ENRON: Aftermath…….Lessons
Learned
AICPA
Alan Anderson
Senior Vice President
In a Way it’s Simple…
In a Way it’s Not…….
Tone at the Top
 Corporate Greed
 Individual Greed
 Market Euphoria
 Corporate Arrogance
 High Risk Deals
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In the Beginning…….
1985 Deregulation
 Houston Natural Gas and InterNorth merger
 Massive Debt coupled with loss of
exclusive use of pipelines
 “Gas Bank”
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Corporate Culture
Best and the Brightest
 “RICE” – Respect, Integrity,
Communication, Excellence
 “PRC” – Performance Review Committee
 Profits, Profits, Profits………..
 Enron Capital and Trade Recources
 Enron Online (EOL)
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Business Model
Enron Finance Corp.
 Enron Capital and Trade Resources
 Enron Online (EOL)
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Became a model for the industry
 Competition Increased
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Financial Reporting Model
Mark to Market Accounting
 Swaps
 Related Party Transactions
 SPE’s (Special Purpose Entities)
 Obscure Disclosures
 Others????
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Potential Red Flags
unduly aggressive earnings targets
 management bonus compensation based on
those targets;
 excessive interest by management in
maintaining stock price or earnings trend
through the use of unusually aggressive
accounting practices;
 Unduly aggressive financial targets and
expectations for operating personnel;
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Potential Red Flags (continued)
inability to generate sufficient cash flow
from operations while reporting earnings
and earnings growth;
 assets, liabilities, revenues, or expenses
based on significant estimates that involve
unusually subjective judgments such
as…reliability of financial instruments; and
 significant related-party transactions.
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Where were ……….
Management
 Board of Directors and Audit Committee
 External Auditors
 Market Makers (Analysts)
 Regulators (SEC, AICPA, others)
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-That is what everyone is
asking
SEC Initial Response: Dec 11,2001
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A system of “current” disclosures, supplementing
and updating quarterly and annual information
with disclosure of material information on a realtime basis;
Public company disclosure of significant current
“trend” and “evaluative” data, in addition to
historical information;
Identification of “most critical accounting
principles” by all public companies
More timely and responsive accounting standard
setting on the part of the private sector;
SEC Initial Response: Dec 11,2001
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An environment of cooperation between the SEC
and registrants that encourages public companies
and their auditors to seek advice on disclosure
issues in advance;
An effective and transparent system of selfregulation for the accounting profession, subject to
SEC’s rigorous, but non-duplicative, oversight;
and
More pro-active oversight by audit committees
who understand financial accounting principles as
well as how they are applied.
Meaningful Reform:
will it……
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1. Help investors make informed investment
decisions?
2. Enhance audit quality and the quality of
financial reporting?
3.Help restore confidence in the capital markets,
our nation’s financial
reporting
system, and the accounting profession?
4. Be good for America’s financial markets and
economic growth?
Wide Range of Proposed Reforms
Federal & State Legislative Proposals
 SEC Chairman & President Bush Proposals
 AICPA’s Main Views and Concerns
 Volcker’s Reform Proposals for Andersen
 Former POB Chair Bowsher’s Proposal
 Several States: NY, Mn, Fla. Ca. and others
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Legislative Activity - U.S. Senate
Highest level of activity in 25 years
 Senate Banking Committee in Lead
 Hearings on Enron debacle in March/April
 Many pending proposals being floated
 Legislation likely in April/May
 Many very important issues in play
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Legislative Activity - U.S. House
Financial Services Committee in Lead
 Oxley/Baker Bill likely vehicle
 Prohibit IA/IT services consistent with
original SEC Chairman Levitt’s proposal
 Dingell introduced his own bill
 New regulatory structure is almost assured
 Only question is how far it goes…….
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Proposals of SEC Chairman Pitt
New body dominated by public members
 New disciplinary mechanism
 SEC handles law violations itself
 Regulatory Body pursues ethical and/or
competence standards cases & complaints
 Quicker disciplinary proceedings
 Body publicizes results and imposes fines
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Reengineer Peer Review Approach
Replace triennial firm-on-firm peer review
 More frequent monitoring of audit quality
 Use permanent Quality Control staff
 Body composed of knowledgeable people
unaffiliated with any accounting firms
 Staff deployed and overseen by new
publicly dominated body and its staff
 Limited to Auditors of Public Companies
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Other Components of Pitt Proposals
Will ban IT and internal audit services
 But says if Congressional proposals to
restrict more services go thru, we will have
far worse quality audits than we have today
 Aggressive enforcement- CEOs & Auditors
 Improvements on financial disclosures
 Timely reporting of events, stock sales, etc.
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President Bush’s Key Proposals
Tougher oversight of auditors
 CEOs sign off on full & honest disclosures
 Take away bonuses & stock gains for
executives when reporting is inaccurate
 Wants SEC to set scope limits vs.Congress
 Audit committees decide on non-audit work
 Rejects tort reform, expensing stock options
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FASB to be more responsive
Board size being reduced, speed increased
 Fast track project to deal with SPEs
 Also dealing with guarantees of debt and
determining fair value on forward contracts
 Move toward more focus on principles
 Accounting details for IASB, not IFAC
 But clear support for working with IASB
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AICPA Input and Views
Testifying in Congressional hearings
 Providing constructive input
 Zero tolerance for violation of rules or laws
 Urging all to be wary of simplistic solutions
which can lead to unintended consequences
 Working to limit cascade effect
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New Public Regulatory Organization
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Radical change from last 25 years
Move from Public Oversight to Public
Participation
New robust private sector regulatory body
Independent of the accounting profession
Structured with SEC oversight to handle:
 Professional discipline and quality review
 Eventually auditor independence issues
Roles of the New Regulatory Body
Perform quality reviews of audit firms
 Enforce compliance with professional stds
 Discipline for violations of prof stds
 Establish rules deemed necessary for such
reviews and enforcement
 Later influence new independence standards
and other standards (eg. audit standards)
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Important Process Issues
Regulatory Body serves as disciplinary and
quality review board, not standards setter
 Ability to move quickly, keep information
confidential, and take remedial actions
 Able to compel production of documents
and protect documents reviewed from
discovery or admissibility in civil litigation
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Non-Audit Services
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Some are necessary part of modern audit
O’Malley Panel - some improve quality
Audit quality dependent on auditor quality
AICPA urges caution, impacts
 Audit Quality
 Future Staff
New restrictions should not impede audit quality
or the quality of financial reporting
Restrictions - Non-audit services
Agree to restrict IT and Internal Audit
 Oppose ban on all non-audit services
 Many unintended consequences:
 Onerous to smaller companies - costly
 Ripple effect to non public companies
 Overrides informed and reasoned
decision-making by audit committees
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Risk of Creating Audit Only Firms
Threat is the risk to audit quality
 Skills/expertise outpaced by changes in
business practices and financial transactions
 Less knowledge of client businesses
 Will lead to loss of necessary expertise
 Eventually, scale and other factors will lead
to audit quality deterioration
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Corporate Governance
Public reporting of audit committee charter
 Audit committees should hire/fire auditors
 And evaluate relationships and services of
the audit firm for conflicts
 Harmful to cast a dark cloud over all
services outside the statutory audit
 Rely on knowledgeable members to decide
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Mandated Auditor Rotation
Audit firm rotation has been proposed
 Most believe the costs outweigh the benefits
 Does not pass public interest test
 Would create significant proposal frenzy
 Rotation of team members seems adequate
 Loss of knowledge of company hurts a lot
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Tort reform ideas
Reasoned law critical to integrity of markets
 1995 law enacted to deal with abuses
 Liabilities are still an enormous deterrent
 Securities class actions cases are on the rise
 Average settlements are also way up
 Profession opposes reform of current law
 Concerns about liability are global
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Employment Restrictions
There are many safeguards required today
 Some legislators propose more restrictions
 Like one or two year cooling-off period
 Many sound easy, but are hard to effect
 They can severely limit eligible audit firms
 Putting limits on individual careers and
client recruiting efforts are hard to legislate
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Financial Reporting Reforms
Improved disclosures – “plain English”
 More timely reporting to investors
 Client reporting on their internal controls
 Auditor assurance on internal controls
 Increased resources for the SEC to oversee
financial reporting disclosures
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Modernizing Business Reporting
Unreported intangibles and discussion of
risk
 Off balance sheet activity
 Non-financial performance indicators
 Forward-looking information
 Enterprise opportunity and risk
 More Timely reporting (movement toward
continuous disclosure)
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Broader Perspective Needs
Broader “bandwidth” of info for investors, a
recommendation long advocated by AICPA
 New distribution channels that recognize
the ubiquity of the Internet communication
 Increased financial reporting frequency, and
ultimately online, real-time reporting
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Volcker Proposals for Andersen
Volcker wants Andersen rehabilitated and
serving as the gold standard for auditing
 Really wants to reform a resisting industry
 This creates concerns for AICPA & Big 4
 Split of audit and consulting businesses
 Separate partnerships; no profit-sharing
 Much broader restrictions of services
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Other Controversial Volcker Ideas
Proposed new restrictions on services:
 “Aggressive” tax planning services
 Presumably includes creating tax shelters
 Legal services and some advocacy roles
 Tax & accounting services for executives
 Also favors cooling off period for partners
joining clients, and 5 year partner rotation
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POB Reverses Long-standing Views
Public Oversight Board quits/terminates
 POB Chairman testified March 19
 Highly critical of profession
 Propose unrealistic measures
 Far in excess of Pitt and Bush Proposals
 Favors big legislative solutions
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A Very Political Process
Congress is more involved than ever before
 Issues are red hot and elections coming up
 High risk of harsh legislative solutions
 Profession working with legislators
 Trade-offs in SEC vs. legislative solutions
 Very hard to forecast the end results
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Recap of Key Issues in Play
Scope of service/independence restrictions
 Considering perception versus reality
 Audit committee judgment or bright lines
 Audit firm or partner rotation proposals
 Firm rotation mandates create concerns
 Appropriate limits on rotation of people
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Other Key Issues in Play
Revolving door/ hiring audit firm people
 Peer review/ new quality assurance
 New regulatory structure for profession
 New disciplinary structure & protections
 Auditor/audit committee relationship
 Corporate governance reforms
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Other Key Issues in Play
Accounting standards
 Process & timeliness improvements
 Depth and coverage of standards
 Auditing standards
 Responsibility for fraud detection
 Fraud reporting reqts and standards
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Other Reform Issues in Play
Who pays for audits
 SEC/FASB/Regulatory Body funding
 Tort reform
 Deductibility of stock options
 Tax shelter changes
 Pension and 401-K reforms
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Remember: There will always be
Strains on the System of Checks and
Balances
Management
 Boards of Directors and its Committees
 Independent Auditors
 Security Analysists
 Regulators (SEC, FASB and others)
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Foundation for the
Future
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Must work to protect the public interest
under the current reporting models
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Must work to develop approaches and
programs to respond to marketplace
demands for assurance under “New
Economic” models
Convergence
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Blurring of Boundaries between
 Auditing of Financial Statements
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Assurance
Attestation on Financial and nonfinancial items
 Need for on-line real time assurance
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What it takes to get Real Time
Assurance.
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Reliable systems
a common method of disseminating information on the
internet
reporting on subsets of financial data as well as non
financial data, industry specific rather than one size fits all,
common global approach
corporate accountability including management integrity,
solid enterprise risk management
Understandable disclosures including the ability to ‘drill
down” into expanded discussion if the user desires to do so
AICPA Initiatives
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Reliable Systems
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Method of
Disseminating
Information
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Financial Data and
Non Financial Data
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Trust Family
(Systrust)
XBRL
VMRC
Performance View
AICPA Initiatives
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Corporate Accountability
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Trust Family (Webtrust)
COSO ERM Project
ASB Fraud Standard
Environmental
Reporting
Audit Committee Rules
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Understandable disclosures
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FASB Projects
VMRC
SEC “Plain English” Plan
Recap
Uncertainty where Enron debacle will end
 Profession needs to play leadership role
 Avoid overreaction & simplistic solutions
 Consider unintended consequences
 Focus on the public interest in all we do
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In Summary
We must work to build a foundation for the
future to continue to protect the public
 We must be responsive to marketplace
changes as our audit model will continue to
decline in relevance
 We should work together Globally
whenever possible
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