Lessons Learned from the Arthur Anderson Scandal - Essay Example

Company Analysis: Number: Arthur Anderson Scandal Founding of Andersen LLP Arthur Anderson and Clarence Delanyfounded Andersen LLP. It was initially known as Andersen, Delany and Co. This was an accounting and auditing firm, which experienced tremendous growth to become one of the biggest accounting firms in the U.S (Martin and Arthur 112). Their activities were so effective that they regained people’s faith in the businesses after the great depression. Company’s Morals The company maintained a positive image in the eyes of the public. Arthur Andersen was widely known for integrity and honesty. This helped the firm to grow and ended up being one of the companies serving the greatest number of clients in the U.S. Those who worked with Andersen were aware of his motto: "Think straight, talk straight.” Andersen also played a big role in upping the standards in the U.S. accounting industry. Additionally, he was involved in innovation of new accounting standards that are still being used today. Andersen was active in social activities that also got involved in charitable organization as well in promotion of education. The firm spent large amounts of money into training new recruits (Martin and Arthur 127). This was crucial in stressing the company’s morals and its consistency around in offering and performing services. The company was admired by many people for the high morals exhibited. He became even more popular when he refused to engage in a fraud case when one of his prominent clients presented flawed accounting records. He chose to lose the client rather than committing fraud, as was the wish of the client. This had a positive impact since it increased his reputation and that of the company. Greed Begins During the 1980s, the company started experiencing internal friction. Then, there were two divisions making up the firm. These were the consulting division and the audit division. The latter was much more established although consulting was then growing much faster than any other portion of the company (Ferrell et al. 327). This unequal growth of the departments led to the conflict arising since the consulting division felt that they needed a bigger share of the firm’s profits. As a result, there were disputes between both divisions, with each side citing the other as being greedy and unfair. Both the audit and the consulting divisions were essentially separate companies. The consulting firm was under the ownership of Andersen. It paid a percentage of their earnings to the parent company (Ferrell et al. 329). Later, Andersen established another consulting division within his company. This new division competed with the other consulting department and this enabled them to retain all the earnings. Later the two sides split, forming separate companies. Fraud begins Andersen was involved in many cases, all of which he was accused of committing accounting fraud. Some of these companies included Sunbeam, Baptist Founding of Arizona, Quest Communication, Waste Management and Global Crossing. Surprisingly, Andersen was able to settle all these claims without admitting any existence of fraud. In case the claims got more serious and had nothing but to admit to fraud, the company put the blame on a few “corrupt partners.” However, the increased fraud cases were not favorable to the company as they were tarnishing the name of Andersen. Analysis It is clear that the continued unpunished behavior of the company’s activities led to a snowball effect that resulted in increased corruption at a high level. The accounting fraud issues had started small in the past. The activities went on unchecked until the management pushed the limits of the fraudulent deeds (Ferrell et al. 317). For a long time Andersen was generally viewed by many people as the symbol for integrity and honesty. Thus, most of these people thought that these fraudulent activities were not occurring at the high level of the firm. The Enron Scandal Enron Corporation was a global energy, commodities and service company that sold electricity and natural gas. It also delivered energy and bandwidth Internet connection as well as provision of financial and risk management services to various clients around the world. Fortunes Magazine named Enron as the most innovative company in America from 1996 to 2000 (Jennings and Marianne 67). However, the company’s reputation was undermined by widespread rumors on political pressure and bribery with the main objective of securing contracts around the world. Later there were series of scandals that involved irregular accounting methods. Consequently, in November 2001 the company was on the verge of undergoing a bankruptcy thought to be the largest in economic history (Markham and Jerry 35). Apparently, the company had a highly decentralized decision-making and financial structure (Jennings and Marianne 67). This was a major reason why it was practically impossible to get a coherent and clear view of the company’s activities and its operations. At the end of 2001, prior to the filing for bankruptcy, it was revealed that the company had reported financial condition substantially sustained by institutionalized, creative, and systematic planned accounting fraud. The Enron’s stock price had dropped from $90 per share to $1 per share from mid 2000 to the end of that year (Jennings and Marianne 67). Consequently, the shareholders lost nearly $11 billion. On revision of the previous five-year financial statements, the company found out that the losses amounted to $586 million. WorldCom Scandal The company’s origins can be traced back to as far as 1983. It was established by a team of investors who had quite big hopes in the telecommunication industry. Initially the company specialized in Long Distance Discount Services. Initially the company suffered a great deal of debts mainly because of the lack of technical experience. However, with enlisting of Bernard J. Ebber the company profitability improved drastically within a short time under Ebber’s leadership. The company became publicly known as WorldCom (Jennings and Marianne 87). By 1998, the company was experiencing tremendous growth under the leadership of Ebber, and Scott Sullivan who was the Chief Financial Officer. The problems started to arise because of the continued growth. Apparently, no stakeholder could have predicted the problems that the company encountered. In 1999, WorldCom made planed to attain Sprint. Unfortunately, the merger was terminated and as was to be seen later, this event led to fall of the WorldCom. Late on in July 2002, WorldCom Company filed for bankruptcy (Markham and Jerry 55). This was a result of a deliberately overstated tax income. The initial accounting statements accounted for almost $4 billion in overstated income. However, further investigation unearthed fraudulent activities amounting to over $70 billion. WorldCom accused their auditor, Andersen, for failing to find the accounting errors in the initial audits (Markham and Jerry 69). Andersen, on the other hand, claimed that the management in WorldCom did not disclose all the required financial information to give proper audit. Andersen’s Role in Enron scandal The revelation of massive accounting irregularities at Enron Company in 2001 made media and regulators focus on Andersen and their role in Enron misreporting of accounting information. Andersen was accused of committing extensive accounting errors that gave misleading information to investors (Markham and Jerry 46). He bound down to pressure and admitted that the audit firm was aware of the errors in the financial statement provided by Enron Management. However, they said that they felt the errors should not be included in the published financial statements since the company was earning huge revenues and this, together with the shareholders equity, would offset the errors (Markham and Jerry 72). Andersen reported company’s profits at such large amounts that it became difficult to reflect such sustained growth in the company’s books. During the third quarter of 2001, Anderson played a big role in the reported $ 1.2 billion in the books of accounts. However, Andersen went ahead claiming that the reported figures were an accounting error. This was not the case but the truth about the accumulated huge losses the company was making for several years. The audit company also disposed of Enron’s documents and other financial data to hinder any efforts to recover any information during the investigation. The act by Andersen violated various laws. It was considered by the investigator as obstruction of justice. Andersen’s Role in WorldCom scandal Arthur Anderson was the external audit of the company from 1990 to 2002. Initially the team was effective in the auditing of the company up until when the WorldCom started its massive expansion strategies that included increased mergers. Andersen focused his audits on analytical review as well as risk assessment. Although Andersen knew that the records supplied to him could have errors, he used the data provided by the company without confirming the accuracy of the records. However, he did not provide information of the high level of risk about this client. Despite these findings, his audit report depicted WorldCom as a moderate risk company. More Analysis Enron scandal revealed the mistakes that led to the collapse of Enron Corporation. Andersen allowed the management of the company to hide the errors in the accounting data until it could not be hide anymore (James and Linda 21). The management of the company did not see the magnitude of their scandals and they probably thought the problem would fix itself if they hide from the public. Andersen and the management of Enron spun off debts of the company into other special-purpose entities in an attempt to make Enron look financially better. The public were kept in the dark about these debts. Most of these investors thought that the stated profits were real whereas it was not. Enron and Arthur Andersen took advantage and exploited the investors’ confidence in public companies (James and Linda 22). Consequently, many people lost their retirement funds and their pension money. The act of hiding such information was an ethical issue since it ended hurting so many people. Apparently, the top-level management positions were the only ones that benefited from the scandal. The people in the management position at the company made profits from shares and stock options. They made sure they had sold off their shares, exercised their options before the collapse of the company. The many people who bought these shares lost out. The insider trading exhibited here is immoral since it is largely considered as stealing. Conflict of interest is evident all through this case. Arthur Andersen earned $1 million a week to perform audits and over $27 million as consulting fees. This was against the code of ethics since Andersen had a close and strong relationship with his client (James and Linda 22). Because of greed, Enron’s true and accurate financial position was revealed. In a capitalist society profit is a major characteristic. In most cases, the goal of maximizing profits overpowers moral reasoning, and this is what happened in this scandal. The management of both Andersen and Enron organizations took a narrow view and focused on personal profit maximization. Apparently, it is clear that they seem to have lost their responsibilities towards the shareholders. If they had taken a broader view and if they maintained their social responsibility, they could have created even more sustainable revenue for themselves (James and Linda 21). Consequences The collapse of Enron led to a series of actions against Andersen for the role they played in the scandal. Firstly, the company was charged in the court of law with obstruction of justice. This was seen whereby the companies employees had destroyed documents and all information related to Enron Company accounting in an attempt to hinder investigation. Initially they were found guilty of the act but later they saw that judgment reversed (Arbogast and Stephen 123). It was held that there was no enough proof that the documents were destroyed because of the company’s wrongdoing. There were many lawsuits filed by the Enron’s investors and its employees against Andersen for the loss they suffered because of the company’s fraudulent audits. These lawsuits totaled at $25 billion were brought up against the company, although they only ended up paying $60 million claims (Arbogast and Stephen 125). Aftermath Andersen Company suffered great losss because of the fraudulent doings that left devastation among various stakeholders of the companies affected by these crimes. At one point, the company had over 28,000 employees (Arbogast and Stephen 215). After the scandals, the company currently had less than 200 employees who are mainly responsible for dealing with existing lawsuits. Initially the company had so many clients but all walked out on Andersen when they lost credibility in the company and the industry as well. Most companies did not want to have any further involvement with Andersen to avoid tarnishing the companies’ names. That was not enough since Andersen suffered other losses. These included having their license revoked in a number of states. After all this, the company voluntarily made a decision to give up the right to practice. After the Enron scandal was uncovered, it revived prior accounting scandals, which Andersen had been involved in. Such cases included Sunbeam which reissued cases against the audit firm now that they were having proof of illegal activities committed by Andersen (Arbogast and Stephen 125). Consequently, Andersen paid millions of dollars to these companies. However, Accenture (Andersen twin consulting division) survived since it had split from the company and was under different management. The split act proved to be a good idea. Lessons learned from the case A study of these cases provides useful ideas that would prevent such scandals from occurring again. Some of the lesson learned is the requirement of having several external accounting firms to perform audits (Arbogast and Stephen 145). This would lead to highly accurate reports that show the true position of the firm being audited. Secondly, the senior executives should be more accountable and the company should institute policies that see to it every issue is taken care of before it is too late. A system is necessary to supervise the executives and yet get the idea of operating situation (Arbogast and Stephen 145). Increased governance from the board could have saved these companies from these scandals. In addition, the board should pay close attention to the activities of the management of their behavior and the way the company makes money. Since Enron’s fall had a bad effect on the entire economy of the U.S, the government should make better regulations that guard against such cases. Lastly, the audit firm should be picked by independent and outside influences that do not have strong relationship with the company (Arbogast and Stephen 146). This would ensure that there is no kind of conflict of interest in auditing. Works Cited Arbogast, Stephen V. Resisting Corporate Corruption: Lessons in Practical Ethics from the Enron Wreckage. Texas: M & M Scrivener Press, 2007. Print. Beasley, Mark S., and Frank A. Buckless. Auditing Cases. Pennsylvania: Pearson/Prentice Hall, 2006. Print. Carmichael, D.R., and Paul H. Rosenfield. Accountants' Handbook. Chicago: John Wiley & Sons, 2003. Print. Ferrell, O.C., John Fraedrich, and Linda Ferrell. Business Ethics. New York: Cengage Learning, 2005. Print. Fridson, Martin S., and Fernando Alvarez. Financial Statement Analysis: A Practitioner's Guide. New York: John Wiley and Sons, 2011. Print. Gaa, James C., and Linda Thorne. "An Introduction to the Special Issue on Professionalism and Ethics in Accounting Education." 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The Arthur Andersen Guide to Talking with Your Customers. Texas: Upstart Publishing, 1997. Print. Read More