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After Enron, No Quick Fixes

September 24, 2006|Barney Jopson | Financial Times

Enron is the scandal that keeps on burning.

It is nearly five years since the energy trader's bankruptcy destroyed thousands of jobs and billions of dollars of wealth. Yet its searing effects are as clear as ever.

Jeffrey K. Skilling, Enron's former chief executive, is awaiting a prison sentence that could run to several decades after his fraud and conspiracy conviction. Kenneth L. Lay, Enron's former chairman and a fellow convict, escaped a prison sentence after a fatal heart attack in July. And a team of extradited British bankers -- the NatWest Three -- await their own trial in Texas next year on Enron-related fraud charges.

Outside the courts, however, the company's meltdown has perhaps had the most profound effect on accounting. Its implications continue to unfold, charted for readers by Nicolas Veron, Matthieu Autret and Alfred Galichon in "Smoke & Mirrors, Inc.: Accounting for Capitalism."

In the first phase of the post-Enron era, public interest in accounting surged as people discovered how its abuse could play a central role in corporate scandals.

The authors write: "Once the accuracy of financial information can no longer be taken for granted, the entire economic and financial system runs the risk of paralysis."

By 2003, the second phase of the post-Enron era had begun with a realization that mitigating the risk of future scandals was not a matter of correcting obvious regulatory faults.

The authors show how the characteristics of today's financial reporting system make the idea of quick fixes to restore damaged trust implausible.

For readers who are affected by accounting but know little about it, technical points are illustrated via the rather corny tale of fictional company Smoke & Mirrors Inc.

There is also a whirlwind historical tour that links the creation of public accounting standards and the requirement to use an external auditor to the October 1929 stock market crash.

The next landmark event was the collapse of Enron, the repercussions of which are evident in three issues explored by the authors.

The first is that accounting, contrary to popular perceptions, is never objective. It depends on judgments.

Accounting standards are not neutral tools but "a set of conventions with the inevitable whiff of the arbitrary." Both U.S. and international accounting standards -- the two predominant systems -- are often the result of negotiations among companies, investors, banks, regulators and tax authorities.

The authors say that because standards can change corporate behavior, they have served as instruments of economic policy. Witness the once rampant popularity of stock options in the United States, encouraged by the fact that they did not have to be treated as an expense.

A second vexing issue dashing hopes of watertight financial reporting is the existence of just four large international audit firms: PricewaterhouseCoopers, KPMG, Deloitte and Ernst & Young.

Arthur Andersen, the firms' former counterpart, disintegrated after an Enron-related indictment and left the verification of the books of the world's biggest companies in the hands of a highly concentrated oligopoly.

There is no suggestion that the audit firms are colluding or abusing their position. But the structure of the market has led to concern that they are now "too few to fail," protected from the consequences of mistakes because no one wants to face the repercussions of penalizing them severely.

It is a problem with no simple solution.

Questions about a third issue -- the geography of regulation -- are equally intractable.

Globalization has created tensions between those who want the regulation of accounting to be standardized and those who argue that competition between different systems is healthier.

In the absence of consensus, the United States is becoming the world's regulator by default, mainly through the Sarbanes-Oxley act.

Many Europeans are appalled. The region's ability to act as a counterweight is hindered by the fragmentation of regulation within the European Union, which hampers efforts to detect and deter accounting fraud.

Disappointingly, the authors are coy about desirable solutions to this or any of the other big issues they address. Their neutral voice makes the book an excellent primer on the political economy of accounting, but it also means the book lacks punch.

Only in a final prophetic passage on Smoke & Mirrors Inc. do the authors stick their necks out.

In 2016, they write, companies are publishing financial statements every two weeks. There are 15 international audit firms. And a single European securities regulator has been created after "an unprecedented series of interrelated accounting scandals in the U.K., Poland, Malta and Luxembourg."

Stranger things have happened. Enron was one of them.

The writer is the financial correspondent of the Financial Times of London, where this review first appeared.

*

Taking account

Smoke & Mirrors, Inc.: Accounting for Capitalism

* By Nicolas Veron, Matthieu Autret and Alfred Galichon (translated from the French by George Holoch)

* Cornell University Press, $29.95, 233 pages

Source: Publisher

Los Angeles Times

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