January 2002

Enron and Andersen: Auditors Under the Microscope

From the moment the Enron story broke, it was clearly a public relations nightmare par excellence: the biggest bankruptcy in history, with the auditing firm's judgment and integrity called into question. The story has been on the cover of Business Week, and it has been front-page news in every major newspaper. The twists and turns the story has taken on an almost daily basis have made for captivating reading. Nevertheless, as Louis Grumet points out in his Publisher's Column on page 9, we cannot rush to judgment. Once the initial shockwaves of the Enron case have receded, careful, reasoned judgment will be required to develop correctives to ensure this kind of disaster does not happen again. In this light, The CPA Journal presents the thoughtful perspectives of four people worth listening to on the subject-a contribution to the comprehensive dialogue on the unfolding events.

Audit Committees Under the Microscope

Enron raises many interesting issues because the company has high-quality board members and a reputation for good ethical standards. One thing that will definitely happen as this unfolds is that the audit committee issues will go under the microscope: What did they know? Did they really understand what they were told? Did they look at what was happening? The company was interacting with many partnerships. Audit committees need to understand those areas, and they need to understand derivatives and external auditors.

I think it will take about a year to 18 months for the entire episode to play out. Class action suits have been filed and are being consolidated.

H. Stephen Grace, PhD, is the founder and president of H.S. Grace & Company, Inc.

Don't Rush to Judgment

This case involves very difficult, complex transactions, and the accounting standards that apply to such transactions provide an entity with wide latitude. Auditors are in a tough position-it's hard to get your arms around all of the facts. I disagree with Lynn Turner and others who say that Andersen compromised its audits in order to maximize its consulting fees. No one is going to compromise an audit of that size. I'm also reluctant to see a pattern in the fact that Andersen was also the auditor for Sunbeam and Waste Management. Furthermore, I'm very reluctant to rush to judgment about an auditing crisis-either at Andersen specifically or within the auditing profession generally.

Gary Illiano, CPA, is a partner and northeast regional director of professional standards at Grant Thornton and editor of The CPA Journal's "SEC Advisor" department.


No Time for Speculating

The Enron case is so complex that, rather than speculating about the implications for auditing, we should wait for the investigation and the testimony to unfold. I think it is a serious mistake for so much of this case to be played out in the media. Based on what I've seen in the press, this will probably be a major learning experience for everyone interested in corporate governance issues, including the regulatory agencies. If I were playing a role in the investigation, I would be fearful that the staggering dollar amounts being discussed would make the participants protective and very reluctant to cooperate.

The individuals that will do the investigative work-the SEC, the Justice Department, and the plaintiffs' bar-are all very smart people. Even so, building a good understanding of the fundamentals of the case could take as long as a year.

Aside from the important corporate governance issues that the Enron case will continue to raise, it has already provoked politically inspired discussion about the role of regulation and the free market. One worry is that the fallout will lead to a call for more regulation of the energy market and other markets Enron participated in.

The Enron case does not appear to be a run-of-the-mill fraud: It appears to be an instructive case study and we should treat it as such. This requires that we wait until we have enough facts, rather than speculating about what might have happened.

Robert J. Sack, CPA, is an emeritus professor of business administration at the Darden Graduate School of Business Administration, University of Virginia.

Rethinking Audit Regulation

It's important to view and consider Enron in the context of the magnitude of the losses. Cases such as Waste Management, Cendant, MicroStrategy, and Xerox have been like an earthquake that cracks the foundation of trust that our markets depend on. Now that is followed by Enron, which is like a tsunami that destroys the public's trust in auditors, management, and the audit committee, all in an instant.

A key issue I see in Enron's 8-K and 10-Q filings is that the company issued stock in exchange for a note receivable and reported it as an asset in debt equity. The company has already noted that it shouldn't have done that and has restated its financial statements. The company has also acknowledged that its accounting for special purpose entities it had sponsored did not comply with existing GAAP, resulting in further restatements of the financial statements, going back to 1997. As a result of those restatements, adjustments on the company scoresheet that in the past were immaterial have now been deemed material.

It's time we look at replacing the accounting profession's regulatory and disciplinary systems with an SEC-supervised self-regulatory organization. This SRO should be governed by an independent public interest-type board. Any peer review system should be under the supervision and oversight of the SRO. I would put the auditing standards-setting organization under the SRO and fund the SRO either by charging fees to the CPA firms that audit companies or by charging a licensing or other fee to public companies.

I don't think we've seen the last major audit failure. I have previously expressed to the Public Oversight Board (POB) that I was concerned about the backslapping I saw among the Big Five where peer reviews are concerned. I hope the POB will fulfill its public mandate by investigating both the issues underlying these horrendous financial frauds as well as the series of issues at Andersen. The POB is supposed to represent the investing public, and it was disappointing that during the SEC's proposed rulemaking on auditor independence during the summer of 2000, at no point did the POB speak out on behalf of the investing public.

Lynn Turner, former SEC Chief Accountant, is currently a professor of accounting at the college of business at Colorado State University, where he is also director of the Center for Quality Financial Reporting.

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