Inside Major Corporate Accounting Scandals | Bigger Than Enron (full documentary) | FRONTLINE (PBS)

It was a meteoric rise. >> We will become the worldleading company >> and a devastating collapse. Enron [music] is a corporate Chernobyl. >> You have the entire system playing fast and loose. >> It is not just Enron. It's an industry problem. >> It is real real damage to the country. >> Why didn't anyone sound an alarm? >> The watchdogs work for executives and Wall Street. They don't work to protect shareholders. But once again, >> correspondent Edric Smith investigates [music] how greed and politics undercut America's financial watchdogs. >> Is anyone protecting the public? [music] >> Tonight on Front Line, bigger than Enron. >> Corporate support for Frontline was provided by >> So that's our pitch. >> But if AI can't explain itself, who's liable when it's wrong? >> Well, of course. um process. Interesting thing about that is >> we're in uncharted territory.

>> Humans have less and less understanding of what it's actually everyone everyone has a different piece of the puzzle. >> I think what Michael's trying to say is >> support provided by the economist newspaper limited. Everything about Enron seemed larger than life. from its glittering Houston headquarters reaching to the skies to its spectacular downfall. But Enron's collapse was more than the shattering of one American success story. It was a warning of a far wider malaise in the marketplace. Enron was the climax of an avalanche of American companies that cost investors as much as $200 billion by issuing deceptive financial reports. The roots of the Enron debacle stretched to Wall Street where the accountants and other watchd dogs were supposed to keep score on corporate America and make sure the market is honest.

The trail leads also to Washington, where Congress weakened the protections and tied the hands of regulators, making it easier for aggressive companies like Enron to push the envelope. Enron's collapse did not occur in a vacuum. Its backdrop is an obsessive zeal by too many American companies to project greater earnings from year to year. When I was at the SEC, I referred to this as a culture of gamesmanship. A gamesmanship that says it's okay to bend the rules, to tweak the numbers, and let obvious and important discrepancies slide. A gamesmanship where companies bend to the desires and pressures of Wall Street analysts rather than to the reality of the numbers. But where were the watchd dogss who were supposed to warn us when companies were playing fast and loose with their books? The stock analysts, lawyers, bankers, securities and exchange commission.

Above all, where were the accountants? By law, auditors have the official responsibility to ensure that corporate financial reports are honest. They're the first line of defense. But in the booming 90s, the big accounting firms like Arthur Anderson, which audited Enron's books, failed to protect us. And what happened at Arthur Anderson illustrates the wider story of how our watchdog system broke down. >> Institutions are built on beliefs. Arthur Anderson was a man of unwavering beliefs that found marvelous new expressions over the years. >> 90 years ago, Arthur Anderson founded his firm on old-fashioned virtues. Accountants, he insisted, must think straight, talk straight, and dig beneath the numbers to get the truth. >> His firm [music] was built on these beliefs. Over the decades, the firm built a global business on its reputation for rock ribbed integrity. >> True to our clients and true to our founder. >> I've put 35 years of my life in Arthur Anderson. One of, if not the only reason I chose Anderson over the other firms was this this idea that Anderson had a a sense of integrity about it. Uh that was undeniable, at least to me as a young person. And that that notion of integrity of of being keepers of the Holy Grail, that that was Arthur Anderson. That's what we did.

But the go- go '90s put unprecedented [music] stress on the integrity of the old safeguards. American capitalism went into overdrive. The stock market skyrocketed. Every CEO was out to boost his company's stock by beating Wall Street's expectations. So, companies pushed their numbers to the limit and some beyond. The incentives were astronomical. High executives were getting massive grants of stock options, [music] a special perk that let corporate insiders pick their moment to buy low, sell high, and cash in big on company stock. You have executives in many companies who have uh measure their option packages in millions of shares and sometimes tens of millions of shares. And with that, of course, grows a pressure to make the stock perform at higher levels.

At Enron, the executives had the ability by jacking up the stock price to take hundreds of millions of dollars out of the company and keep them through the vehicle of stock options. and the lure of enormous personal fortunes tempted some corporate executives to cook the books. >> When an executive has a uh a portfolio of a hundred million stock options, uh they can make far more money by getting the stock to move um a few dollars uh in response to false information than anybody could do in most insider trading cases. >> But options were a hidden cost that never showed up in a company's balance sheet. And that made it harder for ordinary investors to gauge corporate performance. >> Stock options should be charged to earnings. They're often a massive cost of production and they need to show up in the financials in a very clear way so that someone investing in the company today doesn't miss the fact that a couple years down the line their stock is suddenly going to be diluted massively and be much less valuable.

>> So it's honesty and accounting. >> It's honesty in accounting. To help investors and clean up the books, the accounting industry's standard setter, an obscure entity in Norwalk, Connecticut known as Fazby, the Financial Accounting Standards Board, decided in 1993 to close the options loophole. Jim Lizenring was then a Fazby Commissioner. the the costs are fairly significant and we think that this is a credibility issue that in fact financial statements are omitting compensation expense for some companies very material amounts of compensation expense. So we thought and still believe that it's a matter of the marketplace deserves that information. >> Keep our stock options alive. >> That touched off a firestorm in corporate America. Ground zero was Silicon Valley where dotcom staged a giant demonstration.

>> We're here for one reason, to stop Fazby from raining on our parade. >> People had on, you know, t-shirts that with a big stop sign on the front that said stop Fazby that they were passing out. >> Software lobbyist Mark Nebergall was there. >> Uh people were signing petitions to the president saying, you know, please don't let him do this. Don't take away my stock options. People were hot under the collar. Corporate America was livid because making options a business expense would be devastating to the bottom line of many companies. At Internet Dynamo Cisco, for example, a $2.6 billion profit one year would have been cut nearly in half. A Maryland study found that expensing options would have slashed profits among leading high-tech companies by an average of 60%. Fazby's just got to get out of this. They can go argue the technical side all they want, but stay out of our stock options. [applause] >> The more emotional arguments came from the so-called new economy companies, but there was strong opposition from traditional big companies we all know of, General Electric, General Motors.

They were opposed as well. >> From all over the country, CEOs descended on Washington to beat back Fazby. It was one of the most impressive lobbying efforts on earth. It was protecting CEO's pay packages. >> It was what? >> Protecting CEO's pay packages. >> So that's why it generated such enormous heat. >> I mean, there's nothing in CEO's salaries that compares to the numbers in CEO's stock options. It was protecting CEO's pay package. They were out in force. What's what's on the line here really is the future of jobs in this country. >> Corporate America turned to friends on Capitol Hill like Senator Joe Lieberman of Connecticut. startup >> Silicon Valley companies came to me at that time and said, "We need to use these stock options to lure the brilliant minds from the big companies that are paying them the kinds of salaries we can't pay them because we're going to give them a stake in the company."

>> I don't buy that argument one single bit. >> Arthur Levit, President Clinton's new chairman of the SEC, was a Wall Street veteran and former head of the American Stock Exchange. If it takes a stock option to induce an employee or an executive to come to a company and that stock option has to be represented as a cost on the balance sheet, in my judgment, America's executives are going to pay that price. >> Stock options are a remarkable and uniquely American device. >> Senator Lieberman, echoing the accountants, also contended that the cost of options was impossible to calculate. the the concern that that I had back in 93 and '94 that I still have is how do you accurately value an option on the day it's granted? >> Companies don't have any trouble figuring out how much options cost them when they list them on their tax returns to reduce their taxes.

>> Well, um you know that that's a separate question which is an an important question. Uh, usually that's done and it's done more more effectively at the time they're exercised. >> Why would Lieberman of Connecticut be so desperately interested in this to take the lead? >> Well, the insurance companies in Connecticut and the accountants are heavily based in Connecticut. Fazby's in Connecticut. Both Senator Lieberman and Senator Dodd have historically been very protective of accountants uh and very protective of executives even though they talk a good liberal democratic line. And if you look at the votes and you look at the actions, it's not there. >> Led by Senator Lieberman, the Senate passed a non-binding resolution in May 1994. >> Clerk will call a ro >> condemning the Fazby proposal by a lopsided 88 to9 vote. >> It wasn't an accounting debate. We switched talking from about rather have we accurately measured the option to things like western civilization will not exist without stock options or that there won't be jobs anymore for people without job without stock options.

People tried to take the argument away from the accounting and over to be just plainly a political argument. >> Why is the Senate voting 88 to9 or something like that? There was no question campaign contributions played the determinative role in that Senate activity and the Congress was responsive to that. >> In fact, since 1990, the accounting industry has given over $43 million to candidates for Congress, including nearly 6 million in 1994 during the battle over stock options. When Republicans took over the House with a pro business agenda that fall, threats to Fazby escalated. >> Was the congressional pressure in effect a threat to the independents and even the financial? >> No, I'd say it was a threat to the existence of the FASB. The threats were to our existence. >> My concern was that if Congress put through a law that muzzled Fazby, that would kill independent standard setting.

So I went to Fazby at that time and I urged them not to go ahead with the rule proposal. Levid and Fazby retreated. Fazby passed a rule that the cost of stock options should be disclosed, but only in the small print footnotes of corporate reports. >> It was probably the single biggest mistake I made in my years at the SEC. that integrity is a bond, a promise between client and firm, between clients and their [music] customers. >> The options battle had tested the loyalty of accountants. In the end, Arthur Anderson and the other big accounting firms sided with corporate America against their own industry's standard setter. James Hooton, then chief of Anderson's worldwide auditing, feared the consequences. It was the first time that accounting principles had become very very much influenced by commercial interest and political interest. Uh Congress got involved in that debate. Uh certainly every company in the United States with a commercial interest got involved in that debate.

>> And was that good or bad? >> It was bad. If you move accounting and accounting standards into the political environment, then you've lost control over whether those standards are the best standards. uh if you move it into a commercial environment, you've lost control over whether those standards are the best standards. >> And what did that decision say? >> That that decision moved who's in control away from the principles and the professional standards and more to the commercial side, the client side of the business, the the presenting a transaction, the best way to present it to show the the the company side of the story as opposed to the profession side. In the battle for stricter accounting, the options fight was a watershed moment, a signal to accountants of looser standards and a green light for corporations to issue options by the truckload. >> I've never seen the company stronger.

I've never seen a better position. So the size of the stock packages create a temptation for economic gain that is very corrosive and will lead some people to be willing to lie to cook up false income to not tell the truth about negative factors and in Enron's case to create an entire picture of a company that didn't exist. has a new sunbeam shining on a bright sunny day. What could be better? >> And painting a picture that didn't exist was going on at lots of American companies in the '90s. That's what happened at Sunbeam, which like Enron was a client of Arthur Anderson. >> Back in 1998, I profiled Sunbeam's controversial CEO, Al Dunlop, for PBS. >> Hi there. How are you doing? Dunlop was an aggressive corporate turnaround artist brought in by Sunbeam's main owner to make it look good for a corporate takeover and a big financial killing.

>> I believe the shareholders own the corporation. We work for you. >> Dunlop comes in and all of a sudden Wall Street goes gaga. The stock price went from $1250 to a peak of $53 a share. >> With a pay packet that included more than 7 million shares in options, Dunlop stood to make over $200 million personally if he could keep Sunbeam stock price flying. Playing to Wall Street, Dunlop promised totally unprecedented gains for a home appliance maker. You look at the uh layoffs that took place there were about >> He touted the formula of mass layoffs and cost cutting that had earned him the nickname chainsaw owl. >> We've gone from 26 factories to eight. We've sold all the businesses that don't make sense. We've cut 225 million of cost. >> But Dunlap was hiding a secret. It wasn't only his hard-nosed tactics that were driving up the stock. He was using simple accounting tricks okayed by the auditor from Arthur Anderson. It began when Dunlop arrived.

>> He took a bigger financial writeoff than he needed to restructure Sunbeam. >> That gave him two advantages. It made things look dismal when he arrived. And he had a huge slush fund to use later to make it look as though he was generating new profits. >> At Sunbeam, the company initially established reserves. We call them cookie jar reserves. You can borrow from the reserve and have a little jolt to income. >> That's exactly what I asked Dunlop about. >> You said the company lost $230 million in 1996. But the write-off was 337 million. If they lost 230 million, that means without the write-off they would have made hund00 million. So it was a profitable year in 1996 except for the write-off. >> No, it wouldn't have been. the losses would have been substantially more than that. Remember, I arrived in July. We instantly made enormous changes to the company. This company was headed downhill. What Al is doing is creating the steps that he needs to create the illusion of a turnaround. The worst it looks coming in, the better it looks going out.

>> Over here, we have a total new line of grills. >> Dunlap had other gimmicks. In the winter of 1997, he booked millions of dollars of sales of summer products like outdoor grills. >> But this is a prototype. >> In fact, Sunbeam wasn't shipping them out, and retailers were not paying for them. They were paper transactions that made Dunlop look great in the short run, but put the future at risk. >> You stuff the sales channels. You sell product so far out into the future that when the future comes, you've sold too much product in past times and it's not likely that you're actually going to be able to maintain that level of sales. There's nothing wrong with that in concept, but if it's not properly disclosed, then you've misled people and you've committed a fraud. And that's what happened in Sunbeam. >> In the spring of 1998, Dunlop and his team ran out of accounting tricks. The general counsel of the company met privately with several board members and said, "Al didn't tell you the truth. The quarter is coming in horribly. The numbers are a disgrace.

New products that have no sales, inventory issues, accounting issues, and the board decides to fire both Al and the chief financial officer." With the plot exposed, Sunbeam corrected its books, declared bankruptcy, and the stock price plunged from $53 at its peak to just pennies today. What are the parallels between Sunbeam and Enron? >> The checks and balances at both places fail miserably, right? The auditors at [clears throat] both these companies didn't do their jobs. The lawyers, uh, the external lawyers at both these companies didn't do their jobs. The board of directors in one way or another didn't really do their jobs. >> For two years, the SEC said this man, Anderson's senior auditor, Philip Harlo, blessed Dunlop's bad books. >> We charged the auditor with fraud, that he uh knowingly or recklessly made false and misleading statements. This wasn't an accident.

Harlo is fighting the charges, but with an SEC lawsuit still pending against him and senior Sunbeam officials, Harlo's lawyers wouldn't let him talk to us. At Sunbeam, the SEC uncovered another, more ominous harbinger of the Enron scandal. Anderson accounting documents were destroyed. With an SEC investigation underway, Harlow got orders from Anderson to get rid of certain work documents, and two boxes of papers that should have been kept were destroyed. Harlow claimed by mistake. No criminal case was filed, and even though Anderson later admitted that there were significant mistakes in the Sunbeam books endorsed by Harlo, the firm kept him on as managing partner of its Fort Lauderdale office. To critics like Wall Street investment manager Jim Chenos, the reason managements get their way is simple. They've bought off the watchd dogss. >> The auditors are paid by the corporations. U the bond rating agencies are paid many cases by the issuing corporations. Uh analysts are paid uh often on the basis of their uh investment banking fees that their firms bring in for the companies they are either recommending uh to buy or sell.

So, we have all kinds of conflicts of interest that revolve around um who is paying whom. >> Investor advocate Sarah Teslick puts it even more starkly. >> We all know that if fifth graders hired their teachers, teachers would give all A's. That's exactly the situation we currently have. Managers hire auditors to bless the books. Auditors bless the books. >> So, what you're saying is we shouldn't be surprised that things go ary. >> They can't go any other way. people invariably act in their self-interest. >> Is anyone protecting the public? >> You know, uh I think the SEC is trying to, but I think that the SEC is um basically out of it as well because they're understaffed. It's a major problem. >> So the SEC is outgunned, outspent, outmanned >> completely. Doesn't have a chance. Four years later, the SEC is still tied up in court pursuing Sunbeam. So far, the only real penalty has come through private litigation. Well, Anderson ended up settling one key lawsuit for $110 million.

Al Dunlop has settled three separate suits, having to pay $15 million out of his own pocket. But even the deterrent of private lawsuits has been blunted by special interest legislation. >> It is my great privilege to introduce the next speaker of the people's house, N. Gingrich. >> In the mid 1990s, N. Gingrich and the Republicans staged a political revolution. [applause] High on their pro business agenda when they took over the House of Representatives, tort reform, including a law to curb shareholder lawsuits against companies and their accountants. [cheering] For accountants, it was the climax of years of struggle. They'd paid out a billion dollars in stockholder settlements after the savings and loan scandals in the 1980s.

>> I talked about those lawsuits with Joseph Beradino, a longtime partner at Arthur Anderson, who would later head the company as the Enron scandal broke. >> Tort reform was something that the profession had talked about for years and frankly got spooked by the uh savings alone problems. >> What were you trying to do? What did you want to reform to do for you? tort reform was an attempt to at least rein in or limit damages so accounting firms wouldn't go out of business. >> As the point man to make their case to Congress in 1991, the accounting industry chose a prominent securities lawyer, Harvey Pitt. Pit's clientele included corporations and big accounting firms like Arthur Anderson. There have been cases that were filed that I thought uh raised um frivolous issues and in which companies were in effect blackmailed into settling or else required to spend extraordinary amounts of time and energy getting rid of. The sole thing the bill was aimed at uh curtailing were frivolous lawsuits.

>> All these people got together to say we don't like being sued for falsehoods and misbehavior. But they said it was to stop frivolous uh lawsuits that there were lawsuits that were insubstantial. There were too many of them being brought. >> Yeah. >> Was there something to that? >> Any any lawsuit in their lexicon was frivolous? >> Any lawsuit brought by San Diego attorney Bill Lack was what the accountants and their business allies wanted to stop. >> This fraud could not have been accomplished by a few corporate executives. Lorac had become the despised poster boy for the tort reform cause, earning tens of millions of dollars personally from filing class action suits against corporations. >> Bill Lorac was the guy whose whose picture had the target on it. When you thought of of securities litigation reform, you thought of of of trying to put Bill Lack out of business. Uh he was he he he was the the antichrist, if you will. And this complaint now names additional parties.

>> Among Lak's favorite targets were Silicon Valley high-tech firms. >> Virtually any company in in Silicon Valley was was was scared to death of the guy. They all knew who he was. >> Pressed by the high-tech and accounting industries, the House and Senate passed the bill by large majorities. But President Clinton vetoed it, asserting that it would close the courthouse door on investors with legitimate claims, >> including countless meritorious. >> Some Senate Democrats rallied behind their president. >> But it's safe to say that crooks will be emboldened. Investor confidence in our markets will go down and defrauded investors will not be compensated. >> But what happened next stunned observers. >> But I believe that the override is the proper course to follow here. Senator Chris Dodd of Connecticut, then head of the Democratic National Committee, led the effort to overturn Clinton's veto. >> It is with a a deep sense of regret that I'm on the opposite side of my president on this issue.

>> Chris Dodd, here he is as chairman of the Democratic Party, but he's also the leading advocate in the US Senate on behalf of the accounting industry. And he helps overturn the veto of his own president who installed him as Democratic chairman. Chris Dodd uh might as well have been on the accounting industry's payroll. He couldn't have helped them any more than he did as a US senator. >> By way of thanks, the accounting industry gave Senator Dodd nearly one quarter of a million dollars in political donations. Even though at the time Dodd was not up for reelection, >> the accountants were the big winners uh with the litigation reform act. the law imposed a proportionate liability standard which means that if the accountants only contribute to say say 20% of a loss then they would only be responsible for 20% of the amount that would have to be paid. >> Less risk for accountants among others critics said would mean less of a deterrent to wrongdoing. >> But after the bell a round of high-profile warnings >> and the late 90s brought an explosion in major accounting failures. Dollar General has fired Deote and Touch as its auditor and >> Ernston Young had signed off on this company.

>> Audit information from Lucent's outside accounting firm Price Waterhouse Coopers as part of it. >> Corporate financial restatements skyrocketed to levels never seen before. Just three in 1981 up to 156 in 2000. All the big accounting firms were implicated. Price Waterhouse, Coopers, Anderson, KPMG, Deoid and Touch, Ernst and Young. During the 90s, more than 700 US companies had to correct financial reports that were just plain wrong. For the last half dozen years, investors had lost probably close to hundred billion dollars, suffered those type of losses from these situations like Sendant, uh, Waste Management, Sunbeam, Micro Strategy, Ride Aid, Lucent, Zero Rock. Then along comes Enron, phenomenal. And we add on now every day Global Crossing and others. Investors are now looking at losses probably coming close to $200 billion.

It is real, real damage to the country. >> Finally, the SEC had had enough. On the next case, in fact, the biggest case until Enron, it went after Arthur Anderson. The first time in 20 years the SEC had sued a major accounting firm. It charged Anderson with helping to cover up what the agency called a massive financial fraud motivated by greed. It involved a trash collecting empire, waste management. Waste Management was the Microsoft of the 80s. They bought hundreds and then thousands of garbage companies and they increased their sales and their profits year after year after year. There were obvious parallels to Sunbeam and Enron. Anderson was the auditor. The company's stock price had soared and its top managers had made tens of millions of dollars on stock options. But then Waste Management hit a wall.

They couldn't buy thousands of garbage companies anymore. There weren't that many left. So the strategy, this growth strategy that propelled them as a high-flying stock was gone. So they turned to accounting tricks to make Wall Street think the company was still growing. One gimmick simply involved stretching out depreciation on company assets. Garbage dumps, trucks, giant metal trash bins. They changed the earnings of the company by quite a bit of money, more than $100 million. >> Wait a second. You can change the earnings picture of waste management by more than hund00 million simply by changing the lifespan of garbage containers >> of an appetite. Well, he had a million of them. These were these huge big steel containers. And so if you're if you're depreciating them over 12 years, it's a lot more expensive than if you depreciate them over 18 years. Former Republican SEC chairman Rod Hills joined the board of directors in a shakeup forced by big outside investors.

The new team found that the company had exaggerated its earnings by $1.7 billion, a gambit that would cost investors a fortune when the stock plummeted. Arthur Anderson's senior auditing partner, James Hooton, reviewed his own firm's work. >> He was wrong. Flatout easy, clear wrong. Not all things easy clear. Not all things easy clear. Some were easy clear wrong. I won't I won't duck that. Some were easy clear wrong. Others were more difficult. >> The SEC discovered a longunning coverup not just by Waste Management, but by Arthur Anderson as well. Arthur Anderson allowed the company to publish its financials knowing that there were mistakes in the financials with a promise that the company would in the future make whatever changes and adjustments were necessary to correct the failures of the past. Unfortunately, the company never did what they were supposed to do. It was actually a treaty. They all signed it. The auditor signed it. The management signed it and said, "We will do this." And >> did they do it?

>> No, they did not do it >> for how many years? at least six. >> How can this go on for six years and and neither the board nor the auditors blow the whistle? >> The board doesn't know about it. At least the audit committee does not know. Audit committee of the board does not know of it. Uh and management doesn't want to tell them and the auditors don't want to tell them. >> But I mean that's a breakdown in the system, isn't it? >> You bet it is. You bet it is. It absolutely tells you that the weaknesses that you see in Enron and Waste Management can be seen in many other companies. I've had to participate in the firing of nine chief executive officers over 30 years. In each case, the auditors after we asked the CEO to leave told us of problems that were in the statements that they had not brought to the attention of the board >> because >> because they management didn't want them to. It's a it's the it's the pressures. You can't under you you cannot possibly understand the fear. If you are the audit partner in charge of a large account, you need to keep that account.

And if and if you're not protected by the outside audit committee on that board, you will yield on the margin to something management wants you to do that in your heart you think you shouldn't do. >> Anderson and Waste Management paid a steep price in stockholder settlements, but no one went to jail. We certainly have seen in the securities markets the clear lesson that when people stand to make millions and millions of dollars from breaking the law that the risk of simply getting a civil judgment is not enough to defer the conduct. And so a realistic criminal deterrent is part of a healthy system. People have to understand that if you knowingly allow millions of people to be cheated, you can end up in jail. The SEC fined Anderson $7 million. Anderson promised never to do it again, but they were already inshed in new trouble at Enron. >> It would appear from the outside that Anderson took the waste management injunction and the whole process is not much not much more seriously than you or I might take getting a ticket for going 35 in a 25 mph zone. I just didn't use that as the wakeup call to say, "My god, how could this happen in our firm, and we need to make changes to never let this happen again."

>> That inventiveness isn't just a goal. It's the way we do business. >> By the late '9s, corporations had put the squeeze on auditing fees >> and that the product of our inventiveness should be real. >> So, accountants had to find a new way to cash in on the boom economy. In fact, we created most of the 43 service lines we're now in, including Anderson Consulting. >> Consulting once a small fraction of their business. Consulting on finance, partnerships, computer programs, taxes, had become the main profit center. At the SEC, Arthur Levit saw that as a conflict of interest. Accountants fearing to lose rich consulting deals with a corporate client as a result of a tough audit. They clearly had a conflict of interest and some of them abused the public that they were supposed to protect. >> Levit had a fix. Get the big accounting firms to stop doing major consulting jobs for their audit clients. In early 2000, he floated the idea to the accounting industry.

>> They told me, "We are not with you, Arthur. This is going to be war. We're going to fight you all the way. We'll fight you in the Congress and we'll fight you in the courts. >> Well, you're taking the bread and butter away from large uh accounting firms when you make a proposal that would take away their largest growth opportunity. So, understandably, there was quite a very strong uh violent reaction. >> Leading accountants like Anderson's Joe Bidino claimed there was no conflict of interest and bristled at regulation by the SEC. Among other things I disagreed with at the time is that the government was forcing the whole profession to a certain model. I do believe the market is a better place than the government in deciding how the market should be formed. >> It was decided. It sounds like both of you talked about it and decided it together. To block Levit, the accounting industry turned to friends on Capitol Hill like Louisiana's Billy Tosan, a powerful House Republican. Toan had received nearly $300,000 from the accounting industry since 1989.

>> Billy Tolen seems to have been especially important in that process. Why? >> He had an oversight responsibility and budget and otherwise for the SEC. So, he had a special interest. >> So, he could get Arthur Levit's attention in a way almost nobody else could. >> Yeah. and Tozanne took the queue along with fellow Republicans Thomas Blly and Michael Oxley. Toan sent a clear message to Arthur Levit. This is a letter from the congressional committee that oversees the SEC that has a chokehold on the existence of the SEC directing me to go slow on this issue. >> How do you interpret that? >> That was a threat. >> Shot across your bow >> without a question. In their war against Levit, the accountant spent $23 million in campaign contributions and lobbying. Their efforts set loose a flood of mail from Congress, pressuring Levit to back off. >> We were getting letters from people we had never heard from. And the types of letters we were getting from them were very similar in terms of tone and and phrases and words. Uh, >> and what's that say to you? Well, it says to me that the accounting lobbyists were writing their letters.

>> Levit refused to back down and Congress turned up the heat. >> As we got down toward the end of the congressional session, the threats were made. Arthur, if you go ahead with this proposal, it is likely that a writer will be placed upon your appropriations bill, which says that the SEC will not be funded if they proceed with the issue of auditor independence. >> Who who made that threat? A variety of members of Congress told me that they weren't going to do it, but they knew others who were going to do it. >> Finally, Levit gave in. He let audit firms keep their consulting work. All they had to do was inform corporate audit committees. >> As a result of this pressure, we modified the rule. And that was a compromise that I would not make today that I agreed to at the time.

When you look back on this whole episode, what's the lesson to you? >> I saw a group of of entities that I think had forgotten uh their public responsibilities. The accounting profession is the only profession private profession with public responsibilities. And I saw them fight tooth and nail to instead of accentuating and emphasizing their public responsibilities. They said our business model is about consulting and once and for all we're going to let you know that you can't mess with us. And they did that through the force of money. >> And those who got the most money from accountants like Billy Toan trying to tell me that wasn't an extraordinarily limited review of >> are today among the most vocal critics of Enron on Capitol Hill. >> Many of the people complaining loudest about how shocked shocked they are that there's a problem with this industry not being closely regulated were two peas in a pod close with the industry themselves helping the industry get deregulated throughout the 90s. Billy Tozanne, >> Chris Dodd, >> Senator Lieberman from Connecticut, >> and when journalists try to talk to them now about their flip-flop, uh, many of them are just not available for comment.

>> Thank you very much for your time. >> Senator Lieberman had talked to us, >> but both Senator Dodd and Chairman Tosan refused our repeated requests for interviews. I think are decent. [music] >> By the end of the '90s, accountants were so intertwined with their corporate clients, the line between them was often blurred. In [music] fact, when the SEC tried to break them apart to reestablish auditor independence, Levitt received this very revealing letter from one Kenneth Lei, CEO of Enron. Ken Lay wrote me a letter during the debate over the issue of auditor independence urging me not to proceed with this rulemaking because his relationship with his accountant Arthur Anderson had been such that consulting was terribly important to the well-being of Enron. >> So Kenlay didn't want that broken up that relationship with Anderson.

>> No, he did not. According to Lay's letter, Arthur Anderson, with more than a hundred people working on the $ 58 million Enron account, had become an integral part of the Enron team. In fact, according to an investigation for Enron's board, Anderson was closely involved in structuring Enron's controversial offbook partnerships. >> Why does a company like Enron, which is going gang busters, create hundreds of these offbalance book partnerships? What's the point? >> To get debt off the balance sheet, to make the company look uh more stable financially than it really is. >> Enron's accounting practices became so aggressive that several Anderson audit experts like partner Carl Bass began to object. Bass was part of an elite group at Anderson protecting the quality of audits. >> So Carl Bass and the technical group would have been one of those who was keeping the rules pure. He was a member of that group that kept the rules pure, the keepers of the holy grail. They're the experts. They're the best that your firm has to offer. For two years, Bass fired off memos challenging Enron's accounting.

Eventually, Enron got so angry at what it called Bass's cynicism that it demanded that he be taken off the account. And Anderson complied. Why would you remove the technical guy who's the protector of your integrity at the request of a client? >> Well, it's um very unusual that we would remove somebody. The client wants to feel that you're understanding their business problem, that you're understanding what they're trying to accomplish with their accounting for a business uh transaction. And if you have people that either don't have the bedside manner, don't have the capability, don't have the expertise to get in the client's shoes to understand it, clients react negatively. Okay? Then we've got to make a judgment call as to whether they're objecting to that service for the right reason or the wrong reasons. >> And uh you know, it's very rare that we remove somebody. Um and u obviously this is one of those rare those rare situations.

But other Anderson partners were also growing uneasy. In a conference call between Houston and Chicago in February 2001, 10 months before Enron went bust, 14 Anderson partners debated whether to keep Enron as a client. But they projected that the Enron account would soon be worth $und00 million a year to Anderson and decided to stick with Enron. Even inside Enron, people were sensing imminent disaster. Last August, Enron Vice President Sharon Watkins, herself, a former Anderson accountant, warned CEO Ken lay that Enron was about to collapse in a wave of accounting scandals. Later to Congress, Watkins implicated Anderson. >> Is it possible that author Anderson has some culpability here because they signed off on it? Well, I think so because they're they're charged with auditing um the results and a sensitive related party transaction should get a lot of scrutiny.

>> So Arthur Anderson, in your opinion, signed off on something they shouldn't have. >> Yes. >> Do you think they knew what they were signing off on? >> They sure should have known what they were signing off on. >> Okay. >> In August, Watkins had also warned Anderson, >> but it took two more months before Enron's books were corrected. restating and reducing Enron's net worth by $1.2 billion and sending Enron's stock into a tail spin. >> I suggest you fasten your seat belt. >> By then, Anderson was in big trouble. The SEC was investigating. >> Will you please come forward? Would you please rise and raise your right hand? >> And David Duncan, its lead partner on the Enron account, had his staff shredding documents. >> On Anderson's orders, he later testified. But Anderson CEO Joseph Beradino blamed Duncan and fired him. >> And I wanted to give a message because at the time everyone was looking at me and at us that this was not a culture that would stand that kind of behavior.

>> Something like 80 people in office were involved. If this had been something that had really been against Anderson policy, wouldn't some of those people have picked up the phone or written an email to headquarters and say, "Hey, we're destroying 20 boxes of of Enron material. Should we be doing this?" >> All I know is that that those activities were taken under David's direction. There was absolutely no cover up or direction to go destroy documents. Uh but documents were destroyed. >> Suddenly the firm once considered the gold standard of accounting was drowning. >> But we will stay together regardless of what happens. >> Its employees reduced to pleading for public faith in their integrity. >> We're dedicated to serving our clients and we're dedicated to each other. >> Do you regret maybe not having listened to Kyle Bass earlier? >> You know, there's been so much pain that's coming out of this Enron uh situation. stockholders, their employees, now our employees.

People would always ask me, "How do you sleep at night?" And I say, "I sleep like a baby. I wake up every two hours and cry." Anderson's demise didn't solve the broader problem of the cozy collaboration between auditors and their corporate clients. In the '9s, all the big accounting firms worked handin glove with companies in Wall Street to find loopholes in the accounting rules. What are you talking about? >> Lynn Turner worked that game as a former Wall Street partner at the accounting firm of Coopers and Librand before becoming the SEC's chief accountant. In my prior life, we actually had a retainer arrangement with each of the major Wall Street investment banking firms under which we would help them financially engineer or structure uh hypothetical transactions for uh you know finding financing, keeping it off balance sheet, uh making companies look uh better than quite frankly they really were. >> You mean doing the kinds of things that Enron and Anderson did?

>> Yes, exactly. >> So there's a whole system that does this. There is a system that turns around and does it. Every one of the big accounting firms have such a group >> and all the big investment banks have. >> Uh yes, the investment uh banking groups in fact they make uh good money trying to figure out how to structure these transactions. >> So we haven't in Enron just stumbled into something that may have happened. This this is way off an oddball thing. We've run into something that is a fairly common practice. This is day-to-day business operations in the accounting firms and on Wall Street. There is nothing extraordinary, nothing unusual uh in that respect with respect to Enron. >> Give us some guidance as we begin our investigation as to why >> but Enron's collapse galvanized Congress. >> Based on your considerable experience, >> Arthur Levit returned to center stage urging major reforms. So with that, >> we've got to begin to reinvigorate the financial checks and balances that over the years as a result of nothing less than a cultural change has eroded in America.

>> But Levit is no longer in charge. >> Now it's up to President Bush's SEC chairman Harvey Pitt. >> Well, you're doing a good job. It's a tough >> like his former clients, the accounting industry. PIT is cautioning Congress to go slow. >> We are opposed to those who say that accounting firms as a whole should be restricted to providing only audit services >> whether on auditor independence >> or reversing the tort reform. >> We strongly urge you to refrain from making any changes in that legislation >> or expensing stock options. Pit favors the status quo. Chairman Greenspan has said that if he could do one thing to learn from what has happened with Enron, the auditing and everything else, he would expense stock options. You agree with him? >> Having gone through this exercise, I would be exceedingly reluctant to reopen the issue. I don't think uh that the non-expensing of options caused what happened in Enron. Um, >> your basic message seems to be go slow.

Don't be too radical and hasty on reform. Why do you say go slow? >> I don't say go slow. There are people who want you to believe that that's what we're saying. That is not what we're saying. We're saying it's not a question of more regulation. >> I mean I mean it sounds as though you're saying very much what the accounting industry itself wants and not what investors investors representatives are asking for. We are in the process of forging an incredible new system for the benefit of individual investors. Something that should have been done 5 10 years ago but was allowed to lie dormant. >> Pit is pursuing vigorous enforcement. And rather than stronger government controls, he proposes a new private sector oversight board including accountants among the members. it would have the power if they found that a firm was not doing the highest quality audit work to uh dictate that uh the client pick another auditor. So the stakes would be exceedingly high for the audit firms to come up with high quality controls and make sure they're performing at the highest level. But critics including major investor groups and the Wall Street Journal have questioned whether Pit is genuinely prepared to cross the accounting industry. People are talking about your reforms as putting the fox in the in the hen house. Uh pulling your punches. I mean, isn't it time to get tough and be clear?

>> Absolutely. That's why the proposal that we have will achieve that result and it's going to be done to the benefit of investors and be done the right way. >> I hope you're right. >> I know I am. Here in Washington, strong reforms have been watered down by accounting lobbyists, and Congress is likely to fall short of doing what's needed. In Houston, Arthur Anderson was found guilty of obstructing justice, a fatal blow to the firm, and a dark legacy for the industry. On Wall Street, with investors still uncertain whether they can trust anyone, come warnings that without much stronger protections, more Enrons lie ahead. Next time on Front Line.

The last decade in the Middle East has seen an endless cycle of the promise of peace >> and the despair of violence. >> We are talking here about [music] the more sensitive issues. >> My heart aches cuz I know you were so close. >> Can Israelis and Palestinians ever make peace? Watch Shattered Dreams of [music] Peace next time on Front Line. To obtain a VHS copy of [music] Bigger than Enron, call PBS Home Video at 1 800 Play PBS. >> [music] [music] >> Frontline is made possible [music] by the annual financial support of PBS viewers like you.

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