The head of a leading European accounting board says he believes the recent series of accounting scandals in the United States will not spill over into Europe's financial markets. The official, Goran Tidstrom of the Federation of European Accountants, told RFE/RL that European accounting standards differ from their American counterparts in crucial ways that would prevent the types of abuses seen recently in the U.S.
Prague, 7 August 2002 (RFE/RL) -- The president of the main pan-European accounting-standards board says Europe is not likely to be rocked by the same types of corporate-accounting scandals that have recently roiled U.S. financial markets.
Goran Tidstrom, president of the Federation of European Accountants, says European companies use a different accounting philosophy from that in the U.S.
Tidstrom says that in the U.S., accounting standards are "rules-based," while in Europe, standards are based on principles. In other words, in the U.S. what is not specifically forbidden is allowed. In Europe, an accounting decision must be justified on the basis of sound business principles. He explained in a telephone interview from his office in Sweden: "[In] the U.S., [one is] living under the impression that everything that is not regulated in detail is allowed. And as long as you are not breaking what is stated in a specific standard, it is [allowed]. That would definitely not be the case [in Europe], if [an accounting decision] were at the same time against sound interpretations of the business deal."
Tidstrom points to last year's Enron bankruptcy to illustrate his point. Enron, once the seventh-largest company in the United States, hid enormous debts by transferring them to special off-the-books partnerships that were fully legal under U.S. law. The partnerships were apparently sanctioned by Enron's auditor, the Arthur Andersen firm.
When the debts were later discovered, the company's creditors called in their loans to Enron, and the company was forced to declare bankruptcy. Investors, unaware of the company's massive debt, were left holding billions of dollars of worthless Enron shares.
Such partnerships are legal in Europe, too, but Tidstrom says European companies could not lawfully misuse them the way Enron did because the practice could not be justified from the standpoint of sound business principles. "[In Europe,] there are 'special vehicles' [such as off-the-book partnerships], but you have more rules that are more based on principles and on what makes sense. [The partnership would have to be evaluated to see] whether it is a stand-alone economic entity or not," Tidstrom said.
In the case of Enron, these partnerships were clearly not stand-alone entities but existed solely for the purpose of hiding debt.
The U.S. justifies its rules-based system of accounting standards by saying that specific rules give companies clearer guidelines and leave less to interpretation. But Tidstrom says that in Europe, the belief is that the more rules, the more obscure the underlying principles become. "Behind the U.S. rules there are principles, but the more you have detailed rules that are subdivisions of the principles, the further you get away from really thinking about what is the sound accounting following the principles," Tidstrom said.
The Enron bankruptcy and the more recent collapse of WorldCom, both following admissions by company executives that they misled investors, have roiled U.S. and international financial markets. The revelations badly damaged the U.S.'s reputation for having the world's best-regulated financial markets and led investors to withdraw billions of dollars from the U.S. stock market.
The damage has not been limited to stocks. The U.S. dollar has dropped in value as international investors sell their U.S. holdings and exchange dollars for other currencies.
So far, Europe has weathered the scandals well. The euro has strengthened against the dollar. And while European stocks have fallen along with their American counterparts, there have been no high-profile bankruptcies on the order of an Enron or WorldCom. The reputation of European financial markets remains relatively good.
But some have recently questioned whether Europe's reputation is justified.
James Leisenring, a member of the London-based International Accounting Standards Board, was quoted 2 August in "The Wall Street Journal Europe" as saying European regulators would never have uncovered a scandal like Enron because Europe lacks a central enforcement agency like the U.S. Securities and Exchange Commission (SEC).
Leisenring pointed out that in Europe, each country has its own enforcement agency and its own system of standards to enforce.
Leisenring was not available to be interviewed for this story.
European Union countries have pledged to adopt a uniform international standard of rules in 2005, but that still leaves three years for companies potentially to hide poor results. And it's not clear yet how the situation will change if and when the EU takes on additional members in 2004.
Tidstrom admits that at present, there is no European SEC, but says the various national regulators have started to work together more closely ahead of a planned synchronization of standards in 2005. "There is no European SEC. But as a response to the creation of the single European capital market and the financial-services action plan, you have the formation of the very strong cooperation [among] the various securities regulators in Europe, who are aligning their strategies and creating equal frameworks," Tidstrom said.
Following the accounting scandals, the U.S. has taken steps to prevent future accounting abuses. New rules approved by the U.S. Congress would impose stiff penalties on companies and accountants that falsify accounts. They would also set up an oversight board to monitor the accounting profession to prevent the worst of the abuses in the future.
In many cases, these rules go beyond what is the current practice in Europe.
Tidstrom concedes the U.S. has taken some positive steps, including the creation of an oversight board, that Europe might do well to emulate. "No, [Europe does not have] at the time being [such an oversight board], but the idea has been initiated where the oversight mechanism exists in a number of countries. There are countries who have recently introduced oversight boards -- the U.K. is such a country. There are other countries that have had such boards for a long time as stipulated by law: Italy, France, [and] my country, Sweden. The process has been started [to introduce a general European oversight board]," Tidstrom said.
Only time will tell whether there are now bankrupt European companies hiding behind rosy -- and false -- corporate accounts. For the time being, Europe's accounting leaders appear confident their system works.