Examination of Witness (Questions 257-259)|
TUESDAY 2 JULY 2002
257. Good morning Lord Sharman. Thank you very
much for taking the opportunity to come and give us your views
on our inquiry into the financial regulation of public limited
companies. You have very helpfully sent us a paper which we have
all read and it forms the basis of our questioning. Could you
(Lord Sharman) I am Lord Sharman, a Member of the
House of Lords. Until September 1999 I was the International Chairman
of KPMG, one of the so-called Big Five then, now Big Four. In
addition to my responsibilities in the House of Lords I am now
a non-executive member of the boards of five public companies
and I chair the audit committees of three.
258. In your paper you identified a litany of
failures in the Enron case involving a wide range of factors.
To what extent are these same factors present in the UK arrangements
and regulatory system? We had WorldCom last week and we had Enron.
Some people have told us that the situation which applied in the
United States will not happen here. Can we bank on that?
(Lord Sharman) The short answer to that is no. I see
the situation in Enron and WorldCom as being quite different.
In the case of Enron, there was a situation which was engineered
financially, where a whole series of structures was used to support
the growth and development of a business which was fragile in
the extreme so that when something went wrong in the first instance
the thing collapsed very rapidly. They were using techniques such
as securing debt with their own stock, which was dependent on
the stock being at a certain level which meant that once the stock
price began to fall the thing unwound very rapidly. If you look
at the Enron financial statements and take note of what was said
as far back as March of last year by Fortune magazine, the accounts
are very nearly unintelligible. I have to say that I find them
very, very difficult to interpret. That was one set of circumstances.
As I said in my speech, there there was a failure of management
compounded by a failure in governance compounded by a failure
in auditing. I know little about the detail of the WorldCom case
other than what I have read in the reports. What you seem to have
here is straightforward cooking the books, in the sense that a
group of people decided to book something quite differently: they
treated it as capital when it should have been revenue and I believe
then embarked on a process of cover-up. In that case there was
clearly a failure in auditing because subsequently it appears
that it was found by an internal audit. One would expect that
mis-statements of that magnitude, particularly of the nature in
a developing company, would be found, so there was quite clearly
a failure of auditing there. The difference between Enron and
the United Kingdom is that the accounting rules in the case of
Enron are rules based and therefore when you have a rules based
system you tend to develop an industry which is designed to get
round the rules. If you have a principle based accounting system,
it is much more difficult because you have to look at the substance.
The big difference between Enron and the UK is that it is unlikely
that the Enron off balance sheet special purpose vehicles would
have been able to survive scrutiny here. That does not mean to
say that things like WorldCom could not happen: they could.
259. Because of booking expenses.
(Lord Sharman) Yes. Anybody can decide to book capital
instead of expense and try to cover it up and hope the auditor
does not find it.