by Sylvain Comeau

Enron may be a financial apocalypse, but this makes it an ideal case-study subject in many classrooms. As soon as the biggest U.S. bankruptcy in history hit the news, Accounting Assistant Professor Maureen Gowing knew it would be perfect for her senior undergraduate course in accounting theory.

“I use stories in the news as often as possible, to illustrate the theories that I teach. One theory in particular says that accounting’s job is to create and maintain trust. Enron, as it is being portrayed by the media, is an ideal example to ask the question: Were the accountants doing that job?”

Gowing, who emphasizes that she doesn’t know any more about Enron than anyone else who is reading the papers, is particularly interested in the auditing by accountants of a company’s financial disclosure.

“That is one of the most high-profile tasks of accountants. The job of the auditor is to be professionally skeptical, applying certain tests to the numbers they are given, in order to be satisfied that the numbers represent fairly the financial situation of the company. That was [Enron auditor] Arthur Andersen’s job.”

Charges are premature

Gowing argues that there is simply not enough hard evidence to justify convicting the firm of failing to do their job or even being complicit in financial wrongdoing within Enron. For one thing, Enron’s business activities were cryptic and labrynthine — a puzzle for any auditor without expertise in hedging.

While Enron started out as an oil company, its main business in recent years was hedging. Hedging is a complex web of transactions in which companies bet one way on the financial markets, while simultaneously making what amounts to side bets to reduce their losses in case they are wrong.

“In the congressional hearings on Enron, the issue of transparency comes up over and over. In the accounting context, transparency means that an outsider looking at a company’s financial disclosure understands what the numbers mean. One of the big problems with Enron is that the business proposition of the company — hedging through the use of financial instruments called derivatives — is not a transparent activity.”

In fact, Gowing says that most people do not understand hedging or derivatives, and probably would still be baffled even if someone tried to explain it to them.

“Yet, accountants have to create standards and regulations of disclosure that would tell an outsider, transparently, the value of those activities. That’s very, very difficult.”

Gowing says that as more and more publicly traded companies increase their hedging to keep the financial risks they take within acceptable limits, that lack of transparency is everyone’s problem, not just that of auditors. But in this case, the auditors are in the position to be blamed, particularly by former Enron employees who lost everyting because they tied up all their retirement savings in now worthless Enron shares.

“When people lose everything, there is a tendency to want to retrieve something; Arthur Andersen, as well as Enron’s investment bankers, may be the target of lawsuits because they have a lot of money, while Enron itself doesn’t have any left. One has to feel for those people who lost their life savings, and we all have some sense that there is something profoundly wrong when this kind of thing happens, but we don’t know what that is yet.

“To say publicly that any one of the major players in this drama is a crook before you have appropriate evidence amounts to slander. Remember that those hurling the accusations are protected by privilege in the congressional hearings — we are not.”

Accountability essential

The bottom line for Gowing’s students is that they will face a heavy burden of responsibility if they are put in a similar situation.

“What I ultimately tell my students is that they will be held personally accountable. That is what the situation with Enron and Arthur Andersen is highlighting more than ever. Whether it’s right or wrong, when businesses unexpectedly fail, auditors pay a high price.

“Andersen has reportedly offered an $800-million settlement. That’s a huge amount of money, but the bankruptcy has been estimated to have cost over $90 billion.”

Tellingly, Gowing says she will not be writing any papers on Enron until a lot more evidence on the case emerges.