Accounting companies providing auditing services and stock market analysts making investment recommendations took it on the chin Tuesday in the first of what promises to be a lengthy Senate investigation into the collapse of Enron Corp., and the failure of Wall Street watchdogs to sound a warning before the meltdown, described as “one of the largest, most destructive company failures of all time.”

“Conflict of interest” was the phrase applied over and over during the hearing before the Senate Commerce Committee into the Enron failure. Of the 17 analysts who regularly covered Enron, all but one had a buy, or a strong buy recommendation in effect as of September, after the CEO had resigned and the stock price had dropped 60%, Bill Mann, senior analyst for the Motley Fool, an online investment advisory service, told the committee.

Even as Enron declared bankruptcy Goldman Sachs and Lehman Brothers, both of which had provided significant banking services to Enron, still were recommending investors hold the stock, he pointed out. Lehman actually was issuing an aggressive buy recommendation. A Lehman employee also was on Enron’s board of directors, Mann said.

While the blame for the company’s failure “clearly lies with Enron senior management,” analysts helped make it possible for them to defraud the public by failing to demand facts and figures from the company. “Enron routinely failed to provide a balance sheet with their earnings announcements. They were a black box. No one, not analysts or individual investors knew what was going on,” Mann said. “There ought to have been pointed questions from analysts.”

Enron may not be the only casualty, Harvard Professor John Coffee testified. “The gatekeepers are too conflicted to be effective watchdogs. More errors of judgement are made when people are subject to conflict of interest.” Coffee noted that the number of companies having to restate their earnings has gone up “alarmingly, a 47% rise over a two year period.”

Coffee faulted the accounting firms that conduct so-called independent audits. He pointed to a serious problem stemming from the expansion of accounting firms into myriad services. They view the auditing business as a point of entry or loss leader to allow them to cross-sell their other services. In this position the accounting firms have an incentive to retain the companies’ good will by reporting favorably on their audits. Also, Coffee blamed the leniency of the courts, and in particular the Supreme Court, for removing the legal threat that auditors face in the case of fraud. He recommended that accounting firms develop a tough self-policing agency or face a crack-down from Congress and the courts.

Several committee members suggested the revival of a revision proposed last year by the chairman of the Securities and Exchange Commission to the independent auditor rule, which would have put restrictions on the marketing of non-auditing services.

Meanwhile, “there are more Enrons out there ready to blow up and devastate more investors,” Scott Cleland, CEO of The Precursor Group, told the committee. He cited conflict of interest as the key to the failure of the system in the Enron case, saying “all of the watchdogs are being paid for someone else.” Judging from the number of special off-balance sheet entities Enron had set up over the years, the company “should have been caught in 1997, 98, 99 and 2000. The system is supposed to catch these things.”

If the problems had been caught earlier the company’s stock would have suffered some reversals, but the situation would not have cascaded and Enron would not be in the position it is today. Cleland suggested passage of a sense of the Congress resolution that “Conflicts are not a good idea.” He said auditing firms increasingly are doing both inside and outside auditing work for companies. “They are essentially grading their own papers.”

Cleland also said that most of the research work put out by Wall Street, essentially has been bought and paid for by the companies the research is about. He warned that problems with other companies would surface, threatening the retirement funds of the baby boomers.

A representative of Enron’s auditor, Arthur Andersen (AA) defended his company’s performance, saying that except in one case Enron had kept secret information that would have led to questions from the auditing firm. In the one case, when Arthur Andersen learned of a partnership that added a serious debt load to the balance sheet, it immediately notified the audit committee of the company’s board of directors. AA executive C.E. Andrews said his company was paid $52 million by Enron, most of it for auditing work. He also pointed out that the payment from Enron was a small part of its $10 billion annual business.

The hearings will resume after the Congress returns on Feb. 4 with testimony from Enron Chairman Kenneth Lay, who has agreed to appear. The committee also will request testimony from former CEO Jeffrey Skilling and former CFO Andrew Fastow.

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