Enron Mess Puts Accountant Under Fire
By Peter Dizikes ABCNEWS.com
Tuesday January 08 03:26 PM EST
Enron's collapse brought many under fire. Who's watching the watchdogs?
If misery loves company, then collapsing energy giant Enron is only too happy to make room on the hot seat for its accountant, Arthur Andersen.
With ongoing government investigations into Enron's sudden bankruptcy, and four congressional committees intending to hold hearings starting later this month, things are already uncomfortably warm for the accounting firm.
The Senate's Governmental Affairs Committee said last week it will subpoena audit records from Arthur Andersen — now going by just Andersen — before a Jan. 24 hearing, as it scrutinizes exactly how hundreds of millions of dollars in Enron debt could have eluded the accountant's gaze.
Likely to be another hot topic on Capitol Hill: the potential conflicts of interest Andersen, fifth-biggest of the so-called Big Five accounting firms, may have faced while serving as both auditor and a consultant for Enron, while reaping tens of millions of dollars for its services. It's an arrangement some experts say needs a legal overhaul.
"If it were up to me, I would not allow an Arthur Andersen to consult and audit for the same companies," says J. Edward Ketz, a professor of accounting at Penn State University. "There's a terrible conflict of interest inherent in doing consulting and auditing at the same time."
Pointing Fingers
Andersen's CEO Joe Berardino has already endured one Capitol Hill grilling in December, during which he pointed a finger at Enron, saying the company had engaged in "possibly illegal acts." But Berardino also acknowledged, "Andersen will have to change."
From an accounting standpoint, the crux of the Enron mess, according to Berardino, is the way Enron hid heavy losses in off-balance sheet investment vehicles, especially one "special purpose" entity called Chewco.
According to accounting rules, Enron did not have to include Chewco's losses on its own balance sheet since three percent of Chewco, worth $11.4 million, was bought in 1997 by an outside firm (which Berardino only called "a large international financial institution").
But, Berardino says, Enron actually fronted half of the outside firm's investment, which Andersen only discovered in time to report the matter on Nov. 2. Shortly thereafter, Enron, already reeling, announced it would have to revise its financial statements from 1997 to 2000, to the tune of a staggering $591 million in profit reductions and $628 million in debt.
The company, ranked seventh on last year's Fortune 500 , declared bankruptcy within a few weeks of the announcement.
Dingel: ‘Corrupt or Incompetent’
Lawmakers have been dissatisfied with the explanation for Enron's collapse, and have expressed displeasure with other elements of Andersen's Enron audits, like a $172 million misstatement Berardino described as "a very small item relative to total assets and equity."
"Arthur Andersen was either corrupt or incompetent," said Rep. John Dingell (news), D-Mich., a longtime industry critic. "It's possible they were both."
For its part, though, the company just announced on Jan. 2 that it has passed a standard every-three-years peer review process, conducted by fellow Big Five member Deloitte & Touche. According to Andersen, the study was expanded after the Enron controversy developed, meaning its seal of approval comes after "the most extensive peer review in the firm's history."
And Andersen spokesman Patrick Dorton, while declining to comment specifically on potential subpoenas, says the company is "cooperating with SEC, Congress, and other appropriate parties, and working to provide the appropriate information" to them.
Three Strikes?
Still, it has been a rocky 12 months for Andersen. The company seems in good financial health, reporting $9.3 billion in revenues for its fiscal year ending Aug. 31. But it also paid $110 million to settle a lawsuit over now-bankrupt company Sunbeam, plus a $7 million SEC fine involving Texas-based Waste Management, Inc. Andersen's deep pockets may make it a bigger target of civil lawsuits in the Enron case than Enron itself.
And accounting experts are using this opportunity to vigorously question the institutional arrangement which led Enron to paying Andersen $52 million in its last fiscal year, according to its SEC filings — but only $25 million for auditing. In his testimony, Berardino claimed the total amount was $47.5 million, with $34.2 million for auditing and tax-related work, and the rest for consulting.
"I do not believe the fees we received compromised our independence," Berardino added. "Obviously, some will disagree." Those people include academics who have consistently contended that auditing firms should not branch out into other areas.
"What we need is an independent set of audit firms," says Wayne Shaw, a professor at Southern Methodist University's Cox School of Business in Dallas. Shaw says such firms would make money, but that large accountants have ventured into consulting to seek ever-higher profits.
Of course, auditors aren't the only firms that rely on a separation of business units to meet ethical standards. Investment banks arrange corporate deals while their analysts grade the same corporations' stock — an arrangement that has drawn fire of its own in recent years, but is in no danger of being ended.
But Shaw, for one, argues the role of a public company's auditor is simply too crucial to compare to the work investment banks do. "The one thing an investment banking firm does not do is to be a watchdog," he notes. "You shouldn't consult if you audit."
What Should Be Done?
If some critics seem certain the dual consultant-auditor role is the source of the problem, though, no one is quite sure how to change matters.
The SEC itself has tried in recent years to push through modifications of accounting rules, but with little success. Its most recent major initiative, in the fall of 2000, largely stalled out after opposition from the accounting firms.
The Big Five firms themselves recently released a joint statement blasting the so-called old accounting methods and calling for new accounting methods, saying the current "backward-looking financial statements delivered on a periodic basis are no longer sufficient to communicate real risk and value."
Ketz, for one, says he would welcome some changes in accounting procedures, but adds that as a general rule, "It doesn't matter if you use old or new accounting, the main problem is truth-telling."
In his view, the most immediate practical change in the business would be more dollars for SEC enforcement, calling it "the easiest thing to implement. The SEC's budget has not really increased … the SEC has some power but it's not sufficient."
Without some decisive action, though, it seems possible the same kinds of issues facing Enron, Andersen, and Enron's shareholders could resurface elsewhere.
"The magnitude of the problem is enormous," says Shaw. "I think there are more failures waiting to happen." |
