Broken Government

Published — December 10, 2008 Updated — May 19, 2014 at 12:19 pm ET

Lack of regs fueled accounting scandal

Corporate “game of nods and winks” leaves host of innocent victims in its wake

Introduction

Critics believe a lack of government regulation helped fuel questionable accounting practices — practices that allowed the huge energy trading firm Enron to report profits of hundreds of millions of dollars ($979 million in 2000, alone) before collapsing in 2001, in what was then the largest corporate bankruptcy in U.S. history. The erosion of accounting practices was believed to have begun in the 1980s, as firms tried to balance strict standards with a desire to please clients and expand consulting business, but the scandals burst into public view under President George W. Bush. Certainly by the time Bush was elected, there was ample reason to question the overall validity of corporate financial statements, given that restatements of Securities and Exchange Commission (SEC) filings had skyrocketed from just three in 1981 to 270 in 2001. (The SEC says some of the blame lies with the Financial Accounting Standards Board, the private nonprofit organization it designated to set rules for corporate financial disclosure. In 2000, for example, it adopted a rule allowing companies, including Enron, to keep certain holdings off their balance sheets.)

As former SEC Chairman Arthur Levitt warned in a now-famous 1998 speech, without adequate government regulation, “Too many corporate managers, auditors, and analysts are participating in a game of nods and winks.” The giant accounting firm Arthur Andersen was convicted in 2002 of obstructing justice for shredding documents in relation to its auditing of Enron. The Supreme Court reversed the conviction in 2005 due to problems with jury instructions, but the firm’s accounting business was essentially ended by the case, amid questions about other Andersen audits. The Enron case left in its wake a host of innocent victims; shareholders — including many pensioners — lost over $80 billion as the value of the company, once considered a reliable blue-chip stock, disintegrated. A series of other accounting scandals followed, raising further questions about the proper regulatory role for the government.

Follow-up:
Following numerous hearings, Congress scrambled to act in 2002. That July, both chambers voted to enact the Sarbanes-Oxley Act, which quickly received President Bush’s signature. The bill established enhanced standards for U.S. public company boards and accounting firms, as well as a new agency under the SEC to monitor and discipline accounting firms in their auditing of public companies: the Public Company Accounting Oversight Board (PCAOB). Last December, Deloitte LLP became the first of one of the “Big Four” accounting firms to be fined by the PCAOB for a $1 million civil penalty. An SEC spokesman told the Center the agency has taken significant actions to increase disclosure of risky positions within the last year, especially regarding off-balance sheet arrangements.

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