POST-ENRON PROGRESS

POST-ENRON PROGRESS
Washington Post: It's been about a month since Enron emerged as a full-blown scandal, but the financial markets are still struggling with the revelation that corporate accounts can be utterly misleading. Investors cannot know how many more Enrons lurk, so they are dumping stocks at the first rumors of shady accounting. In some cases they are punishing firms that are rumor-free but that belong to an industry (for example, energy or telecommunications) now suspected of aggressive bookkeeping. The whole class of acquisitive companies has fallen from favor, because acquisitions are often associated with poor financial disclosure. Investors' confusion underlines the need for reform of auditing.
Until the profession is cleaned up, there is no way that investors can distinguish sound firms from weak ones -- and therefore no way that capital can be allocated efficiently.
Reform: Fortunately the momentum for reform is growing. A new bill in the Senate grapples with the issue of stock options, which companies can count as an expense for the purposes of reducing their tax liability while simultaneously not counting as an expense for the purposes of reporting profits to shareholders. The Securities and Exchange Commission has proposed rules requiring prompter financial disclosure, notably of share dealings by executives: This might stop bosses from loudly recommending their stock while simultaneously dumping it. The Financial Accounting Standards Board has promised to issue tougher rules soon on the partnerships that companies use to hide their real financial positions -- rules that have been a decade in the making.
Perhaps last week's most promising initiative came from Rep. Michael Oxley, R-Ohio, the chairman of the House Committee on Financial Services. Mr. Oxley and his colleagues are considering legislation that would ban auditors from selling consulting services to their clients, a conflict of interest that might dampen auditors' willingness to blow the whistle on deceptive bookkeeping.
At the same time, Mr. Oxley is contemplating a new institution to oversee auditors, replacing the toothless self-regulatory body that exists now. This proposal strengthens an earlier one from Harvey Pitt, the SEC chairman: If set up by Congress with statutory authority, the new regulator may get the financial independence, subpoena authority and powers of punishment it needs to be effective.
This post-Enron progress is encouraging, but it is just a start. The scandal has revealed a chain of weaknesses in the nation's financial system that will require a chain of responses: Strengthening the SEC's enforcement division, sharpening the legal liability of auditors and other corporate advisers, and bolstering the financial independence of the Financial Accounting Standards Board are all necessary as well.
Defeatism: The challenge is to prevent the necessarily long list of needed reforms from inducing eye-glazing defeatism. Unless bookkeeping clarity can be squeezed out of the financial machinery, America's stock market system won't function as it should.