NEW YORK — Enron’s collapse added a smacking insult to the injury of the stock market’s decline over the last two years.
That kind of slap is what businesses and investors, and those tasked with watching over them, may have needed.
Many had claimed to be chastened by the painful reverse in fortunes of Internet and technology companies, and their stocks, more than a year ago. There was soul-searching over the ways companies calculated their profits or losses, and how they revealed their liabilities. There was an examination of auditors’ conflicts of interest when their firms did other business with the companies whose books they monitored.
Humbled investors acknowledged the need to lower their expectations of fat, quick returns. Many of the analysts who helped build expectations faced a grueling public examination because of the stakes they, or their firms, had in the performance of stocks they covered.
But real action was limited. Some investment banks faced sanctions for possibly manipulating the sales of coveted first offerings of stock during the tech boom. Beyond that, the general attitude can be summed up: Yes, the system needed some fine tuning but, since we’re all acting in good faith, why rush to reform?
The apparent bad faith at Enron Corp. and some Arthur Andersen LLP auditors, dramatized by the alleged shredding of documents even after a Securities and Exchange Commission investigation began, changed all that.
“I think it could lead to some good reforms in the long run,” said Jeremy Siegal, a finance professor at the University of Pennsylvania’s Wharton School of Business.
He cited, among others, the need for standardizing how businesses report their earnings. Companies now have a lot of latitude in formulating profit or loss, how they add up revenues and expenses, where and even whether they list their debts or other liabilities. Different companies use different formulas, creating confusion about a company’s real bottom line.
In addition, Siegel said in a telephone interview, the system needs firewalls between accountants who audit a company’s books and others who, working for the same accounting firm, do consulting or other work for the company. He urged a formal division “like we had 60 years ago between commercial banks and investment banks.”
Several of the big accounting firms last week were beginning to build those walls, spinning off or otherwise separating auditing and consulting operations.
Siegel, long an advocate of the stock market as the best place for long-term investment, also hoped for a return to an emphasis on dividends for company shareholders — a tried and true indication that a company is really making money, not just tweaking its books or making promises it can’t keep so its stock will get a short-term boost.
He saw no reason for investors who lost money on Enron stock to lose faith in the market or business in general. “The vast majority of CEOs and CFOs are honest people,” he said.
But if small investors come to realize just how hard it is to analyze a business’s balance sheet, that won’t be bad.
“Most small investors have no ability to translate those sheets,” Siegel said.
Wayne Firebaugh, an independent financial planner in Roanoke, Va., agreed that in recent years “people were investing in businesses they didn’t understand.” People interested in buying Enron stock, for instance, often were asking him, “What does Enron do?”
They’re simply aware a stock is rising and “they’re buying on momentum,” he said.
The problem, of course, is that by the time a small investor gets wind of a stock’s potential for success, the big traders probably have already moved in — and in fact may have found reasons to move out.
Like Siegel, Firebaugh sees a silver lining to the storm over Enron. “It has increased understanding, and hopefully will change some behavior,” he said.
He finds individual investors more easily steered toward mutual funds, where an expert can make investment decisions, and away from individual stocks. They better understand the need for a diversified portfolio, where losses in one company or sector can be balanced by a better performance elsewhere, he said.
And they’ve gained a new skepticism toward those who tout stocks, he said, listening more closely when he explains why some analysts would promote some stocks and not others.
“You have a competition in who’s going to get into a good deal, and you also have a competition in who’s going to get out of a bad deal,” he said. The competition is who will get there first, and anyone who isn’t a professional probably won’t.