1. What did Arthur Anderson contribute to the Enron disaster? Arthur Andersen (AA) contributed to the Enron disaster when AA consulting became its own separate entity, named Accenture. Revenues from consulting services surpassed revenue from auditing services. A natural competitiveness grew between the two rivals and this is where the problems began to start. Management held maximinizing revenues as their primary focus of success and promotions/bonuses were based on this factor.
The CEO of AA, Joe Berardino, was an extremely aggressive pursuer of revenue. This set a negative culture at the top of the company and partners were expected to comply and atttain that demand. In addition, AA recognized the retention of audit clients as imperative and a loss of a client would be detrimental to an auditor’s career. This is where the issue in regards to auditors standing up to management and the client became unclear. AA was the only firm to allow the partner in charge of the audit to override a ruling of the quality control partner.
The auditor had a fiduciary duty to the shareholders of the company being audited not to the company itself. Another major contributing factor was AA’s approval of Special Purpose Entities (SPE) that was used to generate false profits, hide losses and keep any undesirable information off Enron’s financial statements. 2. Which Arthur Andersen decisions were faulty? AA made many decisions in regards to the Enron audit which led to their ultimate downfall. Briefly discussed below are some decisions made by AA that failed to adhere to GAAP.
AA approved the structure of many Special Purpose Entities (SPE) that were used to generate false profits, hide losses, keep financing off Enron’s consolidated financial statements, and failed to meet the required outsider 3 percent equity at risk, and decision control criteria for non consolidation. In addition, various transactions between Enron and the SPEs were not in the interest of Enron shareholders since: * Enron profits and cash flows were manipulated and grossly inflated which mislead investors and falsely boosted management bonus. Extraordinarily overgenerous deals, fees, and liquidation arrangements were made by Fastow, or under his influence, with SPEs owned by Fastow, his family, and Kopper, who was also an employee of Enron. AA failed to recognize GAAP by allowing Enron to record shares issued as an increase in shareholders equity even though they were issued for notes receivable and not cash. It did not find significant audit evidence, or did not act upon evidence found, related to erroneous valuation of shares or share rights transferred to SPEs.
Furthermore, AA did not act upon evidence found in regards to side deals between Enron and banks removing the banks’ risk from transactions such as: * Numerous prepay deals for energy futures even though AA made a presentation to Enron on the GAAP and AA requirements that prohibited such arrangements. AA failed to inform Enron’s audit committee that Andrew Fastow (Enron’s CFO), and his assistants were involved in significant conflict of interest situations without appropriate alternative means of managing these conflicts.
The decision to allow the partner in charge of the Enron’s audit (David Duncan) to override a ruling of the quality control partner (Carl Bass) was a faulty decision by AA. The final disintegration of AA was caused by its decision to shred Enron audit documents and the conviction on the charge of obstruction of justice that resulted. AA tried to argue that it was company policy to destroy extraneous and redundant material and that they were simply trying to get organized . However, this argument backfired against AA once Duncan testified against AA. 3.
What was the prime motivation behind the decisions of Arthur Andersen’s audit partners on the Enron, Worldcom, Waste Management, and Sunbeam audits: the public interest or something else? Cite examples that reveal this motivation. The prime motivation behind the decisions of AA’s audit partners on the Enron, WorldCom, Waste Management and Sunbeam audits was based on revenue generation and not public interest. Ethical behaviour in an organization is guided by the ethical culture of the organization, by any relevant professional norms and codes, and particularly by the tone at the top and the example set by top executives.
AA’s CEO at the time, Joe Berardino played a significant role in misguiding the firm and pushing revenue generation rather than working towards decreasing the conflicts between the auditing profession and the public interest. On April 2, 2002, U. S. House Energy and Commerce Committee released a memo dated December 9, 1999 from Carl Bass a partner in AA’s Professional Services Group to David Duncan, the AA partner in charge of the Enron account. This memo asked for an accounting change that would have resulted in a $30-$50 million change to Enron’s earnings (believed to be in regard to the SPE transactions).
In February 2000, Bass attempted again to bring light on what he believed was an arm’s length transaction by emailing Duncan to object setting up LJM Partnership (LJM was a company set up by former Enron CFO Andrew Fastow). Duncan overruled Bass on the first memo and shortly after the second attempt where he questioned the CFO, Andrew Fastow and his role with the SPE’s was Duncan removed from the Enron account entirely. In any other of the Big 5 firms, Bass would have been able to overrule Duncan.
However, this is a great example that stresses that AA’s objectives were not quality-focused but rather revenue driven. 4. Why should an auditor make decisions in the public interest rather than in the interest of management or current shareholder’s? Auditors should make decisions in the public interest rather than management or current shareholders as its fiduciary duty lies towards the public. By making decisions in the public interest, auditors avoid bias by giving a true and fair dipiction of the state of affairs of the company at the end of the financial year while complying with accounting standards (GAAP).
If decisions were based in the interest of management or current shareholders, there is a higher chance that auditors would like to please management, thus motivating them to avoid GAAP by portraying false and misleading financial statements. 5. Why didn’t the Arthur Andersen partners responsible for quality control stop the flawed decisions of the audit partners? Carl Bass, AA’s quaility control partner raised quality control issues to David Duncan, the AA partner in charge of Enron. In 1999, Bass informed Duncan to make an accounting change in regard to SPE transactions which would decrease Enron’s earnings by $30-50 million.
In early 2000, Bass rasied concerns regarding setting up a LJM partnership that lacked substance. In both these cases, Duncan completey ignored Bass’s concerns. Bass decided to inform Andrew Fastow, AA’s CFO at the time. Duncan overruled Bass on the first issue, and was removed from Enron audit oversight, less than two weeks after informing Fastow of his concerns. Given this ‘tone at the top’ it is reasonable to assume that AA partners were going to be motivated by revenue recognition based on Joe Berardino aggressive pursuit of revenue. It was his values that drove the firm onwards.
This attributed to the internal control flaws by pushing auditors into the pursuit of higher revenue, thus sacrificing quality of work over quantity of revenue. The general trend at the firm suggested an acceptance for this behaviour, thus auditors pursuing client and managemnt interests over those of the general public (potential/future shareholders). Arthur Andersen partners responsible for quality control didnt stop the flawed decisions of the audit partners because of the “tone at the top”. Although some attempts were made, they were vitoed by managment, thus enforcing the aggresive pursuing of revenue by management. . Should all of Arthur Andersen have suffered for the actions or inactions of fewer than 100 people? Which of Arthur Andersen’s personnel should have been prosecuted? All 85,000 of the Arthur Andersens employees and partners worldwide should not have suffered for the actions, or lack thereof, of 100 people. After the scandal became public AA’s reputation as a leader in professional services was destroyed forever. Their reputation was so damaged by the Enron scandal that no company wanted to be associated with AA as it would weaken the company’s ability to attract financial at lower rates.
Although the responsibility of this scandal lays in the hands of the US based operation, operations in other countries were also destroyed. Specifically, those that were first-handedly responsible for the scandal should have been persecuted as they commited fraud and had also ruined the integrity of the auditing profession. Altough this situation was very unfortunate for AA it sent a message that unethical practices will not simply be dismissed or overlooked and will be persecuted with not only large fines but prison sentences.
7. Under what circumstances should audit firms shred or destroy audit working papers? Audit firms can destroy their audit working papers when they are no longer needed or required for proper record retention policies. Multiple factors should be considered, firstly, is there a legal requirement to keep the record as per the municipal, provincial or federal government. Also, after a document has passed it’s useful life what other purpose can it serve. For example, could it be used to support the company in possible future litigation. Furthermore, what are the consequences for not being able to locate the document.
For example, AA claimed that they destroyed papers for organization purposes. Ultimately, the presumption is that it was done deliberately. Keeping records could greatly secure and defend a company. Lastly, can the item be reproduced elsewhere if needed. It is understand that it may require a lot of space to keep all the records and documents of an accounting firm. If possible, a company should keep an electronic record of the file if it cannot keep a tangible one in order to secure itself in future circumstances. 8. Answer the “Lingering Questions” on page 120. a. Was this an appropriate outcome?
The outcome of the AA’s downfall was appropriate because the culture of the firm was focused on the maximization of the revenue, and the quality of the work was a secondary item. It is evident from the AA’s involvement in the several major financial scandals, for example, WorldCom, Sunbeam, Waste management. Even if the rest of them had survived, they would not likely to get as many clients because its public image had been tarnished by those 100 people. Moreover, the outcome of this firm will serve as a lesson to many others who would try to engage in this kind of behavior. . Will the Big 4 be able to serve the public interest better than Big 5? The Big 4 will be able to serve the public interest better than Big 5 if their employees act in a prudent manner for the best interest of the public. After AA, the Big 4 will probably follow the professional code of conduct more strictly, and the guidance for the auditor’s role and fiduciary duty towards the general public will be a priority of these firms. c. What if another Big 4 firm has difficulty. Will we have the Big 3, or we are facing the final four?
This is highly unlikely that any of the Big 4 will have difficulty because auditors will be lot more careful while conducting their audit functions. In addition, their clients will also act more responsibly and ethically. However, if one of the Big 4 goes down, then probably we will have several small firms in addition to the Big 3, and the all the services (auditing, consulting) provided by these firms will probably be segregated, so that there is no conflict of interest. d. Will fate await other individual AA partners and personnel beyond David Duncan, or by the AICPA through the exercise of its code of conduct?
Probably not, because after the whole scandal of Enron, the work performed by the AA partners under the name of the firm will not be reliable to the users of the financial statements. e. Will the similar tragedy occur again? It is highly unlikely that this kind of tragedy will occur again because the firms will be a lot more careful in their work performance. Standard setters will also be careful, and more emphasis will be given to the ethical behavior. AA will serve as a lesson to the existing and new professionals who would like to work as an accountant or auditor.
