I’ve just completed some fascinating reading about the distortion of reality and its negative impact on the many people it touches.
No, I’m not talking about the book “A Beautiful Mind,” which chronicles the tragic breakdown of a genius suffering from schizophrenia. I’m talking about the Enron Corp. annual report released more than a year ago.
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“At a minimum, we see our market opportunities company-wide tripling over the next five years,” reads that report’s delusional proclamation from former Chairman Kenneth Lay and former Chief Executive Jeffrey Skilling, whose maneuvers drove company, employees and shareholders into the ground. “Enron is laser-focused on earnings per share, and we expect to continue strong earnings performance.”
What about cynics who questioned such projections?
“Our performance and capabilities cannot be compared to a traditional energy peer group,” Lay and Skilling sniffed in the shareholder letter. “Our results put us in the top tier of the world’s corporations. We have a proven business concept that is eminently scalable in our existing businesses and adaptable enough to extend to new markets.”
At least the report’s financial data was carefully scrutinized, right?
“Management’s assertion that the system of internal control of Enron Corp. and its subsidiaries … was adequate to provide reasonable assurance as to the reliability of financial statements and the protection of assets from unauthorized acquisition, use or disposition is fairly stated based on current standards of control criteria,” Arthur Andersen LLP confirmed in its independent public accountant’s statement.
That accounting firm not only helped structure Enron partnerships or “entities” that were kept off the books–and whose debt accelerated the company’s failure–but as the firm’s auditor it also approved that treatment of them.
“Because of inherent limitations in any system of internal control, errors or irregularities may occur and not be detected,” Andersen noted in accounting terminology, which in this case was understatement of mythic proportions.
Enron isn’t the first corporation to give incorrect financial information or withhold vital information, but the sudden tailspin that made it the biggest bankruptcy in history created a landmark scandal.
Accountability of corporations and accountants is especially important in a troubled economy.
In the case of a company with rising earnings, stock appreciation and awesome prospects, nobody wanted to believe the worst.
“Anyone who looked at Enron’s financial statements would have seen that the business couldn’t possibly sustain the kind of earnings it was presenting, and that’s a major red flag,” asserts Lawrence Mitchell, law professor at George Washington University and author of “Corporate Irresponsibility: America’s Newest Export” (Yale University Press: 2001).
“We’re going to see improvements in the handling of accounting principles and regulation of the accounting profession because people realize they’re not getting a lot of information from financial statements,” said Robert Willens, accounting and tax analyst at Lehman Brothers.
Convinced there are “probably one or two more Enrons out there,” Willens believes financial statements must become “user-friendly” if the accounting profession is to regain the confidence of Americans. He urges investors to look at all footnotes listed under “Investments in Unconsolidated Affiliates” to find “entities” in which a company has invested that aren’t included in its consolidated financial statement.
“We’re studying circumstances under which an entity set up for a special purpose should be included in the financial statement,” said Tim Lucas of the Financial Accounting Standards Board. “We should have a draft issued for public comment in the second quarter.”
Note that this issue has been argued within the accounting profession for more than 20 years. In the meantime, don’t believe everything you read.
“An auditor’s report is not a `Good Housekeeping Seal of Approval’ that the company is a good investment, but rather assures financial statements have been prepared in accordance with generally accepted accounting principles,” concluded Chuck Landes, director of auditing standards for the American Institute for Certified Public Accountants in New York.
“After looking at the historical financial statements that the audit provides assurances on, don’t make a leap of faith that the future will be just like the past.”