Enron committed financial fraud prior to its collapse in 2001 by overstating its earnings and using mark-to-market accounting essentially to cook its books and dupe third-party auditing firm Arthur Andersen. Enron’s CFO Andy Fastow and its CEO Jeff Skilling used mark to market accounting to log future estimated profits as actual profits and a number of other financial fraud practices were used—such as creating shell vehicles to hide losses and create fantasy profits. The company used the same fraudulent practices as Charles Ponzi and other Ponzi-scheme artists, like Bernie Madoff, to create the illusion of generating enormous returns, all the while depending on new investors to keep up the illusion of cash flow.
Skilling benefited for a time, getting recognized as a genius who transformed the energy company into a financial company. Fastow benefited because he was skimming off the top. Investors in the publicly-traded company benefited as the share price of the company climbed from around $15 in the mid-90s to more than $90 in 2000 with a $70 billion market cap (Segal, 2019). Those investors who bought puts before the crash, which occurred shortly thereafter, or who sold out of their shares altogether, were able to profit handsomely. The outcome for the fraudsters was prison: Fastow and Skilling were both sentenced to multiple years in jail. Ken Lay, the Chair, was also facing jail time but died in an accident.
Fraud could have been prevented had Arthur Andersen been more attentive to what was going on with the accounting practices. Likewise, the fraud investigation techniques that may have been used to detect financial statement fraud include vertical and horizontal financial statement analysis and comparative ratio analysis—both of which could have helped to detect and prevent the fraud before individuals and institutions were left holding the bag.
References
Segal, T. (2019). Enron scandal. Retrieved from https://www.investopedia.com/updates/enron-scandal-summary
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