Enron — Lessons Learned

Recently I was recommended to watch “smartest guys in the room” which is a documentary about Enron. I had never heard of the company but obliged, and subsequently went down the rabbit hole of the Enron story. I feel there is so much to be learnt from what was one of the largest frauds in history, so I have summarised some of my key takeaways.

High Level Summary

• Enron was an energy company, founded through the merger of two large gas companies in the US. Enron made the move into the general energy space and pioneered the financialisation of commodities through derivatives.

• Enron gamed the Californian energy market by attacking flaws in the newly built system, driving up electricity price by over 800%. As well as this, they would buy assets, use mark-to-market accounting to book farcical future profits and then sell them off to shell companies (SPEs), who happened to be owned by a firm run by Enrons CFO (if that isn’t a conflict of interest I don’t know what is).

• Enron at its peak had over 20,000 employees and generated over $101 billion in revenue. On December 2nd 2001, Enron filed for Chapter 11 Bankrutcy. Its $63.4 billion in assets made it the largest bankruptcy in US history at the time.

Investopedia / Source Data: Forbes

Key Takeaways

Company Culture

• Enron was very much focussed on share price. The decisions they made were always aimed to grow the share price, regardless of the cost. This ultimately drove them to cover up huge losses and omit relevant data from shareholder documents. The company’s share price was plastered throughout their offices, so that employees were reminded of their goal. This led some traders to take enormous gambles which rather than being reprimanded for, they were praised and the actions were hidden by management.

• I think Enron is a great example of how a top down approach can go wrong and the importance of building a strong executive/management team.

Diversification

• While executives were selling off their options in the background, they would continually encourage their 20000+ employees to invest their 401k in Enron stock. At the time it seemed like a great investment, with the company making huge returns. Many employees were fully invested in Enron and when the company went bankrupt, only had a few thousand dollars in their retirement fund.

• This highlights the importance of diversification in investments, regardless of amazing performance. It demonstrates how being too heavily invested in an individual company or sector can expose you to risk and severe losses when building a long term portfolio.

Balance between the free markets and regulation

• When an industry is too heavily regulated, there is a lack of competition which impacts both cost and innovation. However, Enron is a prime example of the dangers of complete deregulation, whereby they were exploiting loopholes in the energy market, much to the detriment of the Californian public.

• As fraudulent as a lot of Enron’s dealings were, they pioneered considerable advancements. They pioneered the use of energy derivatives which are now a key hedging tool used by most if not all energy market participants. Another significant development which can largely be attributed to Enron is Renewable energy certificates (RECs) which have become instrumental in the clean energy transition, providing additional financial incentives for renewable projects.

The good in the bad

• As part of the investigation into Enron, over 600k company emails were released. These emails became available to the public and went on to be key training material for many natural language models such as Siri and a prototype of gmail’s “smart compose”.

• In reaction to the fraud investigations of Enron, Worldcom and Tyco, the Sarbanes Oxley Act was put into legislation as a mechanism to improve disclosure requirements to prevent dodgy accounting practices from going unnoticed by investors. This key piece of legislation helped to end the nearly 100 years of corporate self accounting and improve the accuracy of corporate financial statements.

There is so much more to the Enron story that I haven’t covered. I would strongly recommend reading or watching “The Smartest Guys in the Room” if you want to learn more about this incredible story.