Enron's lesson: taking a proactive stance to red flags, says Institute of Internal Auditors

<p>ALTAMONTE SPRINGS, Fla. – As Enron Corp.’s relationship with its auditor, Arthur Anderson continues to come under heavy fire, one trade group has reemphasized the need to spot red flags and be aware of sudden and questionable changes in management style. The Institute of Internal Auditors (IIA), an international association with 75,000 members in internal auditing and risk management has beefed up its stance on assessing risks in financial reporting including posting online surveys to garner feedback on verification practices. “We’ve heard from more than 300 of our members, and some of the directors polled are saying they were not aware of some risky transactions, others are questioning whether there was a dichotomy between what the auditors were seeing and what the directors were seeing,” said Bill Bishop, IIA’s president. It’s these types of discrepancies that heighten the need for a review of internal audit practices, Bishop emphasized. To start, the IIA has listed a number of cautions on its Web site, www.theiia.org, which urge auditors to be aware of “aggressive” accounting practices used to meet analysts’ earning estimates. The trade group also alerts members to be careful about pensions funded solely or substantially with company stock as was the case with Enron. The Association of Credit Union Internal Auditors (ACUIA) mirrors the IIA standards with just as strong an emphasis on promoting a separate, independent audit function, cohesion between the internal auditor and supervisory committees and ongoing training, said Randy Manscill, ACUIA board member and recent chairperson of the 600-member group. Manscill is also chief audit executive for America First Credit Union in Odgden, Utah. “Enron will be one of those defining events for our industry because it emphasizes our ongoing promotion of a separate set of eyes and ears that are necessary in an organization,” Manscill said. “We don’t think outsourcing is the best option. We’ve always promoted the idea of a credit union hiring someone to be the chief audit person.” The IIA has listed a number of areas that deserve scrutiny including: </p> <p>being aware of aggressive accounting practices employed in response to pressure to meet analysts earning estimates; </p> <p>keeping in mind that managers who are notable for their creativity are often the very same managers who take the biggest risks; </p> <p>avoiding shying away from risk-management issues and be sure to follow up on audit findings; </p> <p>determining whether financial controls are adequate and whether management can override controls; </p> <p>being sure that the right people are telling the right things. </p> <p>large, last minute transactions that result in significant revenues in quarterly or annual reports; </p> <p>overly optimistic news releases or shareholder communications with “the CEO acting as an evangelist to convince investors of future potential growth;” </p> <p>use of reserves to smooth out earnings – large additions to reserves that get reverses, for example; </p> <p>widely dispersed business locations with decentralized management and a poor internal reporting system. It will take years before all the facts come out at Enron, but even a cursory review of industry red flags can point out clear danger signs, Bishop said. “With an unprecedented 151% increase in revenues during 2000, Enron’s reported revenue of $100 billion definitely seems in hindsight to be `too good to be true,’ ” Bishop said. He added, by comparison, the second-ranked pipeline company on the Fortune 1000 list, Dynegy, reported less than $30 billion in revenues. “ Enron’s growth was unusually rapid compared to other companies in the same industry but instead of being viewed as a red flag, this growth rate made Enron the darling of Wall Street financial analysts,” said Bishop. Meanwhile, the IIA continues to revisit the emphasis on assisting members with keeping their organizations financially sound including sending timely biweekly bulletins to one of its subsidiary groups, the Chief Audit Executives, which has 750 members who run internal audit departments at Fortune 1000 companies. IIA is also developing a facilitator’s guide to assist with roundtables that will focus specifically on Enron at each of the group’s 200 chapters nationwide. “We have many internal auditors that report directly to the CEO and we think the communications lines needed to be strengthened,” Manscill said. “It starts with setting up the correct charter, having periodic meetings for accountability and making sure the lines of communication are open so that everyone and anyone can ask questions.” [email protected]</p>