Exposing The Enablers Of Corporate Corruption
Time to expose the methods used by the quiet enablers who give corporations their outsized wealth and power and allow them to undercut capitalism — their accountants and auditors.
In a 2009 interview with Stanford University’s professor Joseph A. Grundfest, Charlie Munger, Warren Buffet’s right-hand man, accused the accountant profession of a total lack of ethics:
I would argue that a majority of the horrors we faced would not have happened if the accounting profession were organized properly…
And they are way too liberal in providing the kind of accounting the financial promoters want. They have sold out and they do not even realize that they’ve sold out … Compared to what could reasonably be with intelligence and honor, the accounting profession is a sewer.
Why is Munger so down on accountants? Let’s have look at the evidence.
A Monty Python skit with Michael Palin as an accountant and John Cleese as his career adviser satirized the common view of accountants. Cleese’s character described Pailin’s character in the most unflattering language, something like: ‘Our experts describe you as an appallingly dull fellow, unimaginative, wimpy, spineless, easily dominated, no sense of humor, tedious company and irredeemably drab and awful. A total wuss.’ Then, Cleese comforted Palin. ‘And whereas in most professions these would be considerable drawbacks, in accountancy they’re a positive boon.’
I tried to avoid using ‘accountants’ in the intro of this article until the last line of the introduction as I know how the mere mention of that term would telegraph to readers that this could not possibly be about anything significant. All accountants do is count the beans in a jar.
There are a number of ways that some accountants have quietly helped many corporations obtain their disproportionate wealth that corporations use to control governments.
In another article, I detailed how many accountants help corporations and the super-rich use offshore tax havens to easily evade tax here.
This time I’ll discuss the unrecognized help mega-corporations get from accountants acting as auditors of their financial statements; the ones who are supposed to be our watchdogs— but have turned into corporate lapdogs. The 2008 Crisis exposed how the rating agencies do the banks’ bidding; similarly, auditors obey corporate commands.
When Auditor Complicity in Corporate Fraud Became Unavoidably Obvious
The story of Enron’s fall from dizzying heights of America’s seventh largest corporation to the ignominy of bankruptcy is an early story of the accountants’ sell-out that Munger described.
The deregulation bonanza of the Reagan and Clinton eras that eventually contributed to the near failure of Wall Street banks in 2008, also let Enron create and sell derivatives on energy contracts and other futures contracts as a major source of its income totally without any oversight— except from its auditors. However, Enron did not merely claim its commissions on the sale of the derivative as income but the entire contract price immediately — even though that might not be paid over 10 years or so. There was no allowance made that this might possibly be a bad debt — as it was in so many cases eventually.
For an explanation of that fearsome term ‘derivatives’ see Deconstructing Derivatives here.
To compound this inflated income, Enron then created its own additional source of eager buyers through investment partnerships by entities called special purpose vehicles (SPVs) supposedly in partnership with arms-length entities. It disguised the fact that the other minor partners were often controlled by a non-arm’s length Enron executive, and that Enron was the major and controlling partner. Without digging deeper to verify the apparent independence, auditors Arthur Anderson said the SPVs did not have to be shown on Enron’s financial statements. These are called ‘off-balance-sheet’ items in accounting jargon.
Enron then transferred some of its stock to the SPV which it used as collateral for a bank loan. The funds were used to purchase failing assets from Enron. Thus the loan that was shown as a debt on the SPV’s book wonderfully became income on Enron’s financials while it also got losing assets off its books. Medieval alchemists would have been astounded at the accomplishment.
The scams involved billions and Arthur Anderson was cool with it all.
The above is a stripped down explanation of the underlying structure of the major scams. They were hidden in a complex web. For a more detailed, yet still somewhat simplified, discussion see the Everything Explained site.
Investor skepticism on how Enron continually reported such high earnings relative to other businesses in the same industry grew. Enron refused to disclose how it made its sensational profits protecting its supposedly innovative methods posing like a chef protecting a secret sauce. However, in November 2001, the SEC began an investigation into Enron for fraud. When it disclosed a 12-page internal memo from Enron accountant Sherron Watkins describing Enron’s improper accounting practices in detail and announced probable civil fraud charges against Arthur Anderson. Enron’s stock tumbled and it entered into the largest bankruptcy to date— a title it soon lost to another Arthur Anderson audited company.
BTW: 2001 was the beginning of very bad terrible times for Arthur Andersen. Its bad luck came in fours: before the Enron scandal, it had been implicated in fraud level misconduct in the audits of Sunbeam and Waste Management, Inc. Then in 2002, a mere one month after it had been convicted for obstruction of justice for destroying documents in the Enron investigation, Worldcom, audited by guess who, beat Enron for the title of the largest bankruptcy to date.
A Legal Geek Intrusion: Later, on appeal, Arthur Anderson was acquitted of the charge of obstructing justice because of a technical error in the trial judge’s instruction to the jury. A judge is required to fully explain every defense to a jury (even if they think it implausible). The trial judge did not tell the jury they could consider that Arthur Anderson auditors were just carrying out its normal document retention policy.
By this time, however, Arthur Anderson’s reputation was ruined. No one would trust its audit opinion. The partners sought refuge in the four remaining ‘Big Four’ firms. As with the usual DOJ policy, no thought was given to charging or suing the partners who signed the audit opinions. They kept all the fees earned by looking the other way. Their professional body did not revoke their license to sign audit opinions. They lived to audit another day.
In my next article, I review the mounting evidence from the 2008 Crisis onward demonstrating the complex Sarbanes Oxley’s total ineffectiveness and recommend a straightforward one line solution in place of the Sarbanes-Oxley complexity that should appeal to deregulation fans.
Disclaimer: While I acted for Lloyd’s of London who insured Canadian auditors in the 1980s, I have not referred to any cases in which I represented or advised auditors. All references are to publicly available information.