The CPA Journal

With no regulatory infrastructure, "Who's Watching the Store?"

The role of the auditor rarely receives such intense attention from lawmakers and the media as when the Enron story broke last November (see "Enron and Andersen: Auditors Under the Microscope," page 8). Even two years ago, when the SEC and the accounting profession's self-regulatory agencies began publicly grappling with the auditor independence issue, the coverage was much less fierce. What's different is that Enron is the largest bankruptcy in history and the country was still reeling-economically and emotionally-from the events of September 11. But we need to suppress the urge to demand immediate and sweeping changes in accounting standards before fully examining the circumstances surrounding the Enron bankruptcy. Remember that the business sector's system of checks and balances, like everything in life, was not created out of whole cloth in one day. It is the cumulative result of decades of decisions and experience.

To make a case about the consequences of underregulation, an analogy can be drawn to the Glass-Steagall Act, which the federal government passed in 1933 to establish different regulatory agencies in the financial sector aimed at ensuring that the bank failures that triggered the Great Depression would never happen again. With the objective of reducing market competition and protecting investors, consumers, and local institutions, Glass-Steagall separated the banking, insurance, and securities industries by splitting up commercial and investment banks, banning interstate banking, and prohibiting banks from owning insurance companies. The scope of Glass-Steagall eroded over the years, but it continued to shape the financial services industry and the major mergers in that sector. In the 1990s, the government gave Citigroup a five-year exemption from Glass-Steagall that allowed the banking giant to buy Travelers Insurance and, later, Salomon Smith Barney. Eventually the government repealed Glass-Stieigel altogether.

With Glass-Steagall gone, the regulatory environment changed dramatically. The eventual deterioration of our system of financial checks and balances was probably inevitable. As usual, when we find ourselves in serious trouble that we allowed to happen, our reaction is twofold: First, assign blame; second, overreact and overcompensate. In the case of Enron, many of the earliest and most vocal observers expressed shock and dismay. They have called for a massive overhaul of the auditing system, an overreaction that would swing the pendulum of vigilance to the other extreme, away from the undervigilance of the 1980s and 1990s that was capped by the repeal of Glass-Steagall. Neither extreme is prudent.

First, we should determine what actually happened at Enron. Second, even though audit failures are very rare, we must learn from them and adjust the system in order to ensure that they don't happen again. I'm concerned, however, that the sensationalism of the Enron scandal will steer us toward the easy answer-blame the auditors-and create the illusion of a quick fix: namely, that financial stability would be aided by tossing out an auditing system that happens to work more than 99% of the time.

Nevertheless, the CPA profession needs to be careful not to rest on that 99%-plus track record. The Enron case is no small problem. Auditors cannot just say, "Hey, the financial statements aren't ours, they're management's" and "Audits aren't for finding fraud." The public expects-and deserves-more from auditors, and the public is whom auditors serve.

The bad business decisions, bad government policymaking, and spectacular frauds of the 1920s and 1930s led to the passage of Glass-Steagall: Nobody was minding the store, and something had to be done. The CPA profession played a key role in reestablishing the integrity of the U.S. economy and its markets. The Enron disaster notwithstanding, business is as sound now as ever. But once again, the auditing profession needs to assert that its voice is one of reason and prudence. CPAs have proven before that they have the know-how to do that.

Louis Grumet Publisher, The CPA Journal Executive Director, NYSSCPA lgrumet@nysscpa.org hen Inefficiency Becomes the Status Quo