Group 6 Case Study: Fall of Arthur Andersen The case examines the emergence of Arthur Andersen as one of the leading auditing and consulting firms in the world, on the basis of its emphasis on integrity and ethics in business. The case explains the factors that led to deterioration in the firm's culture during the 1990s. "They [Andersen] can never clear their name. In the court of public opinion, they have been tried, convicted and hanged. After WorldCom, there was just nothing you could say." 1 - Lynn Turner, Former Chief Accountant, Securities and Exchange Commission (US), in June 2002. Grace to Disgrace In March 2002, Andersen (previously Arthur Andersen), one of the world's leading audit firms, was indicted by the US Department of Justice (DOJ) on charges of obstructing the course of justice in the Enron (one of Andersen's clients) case. DOJ claimed that Andersen shredded many Enron-related documents, while Enron was being probed by the Securities and Exchange Commission (SEC). 1 Enron, which had filed for bankruptcy in December 2001, was being investigated for illegal accounting practices. DOJ had begun a criminal investigation into Andersen in January 2002 in connection with the Enron case. All along, the media and Andersen employees had expected the firm to reach out of court settlement with DOJ. However, such a settlement did not materialize. DOJ's investigation revealed that Andersen had deliberately destroyed crucial documents relating to Enron during October-November 2001. This revelation and the fact that the firm had been embroiled in many controversies during the late 1990s destroyed all chances of an outside court settlement and led to the indictment. Through the late-1990s, Andersen's name had figured prominently in various instances of business fraud by its clients, namely, Sunbeam, Waste Management Inc., Quest Communication, Global Crossing, and Baptist Foundation of Arizona.2 The firm faced civil charges for its supposed misrepresentation of accounts in most of these cases. The audit partners, who were involved in the audit of these companies were indicted and penalized by the SEC. In many of these cases, Andersen had settled investor claims, without acknowledging any fraud on its part (Refer Exhibit I for the settlements). Following the indictment by the DOJ, many of Andersen's clients as well as employees left; the remaining employees took to the streets, protesting the DOJ's decision. They said that punishing the whole firm and its thousands of employees for the wrongdoings of a handful of corrupt partners was not justified. As negative publicity for Andersen mounted, it seemed certain that the firm would never be able to do business the way it had for over eight decades. Industry observers remarked that it was indeed painful watching the accounting firm that had set the standard for honest and law-abiding accounting in the US fall from grace. Background Note Arthur Andersen (Arthur) and Clarence Delaney founded Andersen in Chicago, in 1913. The firm was initially named Andersen, Delaney & Co., and was engaged in offering accounting services to companies. Andersen was essentially a partnership firm, with all the chief auditors having a share in the firm. The firm changed its name to Arthur Andersen (Andersen) in 1918. Arthur gave a lot of importance to ethical values and insisted on honest accounting and the elimination of conflicts of interest in accounting the firms. During the late 1920s, because of the depression in the US economy, many investors lost faith in companies. Reportedly, Andersen, under the leadership and guidance of Arthur, was instrumental in restoring the faith of US investors in companies based on its integrity and high professional values. Arthur also focused on creating a firm with its own set of business standards. His emphasis on 'Arthur Andersen specific' business standards evolved into the concept of 'One Firm' over the years. This concept ensured that all Arthur Andersen clients across the world received the same quality of work, the same kind of approach to work, and the same caliber people trained in the same way. Such consistency in offering services and quality was achieved by imparting rigorous training to all new recruits. The training sought to help new recruits imbibe the Arthur Andersen culture, popularly known as the 'Andersen Way.' After Arthur's death in 1947, Leonard Spacek (Spacek), a partner in the firm, became the CEO. By the early 1950s, the culture of ethics and honesty was so deeply ingrained in the firm that the firm was elected to the Accounting Hall of Fame of Ohio State University in 1953. In the early 1950s, realizing the potential of technology, especially computer technology, Andersen began investing in the same. By the mid-1950s, Andersen was offering consultation and installation services through its new Administrative Services Division... The fall - Was Andersen Guilty? In October 2001, Enron, a leading energy trading company in the US and one of the biggest clients of Andersen, announced its third-quarter results for 2001. The third-quarter results included a loss of $638 million, a $35 million write-down due to losses on its partnerships, and a decrease in shareholder's equity by $1.2 billion. This announcement led to a sharp decline in the stock price of Enron (40%). Following this, suspecting Enron of financial misappropriations, the SEC launched an investigation into Enron's financial dealings in late October. The investigation revealed serious accounting misappropriations by Enron between 1996 and 2001. In November 2001, Enron restated its financial statements for the years, 1997 to 2000 and for the first two quarters of 2001, and reported a loss of $586 million for that period. According to reports, Enron had huge accumulated debts on account of its dubious financial dealings with its partners and had even traded its shareholders' equity... The Fall - Nailing Andersen In April 2002, Duncan pleaded guilty to the charge of obstruction of justice (by shredding documents) and agreed to cooperate with the DOJ and testify against Andersen. Duncan testified that though at first the Andersen audit team had known about certain accounting errors at Enron, it did not force Enron to reflect it in its financial statements. This was because the team found that amount to be negligible compared to the company's vast revenues and shareholders' equity. However, in mid-2001, the team changed its mind and forced Enron to write-down $1.2 billion in shareholders' equity and asked it to attribute the write-down to an accounting error. Commenting on this, analysts felt that Duncan had been willing to play the same game his colleagues played at Waste Management and at other companies, 'Let it go and hope it fixes itself later'... The Debate on the Role of Auditors During the 1990s, the audit firms tended to become business consulting firms which also did auditing. This shift in focus from auditing to consulting had a negative impact on the business of audit firms on account of their consulting services created certain problems. As most of the audit firms were partnership firms, they lacked the leadership necessary for coping with rapid growth. The partnership model did not suit the expanding consulting business model. It resulted in a lack of proper span of control as all partners had equal control over the firm. This in return resulted in lack of effective communication channels that led to huge gaps in communication between the partners working on various projects... The Aftermath- In August 2002, Andersen Worldwide, the parent company of the US-based Andersen, agreed to pay claims worth $60 million to Enron shareholders and creditors (against claims of over $25 billion). Andersen Worldwide also stated that it was not responsible for the deeds of Andersen (US), as Andersen (US) operated as an independent division. In October 2002, Andersen received the DOJ verdict: the firm was given the maximum court sentence (in such cases) of five years probation on its US operations and a $500,000 fine for altering evidence of its Enron work... Discussion Questions: 1. Discuss the management Practice issues in the case 2. Using the elements of Ethics, Discuss the importance of ethics, integrity and professional standards in the audit business. The need to balance economic and social benefits in corporate decision making in the Organization. Give examples from the case and industry 3. Using principles would have done differently as a member of the Board of Directors of both Andersen and Enron. one of its major clients and the unethical practices of audit firms in the 1990s. Discuss what you the of ethics and values describe Andersens role in accounting fraud at Enron, 4. Discuss the various initiatives taken by the government and other regulatory authorities, such as SEC from Kenyan industry wide How would you compare this with the Kenyan Regulatory environment? Give specific examples and world . and AICPA, to restore the trust of investors in corporate firms and audit firms in the US?