The following article was published in "The Guardian", newspaper
of the Communist Party of Australia in its issue of Wednesday,
March 13th, 2002. Contact address: 65 Campbell Street, Surry Hills.
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Enron: Capitalism in a nutshell (Part 4)
Auditors: Watch dogs or partners in crime?
How can a company's shares be worth over US$60 billion (almost A$120
billion) and a year later have lost 99 per cent of their value and -
according to some analysts - be still overvalued? Where were the
auditors? Where were the regulators?
by Anna Pha
Enron Corp - once touted as on the way to being the biggest corporation
in the world, is now the largest bankruptcy case in US history.
"Why did all these people look the other way for so long?", asks Allan
Sloan writing in "Newsweek".
"Money talks or, with Enron, shouts. The company put lots of money in
the pockets of the people and institutions that were supposed to police
it", says Allan Sloan, answering his own question.
The thousands of Enron employees and other shareholders including
pension funds had no inkling of what was going on.
Wall Street loved Enron, "Fortune" magazine heaped accolades on the
company and, perhaps most importantly of all, one of the most reputable
and experienced accounting firms in the world was said to be keeping a
watchful eye on Enron's books.
Enron paid its auditor, Arthur Andersen, US$52 million a year for
auditing and other services.
Surely the shareholders had every right to believe Arthur Andersen's
report that "the financial statements referred to ... present fairly, in
all material respects, the financial position of Enron Corp. and
subsidiaries ... in conformity with accounting principles generally
accepted in the United States"? This statement was a flagrant lie.
According to Allan Sloan's calculations, Enron's debt was soaring by the
late 1990s. "Enron lost about $2 billion on telecom capacity, $2 billion
in water investments, $2 billion in a Brazilian utility and $1 billion
on a controversial electricity plant in India", said Mr Sloan.
"Worse, what a few people knew was that Enron had engaged in billions of
dollars of off-balance-sheet deals that would come back to haunt the
company if its stock price fell."
Enron used partnerships and subsidiaries that were "off the books" and
unknown to shareholders.
Sloan estimates that the JEDI and Chewco partnerships inflated Enron's
1997 profits by 75 per cent, and over the next three years, by a total
of US$396 million.
When Deloitte & Touche were called in late last year to examine the
books they quickly drew the conclusion that Enron's profits had been
grossly overstated and its debts understated for five years. (See
previous three issues of "The Guardian".)
Accounting is big business
In recent years the big accounting firms have undergone a considerable
transformation, with mergers and rapid growth. They now provide a much
wider range of services to the big corporations.
Apart from standard accounting, auditing and taxation advice, these
global businesses advise on mergers, risk management, outsourcing of
financial management, corporate restructuring (subsidiaries, offshore
activities, partnerships, etc), and new business models.
Arthur Andersen is the smallest of the Big Five accounting firms, with
operations in 84 countries. It reported net revenues of US$9.3 billion
in the year to August 2001.
It was the auditor for the failed Australian insurance company HIH and
is presently before the courts over its association with the Bond
Corporation.
Independent
Arthur Andersen signed off Enron's books as "Independent Public
Accountants", but Enron paid Arthur Andersen US$25 million for its
"independent auditing" and US$27 million for other consulting services!
When Arthur Andersen signed off the books, saying Enron's practices were
"in conformity with accounting principles generally accepted in the
United States", they really were in conformity with practices generally
accepted in the US.
On average, corporations pay the same auditor similar amounts for
non-auditing work as they do for their auditing.
A survey of 67 firms by the Australian Securities and Investments
Commission (ASIC) found a similar pattern in Australia.
David S Hilzenrath, staff writer for the "Washington Post", said: "fees
for non-audit services often eclipse those for audits".
He cited KPMG which billed electronics manufacturer Motorola US$3.9
million for auditing and US$62.3 million for other services. Ernst &
Young charged phone company Sprint Corp US$2.5 million for auditing and
US$63.8 million for other services, and the list continues.
Regardless of the individual integrity of those involved, this situation
raises a serious conflict of interest.
Where an auditor is providing other services to a company it is
auditing, it can hardly be said to be independent and it is less likely
to be critical or do anything that might embarrass management.
Companies may hire or fire an auditor. Consequently, with future career
prospects and income hanging in the balance, there is little incentive
for an auditor to publicly expose improper behaviour or "creative"
bookkeeping being used by the company they are auditing.
The accounting firms even speak in terms of auditing as an "entree" to
companies to acquire more profitable business with them.
Enron, HIH and a number of the other collapsed companies have brought
into prominence the practice of corporations employing people who had
previously audited their books.
This is similar to government officials and ministers taking jobs in the
corporations affected by the policies they administered. Former Defence
Minister, Peter Reith's employment as a consultant to firms supplying
equipment to the navy is an immediate example.
To paraphrase a well known proverb: "Whose books I audit, their numbers
I sing.
Leaving it to ethics
The question of whether auditors should provide other advisory or
consultancy services for the companies they are auditing is pretty
straight forward to most people, especially shareholders and workers.
But apparently not in the accounting industry.
The "Financial Review" (17-1-02) quotes the chief executive of the
Institute of Chartered Accountants (Australia), Stephen Harrison, as
saying there was no reason to ban auditors selling consulting services
to their audit clients.
"Clients are addressed through professional ethical requirements and by
... company audit committees", said Harrison.
The leading US group representing accountants, the American Institute of
Certified Public Accountants (AICPA) suggests that the auditor should
think of himself as a "business adviser" and promote his accounting
firm's consulting services because "intense competition has reduced the
audit to a mere commodity that is distinguishable to the consumer only
according to price."
At present the Australian Government is considering a report (the Ramsey
Report) on these very questions. Enron has added a little bite to the
debate which the collapse of HIH had already fuelled.
Cosy relationship
Arthur Andersen presents itself as "creating value" for its customers.
"Our mission is to build relationships and develop innovative solutions
which help dynamic people and organizations create and realize value."
In response to a question about developing her relationship with the CEO
of a client, Arthur Andersen's Peggy Smyth said, "A good client
relationship is like a marriage-in order to thrive you must have trust
and mutual respect for one another." In other words, trust the
statements and practices of the company you are auditing?
The "Washington Post" staff writer David Hilzenrath tells the story of a
Samuel Greenspan who was retained by carpet cleaning ZZZ Best Corp to
audit its financial statements.
Greenspan relied on a report by a prior auditor named Richard Evans
which ZZZ Best's management gave him.
"Had Greenspan checked, he would have discovered that Evans didn't
exist, the Securities Exchange Commission said. Had he bothered to
inspect the eight-story building described in the company's
second-largest contract, he would have learned that it didn't exist either.
"Greenspan never visited any of ZZZ Best's 15 purported job sites, the
agency alleged when it permanently barred him from auditing public
companies in 1991."
"I wasn't hired to detect fraud", Greenspan said in an interview. "I was
hired to do an audit." Greenspan added that he was investigated by AICPA
and was "exonerated completely".
The chairman of the US SEC Arthur Levitt Jnr, appointed by the Clinton
administration, raised the alarm over outside auditors joining corporate
executives "in a game of winks and nods", and made accounting
manipulations a prime target of SEC enforcement.
Levitt tried to prohibit accounting firms being consultants to the
companies they audit. Three of the Big Five and AICPA strongly opposed
his moves. In the end he settled for a requirement that corporations
disclose how much they pay accounting firms for auditing and other services.
On the ABC's "Background Briefing" in May 2000, Mr Levitt said that the
whole process of auditing financial information in modern companies has
been corrupted by getting too big and diverse.
"Can the audit engagement partner truly be perceived as discharging his
public duties while trying to sell his audit clients legal advice or
consulting services", exclaimed Mr Levitt.
But President Bush came to the rescue of the corporations and the
accounting industry by replacing Levitt with Harvey Pitt, a securities
lawyer who has represented each of the Big Five and AICPA, including in
battles against the Securities Exchange Commission.
Pitt promised the industry "a new era of respect and cooperation".
Internal auditors
It is common practice in big corporations for the board to appoint an
internal audit committee.
Again there are questions of independence. The Investment and Financial
Services Association, representing the largest institutional investors
in Australia, has a Blue Book of guidelines which are generally accepted
as industry standards.
It recommends that company audit committees should be composed of a
majority of independent directors (i.e. not paid executives of the
company) - a recommendation that is often ignored.
In the case of the collapsed Harris Scarfe, the three-man committee was
made up of the Executive chairman of the company, its Secretary and
Chief Financial Officer and a former partner of Price Waterhouse Coopers.
"An audit committee has a responsibility to ensure the independence of
the auditors, and to have ex-partners sitting on the audit committee and
being in a position of a cosy relationship with their old friends seems
to me to be a very unusual and not a recommended practice at all", said
Henry Bosch, head of corporate regulation in the 1980s, when interviewed
by "Four Corners" (13-5-2001).
There are no laws against such practices-only voluntary industry
standards and guidelines. Nor is it illegal to donate bags full of money
to the regulators, politicians and, even to judicial candidates in the US.
Excuses are trotted out: "Everybody does it", "It wasn't illegal", "We
used standard accounting practices" and so on. These statements are mere
cover-ups for the incestuous, immoral and corrupt behaviour, the fraud
and other criminal activities that have to some extent been brought out
into the open by the Enron and other bankruptcies.
Worrying about the system, Levitt recently said that the greatest threat
to capitalism isn't the anti-globalisation protestors but the loss of
faith in the system created by the Big Five audit firms and the way they
do the books for American companies.
Restoring confidence
Such fears have prompted calls for measures to restore confidence in the
auditing industry.
For a system already in serious economic crisis, the last thing they
want is a stockmarket collapse, which could well be on the cards if too
many investors, particularly pension and superannuation funds turn
elsewhere.
Since the Enron bankruptcy filing, Deloitte & Touche, Ernst & Young,
KPMG, Price Waterhouse Coopers, and Arthur Andersen (the Big Five) have
been frantically trying to restore public confidence in their firms.
But their calls are for a mere cosmetic tinkering to give investors the
illusion that there are changes. They steadfastly refuse to accept
re-regulation or public accountability of their activities.
None of the changes proposed so far will end the corruption, the fraud,
the loss of jobs, workers' entitlements and savings and the catastrophe
that has overtaken many small shareholders. Nor will they change the
characteristics of the capitalist system.
Enron was touted as the showcase of capitalism and there are many more
like it on the brink of exposure and collapse.
How far they are forced to make changes will depend on the success of
campaigns mounted by shareholder organisations, superannuation and other
retirement funds, trade unions and the smaller businesses that are also
put at risk.
Globalisation and the growth of monopolies such as the Big Five
accounting firms that share global domination, mean that when the
crashes do occur the losses are far more serious and far-reaching in
their impact. Many will get burnt.
Next week: How workers were ripped off.
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