ENRON AND ARTHUR ADNDERSEN: THE CASE OF THE CROOKED E AND THE FALLEN A

Global Perspectives on Accounting Education, 2006 by Cunningham, Gary M, Harris, Jean E

Internal Control at Andersen

For investors to have confidence in financial reporting, it is essential that both the reporting company and its auditor have strong internal controls. Information that has surfaced indicates that Andersen had serious internal control weaknesses. Accounting advice from Andersen's national office was disregarded by the on-site audit team; no controls were in place to assure the advice was followed. What controls failed at Andersen to permit this? Enron was Andersen's second largest client. Why did the protections of audit review by a second partner and of peer review not operate? Why were indications of the manipulation of earnings by Andersen's detection model largely ignored? Why did Andersen acquiesce to the demands of Enron to remove from its audit a respected professional? Was Enron, in substance, in charge of its own audit? Given that Andersen, because of its role in another scandal, was operating under a consent order from the SEC, why were its internal controls not reviewed and strengthened? The simplistic answer of one bad partner is not defensible. Accounting firms whose own internal control systems are weak do not merit investor confidence. Did Enron and Andersen travel together to a dangerous moment in time partially because each organization neglected the fundamentals of internal control?

AFTERMATH AND REFORMS

The Enron-Andersen debacle continues to generate news and likely will for a long time as the SEC files additional criminal charges and civil settlements are negotiated. Enron as a corporate entity is emerging from bankruptcy and continues to operate because many of its business activities are sound. Andersen was convicted in a US federal court for shredding documents, knowing they might be used as evidence in legal proceedings. As a result, Andersen lost its credibility and lost clients. Moreover, Andersen lost its license to practice accounting in the State of Texas because of professional misconduct. While this applied only to Texas, such a loss destroyed the firm's credibility. Andersen had already announced its intent to cease to operate, and in the process it was able to sell most of its practices outside the US. There was no possibility of selling practices within the US because competing firms were not willing to pay for clients they could obtain for no cost. In 2005, the US Supreme Court overturned Andersen's criminal conviction and sent it back to the lower court for re-trial. The English-language media have emphasized that the Supreme Court did not exonerate Andersen from guilt and the media stated that it is likely that Andersen was in fact guilty of the crime. Nonetheless, it is highly unlikely the case will be re-tried because such a trial would be pointless.

Efficiency of Markets is Open to Question

For at least the last 20 years, the regulation of financial reporting in the US has been based on the assumption that markets are efficient, i.e. they will react immediately and in an unbiased manner to all publicly available information. The SEC adopted its approach to regulation based on the assumption that all investors have access to financial intermediaries, e.g. financial analysts, and that the financial intermediaries will automatically act in the best interests of their clients, which will be in their own best interest as well. Thus, the focus of reporting financial information has been on providing information to the financial market place, not necessarily to individual investors. However, the assumption that the best interest of financial analysts parallels the best interests of investors is now questionable.