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Time to audit the auditors?

Enron fallout may bring tough policing of accounting firms

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After decades in which accountants managed to convince the public of their ability to bless the books of Corporate America with virtually no regulatory oversight, there is growing skepticism about whether accountants can continue to police themselves.

In a way that no previous accounting scandal has — and there have been plenty of late — the collapse of Enron and the role of its auditor, Arthur Andersen & Co., have galvanized a discussion in the profession, among regulators and within Congress over the future of the industry. Investors, including thousands of the company's own employees, poured billions of dollars into Enron as it reported strong profits, only to see their stock dwindle to nearly nothing amid doubts about the reliability of the company's financial statements.

Andersen is now the subject of a Department of Justice investigation, numerous congressional inquiries and lawsuits from shareholders over its stamp of approval on Enron's books. The firm's admission last week that it destroyed documents involving Enron has only intensified speculation about whether the firm acted improperly in some way.

"This is potentially a seminal breach of CPA standards and ethics," said Rep. Jim Leach, R-Iowa, a former chairman of the House Banking Committee, referring to certified public accountants. The result will likely be a careful analysis of both the profession's standards and the means for enforcing those standards, he said.

In recent years, concerns have mounted about whether auditors are truly independent of their clients. Accounting firms have come to rely more on consulting work, rather than traditional audits, for their revenues, raising questions about their ability to stand up to clients if improper bookkeeping is suspected.

In the case of Enron, consulting work accounted for slightly more than half of the $52 million that Andersen received in fees in 2000. Even more important, though, was the potential income from consulting, according to John C. Coffee, a law professor at Columbia University. "Enron was a potential market for $50 million or $100 million in consulting fees," he said.

Accountants have always been paid by their clients for their role in reviewing their books, and critics have also argued that auditors are increasingly reluctant to alienate a big client that may contribute a significant proportion of its revenues. Andersen has conceded that Enron was one of its biggest and most desirable clients, something that would give pause to any auditor thinking about challenging the energy concern.

"There's no way that you could have a client which is that huge and important to you, and not be tempted to turn your head away from problems," said Dan L. Goldwasser, a lawyer who often advises accountants. "If the audit partner who's on the Enron account lost that account, they were history."

Many companies also hire former auditors, making the relationships between the accountants and the companies particularly cozy.

But critics also say that accountants are far less liable today for mistakes in signing off on a company's books than they were a decade ago. Suing accountants in state and federal courts has become increasingly difficult because of new laws governing securities class-action lawsuits, and a Supreme Court decision has made it harder for shareholders and others to sue a company's auditors, Coffee said.

"Over the last 10 years, the legal threat that kept auditors honest has been greatly diminished," he said.

The industry has managed to beat back most attempts for greater oversight, including a rule proposed by Arthur Levitt while he was chairman of the Securities and Exchange Commission that would have significantly reduced the amount of consulting work that an auditor could perform for its clients. A compromise was reached to require greater disclosure of the fees for audit and consulting work. Many industry observers cynically note that however big the scandal, accountants have emerged largely unscathed.

Accountants have regulated themselves, largely though an entity called the Public Oversight Board. The board was created in 1977, after Senate hearings debating whether the government should have a more active role in regulation.

"There may be questions about the adequacy of the Public Oversight Board, which is an entity that most Americans have never heard of," said Richard C. Breeden, a former SEC chairman. "There certainly have been concerns expressed in the past that it was not adequately funded and did not have the realistic ability to oversee the conduct of audits."

To ensure the quality of audits, accountants generally rely on peer reviews. Andersen was recently given a clean bill of health by Deloitte & Touche.

The SEC is already in discussions with the Big Five and the industry association about how to improve the way accountants regulate themselves, according to a commission spokeswoman.

Some members of Congress, including Sen. Joseph Lieberman. D-Conn., are discussing the possibility of greater oversight, in light of disclosures by Andersen. "Should there be more law with regard to Arthur Andersen?" Lieberman asked rhetorically. "Should there be more law and less self-regulation by the industry?"

Sen. Paul Sarbanes, D-Md., who chairs the Senate Banking committee, has scheduled hearings on some proposed industry changes next month.

Critics of the accounting industry have long complained of potential conflicts of interest that prevent auditors from being totally independent and calling for increased oversight. Former SEC Chairman Levitt, for example, has described the current environment as "an opportunity to rethink the way the industry is overseen and the way standards are set."

Though the industry has discussed changes to financial reporting, the Enron collapse points to a lack of compliance with existing rules, according to Lynn Turner, a former chief accountant with the SEC who is now an accounting professor. The industry may need a new independent body, akin to the regulatory bodies at the National Association of Securities Dealers or the National Transportation Board, to address problems like Enron. "We have got nothing like that in the accounting profession," Turner said.

Many of the big accounting firms declined to comment for this article. The American Institute of Certified Public Accountants, the industry association, has unveiled no specific plans to address concerns about the adequacy of its self-regulation. "We are obviously as concerned as anybody about the fallout from Enron," said a spokesman, noting that the facts surrounding the company's collapse are not yet known.

"We are prepared to make changes where necessary as soon as we could do that," he said.

But many within the industry acknowledge that the problem may be a lack of enforcement of the existing rules. If the rules "are not being enforced sufficiently, the first thing we need to do is figure out what it would take to get them enforced," said Louis Grumet, executive director of the New York State Society of Certified Public Accountants.