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Ignoring the Numbers

by lawrence a. cunningham

Law graphic If the legal academy starts minding its 1's and 2's by teaching accounting, business lawyers will be better prepared to prevent future Enrons.

The scenario is all too familiar: a business deal is being negotiated when the parties hit an impasse. The accountant declares the snag a "legal problem," while the lawyer counters that it's an "accounting problem." Both may be right, of course, but in a business world where the gap between law and accounting has been growing wider by the decade, the two sides find it increasingly difficult to understand each other's language, let alone to check and balance each other's actions. Instead of building a corporate environment that values the intersection of law and accounting in such matters, the prevailing professional culture has created a divide that fraud artists can exploit. The Enron Corporation and its auditors, Arthur Anderson, are but the latest in a long line of companies to fall into this crack-and to suffer the consequences of a little noticed but significant slackening of interest in accounting in our nation's law schools.

In the 1970s, when a series of accounting calamities at Leasco, Penn Central, and National Student Marketing revealed the potential for major corporate meltdowns, reformers proposed to take accounting rulemaking authority from the industry's private standard-setters and give it to Congress or the Securities and Exchange Commission. The proposal, which would have turned accounting into a subject of law, was shelved, but not without protest from members of the bar who stressed how central accounting is to business law. As one such attorney quipped in 1975: "To paraphrase Clemenceau on war and generals, accounting has become just too important to be left to the accountants."

Ironically, at the very time that there was recognition of accounting's growing importance in nearly every aspect of a business lawyer's practice, the legal academy began to turn away from teaching it. Accounting had enjoyed a good run in law schools beginning in the 1950s; teaching and scholarship grew steadily, reaching their peak in 1975, when 150 full-time law professors taught the subject. Today, however, only 96 teach accounting, a drop of 36 percent-this in a period when, as Enron has shown us, business lawyers need more accounting acumen than ever.

One reason for the decline of accounting in the law school curriculum over the past three decades was the rising intellectual influence of modern finance theory, which became the centerpiece of a rival course: corporate finance. Modern finance theory boils accounting relevance down to a single number-earnings per share-vastly reducing the significance of other accounting data. A new breed of scholars found in corporate finance the opportunity to discuss contemporary business law using the vocabulary and tools of economics in a way they could not when using the language of accounting. Since 1975, the number of law professors teaching corporate finance has increased by 33 percent, a figure nearly equal to the percentage of spaces vacated by those teaching accounting.

The string of accounting debacles culminating in Enron shows the folly of this trend. The failures also pose a challenge to the professional ethics of business lawyers, whose duty of competence should require some knowledge of accounting. Unfortunately, the law of professional responsibility allows lawyers to meet this obligation simply by associating with accountants who possess the core competency.

Just because a duty can be technically discharged in a painless manner, however, does not mean client interests are served, particularly when rival lawyers are masters of the competency. Clients without such lawyers are twice disadvantaged. As St. John's University School of Law Dean Joseph Bellacosa put it, when serving on New York's Court of Appeals, "The measure of an attorney's conduct is not how much clarity can be squeezed out of the strict letter of the law, but how much honor can be poured into the generous spirit of lawyer-client relationships."

This is not to argue that if lawyers working on Enron matters had better understood accounting, their discussions about relevant rules to prevent the accounting shenanigans, or even Enron's collapse, would have been more credible. The cautionary tale is more modest, yet still meaningful. Lawyers with accounting capabilities will be better prepared to prevent abuses in the future, and that capability will pay off, at least some of the time.

As the language of business, accounting is a central force in the allocation of capital and hence the distribution of wealth. When abused, accounting can be used to misallocate capital and redistribute wealth to perpetrators of fraud. The investing public puts enormous trust in business lawyers, whose work usually goes unchecked by the adversary system and similar constraints, and instead must be taken on faith. Earning that faith depends on competence, which now, more than ever, includes a knowledge of accounting.


Lawrence A. Cunningham, a visitor at BC Law in the 2001-2002 academic year, joined the Law School faculty in June as Professor of Law and Business. His most recent book, Outsmarting the Smart Money, was published in May by McGraw-Hill. A fuller version of his views on law and accounting following the Enron collapse will be published in August in The Business Lawyer.