Senate Report Faults SEC in Enron Debacle
Business: Committee says the securities agency should have caught corporate financial abuses early, before they led to calamity.
By RICHARD SIMON and WALTER HAMILTON
LOS ANGELES TIMES STAFF WRITERS
October 7, 2002
WASHINGTON -- A Senate panel investigating Enron Corp.'s collapse said the Securities and Exchange Commission missed early signs of financial abuses at the energy giant, raising questions about whether the agency is "effectively functioning as the lead market watchdog that it is meant to be."
The probe by the Governmental Affairs Committee, led by Sen. Joseph I. Lieberman (D-Conn.), found a "systemic and catastrophic failure" by those charged with protecting investors—including stock analysts, credit rating firms and the SEC, according to the committee's report, which is to be released today.
Some of the harshest criticism was directed at the SEC, whose chairman, Harvey L. Pitt, has been accused of not being aggressive enough in rooting out corporate wrongdoing—although many of the shortcomings highlighted in the committee's report date to before Pitt took over as chairman in August 2001.
"The SEC, with its relatively small staff, does not, and is not set up to, directly perform many of the tasks necessary to root out corporate fraud," the report said. In a list of suggested reforms, the report recommended that the agency dramatically upgrade its oversight of corporate finances, possibly including performing random corporate audits.
Enron's financial collapse and filing for bankruptcy, which followed disclosures that it used off-the-books partnerships to hide debt, spawned a frenzy of congressional hearings, contributed to passage of sweeping accounting reforms and led last week to the arrest of Andrew S. Fastow, the company's former chief financial officer, on charges of fraud.
Enron also faces two probes by federal grand juries: one in Houston, where it is headquartered, that is looking into the company's collapse; and another, out of San Francisco, that is investigating the role played by Enron and other electricity marketers in the California energy crisis.
The Senate committee investigation focused on whether the government and private-sector watchdogs could have done more to prevent Enron's collapse and the loss of billions of dollars by its investors, including Enron employees who held company stock in their retirement plans.
The Enron case suggests that the SEC's passive approach to regulation "likely led it to miss warning signs of corporate misconduct," the committee concluded.
Specifically, the committee berated the SEC for failing to review any of Enron's post-1997 financial filings. As a result, the agency "missed its best opportunity to focus on the red flags in those documents, such as the opaque and questionable references to transactions with entities run by the company's own chief financial officer," the report said.
In addition, the committee faulted the SEC for not following up on changes in Enron's accounting methods in 1992, saying that failure deprived the commission of an early opportunity to uncover financial abuses.
The committee also said the SEC's "lackadaisical" approach in the handling of an Enron request in April 2000 for an exemption from the Public Utility Holding Company Act "may have opened yet another door to Enron improprieties." The agency's failure to work with the Federal Energy Regulatory Commission allowed Enron to receive "certain regulatory and economic benefits" for some of its wind energy projects from FERC, the report said.
The committee plans to hold a hearing this month on FERC's dealings with Enron.
Pitt said Sunday that his agency would "carefully consider the report's conclusions."
"Working together with the Congress and other governmental representatives," Pitt said in a statement, "we are well underway toward taking and completing the tasks necessary to restore investor confidence."
Although the committee acknowledged the SEC's more aggressive post-Enron efforts to enforce securities laws, the report said the commission has been "less than proactive in attempting to address fraud at an earlier stage, before it becomes a corporate calamity."
The committee's report may help to put public attention back on corporate scandals, which have been overshadowed in recent weeks by the debate over Iraq. Democrats hope to use the issue against Republicans in the November election.
"This is clearly a part of the Democratic effort to reintroduce the corporate scandal issue during the critical, final month of the campaign," said Larry Sabato, a University of Virginia political scientist.
However, Sen. Fred Thompson (R-Tenn.), the committee's top Republican, joined Lieberman in sending a letter along with the report to Pitt urging him to implement a number of reforms.
Among its recommendations, the committee said the SEC should review corporate financial reports more frequently and must look aggressively for signs of fraud.
In a potentially controversial suggestion, the committee said the agency should consider random audits of companies, just as the Internal Revenue Service scrutinizes selected taxpayers. If pursued, that idea probably would raise the hackles of corporate America. It also could require significantly expanding the SEC's staff, the report said.
The agency also should make far better use of technology to sift data for hints of financial misconduct, the committee said.
The SEC already has taken steps to boost its monitoring of companies—for instance, it announced late last year that it would review the annual reports of the 500 largest U.S. companies. And recent legislation requires the agency to review corporate financial filings more often.
The committee report also criticized Wall Street stock analysts and credit rating firms for failing to detect Enron's problems earlier. Analysts, in particular, have been accused of acting as company cheerleaders rather than independent evaluators, and the SEC passed toughened stock-analyst rules this summer. In addition, the New York Stock Exchange and NASD (formerly known as the National Assn. of Securities Dealers) proposed a second set of regulations last week.
The committee recommended that the SEC require a complete separation of stock analysis and investment banking at brokerage firms to eliminate conflicts of interest.
The report said the major credit rating firms "displayed a disappointing lack of diligence" in monitoring Enron's financial dealings. Rather than aggressively dissecting the company's books, the agencies "generally just accepted at face value what they were told by Enron officials," the report said.
The rating companies should themselves be monitored more closely to make sure they adequately scrutinize companies, the report said, and the SEC should set uniform standards for credit raters to follow when evaluating a firm's credit worthiness.
A spokeswoman for Moody's Investors Service, one of the three major credit rating firms, said Sunday that "like all market participants, we were given misleading, inaccurate and fraudulent information by Enron."
The two other leading firms, Standard & Poor's Corp. and Fitch Ratings, could not be reached for comment.
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Simon reported from Washington, Hamilton from New York.
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