Accountants primed for a thorough audit

ON WALL STREET: In a previous existence, long ago, I worked as an articled clerk to a Belfast accountant. Accounting was then considered an honourable, but dull profession. An accountant was said to be someone who realised he didn't have the charisma to become an undertaker. There were said to be three types of accountant, those who could count and those who couldn't.

I had to be able to count. Most of our clients were publicans. My job was to take the stock in pubs every Monday. I listed every bottle and spirit measure. Then I did a balance: the stock plus the take had to equal the stock on the previous Monday plus the deliveries. If it didn't, the barman was sacked for fiddling.

It was a pretty basic audit, but that is what accounting is about: balancing the books and keeping people honest. And the rules and methods of auditing are relatively straightforward, or at least they used to be. As Sean, the very dull accountant in Maeve Binchy's Circle of Friends, remarked to Benny: "The double entry system is your only man."

Now, accountants have to deal with complications like derivatives, off-balance sheet financing, third-party receivables and off-shore accounts.

But the bottom line in the Enron scandal is that the books didn't balance. The Houston energy-trading giant hid its debts to keep its share values high, as basic a deceit as if a Belfast barman added borrowed cash to his takings to hide the fact the business was going down the drain.

The Enron accounts were, however, written in such an opaque way that almost everyone was fooled. Bethany McLean was an exception. The 31-year-old Fortune magazine reporter suggested a year ago that the king had no clothes.

When she asked probing questions, Enron chairman Kenneth Lay rang her boss to complain, and three executives flew to New York to bend the ear of her editors. The magazine went with her story on March 5th. It warned that the company was burying information and of a "nasty surprise" in the offing. It was ignored by a financial community dazzled by Enron's share price (Ms McLean is now much sought after).

Another exception was bond analyst Daniel Scotto of BNP Paribas. He suggested in August, four months before Enron's bankruptcy, that clients should get out of the Texas company.

He was fired. Paribas denied a connection, but many Wall Street firms prefer their analysts to hype stocks and bonds, and increase their prospects of lucrative consultancy work.

If Ms McLean and Mr Scotto could see that something was wrong, how was it that the 100 green eye-shades from Arthur Andersen employed on the Enron account, taking $25 million (€29 million) in auditing fees in 2000, did not raise a red flag? They could have refused to certify Enron's financial statements, but they did not. There was too much at stake. The accountants earned another $27 million from Enron in consulting fees, making scepticism a firing offence.

Accountancy firms are compromised by such conflicts of interest, and it is getting worse. Over half of industry fees now come from consulting, up 20 per cent in six years. For every dollar of audit fees, accountancy firms got $2.69 for other services, according to a survey by Prof Andrew Bailey of Illinois University.

The sheer size of the $50 billion Enron bankruptcy and the fear of more to come has made reform of the accountancy business an urgent priority in the United States. Investor losses over the last six years due to earnings restatements are put at $200 billion, and such cases have doubled since the mid-1990s to more than 200 a year.

Up to now, the industry has been allowed to police itself through professional peer review. This clearly isn't working. On January 3rd, Andersen and its Houston office was, incredibly, given a pass by its fellow Big Five auditor, Deloitte & Touche.

For years the Big Five resisted change. Now the US Congress is drafting laws to force auditors to drop consultancy work. Harvey Pitt, the new Securities and Exchange Commission chief, is proposing a new disciplinary body and the end of peer review.

Mr Pitt is compromised by his previous anti-regulation work for the Big Five and is being urged by the business press to go much further.

His predecessor, Arthur Levitt, says the industry has defied disclosure too long by embracing a "fortress mentality".

Another aspect of accounting is also being blasted - the practice of cross-overs. All the top financial people from 1971 to 1997 at Waste Management, which in 1998 confessed to overstating earnings by $1.4 billion, came from Andersen. Enron's management ranks, too, featured many Andersen alumni. Mandatory rotation of auditors is another suggested reform.

The heat is now on. The media is in full cry. Analysts are out to save their reputations. Investors are asking if stocks are badly overvalued. The entire profession is now under a cloud for not keeping people honest.

As DT Max noted in the New York Times, accountants need to become dull again, like CC Baxter, in Billy Wilder's 1960 film The Apartment, who loses out by not letting his boss take a mistress to his apartment, but keeps his self respect.

Otherwise, the image of the shy and retiring accountant will be an accountant who is a million dollars shy and is retiring to the Bahamas.