Confessions Of A Former Auditor
Richard Lehmann, Forbes/Lehmann Income Securities Investor, 05.15.02, 2:00 PM ET

The current wave of accounting concerns is welcome because it instills caution in an investment market that too recently succeeded by shooting from the hip. Aside from this, it is a necessary comeuppance for those thirty-something MBAs running their investment portfolios as if numbers tell the whole truth. Accounting is not an exact science, nor are corporate managers meticulous in telling on themselves. I was an auditor for PricewaterhouseCoopers for many years, and I can attest that manipulation of the books goes on in most corporations--usually for the good of shareholders. This is due in no small part to the market's knee-jerk reaction to short-term disappointments. I ask you, what shareholder really benefits from class-action suits automatically filed by predatory tort lawyers just days after any unexpected earnings shortfall? Since auditors don't certify quarterly results, management has leeway to lag in reporting bad news while preparing shareholders.

Aside from the numbers, there are any number of corporate events, which all investors--equity and fixed-income--should look out for.

• CEO Retirement--When the top dog is scheduled to retire, it will generally be a bumper quarter or year. He wants to go out with a bang, as well as a big bonus and high exercise price on his remaining options. Needless to say, the follow-on year should be a downer. For example, just look at General Electric (nyse: GE - news - people ).
• CEO Overhaul--If the new chief executive is an outside hire or replaces one who left under a cloud, look out! The first priority of such an executive, if he's smart, is to write off anything not nailed down. In this case, the follow-on year should look quite good.
• Restructuring Rumblings--If management begins talking about reorganizing or restructuring the business, expect bad news. Such talk is a euphemism for big-time screwups that need to be buried in a larger event. The news here is negative, but oddly enough the market often reacts positively, perhaps because it's pretty good at knowing that, when guys can't shoot straight, the bad news is factored in. Also, often the writeoffs have unburdened future years' earnings.
• New Bean Counters--When the company auditors resign voluntarily, run for the phone. This is almost always bad. We are likely to see it happening a lot more, post Enron (otc: ENRNQ - news - people ). Similarly, when the company decides to change auditors suddenly, look out. This can mean they wouldn't go along with some questionable transactions or practices. In today's market there will be little tolerance for this.
• CFO Leaves--The top financial guy should have the inside scoop on the company's books. If he quits or--even worse--is fired, there is usually big trouble brewing.
• PR Double-Talk--If the pace of company press releases slow and/or begin using terms like "unforeseen," "may result in" or "could portend," watch out. Also, any "special" announcements are worrisome. Assume the worst when you see wording such as, "We have retained the services of _____ to (investigate, explore, pursue, study) the (possibilities, alternatives, remedies) for _____ ."
• Informal Inquiries--Of course if the company reports that it has received notice of an informal inquiry from the Securities and Exchange Commission, Justice Department or any other regulatory body, head for the exit--fast.

And don't think that by merely buying a mutual fund instead of investing directly, you will be spared. Fund managers are just as sheepish as Wall Street analysts. Plenty of fund managers owned Enron while the stock plummeted. Investors need to take responsibility for their decisions. A Morningstar Star rating is no insurance policy.