Let Auditors Be Auditors

Sunbeam, Waste Management, and now Enron. Auditor Andersen has certainly had a bad run. It has vouched for company books that have turned out to be pages of false and misleading statements, leaving investors dumbfounded and poorer. Andersen paid $110 to settle Sunbeam Corp. shareholder litigation and $7 million in fines for Waste Management Inc.--plus part of a $220 million class action. Investors have lost nearly $80 billion on Enron's collapse, and Andersen is facing new class actions over its mishandling of the financial statements of the once-mighty energy trader.

When is this going to end? America's equity culture requires honesty and transparency from its companies so that investors can calculate risk. People need to know how to properly value companies, and they can't if income is overstated and assets and debt are hidden in secret partnerships, which appears to be the case with Enron Corp.

Securities & Exchange Commission Chairman Harvey L. Pitt is launching a formal investigation into Enron's collapse. He has several worthy proposals to reinforce the self-regulation of the auditing function. But Pitt is naive to think that modest changes will solve the problem. Andersen made more money selling consulting services to Enron last year than auditing its books. In many firms, auditors are compensated for the service business they bring in. Until this conflict of interest is ended, there will always be the temptation to go easy on the company that provides service fees. Independence of the auditing function is critical.

Pitt is right to emphasize preventive maintenance. He is encouraging companies and their auditors to consult with the SEC early to clear up confusing gray-area accounting issues. The antagonism between the SEC under Chairman Arthur Levitt and the auditing profession was so palpable that there was little communication between the two.

Pitt is also correct in trying to strengthen the role of audit committees on the boards of directors. He wants to make it a duty for them to sit down with management and outside auditors and single out the four or five key accounting principles that have the greatest impact on their company's financial position. They should clarify and define the most complex and ambiguous standards and get the company to operate by them. The audit committees should also make those standards available to investors.

But neither proposal goes far enough. GAAP, the generally accepted accounting principles, desperately need to be revamped to deal with cash flow and other issues relevant in a fast-moving, high-tech economy. The whole move to off-balance-sheet accounting should be reassessed. Opaque partnerships that hide assets and debt do not serve the interests of investors. Under heavy shareholder pressure from the Enron fallout, El Paso Corp. just moved $2 billion in partnership debt onto its balance sheet. Finally, Pitt should consider requiring companies to change their auditors every three or four years. Companies naturally tend to retain auditors who go easy on them, as we have seen time and again.

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