Will EU exorcise Enron’s ghost?

IN THE POST-FINANCIAL CRISIS era, bankers have replaced Enron and WorldCom as public totems of corporate mismanagement. As a result, particularly in the UK, it is easy to forget just how significant an event it was.

When Enron filed for bankruptcy on 2 December 2001, it had a devastating effect on its shareholders, many of them former employees betting their whole 401K pension pots on the company.  There were also far-reaching, and generally more useful implications for corporate governance practices.

In the UK, some of the key lessons of the Enron collapse were reflected in changed corporate governance practices, and ultimately written into the Combined Code (now the UK Corporate Governance Code).
One of the most important of these lessons has been the separation of a company’s internal and external audits.

The US Senate Committee’s investigation into Enron’s collapse highlighted its outsourcing of internal audit to its external auditors Arthur Andersen as a major factor in the company’s downfall. They said that it created a major conflict of interest that prevented the company’s dubious accountancy practices from being exposed earlier.

Today, it is widely accepted that it is good practice to ensure that internal and external audit functions are properly independent of each other.

The UK Corporate Governance Code requires companies’ audit committees to provide an explanation of how external auditor objectivity and independence is safeguarded if the company’s external auditor also provides it with non-audit services, including internal audit.

However, in recent years there have occasionally been instances when a company’s decision to place internal audit services with its external audit provider has been challenged.

It may theoretically be possible to design adequate Chinese walls to prevent conflicts of interest occurring, but investors are entirely justified in demanding extensive reassurance on these sorts of arrangements.

In the view of many, including the IIA, there is a strong case for going further still. We welcome the debate that will ensue from the EU’s proposals announced this week to ban audit firms offering internal audit services.

Dr Ian Peters, chief executive, Chartered Institute of Internal Auditors

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