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December 6, 2011

Accounting not to blame: Enron whistleblower

A remuneration system that encourages C-suite executives to inflate a company’s share price was the root cause of Enron and the subsequent focus on accounting and auditing has done little to combat fraud, according to Enron whistleblower Sherron Watkins.

Watkins, who is currently a speaker on leadership and ethics, said that Enron, Worldcom and many other major cases of US fraud are essentially corporate governance failures. Accounting tricks are only tools used by corrupt executives to carry out white collar crime.

Watkins was Enron’s former vice president of corporate development when she first raised concerns about false accounting to chief executive Ken Lay in 2001. She was speaking to International Accounting Bulletin 10 years after the former energy giant Enron filed for bankruptcy.

Enron was one of the largest frauds in history and considered a huge audit failure that struck a nail into the operations of audit firm Arthur Andersen, the fifth largest firm at the time. Andersen was subsequently banned from auditing and later dissolved.

A spate of large corporate frauds following Enron led to the introduction of the Sarbanes-Oxley Act, which overhauled the audit oversight system and introduced rigorous internal control requirements for listed companies.

But Watkins believes the focus on the accounting profession does not address the underlying problems that led to Enron.

“If we keep looking at it as an accounting problem we will never fix it,” Watkins, a former accountant at Arthur Andersen, warned. “I think [accounting] is just a tool that is making then prop up their earnings.”

Watkins said accounting rules are so complex that “they can be twisted by anyone that wants to twist them” and the Sarbanes-Oxley that was introduced as a response to Enron “only codified best practices that Enron and other companies were already following”.

At the heart of the problem is a remuneration system that rewards company executives for taking risks to inflate their company’s stock value.

In 1993, a law was passed in the US to cap executive cash pay at $1m. Watkins said this had an “unintended consequence of really blowing up the use of stock options”.

“Many chief executives’ of the top companies were making $3m or $5m a year so that meant their companies lowered their pay to $1m and then they had to make up the difference and they typically made up the difference with stock options,” she explained.

“All the sudden companies and their executives were really incentivised to gamble the company and take on greater risk, to really grow that stock as it benefited them directly,” Watkins said.

In the wake of Enron, US Congress looked at how C-suite executives exercised stock options but reforms were taken off the agenda after backlash from the businesses community.

Instead, Enron was considered an ‘accounting’ problem rather than one that also tackled remuneration and corporate governance structures.

“There is not a corporate board in America that truly governs,” she said. “I think it’s a misnomer that we have corporate governance because the chairman of the board who really runs the board is usually also the chief executive or the retired chief executive, which means it doesn’t matter how many independent people you have on the board it’s not an independent board and it’s not doing its job.”

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