SINGAPORE (Sept 10): A response from Iceberg Research to a tweet about Jeff Skilling (pictured, main image) this past week alerted me to the news that the former CEO of Enron Corp had just been released from prison and relocated to a halfway house for the remainder of his jail term. “Chairman position vacant at Noble Group. Fits your skills perfectly,” Iceberg said in its response to the tweet.

It wasn’t the first time that Iceberg had associated Noble with Enron. It began doing so in its earliest reports on the commodity trader back in 2015. For instance, in a report dated March 21 2015, Iceberg said Noble had fabricated the value of its assets, and specifically inflated financial figures that credit rating agencies closely monitor. “Noble, like Enron, intelligently spots the accounting loopholes… and exploits them with the help of a complacent auditor,” the report added.

Enron, which was once one of the largest sellers of natural gas in North America, is said to have adopted aggressive mark-to-market accounting for its long-term supply contracts and used special purpose vehicles to keep debt off its balance sheet. But it all unravelled in 2001. During that tumultuous year, Skilling resigned, chief financial officer Andrew Fastow was ousted, Enron restated its earnings for previous years, plans for the company to be acquired fell through and it filed for bankruptcy.

The whole scandal sparked a criminal investigation by the US Justice Department, sank Enron’s auditor Arthur Andersen and helped spur US lawmakers to pass the Sarbanes-Oxley Act of 2002. Kenneth Lay, who formed Enron in 1985, and had been its chairman and CEO, was found guilty of securities fraud conspiracy and lying to banks. He died before sentencing, resulting in his conviction being annulled. Fastow, who informed on other Enron executives  served a reduced jail term of six years for wire and securities fraud. Skilling was convicted of securities fraud, conspiracy, insider trading and lying to auditors. He was given a 24-year jail sentence that was later reduced to 14 years. He is scheduled to be freed in 2019.

Since Iceberg began sounding the alarm about Noble, the commodity trader has seen its market value shrink by some 97%. However, the authorities in Singapore have yet to see the need to take direct action, much to the chagrin of Noble’s detractors like Michael Dee, a former senior managing director of Temasek Holdings. “Singapore has a well-deserved and established reputation for regulatory excellence. However, in the Noble case, [the authorities] were well informed and yet have failed miserably over 3½ years to protect investors and maintain the integrity of their financial markets,” Dee told The Edge Singapore last month. “Their excuses are lame and misleading, their investors have lost billions and, worst of all, they have shown others who would deceive that there is little risk of being held to account.”

On the other hand, the regulators seem to think the mechanisms already in place ought to be allowed to function. Responding to queries about Noble last month from The Edge Singapore, a Singapore Exchange spokesperson said: “We have been putting the onus on Noble’s auditors to justify its audit, and their accounting practices were reviewed by a Singapore-registered auditor. Most recently, we have required Noble to appoint a Singapore-registered auditor to jointly audit the accounts for FY2018 and appoint a new Singapore-registered auditor for FY2019. If there is any failing by any auditor, we will refer the auditor to the appropriate accounting regulatory bodies.”

On Aug 27, shareholders of Noble voted to reappoint Messrs Ernst & Young as auditors for the company.

Hotel Kenneth Lay-a

Two months ago, this column explained the purpose of corporate governance as being primarily about overcoming the problems related to the separation of ownership and control. Owners of a public-listed company need to ensure that their managers do not expropriate or waste their money. And, they need to be assured that financial statements accurately reflect the true state of affairs at their company. For the most part, this is addressed through legal protections, which include having a sufficient number of independent directors on the board and regular external audits. But there are obvious shortcomings to such protections. External auditors and independent directors often owe their appointments to the executives of their companies.

The lengths to which they may go to maintain good relations were exposed in the Enron case. In particular, Arthur Andersen was found to have shredded documents related to its audits of Enron, just as investigations were intensifying. It also came to light that employees of Arthur Andersen and Enron had close personal relationships, and even took vacations together.

Interestingly, at a court hearing in 2002, evidence introduced by the authorities to demonstrate the influence Enron had over its auditors included alternative lyrics to the song Hotel California that had been penned in 1995 by an Arthur Andersen partner named James Hecker. The parody version of the song, cheekily titled Hotel Kenneth Lay-a, included several hints that Enron had a habit of putting pressure on its harried auditors, including these lines: Welcome to the Hotel Mark to Market. Such a lovely place, such a fragile place. They’re livin’ it up at the Hotel Cram it Down Ya. When the suits arrive, bring your alibis.

There were also references to Enron’s creative accounting methods and use of complex valuation techniques with lines like: Her mind was Black and Scholes-twisted, though her margins are thin. She’s got a lot of pretty, pretty spread that she takes in. And, the last segment of the song, suggesting growing hubris at Enron, is pure gold: Last thing I remember, I was running for the door. I had to find the entries back to the GAAP we had before. “Relax,” said the client, “we are programmed to succeed. You can audit any time you like, but we will never bleed.”

Hecker was not himself involved in audits of Enron. He testified during the trial that he did not believe Arthur Andersen or Enron had committed any crimes, and that the parody song was meant to be a joke.

Watchdogs and bloodhounds

Is SGX right to put the onus of justifying Noble’s accounting on its auditors? How tough can auditors really be on their own clients? In my view, regular audits of a company’s books cannot be expected to uncover every instance of wrongdoing. Such a wide scope would drive up the costs of these audits, and ultimately burden investors. More importantly, it would require an auditor to have a suspicious mind when dealing with clients. It is just not possible to have a good ongoing working relationship with people who you are convinced are liars — I’m informed by my own life experience on this.

In short, auditors should be thought of as watchdogs rather than bloodhounds. Their role is to bark when they spot something that doesn’t look right, not relentlessly seek out evidence that their clients are involved in some form of misconduct. Of course, that means investors should not assume that a company is in good shape simply because it has been given a clean bill of health by its auditor.

Instead, investors ought to maintain a healthy sense of scepticism when sizing up companies, and ask tough questions whenever they get the chance. Regulators can help by pushing companies to make information sought by the market widely available, limiting the ability of public-listed companies to sue for defamation, and ensuring that the gripes of investors are taken seriously.

However, the only real protection from determined fraudsters within a company is a regulator that is prepared to take proactive action when presented with a compelling hypothesis by market watchers that something untoward is happening. Analysts and investors often do not have all the facts, even when it is plain to them that something has gone wrong at a company. Unless the authorities have the gumption to look into these cases, the whole truth may never be revealed, and the market would be worse off.

In my view, a thorough investigation into what happened at Noble would boost confidence and trading interest in the local market, even if no outright wrongdoing is ultimately uncovered.

This story appears in The Edge Singapore (Issue 847, week of Sept 10) which is on sale now. Subscribe here