Learning From Enron

A mega power company, a former presidential adviser, alleged insider dealing, and documents hastily shredded before investigation - it has all the makings of a Hollywood blockbuster. Unfortunately for Enron and its employees, creditors and investors, not to mention its auditors, this is no film but a true story. When Enron filed for bankruptcy on 2 December 2001, it was by far the largest company ever to do so.

Enron developed from an organisation dealing only in gas and crude oil into the world’s largest internet trader of a range of products such as electrical power price risks and weather exposures. Although still the largest supplier of natural gas and electricity in North America, its new activities came to represent more than 80% of its revenues ($40bn in 1999). After 15 years, it ranked seventh on the Fortune 500 list of companies.

Enron’s admission in October 2001 that it had overstated profits for four years, reducing shareholders’ equity by $1.2bn, led to a loan of $3bn to ensure liquidity, lawsuits and an investigation by the Securities and Exchange Commission (SEC). It also triggered doubts as to Enron’s creditworthiness, and many energy traders moved from Enron’s own B2B online trading system to other marketplaces such as New York Mercantile Exchange and the Intercontinental. Investors took fright, dumping the company’s shares and sending the price plummeting. With the failure of a proposed merger between Dynegy and Enron that would have provided a $9bn lifeline, credit rating agencies demoted Enron bonds to junk status, sounding the company’s death knell.

The company chose to file for bankruptcy under Chapter 11, a route that allows it to reorganise and keep in business. While its future remains in the balance, it is beset by a host of investigations and lawsuits. The fall-out has been huge. Enron’s auditors and consultants, Arthur Andersen, look unlikely to emerge untarnished, while banks, insurers and others are involved in actions and negotiations, trying to emerge as well as they can from the debacle.

Much of the media focus is on the behaviour of Enron’s management when it realised things were going wrong. Complex partnerships were used to hide huge debts by moving them off the balance sheet. Senior executives sold shares at a high price when they clearly knew the company was foundering. But the core problems started earlier. Possibly, they were not simply the result of a defective business plan, but reflected the pressure of a culture which placed a huge emphasis on success.

In its early years, Enron was extremely successful. It was high in the league tables, with accolades for creating the best internet venture ever and being a wonderful place to work. So, when some business decisions proved ill-founded, management did not want to admit failure openly. Unfortunately, Wall Street appears to have played along. Analysts, lenders and consultants all had a lot to lose by blowing the whistle, even if they had started to spot the warning signs.

It seems likely too that Enron’s management was hopeful of being able to trade out of trouble in a re-run of the ‘Maxwell syndrome’, that if you are big enough and look confident enough, failure seems unthinkable. Critics were discouraged. And it cannot have done any harm in maintaining the image of success that Enron’s auditors Arthur Andersen were also employed as consultants.

The demise of Enron could be said to strike a blow at the perceived effectiveness of enterprise risk management. Here, on the face of it, Enron did everything right. Headed by a chief risk officer with executive management status, the company’s risk assessment and control group, comprising around 150 people, focused on every aspect of Enron’s activities. The company had developed its own risk analysis and risk quantification tools and strategies. Its approach to risk seemed so successful that it was held up as an example to others.

For example, a feature in Treasury & Risk Management in December 2000/January 2001 gives a full description of how Enron ‘learned how to profit from risk’. The article (somewhat ironically in hindsight) was called Viewing the Opportunity in Risk, and quoted Rick Buy, Enron executive vice president and chief risk officer, as saying “You won’t make any money these days without taking on risk. We want to take on risk - a lot of risk - subject to prescribed limitations and insight into the associated outcomes. If the outcomes are palatable, we’ve got an appetite.” Unfortunately, for many companies, the outcome of having dealt with Enron is proving far from palatable.

Sue Copeman is editor, StrategicRISK

WARNING SIGNS
While the demise of a giant like Enron causes ripples around the world, even a much smaller company’s insolvency can produce significant losses for its creditors.

Apart from obvious signs of impending financial difficulty, such as a slowdown of established payment pattern and county court judgments, there are a number of possible clues as to future problems. Derek Barnett, underwriting manager for trade credit, QBE International Insurance Ltd, advises companies to watch out for the following. While the list is not exhaustive, it does include a number of the common indicators. Where several of these apply, you may well have a problem brewing.