Get All Access for $5/mo

Enron Ignored Unheeded lessons from the nation's most spectacular bankruptcy have left the U.S. with another crisis.

By Kate Murphy

Seven years ago this month Houston energy company Enron collapsed and spurred financial regulations that were meant to prevent the kind of corporate mischief that led to that historic flame-out .

Well, these days it looks like those regs did little to protect the U.S. financial system from the latest round of shenanigans, and the ensuing meltdown that has cost investors billions and thrown the global economy into a tailspin.

What did we learn from Enron? It might be easier to see what we didn't:

1. Leverage, hidden or otherwise, can be lethal.
The offshore special-purpose entities that Enron famously used to take debt off its balance sheet and camouflage its risky securitized debt and derivatives investments are similar to the vehicles that Wall Street firms used to invest in mortgage-backed securities and credit default swaps. It took an army of auditors to figure out where all the money went at Enron and Treasury chief Hank Paulson and his crew have yet to untangle Wall Street's web of dodgy deals.

"The difference is that Enron went under when it was leveraged 11 to 1 whereas at Lehman it was more like 30 to 1," says John Olson, an energy hedge fund manager, who was a lonely critic in the 1990s of Enron's arcane accounting when he was a Merrill Lynch analyst. Enron bigs eventually had him fired from that job.

2. Top Executives Aren't Boy Scouts
Enron's chief financial officer, Andrew Fastow, enriched himself in a few of the deals and violated accounting rules in the process, but his ill-gotten gains were pennies compared with the hidden debt that eventually cratered the company.

Enron-inspired regulations in the 2002 Sarbanes-Oxley Act "were just for show" and "didn't do anything," says Dean Baker, co-director of the Center for Economic and Policy Research in Washington. The legislation included provisions requiring executives to personally sign off on financial statements and increased the amount of outside capital that must be at risk in special purpose entities.

At the trial of Enron executives Jeffrey Skilling and Kenneth Lay, jurors dozed and looked at the ceiling during testimony about the company's complicated and risky investments. They ended up convicting on the more straightforward charges that Skilling and Lay "presented a rosier picture of the company than they knew to be true," says Andrew Weissmann, the former director of the Department of Justice's Enron Task Force and now a partner at Jenner & Block in New York.

And that may be how Wall Street executives will be held accountable. "There are definitely investigations now as to whether the heads of A.I.G. and Lehman did the same thing as things were going down," Mr. Weissmann says, referring to their repeated public statements that their companies were sound.

3. Rules Are Meant to Be Worked Around
As lawmakers once again ponder how to ensure the integrity of the financial system, Baker says, "Definitely, special-purpose entities should be reported and visible on balance sheets." Moreover, he says, Enron's collapse foretold the dangers of an unregulated derivatives market. Just as Enron traded heavily in these complex financial instruments, so did Wall Street firms in the form of credit-default swaps.

Also worth noting is the creative use of mark-to-market accounting that first Enron and then Wall Street bankers applied to their structured finance products. Mark-to-market accounting, which some critics call "mark-to-make-believe" accounting, allows booking anticipated profits rather than waiting until they are actually realized. It works well if the estimates are accurate but can lead to disaster if they are not.

Comparing Enron's and Wall Street's collapse, Mark Fagan, senior fellow at the Center of Business and Government at the Harvard Kennedy School in Cambridge, Massachusetts says, there is "a similarity in the lack of correct valuation of assets."

Enron relied on the continuing increase of its share-price, which was the basis of many of its deals, he says, and Wall Street firms bet on ever-escalating home prices.

4. Auditors and Ratings Agencies Can Be Bought
Just as Enron blamed its auditors, Wall Street firms are pointing fingers at rating agencies. A commonality is the lack of independence that plagues both.

Sarbanes-Oxley regulated how cozy auditors could be with their clients. For example, auditors are now prohibited from simultaneously providing auditing and financial consulting services. Duke University School of Law professor James Cox, argues that the rater should not be paid by the rated.

"The rating agencies turned a blind eye in the run up to the current crisis because they were generating fees like never before," Cox says. He not only supports rules banning such payments but also wants to require raters to disclose the models they use to evaluate assets: "They need to tell us what algorithm they used and how they came up with the variables."

Many legal and economic experts wonder if effective reform is possible as the financial sector seems to always find a way around the rules. "Part of the problem," says Baker at the Center for Economic and Policy Research, "is that few people really understand these complex instruments and transactions much less how to effectively regulate them."

Visit for the latest business news and opinion, executive profiles and careers.© 2007 Condé Nast Inc. All rights reserved.

Want to be an Entrepreneur Leadership Network contributor? Apply now to join.

Editor's Pick

Business News

'We Pulled Off An SEO Heist': Entrepreneur Stole 3.6 Million Pageviews From Competitors — And Your Business Could Be Next.

This has huge implications for businesses that rely on Google's organic traffic for revenue.

Business News

Wells Fargo Reportedly Fired More Than a Dozen Employees for Faking Keyboard Activity

The bank told Bloomberg that it "does not tolerate unethical behavior."

Starting a Business

Spend Less Time Worrying About Your Company's Runway — And More Time Rethinking Your Strategy. Here's How.

Perceived short runways leave founders in angst. It does not have to be this way; the best way to extend the runway is the right strategy.

Business Ideas

63 Small Business Ideas to Start in 2024

We put together a list of the best, most profitable small business ideas for entrepreneurs to pursue in 2024.


7 Ways You Might Be Damaging Your Credibility as an Entrepreneur

Here are seven credibility killers entrepreneurs need to be aware of.