Opportunity for Corporate Fraud Has Shrunk -- but It's Still
By Carrie Johnson and Ben White, Staff Writers
Thursday, January 26, 2006
Four years after the collapse of Enron Corp. spurred the
most sweeping revisions in business regulation since the
Great Depression, experts warn that the ingredients for a
similar financial disaster remain.
Despite new laws and regulations, companies still face
enormous pressure to meet short-term financial goals,
creating a powerful motive for accounting fraud. Outsized
executive compensation grows by the year, offering another
rich incentive to cook the books. And there is no certainty
that Congress will continue to fund regulatory budgets at
But some things have changed since December 2001, when
Enron's sudden descent into bankruptcy protection rocked
investor confidence and left the markets reeling.
Accountants face independent oversight for the first time in
70 years. Most corporate board members take their jobs far
more seriously. Wall Street is somewhat less willing to
accommodate clients' interests.
Nearly a dozen experts contacted by The Washington Post,
including regulators, accountants, chief executives, board
members and investor advocates, agreed to fill out a
corporate governance report card on the eve of the Enron
The Houston energy trader's implosion exposed wide gaps in
the safety net designed to protect shareholders, some of
which remain today. Former executives Kenneth L. Lay and
Jeffrey K. Skilling go to trial Monday on fraud and
Accountants exploited loopholes to curry favor with
companies that paid their fees. Executives collected more
than $400 million in salary and bonuses but denied knowing
about fraud on their watch. Investment bankers engaged in
sham deals to help clients meet quarterly profit targets.
Boards of directors waived conflicts-of-interest policies
and turned a blind eye to overly aggressive business
practices. And overwhelmed regulators failed to devote
enough resources to combat fraud.
Congress passed the Sarbanes-Oxley Act in July 2002,
imposing new duties on corporate executives, auditors and
directors. The Securities and Exchange Commission and the
Justice Department spent tens of millions of dollars to root
out malfeasance. Along the way, prosecutors won criminal
convictions and decades-long prison terms for former leaders
of Adelphia Communications Corp., Tyco International Ltd.
and WorldCom Inc.
But in a sense, the government efforts may have backfired,
inspiring a dangerous overconfidence among investors.
"I just don't think we are as far along as we need to be,"
said former SEC chairman Harvey L. Pitt, who led the agency
when it brought the biggest-ever fraud case against
telecommunications company WorldCom Inc. in 2002. "Many
shareholders may have been led to believe that [reforms]
have cured all the problems, and we're home free.
Unfortunately, that's a prescription for disaster."
The lingering problems were on display late last fall, when
commodities-trading firm Refco Inc. collapsed in an
accounting scandal just two months after an initial public
offering, led by blue-chip investment bank Goldman Sachs and
Co. Investors snapped up Refco shares even though the
company admitted in its prospectus that there were serious
problems with accounting controls. "Could Enron happen
again? Sure it could. Just look at Refco," said Henry T.C.
Hu, a law professor at the University of Texas at Austin.
The grades suggest that the greatest improvement has been in
the regulation of the behavior of accountants who serve as
gatekeepers to the markets. New York Attorney General Eliot
L. Spitzer said the profession has been "scared straight" by
fallout from the scandals, which included the death of
accounting firm Arthur Andersen LLP and a $456 million
deferred prosecution settlement by KPMG LLP last year.
Corporate boards get fair marks for meeting more often and
paying more attention to the work of auditors. Last year,
longtime directors at insurer American International Group
Inc. overthrew Maurice R. "Hank" Greenberg as chairman after
nearly 40 years at the helm after regulators stepped up an
accounting probe at the company. And Hewlett-Packard Co.'s
board fired star chief executive Carly Fiorina because of
dissatisfaction with the way she handled a merger. She was
not accused of any wrongdoing at the company.
Even so, many board members still lack the financial
know-how to interpret complex information, said Dennis R.
Beresford, former chairman of the audit committee at MCI,
At the same time, opposition to some of the changes made
since Enron is growing. Increasingly, trade groups,
including the U.S. Chamber of Commerce and securities law
professors, have complained that boards and accountants
spend too much time meeting meaningless criteria rather than
getting to the root of more insidious problems.
Bob Merritt, the former finance chief at Outback Steakhouse
Inc., noisily resigned his post last April after decrying
"overzealous" regulations that tied him up in minutiae, far
away from business decisions. Many other executives across
the country privately applauded his stance.
Jeffrey Stone, a former federal prosecutor who now heads the
white-collar defense practice at McDermott Will & Emery,
said some new rules, especially one that requires a company
and its auditors to examine financial controls, impose heavy
costs "that far outstrip the protections that are afforded."
Each of the experts stressed that crooks bent on stealing
from a company will still take their chances and some will
succeed. Regulators can never pass laws that will force
executives to act with integrity -- or force investors to do
their homework before they buy stock.
Little has changed to shrink the incentives for taking big
risks, business as well as ethical, that can give rise to
Wall Street analysts and reporters still seek guidance about
company revenue each quarter. Businesses pay a price for
missing targets by even a penny or two. The earnings
guidance is "like heroin" for analysts, said Colleen Sayther
Cunningham, who leads a trade group for corporate finance
officials. "Once you put it into your arm, you can't kick
There has been no slowdown in the race for higher executive
pay, the experts said. Chief executives won a median pay
raise of 30 percent in 2004, twice the increase from 2003,
according to the Corporate Library, a watchdog group that
rates public companies on corporate governance. Repeated
studies have shown virtually no connection between high
compensation and good corporate performance.
"As long as CEO pay is so fundamentally out of whack, we
cannot say that boards are doing their job or that corporate
governance reform has been accomplished," said Nell Minow,
an investor advocate and co-founder of the Corporate
Some companies have moved away from compensating top
executives with stock options now that they are required to
count them as an expense. But in numerous cases, they have
simply replaced option, which pay off only if a company's
stock performs well, with restricted shares, which promise a
gain for executives no matter what. Critics refer to such
compensation as "pay for pulse."
William J. McDonough, former leader of an accounting
industry oversight panel, said recent initiatives, including
a drive by the SEC to beef up disclosures about executive
pay, are heartening. In all, though, there is "not as much
(progress) as I'd like to see. I don't think anybody
including me has any theory of how executive compensation
should be set."
In addition, investor advocates said they fear that once the
Enron trial ends and the focus on corporate crime fades,
regulatory budgets could again get squeezed. "Already,
recent appropriations have not matched agency funding
requests," said Barbara Roper, chief of investor protection
at the Consumer Federation of America.
The outcome of the Enron trial could have a more profound
impact on attitudes among corporate executives in the long
run than the regulatory changes, said Harvey J. Goldschmid,
a law professor and former SEC official.
"Deterrence is very important, and this trial is of large
consequence for that reason," Goldschmid said.
Staff writers Brooke A.
Masters and Steven Pearlstein contributed to this report.