Enron and the Fall of Arthur Andersen

The story

In 2000, Enron looked like one of the most successful companies in America. Based in Houston, Texas, it had grown from a natural gas pipeline business into a huge trader of energy and other contracts. That year it reported about $111 billion in revenue and had about 21,000 employees. Its stock traded around $90 a share in August 2000, and business magazines praised it as a model of the new economy.

Behind the shine, something was badly wrong. A jury later found that Enron's top leaders had misled investors with off-the-books deals. Those were side companies and arrangements that kept debt off Enron's own financial reports and made profits look larger and steadier than they really were. To an outsider, Enron looked strong. In truth, it was carrying risks and losses that ordinary investors could not see.

The cracks showed in 2001. Chief executive Jeffrey Skilling suddenly resigned in August after only about six months in the job, and founder Kenneth Lay took the top job again. Days later, an Enron finance executive named Sherron Watkins met privately with Lay to warn him about the company's accounting. In October, Enron announced a third-quarter loss of more than $600 million and a $1.2 billion cut in shareholder equity, which is the value that belongs to the owners. The Securities and Exchange Commission (SEC), the government agency that polices the stock market, opened an inquiry. In November, Enron admitted that its earnings for the previous five years had to be corrected to show $586 million in losses. A planned rescue by a rival, Dynegy, fell through, and on December 2, 2001, Enron filed for bankruptcy. Its stock had dropped to under a dollar.

Thousands of people were hurt. Many employees lost their jobs and also their retirement savings, because those savings were heavily invested in Enron stock. Investors lost billions of dollars.

The courts later sorted out who was responsible. Former finance chief Andrew Fastow pleaded guilty to conspiracy in 2004, testified against his old bosses, and served a six-year prison sentence. In May 2006 a jury found Skilling guilty on 19 counts, including fraud, conspiracy and insider trading, and found Lay guilty of fraud and conspiracy. Lay died that July before he could be sentenced, so under the law his conviction was wiped away. Skilling was sentenced to 24 years in prison, later reduced to 14 years in a 2013 agreement that also sent more than $40 million of his money to victims.

Enron's fall also brought down one of the most famous names in accounting. Arthur Andersen was Enron's auditor, the outside firm whose job was to check that the company's numbers were honest. As the SEC began looking at Enron, Andersen staff destroyed large amounts of Enron-related documents, which the firm said was routine housekeeping under its records policy. Prosecutors disagreed. In June 2002 a Houston jury convicted Andersen of obstruction of justice, and its lead Enron partner, David Duncan, pleaded guilty and testified for the government. By August 31, 2002, Andersen had given up its right to audit public companies. In 2005, the U.S. Supreme Court unanimously overturned the conviction because the jury instructions had been too vague about what the government had to prove. But it was too late. A firm that once employed about 28,000 people had already shrunk to a few hundred.

Enron's collapse led Congress to pass tougher accounting and corporate-responsibility rules in 2002, known as the Sarbanes-Oxley Act. For business owners large and small, the story is a reminder that a company's reputation rests on whether people can believe its numbers, and that the people checking those numbers must be willing to say no.