Taking Sides: Enron debacle tests Mr. Pitt’s new puppy

With the collapse of Enron Corp., Big Five accounting firms are in danger of being looked upon as the business equivalent of airport security screeners.

The accounting firms argue that they audit thousands of businesses without incident, just as security companies pointed out in the wake of Sept. 11 that they had screened tens of thousands of passengers daily without lapses.

But that is missing the point – screening is not the issue; detection is.

The fact is, most companies, like most airline passengers, play by the rules. The cases in which they don’t are the ones that really count.

Whether airport screeners fail to detect a security breach, or auditors fail to catch financial reporting irregularities, the result is often the same: a catastrophe.

Airport screeners, however, are at times merely incompetent; auditors are often complicit.

Enron is merely the latest case in point.

The Houston company was a fairly straightforward supplier of oil and natural-gas products and services until the advent of deregulation in the 1990s.

Freed of regulatory shackles, utility companies could buy and sell power at will, and Enron evolved into a hybrid company. It sold oil and natural gas, and acted as a commodities broker that used complex hedging strategies and derivatives to conduct energy deals around the world.

Even the company can’t easily explain itself. “It’s difficult to define Enron in a sentence,” the company says on its website, enron.com. “But the closest we come is this: We make commodity markets so that we can deliver physical commodities to our customers at a predictable price.”

The smoke has yet to clear, but the company’s problems apparently arose as it became increasingly burdened with debt. Although the accounting machinations are too complex to detail here, Enron executives engaged in a series of actions that artificially inflated profits.

And where was its outside auditor, Arthur Andersen, in all of this? It was signing off on Enron’s accounting statements at the same time it was raking in as much as $27 million for consulting work.

Enron began to unravel this fall after its certified financial statements were called into question. Investors bailed, and the company’s trading partners balked, leading to a spectacular and sudden failure.

Executives now acknowledge that they had overstated profits by $600 million since 1997.

As always, investors were left holding the bag on stock that plunged to less than a buck a share.

For its part, Andersen has offered up the airport screener’s defense. Spokesman David Tabolt told The New York Times that the Big Five firm audited about 2,500 public companies a year, and “the number of audits where there are questions raised is very rare.”

The message was the same from Al Anderson, senior vice president at the American Institute of Certified Public Accountants: “In a typical year,” he told the Times, “more than 16,000 audits are done before the SEC for public filings – 99.9% of those audits are high quality.”

How reassuring.

Of course, it would be one thing if the Enron debacle were an isolated incident, but it’s just another in a long series of serious audit failures that involve not only Andersen but other Big Five companies as well.

Toward the end of his tenure as Securities and Exchange Commission chairman, Arthur Levitt tried mightily to curb accounting industry abuses in the face of stiff industry opposition.

Now the spotlight is on his successor, Harvey Pitt.

In his first speech on the job – before the AICPA on Oct. 22 – the nation’s chief securities watchdog strongly repudiated Mr. Levitt’s aggressive reform posture toward the accounting industry. At the time, some questioned whether Mr. Pitt was signaling his intention to play puppy dog instead of watchdog.

Now his words have come back to bite him on the duff. Handling the Enron situation will be a clear test of whether the agency under his aegis is capable of biting back.