Recently there has been a lot of press about a company called Enron filing for Chapter 11 (bankruptcy).

Who is Enron?

Why is it making headline news when many companies file for bankruptcy every day? And what does a company filing for bankruptcy have to do with insurance?

Enron was formed in 1985 as a gas pipeline company when Houston Natural Gas and InterNorth of Omaha, Nebraska merged. Phenomenally, after only 15 years later in operations, Enron diversified into telecommunications, insurance, lumber, paper production and investments, and became regarded as the industry leader for the energy industry.

It was showing revenues in excess of $100 billion and had 21,000 employees world wide. Enron was highly acclaimed as the "pioneer and master of the new competitive markets in energy" because it invented the concept of buying and selling simple products like energy, water and telecommunications on the open market in the same way as people trade stocks and bonds.

Enron won several prestigious awards for its market innovations including being named as "America's most innovative company" by Fortune magazine for six years in a row. As recently as August 14, 2001, Fortune magazine listed Enron as one of the top 10 growth stocks of the decade.

So how did it all go wrong for the darling child of the investment world when Enron filed for what is purported to be the US's largest bankruptcy case ever?

The word in the financial world is that Enron was forced into bankruptcy not from the failure of its core business operations but rather from its rather shady investment practices. John Olsen, director of research at securities firm Sanders Morris Harris was quoted as saying, "the trading company did not bring Enron down. The energy outsourcing and pipelines did not cause Chapter 11 (bankruptcy). It was an egregious and overtly aggressive financing strategy that blew up in their faces and everyone else's."

The demise of Enron was sealed when the much smaller energy marketing and trading company, Dynegy, backed out of the deal to take over Enron.

Even respected investors like Warren Buffett would not go near Enron and were surprised by Dynegy's enthusiasm for it.

Signals were there long before Enron officially filed for Chapter 11 that there was something seriously wrong with the company. Six weeks prior to declaring bankruptcy, a discrepancy in Enron's accounts prompted an investigation by the US government. Enron later admitted to overstating profits by $600mil from 1997-2001.

Enron is now blaming Dynegy for its bankruptcy saying that if Dynegy hadn't backed out of the deal, it would have had enough money to pay off its debtors. Dynegy, claiming it had no idea Enron's financial woes were so dire, withdrew from the negotiating table when Enron admitted its profits were less than reported. Dynegy is now being hailed as the David who triumphed over Goliath, Enron. The acquisition of Enron by Dynegy has been compared to Pepsi buying out Coca-Cola.

Many of Enron's employees have lost their retirement savings because Enron's 401K (retirement plan) was heavily invested in company stock.

Many outside shareholders - including major financial institutions - had significant investments in Enron. At its peak Enron was selling at $90/share. At its demise, it was trading as low as 10 cents/share. It doesn't take a rocket scientist to work out that many people who invested in Enron have been wiped out.

It has been reported that a slew of lawsuits have been filed on behalf of shareholders and employees who watched their saving plans shrivel to virtually nothing as Enron froze them before they could sell out.

With statements from senior financial advisors about Enron's dubious trading, admission from Enron that it fudged its profits for the last four years, it's no wonder we are seeing a slew of lawsuits. The liability for making such dangerous decisions to leverage the company will undoubtedly fall onto Enron's senior management including its corporate directors and officers.

This is where insurance, namely Directors and Officers insurance will come in. The principle reason being allegations emerging about why Enron filed for Chapter 11 (bankruptcy).

Enron has broken several of the major responsibilities it owed to shareholders including the safeguarding and approval of changes in the corporation's assets, approval of financial matters and seeing that proper annual reports and interim reports had been given to shareholders.

One of the allegations is that Enron financed some of its tremendous growth off the balance sheets with outside partnerships. Therefore Enron was sending out fraudulent balance sheets to shareholders, which is in direct violation of its responsibility to them.

The omission of these deals gave shareholders a false sense of security about Enron's financial strength. Even Wall Street analysts were caught off guard by Enron's admission to overstating profits.

Enron's directors and officers also have "fiduciary duties" to their shareholders, board of directors and the general public. Fiduciary duties are duties to act in the best interest of the company. Each director and officer, by virtue of position, is obligated to act in good faith, honestly and in the best interest of the organisation and therefore must show care, diligence and the skills of a reasonably prudent person. One of the main fiduciary duties Enron has been accused of violating is the duty to disclose.

The duty to disclose means officers and directors have the general duty to disclose material facts to all persons who have a right to know such facts and would not otherwise be able to obtain them. If the allegations are correct that Enron's management intentionally leveraged the company's assets and hid this fact from shareholders, then the shareholders definitely have a case against Enron. Proof of this allegation would also confirm Enron violated its duty of loyalty to shareholders and its duty of care.

Enron has allegedly breached many fiduciary duties and responsibilities to its shareholders, the general public and its board of directors. This explains why its directors and officers are being sued.

Next week, I will explain the types of suits Enron's directors and officers are likely to face and briefly what Directors and Officers insurance does.

Cathy Duffy is a Chartered Property Casualty Underwriter (CPCU) and is now a freelance writer. She is a former executive of Zurich Global Energy and has 15 years experience in the insurance industry. She writes on insurance issues in The Royal Gazette every Monday. Feedback crduffy@ibl.bm