Adecco: the Enron that never was
Mistrustful regulators are picking holes in healthy companies.
Institutionalised mistrust of company accounts is causing needless losses to business.
Last week the temporary employment giant Adecco published its second quarter results for 2004. The results for the first half of 2004 look healthy, with sales of 8080million euros, up six per cent on the same period last year, and a gross margin of 1346million euros, up three per cent. Unfortunately for Adecco, certain one-off costs have reduced its half-year operating profit to only 125million euros, 17 per cent down on the first half of 2003.
The reason for this is that Adecco is the Enron that never was. Back in January 2004 the auditors Ernst and Young refused to sign off Adecco’s 2003 accounts, stating that there were ‘material weaknesses in internal controls in its North American operations’. Commentators immediately drew comparisons between Adecco and the recent financial scandals of Ahold and Parmalat. Indeed John Tiner, chief executive of the Financial Services Authority (FSA), wasted little time in linking Adecco to these cases of fraud, stating in a speech in February that ‘we have witnessed major reporting problems here in our own back yard…Ahold, Adecco and, of course, Parmalat. Investors are reasonably asking themselves – can we trust the integrity of the capital markets?’. Presumably not.
The initial response to this news was a 35 per cent fall in Adecco’s share price – which has yet to recover. Three days later Adecco’s chief financial officer (CFO) Felix Weber was forced out, soon to be followed by the head of American operations Julio Arrieta. Adecco hastily arranged conference calls with the media, analysts and investors. Following the advice of its lawyers Adecco revealed little information, serving only to add to the uncertainty. The share price fell further.
On 20 January, three US law firms launched a class action lawsuit against Adecco, alleging that the ‘defendants caused Adecco’s shares to trade at artificially inflated levels through the issuance of false and misleading financial statements’. Commentators speculated that Adecco might have to restate its earnings by as much as 50million euros. There followed public squabbles between Adecco’s larger shareholders and its board, with rumours of resignations and a boardroom shake-up. Adecco’s press statements were curt and unenlightening.
In June, six months after the start of the affair, after 160,000 hours of forensic accounting work, and an investigation that covered 22million pages of documents and more than 150 interviews with company managers, at a cost to Adecco of 100million euros, Ernst and Young signed the accounts with no qualification. There was never anything wrong with the accounts. So what was all the fuss about?
Since the introduction of the Sarbanes Oxley Act (SOX) in the USA in July 2002, the fact that a company’s accounts give a true and fair view of the financial position of a company is no longer sufficient for an audit to be signed off. When Ernst and Young refused to sign off Adecco’s accounts in January, it was applying section 404 of the act, which requires auditors to attest to the effectiveness of the company’s internal controls and procedures for financial reporting. Auditors of public companies listed in the USA now have the dual responsibility of attesting to whether the accounts are correct, and also whether a company’s management has put in place sufficient measures to ensure that the accounts are correct.
The ostensible intention of SOX was to reassure investors in the wake of Enron and WorldCom, toughening up regulation to ensure that such scandals would be less likely in the future. But the Adecco affair was less a result of corporate corruption, than the direct consequence of the legalised suspicion that is the Sarbanes Oxley Act.
The act has formalised the assumption that a company’s directors cannot be trusted. Not that we can truly trust the auditors’ opinions either. The fact that Ernst and Young had identified no issues with the accounts of Adecco in January was of little consequence; the accounts could not be signed off. Under the Sarbanes Oxley Act, investors are told that they cannot rely on a clean audit of the accounts when judging a company’s financial position. So whom can we trust? The regulators perhaps. Such as the FSA’s own John Tiner, who asks whether investors can ‘trust the integrity of the capital markets’.
The weakness of internal controls for a rapidly expanding multinational company is hardly shocking. In 1999 Adecco had 3500 branches worldwide; by 2003 this number had increased to 5800, and the number of branches in North America had doubled. That Adecco had lost some cohesion over this period is an operation business issue that any expanding company would need to address. Instead of seeing Adecco as a success story, the default position has now become one of suspicion.
Adecco, the scandal that never was, is now used as a bogeyman to warn young managers of what could happen to them if they don’t watch their backs. The fact that Adecco is a profitable company, the dominant market leader, is somehow forgotten.
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