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The real scandal Print

America's capital markets are not the paragons they were cracked up to be
Jan 17th 2002 Like 190 Tweet
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THE collapse of Enron was spread over several months


late last year, when the world's attention was still on
Afghanistan. The Texas-based energy-trading giant,
once America's seventh-biggest company, declared
bankruptcy on December 2nd. Yet it has taken until now Latest updates »
for this simmering affair to boil over in Washington, DC.
And, as so often, the ensuing scandal risks focusing on The Economist explains: How the
the wrong issues. international community has failed South...
The Economist explains | Feb 16th, 05:17
On Capitol Hill, much of the talk has been of the close links that Kenneth Lay, Enron's
chairman, had with George Bush and other Texas Republicans. The press has been Hailemariam Desalegn’s abrupt
burrowing into how often Mr Lay and other Enron bosses called administration officials to departure: Ethiopia’s prime minister...
Middle East and Africa | Feb 15th, 19:36
beg fruitlessly for help. There has been tut-tutting about congressmen collecting
campaign money from Enron, which, far from buying Republicans alone, was admirably
bipartisan: three-quarters of the Senate took Enron cash. And public indignation has been Making the personal political: The art
born of opioid addiction
roused over how much Mr Lay and his colleagues made from Enron shares, unlike their
Prospero | Feb 15th, 18:23
workers, whose pension funds were largely invested in Enron stock that they were unable
to sell in time.
Daily chart: The glass-ceiling index
Graphic detail | Feb 15th, 12:43
Yet little of this is new. Certainly, Enron's demise confirms some unattractive features of
American public life (see article). The campaign-finance system puts too many politicians
under obligations to big-business donors: Enron lobbied successfully for exemption from
Indicators: Retail sales, producer prices,
financial regulation for its energy-trading arm, and it also helped to draw up the wages and exchange rates
administration's energy policy. Executive pay and stock options have long given bosses Markets and data | Feb 15th, 10:38
too much for doing too little. Some companies have been at fault in encouraging workers
to invest pension money in their shares; after Enron, legislation to limit this is urgently Indicators: Foreign reserves
needed. But for the most part, the bankruptcy of Enron was just part of the rough-and- Markets and data | Feb 15th, 10:36

tumble of American capitalism, the most successful system the world has known.

In this section The Economist explains: “Cow


vigilantism” in India
Who guards the guardians? The real scandal The Economist explains | Feb 15th, 06:26
Yet there is one big issue that should now attract more Stoiber v Schröder
attention: the governance of the public capital markets, and More latest updates »
The saving of Pakistan?
especially the role played by auditors. The capital markets,
Still giving Italy a bad name
and indeed capitalism itself, can function efficiently only if
The rights of terrorists
the highest standards of accounting, disclosure and Most commented
transparency are observed. In America, well-policed Restoring the fiscal option

stockmarkets, fearsome regulators at the Securities and Reprints 1


Exchange Commission (SEC), stern accounting standards Making the personal
political
in the form of generally accepted accounting principles The art born of opioid
Related items
(GAAP), and the perceived audit skills of the big five addiction
Enron: The twister hits
accounting firms, have long been seen as crucial to the
biggest, most liquid and most admired capital markets in the Jan 17th 2002

world. The politics of Enron: Four Products and events


committees in search of a
scandal

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2/16/2018 The real scandal | The Economist

The collapse of Enron is now raising some big questions Jan 17th 2002
Test your EQ
(see article). Andersen, the company's auditor, has admitted Take our weekly news quiz to stay on top of the
to an “error of judgment” in its treatment of the debt of one of Enron's off-balance-sheet headlines
vehicles; these vehicles led to an overstatement of profits by almost $600m over the
years 1997-2000. This week Andersen fired the partner in charge of the Enron audit, Want more from The Economist?
when it found that he had ordered the disposal of documents even after the SEC had Visit The Economist e-store and you’ll find a range of
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subpoenaed the firm as part of its investigation into Enron. This is not the first time that
pleasure, Economist books and diaries, and much
Andersen has been in trouble: last year, it was fined over its audit of another Texan more
company, Waste Management, and it also had to settle a suit over the audit of Sunbeam,
a Florida-based company.

If this were simply a case of one accounting firm doing wrong, that would be regrettable
but containable. Andersen may go under thanks to Enron litigation anyway. But the truth
is that it is not unique. It may have been unusually culpable, but all the accounting firms
have made mistakes in the past. Only this week, KPMG became the latest to be
censured, this time for breaking rules barring investment in audit clients.

That points to the need for systemic reforms, in three areas. The first is the regulation of
auditors. For years the profession has insisted that self-regulation and peer review are
the right way to maintain standards. Yet Enron has shown that this is no longer enough.
The Public Oversight Board should be turned from a self-regulatory body appointed and
financed by accountants into a statutorily independent organisation reporting to the SEC.
And it should be given teeth, including the power to ban or fine auditors for misdeeds.

Second is the urgent need to eliminate conflicts of interest in accounting firms. Andersen
collected audit fees of $25m from Enron, its second-biggest client, last year, but it earned
even more for consulting and other work. The accounting firms have fought off attempts
to limit or stop them undertaking consulting work for audit clients; they insist that there is
no real conflict of interest. Yet if confidence in auditing is to be regained, perception is as
important as reality. The SEC should now pursue again the ban that its previous
chairman, Arthur Levitt, sought to impose in 1999. There is also a strong case for
compulsory rotation of auditors, say every seven years: Andersen had audited Enron
since its birth in 1983.

Lastly come America's accounting standards. GAAP standards used to be thought the
most rigorous in the world. Yet under British standards, Enron would not have been able
to overstate its profits by so much. And, once again, although Enron may have been
egregious, it is not a lone offender. Several dotcoms and technology companies have
used what is euphemistically called “aggressive accounting” to boost reported earnings.
Too many companies have got away with “pro forma” accounting that delivers nice
numbers by omitting such items as stock write-offs, special transactions, interest charges
or depreciation. And the accounting treatment of stock options has long been a disgrace.

The SEC and its standard-setting body, the Financial Accounting Standards Board,
should now revisit GAAP; they might even embrace international accounting standards
instead. There is a lesson from British experience in the 1980s, when several audit
scandals led to both tougher regulation and more rigorous accounting standards. The
Enron scandal shows that America can no longer take the pre-eminence of its accounting
for granted. That is a far bigger concern than any number of congressional investigations.

• This article appeared in the Leaders section of the print edition

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