PracticeAuditFor and Against: Transparency in the wake of Enron

For and Against: Transparency in the wake of Enron

In the wake of Enron, Roger Davis argues the case for establishing transparent principles over rules as the world standard but Duncan Hughes fears that some in the US are bent on revenge rather than reform...

It’s a matter of principles
Roger Davis

The world is learning two lessons from the aftermath of Enron. Legalistic accounting doesn’t necessarily produce the right answer. It is a great opportunity to establish transparent principles rather than rules as the world standard. Box ticking cannot command business success, nor good accounting and auditing.

Take corporate governance. A competitive global economy would be poorer from trying to clone management structures, such as one or two-tier boards.

But there must be some globally transparent principles of investor protection.

Likewise, market regulation must be based on consistent principles, which market regulators will reciprocate, to facilitate cross-border listings.

It is unrealistic to expect a single world regulator. The detail and approach to regulation will always differ domestically, and there is nothing unhealthy about that for competition among capital markets.

While there is encouraging talk in the US of using principles, regulation there is always likely to be more prescriptive. There are cultural reasons, such as the prevalence of lawyers in US society and the sheer scale of the country, which require a more formal approach than most.

Now to accounting. As we all know, rules encourage the ‘show me where it says I can’t do it’ mentality. Everyday accounting, like providing for troubled debt or contracts, will always require judgement. Companies fail because the overall picture misleads people – management as well as shareholders – not because a technical rule is not precisely applied.

There is another reason for principles we haven’t heard much about. Auditors should be in the boardroom putting their views in no-nonsense English, not spending a disproportionate effort down the corridor box-ticking arcane rules. Yet the debate on auditing is around ticking boxes on independence.

Quite what would be achieved by enforced rotation is unclear. It suggests, paradoxically, that audit committees can’t be trusted to make up their own minds on the independence and demeanour of the audit team, but they can be trusted to hold enforced beauty parades.

But audit firms, too, must be transparent about their quality procedures – setting the same standards for themselves as they do for clients in capital markets.

The UK’s governance code has got it right. Be transparent on how principles have been applied. Now do it globally. Put auditors in the crow’s nest warning of icebergs, not below decks defining what an iceberg looks like.

By Duncan Hughes

In the highly-charged atmosphere following the collapse of Enron, the US chief securities and accounting industry gatekeeper Harvey Pitt could have trouble knowing whether he is on the out or the inside.

Pitt, an industry veteran whose prior links to the accounting industry have posed questions about his partisanship, has not veered from his long-held position that the profession should move to a principle-based system.

‘Don’t over-react’, is his warning to legislators and the investing public looking for more than the corpse of Andersen to appease the wrongs of Enron.

Pitt has been a long-time opponent of rule-based standards and the ‘check-the-box mentality’ that downplays judgements and creates the conditions for the legalistic advice that can breach the spirit of accounting standards.

He envisages a time when not all transactions are recorded in the same manner but with regard to core principles that will preserve comparability and boost investor confidence that auditors are not for sale.

For decades, the US accounting industry has successfully fought off efforts by lawmakers and regulators to impose tougher government controls. Instead it has promoted self-regulation combined with an oversight board to ensure its effectiveness.

But Enron has guaranteed that this is no longer a discreet debate between the profession’s cognoscenti, Washington lobbyists and lawmakers.

The Bush administration and Securities and Exchange Commission’s reluctance to hold the industry accountable has left an opening for the mob that want to lynch Andersen and then the industry with tougher regulation.

Legislation being favourably considered by Congress would put a ban on all consulting, except tax work, by auditors and limit auditors’ ability to transfer to senior management jobs in the companies whose books they kept. Enron paid its auditor, Andersen, $52m in fees in 2000. Only about half was for auditing.

Pitt, whose views are widely believed to toe the administration’s line, is looking for stronger enforcement, tougher penalties and clearer financial disclosure.

That would also create the conditions for a principle-based system to be put back on the agenda.

It will be a test of Pitt’s political skills whether he can silence the sceptics while refocusing the debate on reform, rather than revenge, and the quality of audits.

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