Strategy & Operations » Governance » Enron: 10 years on

WHEN 250 former Enron employees met on 2 December at London’s Texas Embassy Cantina restaurant to mark the 10th anniversary of the collapse of their former employer, there was much talk about learning lessons and moving on.

But has the corporate world really learned the lessons? Or was Enron just a milestone – albeit an especially mud-stained one – in an unending journey that will feature more company collapses and scandals in the future?

“The key lesson learned from Enron is that, perhaps, the lessons weren’t learned,” warns Paul Moxey, head of corporate governance and risk management at the Association of Chartered Certified Accountants (ACCA). The Enron diseases of excessive leverage, skewed incentives, and special-purpose vehicles have resurfaced in post-Enron financial scandals, including WorldCom and Lehman Brothers.

Despite a vast increase in regulation and compliance activity in the post-Enron world, Meziane Lasfer, professor of finance at the Cass Business School, City University, believes that there is still corporate risk in three areas that were fundamental to the Enron collapse.

First, despite the fact there is a more rigorous approach to revenue recognition – a key way in which Enron inflated its earnings – Lasfer believes that some companies are still struggling with the problem: “When we look at revenues of companies, we really don’t know whether there is still some turnover at risk – for example, from returned products.”

Then there is the question of cost recognition, where Enron devised scams such as capitalising revenue costs or moving them into subsidiaries. “When we look at accounts, we cannot say the tricks used by Enron have disappeared,” he says.

Finally, there are the debt levels and leverage that companies report. Enron hid debt in subsidiary companies. “We don’t yet know whether there are accounting firms devising other ways to hide debt,” adds Lasfer.


But although there may be the potential for more problems – and it would be a foolish finance director who bet on there never being another corporate scandal – there is little doubt that life in the finance suite has changed in the past 10 years.

“The role of the FD has changed since Enron,” says Moxey. “The effects of Sarbanes-Oxley have been felt well beyond the US, creating a lot more responsibilities for FDs for documenting procedures. There has been a surge in internal control documentation, for example, but this does create the risk of re-enforcing compliance mentalities. Enron has required FDs to understand their business models more, especially how accounting practices interact with them.”

Richard Francis has occupied a number of CFO roles, most recently as CFO of an Adobe Systems company. “I think that the Sarbanes-Oxley legislation that followed in the US post-Enron was a sledgehammer to crack a nut,” he says.

“While there were some welcome new requirements – such as bringing greater accountability by officers of corporations – it was so far-reaching as to make many companies highly risk adverse and backwards-looking. In one company I worked at, the finance organisation almost had to take six months’ leave from assisting the commercial side of the business in order to tick all the boxes, which was a huge cost to the business.”

But Francis, who now runs his own consultancy, Francis Vienne, says that Switzerland, where he also worked as a CFO, is an example of how regulation can be proportionate. “The Swiss recognise the need for strong internal controls while at the same realising that there is also a need to run a business,” he says.

Internal audit

One of the lessons learned in the post-Enron world has been the importance of internal and external audits. External auditors have seen restrictions placed on their ability to offer advisory services to their clients. However, Jim Muir, director of AutoRek, a financial controls software company, points out that the restrictions are hard to police.

“In theory, such limitations on services opened the door to companies such as Atos (which acquired KPMG Consulting in the UK) and to the medium-sized firms such as Grant Thornton and specialist advisory firms such as Novo Altum,” he says. “The reality has been somewhat different in practice, with the Big Four re-establishing full-service consultancy offerings and the restrictions having little or no impact on their overall market share – arguably not the intention in any event – and far less specific limitations inside a specific client.”

However, the EU Internal Markets Group recently tabled proposals to strengthen various restrictions on external auditors providing additional services to their clients.

Formal recognition

Standards of internal auditing have also been strengthened under the watchful eye of the Chartered Institute of Internal Auditors. Jackie Cain, the institute’s policy director, says that in a best practice situation the head of internal audit needs to be appropriately qualified and report at a level that provides independence of the functions they are auditing. “They need clear access to the audit committee – a real active reporting line rather than something in a manual,” she says.

One live issue that is still being debated is whether internal audit services should be outsourced. Cain argues that the debate shouldn’t focus necessarily on what the audit committee thinks about an external audit firm’s skills and expertise. “Rather, it’s saying that external audit and internal audit are two separate cornerstones of good governance,” she says.

“We think it’s better that they’re provided by different providers because then you have two heads looking at the situation from different perspectives – serving different customers, doing different work, with different objectives over different time frames. It’s better for the quality of internal audit if they’re separate.”

Cain would like to see internal audit recognised more formally in the Governance Code as a valued source of information for the board. She says that boards’ good governance requires them to focus on the relationship between the head of internal audit, the chair of the audit committee and the chairman of the company, and explore how those relationships may need to be strengthened.

“Those relationships need to be trusting ones, where the people involved know one another well enough to trust the others when they raise an issue that needs attention,” she adds.

Mood of the times

Yet despite regulations and tighter auditing, it seems that scams and frauds of the Enron variety are now far more common than they were half a century ago, for example. John Board, director of the International Capital Markets Association Centre and dean of Henley Business School, believes that this trend is partly the result of the “mood of the times”.

He argues that as the slowdown has begun to bite, companies have searched ever harder for ways to defend their rates of return. But he warns: “There is no system of reporting or compliance that won’t guarantee that these kinds of events [like Enron] won’t happen again. The mistake people make is that they believe regulation can stop scams and frauds.”

He suggests that the investment community needs to focus more clearly on the difficulty of getting high returns without risks. That means investors – especially institutional investors – should be more active. There are signs that this is already happening. For example, there has been a record number of shareholder revolts against FTSE-100 remuneration reports this year.

ACCA’s Moxey says: “The key lesson now for FDs is that they need to learn how to support business and the public interest by giving a clearer view of how their organisations create and deliver value.”

And he concludes: “Remember that value is about more than profit.” However, that is a lesson which FDs and boards still have yet to learn.