Does one bad apple spoil the entire bunch?

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A tainted piece of fruit does nothing to diminish the health or freshness of another that is close by. Even so, because we can see that one apple is stale or sour, it is human nature to question whether or not the good one sitting next to it really is as good as it looks.

This is guilt by association, and it is the reason the collapse of Enron Corporation under a flood of concealed red ink will continue to have ripple effects far more widespread than the tragic financial losses suffered by investors and employees of the Houston-based company.

Enron is in the unique business of selling risk management services to companies who seek to insulate themselves against the effects of unexpected increases and dips in prices and-or availability of products and commodities of other companies. Most of the transactions were risks for Enron — the company could either profit through fees earned by successfully protecting the interests of its clients, or could lose by having to pay its clients. Enron’s product is referred to as risk management, but the best way to describe it is insurance for corporations against variations in expected or budgeted expense due to external factors outside their control.

Apparently Enron was very bad or very unlucky in establishing parameters for its services, because over time the company’s losses mounted. And certain members of the company’s top management embarked on creative ways to conceal the financial losses — namely, creating shell corporations on whose financial statements the losses were reported. Doing so meant that the Enron Corporation could continue to report large profits and maintain the confidence of its current and potential investors.

But the faéade of financial strength began to crack in February of last year when Fortune magazine reported that Enron was debt-ridden and hiding that fact from stock market analysts. That aroused the curiosity of financial journalists and regulators, who began to take a closer look at Enron. And, by last October, Enron executives were selling company stock they owned for a combined price of $1.1 billion, while they were telling employees and investors that the company was in good financial health. A few days later, Enron announced a quarterly loss of $618 billion, and the freefall in stock price and company fortunes was on.

How could Enron’s “creative” accounting practices go undetected? Some answers were realized when it was learned that lawyers for Arthur Andersen, Enron’s external auditor and formerly the largest accounting firm in the world, had directed workers to destroy all audit materials with the exception of the most basic work papers in October, four days before the $618 million loss was announced.

Even people who don’t have degrees in accountancy know that shredding of corporate financial documents is not standard operating procedure. In fact, most companies retain their financial records for at least five years, if not longer, and particularly accounting firms. It appears as though Arthur Andersen has something to hide, and the U.S. Department of Justice thinks so. It indicted Arthur Andersen for obstruction of justice.

The indictment is one in a series of trips through a legal labyrinth for the Chicago-based accounting firm. Last June, it agreed to a $7 million settlement with the U.S. Securities and Exchange Commission (SEC) after allegedly overstating profits for Waste Management, Inc., by more than $1 billion from 1992 to 1996. And just Tuesday, the SEC filed suit against Waste Management’s founder and five other former key executives who “engaged in a systematic scheme to falsify and misrepresent Waste Management’s financial results and thereby enrich themselves and keep their jobs” between 1992 and 1997. The SEC alleges that the defendants “secretly entered into an agreement with Andersen fraudulently to write off the accumulated errors over periods of up to 10 years and to change the underlying accounting practices, but to do so only in future periods.” Andersen provided the defendants with a list of 32 “must-do” items in order to successfully write off the errors without detection, the SEC complaint says. The SEC said that constitutes covering up past fraud through future fraud.

It is in this business atmosphere that Americans are asked to believe in the integrity of corporate accounting and reporting practices. It’s one bad corporation and one troubled accounting firm, but their combined magnitude has made many other guilty by association. This is an incorrect leap of logic, but unfortunately human nature.

The government will need to find a way to restore confidence in the auditing process before Americans begin to invest confidently again. First order of business is to find a way to eliminate relationships like the Enron-Arthur Andersen one, in which Enron paid Arthur Andersen $52 million last year for audit and consulting services. It would be a $52-million decision for Andersen or any company to report fraud committed by the hand that feeds it. And that can turn a lot of even good apples bad.

Mr. Tom Mitsoff is a daily newspaper editor and syndicated editorial columnist. His web address is http://www.tommitsoff.com.

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