Fifteen years ago this month, the big Andersen aftershock of the corporate earthquake known as the Enron scandal took place.
Enron Corp. crashed and burned in late 2001. Venerable Arthur Andersen LLP went down the following summer, after a winter of agony.
Andersen, auditor of the high-flying Houston energy and trading company that was the seventh-largest company in America, got so caught up in the dangerous slipstream of Enron’s house-of-cards dealings that it became a victim. A victim of its own missteps and of circumstances, one Andersen veteran told me—and of historical confluences.
Enron was the leading audit and consulting client for the 89-year-old Chicago accounting house. It paid out more than a million dollars per week, total, in fees to Andersen, former Securities and Exchange Commission Chairman Arthur Levitt Jr. told PBS’s “Frontline” in 2002.
Fatal Feature in the Case.
The standout headlines in January 2002 went to the unusual, ultimately fatal feature of the auditing episode: Andersen had destroyed papers used in the audit of Enron financial reporting that became notorious for keeping huge, crippling liabilities off the Houston company’s balance sheets.
Here is the headline and lead sentence of a BNA story [before the Bloomberg appellation] of Jan. 11, 2001, as reported by my former colleague Rachel McTague:
Andersen Employees Destroyed Documents Related to Enron Audit, Accounting Firm Says
“Big Five accounting firm Andersen LLP said Jan. 10 that its employees disposed of or deleted a significant number of documents related to its audit of Enron Corp., which suddenly collapsed and in December filed for the largest ever U.S. bankruptcy.”
To cut to the chase, efforts to keep Andersen out of the sights of a federal grand jury failed. The firm was indicted in March 2002 on one count of obstruction of justice. Andersen was convicted after a trial by jury in June 2002. It appealed.
By late August of that year, Andersen had effectively ceased as a going concern. It was barred from public company auditing. Andersen’s roll of roughly 28,000 US-based partners and employees was reduced to about 3,000 at the end of summer of 2002, according to The New York Times.
Supreme Court Reverses Conviction.
In May 2005, the U.S. Supreme Court reversed the conviction of Andersen LLP. Its ruling was unanimous.
“The jury instructions failed to convey properly the elements of a ‘corrup[t] persuas[ion]’ conviction under [18 U.S.C.] §1512(b),” according to the high court. “The jury instructions failed to convey the requisite consciousness of wrongdoing. Indeed, it is striking how little culpability the instructions required.”
However, it was too late for Andersen, as former U.S. Comptroller General Charles Bowsher—a two-decade-plus partner at the accounting firm—told me Jan. 17. The respected Chicago firm was history.
Bowsher, who also chaired the old Public Oversight Board, a self-regulatory board for accounting that preceded the Congressionally-mandated Public Company Accounting Oversight Board, faulted the leadership of Andersen for what he views as a failure to head off an indictment. And he criticized the Department of Justice for bringing the criminal action against the firm.
“It was just such a tragedy,” Bowsher said of Andersen’s demise. “It was such a great firm.”
A Negative History.
Andersen unfortunately had also accumulated a history -- one that any firm or company wouldn’t welcome.
In 2000 and 2001, Andersen had gotten into serious hot water with the SEC over its audit of Waste Management Inc. A commission enforcement action led to Andersen and three of its partners, in June 2001, settling a fraud complaint brought by the agency—and to a record $1.43 billion restatement by WMI.
The litigation marked the first time that the SEC had ever accused a big accounting firm of securities fraud stemming from a failed audit, as late Washington University law professor Kathleen Brickey wrote in 2003. [See Brickey’s well-researched writings in her school’s law review, notably “Andersen’s Fall From Grace,” at http://openscholarship.wustl.edu/cgi/viewcontent.cgi?article=1302&context=law_lawreview.]
Also in 2001, Anderson faced unwanted scrutiny for its audit work for Sunbeam Corporation.
The SEC brought a securities fraud case against Sunbeam. It named the Andersen audit engagement partner in that case along with Sunbeam executives. In addition, Andersen settled a shareholder suit against it, stemming from allegations in the Sunbeam audit episode, for $110 million, a notable settlement amount for a shareholder action against a CPA firm.
WorldCom’s Auditor, Too.
Finally, as part of its unfortunate history, Andersen was the auditor of WorldCom, the focus of another huge financial scandal in 2002.
The Mississippi telecom failed in a spectacular meltdown spurred by its having to make a $3.8 billion-plus restatement—and its audit committee finding that a fraud had resulted in overstating revenues by a like amount, as Brickey recounted.
The WorldCom debacle proved to be the spark that restarted Congressional movement toward concrete corporate and accounting reform in the summer of 2002, after legislative efforts seemed to be flagging in the spring. The scandal propelled lawmakers and Pres. George W. Bush to complete the process leading to the landmark Sarbanes-Oxley act and the creation of the PCAOB as well as independent funding for the Financial Accounting Standards Board. [See my blog report of January 2016, on the passing of former Rep. Michael Oxley, at https://www.bna.com/reluctant-reformer-passing-b57982066528/.]
Young and Ciesielski Look Back—and Forward.
I asked a few people who are versed in accounting and its regulation or related litigation to look back on the Enron scandal, the demise of Andersen and what came after.
"It is hard to describe to nonparticipants the hysteria of the moment,” attorney Michael Young, partner at Willkie, Farr & Gallagher LLP, New York, wrote to me in a Jan. 12 email message. “Fifteen years after Enron, this may be a good time to revisit the regulatory reaction and, with hindsight, to think about whether it could be refined a bit."
Young, a leading legal defender in accounting-related cases and author of “Financial Fraud Prevention and Detection” (Wiley & Sons, 2013), explained that “we now have 15 years of experience under our belt and it may be useful to revisit some of the reforms and see if they should be fine-tuned.”
In Baltimore, Jack Ciesielski, a CPA, security analyst, and publisher of Analyst’s Accounting Observer, told me Jan. 12: “Investors are in a better place. This led to reform of auditing through enactment of [the] Sarbanes-Oxley Act.
And for all the tears shed about the costs of Sarbanes-Oxley, we have avoided, to a great degree, the costs associated with corporate flame-outs.
“The unintended consequence has been the emigration of companies from the public markets to private equity,” Ciesielski added. “We haven't yet seen how that's going to play out.”
Levitt, Turner: Risks of Consulting vs. the Traditional Audit.
Levitt and Lynn Turner, about a year after their stints as SEC chief and the commission’s chief accountant, respectively, saw in 2002 the dangers of an audit firm shifting too much into lucrative consulting lines and away from the traditional audit.
“In my judgment, that accounting firm was compromised,” Levitt said of Andersen in the “Frontline” interview. “Putting aside any fraudulent activity that may have been part of this, they were clearly compromised by the nexus of consulting with auditing.”
Turner, a former partner at the pre-PWC Coopers & Lybrand, told the same PBS “Frontline” series in April 2002 about the trend he saw at the giant accounting houses. They were tapping their audit clients for well-paying consulting contracts and the non-audit business was becoming much more important. They sought more revenue and profitability, he said.
“And as we've seen, they all grew their consulting practice phenomenally during the 1990s to accomplish that, and that has become what their business is,” Turner said. “They used to be principally auditing firms. Today they are a business firm, and the CEOs and culture at the top of these firms is, ‘What can we do to make our business more profitable?’ "
The Sarbanes-Oxley law drew boundaries on what non-audit work an independent auditor could do for an audit client.
SEC Accountants’ Words of Warning.
In 2010 and 2012, the top accountants at the SEC—respectively, James Kroeker and Paul Beswick—spotlit audit firms’ consulting practices that were being rebuilt. The reconstruction made for a mix of business that apparently warranted regulatory attention (again).
Beswick voiced concerns about the risks to auditor independence that are presented when leading audit firms boost their non-audit consulting business.
In December, Wesley Bricker, the current SEC chief accountant, issued a similar reminder at the big annual American Institute of CPAs conference in Washington. “[C]onsideration should be given to whether any relationship or service to be provided by an auditor” could impair independence, he cautioned Dec. 5.
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