It's hard to imagine a more grotesque and twisted story than the collapse of Enron.
You could argue that it's so outrageous that it's a one-off; another Enron couldn't possibly happen, so let's not worry about it. Forget about new disclosure rules, regulating auditors and the like. No amount of oversight could have prevented Enron, so leave the rest of Corporate America alone.
Too bad it's not that simple. The reality is Enron has done a lot to damage investor confidence. The financial statements of any high-flying company are now automatically treated as guilty-of-something-nasty-until-proven-innocent.
If option-laden executives were suspected of managing their share price first and the company second, they are doubly suspect now.
U.S. accounting rules, once considered the gold standard for financial reporting, are open to ridicule. Last week, the European Commission attacked U.S. accounting methods and called on U.S. regulators to replace them with a system that's less prone to manipulation. A senior EC official told the Financial Times that Enron's fall was partly due to the "cookery book" approach to U.S. generally accepted accounting principles.
Canadian investors are not insulated from the Enron debacle, even though few of them were direct Enron investors. A national telephone survey conducted by GPC Research, a unit of GPC International, the public affairs and communications firm, showed that 70 per cent of Canadians are aware of the Enron scandal and that 76 per cent think a similar case could happen in Canada.
While almost two-thirds of respondents said their investment decisions will not be affected by the scandal, slightly more than one-quarter said they are less interested in investing in the stock market because of the scandal.
More than two-thirds said accounting firms should be restricted from providing both auditing and consulting services to a client, as Arthur Andersen did with Enron.
The GPC survey is not scientific, of course, but it more than suggests that the Enron debacle has spread like a cancer through the entire securities market. Like a cancer, only radical treatment will fix it.
Some free-market pundits have argued that the markets will suffer a death of 1,000 cuts if more regulations are imposed on the industry, and that no amount of regulation would have prevented Enron from happening. Enron, they say, simply chose to ignore the rules of the game.
This is the ultimate buyer-beware argument. Take it to its logical extreme and all rules of engagement should be eliminated. Investor confidence, the lifeblood of the securities industry, would be shattered. It would be like removing airbags, seat belts and safety glass from cars, and speed limits from the roads.
If investors, as the GPC poll indicates, are wary about the markets because of Enron, and believe another Enron is waiting to happen, it follows that the best way to restore confidence is to help ensure it doesn't happen again.
This means building new safety measures into the system.
At minimum, auditors should be prevented from acting as consultants to the same clients, a simple restriction that would remove an obvious conflict of interest.
If Arthur Andersen were not being paid a small fortune to offer advice to Enron, Andersen's auditing arm might have had more incentive to question the legitimacy, say, of the off-balance-sheet partnerships that were multiplying like bacteria.
Regulatory oversight of auditors by the U.S. Securities and Exchange Commission may be a good idea if the Big Five auditors fail to come up with a proposal that would guarantee their independence.
Accounting is the other big issue. Now that the loopholes in U.S. GAAP have been fully exposed, they need to be plugged.
In the 1970s, accounting standards governing the valuation of oil and gas reserves were all over the map, giving investors a distorted and random picture of asset values. This was cured in the early 1980s, when regulators cracked down and set strict standards for reserve accounting.
As a result, investors today can make valid comparisons among energy companies.
In the wake of Enron, stricter rules for contentious areas, such as revenue recognition, off-balance-sheet entities and the cost treatment of stock options are needed. It's all about levelling the playing field and ensuring that investors learn about potential problems as they arise instead of hearing about them a year later.
Burn investors enough times and they'll stay away forever. ereguly@globeandmail.ca
Eric Reguly