Equity Funding was
not the biggest financial disaster to emerge from the great bear market of the
early 1970s. ... The audacity of the Equity Funding scandal, which was probably
the largest outright corporate fraud since McKesson a generation before,
grabbed the public’s attention, and more than any company, [and] Equity Funding came
to symbolize the go‑go years and the sour bust that followed. ...
Besides creating
hundreds of millions in fake life insurance policies, Equity Funding had printed
counterfeit stock certificates and carried them on its books as assets. “Publicly held companies do not
lose money,” Goldblum had told an Equity Funding executive vice president in
1969 – and he meant it. By 1972 the company
had become so dependent on fake revenues from fake policies that it needed a
separate hidden office to create them.
Goldblum wound up with an eight‑year prison sentence but the FCC and the
big board seemed less concerned about the scam than the fact that Ray Dirks, the analyst who first uncovered the fraud, had
told his clients about it.
In April 1973 while
Equity Funding unraveled, the Big Board formally accused Ray Dirks of failing to follow “good business practice” and
threatened to suspend him for life from the Exchange. The SEC opened its own investigation into Dirks’ actions. The idea that analysts should be encouraged
to perform independent research and follow up on tips apparently did not occur
to the Commission. (Both inquiries
dragged on for several years but Dirks was ultimately cleared). ...
The Equity Funding
scandal along with chicanery at the conglomerates and the Penn Central
bankruptcy produced the most serious criticism of the accounting industry since
the McKesson hearings a generation earlier. ...
In an effort to head
off outside scrutiny in 1971 the AICPA, the industry’s trade group, set up a blue
ribbon committee to review the conglomerate accounting fiasco. The committee, led by former SEC
Commissioner Francis Wheat, found that the Accounting Principles Board, the
industry’s standard-setter, did not have sufficient independence to do its job
and should be abolished. In place of
the industry controlled APB, the Wheat Commission recommended a new industry
controlled board, but there were big differences between the old APB and the
new Financial Accounting Standards Board. First, the former had three words in its name; the latter had four. Second, the APB’s directors had been picked
by the industry; the FASB’s directors would be chosen by something called the
Financial Accounting Federation, whose members would be chosen by the
industry.
Somehow, the
Securities and Exchange Commission accepted the Wheat Committee’s proposal as a
great improvement and the FASB was born in 1973. It quickly became obvious that the new board was as weak as its
predecessor. One accounting expert
predicted soon after FASB’s creation that the Board’s dependence for funding
on its parent industry meant that its members would be “goldfish in a bowl of
sharks”. The next 29 years bore out
that depressing forecast. For most of its
existence the FASB’s main mission seemed to be to avoid the wrath of the Big
Eight accounting firms by not cracking down on aggressive accounting. ...
(Note: the “Big
Eight” were the eight major accounting firms that dominated the profession from
the 1960s through the late 1980s: Arthur Anderson, Arthur Young, Coopers & Lybrand, Ernst &
Whinney, Deloitte, Haskins & Sells, Peat Marwick, Price Waterhouse and
Touche Ross.)
Meanwhile, the Senate
subcommittee that oversaw accounting had come to an even harsher
conclusion. In the 1976 report the
Committee found that
the
traditional public image of the Big 8 accounting firms as impartial, objective
experts is not founded on fact… As
political partisans and purveyors of non‑accounting services they become loyal
agents of the clients which employ their services…
It appears that the Big 8 firms are more concerned with serving
the interests of corporate management who select them and authorize their fees
than with protecting the interest of the public.
A political and
business consensus for greater supervision of accountants seemed to be
forming. In 1978 Congressman
John Moss, chairman of the House subcommittee that oversaw the securities
industry, introduced legislation to create an independent, federally chartered
commission to oversee accountants. The
bill would also have increased the potential liability of accountants for bad
audits. The legislation would have been
the most important strengthening of the securities laws since the New Deal.
But
the push for reform wilted as quickly as it had gathered strength. The Moss bill didn’t
even get out of the House. Most of the
Cohen Commission’s recommendations were never implemented. By the late 1970s memories of Equity
Funding, Penn Central and the conglomerates had faded. Without fresh scandals to stoke the public’s
outrage Congress had little appetite to take on the Big Eight who were
powerful, united and opposed to federal oversight.
Broader political
currents also aided the accounting industry. At a time when trucking, airlines, and telecommunications were being de‑regulated,
lawmakers were loath to put in heavy new restrictions on historically
unregulated business. The SEC also
backed away from imposing tougher rules. The Commission "has
proven to be pretty much a paper tiger in its role as an accounting
overseer. The Commission just muddles
along issuing rules, fanning controversies, never taking a firm stand on
anything," one observer wrote in
1981. Instead of federal oversight,
investors would have to settle for “peer review” of the industry. Every three years the major accounting firms
would check each other for quality and freshness.
Holding back giggles,
the Big 8 claimed they would scrutinize one another as closely as any outside
agency. “A tough, gutsy, no nonsense
process, that’s the way we see peer view,” the managing director of Touche Ross
said. Never mind that any firm that
looked too closely at a competitor ran the risk of getting the same treatment
when its turn came. Not surprisingly, for
the next 20 years no firm ever found serious problems with another during a
peer review. Once again, accountants had
dodged serious regulation. In 1980, the chairman
of PriceWaterhouse could not resist gloating of the industry’s victory:
As
recently as a year ago it seems that the accounting profession would continue
to face strong criticism for an indefinite time... As we enter the new decade, however, there are many signs that a
sense of balance may soon be restored...
We can now turn our full energies to the issues that are of genuine
concern: inflation, capital expansion, government accountability, and the
expansion of our responsibilities to serve the needs of clients and the public.
It was nice to know
that, as always, PriceWaterhouse and its peers were putting the public first. (Chapter 4, “The Death of Equities”)
, makes light of (among other things) our need to name things. The character speaking, Lionel Feffer, is an enterprising young Columbia student who is explaining the rationale behind a business plan where he will take aerial photographs of the plants on people's property, find out the plant species name, and then sell marked up maps to the property owners. Enjoy. - Ed