After the Fall

The experts weigh in on how to prevent future Enrons.

The related issue, from our perspective, is what we call “credit cliff” situations, which are situations where if a happens, the company is rated triple B, but if a doesn’t happen, the company is rated single B or triple C. And the market demands ratings to be forward-looking.

We base the rating on what we believe is the most likely scenario, encompassing some range of other scenarios as well. But when you run into a case where the alternative scenarios are widely divergent, it becomes challenging to make that into a single symbol. So we’re in dialogue with market participants, particularly investors, on how they would like us to share that information in those situations — whether it’s by completely discounting all these remote but very negative scenarios in the rating itself, or whether they would like more disclosure from us in the form of our rationale on the credit implication of alternative scenarios.

Auditors and Consulting

How do we eliminate auditor conflicts of interest? Should accounting firms split off their consulting arms?

Unger: I spent a lot of time analyzing auditors’ conflicts of interest. Part of it is competition: a firm doesn’t want to do more than its competitor in terms of conservative approaches. Because if a company isn’t happy, if that conservative approach is [depressing its] earnings, it will walk down the street to accounting firm number two — taking with it not just its auditing fees, but also its consulting fees. The question is whether you can manage that conflict sufficiently, or whether it’s too overwhelming to have a firm with both of those components servicing one company.

Clapman: From our point of view — and I’m not saying that the accounting firms themselves should split consulting and the auditing function — we strongly believe that a company being audited should not use the same firm for consulting services. That’s our basic position.

Ed, if your firm were forced to split off auditing and consulting, could you attract the people you need?

Nusbaum: If you limited auditing to audit services as currently defined in proxy rules, that would be overly limiting. But I think [we could continue to attract new auditors] if you expanded audit services to include the things that accounting firms traditionally provided, which is the audit, tax services, general business advice — even while avoiding the multimillion-dollar system implementations that really do create conflicts of interest.

So you don’t think that the conflict of interest that even the auditors have with their clients is unmanageable?

Nusbaum: Auditors, like analysts, are paid by the companies, either directly or indirectly, and there’s an inherent conflict of interest associated with that. But it’s still the best system we could possibly have. There are alternatives. You could have the auditors paid by the stock exchanges, or paid by the investors: every securities transaction contributes to an audit. Those things are possible, but that’s a pretty radical change. I don’t see that happening in the near future.

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