Within the first two months of 2002, the SEC launched 45 investigations of financial statement fraud—nearly triple the number of cases in the same period in 2001. This was only partly the result of fallout from Enron. Even before the Enron debacle, the SEC was paying increased attention to corporate financial reporting.
In retrospect, an increase in financial fudging appears to have been an almost inevitable response to recent pressures in the corporate ecosystem. During the late 1990s, with Wall Street focusing ever more intently on quarterly earnings statements, adroit presentation of financial results became an increasingly crucial CEO survival skill. We should not be all that surprised that this endeavor sometimes became a bit decoupled from objective reality.
“Everybody was trying to beat analysts’ earning estimates,” said D. Larry Crumbley, an accounting professor at Louisiana State University, in an interview with the Los Angles Times. “If you missed by a penny, you got killed in the stock market.”
Management resorted to means both fair and foul to play the game successfully. According to a Fortune magazine article entitled “Dirty Rotten Numbers,” one confidential study of big-company CFOs found that fully two-thirds of them had been pressured to misrepresent financial statements, and only 55% had managed to effectively resist.
As the article went on to explain, one favored gimmick was to book sales that might or might not actually occur in the future.
Another technique involved pro forma earnings reporting—originally designed to provide a better upfront look at what was coming, but now subverted to obscure and hide the truth. As an example of this technique’s power, in the first three quarters of 2001, Cisco, Dell, and Intel reported combined pro forma earnings of $4.4 billion. For the same period, their required regulatory reporting to the SEC later showed a combined $1.4 billion loss.
Write-offs, although they can still be valid ways of smoothing earnings to reflect nonrecurring expenses, have gone from relatively rare occurrences in corporate books to an increasingly commonplace form of cosmetic enhancement—with 28 of the country’s largest 1,000 companies registering negative “non-recurring” items for the past eight quarters in a row.
Meanwhile, special purpose entities, or SPEs—the proper technical term for “off-balance sheet partnerships”—have grown from limited-use arrangements, four or five of which within a company would normally be considered a lot, into a veritable Ghent Altarpiece of the art form at Enron, which had nearly 900 of them located in international tax havens.
According to former SEC chief accountant Lynn Turner, the price the public has ended up paying in stock market losses for financial restatements over the past six years has exceeded $100 billion—not counting Enron. The cost of Enron’s failure alone was roughly six times the $15 billion loss suffered in Hurricane Andrew.
