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Could an Enron happen to you?

NCE business Risk management

The astonishing decline of all powerful Andersen following the collapse of one of its major clients has shocked businesses everywhere. But, asks Simon Murray, have civil engineering consultancies taken note.

The impact of the Enron affair on Andersen has been devastating. In a few short weeks a firm of consultants employing more than 80,000 staff around the world has been brought to its knees. And by the end of the year Andersen might have disappeared altogether.

The question that many directors and employees of consultancies in the construction industry must surely be asking themselves is: 'could an Enron happen to us?'

The events that led to Andersen's plight will emerge in the courts over the coming months when we will all learn about the advice that Andersen gave to Enron and about who instructed whom to shred what. While these proceedings will be very interesting, it is doubtful whether they will cast much light on the reasons why a large company like Andersen got into this situation in the first place. If you want to understand how Enron happened to Andersen and whether something similar could happen to you, you have to have to look at the risks that businesses are exposed to and how management goes about controlling them.

Consultancies working in the construction industry carry significant risks. Whether the core business is designing structures, estimating costs or managing projects, the decisions made on behalf of clients can have consequences that are much greater than the value of the company. The reason that consultants can continue to do business under these conditions is that over the years they have become adept at managing these risks through contracts, insurance policies and the arrangements they have for reviewing work before it goes out of the door.

The record suggests that consultants are quite good at managing the risks in their core businesses. Although there are occasional wake-up calls - most recently the Millennium Bridge - it has been rare for such events to bring a company down.

If there are potentially devastating risks in consultancies, they probably lie in their management structures and in the strain that they have been put under as they have grown and diversified. No doubt the partners at Andersen have been asking themselves whether they would have got into the mess that they are in if they had remained totally focused on the boring old business of auditing their clients' accounts for a fee.

The expansion of the major engineering consultants over the last 15 years has been dramatic. This trend looks set to continue as consultants pursue growth in staff numbers and diversification in their activities to maximise their margins and offer their clients the holy grail of a one stop shop.

Consultancies once stuck firmly to their knitting. Now they advise their clients on a wide range of technical and management issues. While these new activities are often very profitable and give the consultants access to new clients, they bring with them new risks.

They also make it more difficult to control the risks by stretching management structures that were developed for much simpler businesses.

For several years before Enron and WorldCom hit the headlines, the City had been taking a long hard look at the whole issue of risk management in public companies. In the wake of some spectacular corporate failures the City wanted companies to have effective and transparent arrangements for identifying and controlling their risks. What has emerged is the Combined Code that sets out some simple standards that companies should comply with. At the forefront is the need for an effective board of directors with independent nonexecutive directors and for effective risk control procedures.

We must be careful in making comparisons between consultants that sell their professional advice for a fee and companies that sell goods and services for a profit. However, if you are asking yourself whether Enron could happen to you it would sensible to start by asking how your company's arrangements for managing risks measure up to best practice in the corporate sector. In particular, how effective is your board and your risk control procedures?

Many consultants still have a partnership culture in the boardroom. They are managed by large groups of directors, each of whom has a considerable degree of autonomy in running their part of the business.

The board is motivated to maintain a consensus among the directors and is often reluctant to interfere in the work that they do. While the partnership culture is very powerful in motivating the directors, it can conflict with the need for transparency in the business and for tight control over the activities in the front line.

The directors of consultancies often grow up within the business and serve on the board for several years before they retire. They undoubtedly have a deep knowledge of their own company but they often lack the wider experience of the business world that is so important in spotting big risks.

Consultants also seem to be reluctant to appoint independent non-executive directors to broaden the experience of the board and to challenge the management. A simple test of the experience of your board is to ask yourself how many directors have held senior management positions outside the company or, indeed, outside the construction industry.

Risk control procedures have become an important part of corporate governance. Most directors of public companies are used to a formal process of assessing the risks in their part of the business and signing an annual declaration that they are properly managed. Consultants are very good at selling risk management to their clients but whether they invest in their own advice is another matter.

There is no suggestion that there is anything wrong with partnerships. Many professional practices are run very effectively on this basis. But as you expand a consultancy and the diversity of its operations, the structure and culture of the board needs to develop to reflect the new scale of the business.

So, we come back to the question of whether Enron could happen to you. By now you will have some ideas on how you might assess this. A very direct way would be to ask your directors whether they are confident that they have all of the risks under control. Probably you will be told not to worry, Enron could never happen here.

But, then again, a year ago an employee of Andersen would probably have got the same answer from their boss.

Simon Murray is a civil engineer and a former main board director of Railtrack. He is now a consultant and holds non executive directorships with a variety of organisations.

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