Enron Used Future Profits Counted as Today's Revenue and Took an Auditor Down With It

Enron was a Houston-based energy company that, through the 1990s, transformed from a natural-gas pipeline operator into a derivatives-trading firm with a power business attached. The trick that made the transformation profitable on paper was an SEC-approved 1992 decision to apply mark-to-market accounting to its long-dated energy contracts. Where a standard utility would book revenue as it was earned, Enron could now book the present value of expected future cash flows the day a contract was signed. If the projected profits never materialized, you simply unwound them quietly later. If you wanted them to look bigger, you pushed your assumptions about price curves a little further.

The trick that made the trick work was the chief financial officer, Andrew Fastow, who built a constellation of off-balance-sheet partnerships with names like LJM and the Raptors. The partnerships ostensibly hedged Enron's positions; in practice they bought up the loss-making contracts and parked them somewhere the consolidated financials wouldn't capture. Fastow personally pocketed about $30 million in fees from running them.

The stock peaked at $90 in August 2000. CEO Jeffrey Skilling resigned for "personal reasons" in August 2001. The Wall Street Journal began publishing detail on the Raptor partnerships in October. The credit-rating agencies downgraded Enron to junk on November 28, and the company filed for what was then the largest bankruptcy in U.S. history on December 2, 2001 — $63.4 billion in assets, about 20,600 employees laid off. Skilling was sentenced to 24 years; Fastow to 6; founder Kenneth Lay died of a heart attack between his conviction and sentencing in 2006. Enron's auditor, Arthur Andersen, was convicted of obstruction in 2002 and effectively dissolved despite the Supreme Court overturning the conviction in 2005. Sarbanes-Oxley followed.