It was Arthur Andersen's responsibility not only to audit Enron's financial statements, but also to assess Enron management's internal controls on derivatives trading. When Arthur Andersen signed Enron's 2000 annual report, it expressed approval in general terms of Enron's system of internal controls during 1998 through 2000.
Yet it does not appear that Arthur Andersen systematically and independently verified Enron's valuations of certain complex trades, or even of its forward curves. Arthur Andersen apparently examined day-to-day changes in these values, as reported by traders, and checked to see if each daily change was recorded accurately. But this Committee - and others investigating Enron - should inquire about whether Arthur Andersen did anything more than sporadically check Enron's forward curves.
To Arthur Andersen's credit as an auditor, much of the relevant risk information is contained in Enron's financial statements. What is unclear is whether Arthur Andersen adequately considered this information in opining that Enron management's internal controls were adequate. To the extent Arthur Andersen alleges - as I understand many accounting firms do - that their control opinion does not cover all types of control failures and necessarily is based on management's "assertions," it is worth noting that the very information Arthur Andersen audited raised substantial questions about potential control problems at Enron. In other words, Arthur Andersen has been hoisted by its own petard.
But Arthur Andersen was not alone in failing to heed these warning signs. Securities analysts and credit rating agencies arguably should have spotted them, too. Why were so many of these firms giving Enron favorable ratings, when publicly available information indicated that there were reasons for worry? Did these firms look the other way because they were subject to conflicts of interest? Individual investors rely on these institutions to interpret the detailed footnote disclosures in Enron's reports, and those institutions have failed utterly. The investigation into Arthur Andersen so far has generated a great deal of detail about that firm's approach to auditing Enron, but the same questions should be asked of the other gatekeepers, too. Specifically, this Committee should ask for and closely examine all of the analyst reports on Enron from the relevant financial services firms and credit rating agencies.
Finally, to clarify this point, consider how much Enron's businesses had changed during its last years. Consider the change in Enron's assets. Arthur Andersen's most recent audit took place during 2000, when Enron's derivatives-related assets increased from $2.2 billion to $12 billion, and Enron's derivatives-related liabilities increased from $1.8 billion to $10.5 billion. These numbers are staggering.
Most of this growth was due to increased trading through EnronOnline. But EnronOnline's assets and revenues were qualitatively different from Enron's other derivatives trading. Whereas Enron's derivatives operations included speculative positions in various contracts, EnronOnline's operations simply matched buyers and sellers. The "revenues" associated with EnronOnline arguably do not belong in Enron's financial statements. In any event, the exponential increase in the volume of trading through EnronOnline did not generate substantial profits for Enron.
Enron's aggressive additions to revenues meant that it was the "seventh-largest U.S. company" in title only. In reality, Enron was a much smaller operation, whose primary money-making business - a substantial and speculative derivatives trading operation - covered up poor performance in Enron's other, smaller businesses, including EnronOnline. Enron's public disclosures show that during the past three years the firm was not making money on its non-derivatives businesses. Gross margins from these businesses were essentially zero from 1998 through 2000.
To see this, consider the table below, which sets forth Enron's income statement separated into its non-derivatives and derivatives businesses. I put together this table based on the numbers in Enron's 2000 income statement, after learning from the footnote 1, page 36, that the meaning of the "Other revenues" entry on Enron's income statement is - as far as I can tell - essentially "Gain (loss) from derivatives":
Enron Corp. and Subsidiaries 2000 Consolidated Income Statement (in millions)
2000
1999
1998
Non-derivatives revenues 93,557
34,774
27,215
Non-derivatives expenses 94,517
34,761
26,381
Non-derivatives gross margin (960)
13
834
Gain (loss) from derivatives 7,232
5,338
4,045
Other expenses (4,319)
(4,549)
(3,501)
Operating income 1,953
802
1,378 |
