Enron’s 2001 collapse: charges, restatement, Dynegy and bankruptcy

analysisAccording to the Joint Committee on Taxation, Enron’s share price peaked at $90.75 in August 2000, opened 2001 at $83.13 and declined throughout the year, closing at $58.10 on March 30, 2001 and $49.10 on June 29, 2001; by September 28, 2001, the end of the third quarter, it traded at $27.23. As investor concerns grew in late 2000, Jeff Skilling, then Enron’s President and Chief Operating Officer, issued a press release on November 24, 2000 stating that “rumors of a potential profit warning are not true”. Press releases of January 25 and March 22, 2001 reaffirmed confidence in “strong business prospects for 2001”, and on June 19 and July 12, 2001 Skilling, by then chief executive, expressed confidence in meeting the company’s earnings expectations, as the Joint Committee on Taxation recorded. ¹

analysisIn announcing the May 2006 jury convictions of Kenneth Lay and Jeffrey Skilling, the Justice Department stated that their scheme with other Enron executives, at various times between at least 1999 and 2001, deceived investors and the SEC about Enron’s true performance, artificially inflating its share price from about $30 in early 1998 to over $80 in January 2001 and stemming its decline during the first three quarters of 2001. That is the Department’s description of the scheme of which the two men were convicted. Lay died on July 5, 2006 and a federal judge voided his conviction in October 2006; Skilling, after several appeals, was resentenced in 2013 to 168 months in prison under a sentencing agreement. ^{2 3 4}

analysisIn February 2001 Enron issued $1.9 billion face value of 20-year zero-coupon notes, which yielded $1.25 billion in proceeds, most of it used to refinance existing debt, according to the Joint Committee on Taxation. The Senate Permanent Subcommittee on Investigations reported on July 8, 2002 that a Finance Committee presentation of August 2001 showed the value of Enron’s “Prepays” and “FASB 125 Sales” rising from $6.7 billion in 1999 to $9.2 billion in 2000 and $6.5 billion in the first six months of 2001. The Subcommittee’s analysis, a congressional finding rather than a court determination, indicated that the prepays operated as loans disguised as trading activity, booked as cash flow from operations rather than as debt. ^{1 5}

analysisOn October 16, 2001, Enron reported third-quarter 2001 results including an unexpected after-tax charge of $544 million, and Kenneth Lay told analysts that shareholders’ equity was being reduced by $1.2 billion; the Powers Committee report stated that both related to transactions with LJM2. The Joint Committee on Taxation, citing Enron’s SEC filings, explained that the charge largely reflected a $710 million pre-tax charge on terminating the Raptor vehicles and that the equity reduction corrected the recording of an investment in the Raptors as an asset. ^{1 2}

analysisOn October 22, 2001, Enron announced that the SEC had asked it to provide information voluntarily about the LJM2 related-party transactions, and on October 24 it announced that Andrew Fastow would take a leave of absence and be replaced as chief financial officer. On October 25, 2001, Enron drew down approximately $3 billion of its available bank lines to repay outstanding and expiring commercial paper and provide immediate liquidity. On October 28 the board formed a Special Committee of three non-employee directors; after two new directors joined and two original members stepped down, the renamed Special Investigative Committee consisted of William C. Powers, Jr. (chairman), Raymond S. Troubh and Herbert S. Winokur, Jr. Enron’s share price fell from $34.30 on October 16 to $13.90 at the close of trading on October 31, 2001, according to the Joint Committee on Taxation. ^{1 2}

analysisIn a Form 8-K dated November 8, 2001, Enron announced that it would restate its financial statements for 1997 through 2000 and the first two quarters of 2001, and that the previously issued statements and the audit reports on the 1997–2000 year-end statements should not be relied upon. Enron concluded that Chewco and JEDI should have been consolidated from November 1997, and a wholly owned LJM1 subsidiary that hedged an investment in Rhythms NetConnections from 1999; the restatement also recorded the previously announced $1.2 billion equity reduction. Enron’s accompanying press release stated that the restatement would have no negative impact on its reported earnings for the nine months ending September 2001. ^{1 2}

analysisThe 8-K’s restatement table reduced Enron’s reported net income from $105 million to $9 million for 1997, from $703 million to $590 million for 1998, from $893 million to $643 million for 1999 and from $979 million to $847 million for 2000, mainly through consolidation of JEDI and Chewco and of the LJM1 subsidiary. Reported debt for 2000 rose from $10,229 million to $10,857 million and shareholders’ equity fell from $11,470 million to $10,306 million. Enron’s third-quarter 2001 Form 10-Q, filed on November 19, 2001, gave detailed restatement figures that varied slightly from those announced on November 8, 2001, according to the Joint Committee on Taxation. In its own aggregation of the charges and restatements reported by Enron, the Joint Committee staff calculated that the October 16, 2001 charges and equity adjustments and the November 2001 restatements together reduced Enron’s net income for 1997 through 2001 by approximately $1.7 billion, including $399 million relating to JEDI and Chewco, $103 million to LJM1, $710 million to LJM2 and the Raptors, $287 million to Azurix and $180 million to the broadband businesses. Reported equity fell from $11.7 billion at June 30, 2001 to $9.6 billion at September 30, 2001. ^{1 3}

analysisEnron’s shares closed at $8.41 on November 8, 2001. On November 9, Enron announced an agreement to be acquired by Dynegy Inc. in a $9 billion stock-for-stock transaction. As part of the negotiations Dynegy, through ChevronTexaco, provided Enron a $1.5 billion cash infusion for a preferred stock interest in Enron’s subsidiary Northern Natural Gas Company, with option rights to acquire that company if the merger terminated; Dynegy exercised the option when the merger negotiations ended. The merger agreement unravelled on November 28, 2001. That day Enron shut down EnronOnline, rating agencies downgraded its long-term debt to below investment grade, and Enron temporarily suspended all payments other than those needed to maintain core operations. Its shares, which had closed at $4.11 on November 27, fell to $0.61 on November 28 and closed at $0.26 on November 30, 2001. ¹

analysisOn December 2, 2001, Enron Corp., an Oregon corporation, and thirteen affiliates filed voluntary Chapter 11 petitions in the U.S. Bankruptcy Court for the Southern District of New York and sought joint administration; further affiliates joined later, and by February 8, 2003 Enron reported 79 debtor companies, among them Enron North America Corp., Enron Energy Services Inc. and Enron Power Marketing, Inc.; Northern Natural Gas Pipeline, Transwestern Pipeline, PGE and other units were excluded. The Joint Committee on Taxation described Enron Corp. as a Houston-based energy and commodities trading holding company that conducted business through approximately 3,500 domestic and foreign subsidiaries and affiliates. The same day it filed, Enron sued Dynegy for at least $10 billion for wrongfully terminating the merger. Enron and Dynegy settled that dispute on August 15, 2002, Enron receiving $25 million in cash and forgoing claims over Dynegy’s exercise of its option on Northern Natural Gas Company; in October 2006 Dynegy agreed to pay Enron a further $44 million to resolve remaining litigation, subject to bankruptcy-court approval, according to a press report. ^{2 1 3}

analysisIn its bankruptcy petition Enron Corp., separately and excluding affiliates, listed assets of $24.8 billion and liabilities of $13.1 billion, a figure the company said did not reflect off-balance-sheet and contingent obligations. The combined listed assets of Enron Corp. and the thirteen affiliates that filed first totalled $63.4 billion, according to the Joint Committee on Taxation. The same report records that in November 2001 Enron Europe, the group’s European energy-trading arm, filed for creditor protection under the laws of the United Kingdom. ¹

analysisOn January 15, 2002 the New York Stock Exchange suspended trading in Enron stock and moved to delist the shares. On January 17, 2002 Enron discharged its auditor, Arthur Andersen, and on February 2, 2002 the Powers Committee report was delivered to Enron Corp.’s board, according to the Joint Committee on Taxation. Enron certified to the SEC that it had no independent auditor, that retaining one was not feasible, and that it did not intend to provide audited financial statements for 2001 or any later unaudited quarterly statements. According to the bankruptcy examiner, Andersen had been unable to finalise the required review of the third-quarter 2001 Form 10-Q, filed on November 19, 2001, because of the pending Powers Committee investigation and the announced restatement. ^{1 2}

analysisIn April 2002 Enron reported that preparing a balance sheet under generally accepted accounting principles (GAAP) at December 31, 2001 would require an estimated $14 billion asset write-down. The Senate Permanent Subcommittee on Investigations described the April 2002 Form 8-K as announcing a $14 billion write-down of asset values that “may have been overstated due to possible accounting errors or irregularities” and another $10 billion on price risk management assets; the Joint Committee on Taxation, citing the monthly operating statement filed on April 22, 2002, put that further adjustment at $8 billion to $10 billion. ^{3 1}

analysisNeal Batson, the examiner appointed in Enron’s bankruptcy case (In re Enron Corp., Case No. 01-16034 (AJG), Bankruptcy Court S.D.N.Y.), filed interim reports on September 21, 2002, January 21, 2003 and June 30, 2003 and a final report on November 4, 2003; his conclusions are an examiner’s findings, not court judgments. In the first report he concluded that six special purpose entity (SPE) transactions were, to varying degrees, susceptible to “true sale” challenges which, if successful, would restore remaining assets worth about $500 million to the debtors’ estates. In the second, of January 21, 2003, he concluded that Enron manipulated its financial statements in violation of GAAP and failed to make appropriate public disclosure of its SPE transactions, found many of the transactions susceptible to “true sale” or substantive consolidation challenges that could restore assets worth an estimated $1.7 billion to $2.1 billion to the estates, and identified potentially avoidable transfers of about $2.9 billion. On September 24, 2003 Enron and Enron North America sued certain financial institutions in the bankruptcy court (Enron Corp. v. Citigroup Inc.), seeking equitable subordination of their claims, recovery of more than $3 billion as alleged avoidable transfers or obligations and damages for alleged aiding and abetting, as the examiner’s final report records. ¹

analysisIn his second interim report, as restated in his final report, the examiner concluded that Enron engineered its reported results so that its financial statements bore little resemblance to its actual condition. In 2000, the last year with audited statements, six SPE-related accounting techniques produced 96% of Enron’s reported net income and 105% of its reported funds flow from operations and let it report $10.2 billion of debt rather than $22.1 billion; he found that the 1999 and earlier statements were misleading as well. According to the examiner’s final report, Enron’s third-quarter 2001 balance sheet filed on November 19, 2001 reported GAAP debt of $12.978 billion, while senior Enron executives told certain bankers the same day that its “debt” was $38.094 billion. Of the additional $25.116 billion, about $14 billion arose from SPE structured finance; Enron’s presentation to the bankers divided it into eight categories, the largest being unconsolidated affiliates ($10.733 billion), commodity transactions with financial institutions ($4.822 billion) and share trusts ($3.352 billion). These are the examiner’s conclusions, not court judgments. ¹

analysisThe examiner’s final report recorded that the debtors’ professionals had concluded that Enron and certain of its debtor affiliates were insolvent as of December 31, 1999, under the tests of the Uniform Fraudulent Transfer Act and/or the Uniform Fraudulent Conveyance Act; that is their conclusion, not a court finding. In his third interim report of June 30, 2003, the examiner concluded that SPE-related transfers of about $368 million could be recovered by the estates as constructively fraudulent or preferential, that certain transfers to insiders could be recovered as constructively fraudulent, and that transfers of about $70 million to professionals could be recovered as preferential. He also found sufficient evidence for a fact-finder to conclude that, in its overall use of SPEs, Enron entered into the transactions with intent to hinder, delay or defraud its creditors. These are the examiner’s conclusions, not court judgments, and he noted that realising such avoidance actions was subject to transferees’ affirmative defences, valuation evidence and collectability, and that a transferee who received payments in good faith would have a defence to the extent it gave value to the debtors. The suit filed on September 24, 2003 against certain financial institutions sought, among other things, recovery of more than $3 billion as alleged avoidable transfers or obligations. ^{1 2}

analysisThe examiner’s third interim report of June 30, 2003 found that Enron’s tax department, through a structured transactions group led by a vice president, used “Tax Transactions” to fill annual earnings targets, creating $886.5 million of net income from 1995 through September 2001. The transactions recorded speculative future tax deductions as current income, sometimes as pre-tax income, in a manner the examiner called materially misleading. This is an examiner’s conclusion, not a court judgment. ^{1 2}

analysisThe Joint Committee on Taxation reported that Enron’s federal income tax returns for 1996 through 2001 showed a tax liability only for 2000 and 2001 and no federal income tax paid for 1996 through 1999. The 2000 return reported a liability of $63.2 million, payments and credits of $70.1 million and an overpayment of $6.9 million; the 2001 return reported total tax of $13,331 and a refund of $20,428. From 1990 the IRS conducted four examinations of Enron’s federal income tax returns, covering 1983–1987, 1988–1991, 1992–1994 and 1995–2001. The first three cycles were closed in 1993, 1996 and 1998 with net agreed deficiencies of $4.3 million; the 1995–2001 cycle was still under examination when the Joint Committee on Taxation reported. ³

analysisAccording to the Joint Committee on Taxation, Enron reported net operating losses for 1996 through 1999 and carried $3.1 billion of them forward into 2000. To close the IRS audit of those years it adopted a strategy of paying tax for 2000: late in 2000 it entered into transactions, part of Project NOLy, intended to generate taxable income absorbing the carryover, and in 2001 losses on closing them out produced a $4.6 billion net operating loss. That is the description and characterisation of the Joint Committee staff; a member of Enron’s tax department told the staff that the transactions were meant to generate income to close tax years: “in the year 2000 we managed our taxable income to pay $60 million in tax so that we’d have a statute and use up the $3 billion NOL we had.” In its Statement of Financial Affairs filed with the bankruptcy court on June 17, 2002, Enron Corp. listed a $63.2 million federal income tax refund as an asset and the IRS as an unsecured creditor with a claim of unknown amount. On August 1, 2002 the bankruptcy court gave the IRS until March 31, 2003 to file proofs of claim against the Enron debtors; the IRS examination of the 1995–2001 returns was still open when the Joint Committee reported. ³

analysisA February 5, 2002 press report, compiled from staff and news service reports, listed losses claimed by public pension funds on Enron, including the Florida state pension fund ($325 million), the University of California ($145 million), the Georgia state pension fund ($127 million), Ohio public employees and teachers ($114.5 million), New York City ($110 million), Washington state employees ($103 million), CalSTRS ($49 million) and CalPERS ($40 million); these are the funds’ own claims and were not independently verified. A 2007 press report summarised Enron’s collapse after years of accounting tricks as costing thousands of jobs, more than $60 billion in market value and more than $2 billion in pension plans, without attributing the figures to an official source. ^{1 2}

analysisThe FBI later described Enron’s December 2001 collapse as precipitating the most complex white-collar crime investigation in its history. In its historical case summary the Bureau stated that top officials cheated investors and enriched themselves through accounting gimmicks such as overvaluing assets to boost cash flow and earnings, and that the company overvalued its international assets by billions and manipulated its quarterly earnings statements to keep its stock price afloat. At their 2006 criminal trial, Enron’s former chief executives maintained that there had been no fraud at Enron and that negative publicity coupled with diminishing market confidence caused its swift collapse, according to a February 2006 press account. The FBI states that the five-year investigation led to jury convictions of top Enron officials and guilty pleas from many others, and that twenty-two people were convicted. ^{3 4}