Berkshire Hathaway v.p. Charlie Munger's recent claim that "To say derivative accounting in America is in the sewer is an insult to sewage," may have been a trifle melodramatic, but many market professionals share his concern and agree that something is rotten in the state of Denmark. In particular, the collapse of energy trader Enron has thrust derivatives accounting and disclosure into the spotlight and ratcheted up the sense of unease among investors.
Enron's collapse raised the specter not of rogue trading, but rather that the company's employees were openly using derivatives that senior managers were ill equipped to monitor. Todd Finkelstein, CFA and director of fixed income at Boston Advisors in Boston, estimates only one in five companies in the Standard & Poor's 500 have in-house derivatives specialists: a statistic that worries him. In the absence of internal expertise, corporates have to trust that Wall Street firms are advising them correctly. This, he said, is "a dangerous approach to using derivatives."
Philip McBride Johnson, head of the exchange-traded derivatives practice at Skadden, Arps, Slate, Meagher & Flom in Washington, D.C. agreed. "If you do have outside advisers, this is not a time to operate on blind faith," he said. "You should have someone in-house to assess the quality of the services being provided and the levels of risk being taken," he added.
A further concern is transparency of derivatives reporting, according to Mike Mullaney, investment officer in Boston for Fiduciary Trust Company, which manages about USD11 billion. Mullaney said he may not invest in a company if an investor relations official can't explain its use of derivatives or find anyone else at the company who can. "You don't buy what you don't know," he added.
