Christopher Walker: Erie memories for Wall Street

If you have a taste for scandal, I shall give you a feast. During the takeover battle for Erie & Co, the aggressors secretly bought as much stock as they could, while deliberately misleading the press and public as to their intention to bid. Meanwhile, the defending management, having realised what was going on, issued shares in ever greater numbers to themselves. When the authorities closed in, the board went into hiding in a New England hotel. Control of the company was established by a gun battle. That was Wall Street 100 years ago. Plus ça change?

My first take on the Enron scandal was that the market was overreacting. I am now starting to think it has not reacted enough. If dramatic changes in corporate governance do not follow, we will need a sea of change in the way we value companies, and possibly markets.

Barely have investors swallowed their losses on Enron than they are treated to the spectacle of the disgraced management being daily roasted. This auto-da-fé in Washington is throwing more and more vanities on the bonfire. The directors of Enron, the non-executive directors, the audit committee, the auditors themselves, investment analysts, credit-rating agencies, market and state regulators: the list of potential culprits is multiplying daily.

Apportionment of blame is going to have a major effect on the way each of these groups conduct themselves in other companies, and in general – not just in the States but across the globe.

At the heart of the Enron scandal is an act of massive financial manipulation which was, to some extent, made public. The 2000 consolidated balance sheet disclosed no less than $5bn (£3.5bn) in off-balance sheet affiliates. Some details about these were also given in "Note 9" to the accounts, including, crucially, revenue of $510m in 2000 and $674m in 1999.

These clues surely should have been enough for some of Wall Street's brightest analysts to smell a rat? But no, nearly all of the 15 analysts who followed Enron rated it as a "strong buy" or "buy". This column has highlighted the challenges to analysts' integrity posed by the massive fees their investment banks earn from corporate business. Four of the strongest buy recommendations came from Enron's four investment banks.

The analysts claim they were misled, and point the finger of blame at the auditors and the board. How thorough are auditors? In one company I was asked to take them through one of the more complex aspects of asset management. Armed with facts and figures, I was disappointed to be confronted by a boy and a child who seemed to have difficulty with basic arithmetic.

But, of course, the bizarre question generated by Enron is the extent to which the auditors were working with the investment bankers to create the financial manipulation. In these circumstances, the burden of prevention would devolve to the audit committee, the board and the non-execs. Their failure to act has raised questions of deceit, but it may be one of complexity. The structures were getting so convoluted that perhaps they didn't understand them. The moves last week to tighten up on non-execs' technical expertise seem very timely.

One post-Enron commentator has suggested that if all the accounting funnies were stripped out of Wall Street, the valuation of the market would be three times higher than we think it is – ie, the US is on a P/E of 70. No wonder investors are spooked. To restore their confidence, we need not just tighter regulation but a clean sweep of corporate governance. Shareholders may have to do this themselves. We need a shoot-out.