Sources: SEC Didn’t Keep a Close Watch on Enron

The Securities and Exchange Commission, the watchdog agency set up to protect investors, did not formally review Enron Corp.’s financial statements for at least three years, from 1998 until the company began to collapse last year, sources familiar with the SEC said last week.

During that period, Enron concealed hundreds of millions of dollars in costs, inflating its profit and boosting its stock price--all without serious scrutiny from the SEC.

In thousands of cases every year, the SEC focuses its scrutiny on the financial statements of public companies when it believes something is amiss.

The SEC reviewed filings from 3,595 companies last year, about 30% of those that filed information, according to the commission’s annual report. But 1,195 of those reviews looked at firms that were offering stock publicly for the first time.

Among some 10,000 already established companies that filed reports with the SEC, 2,400 were reviewed--about one in four.

The fact that the SEC didn’t monitor Enron was just business as usual, former commission officials and other SEC watchers say. The agency relies mostly on private-sector accountants, investors and even the news media to bring serious problems to its attention.

“The kind of digging that would have to have been done [to detect Enron’s flaws] is not ordinarily undertaken by the SEC staff,” said Arthur Levitt Jr., SEC chairman from 1993 to 2001. “The SEC doesn’t do that. It can’t do it.”

For one thing, the agency has only about 90 accountants to review the financial statements that flood in, quarter after quarter, from about 12,000 companies.

Most of those accountants focus on examining corporations that are selling stock to the public for the first time, not established companies such as Enron, officials said.

“The Enron debacle,” as SEC Chairman Harvey L. Pitt calls it, has prompted the commission to change its ways. Last month, the SEC quietly announced that its staff would read the annual report of every Fortune 500 company this year, something it wasn’t doing before.

In that new review, the SEC will pay special attention to any financial report that “seems to conflict significantly with generally accepted accounting principles ... or to be materially deficient in explanation or clarity,” a statement said.

It’s not clear whether that level of scrutiny, if applied to Enron’s annual reports from 1999 through 2001, would have prompted a more extensive review of the energy company’s finances.

“A review could have caught the problems,” said a former official who spoke only on condition of anonymity. “There’s no guarantee that it would have. But it would have been better to have a review than a no-review.”

The commission refuses to say whether its staff looked seriously at any of Enron’s annual reports or other financial statements during those years, citing a policy of strict confidentiality.

The SEC launched a formal investigation of Enron’s accounting in October. But that was only after the company announced that it was making a gigantic correction on its balance sheet, a public admission that something was terribly wrong: a cut of $1.2 billion in shareholder equity, stemming from hidden deals with limited partnerships controlled by the company’s chief financial officer.

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Selective Review Policy

As far back as September 2000, a few skeptical stock analysts, financial experts and investors were raising questions about Enron’s financial structure. Enron President Jeffrey K. Skilling derided the critics as thickheaded, and called one of them an obscenity in an April 2001 conference call with fund managers.

Despite the danger signs, former officials and lawyers familiar with the SEC’s inner workings say there is no indication that the commission launched an official review of Enron, a formal step short of an investigation, before October.

Such reviews are kept confidential, but they often result in corrections or changes to a firm’s financial statements that must be made public.

Enron’s 1997 financial statements were the last to be reviewed, according to former SEC officials. The Wall Street Journal has reported that Enron’s 2000 report was scheduled for a review, but the SEC staff postponed the process for a year to wait for more data on the company’s trading in derivatives. SEC spokesmen refused to comment on that report or to say when Enron’s filings were last reviewed.

The SEC staff chooses what companies to examine under a policy called “selective review,” but spokesmen refused to say what criteria are used in that process.

“It’s a lot like the Internal Revenue Service,” the former official said. “Not every tax return is audited; not every filing by every public company is reviewed.”

The SEC applies a list of criteria to companies to decide whether their filings should trigger a review, he said, including sudden changes in a company’s fortunes--either up or down.

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Too Many Balls in Air

In addition to those criteria, the SEC attempts to review every public company’s financial statements at least once every four years. But even then the staff cannot review all the filings that qualify.

“The workload is just too high,” the former reviewer said. “There are more filings that get triggered than can physically be reviewed....It’s not a question of the [staff] dropping the ball; it’s a question of how many balls they already have in the air.”

After the SEC investigation was announced in October and more accounting problems came to light in November, the confidence of Enron’s creditors and investors collapsed. The company filed for Chapter 11 bankruptcy protection Dec. 2, wiping out billions of dollars in equity held by investors, employees and retirees.

In the aftermath, attention has focused on Enron’s officers, its board of directors and its auditors for producing dishonest financial statements.

But the SEC’s failure to intervene earlier also has renewed a long-running debate over the commission’s size and the limits of its regulatory power.

On one side is Levitt, a Clinton appointee who ran the SEC during much of the time Enron was submitting misleading financial reports; he worries that the commission wasn’t aggressive enough.

On the other side is Pitt, appointed chairman in August by President Bush, who believes that the commission was too aggressive under Levitt--so aggressive that companies concentrated on disclosing as little as possible.

The two SEC chairmen, former and current, have been arguing the point for years--and Enron’s collapse has only fueled the debate.

“I wish we had pursued some of these problems more aggressively,” Levitt said in an interview.

Levitt said the SEC was not reviewing financial statements rigorously enough, largely because it doesn’t have enough staff.

“The enforcement division was denied 35 spaces last year because of budget cuts,” he said. “The average number of times a company gets their statements reviewed is once every four years.”

Also, the SEC’s computers are antiquated. “Their systems are in the dark ages, which further complicates, rather than eases, the staff’s ability to do their work,” said Lynn Turner, the SEC’s chief accountant under Levitt.

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Kinder, Gentler SEC

But Pitt, a prominent securities lawyer, proposes a different remedy. Instead of major increases in spending, staffing or review, Pitt has said he wants to establish a “kinder and gentler” relationship with the companies the SEC regulates.

Pitt has said he believes that the SEC can be effective only if auditors and company officers feel comfortable bringing problems to the commission when they first arise, without fear that they might touch off a punishing investigation.

The debate will play out in Congress over the next few months as several committees investigate whether the SEC dropped the ball on Enron, and whether the commission’s budget or powers should be expanded.

But the accounting industry and other business lobbies have fought against expanded SEC power for years, and few members of Congress have shown much appetite for the issue so far.

The Bush administration also has been silent. The president’s budget proposal would increase SEC funding by a modest 4% overall, including a 6% increase for enforcement, officials said. But that is well below the proposals of critics such as Rep. John J. LaFalce (D-N.Y.), who has proposed doubling the commission’s budget.