Paper 2

Arthur Andersen: The Rise and Fall


“In the beginning, Andersen became successful because it followed clear guidelines and molded first-rate accountants…Together, growth and drift from core services challenged accountability and leadership.  The decisions the firm’s leaders made at each point sent the firm down an ever more tangled path and, ultimately, to the firm’s collapse” (Squires, 22).

Introduction

Arthur Andersen was a very hard working individual and created his accounting firm in this image.  It was focused on hard working and quality individuals who excelled at their jobs.  Everything was done the “right” way because Arthur Andersen ensured it would be.  He held total control over the firm and would do whatever it took to secure a small unified firm.  Even after his death, Arthur Andersen left a set of values which would help the firm continue to grow and thrive:

  1. Integrity and Honesty – Think straight, talk straight values that ensured the auditor’s duty to protect the public established the firm’s reputation.
  2. One Firm, One Voice Partnership Model – A model for unity and cooperation that maintained control of the firm and firm values
  3. Training to a Share Method – A professional development strategy to create a uniform and predictable workforce that could be trusted to do as they were taught (Squires, 38).

It was through these values that Arthur Andersen & Co. was able to become one of the largest accounting firms in the world.  They continued to grow and thrive under these values long after the death of Andersen.  However, Andersen also left another legacy which would ultimately lead to the firm’s collapse, their consulting practice.

Historical Overview

In 1933, the Securities Act of 1933 was passed by Congress granting the Federal Trade Commission authority to set the “ground rules” for accounting standards.  This meant that for the first time ever the corporation as well as the accountants would be held accountable for any problems within the financial statements.  In the following year, Congress went on to create the Securities and Exchange Commission which oversaw the entire financial reporting process for public corporations.  This created a huge amount of work for auditors and their accounting firms.  However, this also meant ensuring the financials all of audited clients are correct and being responsible for any mistakes.

It was with these new laws and regulations that Arthur Andersen & Co soared to new heights.  Their firm, based with the values set by Arthur Andersen himself became one of the largest firms in the world.  “The mutual support of the partnership members and the firm’s strong culture helped Andersen remain stable as it grew from 1950 to 1970 to a total of 87 offices that employed nearly 10,000 people in 26 countries” (Squires, 45).  It was also during this period that they saw their revenues jump from $8 million to $190 million.  This jump solidified it as the second largest auditing firm.

This growth was fostered by how the firm was set up.  Each employee was trained specifically when accepting an offer at Arthur Andersen & Co.  This ensured that each and every employee was up to the standards set forth from the beginning by Arthur Andersen himself.  This also allowed each office to become self-sufficient and allowed them to facilitate all the client’s needs whether it was accounting, audit or tax.  However, these firms were always to act as a single firm, sending a unified message.

Andersen Consulting vs. Arthur Andersen

Auditing had become an essential part of business after 1933 in order to ensure there was never another crash like the one once experienced in 1929.  However, around the late 1970s the audit was no longer seen as essential, rather a burden that businesses had to go through with.  People were no longer focusing on the audit or even remembering that it was created to ensure their safety when investing.  Audit revenues were continuing to decrease more and more.

As if that was not enough, the American Institute of Certified Public Accountants then lifted a previous ban on advertising in 1978.  It had previously been placed in order to ensure the integrity of the auditors and stop competition that might compromise that.  As soon as it was lifted, the competition went through the roof.  Many clients started using a tactic known as competitive bidding in order to drive their audit prices down.  So now, competition was rising, revenues were falling and the client list was growing smaller and smaller.  Arthur Andersen & Co needed a way to remain stable financially.  The answer was consulting.

Although there was major concern from the SEC and Congress about conflicting interests, consulting was able to generate the revenues needed to ensure that Arthur Andersen Co was financially stable.  However, there were issues in Andersen’s promotional process in regards to consulting.   Consultants were being brought in and expected to go through the initial grunt work just as the accountants had.  In addition, promotion to partner was long and uncertain.  These factors among others led to a large turnover rate for Andersen consultants.  They felt no need to stay at Andersen.  It was this reason that modifications were made in order to facilitate the consultants.  These modifications, while small, started turning Andersen into two very different firms with very different cultures.

These growing differences became a much larger issue when consulting began to generate more revenue than auditing.  The consulting practice felt they were being held back by accounting and starting moving towards autonomy.  Finally, in 1989, autonomy was reached and there were now two different business units who acted under an umbrella organization in order for the firm to be viewed as a single unit.  There were separate books and all financials were tracked separately.  With this separation, the two units now moved in very different directions and Arthur Andersen’s audit practice needed to find another way to raise revenue.

Consulting and Shifting Values

It was at this time that Arthur Andersen’s accounting practice once again tried consulting.  They were only able to consult with small businesses in order to satisfy their agreement with Andersen Consulting who worked with mainly large clients.  However, this led to a major shift in the values that made Arthur Andersen’s accounting practice what it was.  The new value that was on top of their list of values was serving the client.  However, this new value had very different meanings in consulting and in accounting.  “Traditionally, client service for auditors was about ensuring compliance with regulatory requirements.  For consultants, client services were about meeting client needs and satisfying the client” (Squires, 94).  And unfortunately for Arthur Andersen, the view that was dominating decision making was the consultant’s view of client service.  This then led to a major conflict of interest that would set Arthur Andersen on a path which would eventually destroy the firm.  This conflict of interest was the conflict between protecting the public and generating their client sales.

The new focus for Arthur Andersen was now on sales.  There was a major shift to younger and more aggressive employees and partners who were responsible for sales.  This also led to the removal of many of the old conservative partners who were fashioned with the values that Arthur Andersen was formerly built on.  As this consulting group began building more client relationships, they focused more and more on their services and less on the obligation of protecting the public.  While this new focus was bad for the public, it was very good for sales.  It saw revenue increase from under $3 billion to $16 billion in 1988.  It was after this that Andersen Consulting decided to separate completely from Arthur Andersen claiming that they were no longer focusing on small businesses.  Clearly the unified firm that was once Arthur Andersen was completely destroyed and finally in 2000 the two business units split completely.

Conflicting Interests

As Arthur Andersen continued to operate as a consulting and accounting firm, they began to see that the two would never be able to harmonize.  Public figures made the issue resoundingly clear in 2000, “The Standard & Poor 500 companies reported paying $3.7 billion in nonaudit fees to their auditing firms while paying only $1.2 billion in audit fees” (Squires, 115).  This major difference in revenue led to serious issues within Arthur Andersen.  When so much money in being brought in through the consulting of a client, how can an auditor be willing to question the legality of the financials being reported by said company?

This is when things began unraveling for Arthur Andersen.  In mid 1990s, a client of theirs, Baptist Foundation of Arizona, was alleged to have been involved in serious illegal financial activity.  They were alleged to have been involved in a major Ponzi scheme and that they had $360 million more in total liability than assets.  Arthur Andersen claimed that all auditors were unaware of these illegal activities, but were forced to settle out of court and pay a total of $217 million in damages.

This departing from their core values continued as more and more of their clients were caught in financial fraud.  Another client, Sunbeam Corporation was found guilty of financial fraud and Arthur Andersen was again forced to pay $110 million in damages.  However, in all of these cases Arthur Andersen claimed that their auditors were working with the proper amount of professional skepticism when conducting the audits of these companies.  It was two other cases that clearly painted the picture of how badly the independence of Arthur Andersen’s auditing practice was implicated.  These cases were those of Waste Management, Inc. and Enron.

Ethical Lapse

Arthur Andersen had been on a downward spiral in regards to their ethics.  They had completely strayed from the values that the firm was built on.  They now did whatever it took to raise profits and would not dare to question the management behind it.  This was the case for Waste Management, Inc.  “In June of that year, the SEC found that Andersen’s audit reports were materially false and misleading for the years between 1992 and 1996 and that the firm engaged in improper professional conduct” (Squires, 121).  Arthur Andersen had violated the public duty they had which was to ensure that these companies were engaged in sound financial activities.  This was due to the new values that had taken root in the firm which was to make as much profit as possible.  These new values were clearly seen when looking at the revenues generated from Waste Management, Inc.  The fees collected from Arthur Andersen for their auditing practices were $7.5 million, while the consulting fees collected were $11.8 million.  There was a clear conflict of interest and lack of focus on protecting the public.

This issue came to its climax when dealing with Enron.  Enron was one of the largest financial scandals in the United States history and was a death sentence for Arthur Andersen.  Arthur Andersen provided auditing services for Enron and continued to do so even when advised not to.  There were glaring conflicts of interest and yet Arthur Andersen continued to approve deals for Enron.  There were multiple instances where the Professional Standards Group of Arthur Andersen advised against deals presented by Enron, however these cautions were ignored and the deals were passed.  David Duncan was the partner responsible for the Enron account and consistently ignored the cautions that were presented to him.  He was focused on the client and the client only.  The duty to protect the public and been forgotten.  The focus was clearly on the client when looking at Enron and the revenue it was going to bring in, “Enron was one of the firm’s largest clients, and this was a gigantic engagement expected to be worth as much as $100 million in revenue” (Squires, 126).  It was this figure in mind that led the decision making at Arthur Andersen and not the responsibility they had to the public.

Just when it seemed that Arthur Andersen could not stray farther from the responsibilities they had to the public, they then started shredding all documents related to Enron.  This process was started when Duncan told everyone involved with Enron to start shredding audit documents in order to prevent them from being used in court.  The reason for this was that Enron was in a serious downward spiral and the SEC was beginning an informal investigation into the matter.  Questions were being brought up about the audit reports and all the financial information verified by Arthur Andersen.  It was at this point that Duncan order that all documents be shredded and did not order anyone to stop until November 8th when the firm finally received a subpoena.  This was the culmination of a culture that had developed throughout Arthur Andersen.  It was all about the client and no longer about the public.  Rather than protect the public interest, which was their duty as CPAs, they now only focused on the client and how to satisfy their needs.  In this case, it was destroying over 30,000 documents related to Enron and necessary for an investigation by the SEC.  It was these actions that ultimately led to the destruction of one of the top five accounting firms in the world.

Conclusion

Arthur Andersen started out as one of the most ethically sound accounting firms in the world.  They followed in the steps of their leader and had a solid set of virtues to guide them.  It was this solid set of virtues that allowed them to be successful for so long.  They were seen as always working with honesty and integrity.  It was in everything they did and the public rewarded them with their trust.  However, in the search for increasing profits, these virtues were lost.  The focus was no longer on being honest or reporting with integrity, but rather garnering the highest profits possible, even at the cost of the public trust.  Their management continued on this downward spiral and it all culminated in the collapse of Enron.  “In light of Arthur Andersen’s role in the Enron debacle, it is important to note that, no matter what the facts, Arthur Andersen had an obligation to look out for the public interest, to protect the integrity of the free-market system” (Duska, 70).  After that trial, all public trust vanished along with their clients.  Their unethical decision making and abandonment of their values led to their ultimate collapse.

Works Cited

Duska, Ronald F., and Brenda Shay. Duska. “Accounting as a Profession.” Accounting Ethics. Malden, MA: Blackwell Pub., 2003. 70. Print.

Squires, Susan E. Inside Arthur Andersen: Shifting Values, Unexpected Consequences. Upper Saddle River, NJ: FT Prentice Hall, 2003. Print.

Toffler, Barbara Ley., and Jennifer Reingold. Final Accounting: Ambition, Greed, and the Fall of Arthur Andersen. New York: Broadway, 2003. Print.

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