Centre for Public Accountability

Headlines scream profusely about the stunning collapse of Enron — the fastest plunge to a corporate bankruptcy in U.S. history. Causes are being speculated wildly in the media, and Congressional hearings should add further fuel to the attribution process. Apparently, at this stage of truth, Enron’s management failed to disclose the financial effects of their risky trading transactions. Management may have accounted for them so as to inflate profits, contrary to generally accepted accounting principles (GAAP). Further, allegations indict Enron senior management for selling their shares of company stock before the market fall, while employees and other investors could not, or were not aware of the impending disaster. Rhetoric has heightened such that Richard Cohen wrote in a Washington Post article, “We all know what happened. A bunch of b——- picked the pockets of their own employees. That’s not a scandal. It’s a blinkin’ outrage.”

Arthur Andersen, Enron’s external auditor, is vying almost equally for the main headline of culpability. The audit firm seemingly accepted Enron’s questionable accounting practices as conforming to GAAP. The firm did not require Enron to disclose, nor did the auditors in their audit reports, information that might have warned investors and others that the roof of financial stability was about to cave in. Admissions of document shredding by Andersen partners and staff further paint a dark scenario of possible impropriety. And, the untimely report by the peer review team of Deloitte & Touche, giving a “clean bill of health” to Andersen’s audit operations after Enron went into bankruptcy, raises more eyebrows on the performances of Enron and auditor and their relationship.

The list of players continues with Enron’s Board of Directors apparently shying away from serious challenges to Enron’s management operating decisions and waiving the code of ethics to sanction certain financial dealings involving company officers and outside interests. And, according to Enron’s meeting minutes, their audit committee (all outside members) gave their blessing to transactions between the company and partnerships run by the company’s chief financial officer, thereby acquiescing to significant debt being kept off Enron’s balance sheet.

The SEC has also been thrust into the spotlight by admitting to not tracking developments at Enron closely, nor conducting sufficient in-depth reviews that could have disclosed possible problems. And, members of Congress kept silent, aided and abetted by lucrative campaign donations.

These are many and widespread. First, the market value decline in the company’s stock of over $60 billion affects investors, creditors and employees directly. It is unlikely that many investors will ever recover their investment and creditors will receive nothing like 100% on obligations owed them, even if the present acting CEO can somehow keep the ship afloat. The big hit has been taken by employees who invested their retirement funds in the company’s 401(k), which prohibited investment diversification and, because of lockout provisions, prevented employees from selling stock from the plan. All this while senior management were able to dispose of their stock for gain. Further, many employees have lost or will lose their jobs.

The accounting profession is suffering the blow of reduced credibility and standing from its previous reputation in the business community. Auditing firms will now be second-guessed on whether they are conducting quality audits and using credible GAAP in rendering their independent opinions on financial statements.

Some feel the equity market per se may now be less attractive to investors wary of companies following “aggressive” accounting practices, or who fail to disclose the nature of complex business transactions and of related-party affiliations.

Finally, the American public have seen the height of personal greed and selfishness apparently displayed by Enron senior management, and audit performance by a large, reputable accounting firm that was sub-standard — or worse.

The many investigative hearings and the ensuing court cases will provide the true picture of what transpired, and which parties are accountable for the harm. When the dust settles, we will see modifications to the private sector accounting and financial reporting system. Our advice to the change agents is this fundamental premise: All accountable parties should be required to answer fully, fairly and publicly for their respective responsibilities and actions — in other words that principles of public accountability be established and upheld for private sector accounting and financial reporting. This is not motherhood: effective principles and standards have been lacking.

The effects of the Enron disgrace are so pervasive that at stake is the moral accountability of the free market system and especially that of the accounting profession. Public accountability dictates that entities such as Enron’s board and the company’s external auditors, who affect others in society in important ways, must be made to answer publicly for their performance, fairly and completely. This follows from two important appraisals:

First, the list of victims embraces stockholders, investors, creditors, employees, governments, potential investors, taxpayers and the public in general. These victims are really stakeholders in that they have provided resources to accountable parties with the expectation of receiving something in return (in this case, return on investment from Enron). This stakeholder list is so vast that only a public type of answering is appropriate for their diverse needs.

Second, regarding the accounting profession, its professionals acquire special capabilities and intellectual capital to perform a specific kind of service to benefit society. In return, professionals obtain a right, such as monopoly over their areas of expertise, and public status. Generally, regulatory bodies permit professions to regulate themselves. Part of the self-regulation should entail adequate public answering for the processes professionals use in carrying out their responsibilities and for the results produced by their activities. It is through public answering that a self-policing influence emerges for professional conduct that assures that professionals accomplish what they say they will.

Our call for new and meaningful standards of public answering in private sector accounting and financial reporting ought to have the full backing of President George W. Bush, who said in his 2002 State of the Union address, as a result of the Enron disgrace, “Through stricter accounting standards and tougher disclosure requirements, corporate America must be made more accountable to employees and shareholders and held to the highest standards of conduct.”

So what might these stricter standards and reporting requirements be? Here are some examples, for starters. One would be the requirement that audit firms report annually and publicly on their management control systems that give assurance that their audit partners and senior management do not “cave in” to the pressure of clients and sign off on clearly questionable accounting practices asserted to comply with GAAP and, most important, accounting practices that simply do not reflect adequate standards of fair and complete disclosure.

Another standard would have corporate boards of directors assert annually and publicly that they have comprehended the nature and financial significance of all major company transactions and dealings, and that they have no consulting arrangements with the company.

A third would have Congress stating publicly that its management control system for oversight assures that the Securities and Exchange Commission and other regulatory agencies having authority over corporations are protected in not permitting corporate executives to frustrate the regulatory process through lobbying and other questionable influencing tactics.

These are only examples of the profound changes needed to alter financial reporting in “corporate America.” The changes in standards must articulate specifically and clearly the responsibilities, actions and reporting rules that all accountable parties involved must follow in an open and transparent environment. The accountable parties for which standards need to be set include: senior management and boards of directors of corporations, independent auditing firms, the Financial Accounting Standards Board (FASB), the Auditing Standards Board (ASB), the SEC and the U.S. Congress.

We cannot rely on government playing the oversight role. This is because Congress and the SEC did not set the conditions and public trip-wires that would have prevented the Enron debacle, and we have no evidence of real intent to change current tendencies and probabilities.

We urge citizens to form Citizens’ Accountability Panels (CAPs) — groups of citizens who are interested in creating an oversight review process based on common sense. The Panels would review the regular public assertions of each accountable party that those with the responsibilities claim to be adequate answering for the discharge of their responsibilities.

The results of the CAPs’ reviews would be made public through the media so that all can assess the adequacy of the answering. Those not meeting the general public standards would be subject to public opinion pressure — and possible stigma — to make the needed changes.

One approach would be to have three separate CAPs. One would review and report on the accountability assertion reports of senior management, boards of directors and the independent auditing firms. Another would review the accountability reports of the FASB and ASB, answering for the professional standards attained. A third would review and report on accountability reports of the SEC and Congress, as answering to the public for the discharge of their oversight responsibilities. Each of these panels could have networks of sub-panels for regional coverage of cities housing major corporations, and for particular industry specialization. This initiative converges with the President’s encouragement for citizen involvement. We might even call the Panels part of the USA Freedom Corps!

Our proposal is a departure from the existing complacent and ineffective arrangements for financial reporting, audit attestation and corporate regulation. But the Enron experience requires solid change, achievable only through an innovative approach that creates genuine accountability. Not only is this public involvement novel; it fits with our free enterprise system and the idea that effective scrutiny is a tenet of American democracy. We can start with network-based citizen-to-citizen dialogue on feasible arrangements for the framework and process. We can also identify possible public interest organization sponsors for the Panels’ operations. We can work out how they can be established as a new way to produce effective checks and balances in the financial and business reporting system. “Let’s roll” fits.

Ernest J. Pavlock, Ph.D, CPA

ernestpavlock@accountabilitycircle.org

Dr. Pavlock of Reston, Virginia is Professor Emeritus, Virginia Tech