It’s not nice to fool the investing public — energy companies and their auditors are learning as Enron’s collapse continues to spark a tidal wave of investigations, recriminations and falling stock prices. Not only the companies are under attack but also the investment analysts who follow them and even the watchdog Securities and Exchange Commission (SEC) itself is coming under fire for a “failure of leadership,” for abdicating its responsibility to set strict financial reporting standards.

Conflicts of interest, “rampant throughout the U.S. capital markets system, virtually ensure that future Enron- type collapses will occur again unless the internal controls of the system are substantially strengthened,” according to Scott Cleland, CEO of The Precursor Group, an independent research firm based in Washington. Cleland issued a press release on testimony he will be offering before the Senate Commerce Committee, Subcommittee on Consumer Affairs, Foreign Commerce and Tourism which is holding a hearing Tuesday.

“The U.S. capital markets system clearly failed thousands of Enron investors, pension holders, creditors, employees and customers. It is clear that the system will continue to fail investors, until the root cause — rampant conflicts of interest throughout the system — are brought under control.”

Wall Street research analysts were still touting Enron as a “buy,” “strong buy,” or “hold” stock even as the company’s financial problems became apparent, Clelands said, noting that “one of the most publicly accessed finance web sites, Yahoo! Finance (Found at https://biz.yahoo.com/z/a/e/ene.html and https://biz.yahoo.com/c/e/ene.html ) demonstrates that investors relying on analysts following Enron would not have thought their investment capital was in jeopardy. The sites track the research recommendations from the last three months and show that even with the recent dramatic news documenting Enron’s financial deterioration, only two research analysts were advocating ‘sell’ or `strong sell’ orders to their clients. In contrast, nine research analysts this month and 12 research analysts last month advised their clients to “hold,” “buy,” or `strong buy’ shares of Enron.

But, could these analysts have done any better, given the confusing and contradictory financial information they had to work with? John Gehman, president of Energy Performance Review (EPR), who has been tracking financial information from energy companies for nearly 20 years, sees the failure of the SEC to set down serious guidelines for companies to report financial information on a “line of business” basis as contributing to the current crisis of confidence.

“It appears you have to have a multi-billion dollar company collapse before anybody starts to get serious about making companies report what they actually do on a day-to-day basis,” Gehman told NGI. The SEC missed its chance when it endorsed the Financial Accounting Standards Board (FASB) rule 131 in 1997, Gehman said. The order loosened accounting standards first installed in 1976 and gave the companies broad leeway in reporting financial results according to the way they manage their businesses, rather than requiring reports according to specified business segments. “This makes it impossible for anyone attempting to track the profitability of a company’s various business activities or to compare it with the results of other companies.”

“The SEC’s decision not to force companies to break out their financial reporting on the basis of business segments was a really dangerous decision.” The lack of clarity in financial reporting “comes back to haunt them when there is a crisis of confidence,” such as the one brought on by Enron’s financial collapse, Gehman continued. “Companies have taken advantage of the loose reporting standards, and now they are suffering from it. You can only have a free competitive market and maintain investor’s confidence if there are strong government reporting guidelines that are enforced,” he added. But most of the companies “just don’t get it.”

It appears the SEC in loosening its reporting standards may have been influenced by the major accounting firms, which in turn, are acting in the interests of their company clients, Gehman said.

Gehman has been prodding energy companies for a number of years to report on a line of business or business segment basis. More companies recently have been coming around to the idea, but too many “just mix everything up, coal, gas electricity, with all kinds of things thrown in.” EPR attempts to sort out the results and maintains a comparative financial and operating database for companies and industries at www.energyperformancereview.com.

An energy analyst who asked to remain anonymous, blamed part of the Enron debacle on the “herd mentality” on Wall Street. “It would have been the end of the career of any analyst who raised questions about Enron while it was a high-flyer, and while all the top analysts were touting it.” He said a number of analysts had questions about Enron’s indecipherable financial reports, but they didn’t dare to be the lone wolf raising them. The fact that there were so many questions just beneath the surface accounts for the energy giant’s swift fall. Once Enron disclosed the partnerships and restated earnings, those with questions “had something to fasten on.”

Meanwhile Cleland and research team have five recommendations for Congress, which he believes would strengthen investor confidence in the capital markets system: (1)official regulatory and industry policy should discourage conflicts of interest that can undermine critical internal controls; (2)auditors should be prohibited from consulting for companies they audit and from conducting “independent” audits of their own internal audits; (3) the overall objectivity of the investment research system should be strengthened so investors get more unbiased research and are more aware of conflicts of interest; (4) analysts should be discouraged from owning a financial stake in the companies they cover; and (5) there should be increased awareness and vigilance of the press to stock manipulation, especially as it applies to “pro-forma” accounting and “Street expectations.”

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