served to highlight the importance of having an established sense of business ethics within an organization. Indeed, the United States Sentencing Commission’s Guidelines for an Effective Corporate Compliance Plan (“USSC Guidelines”) were amended in 2004 specifically in response to Enron and its peer corporate scandals. The focus of that amendment was to underscore leadership’s role in promoting an organizational culture that encourages ethical conduct and a commitment to compliance with the law. Of course, one of the most important responsibilities of the compliance officer (CO) is now to help support board efforts to assure an organizational culture of compliance.
Corporate Ethics: One of the most consistent criticisms of the Enron scandal was that its management structure failed to instill within the organization a lasting sense of business ethics. For example, what constituted the organization’s code of ethics was reportedly suspended twice in one year, in order that certain financial transactions involving a senior Enron executive could proceed.
The 2004 amendments to the USSC Guidelines included within the cultural obligations of leadership a specific reference to an ethics component to an effective compliance program. Of course, in many organizations, the CO now assumes primary (or shares with the general counsel) responsibility for the ethics program.
The Whistleblower Role. A particularly lasting compliance connection from the Enron scandal is the important role a corporate whistleblower can play in uncovering a scandal. In mid-summer 2001, Enron Vice President for Corporate Development Sherron Watkins wrote an (unsigned) memo to Chairman Kenneth Lay warning of the use of improper accounting methods and arguing that the company’s financial statements were grounded in systemic accounting fraud and corruption. “I am incredibly nervous that we will implode in a wave of accounting scandals.” Watkins ultimately met with Mr. Lay and urged him to pursue an independent internal investigation.
Subsequent to the delivery of the letter and the Lay meeting, Ms. Watkins was allegedly subjected to aggressive treatment by corporate management, which included multiple departmental shifts, indications that senior financial executives sought to terminate her, and concerns for her personal safety. Watkins was subsequently named one of three Persons of the Year, by Time, for what it referred to as “The Year of the Whistleblower.” (The other referenced whistleblowers were Cynthia Cooper, a WorldCom executive who informed her board of extreme accounting irregularities at that troubled company, and Coleen Rowley, an FBI employee who alerted leadership that the FBI had ignored advice from one of its field officers concerning the activities of one of the 9/11 co-conspirators.)
In response to these and other similar concerns, the Sarbanes – Oxley Act contained several civil and criminal provisions intended to protect corporate whistleblowers from retaliation. These were ultimately enhanced by the Dodd-Frank law. Of course, in many organizations the CO exercises oversight of the corporate “hotline” whistleblower complaint mechanism.
Document Preservation: Many COs have responsibility for internal controls and protocols relating to the preservation of corporate documents. In many respects, this can be traced to allegations arising from the Enron scandal that both its employees, and its outside auditors, destroyed documents during the pendency of the SEC investigation of the company. The auditing firm was subsequently convicted of obstruction of justice in connection with the alleged document destruction; a decision that was ultimately overturned by a unanimous decision of the U. S. Supreme Court. The Sarbanes-Oxley Act included several sections imposing criminal penalties of document alteration made with the intent of impeding a legal investigation or a bankruptcy proceeding.
Conflicts of Interest: A prominent aspect of many of the suspect Enron financial strategies was the use of the notorious, complex off-balance sheet “special purpose entities” (SPEs), which were intended to achieve certain accounting (rather than operational) goals. A common feature among these SPEs was the role that one or more Enron executives played as principals of such entities, earning lucrative personal returns. These returns created a conflict of interest between their duties to the SPEs and those to Enron; conflicts that were generally waived by Enron or for which approval may not have been obtained and required monitoring not pursued.
Many COs also have responsibility – alone or in conjunction with the general counsel – for the administration of officer and director conflict of interest policies and procedures. The Enron experience has since prompted a much closer evaluation of conflicts of interest identification and monitoring with respect to complex corporate business transactions involving officers and directors.
Twenty years is a long time, especially in the life of a company and the tenure of its executives and board members. It is also a long time in terms of accepted business practices, principles and standards. A new generation of leaders has entered boardrooms since Enron’s bankruptcy, and it is fair to question what they know, or remember, about the fiduciary failures that not only doomed Enron but also served to enhance the importance of corporate compliance.
As corporate leadership is evaluating the implications of the new Department of Justice policies concerning corporate fraud and individual accountability, it may also be useful for it to simultaneously revisit Enron’s important lessons concerning the vitality of the compliance function.