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Enron fallout is spreading
By Nick Beams
21 February 2002
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The collapse of Enron appears, at least so far, to have caused
relatively little disturbance in energy markets where it primarily
traded. One reason for this less-than-expected outcome may be that
Enron�s practice of listing the full value of the trades it arranged
as sales, rather than just the income it secured, vastly inflated its
size. But when it comes to the financial markets more generally, the
shock waves from the Enron collapse are having a major impact and
widening in their scope.
Last Tuesday, for example, Wall Street�s Dow Jones index fell by
almost 160 points, or 1.6 percent, while the Nasdaq index dropped by
more than 3 percent on fears that the accounting methods developed by
Enron to boost profits and hide debts were very widespread.
Indeed it appears that the rot starts right at the top. IBM, regarded as the bluest of
the blue chip stocks, recorded one of the biggest slides. Its shares went down by more
than 3 percent following concerns that its comp
lex accounting methods could cause problems. According to one analyst, they �represent
a can of worms that hasn�t been opened yet.�
Telecommunications companies are another area of concern. Fears over their future in
the aftermath of the Enron debacle were heightened last month when Global Crossing
filed for bankruptcy protection, in the biggest colla
pse to emerge from the telecom industry.
Just as Enron inflated its results, there are fears that telecom companies engaged in
similar practices. As an article published in the Financial Times of February 12 put
it, their reports of booming profits in the 1990s
may have had a �hollow ring.�
�Many telecoms companies,� it noted, �traded with each other, exchanging capacity on
each others� networks, and treated their trades as revenues. But some of those deals
may have been �hollow swaps�, artificial deals conc
octed merely to create the illusion of activity, according to a growing chorus of
industry analysts.�
One of those to come under investigation for such practices is Qwest Communications,
which has received subpoena from the US Securities and Exchange Commission for
documents relating to its dealings with Global Crossing.
The investigation was triggered by claims by a former Global Crossing accounting
executive that swap transactions were artificial and aimed at inflating the company�s
stated revenue.
Concerns over accounting practices have significant financial consequences. One of
these is to shut companies coming under suspicion out of commercial financial markets.
Qwest Communications has been forced to turn to the
banks for $4 billion in funding after investors would not back it with short-term
credit. There are predictions that other well-known firms will be excluded from the
commercial paper market, one of the chief sources of c
orporate funding.
JP Morgan Chase has already warned the US telecom firm, Sprint, is �overextended� in
the commercial paper market and that �there is a reasonable chance that Sprint will
have to look elsewhere for financing.� The forecasts
are that Sprint will need up to $2 billion to meet its funding needs this year.
One measure of the nervousness is the contraction in the size of the market. Figures
from the Federal Reserve show that the amount of non-financial commercial paper has
fallen to $209 billion, down 40 percent from its pea
k in November 2000.
A wider accounting crisis
But the problems extend far beyond the companies whose accounting practices have been
called into question. According to the former head of the US Federal Reserve, Paul
Volcker: �Accounting and auditing in this country is
in a state of crisis.�
An article in the New York Times of February 12 reported that in 1998 a survey of 160
financial officers at public companies found that two thirds of them had been asked by
their executives to misrepresent their companies
� results. Twelve percent admitted they had done so.
�Last year,� it continued, �a study by Financial International, a trade group for
corporate executives found that public companies had revised their financial results
464 times between 1998 and 2000, nearly as many restat
ements as in the 20 previous years combined, and the problem probably worsened last
year.
�Some of the world�s best-known companies, including IBM and AOL Time Warner, are on
the list of companies that allegedly use aggressive accounting practices to lift their
earnings.�
The level of concern generated in financial circles by the Enron debacle and its
implications for the financial system as a whole can be gauged by the tone of a series
of articles published in the Financial Times this wee
k.
An editorial covering the four-part series began as follows: �Individual greed on a
spectacular scale. A shocking willingness to overlook questionable practices by
institutions claiming to uphold the highest standards. A
shameful determination to cover up evidence. Politicians eager to accept money from a
company subsequently shown to be a sham. These are the hallmarks of the Enron scandal.�
The editorial warned that the accounting practices that accompanied the
high-technology bubble, the hiding of debts off balance sheets and rogue trading �have
shaken public confidence in big business and the way it is con
ducted.�
Enron�s collapse had to mark a watershed. Just as the collapse of banks and utility
companies in the 1930s led to regulatory reform, so Enron�s demise �should set in
train a similar process� not only in the US but also on
a world scale.
However, the FT counselled against the introduction of more detailed rules and
regulations.
�Detailed prescriptions suffer from a fatal flaw. By spelling out in excruciating
detail what auditors, directors, bank managers and other responsible parties must do,
they create the possibility of observing merely the l
etter of the law. As long as you have complied with the manual�or persuaded some
luckless auditor that you have done so�your real actions and purposes can be as
reckless or flagrant as you like. Since no set of regulation
, not matter how detailed, can outmanoeuvre a really determined manipulator, the rules
provide, in effect, a road map for abuse.�
Rather than the detailed prescriptions of the US Generally Accepted Accounting
Principles it called for the development of standards devised by the International
Accounting Standards Board that call for an emphasis on sub
stance rather than form. But, like everything else in the business world, accounting
standards and rules are a matter of fierce competition and the IASB approach �has been
treated with mild suspicion in the US.�
But in the view of the editorial, new measures will have to be set in place, along
with �a new determination on the part of all participants to act in accordance with
their letter.�
While this would not stop fraud, it would restore public trust in routine transactions
and �stop the poisonous erosion of confidence in everyday activities and financial
reports that has been so marked a feature of the pa
st weeks.�
The conclusion of the editorial revealed some of the fears in ruling circles about the
political implications of the Enron disaster. Describing trustworthy business
standards as �among the most important social capital th
e developed world possesses,� it warned that the weaknesses revealed by Enron, �if
left unremedied, could ultimately imperil a precious collective achievement.�
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