Federal regulators and Wall Street watchdogs were entangled in a web of “systemic and catastrophic failure” in the Enron collapse, a failure that meant “investors were left defenseless,” maintains a scathing Senate committee staff report that will be released today.
“Virtually no one in the multilayered system of oversight and controls relied on by the public detected Enron’s problems, or if they did, they did nothing to correct them or alert investors,” Sens. Joseph I. Lieberman, D-Conn., and Fred Thompson, R-Tenn., say in a letter accompanying the 131-page report.
The report, which contains the findings of a lengthy investigation and a series of hearings by the Senate Governmental Affairs Committee that Lieberman chairs, details the breakdowns, gaps and laziness in the system that was designed to protect the public from unscrupulous companies and their officers.
The Securities and Exchange Commission was often too cozy with the companies it regulated, Wall Street analysts did virtually nothing to warn the public about Enron’s problems, and credit rating agencies were lax in asking the questions that may have made them suspicious of problems at the Houston-based energy company, according to the report.
“Not one of the watchdogs prevented or warned of the impending disaster,” the report states.
“These failings call into question the basic assumptions on which our financial regulatory framework is built.”
Wall Street analysts are too often beholden to the companies they watch. “Enron exposed a dirty little secret,” the report states, “that Wall Street analyst recommendations were of questionable reliability.”
In fact, the senators say in their letter, “analysts have often gone so far as to serve essentially as marketers working for the companies they cover rather than advisers to the investors using their research.”
Credit rating agencies were simply lazy. The agencies, the committee staff found, “did not ask sufficiently probing questions in formulating their ratings, and instead generally just accepted at face value what they were told by Enron officials.” The agencies “apparently ignored or glossed over warning signs.”
Lieberman plans to discuss the report at a Washington news conference today. The report is not likely to lead immediately to new legislation, but could form the basis for further congressional investigations. President Bush earlier this year signed into law a measure that provides tough new penalties for corporate abuse and addresses some of the problems the report discusses.
The report does not deal with any relationships between Bush administration officials and Enron, but that was not its intent. The committee staff, though, is looking into those relationships.
Congress’ actions are also not discussed in the report. Lieberman as well as many of his colleagues have come under fire for encouraging the awarding of stock options to top corporate officials, and others have been criticized for lax oversight of regulatory agencies.
At the SEC, Chairman Harvey Pitt issued a statement Sunday saying he had not yet read the report in full. The study, he said, was “an effort that needed to be undertaken, and we will carefully consider the report’s conclusions.”
He saw the criticisms as aimed at “the bigger aftermath of the over-exuberance of the 1990s,” during the Clinton administration. “Under my leadership,” he said, “we are already well engaged in taking important steps to improve corporate disclosure and enforce securities laws without delay. … We are well underway toward taking and completing the tasks necessary to restore investor confidence.”
Pitt may find, though, that his agency will have to spend time defending itself from a report that’s almost sarcastic in its initial assessment of what went wrong.
“The SEC calls itself `the investor’s advocate,’ and it should be,” the senators say. But, the committee staff found, “the SEC’s investor protection efforts in the case of Enron fell far short of that `advocacy.'”
The committee’s investigators found that there were signs of problems mounting at Enron and other companies for years, but the SEC either ignored them or was not aware of their magnitude.
One clue was the volume of revised financial statements filed with the SEC by many companies. The SEC chairman at the time warned about the decreasing quality of financial reporting, as well as the restatement trend.
But, the report states, “the SEC did little to react to these vulnerabilities and ultimately failed to fulfill its mission to protect investors.”
In another instance, the lawmakers discussed how, in 1992, the SEC allowed Enron to use a new accounting system to record the value of certain energy contracts. Though it imposed strict conditions on the company, the SEC then “never checked to make sure that Enron was meeting those conditions,” the report states, adding that this lack of action rendered the SEC’s conditions “meaningless.”
There is now evidence, the committee investigators found, that Enron abused the accounting system to “substantially inflate its reported revenue and earnings.”
The senators conclude that had the SEC been a more tenacious watchdog, “it is much less likely that Enron would have been able to engage in its abusive practices.”
A third example of the SEC not performing well occurred in 2000, when Enron sought an exemption from the requirements of the Public Utility Holding Company Act to conduct certain business. Not only was the SEC “lackadaisical” in its approach to the request, the committee staff found, but it did not consult with federal energy regulators. This, say the senators, “may have opened yet another door to Enron improprieties.”
At the same time, others outside government, who could have put on brakes, or at least offered warnings about Enron, did not do so.
The report is particularly critical of Wall Street analysts. Enron, as is common in business, used investment bankers. And, the report states, the company used “its business and potential business as leverage not only to convince firms to invest in Enron’s questionable partnerships, but also to attempt to influence the ratings of the company’s stock by those analysts affiliated with investment banking firms.”
The “enormous” investment fees Enron paid to Wall Street companies, the report states, are “incentives to the firms to bend too far to please those clients and potential clients.”
This was particularly galling, the report states, because “hard-working, middle-class people trying to save for their retirement or their children’s retirement or their children’s college education rely on the analyses and recommendations offered by the stock analysts at Wall Street firms.”
Then there were the credit rating agencies, another supposed source of independent information about a company’s health because they have even more access to inside information than analysts.
They routinely “failed to sufficiently consider factors affecting the long-term health of the company,” the senators say, “particularly accounting irregularities and overly complex financial structures.”
And because the agencies are subject to few regulations, and their liability is limited, “there is little to deter future poor performance,” the report warns.
The report contains a number of recommendations, many of which are being considered in Congress or have already become law.
More frequent SEC review of corporate filings, recommended by the committee is now on the books. But the committee staff also wants the regulators to require a complete separation of investment banking and research, and to bar analysts from sharing reports with a company before the reports are released.
The staff also recommends that credit raters be subject to strict industry-related criteria that would be overseen by the SEC.