Andersen LLP: Questionable Accounting Practices - Essay Example

Abstract Arthur Andersen LLP, one of the five famous accounting firms lasted in business from 1913 to the end-of August 2002. The downfall of the firm was brought about by collective effects of, a number of clients going bankrupt (or closer to it) and ensuing doubts about the credibility of the relevant audits conducted by the Arthur Andersen LLP. Three questions have been answered to the best of my ability. Questions and Answers Question No. 1 Describe the legal and ethical issues surrounding Andersen’s auditing of companies accused of accounting improprieties? Answer : Legal and Ethical issues: Auditing of companies by Andersen Arthur Andersen LLP was a well-known Chicago based accounting firm. The firm started the business of accounting in 1913; when founded. After about Ninety years, by the end of August 2002, the firm was convicted of a felony and it was forced to close its doors (Ferrell, Fraedrich, and Ferrell, 2005). Trust, integrity and ethics are values crucial to any of the firms charged with independent auditing and confirming the financial statements of public corporations. Arthur Andersen LLP, for most of its active business years, exhibited undeniable integrity in the accounting profession; reduction of useful life of mainframe IBM computers (in 1970) for the purpose of depreciation was an outstanding example, which others had to more or less follow (Ferrell, 2005). High profile bankruptcies (or some other troubles) of Andersen client companies in tandem raised questions about the quality and work ethics of the firm. Following companies were in trouble from mid-nineties to August, 2002. Baptist Foundation of Arizona (BFA) filed for Chapter 11 Bankruptcy 1999. Sunbeam Corporation filed a voluntary petition in the U.S. Bankruptcy Court for the Southern District of New York, for chapter 11 bankruptcies, in February 2001. However, in August 2002, Sunbeam came out of Bankruptcy protection. Then, Security and Exchange Commission (SEC) Complaint against Waste Management‘s questionable accounting practices around 2001, had adverse effect on reputation of Andersen. Newly appointed CEO of Andersen LLP, Joseph Berardino, had to had to tackle a number of law suites on behalf of Andersen LLP, relevant to firms auditing practice in the U.S. Andersen paid huge amounts to settle claims by the client companies. Andersen paid $110 million to in May 2002, to settle claims of the Sunbeam investors. Shortly after this, Andersen LLP had to pay $100 million to settle similar claims by investors or shareholders of Waste Management. In the meantime, public discovered the overstatement of earnings by Enron. This was disastrous and it shocked the financial market. Many of the firms, including clients of Andersen were asked to restate earnings. The case of Enron was the biggest and the final punch for Andersen. Further to Enron case, Ferrell states, “Unfortunately for Andersen, the accusations of accounting fraud did not end with Enron” (Ferrell, 2005). Subsequent cases of telecommunication firms WorldCom, Global Crossing and Qwest Communications were equally bad for Andersen. Repeated involvement of Andersen LLP in malpractices in auditing proved disastrous. Also the firm was de'facto accused of wrongfully covering up the questionable financial declarations of the client firms. This was not acceptable to the regulators. On the ethical front, it was concluded that Arthur Andersen indulged in accounting irregularities and fraud, specifically in the nineties. It was obvious that Andersen was more concerned about its own revenue growth than where the revenue came from. Its independence as an auditor had been compromised. On the legal front, Andersen was indicted for shredding of Enron related documents; it was adjudged to be obstruction of justice. However, later in 2005, U.S. Supreme Court annulled this conviction. By that time damage was done and Andersen was out of auditing business for about three years. Question No. 2 What evidence is there that Andersen’s corporate culture contributed to its downfall? Answer : Contribution of the Corporate culture to the downfall of Andersen LLP Philosophy of combining auditing and consulting services goes in contrast to the philosophy of uncompromising insistence on auditor independence. Following the death of Arthur Andersen, Leonard Spacek joined Arthur Andersen LLP, in 1947. He strictly believed in auditor independence; in the later years this changed. Andersen was providing consulting services to big clients like; General Electric etc in the 1950s. Ferrell says “The primary responsibility of an auditor is to express an opinion on a client firm’s financial statements after conducting an audit to obtain reasonable assurance that the client’s financial statements are free of material misstatement. It is important to note that the financial statements are the responsibility of a company’s management and not the outside auditor” (Ferrell, 2005). Andersen, the firm increased its focus on its own growth. This resulted in a big change in the corporate culture of the organization. The company linked its auditing and consulting business arms in joint cooperative relationship. This action compromised its auditors’ independence. This lucrative full service strategy posed ethical dilemma for Andersen and its partners. About the court proceeding of 2002 relevant to Andersen, In June 2005, Barry Tarlow provided some further insight in to the corporate culture of Andersen LLP. Prosecution believed Andersen corporate culture was so degenerated that it not only supported financial fraud of Enron but also helped them to sustain it. There was evidence, that many of the ex-employees from the accounting staff of Andersen LLP, were employed by Enron with obvious objectives; for example Chief Accounting Officer and Treasurer of Eneron, during this period, was an ex-employee of Andersen LLP. In one case atleast, Andersen LLP stopped and removed an accountant from the auditing assignment with Enron because Enron had disagreed to his auditing advice (Tarlow, 2005). For the year 2002, Andersen LLP had the projected revenue of $ 100 million relevant to Enron, the client of the firm. It was obvious that part of the Enron ailment had spread at least amongst some staff of Andersen LLP. Both organizations were sharing upper level of staff, to maximize their illegal gains. Further to it, Barry Tarlow says, “As part of its close relationship with Enron, the firm helped the company create special purpose entities, or “SPEs,” known as “the Raptors” to hide income and losses and to engage in cloaked “transactions with ‘LJM,’ an entity run by Andrew Fastow, Enron’s Chief Financial Officer.” Id., at 285. These insider transactions ostensibly occurred out of the public eye, in a way that some of the firm’s Chicago partners told Duncan ran afoul of the rules. Id. Yet the firm did nothing to stop it.” (Tarlow, 2005). Going through the history of the Andersen in a chronological fashion, it is obvious that in almost all cases the decay or change in the corporate culture was behind wrong practices of its auditors. In almost all of the trials and hearings the accusing finger was pointed on the audit-quality or intentional-cover given by Andersen auditors to the involved firm. Whether it was Baptist Foundation Arizona (BFA) or finally Enron, the story was same. In all cases the intentional or non-intentional neglect was obvious. Behind all the trouble was the bad corporate culture of the firm. A further testimony of the involvement if the corporate culture, is the enactment of Sarbanes-Oxley Act, in the immediate aftermath of the Andersen/ Enron case. Question No. 3 How can the provisions of the Sarbanes-Oxley Act help minimize the likelihood of auditors failing to identify accounting irregularities? Answer : Reduction of Audit and Accounting Regularities by Sarbanes-Oxley Act The Sarbanes-Oxley act was signed for print on 24 July 2002 and became law on 30 July 2002. Highly significant legislative changes to regulation of corporate governance and financial practices were enacted. New rules were established for protection of investors through improvement in accuracy and reliability of corporate disclosures. The enactment of the Sarbanes-Oxley act was in the wake of high profile scandals like Enron case. It was designed to prevent and punish corporate and accounting fraud and corruption, and protect the interests of innocent workers and shareholders. A remarkable aspect of this legislation is that its enactment is well known in public due to exposure through the media. The public focus has been intense and therefore, compliance is a must; there is no escape. This act also protects employees of publicly traded companies who report violations of Securities and Exchange Commission regulations or any provision of federal law relating to fraud against the shareholders. Implementation of various sections of this law results in correct actions by relevant actors like the accounting auditors. This also results in avoidance of questionable practices by them. The actions through various important sections of the act are as follows. Section 104: relevant to inspection of registered public accounting firms, to verify accuracy of financial statements, and to prevent wrong accounting practices. Section 201: relevant to prohibition of activities outside the scope of auditors, to restrict auditors to auditing activities only, and to prevent fostering of relationships with a purpose to prevent compromising of audits, for more revenue. Similarly other sections of the Act deal with: Audit partner rotation, reporting of auditors to Audit Committee, assigning corporate responsibilities for financial reports, improper influence on conduct of audits, management assessment of internal controls. Besides that Title VII: Corporate and Criminal Fraud Accountability Act of 2002 makes it a felony if any of the federal investigations is impeded. Section 1102: relevant to tampering with a record or otherwise an official proceeding is to prevent others from attempting to interfere in an official investigation (Ferrell, 2005). Although Sarbanes-Oxley (SOX) act was designed in almost immediate reaction to cases like that of Enron, yet it has been well designed, to prevent wrong practices and frauds in the audits. It also aim to control the do’s and don’t s of the corporate culture. There is also evidence of the use of management and quality assurance procedures and standards like ISO 9001 for development of toolkits for SOX compliance. If I may be permitted to quote from a web-source browsed on 10 April 2009, “On January 28, 2003, the Securities and Exchange Commission (the “SEC,” or the “Commission”) issued final rules pursuant to Section 208(a) of the Sarbanes-Oxley Act of 2002 (the “Act”) designed to enhance auditor independence requirements. The article gives an overview of the newly adopted rules, prohibited non-audit services, permitted non-audit service — tax service, audit committee pre-approval of services provided by the auditor, disclosures to investors of services provided by the auditor, Audit Partner Rotation and Compensation and auditor communication with audit committee.” The act seems to have the capacity to ensure the least likelihood of auditors failing to identify accounting irregularities. However, there will always be a room for further improvement. References Cullen J (1999). Managing Ethical and Social Responsibility: Challenges for Multinational Companies, in Multinational Management, A Strategic Approach. International Thomson Publishing. Deresky H (2000). Managing Interdependence: Social Responsibility and Ethics in International Management, Prentice Hall. Ferrell O. C., Fraedrich J and Ferrell L (2005). Business Ethics: Ethical Decision Making and Cases, 7th edition. Houghton Mifflin. Tarlow B (2005). Corrupting The Meaning Of 'Corruption': Supreme Court To Decide Whether Advocacy Is A Crime, RICO Report June 2005, Page 51, 09 April, 2009 Web Page, browsed on 10 April, 2009 Read More