By Nanette Byrnes
It's not easy to shock investors these days. Hardened by three years of falling stock prices and regular revelations of corporate wrongdoing, they've become jaded about governance issues and accounting failures. But even this bunch has been shaken by the HealthSouth (HRC ) meltdown.
With the aid of a former chief financial officer and other repentant insiders, federal regulators have accused the company and now-fired Chief Executive Richard Scrushy of fabricating $1.4 billion in earnings over the past four years. "I was taken aback by the brazenness," says Jim Grant, editor of Grant's Interest Rate Observer and a longtime market bear. "It seems awfully late in the game not to have gotten the memo that we're not doing this stuff anymore."
Unfortunately, HealthSouth isn't the only company not checking its in-box. More than a year after Enron filed for bankruptcy-court protection, the drumbeat of misdeeds pounds on. On Feb. 24, Dutch supermarket giant Ahold (AHO ) revealed that its U.S. Foodservice division had overstated earnings by $500 million in the last two years. In late March, AOL Time Warner (AOL ), already a record-setter on financial restatement, said the Securities & Exchange Commission is now questioning its accounting for an additional $400 million in advertising revenue.
For those who had hoped congressional and stock exchange reforms would end all this, it has been a painful reminder that wringing out all the excess of the '90s boom could take a long time. Before HealthSouth, "investors were feeling good," says Robert Willens, Lehman Brothers' accounting expert. "They thought they were never going to see another major scandal. Now everyone is just petrified that they're invested in the one or two or three that are yet to be revealed."
Aggressive accounting and weak oversight have certainly turned out to be more prevalent than ever suspected. Since the demise of Enron auditor Arthur Andersen LLP, a host of its other clients have recalculated their numbers. According to Huron Consulting Group, 40 onetime Andersen audit clients restated their financial reports in 2002, up from an average of 11 a year from 1997 to 2001. Some 26 of the 40 came after a new audit firm took over.
Not all the post-Enron reforms enacted last year in Washington and on Wall Street have kicked in yet. Some of the so-called Sarbanes-Oxley Act has yet to be translated into regulatory rules. That includes a section requiring executives to take responsibility for their company's internal financial controls, document how well the controls are working, and assert that all deficiencies have been brought to their audit committees' attention.
When those rules take effect this fall, they should, at the very least, help identify problems before they get to the devastating size of an Enron or a WorldCom (WCOEQ ), says Tim Welu, CEO of Paisley Consulting, which sells a financial-control system for large corporations.
In their drive for action, however, reformers may have favored easy-to-measure fixes over broader, perhaps more far-reaching, changes. In accounting, for example, questions are being raised about whether audits should be redesigned to encourage more skepticism, as investors wonder how a fraud such as HealthSouth's could have gone undetected for so long. While such reforms may yet come, they won't be part of the current rule-making.
Similarly, some of the governance reforms now being embraced may prove to be off the point. Dividing the role of chairman and CEO, one current favorite, didn't save Tyco (TYC ), Enron, or WorldCom, all of which had separate chairmen before they hit the headlines (see BW Online, 1/10/03, "This Corporate Reform Lacks Spine").
Jeffrey Sonnenfeld, associate dean of the Yale School of Management, would rather see a greater emphasis on less quantifiable goals, such as creating boards that encourage dissent. Boards need to be more vigilant in sizing up the character of the CEO, Sonnenfeld argues. Yet, "the system is still based on a lot of vulnerabilities," he warns. For even the most jaded investor, that's unsettling news.
Byrnes covers accounting issues for BusinessWeek in New York