73 Pages Posted: 30 Apr 2004
This Article analyzes Enron's financial collapse from a unique perspective: that of one of the prosecutors on the case, from 2002 to 2003.
Part I of the Article discusses Enron Corp.'s business operations in the years before its bankruptcy. During this period, Enron was engaged in a costly and ultimately disastrous diversification strategy, starting a series of business initiatives in water, telecommunications, energy and other sectors of the economy that cost the company billions but failed to produce significant revenue. To meet its rapidly escalating costs, Enron had to raise billions of dollars in capital markets but it needed to do so quietly, so as not to alarm banks and investors. Faced with this quandary, the company resorted to deception.
Part II explains how Enron's deception worked. Enron wanted to appear profitable, raise billions of dollars in cash, and keep its reported debt low. To accomplish this legerdemain, Enron employed a series of schemes to manipulate its financial statements. These techniques helped Enron dramatically inflate its reported revenue and hide billions of dollars in debt. They also misled investors and violated both federal criminal laws and relevant accounting rules.
In Part III, I discuss what may be the most alarming aspect of the Enron case - the failure of Arthur Andersen, the Enron Board of Directors, Wall Street equity analysts, and the SEC to catch and disclose Enron's deception before it was too late, despite some critical warning signs. I analyze the performance of each of these institutions in the Enron debacle and try to assess what went wrong. I argue that the existence of systematic conflicts of interest, lack of incentives for diligent work performance, and the absence of meaningful checks on or reviews of institutional performance made protection of investors a low priority for the Enron board, auditors and stock analysts. In the case of the SEC, I suggest that its performance was derailed by poor management and a misplaced sense of priorities.
Since Enron, we have seen a period of intense reform. In Part IV, I briefly discuss and assess some of these efforts to improve securities laws and regulatory practices, including the Sarbanes-Oxley Act, amendments to the United States Sentencing Guidelines, rule changes by the SEC and FASB, and reforms that resulted from litigation brought by New York's Attorney General, Elliot Spitzer. I argue that many of these changes are useful, but that others are actually counter-productive. I also address the most critical practical issue: where do we go from here? The most basic question we need to ask is whether the reforms implemented since 2002 are adequate - whether they sufficiently address and correct the problems with our system of securities regulation evident in the Enron debacle and similar cases. I argue that Sarbanes-Oxley and related reforms, though very useful in many respects, fail to mitigate sufficiently some of the major problems in the securities market, leaving investors extremely vulnerable to fraud and deception.
Finally, in Part V, I discuss my three reform proposals to improve securities market oversight, protect investors, and prevent more Enrons in the future: criminalization of conduct by executives who negligently release material false information to the securities market, radical reform of the SEC, and mandatory auditor rotation. These measures will improve the accuracy of information provided to investors and ensure that our equity markets continue to function in a safe, reliable, and efficient manner.
Keywords: Enron, Securities, Fraud, Criminal Law
JEL Classification: G10, G32, G34, M41
Suggested Citation: Suggested Citation
Kroger, John R., Enron, Fraud and Securities Reform: An Enron Prosecutor's Perspective. University of Colorado Law Review, December 2004. Available at SSRN: https://ssrn.com/abstract=537542
By Robert Clark
By Robert Rosen