WASHINGTON, Feb. 14 (UPI) -- Grossly inflating the value of assets while wildly understating liabilities since 1997, bankrupt energy giant Enron Corp. and its accountant, Arthur Andersen LLP, have admitted that they had violated existing accountancy regulations.
Their confession of deliberately misleading the public about the energy trading company's financial performance is by no means surprising, but the question remains whether any pre-emptive measures could have kept companies from misreporting their earnings deliberately, and whether an agency that regulates accountancy firms more closely should be established.
"You can't play the game and keep score at the same time," said Rep. Edolphus Towns, D-N.Y., at the House Committee on Energy and Commerce's subcommittee on consumer protection Thursday.
Towns pointed out that while companies focus on increasing profits, accountants must be the objective referees of the marketplace, ensuring that businesses keep to the rules while they play the game. Yet in the case of Enron, accountants at Arthur Andersen were clearly violating the role they had been hired to do, as they went out of their way to misreport on the company's financial status.
The current system of corporate accounting has few mechanisms to ensure that companies adhere to the Generally Accepted Accounting Principles, known as GAAP, as outlined by the independent Financial Accounting Standards Board.
"The FASB has no authority to enforce its standards," the board's Chairman, Edmund Jenkins, told assembled Congressmen, given that the agency merely sets the rule and has no legal means to impose the GAAP on companies. Moreover, neither the U.S. Securities and Exchange Commission nor the American Institute of Certified Public Accountants has any real power to penalize firms misreporting their books, either intentionally or not.
For now, the system works in favor of the company hiring the accountancy firm. All listed companies are required to hire accountants from outside their own group to ensure that financial reports issued to shareholders and the general public, as well as to financial regulators, are actually accurate and objective.
The problem is that the companies themselves pay for the accountants to oversee them, and it is only too often in the interest of the accountancy firms to report favorably about the businesses that employ them. Moreover, the so-called Big Five accountancy firms, including Andersen, are heavily dependent on their management consultancy operations for boosting revenue, and the companies that call for their consultancy services are precisely those that they audit. To ensure more business coming in from lucrative consulting operations, accountancy firms are encouraged all too often to report favorably on their clients' financial standing.
"The current system of self-regulation should be replaced ... by a board consisting of members of the public, and not just from the profession of accountants," said the SEC's chief accountant Robert Herdman, who also testified before the House subcommittee. Specifically, Herdman said it would be healthy to have non-accountants look over the books of corporate earnings, as it would potentially broaden the scope of examination and work more in the interest of investors rather than the companies themselves.
The head of the AICPA, James Castellano, also agreed with that assessment, and added that a broader range of examination, coupled with more frequent reporting of financial conditions beyond the quarterly and yearly statements currently required would also preempt exaggerated earnings performance by companies.
Yet at the same time, the SEC's Herdman tried to reassure assembled Congressmen, stating that he did not see any potential Enrons blowing up in the future -- that is no major company filing for bankruptcy so quickly. He did not, however, say that there are unlikely to be more companies inflating financial performance.
Of the many lessons to be learned from Enron's collapse, one clearly is that accountants need to be more strictly surveyed by a third party so that investors can actually trust any financial statements they issue. But there remain some concerns as to who the accountants' watchdog could be, and how much it would cost.
Clearly even the watchdogs have not been immune from manipulation. The London-based International Accounting Standards Board, for instance, had asked Enron for a $500,000 donation that the company thought would help them influence global accounting standards.
The chairman of IASB's trustees and former chairman of the Federal Reserve, Paul Volcker, solicited a donation from former Enron Chief Executive Officer Kenneth Lay early last year, according to the Financial Times. The IASB had been set up last year by the private sector to push for global accounting rules, and the European Commission still plans to make companies listed in European Union markets comply with IASB rules.
This month, Volcker took on another responsibility: chair of the Independent Oversight Board working with Arthur Andersen to change its audit practice.
While the donation Volcker requested was not made in the end, some Congressmen are wary of that if the SEC or any other organization is given more control to oversee accountancy firms, they would be strapped for cash to do the job they are entrusted to do, and would have to resort to more fundraising, which in turn could sway their objectivity.
The task that lies ahead for financial regulators involves not only adding another layer of surveillance between accountants and investors, but also figuring out just how that added piece of bureaucracy can be funded without compromising their independence.