Did Enron's investors fool themselves?

This article focuses on the professional investment community – fund managers and financial analysts.

Did Enrons investors fool themselves 974x296

So far the Enron story has mostly been about executives and accountants.

This article focuses on the professional investment community – fund managers and financial analysts.

It argues that the data in Enron’s published accounts should have been sufficient to trigger warning bells long before the share price started falling.

Enron’s reported revenue grew fast, but at lower margins – with the result that it was failing to earn an adequate return on capital. As with the internet bubble, the investment community neglected the question of whether the growth was valuable.

Enron’s announcement in late-October 2001 of a $1.2bn charge for losses in LJM, an off-balance sheet equity fund, triggered a plunge in stock price.

LJM was one of a complex web of affiliates created by Enron, with the apparent motive of parking currently under-performing assets off balance-sheet, thus flattering earnings and reducing reported borrowings.

The stock price fall through 2001 was catastrophic for Enron since it had used its own equity to support some of these vehicles.

This, and the attendant collapse in investor confidence, led to its bankruptcy on 2nd December.

The Enron affair has put the spotlight on the finance profession in its various guises, and on financial governance.

Enron subsequently admitted errors in accounting over a number of years, and claims have been made that the auditor, Arthur Andersen, was complicit.

As users of Enron’s accounting statements, professional investors – another branch of the finance profession – have emerged as the victims of the piece. I argue differently in this article: if investors were the victims of Enron’s accounting, there appears to have been contributory negligence.

I argue that it is the responsibility of the finance profession to counterbalance the advocacy and selfbelief of senior management.

We need accountants to be conservative and sceptical. Financial governance breaks down if either the finance function within the firm or the auditors forget their role and absorb the belief system of top management; in other words, if the accountants go native.

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