By COLIN LEINSTER 

IN the second of a two-part article, Lynn Turner, the Securities
and Exchange Commission's (SEC) former chief accountant,
provides some answers to a few questions on the Enron fiasco.

Q: What's the big message from Enron to members of audit
committees?

A: Enron has become the poster child for audit committees. And
although we shouldn't prejudge its audit committee - we don't
know if its members asked the tough questions or, if they did,
who provided the answers and what the answers were - Enron
should definitely sensitise audit committees to a number of
issues, if they were not sensitised already.

First, each committee member needs to be financially literate
enough to understand the company's financial statements and
disclosures. If you don't comprehend the basic economics of the
business and how they are affecting financial statements, ask
the CFO to provide some training sessions.

Every committee member should examine closely the financial
reporting and accounting policies for all significant
transactions in the company. Committee members should ask both
the CFO and the independent auditor if the accounting for
transactions, as reported and disclosed in the financial
statements, reflects the highest standard that could be used,
and if not, why.

This means the transactions are accounted for in a fashion that
reflects the true economics of the transaction. I would ask the
audit partner if he or she would change any of the accounting
policies or numbers in the financial statements.

I would also ask the CFO and the auditor if there were any
information they would want if they were considering investing
in a company that was not disclosed. The minutes of the audit
committee provide a good venue for documenting the response.

It seems that all too often audit committees find out about
problems only very late in the day; material weaknesses in
controls are highlighted by the independent auditor only after
the audit was done or problems arose.

In many cases, the audit committee only found out about problems
when they surfaced during the course of an SEC investigation.

The Financial Executives International, the US General
Accounting Office and most recently the independent Panel on
Audit Effectiveness (commonly referred to as the O'Malley Panel)
have all argued for greater reporting on internal controls by
management.

I would encourage each audit committee to get an annual
statement from the CEO and CFO that the company has internal
controls and that they are operating effectively. Many public
companies now follow a best practice of including such
management reports in their annual reports.

I would also request that the auditor provide the audit
committee with all the comments he might have on the company's
internal controls. The message should be clear: "No surprises
here!"

It is important that the audit committee and independent auditor
have open lines of communication and a clear delineation that
the auditor is working for the audit committee. I would
encourage audit committees to ask the auditor to identify the
most sensitive accounting and auditing issues and to describe
the steps he is taking to test whether those transactions are
properly accounted for and disclosed.

Q: Enron has also raised the issue of companies paying fees to
audit firms for non-audit services. What's happening there?

A: In some cases, non-audit fees have amounted to 20 times the
amount paid for the actual audit. The big issue is whether any
of these extra services impair an auditor's independence.

The O'Malley Panel has recommended that audit committees
pre-approve such services. The SEC has encouraged audit
committees to consider various criteria that will help directors
assess whether such services could impair an auditor's
independence.

Audit committees should become more informed about the nature of
the consulting that audit firms do for the company.

A CFO might ask how to properly account for a specific
transaction, and it's good to get the auditor's input at the
earliest possible date. But sometimes an auditor is asked to
help structure a transaction in a fashion that will reduce the
level of disclosure or transparency to investors, lenders,
rating agencies and others.

I have seen accounting firms work with investment bankers to
find ways for their corporate clients to get around a particular
accounting rule. Audit committees need to ask their auditors if
they are involved in any such assignments. If so, the committee
members should ask themselves whether the shareholders they
represent would consider this auditor to be the independent
third party he's supposed to be.

Q: What does the Enron collapse mean to auditors and their
reputation?

A: There is no doubt that auditors have lost the trust and
confidence of many shareholders. This isn't just because of
Enron, either. There's been a constant parade of companies
-Cendant, Waste Management, Xerox, Lucent, Rite Aid, WR Grace,
Sunbeam, Micro-Strategy - where auditors dropped the ball.

Auditors will have to make fundamental changes in how they do
their work. The O'Malley Panel recommended two years ago that
certain forensic auditing procedures be required and that
current standards be reconfigured to provide greater detail in
the procedures. Auditors also need to recognise that many
financial frauds continue to involve improper revenue
recognition, establishment of "cookie jar" reserves, and large,
unusual adjustments.

But there's been no real progress in setting new auditing
standards that would result in auditors working more
effectively. Even existing accounting and disclosure standards
and requirements are often ignored.

We can have all the accounting rules one can write, develop new
ones for SPEs or valuing derivatives, and require greater
disclosure of key financial metrics or related-party
transactions. In the end, none of that will matter if the CEOs
and CFOs play the numbers game and cook the books, and if the
auditors don't stir the pot enough to figure out what's being
cooked and whether it is edible by investors and the markets.

Q: How should shareholders feel about auditors?

A: If you mean, "Is the current oversight of the accounting
profession working?" the answer is no. The profession vigorously
lobbied Congress and the SEC 25 years ago for the system of
self-regulation that we now have and it has turned out to be far
too self-serving.

The profession has taken a much more proactive approach in
Britain. Faced with public criticism as a result of frauds
involving the Maxwell empire, BCCI, Barings Securities and
others, it drafted a framework for a new regulatory-oversight
mechanism.

Some of the key elements include an oversight board called the
Foundation and four separate boards. One reviews the work of
auditors and the other boards. Two others set standards for
audits and auditor independence, and the fourth is a
disciplinary body.

The eight or so members of the Foundation all come from outside
the accounting profession, representing the Bank of England, the
National Association of Pension Funds, and the like. The other
boards either exclude accountants entirely or at least those
currently in practice.
  
o This interview is extracted from "What Directors Can Learn
From the Enron Fiasco" by Colin Leinster in Corporate Board
Member (March/April 2002). For more information, call MIM
Customer Service at 03-2165 4611 or visit our website:
www.mim.edu.