Perhaps you remember from your childhood the story of The Emperor's New Clothes written by Hans Christian Andersen. It went something like this:

Once upon a time there lived an emperor who was very vain and foolish, and cared very much about his clothes. Two crooks came up with an idea to swindle him. They told him that they could make him the finest suit of clothes from the most beautiful cloth. This cloth, they said, was very special; it was invisible to anyone who was either stupid or incompetent.

Being concerned about whether he would be able to see the cloth, the emperor first sent two of his most trusted men to see it. Of course, fearing for their jobs, neither of them would admit that they could not see the cloth and so praised it.

The emperor, not wanting to admit that he was too stupid to see what he was wearing, allowed himself to be dressed in the clothes for a procession through town. Of course, all the townspeople, wildly praised the magnificent clothes of the emperor, until a small child in the crowd cried out: "But he has nothing on!"

This was whispered from person to person until everyone in the crowd was shouting that the emperor had nothing on.

The moral of the story is this: Just because everyone else says something is true, doesn't mean that it is. Sometimes you have to be willing to go against the crowd.

A massive fraud like Enron can go on for a long time without being detected if no one wants to see the fraud. Audit procedures are designed to confirm that financial statements are free of material misstatements; they are not designed specifically to detect fraud. However, weak or non-existent financial controls should be reported, but weren't in this case.

Still, careful analysis of Enron's financial statements contained clues for anyone who took the time to look. Hedge-fund manager James Chanos was just such an individual. He was looking for a stock to short and felt that Enron might be a good prospect when he spotted the fuzzy references in the Notes regarding "related party" transactions involving Enron's senior officers. No matter how many times he read the materials he simply couldn't understand what they referred to. He consulted with other financial experts and they couldn't explain it to his satisfaction either. He concluded that the Enron executives were trying to hide something but didn't know what it could be. In 2000, a full year before Enron went broke, he shorted the stock and made a huge profit for himself and his clients. In February 2001, Chanos tipped off a reporter at Fortune magazine, Bethany McLean, who in March, published a story entitled "Is Enron Overpriced?" That story started a chain of events that eventually led to the company's demise and the Sarbanes-Oxley Act of 2002.

Mike Morley is a Certified Public Accountant who holds the top credit designations in the U.S., Canada, and the U.K. Mike is the author of "Sarbanes-Oxley Simplified", which is an easy-to-read explanation of the requirements of the U.S. legislation that makes CEO's & CFO's personally responsible for the accuracy of their company's financial statements. If you are interested in learning more about forensic accounting, Mike will be teaching a one day seminar entitled Spotting Fraud: Forensic Accounting Techniques in Mississauga on June 13. For more information call 416-275-1278 or go to www.mikemorley.com