Lessons Learned from the Enron Scandal
What Was the Enron Scandal?
At one point in history, Enron was one of the most powerful companies in the United States. The Houston, Texas based energy company was applauded for its expansions and ambitious projects, earning the title of “America’s Most Innovative Company” by Fortune for six consecutive years between 1996 and 2001.
In the mid 2000s, one share of Enron was worth $90.75 but, by the end of November in 2001 the same share plummeted in value, and was worth less than $1, leading shareholders to file a $40 billion lawsuit. While many found this large economic scandal hard to fathom, it was uncovered that Enron’s executives used fake holdings and off-the-books accounting practices to trick regulators and hide mounds of debt behind special purpose vehicles (SPVs) to isolate money in the firm until they declared bankruptcy in December of 2001.
The wake of the Enron scandal was felt by all of Wall Street, and shareholders who lost a total of $74 billion dollars leading up to the bankruptcy. It also led to executives facing criminal charges from a laundry list of conspiracy, fraud, insider trading, and obstruction of justice. As a result of this chaos, new regulations were created to improve the accuracy of financial reporting for publicly traded companies, including the Sarbanes-Oxley (SOX) Act signed into law by President George W Bush.
What Are the Biggest Lessons from the Enron Scandal?
Fully Understand Your Investments
It is crucial to avoid investing in anything you cannot fully understand. In terms of Enron, many shareholders could not explain the complicated business model of the company, which made it much easier for the executives to hide their deceptive practices. Additionally, the extremely complicated business model escalated its downfall.
Financial Cleverness Cannot Replace Sound Strategy
The leaders at Enron thought they could work their way around the system, which ultimately led to their brutal demise. The Enron Scandal was a lesson in ethics for all who watched the company fall.
Invest in High Quality Management Teams
The biggest downfall in the Enron scandal was the unethical and misuse of power and authority. When you are investing in a company, you are investing in its people. As an individual investor, it is likely impossible to ever come face-to-face with the executives running these companies, however, with the internet at your disposal, you can easily find an ample amount of information. Additionally, quarterly investor conference calls, insider trading transactions, and news media all exist to help you gain insight into companies and their employees.