Enron

How can we prevent another Enron, or worse?

July 10, 2012: 10:08 AM ET

If reforming our auditing system could reduce the probability of a financial disaster, even by a little bit, we should be willing to endure costly and disruptive change to do it.

By Don Moore and Max Bazerman

FORTUNE -- Remember the adage that those who forget the past are condemned to repeat it? Unfortunately, history lessons don't seem to appeal much to the corporate world, even the firms tasked with making sure companies' books are on the up and up: the auditors.

Take the case, for example, of Ernst & Young, one of the Big Four audit firms. E&Y also operates a lobbying firm that also works with its audit clients, including companies like Amgen (AMGN), Verizon (VZ), and yes, Groupon (GRPN). Groupon stock is now trading around $8 per share, down from a February high of over $24. In March, the startup revised its profit numbers downward and E&Y voiced concerns about the company's accounting systems. Wasn't E&Y required to voice such concerns before Groupon's November 2011 IPO? No, it turns out that audit regulation applies to public companies, not to companies planning to go public. Nor does the law require Groupon to disclose what other services E&Y has provided the tech company.

Although Ernst & Young has argued that its work complied with the rules, we think the rules may be the problem. Just think back a few years to when Arthur Andersen was auditing Enron's books. While that auditing firm was approving the company's misleading financial statements, it was also collecting some $27 million in consulting fees from Enron. Arthur Andersen also argued that its arrangement didn't violate auditor independence rules.

MORE: Healing our nation of corporate lemmings

The problem is not compliance with the rules. No, the problem is the rules themselves, which permit conflicts of interest and ultimately undermine auditor independence.

Auditor independence is a cornerstone of our capital markets. It means that auditors should be able to objectively assess whether publicly traded companies are telling the truth about their finances. And this independence is threatened by cozy, long-term partnerships that develop between firms and their auditors.

So, then, what can we do to make sure we don't have to face yet another (and another) Enron, or worse? More

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