Public Company Accounting Oversight Board Chair Erica Williams has resigned at the request of Securities and Exchange Commission Chair Paul Atkins. Atkins has said he wants to terminate the PCAOB as a separate body and incorporate it into the SEC.
This action reflects the big-business friendly orientation of the Trump administration and the abandonment of regulations created to protect American consumers and investors.
Of course big businesses would prefer to have the freedom of eliminating regulation. It would be great if business leaders behaved like the demigods in Atlas Shrugged but they don’t. They misbehave, resulting in the injury and death of consumers and financial losses to investors.
What was the scandal that inspired Congress to create the PCAOB?
Enron was the darling of Wall Street during the 1990s and early 2000s. It was the largest natural gas provider in North America in 1992. In 1999, the company’s stock increased 56%, and in 2000, it increased an additional 87%.
The CEO of Enron was Kenneth Lay, who was a charismatic leader and close friend of the (Presidents) George Bush family. The “whiz kid” brains of Enron was Jeffrey Skilling, who had previously worked at McKinsey & Company.
Skilling introduced a number of innovations at Enron.
One was adopting mark-to-market accounting. Revenue was recognized for contracts when they were accepted, based on the total management estimate of revenue for the contracts before the services were performed. Skilling was able to get SEC approval for this method, so the auditors accepted it.
Although the company reported substantial profits, it never had positive cash flow.
In order to avoid having debt disclosed on the corporate balance sheet, the debt was incurred by “special purpose vehicle” subsidiaries of Enron, secured by Enron stock and recorded as related party transactions.
The company got control of a trading market for energy. The traders were able to manipulate the energy market in California with the cooperation of the switching stations, dramatically increasing the price paid by California utilities for energy and resulting in brownouts or shortages of energy provided within the state.
In the early stages of the internet, Enron introduced a broadband service that generated significant losses and eventually was closed. The Broadband Services department reported a financial loss of $102 million for the second quarter, 2001.
Kenneth Lay and Jeffrey Skilling continously encouraged employees to invest in Enron stock in their 401(k) accounts, while Lay, Skilling, and other Enron executives were selling their shares.
Enron acquired Portland General Electric (PGE) in a stock-for-stock exchange. PGE stock held in the 401(k) accounts of PGE employees was replaced with Enron stock.
Sherron Watkins, a Vice President for Enron, expressed concerns about Enron’s accounting practices, and wrote an anonymous letter to Kenneth Lay explaining her concerns. She presented a six-page report of her concerns to Lay and to the company’s lawyers and accountants. They didn’t agree with her concerns.
By October, 2001, Enron reported a third quarter loss of $618 million and announced it would restate its financial statements from 1997 to 2000 to correct accounting violations.
On November 28, 2001, credit rating agencies reduced Enron’s credit rating to junk status, leading to its $63.4 billion bankruptcy, the biggest on record at the time.
Arthur Andersen, the company’s auditor, was fired. The auditors shredded evidence in their possession. The scandal led to Arthur Andersen losing its license to practice public accounting, destroying the fifth largest CPA firm in the United States. (In addition to its audit work, Arthur Andersen had several consulting assignments with Enron.) (The surviving piece of Arthur Andersen is Accenture, renamed from Andersen Consulting.)
Kenneth Lay was convicted of six counts of securities and wire fraud, subject to a maximum sentence of 45 years in prison. He died before being sentenced.
Jeff Skilling was convicted of 19 counts of securities fraud and additional charges of insider trading. He was sentenced to 24 years and four months in prison, later reduced by 10 years in a deal with Department of Justice.
You can watch a documentary of the Enron story, Enron: The Smartest Guys In The Room, for free on YouTube here. https://www.youtube.com/watch?v=7tx9B53s5XU
In Congressional hearings, it was revealed that the bankers, securities brokerages, utilities regulators, auditors, and the SEC were all complicit in the Enron scandal. Nobody wanted to question the honesty of the corporate officers.
As a result of the Enron scandal and other scandals, like Worldcom and Tyco, Congress passed the Sarbanes-Oxley Act of 2002, including the creation of the PCAOB for the oversight of the public accounting profession. The Financial Accounting Standards Board also adopted rules to curtail the use of questionable accounting practices.
The PCAOB had it most effective enforcement year to date in 2024. The agency made public 51 settled orders, compared to 40 settled orders each year for 2022 and 2023. KPMG Netherlands was fined $25 million, the highest civil money penalty in PCAOB history. Most of the PCAOB’s audit activity and penalties relate to international operations.
Without the continued oversight of the PCAOB, it seems likely that investor risk of fraud will increase and we will see more of the scandals experienced during the 1990s and 2000s.