By COLIN LEINSTER
 
ACCORDING to Lynn Turner, the Securities and Exchange
Commission's (SEC) former chief accountant, a number of red
flags signalled potential trouble at Enron. They may also be
flying over your company - and you shouldn't count on your
auditor to sound the alarm.

He thinks that directors everywhere, and particularly members of
audit committees, need to get tougher with management and
auditors if they want to avoid the kind of legal trouble facing
the Enron board.

Turner, who was CFO of Symbios, a software manufacturer (now LSI
Logic), and a partner at Coopers & Lybrand (now
PricewaterhouseCoopers), was chief accountant at the SEC from
1998 until last year.

In the first of a two-part article extracted from What Directors
Can Learn From the Enron Fiasco by Colin Leinster in Corporate
Board Member, Turner stresses on corporate governance and
accountability.
  
Q: What can directors learn from what's happened at Enron?

A: An important lesson is that they should understand the
operations and economics of their company, its strategy and the
key performance indicators that give them some idea of how the
business is doing. Excellence in corporate governance is
critical to the accountability and integrity of any company, and
that requires knowledgeable, active and independent board
members.

Outside board members need to be sure they don't have economic
ties to the company or other possible conflicts of interest that
might seem to compromise their independence.

While directors should not micromanage or second-guess top
management, they absolutely cannot shy away from their
responsibility to ask tough questions. And if, after asking
those questions, directors are not comfortable with the answers,
then they need to consider whether they should seek outside
counsel and advice.
  
Q: What danger signs or signals that something was wrong do you
think Enron directors missed? Do similar signals exist at other
companies?

A: There were a number of red flags and none of them is unique
to Enron. They included all kinds of transactions between
members of management and outside firms and affiliates, any one
of which might provide an opportunity for self-dealing.

I can't tell you how often I have heard that such related-party
transactions were negotiated on an arm's-length basis. The
problem is, there is no way you can prove whether they were or
not.

Directors should consider whether there is a legitimate business
reason for the company to enter into any such transaction. If
necessary, get outside legal advice, and make sure that all the
important terms and details of the transaction are disclosed in
plain English in the financial statements and in filings with
the Securities and Exchange Commission.

Another red flag is a build-up in off-balance-sheet financing,
such as securing debt with leases and special-purpose entities
(SPEs). Investment bankers, lenders, auditors and other
outsiders often help put these kinds of deals together as a way
to get around showing debt in the financial statements.

There may be legitimate reasons for doing this, but it is often
done in order to hide just how leveraged a company is.
Ultimately, it is a clear warning that the company is getting
overextended.

My advice for directors is to request the CFO or treasurer to
provide a quarterly summary of all debt, both on and off the
balance sheet, along with information on where the cash will
come from to service the debt.

Finally, get the management team to provide an analysis of the
company's balance sheet so that you can compare various
debt-to-equity and liquidity ratios with others in your
industry. If there are big disparities, don't hesitate to ask
why.
  
Q: And derivatives?

A: Now there's an ugly face we've seen in the past, at Procter &
Gamble, Kidder Peabody and Bankers Trust, among others. And
these days companies are using ever more complex derivatives to
manage all kinds of risk, from the weather to currency
fluctuations and the financial statements should reflect their
changing values in a timely fashion.

This is not an issue for derivatives that are readily traded.
But measuring the value of derivatives and other financial
instruments that do not have an actively traded market may be
complex. These valuations can also be a way to manage earnings
if proper controls are not in place.

To avoid such shenanigans, directors should make sure that: (1)
the company has up-to-date written risk-management policies,
procedures, and internal controls and that they're in place; (2)
the internal controls include sufficient safeguards, such as
adequate segregation of duties, that prevent any one person in
the company from executing improper transactions or doing
improper accounting; and (3) the company has established
well-reasoned and supportable methodologies that consistently
measure the fair values of derivatives and financial
instruments.

A board would be well advised to ask independent auditors or
other experts to assess the company's policies and controls on
this topic.
  
Q: Do you expect to see more Enrons?

A: History has told us the answer is yes.
  
Q: What should directors do if they're unsure of what's really
going on?

A: I would encourage them to spend some time onsite with
management and company personnel. One thing I learned was, it
was difficult to get your hands around an issue when the issue
was a thousand miles away.

Don't be afraid to ask a lot of questions. As both a CFO and an
audit partner, I had greater respect for the audit-committee and
board member who had the fortitude to ask questions, as opposed
to the one who sat silent and contributed little to improving
the company.

I know some of the questions I was asked put me to the test and
no doubt enhanced some of my decisions. More important, it was
always easier to work with an informed board member as opposed
to one who was uninformed.

If, at the end of the day, directors were still unsure and
uncomfortable with what they were seeing or hearing, I
encouraged them to seek legal advice. Keep in mind that the
board has an important role as the overseer of corporate
governance. Sometimes seeking outside counsel is simply
something that has to be done.

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