Don't they know we get it?
We understand that the scams perpetrated at
and the fraud that eventually led to the destruction of billions of dollars in investor capital weren't the work of some isolated group of cowboys at one company in Houston.
Decades of work under Republican and Democratic presidents by the biggest and brightest of accounting firms and investment banks, by legions of lobbyists and lawyers, led to a rewriting of the rules in a way that made an Enron possible.
And some of the people who now loudly express shock and outrage over the scams perpetrated at Enron -- figures such as Harvey Pitt, chairman of the
Securities and Exchange Commission
, and Sen. Joseph Lieberman (D., Conn.) -- were instrumental in creating this system.
That worries me. Investor confidence in the fair workings of the capital markets has been badly shaken, and restoring that confidence is a pressing need. But the track record of the current major players makes me wonder if we're going to get meaningful, confidence-restoring reform anytime soon.
How Good are the Good Guys?
It doesn't take a Woodward or a Bernstein to figure this out. It's clear from even a quick look at the resume of some of the "good guys" investigating Enron.
The Securities and Exchange Commission's online biography of its chairman notes that for 25 years before his appointment as SEC commissioner in August 2001, Pitt was a lawyer in private practice. It doesn't, however, mention whom Pitt represented during those years: each of the Big Five national accounting firms, including Arthur Andersen, Enron's accountant in the current mess, as well as the accounting industry's chief lobbying and trade group, the American Institute of Certified Public Accountants.
Pitt was a critical lobbyist in defending the industry's right to regulate itself through groups such as the industry-funded but toothless Public Oversight Board. And he was instrumental in winning passage for the 1995 Private Securities Litigation Reform Act that shielded corporate executives from liability if they made dubious financial projections. Is anyone surprised that Pitt's solution to the current crisis is more self-regulation by the accounting industry?
The 1995 law grew out of the savings and loan scandal that had cost the accounting industry more than $1 billion in damages in the early 1990s. Since the accounting firms had approved the fraudulent and misleading savings and loan books, the government successfully argued that accountants should be liable for part of the bill.
The massive lobbying by the accounting industry -- and by its new allies among the technology companies of Silicon Valley -- was an effort to make sure that didn't happen again in some future investment scandal. Like the current one. Sen. Dodd (D., Conn.) was one of the point men in that effort, lobbying members of the House of Representatives personally to round up enough votes to overturn President Clinton's veto of the bill. From 1989 through the end of 2001, Dodd received more than $500,000 in campaign contributions -- more than any other currently sitting senator -- from accounting firms and their employees, according to the Center for Responsive Politics. Dodd is now chairman of the Senate Banking Subcommittee on Financial Institutions.
Connecticut's other Democratic senator hasn't been any slouch either when it comes to supporting accounting firms on Capitol Hill. He played a key role in killing two major pieces of accounting reform over the last eight years. In 1994, the Financial Accounting Standards Board, the very slow-moving accounting industry body in charge of setting what is known as generally accepted accounting principles, proposed rules that would require companies to charge the value of stock options granted to workers against current earnings. You can imagine how popular that was with high-tech companies.
The Senate passed a Lieberman-sponsored resolution urging the Financial Accounting Standards Board to back off on its proposed rules. Under the intense pressure, the board did. In 2000 Lieberman joined with 13 colleagues to write a letter to the board, urging it to postpone rules that would have called for new disclosure on mergers and acquisitions. Again the board backed off critical parts of its new rules.
Lieberman chairs the Senate's Governmental Affairs Committee that is holding hearings on Enron. According to
The Wall Street Journal
, one of the questions he wants the hearings to answer is, "Why did Enron's auditors allow the company to overstate its profits for years by over a half-billion dollars?"
I'd hate to give the impression that only senators and Democrats carried water for the accounting industry. Rep. Oxley (R., Ohio), now head of the House Financial Services committee, was a big mover in the 1995 effort to pass the Private Securities Litigation Reform Act that could now limit the liability of the accountants and Enron executives his committee is grilling.
Rep. Tauzin (R., La.), who has had nothing nice to say about Enron's accountants in this go-round, is the biggest recipient of campaign contributions from that firm in Congress, with the total reaching almost $60,000 since 1989. Tauzin, who heads the House Commerce Committee and who is holding hearings, too, has pulled in almost $290,000 from the accounting industry as a whole since 1989, according to the Center for Responsive Politics.
The Securities and Exchange Commission.
Commissioner Pitt may have a hopeless conflict of interest, but the problem stretches far beyond the office of the commissioner or the current administration.
As a regulator, the SEC isn't about to deter anyone. For example, in 2000 the SEC fined Arthur Andersen $7 million over a botched audit at
. (The accounting firm neither admitted nor denied committing any offense.) That was the largest fine ever against a U.S. accounting firm -- but it still represented less than 10% of the $80 million fee Arthur Andersen received for its accounting work from Waste Management in 2000.
Not only are fines so small that they're hardly a deterrent, but the odds that the SEC will catch anyone are extremely small and about to get smaller. The Bush administration's budget for fiscal 2003 includes a 6.6% increase for rent, computers and security, but not a single dollar to hire more accountants or lawyers to beef up the enforcement of securities regulations. And this after the Enron scandal broke!
The Claude Rains Reaction
If this were a movie, I'd get a kick out of all this. I do, after all, laugh at the scene in
where Claude Rains, the cynical French chief of police, gives in to Nazi pressure and shuts down Rick's Caf¿ saying, "I'm shocked, shocked to discover that gambling is going on here." At that point, this being a movie, one of Rick's croupiers hands Rains a bundle of cash. "Your winnings, sir," he says.
But this isn't a movie. Real people lost real money that was supposed to pay for real retirement, real education and real houses. Now that money is gone. And not just the money that was invested in Enron, but also the cash that went into
and other flameouts where it looks like management manipulated the numbers.
So what to you do about this?
Step one: If you were scammed, and I think Enron was clearly a scam -- and evidence is starting to emerge that Global Crossing was as well -- don't fall into the trap of feeling ashamed that you were bilked. The crooks perpetrating scams like these count on that reaction. They know that most of their victims will feel too embarrassed to hunt them down. Instead, get angry, demand that the crooks go to jail, and seek to recover as much as you can in the courts. And demand that the politicians, the regulators, the accountants and the investment bankers provide a level playing field for all investors.
It's not hopeless. Although most of the loudest voices in Washington on Enron so far are thoroughly compromised, I think investors can expect real proposals for meaningful reform to come out during the hearings chaired by Sens. Carl Levin of Michigan and Ernest Hollings of South Carolina, both Democrats. And I wouldn't even be surprised to see something with teeth emerge on the House side from Tauzin's hearings. The Louisiana Republican has shown a career-long willingness to bite the hand that feeds him.
Step two: Become more skeptical and critical of yourself as an investor, and of your relationship with others whose advice you might follow from time to time. Are you taking too much on faith? Most of us do as investors -- and it's important to realize the difference between taking unexamined advice from a trusted sibling or long-term financial advisor and taking it from a Wall Street analyst, media pundit or Internet journalist (yours truly included).
Evaluate the quality of those more casual sources and their conflicts of interest. Make sure you understand why they're recommending a stock or a position before you follow their advice with your money. These folks may be the smartest, best-intentioned people in the world, but they don't know you, they don't manage your money, and they aren't responsible to you. Figure out how best to use sources like this. And always remember that you are the only one finally responsible for your money.
I think that means you must apply the same critical skepticism to yourself as an investor that you do to these sources. Are you doing enough due diligence? Do you understand what you own? Are you buying stocks that are good matches with your investment goals and your strengths and limits as an investor?
One of the reasons Enron was such a successful scam was that it played on the universal human reluctance to admit ignorance. Too few analysts, portfolio managers and individual investors wanted to admit that they simply didn't understand what the company claimed to be doing. To do so might have brought condescending smiles and pitying looks. What, you don't understand how trading natural gas derivatives can produce profits like this? Poor guy.
It turns out that this indeed was the right question to ask. Proving once again that there is no such thing as a stupid question.
One aspect of this reluctance to admit to ignorance is that investors all too frequently wind up owning companies they don't understand. There's no need for that. With more than 8,000 equities available to U.S. investors, there are plenty of easy-to-understand opportunities in the financial markets. Right now I think many investors are finding a return to simplicity an appealing idea. In my next column, I'll take a look at what to look for in a comfort stock.
Jim Jubak appears Wednesdays on CNBC's "Business Center" at 6 p.m. EST. At the time of publication, he owned or controlled shares in none of the equities mentioned in this column.