A Senate committee investigation has concluded a “systemic and catastrophic failure” by the Securities and Exchange Commission (SEC) and other industry watchdogs allowed Enron Corp. to get away with its fraudulent activities for as long as it did.

“Despite the magnitude of Enron’s implosion and the apparent pervasiveness of its fraudulent conduct, virtually no one in the multi-layered system of oversight and controls relied on by the public detected Enron’s problems; or, if they did, they did nothing to correct them or alert investors,” according to a report by the Senate Governmental Affairs Committee, called “Financial Oversight of Enron: The SEC and Private-Sector Watchdogs.”

The 127-page report and a stinging letter were forwarded to SEC Chairman Harvey L. Pitt last week. In addition to the SEC, the report assailed the credit-rating agencies and financial analysts for either ignoring or failing to detect the ongoing fraudulent activities of the Houston-based energy company. Enron filed for bankruptcy last December following numerous disclosures of accounting irregularities and off-balance sheet transactions that inflated company profits and hid losses over the years.

The report was the result of a wide-ranging investigation begun by the Senate committee last January into the activities of various public and private watchdogs that are charged with protecting the public from Enron-style frauds.

It referred to Enron as “the poster company for all of the failure of due diligence and objectivity on the part of the watchdogs.” That the collapse at Enron has been followed by a “seeming flood of allegations” of fraud at other large companies “precludes any easy characterization of Enron as simply a ‘bad apple’ or the lapses of the gatekeepers and regulators as isolated breakdowns in an otherwise sound system.”

The SEC bills itself as “the investor’s advocate,” but it “fell far short of that” with Enron, said Committee Chairman Joseph Lieberman (D-CT) and Sen. Fred Thompson, ranking Republican on the panel, in the letter to Pitt. The increasing number of restated financial statements by Enron and other companies, and warnings about the “declining quality of financial reporting and the conflicts and lack of diligence” by regulators, should have put the SEC on guard against potential fraud, the lawmakers wrote. Instead, the SEC “did little to react to these vulnerabilities and ultimately failed to fulfill its mission to protect investors.”

Because the SEC failed to review any of Enron’s annual reports after 1997, its staff missed a number of “red flags in those documents, such as the opaque and questionable references to transactions with entities run by the company’s own Chief Financial Officer” Andrew Fastow. Fastow surrendered to the Federal Bureau of Investigation last week in Houston, and was charged with five counts of fraud, money laundering and conspiracy. He was released on $5 million bond (See NGI, Oct. 7)

The report further charged the SEC may actually have perpetuated the fraud at Enron by mishandling the company’s application in April 2000 for an exemption from the requirements of the Public Utility Holding Company Act. (PUHCA). The SEC’s “lackadaisical approach to the exemption request and its failure to coordinate with the Federal Energy Regulatory Commission may have opened yet another door to Enron improprieties,” Lieberman and Thompson said.

Enron, which already had been exempted from PUHCA on other grounds, sought the “seemingly redundant” exemption in order to receive certain regulatory and economic benefits from FERC for some of its wind energy projects, which “were part of transactions that were the subject of the civil and criminal charges brought against” Fastow and former Enron executive Michael Kopper, they noted. Kopper plead guilty to conspiracy to commit wire fraud and money laundering in August.

The report also found that Wall Street analysts “are subject to too many pressures and conflicts to offer the objective and independent analyses that they purport to provide and that the investing public expects,” said Lieberman and Thompson. The analysts “have often gone as far as to serve essentially as marketers, working for the companies they cover rather than advisers to the investors using their research.”

Credit rating agencies were no better when it came to Enron. They “did not use their legally-sanctioned power and access to the public’s benefit. [They] instead appear to have displayed a disappointing lack of diligence in their coverage and assessment of that company,” the two senators said in their letter to Pitt.

The report proposed a number of actions for the SEC, analysts and credit agencies to prevent another Enron-like collapse. It recommended that the SEC “review more [corporate] filings and review them more wisely and efficiently;” follow up to make sure SEC mandates are met; supplement “aggressive enforcement” with other, more proactive measures; coordinate better with other agencies; and investigate the agency’s apparent mishandling of Enron’s PUHCA application.

As for Wall Street analysts, it proposed that financial analysts be separated from “investment banking influence;” barred from sharing their reports with “subject companies” prior to public release; required to disclose their track records and any conflicts they may have with companies that they cover; and required to disclose the reason or reasons for dropping their coverage of a stock.

Lastly, the report recommended that the SEC, in consultation with other agencies, establish: 1) a set of standards and considerations that credit raters must use in devising their ratings, including accounting issues; and 2) standards for required training of credit-rating analysts. It also proposed that the SEC closely monitor the credit-rating agencies’ compliance with the standards.

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