Lessons of Enron: How could no one have seen it?
Bankruptcy forces a look at accounting, Wall Street practices, and pension plans.
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Andersen served not only as Enron's regular auditor, certifying its financial statements, but also as its internal auditor. It was paid to make sure Enron had the right systems to keep its books in order and detect fraud and irregularities. It was paid $25 million for the audit, $23 million for consulting services.Skip to next paragraph
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Rick Antle, an accounting professor at the Yale School of Management in New Haven, Conn., sees the scandal as a "wake-up call to examine a lot of what we do." He did a study in 2000 for the Big Five accounting firms, including Andersen, which indicated they make 25 cents on every dollar of auditing fees and 17 cents on consulting dollars.
But the consulting business requires less time of managing partners. The amount of profits to Andersen from consulting are "real small" relative to the trouble the firm now faces, he notes.
Another accounting concern is the ability of Enron to count as revenues the total value of the energy contracts it traded, rather than merely the profits or losses on those deals. This enabled it to record revenues of $101 billion in 2000, up from $40 billion in l999. Such growth prompted excitement in the stock market.
An investment bank, dealing in futures or other similar contracts, records as revenues only its profits and losses on trades. A third question was the shift by Enron of various assets and liabilities to semi-independent partnerships it partly owned. This,
the critics say, enabled Enron to keep off its books large amounts of debt. Mr. Antle, after going over the financial statements of Enron, found that the company in footnotes recorded its dealings with these partnerships. "It's not the case that the whole thing was hidden," he says.
Nonetheless, Enron needed to record in its own books only the profit or loss for its share of the partnerships, not the assets and liabilities of these entities. Last year, those partnerships forced Enron to restate its earnings. It disclosed in October it had lost $618 million in the most recent quarter and lopped $1.2 billion off its net worth.
There has been a host of accounting restatements in the past three years that have cost investors billions of dollars in lost equity. These restatements were in part caused by rule changes in the SEC in 1998 that made it tougher for managements to exaggerate earnings.
Still another reform being called for deals with insider trading. At Enron, a big question is whether Kenneth Lay, the company's chief executive, and other top executives knew of the perilous financial status of the firm when they were unloading stock. That's why a letter written last summer by Sherron Watkins, an Enron Global Finance executive, to Mr. Lay warning about its accounting practices has caused a stir in Washington.
Since its 1985 founding, Enron Corp. evolved from gas pipelines into a trading company, pioneering the market for electric-power contracts. But the firm's ever-rising profits relied heavily on unusual accounting methods and little-understood financial deals that kept $500 million in debt off its books.
Then in October, the firm stunned Wall Street with a $638 million third-quarter loss. As its stock value imploded, trading partners shunned Enron. The crisis in confidence plunged the firm into bankruptcy. But deeper causes may emerge from investigations. Enron concedes it overstated profits by more than $580 million since 1997.
Calls are mounting for tighter regulation of accounting practices. Laws governing retirement plans such as 401(k)s also face new scrutiny. The company urged workers to put retirement savings into Enron stock. This fall, workers were told they couldn't sell shares because the 401(k) plan was being switched to a new administrator.
Investors have launched a fraud lawsuit against 29 current and former Enron officials who sold $1.1 billion of their own company shares since 1999.
Seth Stern in Boston contributed to this report.