A Renewed Call to Redo Accounting
Two years ago, Arthur Levitt couldn’t muster much support for a proposal to make accounting firms more independent by limiting their ability to sell consulting services to their audit clients.
Amid strong opposition from the accounting industry, corporations and members of Congress, the then-chairman of the Securities and Exchange Commission backed down.
On Thursday, however, the same proposal held the rapt attention of a roomful of fawning senators and caused Levitt to be mobbed by reporters after his testimony.
“So do you feel completely--or just absolutely, totally--vindicated?” quipped Sen. Mark Dayton (D-Minn.).
In another sign that government priorities have changed as a result of the Enron Corp. bankruptcy, the Senate on Thursday held its first full committee hearing to examine why the energy giant collapsed and what the government could have done to prevent the loss of billions of dollars by employees and investors.
The hearing set the stage for what is certain to be a vigorous debate in the coming months over sweeping regulatory proposals to rein in financial markets, retirement funds, campaign fund-raising and the energy industry.
Sen. Joseph I. Lieberman (D-Conn.), who chairs the Senate Governmental Affairs Committee, promised Thursday to lead an aggressive nonpartisan investigation into the Enron debacle, seeking answers from government agencies including the Commodity Futures Trading Commission and the White House.
“We will follow the facts wherever they lead us,” Lieberman said.
Among the questions Lieberman hopes to answer are: How did Enron hide its debts and losses from SEC oversight? Could the Labor Department have intervened to prevent Enron employees from losing their retirement savings? Are Wall Street analysts providing objective analysis of stocks? Did regulatory gaps allow Enron’s problems to slip through the cracks?
But Republicans warned against rushing to new regulations. Only a year ago, the Bush administration and the Republican Party were vowing to slash government rules in many of the same areas currently under a microscope.
The blame for Enron’s bankruptcy filing Dec. 2--less than a month after it restated earnings to account for $586 million in previously unreported losses--may ultimately rest with illegal activity of individuals, not a breakdown in regulation, said Sen. Fred Thompson (R-Tenn.), the ranking Republican on the committee.
“No system known to man can prevent unscrupulous and clever individuals from manipulating the system and even getting away with it for a period of time,” Thompson said.
He also warned Democrats not to try to take political advantage of the investigation by focusing on “titillating” issues, such as the contacts between Enron officials and the Bush administration.
Levitt called upon Congress to pass new laws to tighten regulation of financial markets, which he said have been eroded by a “culture of gamesmanship that says it’s OK to bend the rules, tweak the numbers and let obvious and important discrepancies slide.”
In addition to renewing his call for limits on the types of consulting work accounting firms can perform for an audit client, Levitt said companies should be required to change audit firms every five to seven years; stock exchanges should require that a majority of directors on company boards be independent; and analysts should be forced to disclose how their compensation is affected by their firms’ investment relationship with companies they cover.
Levitt and Lynn E. Turner, the SEC’s former chief accountant, said a new accounting oversight board is needed with independent members, reliable funding and a mandate to move quickly and aggressively to eliminate accounting loopholes and gimmicks.
Turner said it has taken the Financial Accounting Standards Board longer to approve new rules for special-purpose entities--the kind of off-the-books partnerships used by Enron to mask its problems--than “it’s taken my children to get through high school.”
Derivatives trading is another area ripe for government regulation, said University of San Diego law professor Frank Partnoy, who told the committee Thursday that Enron’s heavy reliance on the high-risk market rivaled that of the Long-Term Capital Management hedge fund, which failed in 1998.
In fact, Partnoy said, Enron reported earning more money from trading derivatives in 2000 than Long-Term Capital Management made in its history.
“Enron makes Long-Term Capital Management look like a lemonade stand,” said Partnoy, a former derivatives trader who is writing a book about Enron’s collapse.
Derivatives, used by sophisticated investors as a risk-management tool, are complex financial instruments whose value is based upon a future variable, such as interest rates or gas prices.
Though some derivative trading occurs on regulated exchanges, the vast majority--more than $95 trillion a year--take place on over-the-counter markets that were exempted from regulation in 2000 under the Commodity Futures Modernization Act.
Enron used derivatives in two ways. First, they were key to structuring Enron’s controversial partnerships, which allowed it to hide debt, mask investment losses and inflate earnings. Enron used them as a kind of financial “plastic surgery to make itself look better than it really was,” Partnoy said.
Second, they were key to Enron’s profit. The company used its Enron Online division to act as a go-between for other parties wishing to trade not only energy-related derivatives, but also contracts for such commodities as fiber-optic bandwidth. By the time Enron filed for bankruptcy, the soaring revenue from the derivatives trading business was masking problems in Enron’s core energy business.
The lack of government oversight may have enabled Enron to smooth out profits from derivatives trading to make the business appear less volatile. He said that was accomplished by creating accounts that enabled Enron to carry over trading profits from year to year.
An Enron spokesman could not be reached for comment on Partnoy’s allegations.
