Report Reveals “Systemic and Catastrophic Failure” of Financial Oversight in Enron Case

WASHINGTON – Governmental Affairs Committee Chairman Joe Lieberman D-Conn., and ranking member Fred Thompson, R-Tenn., issued a committee staff report Monday that charged the system of public and private financial watchdogs with failing to protect Enron employees and investors.

“What this report concludes is that investors were left defenseless,” Lieberman said. “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 – mostly hardworking, middle class people – saw the disaster coming or did anything to prevent it.”

The Securities and Exchange Commission largely left the search for fraud to private auditors and boards of directors – both of whom also failed to execute their duties properly either because they were “doodling at their desks” or embroiled in conflicts that made tough oversight unlikely, Lieberman said.

Wall Street analysts were wracked with conflicts of interest in reporting on companies their investment banking firms were also promoting. And credit raters simply performed their job with a “woeful lack of diligence.”

“What we found was systemic and catastrophic failure,” Lieberman said. He and Thompson outlined the report’s major findings in a letter dated October 7, 2002, to SEC Chairman Harvey Pitt:

• The SEC never adjusted to a rapidly changing business environment in which accurate corporate information was hard to come by. Companies were filing corrected statements, acknowledging error, at an ever increasing rate. Yet the SEC was reviewing a mere fraction of the annual reports filed. The SEC failed to review Enron’s annual reports at any time after 1997, in the years leading up to its collapse.

• When the SEC allowed Enron in 1992 to use a particular accounting method that enabled it to inflate its revenue and earnings, the SEC never followed up to monitor whether the conditions it had set allowing use of the accounting method continued to be followed.

• An application Enron filed in April 2000 requesting an exemption from certain requirements of the Public Utility Holding Company Act was mishandled. Enron was already exempt, it turns out, but sought another waiver because by merely filing a so-called “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. The SEC and FERC say it was the other’s responsibility to evaluate if the application was made in good faith.

• 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 – middle-class people trying to save for their retirement or their children’s education.

• 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 & Poor’s told committee staff that not only did they not read Enron’s proxy statement, they didn’t know all the information it contained. Among the recommendations in the committee staff report:

• 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 as much on others to do this.

• The SEC must put in place a means for monitoring compliance with its decisions.

• Wall Street firms should institute performance-based compensation and promotion systems to encourage accuracy and independence by their analysts.

• The SEC recommends placing 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.

Lieberman concluded: “I 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.”