Matt T

Ken Lay charged

The news that Ken Lay, former CEO of Enron, has been charged on 11 counts, inlcuding bank fraud, share trading fraud and making false statements would perhaps not have registered much with me (except a dim 2001 memory) were it not that I read 'Enron: the rise and fall' on holiday recently.

It's an excellent book, and (the version I read) though written quite soon after the collapse of the company is very comprehensive, and the author seems eminently plausible in his description of what went wrong, and why it went wrong.

The first thing to note is Enron was not like many companies of that era, with nothing to back up the hype. It for many years was voted America's 'most innovative company'' and in its two fields of expertise -- running huge physical infrastructure projects in the power industry, and energy trading, it was a very successful and admired company. It also had a good reputation amongst its staff.

So what went wrong? Essentially Enron's ability to continue growing depended on two crucial assets -- a rising share price and a good credit rating. The rising share price allowed it to cover a multitude of sins through the constant issuing of new stock, whilst the good credit rating gave counterparties confidence in trading with it, a crucial ingredient when it launched EnronOnline, its internet-trading system.

Hence nothing became more crucial to keeping the share price rising, and keeping the credit rating strong. Hence you got the plethora of off-balance sheet entities, designed to hide rising debt obligations. Most of these were funded with promises of Enron stock.

Often the tricks used weren't illegal. One classic one was on EnronOnline. It appears it was legal, though clearly misleading, to book trades as if they were revenue for Enron. Normal practice is to just book Enron's profit. Thus if Enron sold $1m of gas, which they had bought for $999,000, they counted it as $1m of revenue (and $0.998m of expenditure). A more normal treatement would be to just count the $1,000 profit. This allowed Enron to say its revenues were over $100bn, a claim which is still on its website today. Why did it do this? Well counterparties obviously felt better trading with 'American's 7th largest company' than they would with a much smaller one.

THis reliance on a rising share price and good credit rating worked while it worked. But when problems started to mount, in part attributable to failed overseas projects, coupled with the stock market crash of 2001, the whole thing began to unravel. As the share price fell the off-balance sheets entities became insolvent, forcing the credit-rating to collapse, and making counterparties refuse to trade. End of story.

Except of course it's not. There were lots of angry people -- a friend of mine had his entire pension in Enron stock -- and much evidence that the company was not just poorly managed, but fraudently. It looks like he will be found guilty.

posted by Matthew @ 7/08/2004 03:30:00 PM Comments: 0