bigger than enron
homelessonswatchdogspoliticsaccounting warsdiscussion

transcript

Written and Produced by
Hedrick Smith & Marc Shaffer

Directed by
Marc Shaffer

Correspondent
Hedrick Smith

 

ANNOUNCER: It was a meteoric rise.

    VOICE: We will become the world's leading company.

ANNOUNCER: And a devastating collapse.

    VOICE: Enron is a corporate Chernobyl.

    VOICE: You had the entire system playing fast and loose.

    VOICE: It is not just Enron, it's an industry problem.

    LYNN TURNER, SEC Chief Accountant (1998-2001): It is real, real damage to the country.

ANNOUNCER: Why didn't anyone sound an alarm?

    VOICE: The watchdogs work for executives and Wall Street. They don't work to protect shareholders.

ANNOUNCER: Correspondent Hedrick Smith investigates how greed and politics undercut America's financial watchdogs.

    HEDRICK SMITH, FRONTLINE Correspondent: Is anyone protecting the public?

ANNOUNCER: Tonight on FRONTLINE, Bigger than Enron.

 

 

HEDRICK SMITH, FRONTLINE Correspondent: [voice-over] Everything about Enron seemed larger than life, from its glittering Houston headquarters reaching to the skies to its spectacular downfall. But Enron's collapse was more than the shattering of one American success story. It was a warning of a far wider malaise in the marketplace.

Enron was the climax of an avalanche of American companies that cost investors as much as $200 billion by issuing deceptive financial reports. The roots of the Enron debacle stretch to Wall Street, where the accountants and other watchdogs were supposed to keep score on corporate America and make sure the market is honest.

The trail leads also to Washington, where Congress weakened the protections and tied the hands of regulators, making it easier for aggressive companies like Enron to push the envelope.

    ARTHUR LEVITT, SEC Chairman (1993-2001): [Senate committee hearing] Enron's collapse did not occur in a vacuum. Its backdrop is an obsessive zeal by too many American companies to project greater earnings from year to year. When I was at the SEC, I referred to this as a culture of gamesmanship, a gamesmanship that says it's OK to bend the rules, to tweak the numbers and let obvious and important discrepancies slide, a gamesmanship where companies bend to the desires and pressures of Wall Street analysts rather than to the reality of the numbers.

HEDRICK SMITH: [on camera] But where were the watchdogs who were supposed to warn us when companies were playing fast and loose with their books, the stock analysts, lawyers, bankers, Securities and Exchange Commission? Above all, where were the accountants?

By law, auditors have the official responsibility to insure that corporate financial reports are honest. They are the first line of defense. But in the booming '90s, the big accounting firms like Arthur Andersen, which audited Enron's books, failed to protect us. And what happened at Arthur Andersen illustrates the wider story of how our watchdog system broke down.

    NARRATOR: [Andersen marketing video] Institutions are built on beliefs. Arthur Andersen was a man of unwavering beliefs that found marvelous new expressions over the years.

HEDRICK SMITH: [voice-over] Ninety years ago, Arthur Andersen founded his firm on old-fashioned virtues. Accountants, he insisted, must think straight, talk straight and dig beneath the numbers to get to the truth.

    NARRATOR: [Andersen marketing video] His firm was built on those beliefs.

HEDRICK SMITH: Over the decades, the firm built a global business on its reputation for rock-ribbed integrity.

    NARRATOR: [Andersen marketing video] True to our clients and true to our founder.

JAMES HOOTON, Andersen Senior Partner (1976-2002): I put 35 years of my life in Arthur Andersen. One of, if not the only reason I chose Andersen over the other firms, was this idea that Andersen had a sense of integrity about it that was undeniable, at least to me, as a young person. And that notion of integrity, of being keepers of the Holy Grail, that was Arthur Andersen. That's what we did.

HEDRICK SMITH: But the go-go '90s put unprecedented stress on the integrity of the old safeguards. American capitalism went into overdrive. The stock market skyrocketed. Every CEO was out to boost his company's stock by beating Wall Street's expectations, so companies pushed their numbers to the limit - and some, beyond. The incentives were astronomical. High executives were getting massive grants of stock options, a special perk that let corporate insiders pick their moment to buy low, sell high and cash in big on company stock.

RICHARD BREEDEN, SEC Chairman (1989-1993): You have executives in many companies who have- measure their option packages in millions of shares, and sometimes tens of millions of shares. And with that, of course, grows a pressure to make the stock perform at higher levels.

SARAH TESLIK, Council of Institutional Investors: At Enron the executives had the ability, by jacking up the stock price, to take hundreds of millions of dollars out of the company and keep them through the vehicle of stock options.

HEDRICK SMITH: And the lure of enormous personal fortunes tempted some corporate executives to cook the books.

RICHARD BREEDEN: When an executive has a portfolio of a hundred million stock options, they can make far more money by getting the stock to move a few dollars in response to false information than anybody could do in most insider trader cases.

HEDRICK SMITH: But options were a hidden cost that never showed up on a company's balance sheet, and that made it harder for ordinary investors to gauge corporate performance.

SARAH TESLIK: Stock options should be charged to earnings. They are often a massive cost of production, and they need to show up in the financials in a very clear way, so that someone investing in the company today doesn't miss the fact that a couple years down the line, their stock is suddenly going to be diluted massively and be much less valuable.

HEDRICK SMITH: [on camera] So it's honesty in accounting.

SARAH TESLIK: It's honesty in accounting.

HEDRICK SMITH: [voice-over] To help investors and clean up the books, the accounting industry's standards-setter, an obscure entity in Norwalk, Connecticut, known as FASB - the Financial Accounting Standards Board - decided in 1993 to close the options loophole. Jim Leisenring was then a FASB commissioner.

JIM LEISENRING, FASB Vice Chairman (1988-2000): The costs are fairly significant, and we think that this is a credibility issue, that, in fact, financial statements are omitting compensation expense, for some companies very material amounts of compensation expense. So we thought and still believe that it's a matter of the marketplace deserves that information.

HEDRICK SMITH: That touched off a firestorm in corporate America. Ground zero was Silicon Valley, where dot-coms staged a giant demonstration.

    RALLY SPEAKER: [March, 1994] We're here for one reason- to stop FASB from raining on our parade!

MARK NEBERGALL, Software Industry Lobbyist: People had on, you know, T-shirts with big stop sign on the front that said "Stop FASB" that they were passing out.

HEDRICK SMITH: Software lobbyist Mark Nebergall was there.

MARK NEBERGALL: People were signing petitions to the president saying, you know, "Please don't let them do this. Don't take away my stock options." People were hot under the collar.

HEDRICK SMITH: Corporate America was livid because making options a business expense would be devastating to the bottom line of many companies. At Internet dynamo Cisco, for example, a $2.6 billion profit one year would have been cut nearly in half. A Merrill Lynch study found that expensing options would have slashed profits among leading high-tech companies by an average of 60 percent.

    RALLY SPEAKER: FASB's just got to get out of this. They can argue the technical side all they want, but stay out of our stock options!

JIM LEISENRING: The more emotional arguments came from the so-called "new economy" companies, but there was strong opposition from the traditional big companies we all know of. General Electric; General Motors- they were opposed, as well.

HEDRICK SMITH: From all over the country, CEOs descended on Washington to beat back FASB.

SARAH TESLIK, Council of Institutional Investors: It was one of the most impressive lobbying efforts on earth. It was protecting CEOs' pay packages.

HEDRICK SMITH: [on camera] It was what?

SARAH TESLIK: Protecting CEOs' pay packages.

HEDRICK SMITH: So that's why it generated such enormous heat?

SARAH TESLIK: I mean, there's nothing in CEOs' salaries that compares to the numbers of CEO stock options. It was protecting CEOs' pay package. They were out in force.

    Sen. JOSEPH LIEBERMAN (D-CT): [Senate floor, May 3, 1994] What's on the line here really is the future of jobs in this country.

HEDRICK SMITH: [voice-over] Corporate America turned to friends on Capitol Hill, like Senator Joe Lieberman of Connecticut.

Sen. JOSEPH LIEBERMAN: Silicon Valley companies came to me at that time and said, "We need to use these stock options to lure the brilliant minds from the big companies that are paying them the kinds of salaries we can't pay them because we're going to give them a stake in the company."

ARTHUR LEVITT, SEC Chairman (1993-2001): I don't buy that argument one single bit.

HEDRICK SMITH: Arthur Levitt, President Clinton's new chairman of the SEC, was a Wall Street veteran and former head of the American Stock Exchange.

ARTHUR LEVITT: If it takes a stock option to induce an employee or an executive to come to a company and that stock option has to be represented as a cost on the balance sheet, in my judgment, America's executives are going to pay that price.

    Sen. JOSEPH LIEBERMAN: Stock options are a remarkable and uniquely American device for-

HEDRICK SMITH: Senator Lieberman, echoing the accountants, also contended that the cost of options was impossible to calculate.

Sen. JOSEPH LIEBERMAN: The concern that I had back in '93 and '94, that I still have, is how do you accurately value an option on the day it's granted?

HEDRICK SMITH: [on camera] Companies don't have any trouble figuring out how much options cost them when they list them on their tax returns to reduce their taxes.

Sen. JOSEPH LIEBERMAN: Well, you know, that's a separate question which is an- an important question. Usually, that's done and it's done more- more effectively at the time they're exercised.

HEDRICK SMITH: Why would Lieberman of Connecticut be so desperately interested in this to take the lead?

SARAH TESLIK: Well, the insurance companies in Connecticut and the accountants are heavily based in Connecticut. FASB is in Connecticut. Both Senator Lieberman and Senator Dodd have historically been very protective of accountants and very protective of executives. Even though they talk a good liberal Democratic line, if you look at the votes and you look at the actions, it's not there.

HEDRICK SMITH: [voice-over] Led by Senator Lieberman, the Senate passed a non-binding resolution in May, 1994, condemning the FASB proposal by a lopsided 88-to-9 vote.

JIM LEISENRING: It wasn't an accounting debate. We switched talking from about whether, "Have we accurately measured the option?" to things like, "Western civilization will not exist without stock options," or that there won't be jobs anymore for people without job- without stock options. People tried to take the argument away from the accounting and over to be just plainly a political argument.

HEDRICK SMITH: [on camera] Why is the Senate voting 88 to 9, or something like that?

ARTHUR LEVITT: There was no question campaign contributions played the determinative role in that Senate activity, and the Congress was responsive to that.

HEDRICK SMITH: [voice-over] In fact, since 1990, the accounting industry has given over $43 million to candidates for Congress, including nearly $6 million in 1994, during the battle over stock options. When Republicans took over the House with a pro-business agenda that fall, threats to FASB escalated.

[on camera] Was the congressional pressure, in effect, a threat to the independence and even the financial-

JIM LEISENRING, FASB Vice Chairman (1988-2000): No, I would say it was a threat to the existence of the FASB. The threats were to our existence.

ARTHUR LEVITT: My concern was that if Congress put through a law that muzzled FASB, that would kill independent standard-setting. So I went to FASB at that time, and I urged them not to go ahead with the rule proposal.

[www.pbs.org: More on the stock option debate]

HEDRICK SMITH: [voice-over] Levitt and FASB retreated. FASB passed a rule that the cost of stock options should be disclosed, but only in the small-print footnotes of corporate reports.

ARTHUR LEVITT: It was probably the single biggest mistake I made in my years at the SEC.

    NARRATOR: [Andersen marketing video] That integrity is a bond, a promise between client and firm, between clients and their customers.

HEDRICK SMITH: The options battle had tested the loyalty of accountants. In the end, Arthur Andersen and the other big accounting firms sided with corporate America against their own industry's standard-setter.

James Hooton, then chief of Andersen's worldwide auditing, feared the consequences.

JAMES HOOTON: It was the first time that accounting principles had become very, very much influenced by commercial interest and political interest. Congress got involved in that debate. Certainly, every company in the United States with a commercial interest got involved in that debate.

HEDRICK SMITH: [on camera] Was that good or bad?

JAMES HOOTON: It was bad. If you move accounting and accounting standards into the political environment, then you've lost control over whether those standards are the best standards. If you move it into a commercial environment, you've lost control over whether those standards are the best standards.

HEDRICK SMITH: And what did that decision say?

JAMES HOOTON: That decision moved who's in control away from the principles and the professional standards and more to the commercial side, the client side of the business, the presenting a transaction the best way to present it to show the company's side of the story, as opposed to the profession's side.

HEDRICK SMITH: [voice-over] In the battle for stricter accounting, the options fight was a watershed moment, a signal to accountants of looser standards and a green light for corporations to issue options by the truckload.

    KENNETH LAY, Enron CEO: [Enron employee meeting, February 21, 2001] I've never seen the company stronger. I've never seen it better positioned.

RICHARD BREEDEN, SEC Chairman (1989-1993): So the size of the stock packages create a temptation for economic gain that is very corrosive and will lead some people to be willing to lie, to cook up false income, to not tell the truth about negative factors, and in Enron's case, to create an entire picture of a company that didn't exist.

    AL DUNLAP, Sunbeam CEO (1996-1998): There's a new Sunbeam shining on a bright sunny day. What could be better?

HEDRICK SMITH: And painting a picture that didn't exist was going on at lots of American companies in the '90s. That's what happened at Sunbeam, which, like Enron, was a client of Arthur Andersen. Back in 1998, I profiled Sunbeam's controversial CEO, Al Dunlap, for PBS.

    AL DUNLAP: Hi, there. How're you doing?

HEDRICK SMITH: Dunlap was an aggressive corporate turn-around artist brought in by Sunbeam's main owner to make it look good for a corporate takeover and a big financial killing.

    AL DUNLAP: I believe the shareholders own the corporation. We work for you.

JOHN BYRNE, "BusinessWeek": Dunlap comes in, and all of a sudden, Wall Street goes ga-ga. The stock price went from $12.50 to a peak of $53 a share.

HEDRICK SMITH: With a pay packet that included more than seven million shares and options, Dunlap stood to make over $200 million personally if he could keep Sunbeam's stock price flying. Playing to Wall Street, Dunlap promised totally unprecedented gains for a home appliance maker.

    AL DUNLAP: You look at the layoffs that took place, there are about-

HEDRICK SMITH: He touted the formula of mass layoffs and cost-cutting that had earned him the nickname "Chainsaw Al."

    AL DUNLAP: [1997] We've gone from 26 factories to 8. We've sold all the businesses that don't make sense. We've cut $225 million of cost.

HEDRICK SMITH: But Dunlap was hiding a secret. It wasn't only his hard-nosed tactics that were driving up the stock, he was using simple accounting tricks OKed by the auditor from Arthur Andersen.

It began when Dunlap arrived. He took a bigger financial write-off than he needed to restructure Sunbeam. That gave him two advantages. It made things look dismal when he arrived, and he had a huge slush fund to use later to make it look as though he was generating new profits.

RICHARD WALKER, SEC Enforcement Chief (1998-2001): At Sunbeam, the company initially established reserves. We call it the "cookie jar" reserves. You can borrow from the reserve and have a little jolt to income.

HEDRICK SMITH: That's exactly what I asked Dunlap about.

    [on camera] You said the company lost $230 million in 1996. But the write-off was $337 million. If they lost $230 million, that means without the write-off, they would have made $100 million. So it was a profitable year in 1996, except for the write-off.

    AL DUNLAP: No, it wouldn't have been. The losses would have been substantially more than that. Remember, I arrived in July. We instantly made enormous changes to the company. This company was headed downhill.

JOHN BYRNE: What Al was doing is creating the steps that he needs to create the illusion of a turnaround. The worse it looks coming in, the better it looks going out.

    AL DUNLAP: Over here, we have a total new line of grills.

HEDRICK SMITH: [voice-over] Dunlap had other gimmicks. In the winter of 1997, he booked millions of dollars of sales of summer products, like outdoor grills.

    AL DUNLAP: But this is a prototype and-

HEDRICK SMITH: In fact, Sunbeam wasn't shipping them out and retailers were not paying for them. They were paper transactions that made Dunlap look great in the short run but put the future at risk.

RICHARD WALKER: You stuff the sales channels. You sell product so far out into the future that when the future comes, you've sold too much product in past times, and it's not likely that you're actually going to be able to maintain that level of sales. There's nothing wrong with that, in concept. But if it's not properly disclosed, then you've misled people, you've committed a fraud. That's what happened to Sunbeam.

HEDRICK SMITH: In the spring of 1998, Dunlap and his team ran out of accounting tricks.

JOHN BYRNE, "BusinessWeek": The general counsel of the company met privately with several board members and said "Al didn't tell you the truth. The quarter is coming in horribly. The numbers are a disgrace- new products that have no sales, inventory issues, accounting issues." And the board decides to fire both Al and the chief financial officer.

HEDRICK SMITH: With the plot exposed, Sunbeam corrected its books, declared bankruptcy and the stock price plunged from $53 dollars at its peak to just pennies today.

[on camera] What are the parallels between Sunbeam and Enron?

JOHN BYRNE: The checks and balances at both places failed miserably, right? The auditors at both these companies didn't do their jobs. The lawyers- the external lawyers at both these companies didn't do their jobs. The board of directors, in one way or another, didn't really do their jobs.

HEDRICK SMITH: For two years, the SEC said, this man, Andersen's senior auditor, Phillip Harlow, blessed Dunlap's bad books.

RICHARD WALKER: We charged the auditor with fraud, that he knowingly or recklessly made false and misleading statements. This wasn't an accident.

HEDRICK SMITH: Harlow is fighting the charges. But with an SEC lawsuit still pending against him and senior Sunbeam officials, Harlow's lawyers wouldn't let him talk to us.

At Sunbeam, the SEC uncovered another, more ominous harbinger of the Enron scandal: Andersen accounting documents were destroyed. With an SEC investigation under way, Harlow got orders from Andersen to get rid of certain work documents. And two boxes of papers that should have been kept were destroyed, Harlow claimed by mistake.

No criminal case was filed, and even though Andersen later admitted that there were significant mistakes in the Sunbeam books endorsed by Harlow, the firm kept him on as managing partner of its Fort Lauderdale office.

To critics like Wall Street investment manager Jim Chanos, the reason managements get their way is simple. They've bought off the watchdogs.

JAMES CHANOS, Wall Street Investor: The auditors are paid by the corporations. The bond rating agencies are paid in many cases by the issuing corporations. Analysts are paid often on the basis of their investment banking fees that their firms bring in for the companies they are either recommending to buy or sell. So we have all kinds of conflicts of interest that revolve around who is paying whom.

HEDRICK SMITH: Investor advocate Sarah Teslik puts it even more starkly.

SARAH TESLIK: We all know that if 5th-graders hired their teachers, teachers would give all A's. That's exactly the situation we currently have. Managers hire auditors to bless the books. Auditors bless the books.

HEDRICK SMITH: [on camera] So what you're saying is we shouldn't be surprised that things go awry.

SARAH TESLIK: They can't go any other way. People invariably act in their self-interest.

HEDRICK SMITH: Is anyone protecting the public?

JOHN BYRNE: You know, I think the SEC is trying to, but I think that the SEC is basically out of it, as well, because they're understaffed. It's a major problem.

HEDRICK SMITH: So the SEC is outgunned, outspent, outmanned?

JOHN BYRNE: Completely. Doesn't have a chance.

HEDRICK SMITH: [voice-over] Four years later, the SEC is still tied up in court, pursuing Sunbeam. So far, the only real penalty has come through private litigation.

JOHN BYRNE: Well, Andersen ended up settling one key lawsuit for $110 million. AL Dunlap has settled three separate suits, having to pay $15 million out of his own pocket.

HEDRICK SMITH: But even the deterrent of private lawsuits has been blunted by special interest legislation.

    RALLY SPEAKER: It is my great privilege to introduce the next speaker of the people's House, Newt Gingrich!

HEDRICK SMITH: In the mid-1990s, Newt Gingrich and the Republicans staged a political revolution. High on their pro-business agenda when they took over the House of Representatives: tort reform, including a law to curb shareholder lawsuits against companies and their accountants. For accountants, it was the climax of years of struggle. They had paid out a billion dollars in stockholder settlements after the savings and loan scandals in the 1980s.

I talked about those lawsuits with Joseph Berardino, a long-time partner at Arthur Andersen, who would later head the company as the Enron scandal broke.

JOSEPH BERARDINO, CEO, Andersen Worldwide (2001-2002): Tort reform was something that the profession had talked about for years and, frankly, got spooked by the savings and loan problems.

HEDRICK SMITH: [on camera] What were you trying to do? What did you want tort reform to do for you?

JOSEPH BERARDINO: Tort reform was an attempt to at least rein in or limit damages, so accounting firms wouldn't go out of business.

HEDRICK SMITH: [voice-over] As the point man to make their case to Congress in 1991, the accounting industry chose a prominent securities lawyer, Harvey Pitt. Pitt's clientele included corporations and big accounting firms like Arthur Andersen.

HARVEY PITT, SEC Chairman: There have been cases that were filed that I thought raised frivolous issues and in which companies were, in effect blackmailed into settling, or else required to spend extraordinary amounts of time and energy getting rid of. The sole thing the bill was aimed at curtailing were frivolous lawsuits.

REP. JOHN DINGELL (D-MI): All these people got together to say, "We don't like being sued for falsehoods and misbehavior."

HEDRICK SMITH: [on camera] But they said it was to stop frivolous lawsuits, that there were lawsuits that were insubstantial, there were too many of them being brought.

Rep. JOHN DINGELL: Uh-huh. Yeah.

HEDRICK SMITH: Was there something to that?

Rep. JOHN DINGELL: Any lawsuit, in their lexicon, was frivolous.

HEDRICK SMITH: Any lawsuit brought by San Diego attorney Bill Lerach was what the accountants and their business allies wanted to stop.

    BILL LERACH: This fraud could not have been accomplished by a few corporate executives.

HEDRICK SMITH: Lerach had become the despised poster boy for the tort reform cause, earning tens of millions of dollars personally from filing class action suits against corporations.

MARK NEBERGALL, Software Industry Lobbyist: Bill Lerach was the guy whose picture had the target on it. When you thought of securities litigation reform, you thought of trying to put Bill Lerach out of business. He was- he was the antichrist, if you will.

    BILL LERACH: And this complaint now names additional parties-

HEDRICK SMITH: Among Lerach's favorite targets were Silicon Valley high-tech firms.

MARK NEBERGALL: Virtually any company in Silicon Valley was scared to death of the guy. They all knew who he was.

HEDRICK SMITH: Pressed by the high tech and accounting industries, the House and Senate passed the bill by large majorities. But President Clinton vetoed it, asserting that it would close the courthouse door on investors with legitimate claims. Some Senate Democrats rallied behind their president.

    Sen. RICHARD BRYAN (D-NV): [Senate floor debate, December, 1995] It's safe to say that crooks will be emboldened, investor confidence in our markets will go down, and defrauded investors will not be compensated.

HEDRICK SMITH: But what happened next stunned observers.

    Sen. CHRISTOPHER DODD (D-CT): But I believe that the override is the proper course to follow here.

HEDRICK SMITH: Senator Chris Dodd of Connecticut, then head of the Democratic National Committee, led the effort to overturn Clinton's veto.

    Sen. CHRISTOPHER DODD: It is with a deep sense of regret that I'm on the opposite side of my president on this issue.

CHARLES LEWIS, Center for Public Integrity: Chris Dodd, here he is, he's Chairman of the Democratic Party, but he's also the leading advocate in the U.S. Senate on behalf of the accounting industry. And he helps overturn the veto of his own president, who installed him as Democratic chairman. Chris Dodd might as well have been on the accounting industry's payroll. He couldn't have helped them any more than he did as a U.S. senator.

HEDRICK SMITH: By way of thanks, the accounting industry gave Senator Dodd nearly one quarter of a million dollars in political donations, even though, at the time, Dodd was not up for reelection.

[www.pbs.org: Accountants and campaign money]

RICHARD WALKER, SEC Enforcement Chief (1998-2001): The accountants were the big winners with the Litigation Reform Act. The law imposed a proportionate liability standard, which means that if the accountants only contribute to, say, 20 percent of the loss, then they would only be responsible for 20 percent of the amount that would have to be paid.

HEDRICK SMITH: Less risk for accountants, among others, critics said, would mean less of a deterrent to wrongdoing. And the late '90s brought an explosion in major accounting failures.

    NEWSCASTER: Dollar General has fired DeLoitte and Touche as its auditor and-

    NEWSCASTER: Ernst and Young had signed off on this company-

    NEWSCASTER: -audit information from Lucent's outside accounting firm, PriceWaterhouseCoopers, as part of its probe-

HEDRICK SMITH: Corporate financial restatements skyrocketed to levels never seen before- just 3 in 1981, up to 156 in 2000. All the big accounting firms were implicated: PriceWaterhouseCoopers, Andersen, KPMG, DeLoitte and Touche, Ernst and Young.

During the '90s, more than 700 U.S. companies had to correct financial reports that were just plain wrong.

LYNN TURNER, SEC Chief Accountant (1998-2001): For the last half dozen years, investors had lost probably close to a $100 billion, suffered those type of losses from these situations like Cendant, Waste Management, Sunbeam, Microstrategy, Rite Aid, Lucent, Xerox. Then along comes Enron. Phenomenal! And we add on now every day, Global Crossing and others. Investors are now looking at losses probably coming close to $200 billion. It is real, real damage to the country.

HEDRICK SMITH: Finally, the SEC had had enough. On the next case - in fact, the biggest case until Enron - it went after Arthur Andersen, the first time in 20 years the SEC had sued a major accounting firm. It charged Andersen with helping to cover up what the agency called a massive financial fraud motivated by greed.

It involved a trash-collecting empire, Waste Management.

RODERICK HILLS, SEC Chairman (1975-1977): Waste Management was the Microsoft of the '80s. They bought hundreds and then thousands of garbage companies, and they increased their sales and their profits year after year after year.

HEDRICK SMITH: There were obvious parallels to Sunbeam and Enron: Andersen was the auditor, the company's stock price had soared, and its top managers had made tens of millions of dollars on stock options. But then Waste Management hit a wall.

RODERICK HILLS: They couldn't buy thousands of garbage companies any more. There weren't that many left. So the strategy, this growth strategy that propelled them as a high-flying stock, was gone.

HEDRICK SMITH: So they turned to accounting tricks to make Wall Street think the company was still growing. One gimmick simply involved stretching out depreciation on company assets: garbage dumps, trucks, giant metal trash bins.

RODERICK HILLS: They changed the earnings of the company by quite a bit of money, more than $100 million.

HEDRICK SMITH: [on camera] Wait a second. You can change the earnings picture of Waste Management by more than $100 million dollars simply by changing the lifespan of a garbage container?

RODERICK HILLS: Well, they had a million of them. These were these huge, big steel containers. And so if you're- if you're depreciating them at over 12 years, it's a lot more expensive than if you depreciate them over 18 years.

HEDRICK SMITH: Former Republican SEC chairman Rod Hills joined the board of directors in a shakeup forced by big outside investors. The new team found that the company had exaggerated its earnings by $1.7 billion, a gambit that would cost investors a fortune when the stock plummeted.

Arthur Andersen senior auditing partner James Hooton reviewed his own firm's work.

JAMES HOOTON: It was wrong.

HEDRICK SMITH: [on camera] Flat-out, easy, clear wrong?

JAMES HOOTON: Not all things easy, clear. Not all things easy, clear. Some were easy, clear wrong. I won't- I won't duck that. Some were easy, clear wrong. Others were more difficult.

HEDRICK SMITH: [voice-over] The SEC discovered a long-running cover-up not just by Waste Management, but by Arthur Andersen, as well.

RICHARD WALKER, SEC Enforcement Chief (1998-2001): Arthur Andersen allowed the company to publish its financials, knowing that there were mistakes in the financials, with a promise that the company would, in the future, make whatever changes and adjustments were necessary to correct the failures of the past. Unfortunately, the company never did what they were supposed to do.

RODERICK HILLS, SEC Chairman (1975-1977): It was actually a treaty. They all signed it. The auditor signed it, the management signed it and said, "We will do this."

HEDRICK SMITH: [on camera] Did they do it?

RODERICK HILLS: No, they did not do it.

HEDRICK SMITH: For how many years?

RODERICK HILLS: At least six.

HEDRICK SMITH: How can this go on for six years and neither the board nor the auditors blow the whistle?

RODERICK HILLS: The board doesn't know about it. At least, the audit committee does not. The audit committee of the board does not know it. And management doesn't want to tell them and the auditors don't want to tell them.

HEDRICK SMITH: That's a breakdown of the system.

RODERICK HILLS: You bet it is. You bet it is. It absolutely tells you that the weaknesses that you see in Enron and Waste Management can be seen in many other companies. I've had to participate in the firing of nine chief executive officers over 30 years. In each case, the auditors - after we asked the CEO to leave - told us of problems that were in these statements that they had not brought to the attention of the board.

HEDRICK SMITH: Because?

RODERICK HILLS: Because they- management didn't want them to. It's the pressures- you can't possibly understand the fear. If you are the audit partner in charge of a large account, you need to keep that account. And if- and if you're not protected by the outside audit committee on that board, you will yield on the margin to something management wants you to do that, in your heart, you think you shouldn't do.

HEDRICK SMITH: [voice-over] Andersen and Waste Management paid a steep price in stockholder settlements. But no one went to jail.

RICHARD BREEDEN, SEC Chairman (1989-1993): We certainly have seen in the securities markets the clear lesson that when people stand to make millions and millions of dollars from breaking the law, that the risk of simply getting a civil judgment is not enough to defer the conduct. And so a realistic, criminal deterrent is part of a healthy system. People have to understand that if you knowingly allow millions of people to be cheated, you can end up in jail.

HEDRICK SMITH: The SEC fined Andersen $7 million. Andersen promised never to do it again, but they were already enmeshed in new trouble at Enron.

RICHARD BREEDEN: It would appear from the outside that Andersen took the Waste Management injunction and the whole process as not much- not much more seriously than you or I might take getting a ticket for going 35 in a 25-mile-an-hour zone. They just didn't use that as the wake-up call to say, "My God, how could this happen in our firm? And we need to make changes to never let this happen again."

    NARRATOR: [Andersen marketing video] That inventiveness isn't just a goal, it's the way we do business.

HEDRICK SMITH: By the late '90s, corporations had put the squeeze on auditing fees.

    NARRATOR: [Andersen marketing video] -and that the product of our inventiveness should be real.

HEDRICK SMITH: So accountants had to find a new way to cash in on the boom economy.

    NARRATOR: [Andersen marketing video] In fact, we created most of the 43 service lines we're now in, including Andersen Consulting.

HEDRICK SMITH: Consulting. Once a small fraction of their business, consulting on finance, partnerships, computer programs, taxes had become the main profit center.

At the SEC, Arthur Levitt saw that as a conflict of interest, accountants fearing to lose rich consulting deals with a corporate client as a result of a tough audit.

ARTHUR LEVITT, SEC Chairman (1993-2001): They clearly had a conflict of interest, and some of them abused the public that they were supposed to protect.

HEDRICK SMITH: Levitt had a fix: Get the big accounting firms to stop doing major consulting jobs for their audit clients. In early 2000, he floated the idea to the accounting industry.

ARTHUR LEVITT: They told me, "We're not with you, Arthur. This is going to be war. We're going to fight you all the way. We'll fight you in the Congress, and we'll fight you in the courts."

RICHARD WALKER: Well, you're taking the bread and butter away from large accounting firms when you make a proposal that would take away their largest growth opportunity, so understandably, there was a quite a very strong, violent reaction.

HEDRICK SMITH: Leading accountants like Andersen's Joe Berardino claimed there was no conflict of interest and bristled at regulation by the SEC.

JOSEPH BERARDINO, CEO, Andersen Worldwide (2001-2002): Among other things I disagreed with at the time is that the government was forcing the whole profession to a certain model. I do believe the market is a better place than the government in deciding how the market should be formed.

    Rep. BILLY TAUZIN (R-LA): [committee hearing] It was decided. It sounds like both of you talked about it and decided it together.

HEDRICK SMITH: To block Levitt, the accounting industry turned to friends on Capitol Hill, like Louisiana's Billy Tauzin, a powerful House Republican. Tauzin had received nearly $300,000 from the accounting industry since 1989,

[on camera] Billy Tauzin seems to have been especially important in the process. Why?

JOSEPH BERARDINO: He had an oversight responsibility - budget and otherwise - for the SEC. So he had a special interest.

HEDRICK SMITH: So he could get Arthur Levitt's attention in a way almost nobody else could?

JOSEPH BERARDINO: Yeah.

HEDRICK SMITH: [voice-over] And Tauzin took the cue. Along with fellow Republicans Thomas Bliley and Michael Oxley, Tauzin sent a clear message to Arthur Levitt.

ARTHUR LEVITT: This is a letter from the congressional committee that oversees the SEC, that has a chokehold on the existence of the SEC, directing me to go slow on this issue.

HEDRICK SMITH: [on camera] How did you interpret that?

ARTHUR LEVITT: That was a threat.

HEDRICK SMITH: A shot across your bow.

ARTHUR LEVITT: Without a question.

HEDRICK SMITH: [voice-over] In their war against Levitt, the accountants spent $23 million in campaign contributions and lobbying. Their efforts set loose a flood of mail from Congress pressuring Levitt to back off.

RUSSELL HORWITZ, SEC Policy Adviser (1998-2001): We were getting letters from people we'd never heard from. And the types of letters we were getting from them were very similar, in terms of tone and phrases and words.

HEDRICK SMITH: [on camera] What's that say to you?

RUSSELL HORWITZ: Well, it says to me that the accounting lobbyists were writing the letters.

HEDRICK SMITH: [voice-over] Levitt refused to back down, and Congress turned up the heat.

ARTHUR LEVITT: As we got down toward the end of the congressional session, the threats were made, "Arthur, if you go ahead with this proposal, it is likely that a rider will be placed upon your appropriations bill which says that the SEC will not be funded if they proceed with the issue of auditor independence."

HEDRICK SMITH: [on camera] Who made that threat?

ARTHUR LEVITT: A variety of members of Congress told me that they weren't going to do it, but they knew others who were going to do it.

HEDRICK SMITH: [voice-over] Finally, Levitt gave in. He let audit firms keep their consulting work. All they had to do was inform corporate audit committees.

ARTHUR LEVITT: As a result of this pressure, we modified the rule. And that was a compromise that I would not make today that I agreed to at the time.

HEDRICK SMITH: [on camera] When you look back on this whole episode, what's the lesson to you?

RUSSELL HORWITZ: I saw a group of entities that I think had forgotten their public responsibilities. The accounting profession is the only profession, private profession with public responsibilities. And I saw them fight tooth and nail to- instead of accentuating and emphasizing their public responsibilities, they said, "Our business model is about consulting, and once and for all, we're going to let you know that you can't mess with us." And they did that through the force of money.

HEDRICK SMITH: [voice-over] And those who got the most money from accountants, like Billy Tauzin-

    Rep. BILLY TAUZIN: You're trying to tell me that wasn't an extraordinarily limited review?

HEDRICK SMITH: -are today among the most vocal critics of Enron on Capitol Hill.

CHARLES LEWIS, Center for Public Integrity: Many of the people complaining loudest about how shocked, shocked they are that there's a problem with this industry not being closely regulated were two peas in a pod, close with the industry themselves, helping the industry get deregulated throughout the '90s- Billy Tauzin, Chris Dodd, Senator Lieberman from Connecticut. And when journalists try to talk with them now about their flip-flop, many of them are just not available for comment.

HEDRICK SMITH: Senator Lieberman had talked to us, but both Senator Dodd and Chairman Tauzin refused our repeated requests for interviews.

By the end of the '90s, accountants were so intertwined with their corporate clients, the line between them was often blurred. In fact, when the SEC tried to break them apart to reestablish auditor independence, Levitt received this very revealing letter from one Kenneth Lay, CEO of Enron.

ARTHUR LEVITT: Ken Lay wrote me a letter during the debate over the issue of auditor independence, urging me not to proceed with this rule-making because his relationship with his accountant, Arthur Andersen, had been such that consulting was terribly important to the well-being of Enron.

HEDRICK SMITH: [on camera] So Ken Lay didn't want that broken up, that relationship with Andersen.

ARTHUR LEVITT: No, he did not.

[www.pbs.org: Read Lay's letter]

HEDRICK SMITH: [voice-over] According to Lay's letter, Arthur Andersen - with more than 100 people working on the $58 million Enron account - had become an integral part of the Enron team. In fact, according to an investigation for Enron's board, Andersen was "closely involved" in structuring Enron's controversial off-book partnerships.

[on camera] Why does a company like Enron, which is going gangbusters, create hundreds of these off-balance-book partnerships? What's the point?

JOHN BYRNE, "BusinessWeek": To get debt off the balance sheet, to make the company look more stable financially than it really is.

HEDRICK SMITH: [voice-over] Enron's accounting practices became so aggressive that several Andersen audit experts, like partner Carl Bass, began to object. Bass was part of an elite group at Andersen protecting the quality of audits.

[on camera] So Carl Bass and the technical group would have been one of those who was keeping the rules pure.

JAMES HOOTON, Andersen Senior Partner (1976-2002): He was a member of that group that kept the rules pure, the keepers of the Holy Grail. They're the experts. They're the best that your firm has to offer.

HEDRICK SMITH: [voice-over] For two years, Bass fired off memos challenging Enron's accounting. Eventually, Enron got so angry at what it called Bass's "cynicism" that it demanded that he be taken off the account, and Andersen complied.

[on camera] Why would you remove the technical guy who's the protector of your integrity at the request of a client?

JOSEPH BERARDINO, CEO, Andersen Worldwide (2001-2002): Well it's very unusual that we would remove somebody. The client wants to feel that you're understanding their business problem, that you're understanding what they're trying to accomplish with their accounting for a business transaction. And if you have people that either don't have the bedside manner, don't have the capability, don't have the expertise to get in a client's shoes to understand it, clients react negatively, OK?

Then we've got to make a judgment call as to whether they're objecting to that service for the right reason or the wrong reasons. And you know, it's very rare that we remove somebody. And obviously, this was one of those rare- those rare situations.

HEDRICK SMITH: [voice-over] But other Andersen partners were also growing uneasy. In a conference call between Houston and Chicago in February, 2001, 10 months before Enron went bust, 14 Andersen partners debated whether to keep Enron as a client. But they projected that the Enron account would soon be worth $100 million a year to Andersen and decided to stick with Enron.

Even inside Enron, people were sensing imminent disaster. Last August, Enron vice president Sherron Watkins, herself a former Andersen accountant, warned CEO Ken Lay that Enron was about to collapse in "a wave of accounting scandals." Later, to Congress, Watkins implicated Andersen.

    [committee hearing]

    Rep. STEARNS: Is it possible that Arthur Andersen has some culpability here because they signed off on it?

    SHERRON WATKINS: I think so, because they are charged with auditing the results, and a sensitive related-party transaction should get a lot of scrutiny.

    Rep. STEARNS: So Arthur Andersen, in your opinion, signed off on something they shouldn't have.

    SHERRON WATKINS: Yes.

    Rep. STEARNS: Do you think they knew what they were signing off on?

    SHERRON WATKINS: They sure should have known what they were signing off on.

HEDRICK SMITH: In August, Watkins had also warned Andersen, but it took two more months before Enron's books were corrected, restating and reducing Enron's net worth by $1.2 billion and sending Enron stock into a tailspin.

    Rep. JAMES GREENWOOD: I suggest you fasten your seatbelt.

HEDRICK SMITH: By then, Andersen was in big trouble. The SEC was investigating.

    Rep. JAMES GREENWOOD: Would you please come forward? Would you please rise and raise your right hand-

HEDRICK SMITH: And David Duncan, its lead partner on the Enron account, had his staff shredding documents- on Andersen's orders, he later testified. But Andersen CEO Joseph Berardino blamed Duncan and fired him.

JOSEPH BERARDINO: I wanted to give a message, because at the time everyone was looking at me and at us, that this was not a culture that would stand that kind of behavior.

[www.pbs.org: Read the interview]

HEDRICK SMITH: [on camera] Something like 80 people in that office were involved. If this had been something that had really been against Andersen policy, wouldn't some of those people have picked up the phone or written an email to headquarters and said, "Hey, we're destroying 20 boxes of- of Enron material. Should we be doing this?"

JOSEPH BERARDINO: All I know is that that- those activities were taken under David's direction. There was absolutely no cover-up or direction to go destroy documents. But documents were destroyed.

HEDRICK SMITH: [voice-over] Suddenly, the firm once considered the gold standard of accounting was drowning-

    EMPLOYEE RALLY SPEAKER: But we will stay together, regardless of what happens, regardless-

HEDRICK SMITH: -its employees reduced to pleading for public faith in their integrity.

    EMPLOYEE RALLY SPEAKER: We're dedicated to serving our clients, and we're dedicated to each other.

HEDRICK SMITH: [on camera] Do you regret, maybe, not having listened to Carl Bass earlier?

JOSEPH BERARDINO: You know there's been so much pain that's coming out of this Enron situation- stockholders, their employees, now our employees. People always ask me, "How do you sleep at night?" And I say, "I sleep like a baby. I wake up every two hours and cry."

HEDRICK SMITH: [voice-over] Andersen's demise didn't solve the broader problem of the cozy collaboration between auditors and their corporate clients. In the '90s, all the big accounting firms worked hand in glove with companies and Wall Street to find loopholes in the accounting rules.

Lynn Turner worked that game as a former Wall Street partner at the accounting firm of Coopers & Lybrand before becoming the SEC's chief accountant.

LYNN TURNER: In my prior life, we actually had a retainer arrangement with each of the major Wall Street investment banking firms under which we would help them financially engineer or structure hypothetical transactions for, you know, finding financing, keeping it off balance sheet, making companies look better than, quite frankly, they really were.

HEDRICK SMITH: [on camera] You mean, doing the kinds of things that Enron and Andersen did.

LYNN TURNER: Yes. Exactly.

HEDRICK SMITH: So there's a whole system that does this.

LYNN TURNER: There is a system that turns around and does it. Every one of the big accounting firms have such a group.

HEDRICK SMITH: And all the big investment banks have that.

LYNN TURNER: Yes, investment banking groups. In fact, they make good money trying to figure out how to structure these transactions.

HEDRICK SMITH: So we haven't, in Enron, just stumbled into something that may have happened. This isn't way off, an odd-ball thing. We've run into something that is a fairly common practice.

LYNN TURNER, SEC Chief Accountant (1998-2001): This is day-to-day business operations in accounting firms and on Wall Street. There is nothing extraordinary, nothing unusual in that respect, with respect to Enron.

    Sen. JOSEPH LIEBERMAN: [Senate committee hearing] Give us some guidance as we begin our investigation as to-

HEDRICK SMITH: [voice-over] But Enron's collapse galvanized Congress. Arthur Levitt returned to center stage, urging major reforms.

    ARTHUR LEVITT: [Senate committee hearing] We've got to begin to reinvigorate the financial checks and balances that over the years, as a result of nothing less than a cultural change, has eroded in America-

HEDRICK SMITH: But Levitt is no longer in charge. Now it's up to President Bush's SEC chairman, Harvey Pitt. Like his former clients, the accounting industry, Pitt is cautioning Congress to go slow.

    HARVEY PITT: [Senate committee hearing] We are opposed to those who say that accounting firms as a whole should be restricted to providing only audit services.

HEDRICK SMITH: Whether on auditor independence or reversing the tort reform-

    HARVEY PITT: [Senate committee hearing] We strongly urge you to refrain from making any changes in that legislation.

HEDRICK SMITH: -or expensing stock options, Pitt favors the status quo.

    Sen. CHARLES SCHUMER (D-NY): [Senate committee hearing] Chairman Greenspan has said that if he could do one thing to learn from what has happened with Enron, the auditing and everything else, he would expense stock options. Do you agree with him?

    HARVEY PITT: Having gone through this exercise, I would be exceedingly reluctant to reopen the issue. I don't think that the non-expensing of options caused what happened in Enron.

HEDRICK SMITH: [on camera] Your basic message seems to be, "Go slow. Don't be too radical and hasty on reform." Why do you say go slow?

HARVEY PITT: I don't say go slow. There are people who want you to believe that that's what we're saying. That is not what we are saying. We're saying it's not a question of more regulation-

HEDRICK SMITH: I mean, it sounds as though you're saying very much what the accounting industry itself wants and not what investors, investors' representatives are asking for.

HARVEY PITT: We are in the process of forging an incredible new system for the benefit of individual investors, something that should have been done 5, 10 years ago, but was allowed to lie dormant.

HEDRICK SMITH: [voice-over] Pitt is pursuing vigorous enforcement. And rather than stronger government controls, his proposes a new private sector oversight board, including accountants among the members.

HARVEY PITT: They would have the power, if they found that a firm was not doing the highest quality audit work, to dictate that the client pick another auditor. So the stakes would be exceedingly high for the audit firms to come up with high quality controls and make sure they're performing at the highest level.

[www.pbs.org: More on Pitt's proposal]

HEDRICK SMITH: But critics, including major investor groups and The Wall Street Journal, have questioned whether Pitt is genuinely prepared to cross the accounting industry.

[on camera] People are talking about your reforms as putting the fox in the henhouse, pulling your punches. Isn't it time to get tough and be clear?

HARVEY PITT, SEC Chairman: Absolutely. That's why the proposal that we have will achieve that result, and it's going to be done for the benefit of investors and be done the right way.

HEDRICK SMITH: I hope you're right.

HARVEY PITT: I know I am.

HEDRICK SMITH: [voice-over] Here in Washington, strong reforms have been watered down by accounting lobbyists, and Congress is likely to fall short of doing what's needed.

In Houston, Arthur Anderson was found guilty of obstructing justice, a fatal blow to the firm and a dark legacy for the industry.

On Wall Street, with investors still uncertain whether they can trust anyone, come warnings that without much stronger protections, more Enrons lie ahead.

 

 

Bigger than Enron

WRITTEN AND PRODUCED BY
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ANNOUNCER: This report continues on FRONTLINE's Web site, where you'll find information for investors about how companies lie, the politics of Enron debated by two leading national journalists, FRONTLINE's interviews with SEC chairman Harvey Pitt, his predecessor, Arthur Levitt, and other key players, and much more. You can also find out on the Web site if this program will be shown again on your PBS station and when. Then join the discussion at PBS on line, pbs.org or write an email to frontline@pbs.org or write to this address [Dear FRONTLINE, 125 Western Ave., Boston, MA 02134]

 

 

Next time on FRONTLINE: The last decade in the Middle East has seen an endless cycle of the promise of peace and the despair of violence.

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ANNOUNCER: Can Israelis and Palestinians ever make peace? Watch Shattered Dreams of Peace next time on FRONTLINE.

 

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