July 10, 2002

July 10, 2002 | News Releases on Regulation

Proposed Agency Won't Prevent Future Accounting Scandals, Analyst Warns

WASHINGTON, Jul. 10 2002-The new quasi-government agency some federal lawmakers are trying to create to punish the accounting industry for its role in the Enron and WorldCom scandals would do little to prevent future wrongdoing-and could encourage companies to indulge in even more "creative bookkeeping," says a new paper from The Heritage Foundation.

"This solution sounds tough, which satisfies the understandably high level of outrage these scandals have generated," says David John, a Heritage research fellow and a former vice president with New York's Chase Manhattan bank. "But a new government agency isn't the solution. It would take industry lawyers about 10 minutes to discover loopholes in the strict laws and explicit requirements the agency spent months writing."

Consider how Enron got into trouble in the first place, he says. To reduce its liabilities, the company created "limited partnerships" so that it could shift assets and boost their profits-at least on paper. Such an action may "skate the edge of legality," John says, but it didn't violate the letter of the law-and it's an example of the kind of behavior that's bound to increase if a new agency is handing down detailed rules that can be flouted with ease.

The Senate Banking Committee recently approved legislation proposing a new government agency that would police the accounting industry. A better solution, John says, can be found in a bill the House passed in April. It would set up privately organized entities that would review audits and auditors and take disciplinary actions when necessary-actions that would be reported to the Securities and Exchanges Commission.

"These private groups would be able to respond quickly to changes in the accounting industry and would be far more flexible than their government counterparts," John says. "Since they're not encumbered with federal procedures, they can revise standards faster and make it less tempting for companies to play games with their books and hoodwink investors."

The goal, he says, should not be so much to chastise the industry-however justifiable that be-but to provide the public with accurate financial information.

"That's where the Senate bill comes up short," John says. "It would lock future audits into a straitjacket of government regulations that likely would increase the chance of future problems. The flexible approach proposed by the House, combined with criminal prosecution of willful violations, would do a better job of encouraging companies to keep reliable books and restoring public confidence in the market."

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