The Enron Collapse

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Wrong Accounting Practices:

- Special Purpose Entities (SPE) were used to move assets and liabilities off the balance sheet. While the practice itself was not considered strictly illegal, the issue was the extent to which the organization was doing it.

- Volumetric Production Payments (VPP) was seen as a revolutionary measure used by Enron to provide liquidity to small gas producers where Enron in return would obtain long term fixed price gas supplies. In essence, Enron was repaid in gas rather than cash. To finance these payments, Enron sold the rights to future cash flow from each deal to investors in a series of off balance sheet vehicles.

- Mark-to-Market Accounting: Agreed by the Board in 1990, this essentially allowed Enron to 'monetize' any deal based on future cash flows. It did not matter to Enron whether any deal was profitable in the short or medium term, but as long as it showed a positive speculative NPV after a period of time, Enron would book the profits based on that period. While they were expected to do this only for those products for which there existed a futures price (e.g. gas futures), Enron extended the principle to much longer contracts, essentially drawing their own future cash flow curves, and booking profit on it, basically turning the practice into 'mark-to-Enron'.

- Off balance sheet transactions using 'front' organizations involving Enron employees particularly orchestrated by Fastow and his coterie (Chewco, LJM1) was the final nail in the coffin.

In the entire Enron saga, fault also lies with the accounting firm Arthur Andersen who were both the internal and external auditors for Enron. In spite of knowing Enron's aggressive and borderline illegal practices, Arthur Andersen failed to raise the red flag either to Enron or to the regulators. Enron's board is equally culpable as they decided to turn a blind eye to the practices being followed by the executive management, ostensibly because of the handsome remunerations that the board members and top management were enjoying (In 2000, the top 200 employees were paid a whopping $1.4B, up from $193M in 1998; the board members were also paid handsomely).

Conclusion: The Enron saga is known as a Ponzi scheme or a Pyramid scheme that basically involves 'borrowing from Peter to pay Paul' as is generally called. The collapse of Enron is recognized as the biggest corporate failure of the recent times. Accounting practices and regulations were changed significantly after this failure.