Would the CFA or CPA have helped see Enron coming?

Of course, we are speaking with the benefit of hindsight, but just try to use your imagination.

I see in level 1 that about 28% of of the exam is about financial reporting and corporate accounting. I know level 2 involves a closer look at financial statements.

Would a CFA Charterholder, if he wasn’t biased by his employer, been able to look at the annual reports, look at public information and know that something was amiss before the scandal broke?

Well considering Arther Andersen didn’t see anything wrong (or at least not wrong on the scale that eventually would be known) and they had tons of non-public details to go on, probably not. And your typical CFA Charterholder probably wouldn’t either, just looking at Enron’s public record. It’s an industry that’s hard for outsiders to understand and financial reporting standards often don’t fit such businesses well.

The sad part is I don’t think governance and risk practices in organizations have sufficently moved forward to prevent another such event today.

+1

When people see $$$ coming in, their brains tend to go soft.

People who passed the CPA or have a CPA may well have posessed the skills to figure out Enron, but the reality distortion field and pressure to conform to the team that looked like it was winning was just too great for them to be critical.

There’s no real test you can pass for finding those sorts of things, except having found them in the past.

Curious if bromion agrees here, since part of his M.O. is to identify clear frauds.

One challenge of these kinds of things is that being early on something like Enron is not much different from being wrong. You not only have to identify this sort of thing, but you generally have to time it right if you are going to short. You can take a middle ground, like not hold, but then you look stupid on the way up.

Also,the risk of lawsuit is huge if you’re wrong in calling one of these out. The bull case guy can throw out 10 picks and be right half the time and all is good. If the fraud detection guy is wrong once in his career, he’s done. Game over.

Arther Anderson knew full well what was up at Enron and turned a blind eye; accelerated revenue recognition; ficticious profits on intercompany sales; mountains of debt hidden in SPE’s and unconsolidated subsidiaries; suspect asset valuation models; ridiculous conflicts of interests between firm and senior management. They had to reassign senior accounting experts/consultants off the account to keep the client happy although these issues were certainly apparent to local staff. When you are making $ 50-60M in billable revenues, with the majority from consulting, the clarity of auditor green eyeshades can get foggy!

Actually there were a number of reporters / analysts on these jokers well before the train wreck…but that executive group did everything to intimidate and blow smoke while staying the course. At the time they were touted by McKinsey and Forbes as a “new paradigm” and the “smartest guys in the room” so many were hoodwinked!

It takes 2 to dance. If you dare to be a whistle blower, you will be blackballed.

There’s a good documentary that I believe you’re referring to called “The Smartest Guys in the Room” on Enron. I thought it was really well done and entertaining. Good learning tool for those that didn’t live through Enron.

Enron had a very complicated business that created room for fraud. There’s still a good deal of very large, well known companies that have very complicated businesses that engage complex transactions and have challenging 10-k’s for analysts to comprehend. You can really dig into the numbers, subsidiary relationships, off-balance sheet transactions and find questionable accounting but you really have to place a good deal of faith in the accounting firm that signs off on the statements.

isnt there a whistleblower reward system up to 30% or so?

great film

Marianne Jennings covered this topic extensively in her 2005 FAJ piece, titled “Ethics and Investment Management: True Reform.” If you have CFA Institute website access to the PDF through CFA Pubs, log in and download it. It is a short read. Otherwise, I’m sure you can Google this and come up with a copy floating around somewhere.

John Olson, in Jennings’ tale, is kind of my hero. Plenty saw it coming, but investors, directors and CIOs are deaf when the tickers are green. Nobody wants to be the spoilsport.

True and unfortunate.

Huh? I thought Arthur Anderson got in trouble BECAUSE they knew what was going on (from the nonpublic info)

If that’s true, then it still prompts the question whether an outsider (such as us CFAs and CFA candidates) could tell.

To the comments about being blackballed or having your career end, let’s refocus the discussion to being right, and away from “being right and being politically accepted”.

I guess the question we should be asking is "If we could go back in time with our CFA skills and look at the public information of Enron, would we bet on Enron with our own personal cash?"

Could you elaborate on who “that executive group” is? You mean Enron management? Arthur Anderson’s audit partners? The owner of the newspapers? The management of the sell-side analysts who wanted to publish a negative opinion?

What was stopping a CFA from posting his objective calculations on seekingalpha.com or fool.com or whatever and letting readers look at it? Or did that actually happen?

Nothing. Dude, read the article I referenced earlier. Google Bethany McLean and John Olson. People were talking about something smelling bad at Enron for some time. It’s just that the people who stood to lose from uncovering the truth ignored it. It wasn’t some crazy market conspiracy, it’s just basic investor and businessman psychology.

In fact, I’m surprised you haven’t answered your own question by hitting up Google. I’ve never seen a crisis event that didn’t have hindsight 20/20 bozos scrambling to claim credit for their “prescient foresight” – after the fact, of course.

Except that McLean and Olson were the real deals. There were others out there.

I respect your curiosity but I have to say, your question is quite naive as it makes all kinds of assumptions and attempts to impart claims about the skills and expectations of the public for CFA charterholders, none of which charterholders as a group are at liberty to hold themselves out with. And actually, yes, I think that a CFA charterholder that was worth his salt (and wasn’t getting greased to overlook sketchy financials at Enron) would have had enough background and financial acumen to detect that something was amiss.

Do you know what it is like to actually dig into financials and do onsite due diligence with management teams? It ain’t like it is in the textbooks. There’s a lot of laziness out there too that says nothing about somebody’s skill level. I suspect that there were many highly skilled analysts that just didn’t go deep enough into the financials, and they never got called out by their bosses.

By executive group yes I meant Enron Management who, as is often the case, played hardball (limited access, initmidation, threatening media ties) with analysts and reporters that raised questions they did not like.

Don’t really understand the context of the “whistleblower” remark…auditors are obligated to be independent and objective and perform sufficient audit work so as to be able to draw their audit opinion. Anderson was obligated to surface material mistatements even at the risk of losing the client!

Much of the fraud was in fact hidden from the consolidated financial statements because of accounting transactions / treatments that should not have been allowed, served no true business purpose, and so outsiders were able to see the smoke from outside the firm for awhile and harbor suspicions but it was not until the “tide went out” during the 2000 tech bubble when outside “calls” by 3rd parties (in the form of declining revenues, debts due, etc) revealed all the sins.

The biggest source of the smoke was that Enrons reported revenues and profits continued to skyrocket while its cash flow lagged absurdly…pretty funny when you think that this was the firm that supposedly was executing the speculative model of dispensing with production and transport and refining assets in favor of leveraging intellectual capital and trading agility LOL! Where was the cash hiding in such an agile model? Bad bets and associated big debts (and revenues/profits that were not real) until the music stopped

Working in energy trading industry those prices move on totally unexpected crap(a bird hit a power-line we lost 2million in an hour) and the concept of mark to market feels shady when done on the best of days. I don’t think much has changed to prevent this from happeneing again other than analysts know to look closer into these companies.

They knew it was wrong, AA was complicit in the fraud.

To answer the question though:

CPA would have been better than CFA, but mainly you just needed common sense. There is really no reason ever for a public company to have super complex, obscure subsidiaries. I am short a company right now that is doing this – the reason they are doing it is to shuffle cash to overseas ratholes to the detriment of shareholders. This is one of the ways public companies commit fraud (among several others).