ENRON AND ARTHUR ADNDERSEN: THE CASE OF THE CROOKED E AND THE FALLEN A

Global Perspectives on Accounting Education, 2006 by Cunningham, Gary M, Harris, Jean E

Enron disclosed correct information about its related party transactions with SPEs, although obscure and obtuse, along with misleading financial numbers on the financial statements themselves. These disclosures were sufficient to raise questions by financial intermediaries, but they were largely ignored. Moreover, models using publicly available information that are widely used by banks and others to predict financial distress predicted Enron's potential for failure several months before its failure. This information was also apparently ignored. Information in recent civil cases settled by the SEC indicates that Enron's banks and financial analysts acted in their own best short-term interests, mostly ignoring Enron's manipulations in order to keep lucrative business from Enron. As a result, the financial intermediaries did not act in the best interests of investors. It is too soon to predict the impact of this apparent lack of market efficiency on future regulation of financial reporting in the US.

Reforms

The US Congress responded quickly to the Enron debacle and other scandals by adopting an extensive set of reforms. Most of the reforms are contained in the Sarbanes-Oxley Act of 2002. Much has been written about the Sarbanes-Oxley Act that need not be repeated here. This act applies only to those companies that sell shares in interstate commerce. Although the act does not override any accounting regulatory activity of the states, it substantially expands federal regulation with respect to SEC registrants.

Certification by CEOs and CFOs of Fairness of Financial Reporting

One of the most significant reforms to date has been the requirement that CEOs and CFOs of SEC registrants must personally certify the fairness of the financial statements. It is important to note that the US Congress purposely focused on fairness and not compliance with GAAP. This requirement subjects the officers to individual criminal charges and/or civil liability and thus presumably motivates officers, especially the CEO, to become actively involved in financial reporting processes. Also, the act substantially restricts the kind of consulting which an auditor may do for an audit client.

European CEOs of SEC registrants objected strongly to the certification requirement, arguing 1) that such requirements infringe on the national sovereignty of other countries, and 2) that regulatory mechanisms in Europe are adequate, and even preferable to those in the US. The SEC has pointedly refused to accept these arguments, stating that the European companies have voluntarily chosen to have access to capital markets in the US, and therefore they have voluntarily subjected themselves to US law. Since that time, the Royal Ahold and Parmalat scandals occurred and the objections of the European companies have moderated.

Public Company Accounting Oversight Board (PCAOB) Created.

The US Congress created the PCAOB (www.pcoabus.org), a new body to regulate auditing and other matters not directly related to this case. The oversight board will register and inspect accounting firms that audit SEC registrants. Large accounting firms will be inspected annually and small firms every three years. Many of the activities regulated by this new oversight board are those that traditionally have been self-regulated by the accounting profession or have been regulated only by states. The act's requirements apply to all SEC registrants, including foreign registrants, and to all auditors, including foreign auditors, who participate in auditing SEC registrants. Accounting firms outside the US, including the major international accounting firms, objected to this requirement. In July 2004, the PCAOB adopted rules that will allow the regulatory process of some countries to substitute for continuing review by the PCOAB after a one-time application by the non- US firm and an assessment of the local country's regulatory system. At the current time, only accounting firms in Japan, Canada, and many European countries including the UK are expected to be granted this exemption by the PCAOB.