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+ A Tale of Two Chairmen
When it comes to policing corporate America in the wake of Enron and Arthur
Andersen, the controversial SEC Chairman Harvey Pitt and his equally
controversial predecessor, Arthur Levitt, have defined and galvanized the
central debates over reforming Wall Street and the accounting industry.
+ Who Dropped the Ball?
And what's being done about it? A primer on corporate watchdogs, conflicts of interest, and the new reforms on the table.
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+ "Proposed Rules to Create a Framework for a Public Accountability Board"
A public statement by SEC Chairman Harvey Pitt on June 20, 2002, in which he announced his proposed new system to regulate the accounting industry.
+ "Restoring Investor Confidence: An Agenda for Change"
A widely noted speech by Henry M. Paulson, Jr., Chairman & CEO of the
Goldman Sachs Group, at the National Press Club on June 5, 2002. Click
here to
download in PDF.
+ "The Numbers Game"
A speech by Arthur Levitt at the NYU Center for Law and Business on Sept. 28,
1998, on accounting abuses and the need for integrity in financial reporting.
+ "System Failure"
"Corporate America has lost its way. Here's a road map for restoring investor confidence." (Fortune, June 24, 2002)
+ "Special Report: Crisis of Confidence"
"Phony earnings, inflated revenues, conflicted Wall Street analysts, and directors asleep at the switch. Nearly every known check on corporate behavior -- moral, regulatory, you name it -- seems to have fallen by the wayside. A look back at a dizzying year." (Fortune, June 24, 2002)
+ "Special Report: The Accounting Industry"
This special section from the Washington Post offers a collection of recent news stories related to the accounting industry, as well as a timeline of key events and documents in the Arthur Andersen trial. It also has archived the Washington Post's December 2001 investigation of the industry entitled "The Numbers Crunch."
+ "The Betrayal of Capitalism"
Felix Rohatyn writes, "In 1932, the congressional hearings conducted by Ferdinand Pecora of New York started a major process of reform of our financial system. ... Serious reforms again are needed, particularly to ensure that accounting firms will henceforth act honestly and responsibly." (New York Review of Books, Feb. 28, 2002)
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Chairman of the Securities and Exchange Commission from 1993 to 2001, he
launched an unsuccessful effort to reform the accounting industry.
 What's the significance of the Enron scandal and collapse for the markets as
a whole? Is this symptomatic of something larger?
I think the Enron scandal is symptomatic of something much broader than Enron.
I think it's symptomatic of a breakdown of the ethical values of business over
a period of perhaps 20 years, a gradual erosion of business ethics that brought
us to an Enron, but might very well bring us to a whole host of Enrons as we
move down the road. ...
[In 1998] you made a speech up in New York in
which you used the terms "abuses," "trickery," and "accounting hocus-pocus."
Are things that bad?
I think they are. I think that the seduction of the boards of companies that
are intended to protect investors ... the nexus between the accounting firms
and the corporations, and the aggressive attitudes of CFOs and CEOs, has
created a pattern of deception; that has created a situation which has eroded
public confidence in the sanctity of the numbers which is the basis of our
markets today. ...
What's at stake here?
... If investors lose confidence in the reliability of numbers that are
presented to them, our markets will suffer grievously. ... It will be more
difficult to raise money. It will be more difficult to maintain public interest
in our markets. The source of capital will dry up. It will have very severe
economic and political consequences. ...
Our markets have already suffered a very serious blow. And whether they recover
from that, whether they can restore the kind of public confidence that is
essential to America's markets, depends on how our policymakers deal with these
issues. ...
The Enron story was a story not just of the failure of the accounting firm, but
also the traditional gatekeepers: the board, the audit committee, the lawyers,
the investment bankers, the rating agencies. All of them had a part in this.
...
I don't personally believe that Andersen is any worse than any of the other
firms. I can't speak to fraud, because we don't know the dimensions of that at
this point. But in terms of how they deal with their clients, I think the kinds
of problems Andersen has had, have developed and will develop in other firms in
probably precisely the same way. ...
Is it going to be adequate to let the accounting firms do their own
restructuring and their own reforms? Or are outside reforms going to be
necessary?
Whether it's adequate to have the firms do their own reforms, I think, depends
on the issue of perception as well as reality.
As long as the American public perceives that they can't rely on America's
accountants because those accountants have a conflict of interest, that speaks
for itself. So I don't think that we can rely upon the firms themselves to do
the job.
I think we need an oversight body to oversee the accounting firms in a way that
gives them subpoena power. And that means legislative action. I don't think the
firms can do it by themselves. ... I believe we need an independent agency that
consists of people of impeccable credentials that can oversee the accounting
firms, that has subpoena power to go after not only the accounting firms, but
also their clients, to assure the public that audits are being conducted
fairly, and in those instances where audits are being compromised, that there
is a mechanism for providing immediate relief in the form of sanctions against
those accounting firms. That doesn't exist today. There is no real mechanism
aside from what the SEC can do, and that process takes an extended period of
time. ...
There is no self-regulation that is working in the accounting industry today.
There simply is no effective self-regulation. The SEC lacks the resources on
their own to regulate this industry. ...
As a practical matter, who can we count on as ordinary investors?
I think we should be able to count on the audit committees of boards of
directors to protect us as investors. We should be able to count on a regulator
such as the SEC for overseeing corporate America and the accounting profession.
We should be able to exercise our rights of private action by bringing suit
against the fraudulent presentation of numbers. We should be able to count on
the laws of this country and the efforts of U.S. legislators to help protect
us. ...
[back to top]
Chairman of the SEC since August 2001, Pitt is an attorney who represented the
accounting industry during the 1990s.
Looking back at the Enron affair ... what are the problems that we're facing
here?
Well, I think we have a number of problems. ... We have seen that the auditing
profession, the accounting profession, needs vigorous regulation and
oversight. Efforts were made in the 70s and again in the 80s to provide that
oversight, but I think we are seeing that there's a need for tougher oversight,
regulation, and enforcement of the accounting profession. ...
And what about a company like Andersen, which is there certifying that
Enron's books are accurate? Where do we, as ordinary investors, stand? How do
we know what's going on if somebody like Andersen -- which at one point was
regarded as the U.S. Marines of auditing and accounting -- says it's
OK?
... One of the things that Enron suggests is that there were two problems with
the accounting. One was that they may have gotten some of it wrong. They must
have, because there was a restatement. But a bigger problem is that they may
have gotten a lot of the accounting right, and that would be troublesome,
because you have a lot of these special-purpose entities that were not reported
on the books and which had the effect of shielding certain liabilities from
public observation. That may be technically appropriate in some cases under
the rules -- it might be; I don't know that it is. But if it is, then our
rules don't make sense. If it isn't, then our enforcement should have been
much more attuned to looking to these kinds of problems.
I think investors can rely on the fact that the number of these situations are
very few over the years -- particularly given the number of public companies we
have. But I think they also are entitled to know that we can make the best
system much better than it presently is. And that's what I'm determined to do.
...
In terms of reform and oversight for the accounting industry, I'd like to
understand what it is you're proposing.
... We proposed a very thorough private-sector regulatory body that would
revamp and increase all of the regulation to which the profession is subject.
... We are calling the new oversight board the Public Accountability
Board, or PAB. ... It would be funded not by tax dollars but it would be funded
by those who benefit from the audits of public companies -- investors,
corporations, auditing firms -- but there would be no choice on the part of
auditing firms, so the revenues would be assured.
The PAB would be dominated by individuals who are not affiliated with any
accounting firm. If we had a board of, say, nine, we might have two or three
that might have some affiliation with accounting firms, but they would not be
allowed to vote on disciplinary matters or anything that might affect either
their own firms or competitor firms.
The goal would be to provide three main areas of oversight. The first would be
ethics, the second would be competence, and the third would be quality review.
This body would be required on a yearly basis ... to undertake a review [of the
largest accounting firms] not just to see whether they violated the law, but,
even if they complied with the law, whether they are functioning at the highest
standards and the highest level. They would have the power, if they found that
a firm was not doing the highest quality audit work, to dictate that the client
pick another auditor. So the stakes would be exceedingly high for the audit
firms to come up with high-quality controls and make sure they are performing
at the highest level.
Would this oversight board have subpoena power? Would it set accounting
standards? What would be its jurisdiction?
It would have disciplinary power but it would not have subpoena power. ... If
this board were created and it had subpoena power, it would have the same
obligations as government. ... Under our system, because there is no subpoena
power, there will be a requirement that if you want to be an auditor, or if you
want to be a public company, you must cooperate and make information available.
... Under the government system somebody can come in and take the Fifth
Amendment, and if the government can't put together the case, that person may be
able to go scot free. We think the stakes are too high with respect to
accountants and auditing, and so that's why we want a tougher system. ...
Would your Public Accountability Board have a legislative mandate?
It would have all of the mandate it needs because it would have the SEC's
mandate. We have all of the power now and have had for years to solve these
problems. They just haven't been tackled or solved. ...
People are saying that the reforms you're proposing are half-hearted. They
don't have the teeth to do the job.
If you look at what we are doing and what we have put out and what we will be
putting out, what you will understand is that the proposals we have advocated
have incredible teeth and will solve problems that should have been solved
years ago. I cannot account for the reasons why some publications prefer to
talk about criticisms of proposals that aren't even in print, but they are
criticisms from people who don't want the SEC to succeed. We are going to
succeed. This is going to be done and it's going to be done for the benefit of
investors and be done the right way.
[back to top]
Chief accountant of the Securities and Exchange Commission from 1998 to 2001,
Turner is a former Wall Street partner at Coopers & Lybrand and is a staunch critic of how the accounting industry operates today.
When we're looking at Enron, is this a symptom of something larger in our
economic system?
It's a symptom of something larger. It's beyond Enron; it's beyond Andersen.
It's embedded in the system at this time. ... There's been a change in culture
that arose out of the go-go times of the 1990s. Some people call it greed. But
I think it is an issue where we got a lot of financial conflicts built into the
system, and people forgot, quite frankly, about the investors. ...
I think in Enron's case -- and I certainly don't think they're the only case --
these companies became like the golden goose, and everyone was standing at the
door trying to get a golden egg. And we're not talking a few dollars, or a
thousand, or even hundreds of thousands of dollars here. In some of these
cases, people were paid millions or tens of millions of dollars for doing what
they were doing for the companies. ... You just have to trace the flow of
money, trace the cash. Eventually it runs from Enron back to these people. ...
It runs back to the professionals who they were dealing with: auditors,
attorneys, rating agencies, analysts, underwriters, many other financial
advisors. ...
Having been in one of these Big Five international accounting firms, I can tell
you that over the last 10, 15 years, the mindset has evolved from one of
looking out for the investor and placing their interest first -- because
[auditing] is truly a public function, a public franchise -- to one of, "We're
a great big international business, and business comes first." ...
What do you say to people in the accounting industry who say to us, "There's
really not a problem here; 99.9 percent of the audits in American companies are
great?"
Until October of last year, Enron was one of those 99.9 percent. ... You know,
Waste Management, until it blew up in 1998 -- that was one of those 99.9
percent of the audits that was fine. Quite frankly, we don't know how many
audits are OK and how many audits are bad. The only time you see a bad audit is
at that point in time that the company gets in trouble. That's also the time
when you finally realize that that bad audit has cost those investors millions
-- even billions -- of dollars. Tens of billions of dollars in the case of
Enron.
So this notion that everything is fine in the system just because you can't see
it is, quite frankly, totally off-base. ... It is nothing more than spin
doctoring. ...
What's at stake? Why should we, as ordinary investors, care about all these
intricacies of accounting and auditing, and whether functions are split and how
the rules are written?
No one wants to invest in a company if they can't tell if that company is doing
well, or not doing well. It'd be like going to the craps table in Vegas and
laying a bet down. We don't want to do that with our future retirements, with
our savings, the kids' education. ...
The accounting industry has operated under a system of self-regulation,
frankly, since the SEC was set up. Has self-regulation worked in the accounting
industry?
Self-regulation has not, is not, and certainly at this point in time, given
fundamental changes in business today, self-regulation is not going to work.
... The financial conflicts are too great. ...
Now, SEC Chairman Pitt has come up with a number of proposals for fixing the
problem. What's your assessment of what Chairman Pitt is proposing?
Chairman Pitt's proposals, first and foremost, fall way short from what almost
every single investor group has asked for. ... And it falls way short -- it's
almost like a Grand Canyon chasm -- of what Congress is looking at doing. ... I
think Chairman Pitt's proposal, while it's a start -- quite frankly, it's
almost in fact a nonstarter, because it really doesn't accomplish much. ...
In his reform, he falls way short on improving the independence of the
auditors. ... It doesn't have an effective disciplinary or investigation
provision. ... The new body that Chairman Pitt would propose doesn't even have
the ability to set their own rules with respect to what auditors should be
required to do, or the quality of their audits. He's going to leave all of that
in the hands of the profession. And as we've seen from the last 25 years, as
we've seen from the $200 billion in losses investors have already suffered,
quite frankly, that dog just doesn't hunt. ...
We need a lot more sunlight on the system, so that the public can see what's
going on. ... Because if the accounting profession is scared to operate in the
public domain, out in the sunlight so people can see everything that's going
on, then, quite frankly, that should tell you something -- that there's
something wrong. The accounting firms should recognize it; the public should
understand it. And Congress, probably along with the SEC, needs to make
reforms. ...
Does it take having top managers, top auditors going to jail, the way Ivan
Boesky did, or Michael Milken?
I think when you turn around and go into a 7-11 store and rob the store for a
couple hundred bucks, you go to jail. When you've got auditors who have turned
around and watched top management teams basically rob from their shareholders
by failing to tell them clearly what's going on and, yet, still taking the
investors' money into that company, and the auditor stands by the wayside,
knowing that the numbers aren't right, aiding and abetting the management team
-- quite frankly, I don't see a difference. ...
[back to top]
CEO of Andersen Worldwide from January 2001 to March 2002, he stepped down,
some say belatedly, in a last-ditch effort to save the firm.
What do you think is at stake here?
... Whenever you have a washout like we have had with Enron, it destroys
people's confidence in the system. ... And when you lose that trust you can
second-guess everything you do. And we need to come up with new ideas that
could help govern our profession ... to reengage the investor and improve their
confidence. ...
So my basic posture on this is that if you want to focus on accounting and
auditing, we can do that. Extremely important. But if you look at how you're
trying to protect the investor -- think of it like a manufacturing process --
there is a whole pipeline of activities, starting with management running the
business, to a manager communicating to the shareholders. And a lot of stuff is
happening, and at the end of that pipeline [there's] the auditor, if you will,
the inspector at the end of the assembly line.
And what we're going to do, looking at Enron, is look at Inspector Number 103,
and what he or she could have done differently. I'd say that's fair game. But
it's not the whole story. We need to look at the whole pipeline. Now the board,
the analysts, the bankers, the investors themselves, how do they behave, why do
they behave that way, and what can we learn from that behavior in terms of
education, changing the system? ...
You spoke in one forum of your profession being in crisis. ... What did you
mean when you said your profession is in crisis?
Well, I believe our profession has been in crisis for some time, and we've
referred to this from the profession standpoint as the "expectation gap." What
we do is very different from what people think we do. We don't guarantee the
financial condition of the company. But whenever a company fails people ask,
where were the auditors?
What we do is test the systems that go into the company's calculating,
reporting on its earnings. Based on those tasks we do form an opinion as to
whether those fairly presented results, but whenever a company goes under
everyone expects the auditor to have been able to predict it. ...
So I think there is a fundamental crisis of confidence, of understanding, and
we need to cure it because the investor deserves to know what they can count
on, who they can count on, and what degree of comfort they should take away
from this whole process. ...
Did you feel as though the aggressiveness, the combative relationship that
you mentioned before with the SEC [under Arthur Levitt], did you feel that
Harvey Pitt's arrival at the SEC might change things?
Yes, I was very concerned about the combative role we had with the SEC. ... You
like to work with your government, not fight it. And so I thought Harvey Pitt's
outreach to the profession, after he was confirmed by the Senate, I thought that
was constructive. I certainly received it as constructive.
And frankly, and I've told both Levitt this and I've told Harvey Pitt this, I
want a strong SEC. I'm an auditor but it helps me to know that we've got a
tough, rigorous enforcement agency. And there is no question in my mind then or
now that Harvey Pitt ... will be tough in enforcing the rules. What they will
do, or say that they will do differently, is reach out so we can try to get a
consensual view of the changes that need to be made, rather than a more
combative approach. I think it's a question of style and it's a style I'm
very comfortable with and I'll be more than happy to participate in. ...
What are the risks that we will not have learned enough from the Enron
debacle to actually make the fixes that are necessary?
When I stepped down, I said on national TV that the ultimate tragedy of Enron
would be that we don't learn. I'm not real optimistic. I do think there are
some things in place, you know, this one bill sets up this public oversight
board, or accountability board. God bless them, I really wish them success.
[back to top]
Chairman of the Federal Reserve Board from 1979 to 1987, Volcker was brought in
to lead an oversight panel in an attempt to restructure and save Andersen
in the wake of the Enron scandal. His efforts proved futile when the
government's indictment of Andersen became imminent.
Mr. Volker, the accounting profession looks to be in a credibility crisis. ... Would you agree with that? Where do you see the accounting profession?
... I made a speech to the assembled chief financial officers of the United
States in October, I guess. Enron was beginning to be a problem, but it hadn't
exploded. I said, in my judgment, the accounting profession is in a state of
crisis. I used precisely that word. ...
The crisis was ... so far as auditing is concerned, a relaxation of standards.
But it's not as simple as that. It reflected the pressures on finance and
business generally to deal with the complexities of modern finance. ...
It's not a happy picture. The profession needs reform. ...
The insiders seem to understand the game. But if you're an ordinary retail
investor ... we don't know what to trust.
Well, the trust in the marketplace is what's at issue. I don't want to
exaggerate it -- you know, most companies have fair reports, most audits are
fair audits. In general, I think our system is still the best in the world, as
we say. It's not as good as we brag about, and that's why we've got to make it
better. ...
One of the arguments made by the accounting industry at the moment is, "Let
us do it." Has self-regulation worked, in your opinion?
Well, the people that I have talked to that are much more familiar with
accounting and auditing over a period of time feel very strongly it has not
worked -- that it's been too weak and that it needs to be strengthened,
stiffened, disciplined. And I think we will get legislation in that
direction.
So, would you favor government oversight or some body with oversight
power?
Yeah, I would favor some kind of body with oversight power, with disciplinary
powers, with powers of initiating their own inspection and review of audits.
Yes. ...
You get people now who are saying there are always reasons to have the
accountants running it. Their expertise is necessary. Their consultations are
necessary. And in the end there seems to be no deterrent to bad behavior in the
accounting industry.
Well, look what's going on now. The whole discussion that we are having is a
deterrent to bad behavior. There's no question that what is going on in the
marketplace -- it's not just Enron, [there are] many other cases, with Enron a
spectacular case -- is having a chastening and disciplining effect on the
accounting and auditing profession. And consulting.
But people said that after the savings and loan scandal. They paid a
billion dollars in stockholder suits, and here we are again a decade
later.
Exactly why I think we also need some structural reform so that these pressures
that we feel now and the discipline that we feel now persist. That is
precisely my concern. ... I want to see that oversight body. I want to see a
division between auditing and other services. ...
Does Andersen's disappearance mean the problem is solved, that we got rid of
the firm that was the difficulty?
Well, I think the disappearance of Andersen clearly doesn't solve the problem.
There are those that argue, understandably, that this is a pretty dramatic
event -- that this firm that used to be considered, really, the gold standard
of accounting has fallen on such difficulties that it disappeared has a
chastening and disciplining influence on others. But I don't think it
substitutes for ongoing reform. ...
You know, it's not just in the auditing profession. They're at the end of the
line. That's very important; they have a public responsibility. But these
breakdowns reflect pressures that are very strong and affect other professional
groups, financial groups, as well.
Andersen didn't make up all these things that Enron was doing. Other people
sold those techniques to Enron, or they developed them themselves. Andersen's
function was to rule on them in the end, but they didn't make them up.
So, what you're saying is the Merrill Lynches, the investment banks, the
Goldman Sachs -- these were the people who were engineering the very vehicles
that have gotten Enron and Andersen in trouble.
Yes. ...
Is there an ethical issue?
Oh, yes. I think there is. ... I think there is an ethical issue that
runs right through the markets. ... A lot of it comes back to a basic ethical
approach. Is the object to squeeze out as much money as you can? Or, at some
point, is there a question of what is right and what's wrong? ...
Why do you think ordinary investors should care about this issue of Enron
and Andersen?
Well, ordinary investors in the United States have participated in financial
markets in a way, I think, that's probably historically unprecedented -- here
or elsewhere. They have their fortunes tied up, their retirements tied up, in
the performance of the stock market and financial markets, generally.
Those markets have had exceptionally, almost unreal performance in the 1990s,
and it was almost a magical way to make money. Now, some doubts have arisen as
to how those markets functioned. ...
So, naturally, this raises concerns that are potentially very damaging to the
operation and effectiveness of the financial markets themselves. And that's
why it gets a lot of attention, and that's why it's terribly important that we
deal with this problem -- and in an effective way -- that we listen to these
warning signals that are in the press, and we act.
[back to top]
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