Four years after the collapse of Enron Corp. spurred the most sweeping revisions in business regulation since the Great Depression, experts warn that the ingredients for a similar financial disaster remain.
Despite new laws and regulations, companies still face enormous pressure to meet short-term financial goals, creating a powerful motive for accounting fraud. Outsized executive compensation grows by the year, offering another rich incentive to cook the books. And there is no certainty that Congress will continue to fund regulatory budgets at current levels.
But some things have changed since December 2001, when Enron's sudden descent into bankruptcy protection rocked investor confidence and left the markets reeling. Accountants face independent oversight for the first time in 70 years. Most corporate board members take their jobs far more seriously. Wall Street is somewhat less willing to accommodate clients' interests.
Nearly a dozen experts contacted by The Washington Post, including regulators, accountants, chief executives, board members and investor advocates, agreed to fill out a corporate governance report card on the eve of the Enron trial.
The Houston energy trader's implosion exposed wide gaps in the safety net designed to protect shareholders, some of which remain today. Former executives Kenneth L. Lay and Jeffrey K. Skilling go to trial Monday on fraud and conspiracy charges.
Accountants exploited loopholes to curry favor with companies that paid their fees. Executives collected more than $400 million in salary and bonuses but denied knowing about fraud on their watch. Investment bankers engaged in sham deals to help clients meet quarterly profit targets. Boards of directors waived conflicts-of-interest policies and turned a blind eye to overly aggressive business practices. And overwhelmed regulators failed to devote enough resources to combat fraud.
Congress passed the Sarbanes-Oxley Act in July 2002, imposing new duties on corporate executives, auditors and directors. The Securities and Exchange Commission and the Justice Department spent tens of millions of dollars to root out malfeasance. Along the way, prosecutors won criminal convictions and decades-long prison terms for former leaders of Adelphia Communications Corp., Tyco International Ltd. and WorldCom Inc.
But in a sense, the government efforts may have backfired, inspiring a dangerous overconfidence among investors.
"I just don't think we are as far along as we need to be," said former SEC chairman Harvey L. Pitt, who led the agency when it brought the biggest-ever fraud case against telecommunications company WorldCom Inc. in 2002. "Many shareholders may have been led to believe that [reforms] have cured all the problems, and we're home free. Unfortunately, that's a prescription for disaster."
The lingering problems were on display late last fall, when commodities-trading firm Refco Inc. collapsed in an accounting scandal just two months after an initial public offering, led by blue-chip investment bank Goldman Sachs and Co. Investors snapped up Refco shares even though the company admitted in its prospectus that there were serious problems with accounting controls. "Could Enron happen again? Sure it could. Just look at Refco," said Henry T.C. Hu, a law professor at the University of Texas at Austin.
The grades suggest that the greatest improvement has been in the regulation of the behavior of accountants who serve as gatekeepers to the markets. New York Attorney General Eliot L. Spitzer said the profession has been "scared straight" by fallout from the scandals, which included the death of accounting firm Arthur Andersen LLP and a $456 million deferred prosecution settlement by KPMG LLP last year.
Corporate boards get fair marks for meeting more often and paying more attention to the work of auditors. Last year, longtime directors at insurer American International Group Inc. overthrew Maurice R. "Hank" Greenberg as chairman after nearly 40 years at the helm after regulators stepped up an accounting probe at the company. And Hewlett-Packard Co.'s board fired star chief executive Carly Fiorina because of dissatisfaction with the way she handled a merger. She was not accused of any wrongdoing at the company.
Even so, many board members still lack the financial know-how to interpret complex information, said Dennis R. Beresford, former chairman of the audit committee at MCI Inc.
At the same time, opposition to some of the changes made since Enron is growing. Increasingly, trade groups, including the U.S. Chamber of Commerce and securities law professors, have complained that boards and accountants spend too much time meeting meaningless criteria rather than getting to the root of more insidious problems.
Bob Merritt, the former finance chief at Outback Steakhouse Inc., noisily resigned his post last April after decrying "overzealous" regulations that tied him up in minutiae, far away from business decisions. Many other executives across the country privately applauded his stance.
Jeffrey Stone, a former federal prosecutor who now heads the white-collar defense practice at McDermott Will & Emery, said some new rules, especially one that requires a company and its auditors to examine financial controls, impose heavy costs "that far outstrip the protections that are afforded."
Each of the experts stressed that crooks bent on stealing from a company will still take their chances and some will succeed. Regulators can never pass laws that will force executives to act with integrity — or force investors to do their homework before they buy stock.
Little has changed to shrink the incentives for taking big risks, business as well as ethical, that can give rise to misdeeds.
Wall Street analysts and reporters still seek guidance about company revenue each quarter. Businesses pay a price for missing targets by even a penny or two. The earnings guidance is "like heroin" for analysts, said Colleen Sayther Cunningham, who leads a trade group for corporate finance officials. "Once you put it into your arm, you can't kick it."
There has been no slowdown in the race for higher executive pay, the experts said. Chief executives won a median pay raise of 30 percent in 2004, twice the increase from 2003, according to the Corporate Library, a watchdog group that rates public companies on corporate governance. Repeated studies have shown virtually no connection between high compensation and good corporate performance.
"As long as CEO pay is so fundamentally out of whack, we cannot say that boards are doing their job or that corporate governance reform has been accomplished," said Nell Minow, an investor advocate and co-founder of the Corporate Library.
Some companies have moved away from compensating top executives with stock options now that they are required to count them as an expense. But in numerous cases, they have simply replaced options, which pay off only if a company's stock performs well, with restricted shares, which promise a gain for executives no matter what. Critics refer to such compensation as "pay for pulse."
William J. McDonough, former leader of an accounting industry oversight panel, said recent initiatives, including a drive by the SEC to beef up disclosures about executive pay, are heartening. In all, though, there is "not as much [progress] as I'd like to see. I don't think anybody including me has any theory of how executive compensation should be set."
In addition, investor advocates said they fear that once the Enron trial ends and the focus on corporate crime fades, regulatory budgets could again get squeezed. "Already, recent appropriations have not matched agency funding requests," said Barbara Roper, chief of investor protection at the Consumer Federation of America.
The outcome of the Enron trial could have a more profound impact on attitudes among corporate executives in the long run than the regulatory changes, said Harvey J. Goldschmid, a law professor and former SEC official.
"Deterrence is very important, and this trial is of large consequence for that reason," Goldschmid said.