Senate Report: Enron's Board Knew Accounting Pushed Limits

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On July 7, 2002, the day before the Senate took up the accounting reform bill, the Subcommittee on Investigations released a report finding that Enron's directors failed to perform their duties in several important respects. A key finding described as "one of the most disturbing developments" is the accumulation of evidence that the audit committee knowingly allowed the company to use high-risk accounting practices.

Congressional investigations showed that Andersen had regularly informed Enron's audit committee of the risks associated with the company's accounting policies. The directors were warned that the company was using accounting practices that invited scrutiny and presented a high degree of risk of non-compliance with generally accepted accounting principles (GAAP) because of their novel design, application in areas without established precedent, and significant reliance on subjective judgments by management personnel.

For example, the report describes a typical presentation by lead audit partner David Duncan. His risk profile analysis identified four types of accounting issues at Enron, (i.e., highly structured transactions, commodity and equity portfolio, purchase accounting, and balance sheet issues). To show the level of risks involved, specific issues within each category were assigned H, M or L ratings signifying high, medium or low risk. Each of the accounting issues listed on Enron's report was followed by one, two or three Hs, meaning it was rated as high to very high risk. Andersen's legal counsel explained the analysis showed that the company could later be found in noncompliance with GAAP despite Andersen's backing, and it demonstrated how the elements in the system overlapped – if one element failed, the entire structure might fail.

Mr. Duncan's handwritten notes clarified, "Obviously, we are on board with all of these, but many push limits and have a high 'others-could-have-a-different-view' risk profile." Another partner present at the meeting confirmed that Mr. Duncan informed the audit committee that Enron's accounting practices "push limits" and were "at the edge" of acceptable practice. The committee discussed this. But no member objected, requested a second opinion of Enron's accounting practices, or demanded a more prudent approach.

Expert witnesses at the Congressional hearings expressed surprise and concern over the role of the audit committee in countenancing high-risk accounting practices. The investigations also found evidence that the directors knowingly allowed transactions involving inappropriate conflicts of interest, extensive off-the-books activities, and excessive executive compensation. The report concludes that the board chose to ignore these factors to the detriment of Enron shareholders, employees and business associates, and it strongly urges reforms to strengthen oversight and independence requirements for both directors and auditors.

Download the full report.

-Rosemary Schlank

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