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arthur anderson

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arthur anderson

  1. 1. The Rise and Fall of Arthur Andersen A Cautionary Tale For Those Who Value Profit Over Ethics and Principles. Nina Richardson Seminar in Accounting Topics 11/08/2014
  2. 2. Table of Contents Executive Summary……………………………………………………………………………………………..3 Introduction………………………………………………………………………………………………………4 Values and Ethics Gives Way to Profit…………………………………………………………...........5 The Auditors Dilemma……………………………………………………………………………………….6 The Battle Between Consulting and Auditing………………………………………………………6 Arthur Andersen’s Culture Problem……………………………………………………………………8 Improper Use of In House Lawyers……………………………………………………………………10 Arthur Andersen’s Most Deadly Client……………………………………………………………….11 Arthur Andersen’s Response to the Enron Crisis………………………………………………..12 Why Arthur Andersen Was Found Guilty…………………………………………………………...13 Nancy Temple’s Dilemma…………………………………………………………………………………14 Conclusion………………………………………………………………………………………………………14 References………………………………………………………………………………………………….......16
  3. 3. Executive Summary Arthur Andersen was an accounting firm founded on the principles and ethics of a man who wanted to stand above and beyond the rest. Arthur Andersen had a dream of creating an accounting firm that would do more than audit or bookkeeping. His vision was to create accounting standards everyone else would follow. Arthur was legendary in his time. He was known for standing up for what was right even if it meant losing a client. Arthur’s decision to remain true to ethics and proper accounting made his firm not only profitable but also one with a reputation. Investors knew they could rely on financial statements audited by Arthur Andersen. However, as the years went by the firm and the partners began to forget what they stood for. The pursuit of profit became more important than ethics. The partners followed the path of what became popular to the rest of the accounting world. The attitude in accounting in the eighties switched from saying no to saying yes to the client. Pleasing the client became fashionable even though it meant risking the integrity of the firm. Ultimately, Arthur Andersen paid a terrible price when in 2002 the firm stopped practicing. The firm was brought to ruin by becoming bed partners with one of the most corrupt corporations; Enron. What happened to the firm who began based on integrity to become an auditing firm who helped clients engage in fraud. This paper will discuss what led Arthur Anderson from being a firm that said no to a firm that said yes.
  4. 4. Introduction Arthur Andersen began as a preacher who became an auditor. His mother had taught him, “Think straight, talk, straight”. He set up his accounting practice in 1913 with partner Clarence Delaney. At that time, there were only a few large accounting firms who had their beginnings in London. Andersen wanted to be different than everyone else. He wanted his firm to have a larger focus than making money and bookkeeping. When Arthur crafted the announcement of his firm’s opening on Dec. 1, 1913 he promised to provide “the designing and installing of new systems of financial and cost accounting and organization.” (Brown & Dugan, 2002). He insisted his firm have integrity unlike the accounting firms in London. He set the tone for his company in 1914; when a railroad executive burst into his office and demanded Arthur give his blessing on the corporate ledger. Andersen, whose words were legendary for the firm, declared there wasn’t enough money in Chicago to make him approve bad bookkeeping. Arthur Andersen lost the client, but the railroad went bankrupt a few months later. The reputation of Arthur Andersen was cemented as a firm of independent thinking. The firm experienced prosperity from the commitment to integrity. The firms’ accountants were bold in their stance on accounting issues and were known to make clients angry. However, investors knew they could trust the financial statements of firms audited by Andersen. In 2004, Arthur Andersen declared bankruptcy after losing the majority of their clients. The firm had been found guilty of obstruction of justice and was a major player in several large accounting scandals including Enron, Waste Management, and WorldCom.
  5. 5. Values and Ethics Gives Way to Profit The decline of Andersen did not begin overnight. The descent began gradually with compromises and misjudgments by management. One of the culprits was the modern day computer. In the 1950’s “the firm introduced the “Glickiac” to the world” (Brown & Dugan, 2002). Joseph Glickauf, an Andersen engineer, created the Glickiac. The device proved computers weren’t just for scientists but could be used by companies for bookkeeping. Anderson began setting up the computers for clients who wanted automated bookkeeping. It wasn’t long until the selling of computers was making record profits. The new money caused tension within the firm. The design of the firm and how profits were shared was the problem. Auditors ran the firm and all the profits were collected into a pool and divided amongst the partners. The tables turned with the sale of computers to clients. Consultants were bringing in more money than the auditors. The consultants complained they were bringing in more money and it was unfair the auditors should receive all the profits. The second week of 1989, the consultants won an agreement to separate the company into two units. The two units would be Arthur Andersen and Andersen Consulting united under Andersen Worldwide SC. The accounting side agreed to profit sharing that would be more equal. The firm with less profitability would get a smaller portion of the profits than the more profitable firm.
  6. 6. The Auditor’s Dilemma The new profit sharing equation left the auditors with a dilemma. Traditional accounting wasn’t making much of a profit. There was greater competition in the market, and audit fees weren’t doing so well. Auditors worked long hours, but their salaries were far behind those of lawyers and bankers. They felt embarrassed to be passed up by consultants. Richard Measelle, a top partner of Arthur Andersen, decided to fight back. “It was a matter of pride”, Mr. Measelle said. Mr. Measelle wanted the auditors to do more than audit. He believed they could still do quality work while boosting sales. Job objectives for auditors were changed. They would now be judged on how much business they brought. Auditors were now judged on their numbers and how much money they made the firm. To keep costs from escalating Anderson began requiring partners to retire after they turned 56 years old. The company was able to save money but they were left with more inexperienced partners. There were also fewer partners to oversee audits. The Battle Between Consulting and Auditing The consulting side and the audit side had fierce competition to bring in the most revenue. There was much at stake. The losing side would have less to share amongst the partners. In 1993, the race was so close, people dashed madly through the office trying to find ways to cut expenses to raise revenue. That was the year the auditors won. It was in this environment Steve Samek became a force within Anderson. He quickly made partner at the young age of 32. He was known for sometimes approving aggressive accounting tactics. In the 1990s, he acquired a lucrative contract with a chain of restaurants called Boston Chicken. He was praised
  7. 7. in his performance review for “turning a $50,000 audit fee into a $3 million full- service engagement”(Brown & Dugan, 2002). While auditing the client, he allowed them to keep losses off the financial statements. The client was being prepared for an IPO and needed to look like a success. However, the façade didn’t last because in 1998 Boston Chicken filed for bankruptcy. Arthur Anderson’s auditing went down the slippery slope afterwards. Mr. Anderson, the founder, would have been appalled one of his auditors had approved aggressive accounting practices, which led to financial statements being materially false. The principled ideals of the man who refused to change a financial statement for a railroad tycoon were gone. Mr. Samek continued his climb up the company ladder. In 1996, he was the firm’s worldwide manager of auditing. He gave inspiring speeches to the auditors to sell anything they could to a client. His view of being an accountant was different than those who saw the profession as the gatekeepers for honesty. He mocked the partners who refused to change to his way of thinking. Mr. Samek said, “Accountants tend to be a bit more dry. I tend to be a little different, a little more visual, right brain versus left brain, a little bit more creative”. While Mr. Samek was giving his pep talks to the auditors, the problems with the audits were beginning to grow. “Andersen paid investors $110 million for its botched audits of Sunbeam, the home appliance maker that was caught artificially boosting revenues by offering retailers incentives to accept more product than they could sell” (Brown & Dugan, 2002).
  8. 8. Arthur Andersen’s Culture Problem The war between audit and consulting wasn’t the only reason behind the fall of Arthur Andersen. The firm had a culture problem. In the late 1980s, the high standards of accounting were changing. The shift in attitude was a desire not to anger the client. The desire was more prominent at Andersen because the firm was known for having the highest billings and the largest profits. The stiff competition between auditors and consulting had placed a greater emphasis on profit and fees rather than integrity. The client’s wishes were to be granted regardless if they were ethical or legal. “The worst possible sin one could commit at Arthur Andersen was to upset the client even if the client desperately needed to hear the bad news” (Kinsler, 2008). Jeffrey Kinsler who interviewed for an in house legal position at Arthur Andersen wrote an in depth journal about what was wrong with the company and why it came to ruin. He provided an outsiders view of the culture at Arthur Andersen. During his first interview he noticed quite a few things that warned him against the company. One of the oddities was the lack of individualism. “Everyone I met stressed that there was no room for individualism at Andersen; everyone had to be part of the “team” (Kinsler, 2008). The fervor for lack of individuality had a cult like obsession. His second observation was in house attorneys did not have a private office. They worked in cubicles, which lacked confidentiality. Anyone could eavesdrop on a conversation. When Kinsler pointed this out he was told, “there were no secrets” at Andersen. Kinsler was advised there had to be two interviews because all the in house attorneys had to approve a new hire “because the team was
  9. 9. more important than the individual” (Kinsler, 2008). When Kinsler attended the second interview, he noted the in house lawyers were not interested in practicing law. The were more interested in talking about employee benefits such as flex time and how easy it was to work at Andersen compared with other firms. Kinsler ended up turning down the position because he believed “Andersen was not seeking an independent, legal advisor as much as a legal yes-man” (Kinsler, 2008). His observations during the interview process caused him to suspect in house council was expected to rubber stamp transactions whether or not they were legal or ethical. The culture of Andersen revolved around the belief “protect the firm and clients at all costs”. Everyone from auditors, consultants, attorneys, and management was included in the expectation. Employees at Andersen were referred to as “Androids”. An android is programmed to perform the will of the master and that is what employees were trained to do. If an employee was asked by a partner to violate a legal or ethical issue they did it without question. Challenging a partner was unthinkable. The culture of conformity had been established from the very beginning. “For most of Andersen’s existence, this was not a place where independent activities were tolerated or encouraged. It was a culture in which everyone followed the rules and the leader. When the rules and leaders stood for decency and integrity, the lockstep culture was the key to competence and respectability. But when the game and the leaders changed direction, the culture of conformity led to disaster” (Toffler & Reingold, 2004).
  10. 10. Andersen’s culture was centered on “up or out”. An employee either moved up the ranks or was sent out the door. In the 1990’s, the only way to move up in the firm was to keep the bosses and the people at Enron happy. A sure way to get fired was to disagree with an Enron transaction. Angering a crown jewel client was the ultimate sin and Enron was the top crown jewel. Senior partner Carl Bass’ experience at Arthur Andersen is good example of the “yes man” culture. Mr. Bass served on the Professional Standards Group (PSG) who reviewed and approved accounting issues local Andersen offices had. The word of the PSG group was law at Andersen. Enron was a high-risk client and in 2001, Bass was assigned to monitor high-risk audits. He objected to Enron’s accounting when he audited their statements. However, partners in the Houston office overruled his objections. Bass continued to disagree with Enron’s accounting causing tension between himself and the company. Enron was becoming angry with Bass for being a roadblock to their deal makings. In response, members of Andersen’s PSG group demoted Bass and removed him from oversight of Enron. The demotion was unprecedented and sent a message loud and clear to every employee. Say no to Enron and the employee will be demoted. Improper Use of In House Lawyers The yes culture and profit sharing war between auditors and consultants was not the only problems at Arthur Andersen. The firm improperly used in house lawyers. If the firm had encouraged the attorneys to give independent legal advice Arthur Andersen would have never been found guilty of obstruction of justice. The firm may have even survived the Enron debacle. The culture of pleasing the client
  11. 11. had not only infected the audit side of Andersen but the legal side as well. Everyone was expected to please the client, especially Enron, even if the client was doing unethical business practices. Arthur Andersen’s Most Deadly Client Enron began as a natural gas company but grew itself into an energy trading and investment company in the 1990’s. Arthur Andersen began auditing Enron’s statements in 1985. Enron was Andersen’s largest client and “accounted for $58 million of Andersen’s revenue in 2000” (Samaha, 2010). The client and auditor had a close relationship because more than 100 Andersen employees worked inside Enron’s Houston headquarters. There was also a revolving door between the companies because many executives and accountants of Andersen ended up on the payroll of Enron. In the late 1990’s, Enron began engaging in aggressive accounting practices. They started using special purpose entities (SPEs) Andersen helped design so Enron could remove liabilities off the balance sheet. In 2001, investors began to smell trouble at Enron. In October of 2000, hedge fund manager James Chanos began looking at Enron’s financial statements and was shocked with what he discovered. He found “murky references to related party transactions involving Enron’s senior officers, and massive insider selling” (Sherman, 2002). In February of 2001, Chanos tipped off a reporter at Fortune who published an article “Is Enron Overpriced?”. The story caused a chain reaction that destroyed the company along with Arthur Andersen. On August 14, 2001 Jeff Skilling resigned as CEO from Enron. Sherron Watkins gave her famous whistleblowing memo to Kenneth Lay, Enron’s Chairman, and two senior
  12. 12. accountants at Arthur Andersen, a few days later. Arthur Andersen went into crisis mode immediately. They created an internal crisis group, which included Nancy Temple an in house lawyer from the Chicago office. Arthur Andersen’s Response to the Enron Crisis At the beginning of October, Temple had a meeting with Andersen’s senior in-house counsel. She told them an SEC investigation of Enron and Arthur Andersen was highly likely. On October 12, 2001 Temple sent an email to Michael Odom to suggest he remind the Enron engagement team about Andersen’s document retention policy. Michael forwarded her email to David Duncan, the audit partner for Enron, who felt justified by the email to destroy Enron documents. Michael Odom, the senior Andersen partner, sent a message to all personnel to comply with the document retention policy. Andersen’s document retention policy was to destroy client documents if the client was under investigation. According to Michael Odom, “if it’s destroyed in the course of normal policy and litigation is filed the next day, that’s great…we’ve followed our own policy and whatever there was that might have been of interest to somebody is gone and irretrievable”. The SEC had begun an informal investigation of Enron in October and advised Andersen they would be sending an accounting letter to the firm. The next morning the crisis group had a conference and Nancy Temple reminded everyone about the document retention policy. On October 30, the SEC began a formal investigation of Enron and requested Andersen’s accounting documents. However, Andersen kept the shredding party going. They followed the advice of Nancy Temple, and according to witnesses, “almost two tons of paper were shipped to
  13. 13. Andersen’s main office in Houston for shredding” (374 F 3d 281). The destruction of documents continued until the SEC had a subpoena sent to Andersen advising it to stop shredding documents. On March 7, 2002 Andersen was indicted for obstruction of an SEC investigation. On June 15, 2002 a jury found Andersen guilty. The SEC does not allow convicted felons to audit public companies so Andersen informed the SEC they would cease to practice on August 31, 2002. The firm, which was almost 100 years old, and began with high ethical standards, had been brought to ruin by the pursuit of money at the expense of a commitment to ethics. Why Arthur Andersen Was Found Guilty The reason for Arthur Andersen’s conviction was due to laws regarding document retention policies. During the trial, Andersen’s defense was they were allowed to destroy documents until the SEC notified the firm it was subject to a proceeding. However, if litigation is reasonably foreseeable evidence must be retained. The duty requires the firm to notify personnel and to suspend the document destruction policy. A firm must also follow their document retention policy consistently. The destruction of documents should not be sporadic or unusual. Andersen’s in house counsel advised employees to destroy documents even though it was clear there would be an SEC investigation. Nancy Temple had acknowledged in an email; litigation with the SEC was highly probable. She had an ethical obligation to notify all personnel that an investigation was imminent and to stop any document destruction.
  14. 14. Nancy Temple’s Dilemma Unfortunately for Nancy, she was stuck between a rock and a hard place. She had an obligation for client confidentiality to her employer Arthur Andersen. She also had a legal obligation to follow laws concerning document retention. Nancy could have refused to participate in the destruction of documents but she would have needed to follow the requirements of Illinois Rule of Professional Conduct 1.13(b). The steps required would be to ask the people involved in the destruction to reconsider their actions, advise those destructing documents to seek separate legal opinion, and refer the matter to a higher authority such as senior partners or the CEO if necessary. Obviously the professional advice of Nancy would have fallen on deaf ears, as Andersen’s culture was to protect Enron at all costs. The only option she had was to resign as counsel. Rule 1.6, as it was written in 2001, would have prevented Nancy from sharing the document destruction with the SEC because it would have been an ethical violation of client confidentiality. Conclusion Nancy Temple would have never been placed in the ethical dilemma she faced if Arthur Andersen had remained true to the high ethical standards the firm began with. The founder Mr. Andersen would have declined companies like Enron as a client. The firm’s partners who made profit sharing a competition had led the firm’s management astray. A decline in accounting values and a desire to please the client contributed to the moral decay at the firm. The culture of obedience and conformity to the partners was a weakness. Employees were rewarded for complying and disciplined for questioning authority. Employees lacked an outlet to
  15. 15. voice concerns. The story of Arthur Andersen should serve as an example for accounting firms in existence today. Remaining true to ethical behavior and saying no to a client should never go out of style.
  16. 16. References Brown, K., & Dugan, I. J. (2002, June 7). Arthur Andersen's Fall From Grace Is a Sad Tale of Greed and Miscues. Retrieved September 18, 2014, from Wall Street Journal: http://online.wsj.com/articles/SB1023409436545200 Kinsler, J. S. (2008, February 1). Arthur Andersen and the Temple of Doom. Retrieved September 9, 2014, from Kinsler Article. McRoberts, F. (2002, September 1). The fall of Andersen. Retrieved September 18, 2014, from Chicago Tribune: http://www.chicagotribune.com/news/chi- 0209010351sep01-story.html Samaha, J. (2010). Criminal Law. Boston, Massachusetts: Cengage Learning. Sherman, S. (2002, March). Enron: Uncovering the Uncovered Story. Retrieved October 19, 2014, from The Official Website of Scott Sherman; Contributing Writer. The Nation: http://scottgsherman.com/investigations/onenron.php Toffler, B. L., & Reingold, J. (2004). Final Accounting: Ambition, Greed, and the Fall of Arthur Andersen. New York , New York: Doubleday.

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