"Roman Candle" turns 20: Secrets of Elliott Smith's accidental masterpiece (slideshow)
Elliott and the friends with whom he recorded in middle school in Texas (photo courtesy of Dan Pickering)
In the late 1980s, ratings agencies aggressively analyzed countries’ creditworthiness in order to rate the value of their currency, as well as government debt bonds (the capacity of a country to successfully pay its debts), moving from three rated countries to fifty. Before 1985, most countries received a AAA bond rating, but that changed in the early 1990s, when government debt and currency value became ever more complex and difficult to assess. The ratings agencies and their critics recognized that assessing sovereign debt (government bonds issued by a government to sell to foreign investors) to determine a country’s credit rating was highly speculative. Nonetheless, ratings companies maintained a sacrosanct status.
The reputations of auditing companies were damaged, however, by the perceived conflict of interest in their active role in corporate consulting. The Metcalf Report had criticized the consulting services of the auditing companies, calling them “particularly incompatible with the responsibility of independent auditors and should be prohibited by federal standards of conduct.” Auditing companies continued to provide this service, insisting it was compatible with their roles as independent auditors of the same companies for which they consulted, often for fees ranging in the tens of millions of dollars. In 1981, the journalist Mark Stevens wrote a savage critique of what was happening “behind the pinstripe curtain,” as he called it, of the Big Eight, accusing them of having “a lock” on the massive auditing accounts, and in spite of the Metcalf Report, he called the industry “derelict in its duties.” Accounting was a damaged brand, yet the big accounting firms remained the only ones with the expertise for audits on such a massive scale. As mistrusted by the public as they were valued by corporations, the Big Eight dominated the auditing industry.
In 1989, Ernst & Whinney merged with Arthur Young to form Ernst and Young, and Deloitte, Haskins & Sells merged with Touche Ross to become Deloitte & Touche (there were different mergers in the United Kingdom); the Big Eight became the Big Six. In 1991, Stevens wrote yet another attack on the profession, “The Big Six: The Selling Out of America’s Top Accounting Firms.” Unchecked, he argued, the Big Six “behemoths” were lining their pockets by working as consultants for the companies they also audited. A good audit meant higher corporate value, which, in turn, could mean a payoff for the consulting arms of the accounting firms. According to Stevens, the accountants were even robbing the bankers by providing misleading audits. Wall Street, he went on to charge, sustained a naïve faith in auditing firms to look after anyone’s interest except their own.
Less strident critics, too, began to question the integrity of the large auditing firms. For instance, a financial analyst and bureau chief for BusinessWeek, Richard Melcher, asked in a 1998 piece for the magazine, “Where Are the Accountants?” Rather than fulfilling their roles as impartial referees, Melcher charged auditors allowed their clients too much leeway in risky although legal accounting tactics. Melcher critiqued the fact that more than 50 percent of all income of auditing firms now came from consulting, which was beginning to outweigh the value of their accounting business. With many top-level corporate managers coming from the ranks of firms like Andersen, and with massive, cozy double contracts for consulting and auditing, “suddenly, environmental or other legal liabilities are minimized, or inventory depreciation gets stretched out, or a big push is made to drum up end-of-quarter sales.” The SEC, he hoped, would take notice. Senior partners at Andersen actually discussed Melcher’s article in a meeting and even expressed some concern about their own reliance on consulting. But no steps were taken to ensure independence, let alone examine company ethics and risk taking.
Most accountants stuck to the rules, terrified of the constant flow of litigation stemming from poor audits. Yet the public by now had come to distrust accountants. It was not hard to see why. Corporate clients were clearly less interested in audits than they were in consultants promising ever-greater profits. The consulting business boomed. And the worst was yet to come.
In 1999, with little public or investor protest, the U.S. government, in the name of economic freedom, replaced the Glass-Steagall Act with the Gramm-Leach-Bliley Act, which allowed the consolidation of commercial banks, investment banks, securities firms, and insurance companies. It enabled banks to take deposits and make loans, as well as underwrite and sell securities (such as pools of mortgages). Signing the act into law on November 12, President Clinton recognized that it made “the most important legislative changes to the structure of the U.S. financial system since the 1930s.” He claimed that repealing Glass-Steagall and allowing the “affiliation” between banks and securities firms would spark competition, “enhance the stability of our financial services system,” and help it to “compete in global financial markets.” Clinton insisted that the bill contained “important safety and soundness protections.” But the safeguards for accounting and corporate accountability of the Great Depression were falling away with an “irrationally exuberant” confidence that the boom of the age would last forever with lighter regulation and ever more complex financial products.
Meanwhile, by the 1990s, the Big Six employed literally hundreds of thousands of accountants around the world. The problem was that the audit market was saturated, with little possibility for growth, and profits dropped. Companies now wanted what Arthur Andersen had first proposed— that auditors use their unique quantitative insights for consulting purposes. So strong were their reputations as business fixers that at Andersen, for instance, Andersen Consulting soon eclipsed Andersen Auditing and, in doing so, became a lead player in the disastrous corporate frauds of the 1990s. Visitors to the Andersen headquarters in Chicago were struck by the fact that Andersen Auditing had drab offices, yet Andersen Consulting operated out of plush, well furnished digs. Although other auditing companies also made huge fees in consulting, Andersen let the consulting tail wag the whole company. Doing so made sense purely as a matter of profits. Between 1992 and 2001, profits— 70 percent of which were from consulting— more than tripled. Andersen would consult for high-profile “new economy” firms like Waste Management, WorldCom, and, most notoriously, the Texas energy firm Enron, while also acting as their auditor. All of these companies inflated their stock value by using false accounting statements. Eventually, all, even the once-venerable Andersen, went bankrupt. Andersen & Co. was indicted in Texas in 2002 for producing false financial statements for Enron, and the SEC found fraudulent Andersen audits for companies such as Waste Management and WorldCom.
Andersen was sunk by the sheer massiveness of the Enron fraud along with its clear complicity in inflating the company’s stock price—when it fell, shareholders lost $11 billion. So infamous were Andersen’s false audits that President George W. Bush joked about them at the 2002 annual Alfalfa Club dinner in Washington, D.C. The president claimed he had good news and bad news from Saddam Hussein: “The good news is he is willing to let us inspect his biological and chemical warfare installations. The bad news is that he insists Arthur Andersen do the inspections.”
What is tragically ironic in the Enron case is that certain basic Andersen audits actually worked. In 2001, well-trained, mid-level auditors made smoking-gun reports about questionable Enron transactions and false accounts. Yet, faced with the loss of $100 million in annual consulting fees, top management ignored the audits. The account was just too big to lose. With evidence building that Andersen had covered up its knowledge of Enron’s malfeasance, the partner in charge of the Enron account, David Duncan, was terrified of being charged with violating securities laws and ordered his office staff into an orgy of document shredding. It was wishful thinking. The fraud was so large, the
collusion of Andersen with Enron so criminal, that Enron’s collapse quickly brought down Andersen, too. Duncan would turn state’s witness against his company, and to this day, neither he nor any other
Andersen employee has served jail time for cooking the books in one of America’s worst and most costly financial frauds. Today, Andersen employs a skeleton staff of two hundred to manage its continuing litigation, down from 85,000 worldwide.
In response to Enron and a cascade of other corporate accounting scandals and bankruptcies (among them giants like Tyco International, Adelphia, and Peregrine Systems), President George W. Bush signed the 2002 Sarbanes-Oxley Act, which set up the Public Company Accounting Oversight Board, an attempt to guarantee auditor independence and corporate governance and to clarify the rules of corporate auditing and financial disclosure. This was a pure corporate accountability law. “The era of low standards and false profits is over,” President Bush said. “No boardroom in America is above or beyond the law.” The day of reckoning had come, he intoned, at least for the accountants: “Free markets are not a jungle in which only the unscrupulous survive, or a financial free-for-all guided only by greed. . . . For the sake of our free economy, those who break the law— break the rules of fairness, those who are dishonest, however wealthy or successful they may be— must pay a price.”
Supported by leaders from both political parties, the legislation was seen as so essential and effective that similar laws were subsequently passed in Australia, France, Germany, Italy, Israel, India, Japan, South Africa, and Turkey. In New York, it was hoped that the law would bring confidence to the American stock market after the debacles of Enron and WorldCom. However, a consequence of strict accounting regulation was that weaker accounting firms faced ever more Goliath-like banks and companies that, with their own high-paid teams of internal creative bookkeepers and lobbyists, could remain one step ahead of the auditors.
This would be an issue in the financial crisis of 2008, when unsound and overvalued mortgage securities bundles (CDOs) caused a world financial meltdown. The New York Federal Reserve, the New York offices of the SEC, and the Big Four firms— PricewaterhouseCoopers (PwC), Deloitte Touche Tohmatsu Ltd., Ernst & Young, and KPMG, with nearly 700,000 employees— were only blocks away from Bear Stearns and Lehman Brothers, whose collapse led to the federal emergency bailout of most remaining investment banks through the comically titled Troubled Asset Relief Program (TARP). The auditing firms had warned the banks and regulators that CDOs were Class 3 assets (Class 1 being cash) and that their values were speculative and highly risky. Yet they had no power, and possibly no will, to make the case that the CDOs could lead to a financial crisis. In spite of the proximity of regulators, auditors, and bankers, few seemed aware of the impending crash.
Highlighting the weak position of the auditing companies, in the immediate aftermath of the collapse, the investment banks blamed the Big Four for causing the crash, insisting that their new, risk-averse low assessments of the CDOs’ values fed the flames of crisis by undermining confidence in their value. Caught between a public that suspected the accounting firms of failing to provide correct audits and the corporate and finance leaders who accused them of undervaluing assets, the Big Four continued to tread lightly out of fear that any accounting or legal misstep could lead to Andersen-style litigation and the implosion of the accounting industry. Indeed, regulators in Britain had begun to worry that the monopoly of the Big Four was itself a risk to the industry. Much like the investment banks, all firms’ large accounts have become interconnected through the complex tentacles of finance. The collapse of one of the Big Four firms could bring down the other three. It would seem, then, that the Big Four are too big to fail but too weak to effectively audit their corporate clients.
Dickens would have appreciated the conundrum. To stop fraud at auditing companies, the U.S. and British governments worked to clip their wings, only to find that without effective auditors, it is impossible to oversee finance and industry, let alone government. In spite of the hundreds of thousands of auditors working for accounting firms, the SEC, and the Department of Justice (not to mention European regulatory bodies), no one, as yet, has gone to jail for the 2008 financial crisis. Identifying those who have committed financial crimes, or criminally negligent oversight, and actually sending them to jail— part of the jobs of auditors and government regulators, but something the United States and Europe inexplicably have not elected to do in the years following the 2008 crash— is the sort of aggressive response that might spur reforms and, in their wake, better financial practices. Eric Holder, U.S. Attorney General, has gone on record saying that the size and importance of major investment banks “has an inhibiting influence” on prosecuting financial malfeasance. He has expressed fears that sustained legal action against financial institutions— beyond fines— could destabilize the financial system.
In spite of laws, regulations, and an active financial press, powerful forces are aligned against financial transparency. By the sheer complexity and scale of their operations, banks, corporations, and government bodies have rendered themselves unauditable. How many accountants, really, would it take to truly audit Goldman Sachs, were this indeed a realistic task? Ten thousand? Forty thousand? It might not even be possible. The fact is that government and the auditing companies cannot, for the moment, keep up with the ever-mutating, bacteria-like financial tools and tricks of banking. At the same time, it is unclear that governments can effectively audit themselves. The world financial system is threatened by disaster from bad municipal and government accounting, as countries like Greece and major cities like Detroit go bankrupt because of poor planning but also poor bookkeeping. Government accountants too often calculate that states and cities can pay for pensions. There has been little outcry about bad government accounting by a public unfamiliar with the risks of long-term municipal and government obligations. And despite recent threats by the Department of Justice to pursue financial crimes and the fines meted out to major banks, there have no reckonings on Wall Street or in government. And without one, there can be little incentive for true reform.
Excerpted with permission from “The Reckoning: Financial Accountability and the Rise and Fall of Nations” by Jacob Soll. Available from Basic Books, a member of The Perseus Books Group. Copyright © 2014. All rights reserved.
Elliott and the friends with whom he recorded in middle school in Texas (photo courtesy of Dan Pickering)
Heatmiser publicity shot (L-R: Tony Lash, Brandt Peterson, Neil Gust, Elliott Smith) (photo courtesy of JJ Gonson photography)
Elliott and JJ Gonson (photo courtesy of JJ Gonson photography)
"Stray" 7-inch, Cavity Search Records (photo courtesy of JJ Gonson photography)
Elliott's Hampshire College ID photo, 1987
Elliott with "Le Domino," the guitar he used on "Roman Candle" (courtesy of JJ Gonson photography)
Full "Roman Candle" record cover (courtesy of JJ Gonson photography)
Elliott goofing off in Portland (courtesy of JJ Gonson photography)
Heatmiser (L-R: Elliott Smith, Neil Gust, Tony Lash, Brandt Peterson)(courtesy of JJ Gonson photography)
The Greenhouse Sleeve -- Cassette sleeve from Murder of Crows release, 1988, with first appearance of Condor Avenue (photo courtesy of Glynnis Fawkes)