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Can Britain cope with the next Enron?

Prem Sikka fears the Government is not prepared to take the necessary action
to prevent fresh corporate scandals

ARE   we heading for the next Enron? There are two responses to such a
question. The first is that, due to poor regulation and enforcement, ordinary
citizens are facing Enron-size scandals on a daily basis.

The second response is that headline-grabbing Enron-style scandals are deeply
embedded in capitalist economies where bending the rules for profit or personal
gain is often seen as an indicator of business acumen and stealing a march on
competitors at almost any price is portrayed as an entrepreneurial skill. These
tendencies are aided by inappropriate electoral systems, institutional
structures, stock market expectations, executive reward systems and politics
that are all too prevalent in Britain. Rising interest rates, falling house
prices, the drying up of the consumer boom and corporate lust for more profits
ignite the fuse that leads to Enron, Bank of Credit and Commerce International
(BCCI) and other scandals.

Daily Enrons are manufactured by corporate abuses of power and weak and
ineffective regulation. In pursuit of higher profits and executive remuneration,
numerous profiteering schemes are dreamt up. In principle, these could be
checked by vigilant regulators and effective enforcement, but Britain lacks such
regulators. Too many regulators are "captured" by the very interests that they
are supposed to check and regulate. The inevitable result is profiteering,
exploitation and abuse of people. A few examples would help to support the case.

Banks, supermarkets, electricity, gas, water, credit card, and mobile phone
companies have been indulging in an orgy of profiteering. Railway companies
collect huge public subsidies, but public transport in this country is almost
the most expensive and dangerous in the western world.

Weak regulation and enforcement has encouraged companies to operate cartels,
create monopolies and abuse the public. Argos and Littlewoods fixed the price of
toys. Supermarkets sell farmed fish as "wild", battery eggs as 'free range' and
frozen chickens which are one-third water. JJB fixed the price of replica
football shirts. Fifty independent schools colluded in illegal price-fixing of
fees. Sotheby's and Christie's fixed the commissions on the sale of fine art,
jewellery, rugs and furniture. IMI and Delta have been fined for operating a
copper fittings cartel. ICI was fined for being part of a cartel that fixed the
price of acrylic glass. Royal Dutch Shell was fined by the European Union for
colluding with others to fix the price of synthetic rubber used for tyres.
Indeed, the daily Enrons are experienced from "cradle to grave"   and exist
in virtually all markets.

As regards London's stock market, insider trading is rife. The Financial
Services Authority (FSA) confirms that nearly a quarter of all British takeovers
are preceded by share price movements that indicated insider trading. Despite
huge publicity, financial services continue to be mis-sold. The pensions,
endowment mortgage, split capital invetsment trusts and other scandals are
followed by the payment protection insurance scam. The FSA makes noises, but
does little to discipline offenders.

All the preconditions of Enron and WorldCom are present in abudance. The
"majoritarian" electoral system translates minority votes into huge
parliamentary majorities. The political system does not seek to build any
concensus or reflect the diverse interests of stakeholders. The system is also
captured as political parties are funded and dominated by corporate interests.
Britain gave up the commanding heights of the economy, but has failed to develop
an adequate interventionist apparatus. Thus, the mantra of the day is self (or
private) regulation, deregulation or light regulation to appease corporate
interests. In this climate, more Enrons are likely.

Stock markets expect companies to produce ever higher profits. The linking of
executive remuneration to profits and share prices provides the incentives to
roast the accounts and indulge in shady trading to drive up share prices to
secure bonuses and share options. Britain lacks independent regulators that
contest corporate values, vocabularies and agendas. Neither does it have an
effective Department of Justice to mount prosecutions. Hardly anyone is ever
prosecuted for insider trading, or even poisoning the people for inflicting
slow-death through Creutzfeldt-Jakob disease (CJD) and Bovine spongiform
encephalopathy, commonly known as mad cow disease. Despite the looting of
people's savings through pensions, endowment mortgage and other financial
scandals, hardly any company has been prosecuted.

Britain learns little from scandals. The main tendency is to individualise
and ignore the systemic aspects. Thus Nick Leeson is blamed for the Barings Bank
collapse. The speculative tendencies that underpin the system are ignored.
Cover-up is a frequent response to scandals. The fraud-ridden Bank of Credit and
Commerce Interntional (BCCI) with links to powerful politicians and corrupt
Middle East regimes was closed in 1991, but, unlike the Farepak and MG Rover
episodes, the Department of Trade and Industry did not appoint inspectors to
investigate and document the frauds. There have been no investigations into the
homegrown scandals of Polly Peck, Levitt, Resort Hotels or the Accident Group.
There have been no investigations into British operations of Enron, WorldCom,
Xerox, Ahold, Parmalat and Hollinger. As a result, little is learned from
scandals and appropriate regulatory arrangements are not made.

Numerous episodes show that company auditors have been asleep on the job,
usually in bed with company directors. After Enron, the British Government has
sought to rebuild confidence by perpetuating the belief that auditors would
check crooked practices. This is one of the biggest hoaxes. Company auditors are
hired, fired and paid by directors and their companies. They have no
independence from their paymasters. Auditors could be kept on the straight and
narrow by an effective independent regulator, but this country does not have
such regulators.

Auditors do not owe a duty of care to any individual shareholder, creditor or
any other stakeholder. In the mid-1990s, under pressure from accountancy firms,
the United States introduced the concept of "proportionate liability", which
made it harder for stakeholders to sue negligent auditors. The result was
reckless auditing, as evidenced by Enron and WorldCom fiascos. Following the
Companies Act 2006, Britain is now following the same path. Thus, damages
against negligent auditors, if they can be sued, would be determined not by the
extent of negligence, but by agreement with companies. Britain and the EU are
now pushing for an artificial cap on auditor liability. More audit failures are
inevitable.

The idea of relying on auditors is also doomed to failure. It is doubtful
that auditors can effectively audit a bank operating in 170 countries. With
electronic money transfers, ex-post audits serve little purpose. Almost all
major corporations are placing clever bets on the movement of commodity prices,
share prices, interest rates and currency exchange rates. The eventual outcomes
depend on uncertain future events but can result in huge losses or gains. It is
impossible for any auditor to verify the likely gains and losses reported in
company accounts.

The above mix is now complicated by businesses that seem to escape any
national jurisdiction of regulation. Anonymous companies can be registered in
the British Virgin Islands, owned by another company in Panama and Caymans and
with directors in Bermuda. This tangle makes it impossible to regulate them
effectively and shield people from their activities. Many hedge funds and
private equity firms are financed by high levels of borrowing. Modest levels of
increase in interest rates can bring them down. Britain's consumer boom is
funded by high levels of borrowings rather than by investment and is vulnerable
to changes in interest rates and will set off a domino effect. At such times,
company excutives take desperate steps to maintain the appearance of profits and
cook the books.

Overall, Britain is poorly equipped to deal with major scandals. The
electoral system discourages good policies and regulatory structures. The
regulators are too easily captured and punishments for wrong-doings are low.
There is little sign that any political party is willing to undertake the
serious and necessary reforms.

Prem Sikka is professor of accounting at the University of Essex

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