Treasury Today Country Profiles in association with Citi
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July/August 2006

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True and fair

The prison doors will be shutting on Jeffrey Skilling in the next few months whilst Ken Lay has taken his guilt to the grave. But the impact of their actions will live on for many years. The shareholders in Enron who were duped by these two, will certainly not forget them. However, the impact of Enron and other recent scandals is having a much wider effect. Sarbanes-Oxley may be US legislation responding to US scandals, but its impact is being felt around the world.

Fraud is not a recent phenomenon. It has always been an unfortunate aspect, a by-product, of business. Readers who have observed the UK business scene for many years will recall Polly Peck or Blue Arrow or Guinness, and most have heard of Barings. Initially, we could pretend Enron was different and that such scandals did not happen here in Europe. But then we had Parmalat (and Ahold and Vivendi and Royal Dutch/Shell and so on).

But there is one difference today and that is the remedy being applied by governments to avoid these scandals. The Sarbanes-Oxley (SOX) legislation is very prescriptive and has encouraged a rules-based approach to corporate governance. Implementation has been costly and business has spent billions of dollars meeting SOX requirements. Unfortunately, it is not clear that this will prevent a recurrence of the problem. There is a real danger that this legislative cure may be worse than the fraudulent cause. An example of this is a new EU directive stating that the audit report must be prepared ‘in accordance with the right accounting framework’. Some institutional investors are correctly detecting that this compromises the auditor, who starts to check whether a company is complying with the accounting standards and the reporting rules, rather than having an overall concern that a true and fair view is being given. Audit certificates are now being qualified as giving a true and fair view in accordance with the rules.

History tells us that human ingenuity will find always find a way around any set of rules. The cure must lie not just in a set of accounting standards, but also a set of values. Directors and management have a duty of care. They should act honourably and should report what they have done – presenting a true and fair view. It is whether it is a true and fair view that should be checked by the auditors, not whether a set of rules were met. There is a real danger that the emerging legislation will make the audit a compliance exercise to determine whether a set of rules has been applied, rather than a check as to whether the truth is being told.