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.