BETRAYED BY THOSE WE TRUST MOST

by: Cary Christian

Few things in life are as devastating as being betrayed by people we trust above everyone else. It generally takes a very long time to build trust in the first place. We almost grudgingly grant our trust to people only after they have passed numerous milestones in the relationship with no setbacks. Once trust is built, it remains tenuous. What has taken years to build can be destroyed in moments.

Trust can be built and exists not only between people, but between people and organizations. Granted, this type of trust is not normally as devastating when broken as those bonds between two people. But there are times when we must rely so heavily on an organization to protect us that the effects of a breach in trust may become enormous.

Tonight I am thinking specifically of the debacle surrounding Arthur Andersen's failed audits of Enron and the subsequent charges of obstruction of justice stemming from the shredding of documents by employees of Andersen. You may think this has little to do with you and little relevance to the normal subject matter of this newsletter. PLEASE DON'T STOP READING YET!  These incidents can and will affect your life and your business in many ways.

THE ROLE OF AUDITORS IN OUR SOCIETY

Since the events leading up to the Great Depression, auditors have played an extremely important role in American business.  The Great Depression could have been avoided had companies been subject to the stringent audit and reporting requirements today's companies must comply with. For the most part these rules and regulations have prevented our having another Great Depression by supplying strict accounting rules that must be followed and providing that a company's financial statements must be audited by an independent auditing firm.

However, these rules and regulations depend on the independent auditor being truly independent and having integrity beyond any doubt. The rules are so strict regarding independence that even the mere appearance of a lack of independence is dealt with rather severely. Why then would an auditor participate with a client in falsifying or in publishing misleading financial statements?

THE EROSION OF INDEPENDENCE

Almost all public companies are audited by one of five huge, multinational accounting firms, Andersen being one. These accounting firms not only provide auditing services; they provide tax consultation and preparation services, business consulting services, and systems implementation services as well. Most of the income generated by these giant entities come from the services other than auditing. In fact, it is quite common that audit fees will be reduced to obtain the audit and get a foot in the door in order to sell these other lucrative
services to the client.

A recent article in a Detroit newspaper dealt with the flood of public companies announcing they were in the market to replace Andersen as their auditors. Several companies were cited as examples along with the fees paid to Andersen for various services.

One example that was fairly representative quoted Andersen's fees as being $2.8 million for the audit and $5.3 million for tax and consulting fees. This relationship between audit and other services fees highlights the real problem: losing the audit usually means losing all the other services revenue, so the firm cannot afford to lose the audit under any
circumstances! This is the absolute source of the erosion of independence.

WHAT CAN BE DONE?

It seems almost too simple to suggest that independent auditors should not be allowed to provide any other services to audit clients. But maybe the simple solution will work best for everyone.

For decades, many have suggested that auditing firms should be required to divest themselves of their tax and consulting divisions. In fact, Andersen did separate from its computer consulting division many years ago. The consulting division became Accenture. Then Andersen promptly created a new consulting division to compete with Accenture!

Accounting firms have fought this battle many times before.  They are going to provide consulting services one way or the other, so let them. Just don't let them provide them to their audit clients.

Another alternative is to let a governmental agency assign auditors on a rotating basis to all public companies to prevent the auditors from becoming too close to any one audit client.

WHY MUST SOMETHING BE DONE?

Do you own stock? If not, do you hope to someday? Enron seemed to be an incredibly strong company worthy of your investment in their stock. What if you had bought it? You would have lost every penny.

What about the other companies in your current or future portfolio? Do they have similar problems that are being covered up by the auditors? How safe are your investments?

Makes you wonder, doesn't it? That is the cost of a loss of trust. It might make you pull out of the market altogether. If enough of you pull out, what happens to the market? You get the picture. Our markets are based on trust. Once the trust is gone, we'll be watching our businesses fail left and right because they can no longer raise capital.

HOW COULD THIS HAVE HAPPENED?

Imagine you are an audit partner with Andersen or a similar accounting firm. One of your clients is worth about $10 million in total annual fees to the firm. This client is pressuring you to work with them on revenue recognition or some other accounting principle to prop up their earnings until their situation improves. They point out to you that the literature
could be interpreted in their favor. And chances are, it could.  It's difficult to make everything black and white when it comes to accounting for transactions across industry lines. What are you going to do? Play hard ball and possibly lose a $10 million client or work with them as much as you can?

It's a difficult situation to find yourself in. It is my opinion that we should restructure the way audits are performed so that no one ever has to be faced with this type of decision again.

I don't know how many people were on the Enron audit team, or how many actually participated in making audit reporting decisions that were faulty, but chances are the blame can be laid at the feet of only two or three people. Look at what has happened because of the actions of so few:

o Enron employees and shareholders lost their entire investments. Many Enron employees lost everything they had!

o Our ability to trust the financial statements of public companies has taken a body blow.

o Andersen will probably cease to exist. Most all of the partners will make deals and go to other firms, taking their remaining clients with them. The tens of thousands of employees below partner level will be scrambling to find employment. The little guy will get hurt, just like at Enron. A multi-billion dollar company bites the dust because of the actions of two or three people!

WHAT CAN YOU LEARN FROM THIS?

If you invest now, or plan to in the future, do yourself a big favor: learn how to read a financial statement. Don't depend on your broker. Learn to ferret out the risk factors in a company on your own. It's not as hard as you might think. Remember that the application of accounting principles requires the exercise of judgment on the part of the auditor. Issues are not black and white. Learn how to form your own opinion before you invest your money.

Don't think of these issues as being someone else's problem.  This type of issue affects us all in one way or another. If our markets suffer because of this, all of our businesses are hurt.  Stay informed and be active in voicing your opinions.

WHY DID I CHOOSE TO WRITE THIS EDITORIAL?

I want to thank those of you who read this article. It matters a great deal to me. You see, I spent the first eleven years of my career at Andersen in tax and systems consulting (NOT in the audit division). The training I received during that portion of my career has been indispensable. It makes me both sad and angry to watch as this unfolds. What I wish for those within Andersen who allowed this to happen cannot be printed here.

Many people that I respect a great deal have been hurt by this even though they've never done anything wrong. The vast majority of the people at Andersen are hard-working people just like us whose character is above reproach. They are victims also.


Copyright (c) 2002