10 years later, lessons learned from Enron mess

By Judith McGee

We're fast approaching the 10th anniversary of the Enron fiasco--when investors got a big wake-up call and realized that they'd best start taking a closer look at corporate financial statements.

Since elementary school, most of us have been programmed to trust authority. As we grew up and ventured out into the world, that old trust program automatically included ''authoritative'' paperwork, like annual reports and financial statements. Now we know that this trust is not well placed.

Before Enron's downfall, the average investor never gave much thought to the validity of corporate financial statements. It was simply accepted that all the big-name auditing firms were doing their jobs. After all, the ''Big Eight''--then later reduced to the ''Big Four'' (PricewaterhouseCoopers, Deloitte and Touche, KPMG, and Ernst and Young)--accounting firms that ''independently'' examine and certify these financial records, were considered squeaky clean and above reproach.

But as people watched their life savings in Enron holdings evaporate, they were stunned to discover something else -- an auditing firm can serve corporate clients in other capacities, and even share office space. When auditing firms increase their own bottom lines by tweaking the numbers of the very clients they audit, they cross the line in a conflict of interest.

Even after Congress finally passed the Sarbanes-Oxley Act of 2002--legislation that imposed stricter guidelines for auditing firms -- James R. Doty, the new chairman of the Public Company Accounting Oversight Board, discovered audit failures as recently as 2011. They were of such significance that PCAOB inspectors concluded the auditing firm had failed to support its opinion.

All of this uncertainty places the burden of due diligence and scrutiny squarely on the shoulders of investors or their advisers, and further reminds us to pay heed to the old caveat ''buyer beware!''

An annual report can be a powerful and informative tool to help understand a company's financial position. But to the untrained eye, these documents just appear to be page after page of complex numbers, fluffy text, glossy photos, and the upbeat ''Message from the CEO.''

Financial statements are expected to be straightforward summaries of what actually takes place in a corporation. But the method of reporting those numbers is anything but straightforward. That's because auditors and accountants have a variety of choices allowable within the Generally Accepted Accounting Principles. These choices relate to handling of certain transactions, reserves and the timing of recognizing those transactions. This can present a dilemma for the average person who just wants to know what all those numbers mean.

Footnotes provide narrative details that go beyond the numbers and help explain the accounting assumptions used.

Even if you have done your homework and have a fairly good grasp on reading financial statements, never base investment decisions on a single year of outcomes. The most relevant information can be found by reviewing information that's been reported over several years.

How does one get past the hype and the corporate public relations machine and drill down right to the heart and the meaning behind the math? There are plenty of books on the subject that explain how to read and understand financial statements. But if you don't want to attempt navigating those waters alone, meet with a trusted financial adviser able to guide you.

Judith McGee is the chairwoman and CEO of McGee Financial Strategies Inc., an independent registered investment adviser. She is a co-branch manager of, and offers securities through, Raymond James Financial Services Inc. in Portland, Ore. Contact her at 503-597-2222 or judith@mcgeenet.com.

Published: Mon, Mar 5, 2012