Financial Oversight of
Enron: The SEC and
Private-Sector Watchdogs.
Chairman
Joe Lieberman
October
7, 2002
Welcome. Today,
Senator Fred Thompson and I are releasing the first report to
come out of the full Governmental Affairs Committee’s
investigation into the fall of Enron.
This report - submitted to us by Committee staff -
examines the roles of the private and public sector watchdogs
- the Securities and Exchange Commission, the Wall Street
stock analysts, and the credit rating agencies - that
monitored the financial activities of Enron in the years
leading up to its spectacular meltdown.
What we found was systemic and catastrophic failure
across-the-board.
When Enron
filed for bankruptcy 10 months ago, it triggered a crisis of
confidence in our securities markets that still haunts them
and our economy today. The
investors who placed their trust in our system of financial
controls and put their hard-earned dollars into what was then
the seventh-largest company in the world never could have
guessed they were investing in a house of cards.
When the cards collapsed, thousands of hard-working
people lost their livelihoods, and many more lost their
savings, while those at the top parachuted out of the mess
they created with their ill-gotten wealth intact.
The ripple effect of Enron’s fall - and the parade of
corporate debacles that followed - has scarred the lives of
millions more. The
confidence of the more than 50 percent of Americans who own
stocks - most of them hard-working, middle-class people - has
been shattered. And
every day it is chipped away further by the relentlessly
falling DOW, NASDAQ and S&P.
It is their interests - their education funds, their
retirement plans, their quality of life and how to protect
them - that has motivated our Committee’s investigation from
the start.
In January, our Committee began a review of the
watchdogs who were supposed to protect investors from the
financial calamities we have witnessed in stunning succession
this year. Our
goal was to find out how well these watchdogs performed in the
Enron case and whether they might have done anything
differently to prevent – or at least anticipate –
Enron’s problems.
What Committee staff discovered was that investors were
left defenseless. The watchdogs were asleep at the gate.
Despite the magnitude of Enron’s implosion, virtually
no one in the multi-layered, public-private system that is
supposed to protect investors saw the disaster coming or did
anything to prevent it.
Why didn’t the watchdogs bark?
At the SEC, the search for fraud was largely left to
others - the private auditors and boards of directors, which,
as we now know, were either doodling at their desks, or
engaging in conflicts of interest that made it very unlikely
they would ever bark at their corporations’ fraud or crimes.
Among Wall Street analysts, there were fundamental
conflicts of interest, and among credit raters, a woeful lack
of diligence.
The SEC - which proudly calls itself
“the investor’s advocate” - never adjusted to a
rapidly changing business environment in which accurate
corporate information was harder and harder to come by.
Companies were filing corrected financial statements at
an ever rising rate. In
fact, Arthur Leavitt, the SEC chairman at the time, warned of
the declining quality of financial reporting and the
widespread conflicts of interest among those who were supposed
to account for a company’s numbers.
But the SEC ignored these vulnerabilities and so, may I
add, did Congress.
In 2001,
the SEC reviewed on 17 percent of the annual reports filed by
public companies. Over half of
all public companies have not had their annual reports
reviewed by the SEC in the last three years.
As is well known by now, the SEC failed to review
Enron’s annual reports in the years leading up to its
collapse. Had it
done so, a number of red flags would have been raised.
The Committee report also found that the commission
dropped the ball on a number of other consequential ways.
When the SEC allowed Enron in 1992 to use a particular
accounting method – mark-to-market – that enabled it to
inflate its revenue and earnings, the SEC never followed up to
monitor the effect the change had on Enron’s financial
statements or whether the conditions continued to apply.
Our
committee report also exposes for the first time the
mishandling of an application Enron filed in April 2000
requesting an exemption from certain requirements of the
Public Utility Holding Company Act.
It turns out Enron was already exempt but sought
another waiver - because by merely filing a purportedly
“good faith” application, it could get additional benefits
from the Federal Energy Regulatory Commission.
The SEC has yet to rule on the application, effectively
allowing Enron to retain these economic and regulatory
bonuses. Just this
morning, the SEC announced it has scheduled a hearing on the
issue. Nevertheless,
the two and a half year delay, up until now has allowed Enron
to continue to enjoy economic and regulatory benefits.
Meanwhile, the SEC and FERC say it was the other’s
responsibility to evaluate whether the application was made in
good faith.
As for the private sector watchdogs, the report
concludes that Wall Street analysts are exposed to so many
conflicts that objective, hard-hitting analyses are hard to
come by. Too
often, they tout the companies they cover rather than report
accurately for those who rely on the information - the
middle-class folks trying to save for their retirement or
their children’s education
Our staff also concluded that the credit rating
agencies were dismally lax in their coverage of Enron.
They didn’t ask probing questions and generally
accepted at face value whatever Enron officials chose to tell
them. And while
they claim to rely primarily on public filings with the SEC,
analysts from Standard and Poor’s not only did not read
Enron’s proxy statement, they didn’t even know what
information they might contain.
The report makes a number of recommendations to address
these problems: Among
them that the SEC must review more filings and find better
ways to identify the high risk ones.
The Commission must step up its efforts to root out
financial fraud by using better technology and a more vigilant
staff to pro-actively look for fraud and not rely entirely on
others to do this. And
the SEC must put in place a means for following up on its
decisions.
With regard to stock analysts, we recommend that there
must be an impenetrable wall between them and their firms’
investment banking concerns to diminish the likelihood of
biased reporting. Rules
proposed by NASD (formerly known as the National Association
of Securities Dealers) and the New York Stock Exchange, and
approved by the SEC in May, were a first step.
The Sarbanes-Oxley Act, which requires the SEC to issue
rules addressing analyst independence, offers a better chance
at real reform. The
Committee report recommends that Wall Street firms institute
performance-based compensation and promotion systems to
encourage accuracy and independence by their analysts.
The report further recommends that the SEC place conditions on
the special designation
the SEC confers on the
credit rating agencies that makes them so powerful.
The SEC should establish one set of standards credit
raters must use in devising their ratings and another set of
standards for training the analysts.
The SEC should then monitor compliance with both those
sets of standards.
The collapse of Enron was an alarm call to us in
government to make sure we are doing all we can to protect the
integrity of our markets and the savings and investments of
the American people. Investors
are understandably wary these days - as well they should be.
But I am an inveterate optimist and believe powerfully
in Henry David Thoreau’s credo that people “were born to
succeed, not fail.” We
hope this report stimulates closer, more effective oversight
by the SEC and a greater commitment to honest, independent
information from the private sector watchdogs so that we can
rebuild America’s trust in our system of financial oversight
and restore strength to our economy and growth to our markets.
Thank you. |