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Only a few short years ago, the American system of corporate disclosure—the combination of accounting and auditing standards, the professionalism of auditors, and the rules and practices of corporate governance that are designed to ensure the timely dissemination of relevant and accurate corporate financial information—was championed as a model for the rest of the world. In the aftermath of the Asian financial crisis of 1997–98, which was marked by among other things a woeful lack of disclosure by companies, commercial banks, and even central banks, American commentators and experts were urging not only Asian countries, but others as well, to adopt the key features of the U.S. disclosure system. How much has changed since then! A corporate disclosure system that Americans thought was beyond reproach has turned out to be flawed in ways that few would have imagined or dared suggest only a few years earlier . The shift in attitude is reflected in various measures, among them earnings restatements. The number of American corporations whose earnings have been restated rose modestly throughout the 1990s, but then took 1 The Crisis in Corporate Disclosure 1 01-0890-CH 1 1/30/03 9:33 AM Page 1       a big jump in 1998 and hit a peak of more than 200 in 1999.1 All the while, concern has continued to mount about “earnings management” by many companies. Under this practice, strongly decried by Arthur Levitt, a recent past chairman of the Securities and Exchange Commission (SEC), firms exploit the discretion allowed under accounting rules to ensure that their earnings show continued growth or at least reach the quarterly earnings estimates put out by financial analysts. Nothing, however, has done more to generate widespread public and official concern about the usefulness of current disclosures by corporations than the failure of Enron in the fall of 2001 and the subsequent disclosures of misconduct by its auditor, Arthur Andersen. Among other things, Andersen was alleged to have known about the company’s problems but did nothing to force Enron to reveal them and may even have helped the company deceive the public. In May 2002, Andersen was convicted of obstruction of justice for shredding key Enron documents. Criminal charges and civil lawsuits are still pending against Enron, Andersen, and some of their top managers. The Enron-Andersen debacle would have been bad enough, but it was quickly followed by revelations of accounting irregularities at several other leading companies. In late June 2002, the telecommunications giant WorldCom disclosed an earnings restatement approaching $4 billion, which was subsequently revised upward in November 2002 to potentially more than $9 billion. That announcement was followed by one from Xerox disclosing a $1.4 billion restatement. As of the end of August 2002, high-profile lawsuits and official investigations, involving fifteen major companies, had been launched against five leading accounting firms for auditing failure, as shown in table 1-1. The events relating to Enron, WorldCom, AOL/Time Warner, Xerox, and some of the other companies listed in table 1-1 have had repercussions far beyond the companies involved, their current or former officers and directors, and their auditors. The thousands of employees who once worked for and had their pensions tied to the fortunes of now bankrupt firms have suffered deep economic pain, while investors in these firms collectively have lost billions. The stock markets fell steadily and sharply through much of the spring and into the summer. By the end of July 2002, the S&P 500 Index—one of the broadest gauges of the market—had fallen 01-0890-CH 1 1/30/03 9:33 AM Page 2       nearly 30 percent in just three months.2 The market continued to fall for some time after that, most likely due to jitters over an impending war with Iraq, before beginning to climb again. At this writing, in late fall 2002, the market had recovered, but only to roughly its post-July, depressed level. In any event, the apparent shattering of investor confidence and continued spate of accounting stories pushed Congress into quickly enacting a comprehensive package of measures—the Corporate Responsibility Act of 2002, perhaps better known as the Sarbanes-Oxley Act after its primary sponsors —designed to reform not only corporate accounting but corporate governance more broadly. The fall of Enron also raised broad concerns about current accounting standards that the Sarbanes-Oxley Act did not specifically address, such as whether the standards are too slow in the making and too heavily influenced by...


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