Enron BankruptcyEnron Bankruptcy

Philip B. Livingston, President and CEO

Financial Executives International

Enron - Front Line FailureEnron - Front Line Failure

• Failure rests 75% with the mgt team, 15% Failure rests 75% with the mgt team, 15% with the Board and 10% with the auditorwith the Board and 10% with the auditor

• These events happen on the financial These events happen on the financial management front linemanagement front line– Failed management teams that don’t have the Failed management teams that don’t have the

backbone to do the right thingbackbone to do the right thing– Starts with small compromises and becomes a Starts with small compromises and becomes a

culture of aggressive accounting, then illegal culture of aggressive accounting, then illegal coverupcoverup

– The local audit partner doesn’t have the The local audit partner doesn’t have the backbone to stand up to the client or walk awaybackbone to stand up to the client or walk away

Enron - What Happened?Enron - What Happened?

• Bad investments in “new economy” Bad investments in “new economy” ventures ventures

• Off-balance-sheet entities created to Off-balance-sheet entities created to eliminate losses from the ventureseliminate losses from the ventures

• Rather than face the write-offs, they tried Rather than face the write-offs, they tried to hide them with accountingto hide them with accounting

• Many off-balance-sheet loans collateralized Many off-balance-sheet loans collateralized by Enron stock by Enron stock

• Opaque reporting encouraged short sellersOpaque reporting encouraged short sellers• Form over substance in reportingForm over substance in reporting

Enron - What Happened?Enron - What Happened?

• Self –dealing as CFO trading with the Self –dealing as CFO trading with the company in troubled assetscompany in troubled assets

• Corporate ego overwhelmed control Corporate ego overwhelmed control systemssystems

• Restatements, corrections and new Restatements, corrections and new disclosuresdisclosures

• Collapse of confidence in reporting Collapse of confidence in reporting and integrity of management and integrity of management

• ““Run on the bank”Run on the bank”

Apparent Failures in Apparent Failures in RetrospectRetrospect

• Arrogant corporate cultureArrogant corporate culture• Finance and accounting staff largely Finance and accounting staff largely

recruited from Andersen – independence recruited from Andersen – independence compromisedcompromised

• Opaque reporting posture with investorsOpaque reporting posture with investors• Special investigation by main legal Special investigation by main legal

counsel – not independent counselcounsel – not independent counsel• Andersen apparently consciously Andersen apparently consciously

decided not to resign last year. They decided not to resign last year. They should have.should have.

Enron Fallout:Enron Fallout:Lots of QuestionsLots of Questions

• Opaque disclosure Opaque disclosure • How could the CFO be at the How could the CFO be at the

center of conflict of interest center of conflict of interest concerns ?concerns ?

• Was management conduct Was management conduct unethical?unethical?

• Where were the outside auditors? Where were the outside auditors? • Where was the audit committee?Where was the audit committee?

Enron Fallout:Enron Fallout:Audit CommitteesAudit Committees

• Strengthening the requirements for Strengthening the requirements for financial experts on audit committees financial experts on audit committees (we strongly support this) (we strongly support this)

• Need financial expertise to understand Need financial expertise to understand increasingly complex issuesincreasingly complex issues

• Need to be proactive and engagedNeed to be proactive and engaged• Need to challenge management and Need to challenge management and

the auditorsthe auditors

Enron Fallout:Enron Fallout:Possible Changes?Possible Changes?

• FASB ReformFASB Reform– Time for a new body?Time for a new body?– Time for new leaders?Time for new leaders?– Too slowToo slow– Not responsive to constituents and Not responsive to constituents and

issuesissues

Enron Fallout:Enron Fallout:New FASB Standards?New FASB Standards?

• Need for new Standards:Need for new Standards:– Consolidation of Special Purpose Consolidation of Special Purpose

EntitiesEntities• ““control”-based standard regarding control”-based standard regarding

SPE’sSPE’s

– Determining fair value of forward Determining fair value of forward contractscontracts•Rules for determining value where Rules for determining value where

contracts are not traded or thinly traded.contracts are not traded or thinly traded.

Enron Fallout:Enron Fallout:Audit ProfessionAudit Profession

• New body, not the AICPA, as industry New body, not the AICPA, as industry regulatorregulator

• Prohibit revolving door for audit Prohibit revolving door for audit partners – not employable w/ clientspartners – not employable w/ clients

• Mandatory rotation of auditors?Mandatory rotation of auditors?• Major increase in the level of audit Major increase in the level of audit

firm PEER review workfirm PEER review work• Eliminating the ability of the auditors Eliminating the ability of the auditors

to do consulting for their clientsto do consulting for their clients

Other Possible Changes?Other Possible Changes?

• Affirmative disclosure Affirmative disclosure requirementsrequirements

• Possible high-risk companies Possible high-risk companies targeted for increased reviewtargeted for increased review– Forensic auditsForensic audits

• FEI implement true disciplinary FEI implement true disciplinary procedure?procedure?

• Analyst and rating agency reformAnalyst and rating agency reform

Changes I RecommendChanges I Recommend

• Real prosecution needed for culpritsReal prosecution needed for culprits• Audit committees must have real financial expertsAudit committees must have real financial experts• Audit committees should adopt policy prohibiting Audit committees should adopt policy prohibiting

hiring of auditor personnel 3-5yrshiring of auditor personnel 3-5yrs• Auditors must restore SKEPTICISM as the Auditors must restore SKEPTICISM as the

foundation of their fieldwork. No more “business foundation of their fieldwork. No more “business partnering” mentalitypartnering” mentality

• Audit industry regulation must change to Audit industry regulation must change to maintain confidencemaintain confidence

• High risk situations need more audit workHigh risk situations need more audit work• A majority of Board members must be A majority of Board members must be

independentindependent

FEI’s MissionFEI’s Mission

To be the preeminent association To be the preeminent association forforfinancial executives and to:financial executives and to: Alert members to emerging issues Alert members to emerging issues

Develop the professional and management Develop the professional and management skills of membersskills of members

Provide forums for peer networking Provide forums for peer networking

Advocate the views of financial executivesAdvocate the views of financial executives

Promote ethical conductPromote ethical conduct

FEI Internet CommunityFEI Internet Community

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