Who will watch the watchers?

By Nayana
"Think straight and talk straight." - Motto of Arthur Andersen when he founded the accountancy firm that bears his name in 1913.

"If we can find a technical way to go along, then we are going to do it.... Go along with what the management is pressuring us to do...." - Description of Andersen philosophy circa 2000 by Ralph V. Whitworth who was called in to clean up the books at one of Andersen’s pre-Enron failures.

Less than one year ago the firm of Arthur Andersen LLP was one of the world’s largest accounting firms with a staff running into thousands and revenue running to billions of dollars.

Just over a week ago a US jury found the firm guilty of obstructing just shredding documents relating to the failed corporate giant Enron.

Although the firm intends to appeal, it has agreed to refrain from auditing companies listed on the US stock market for the time being, thereby pre-empting a likely ban by the Securities and Exchange Commission (SEC). That means that its business is effectively dead.

Sentence is yet to be delivered but could include a fine of up to US dollars 500,000. In addition, Andersen faces the prospect of multiple damages claims in civil lawsuits by Enron shareholders.

There are both positive and negative lessons to be drawn from these events.

On the one hand, the speed of the prosecution, concluded in less than a year from the events in question, shows that even in the bastion of free enterprise, the exercise of that freedom is subject to rules that will be enforced.

In the course of the hearing, US District Judge Melinda Hammon did not shirk from breaking new ground. Called upon to decide an issue on which previous authorities were lacking, the judge studied prosecution and defence briefs on the point for over a day before ruling that the jury could find the firm as a whole guilty of tampering with the evidence even if they could not agree on the individual member of the firm who was responsible.

It is believed that further and more lengthy prosecutions of both Enron and Andersen on charges relating to accounting fraud could follow. By moving quickly on the relatively simple document shredding charge, the prosecution has created momentum, inspired public confidence and sent a message to auditors that the watchers are being watched.

Many financial experts have pointed out that it is very difficult for a fraudulent company to rig its accounts without the cooperation of its auditors. It was this knowledge that led Andersen’s straight-talking founder in 1915 to demand that a client shipping company account for the loss of a freighter even though it was lost after the close of the financial year.

Values changed, audit firms started doing simultaneous consultancy work for the companies they were supposed to audit, and Andersen became involved with a number of failed companies which, ironically, did not seem to diminish the demand for its services. Faced with accounting fraud charges, it adopted a practice of paying out of court settlements without liability, and large corporations including the "Fortune 10" listed Enron continued to retain its services.

This has led some observers to ask whether a reputation for bending the rules can sometimes help an audit firm to win contracts with companies engaged in dubious practices.

Hence the importance of criminal prosecutions. It is reported that large numbers of Andersen clients deserted the firm following the Justice Department’s indictment.

Enron executives are themselves facing the prospect of indictment after steering the company to the biggest bankruptcy in corporate history through a series of controversial "off balance sheet" transactions with artificial partnerships that were used to conceal damaging losses from Enron shareholders.

In a separate development the energy giant that made its fortune following the deregulation of the US power sector in the early 1990s, is also facing calls for a criminal investigation into its alleged manipulation of the recent California power crisis.

Today white-collar financial fraud is one of the most lucrative fields of crime. The purveyors of essential consumer services are as predatory as other types of operators. Enron’s energy trading unit is reported to have made billions of dollars by artificially manipulating the market while Californians saw their electricity rates increase tenfold and the State also faced rolling power blackouts.

The US Justice Department has set up a special Enron Task Force to investigate the myriad activities of that company and its auditors. In addition there are six Congressional panels conducting investigations into the company’s collapse.

By contrast, neither the Attorney-General’s Department nor the Auditor-General’s Department in this country is likely to have the manpower to establish that kind of long-term special focus unit. Meanwhile, Parliament only has Committees to investigate the accounts of public departments and enterprises.

While "experts" are constantly urging countries in this part of the world to "deregulate" their economies, the USA provides one of the best examples that even a private sector driven economy requires a firm monitoring and enforcement system to ensure fair competition and adequate disclosure of information to ensure that citizens have the knowledge to make informed decisions.

Rather than relying on (and paying) foreigners with dubious credentials to frame our commercial laws, the interests of society might be better served if that same money was spent on sending hand-picked teams from the Attorney-General’s and Auditor-General’s Departments, the Securities and Exchange Commission and other regulatory agencies to study how their counterparts in developed capitalist societies set about the task of law enforcement and detection of white collar crime.

Parliament should also not shy away from scrutinizing the affairs of private sector entities when there is evidence of fraud or malpractice against consumers or shareholders.

In addition, corporate entities in this country must be made to understand that government will not bail them out of their self-inflicted difficulties, but will leave their directors and senior executives to face the consequences of their actions under the civil and criminal legal process. In the US, the Bush administration refrained from bailing out Enron despite reported "feelers" from the corporation that had contributed generously to Bush campaign funds.

By contrast, observers here point to the crash of the finance companies in the 1980s which saw a massive (but selective) bail-out of these companies with public funds and only a sprinkling of prosecutions against company directors and executives, and none against the auditors who had repeatedly certified the accounts of the tottering companies as being sound.

Such a policy only serves to protect those who follow lax accounting practices. The interests of the public would be better served by strengthening and streamlining the civil and criminal legal systems to enable errant players to be brought to book.

(The information about Enron, Andersen and related proceedings contained in this column was taken from a variety of US print and internet sources.)