The financial nightmare at Enron Corp. underscores the need for increased oversight of auditors, as well as the need for greater autonomy and objectivity by the Financial Accounting Standards Board (FASB), financial analysts, corporate auditing committees and company boards of directors, former Securities and Exchange Commission (SEC) Chairman Arthur Levitt Jr. told a Senate hearing last Thursday.

The irregularities at Enron “did not occur in a vacuum,” but rather were the product of a “culture of gamesmanship” in which it’s “okay to bend the rules, tweak the numbers, and let obvious and important discrepancies slide,” where companies “bend to the desires and pressures of Wall Street analysts,” financial analysts “often overlook dubious accounting practices and too often are selling potential investment banking deals,” auditors “are more occupied with selling other services and making clients happy than detecting potential problems,” and directors are more worried about “not offending management than with protecting shareholders,” he noted. Also to blame are the regulators, who he said “could have blown the whistle” on Enron.

The “most urgent area” crying out for reform is the accounting industry, said Levitt, who called for a “truly independent oversight body” to be created to set standards by which corporate audits would be performed, conduct “timely investigations” of wrongdoers, and discipline them. To preserve its integrity, he noted it shouldn’t be funded in any way by the accounting profession.

Current SEC Chairman Harvey Pitt’s proposal for a similar entity doesn’t go far enough, Levitt said during a Senate Governmental Affairs Committee hearing. While noting that he would have backed Pitt’s plan a year ago, Levitt said, “I think we’ve got to put a lot more teeth” in it. Moreover, he said Pitt needs to provide details about how the new “entity” would be funded, whether it would be truly independent, who would sit on it and how it would be implemented.

Lynn E. Turner, former chief accountant for the SEC under Levitt, said Pitt’s move for increased oversight of accountants was a “step in the right direction,” but he also wanted to see more details.

In addition to an oversight board, Levitt said accountants should be barred from designing or installing information technology systems, performing internal audits for companies, and from consulting with companies on how to structure transactions, such as off-balance sheet partnerships that ultimately led to Enron’s downfall. “This type of work only serves to help management get around the rules.” Corporate auditing committees, not management, should pre-approve consulting contracts with auditing firms, he said.

In order to further prevent conflicts of interests, Levitt recommended that corporations be required to change their auditors every five to seven years. This would ensure that “fresh and skeptical eyes” are reviewing company financial statements.

Ironically, Levitt had proposed many of these accounting reforms several years ago, but his ideas were vigorously resisted by the top accounting firms — including Enron auditor Arthur Andersen LLP — and Capitol Hill lawmakers who received big campaign contributions from the accounting firms.

The FASB, specifically the source of its funding and the make-up of the board, also are in need of reform, he told Senate lawmakers. The funding for FASB should come from sources other than just the securities industry and accounting firms, the very ones for which the FASB sets standards. Levitt also said he never liked that the board was comprised of members from the accounting industry. He believes the SEC should become more involved in this area.

The Enron failure highlights the need for FASB to issue standards at a faster clip as well, said Levitt, noting that the board has a reputation for being “agonizingly slow” in its efforts. “The standards for SPEs [special purpose entities] have taken longer than it has taken my children to graduate from high school,” quipped Turner. Even when new standards are issued, he noted that accounting firms and investment businesses skillfully come up with ways to circumvent them “before the ink dries.”

Even “more perplexing” than the behavior of the auditors in the Enron scandal, Sen. Fred Thompson (R-TN) said, was financial analysts’ continued support for the troubled energy trader and its stock. “What in the world were these analysts looking at” when they touted Enron stock as its value plunged? “Was their desire to be deceived so great?” the senator asked Levitt.

“Analysts, I found, hate to prove themselves wrong,” the former SEC chairman noted. As a result of the Enron debacle, “I think Wall Street…analysis has virtually lost all credibility.” He believes a “cloud” will continue to hang over analysts as long as their compensation is tied to investment banking deals.

Levitt was equally critical of corporate boards of directors. Directors should be required to meet a strict code of independence, barring them from accepting consulting fees or other kinds of “corporate seductions.” If this standard had been in place, three of Enron’s directors would have been disqualified, he noted. He said Enron’s collapse has been a “clarion call” for boards of directors everywhere.

In related developments on Capitol Hill last week:

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