Message-ID: <30064053.1075860844222.JavaMail.evans@thyme>
Date: Thu, 10 Jan 2002 12:10:39 -0800 (PST)
From: billy.lemmons@enron.com
To: kenneth.lay@enron.com, elizabeth.tilney@enron.com
Subject: Accounting Article From Fortune Magazine
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Ken,

Beth suggested that I forward a copy of this article to you.  I've highligh=
ted some relevant points for your convenience.

Regards,
Billy

____________________________________________________________

ACCOUNTING IN CRISIS=20
One Plus One Makes What?=20
The accounting profession had a credibility problem before Enron. Now it ha=
s a crisis.=20
FORTUNE
Monday, January 7, 2002=20
Where were the auditors? People ask that question after every corporate col=
lapse, and lately they've been asking it with disturbing frequency. At Wast=
e Management, Sunbeam, Rite Aid, Xerox, and Lucent, major accounting firms =
either missed or ignored serious problems. The number of public companies t=
hat have corrected or restated earnings since 1998 has doubled to 233, acco=
rding to a study by Big Five accounting firm Arthur Andersen. Now, followin=
g the stunning bankruptcy of Andersen's own client Enron, that question--wh=
ere were the auditors?--has become a deafening refrain. "I believe that the=
re is a crisis of confidence in my profession," Andersen CEO Joseph Berardi=
no told a congressional committee investigating Enron's collapse in mid-Dec=
ember. "Real change will be required to regain the public trust."=20
The full story of the Enron debacle--and what Andersen did or did not do in=
 its audit--will take months to emerge. In the meantime, no one disagrees w=
ith Berardino's diagnosis that there's a crisis in accounting--even if his =
sudden emphasis on industrywide reform springs from a desire to deflect att=
ention from Andersen's own culpability. But the kind of "real change" requi=
red is a matter of substantial debate. The government gave the franchise of=
 auditing public companies' financial statements to the accounting industry=
 after the 1929 stock market crash. In the decades since, the accountants h=
ave adroitly avoided significant government regulation by arguing that they=
 can police themselves. Now, post-Enron, they're doing it again. The Big Fi=
ve CEOs issued a rare joint statement outlining how they intend to strength=
en financial reporting and auditing standards. "Self-regulation is right fo=
r investors, the profession, and the financial markets," the release conclu=
des.=20
But is it? Accounting's main self-regulatory body, the Public Oversight Boa=
rd, is a monument to the profession's failures. The POB was created in the =
late 1970s, when Congress held hearings on a string of audit failures at pu=
blic companies that had--much like the recent rash--shaken confidence in th=
e major auditing firms. The POB, which has no enforcement power, investigat=
es alleged audit failures and oversees a triennial review process in which =
the major accounting firms examine one another's procedures. And yet proble=
ms persist; arguably, they have grown more acute. "Is accounting self-regul=
ation working? On the face of it, it is not," says Representative John Ding=
ell, the powerful Michigan Democrat who has long sparred with the accountin=
g profession.=20
In their defense, the auditors note that current accounting methods, many o=
f which were designed 70 years ago, are difficult to apply to today's compl=
ex financial transactions. And there is no way, they insist, to prevent sop=
histicated fraud. The American Institute of Certified Public Accountants (A=
ICPA), the industry's professional association, points out that accountants=
 examine the books of more than 15,000 public companies every year; they ar=
e accused of errors in just 0.1% of those audits. But oh, the price of thos=
e few failures. Lynn Turner, former chief accountant of the Securities and =
Exchange Commission, estimates that investors have lost more than $100 bill=
ion because of financial fraud and the accompanying earnings restatements s=
ince 1995.=20
Perhaps the most glaring example of self-regulation's deficiency has been a=
ccountants' unwillingness to deal with conflicts of interest. Over the year=
s, the major auditing firms have transformed themselves into "professional =
services" companies that derive an increasing portion of revenues and profi=
ts from consulting: selling computer systems, advising clients on tax shelt=
ers, and evaluating their business strategies. In 1999, according to the SE=
C, half of the Big Five's revenues came from consulting fees, vs. 13% in 19=
81.=20
Auditing, meanwhile, has become a commodity. Firms have even been accused o=
f using it as a loss leader, a way of getting in the door at a company to s=
ell more-profitable consulting contracts. "Audit work is a marvelous market=
ing tool," says Lou Lowenstein, a professor emeritus of finance and law at =
Columbia University. "You are already there doing the audit. You say their =
internal controls are no good. Well, who are they going to call to fix it?"=
 But this requires a firm to work for the public (auditing) and management =
(consulting). "You cannot serve them both," says former SEC commissioner Be=
vis Longstreth.=20
This conflict may have played a role at Enron. Andersen received $25 millio=
n in auditing fees from Enron last year. That's money Andersen was paid bot=
h as Enron's outside auditor, certifying its financial statements, and as i=
ts internal auditor, making sure Enron had the right systems to keep its bo=
oks and working to detect fraud and irregularities. This double duty alone =
raised a serious potential for conflict. Besides $25 million in accounting =
fees, Andersen was paid $23 million for consulting services. "If you are au=
diting your own creations, it is very difficult to criticize them," says Ro=
bert Willens, a Lehman Brothers tax expert who disapproves of the accountin=
g profession's recent move into selling aggressive tax shelters. Andersen h=
as not revealed the details of its work on Enron's highly controversial off=
-balance-sheet transactions, but the accounting firms have never believed c=
onsulting fees compromise their objectivity. "They have militantly refused =
to ever acknowledge the possibility of a problem," Longstreth says.