Year of the accountant — The numbers game

We called it the year of the gilded reptile, and for good reason. We still shudder looking back at 1997, the annus horribilus that brought us the Busang salting scandal and assorted lesser scandals. Regulators, including a few who had nodded off at the switch themselves, suddenly snapped to attention and wasted no time telling the mining industry to clean up its act. Committees were set up and, lo and behold, a new set of guidlines emerged to govern the way mining companies do business.

But while the regulators fretted and fussed about assaying techniques and the proper definitions of proven and probable reserves, another problem surfaced that shook the integrity of security markets: creative accounting of the type that would do the British Columbia government proud.

The highest-profile case north and south of the border was the alleged $100-million fraud at Livent, an entertainment company that sought bankruptcy protection last fall. But there have been others — so many that securities regulators have dubbed 1999 the year of the accountant.

In a speech in Utah earlier last spring, Commissioner Norman Johnson of the U.S. Securities and Exchange Commission (SEC) said the top enforcement priority this year is financial fraud.

“No one who follows the financial pages could escape awareness of the recent allegations of apparent large-scale financial fraud, often involving hundreds of millions of dollars or manufactured or ‘managed earnings’ at many prominent public companies,” he said. “While the problem is not new, it is happening with alarming frequency. Barely a week goes by without an announcement that another large company is restating its past results.”

Johnson went on to list a number of dubious practices that companies employ to “manage their earnings,” including such things as “big bath” restructuring charges, creative acquisition accounting, “cookie jar reserves,” “immaterial” misapplications of accounting principles, and the premature recognition of revenue.

SEC Chairman Arthur Levitt has also spoken out about “the numbers game.” In a fall address in New York City, he expressed concern about “earnings management,” a process he characterized as “a game among market participants that, if not addressed soon, will have adverse consequences for America’s financial reporting system.”

Strong words perhaps, but he was just getting warmed up. “Too many corporate managers, auditors and analysts are participants in a game of nods and winks. In the zeal to satisfy consensus earnings estimates and project a smooth earning path, wishful thinking may be winning the day over faithful representation.”

Canadian regulators are also not amused by the sudden proliferation of creative accounting. David Brown, chairman of the Ontario Securities Commission, has warned auditors and corporate managers to “get off steroids — off the performance enhancers — away from the creative use of accounting standards that can enhance reported performance numbers.”

Even auditors — the supposed last word on financial reporting — are getting a tongue-lashing from regulators. Some are openly questioning whether accounting firms are accommodating audit clients in hopes of selling higher-cost services.

The practice of funny numbers hasn’t been confined to corporations. The British Columbia government (make that the New Democratic Party and its newly deposed leader, Glen Clark) told voters, just before the last election, that the provincial budget was balanced. After the election, the tune changed to: Sorry folks, this huge deficit just popped out of nowhere.

Mathematicians are fond of saying numbers are the highest truth humans can aspire to understand in an imperfect world. Two and two equals four, they say, not six or nine. Maybe they’re right. Maybe numbers don’t lie. But people do, and therein lies the problem.

And make no mistake, it is a problem. North American markets today enjoy the confidence of the world. But as Levitt asked, “How many half-truths and how much accounting sleight-of-hand will it take to tarnish that faith?”