Introduction
It was on 28th November 2001 that the then Andersen CEO Joseph Beradino received a phone call indicating that the justice department in New York City had commenced accounting scandal investigation in relation to the firm’s operation. This came as a surprise particularity to Beradino who was at the time upbeat about the future of Andersen. By the end of the year, Andersen was facing growing criticism as a result of the Enron scandal owing to the fact that this was not the first scandal that the firm was being attributed to. There had been a series of poor audit practice that had greatly tainted the company’s reputation and the general perception of the firm’s capability to conduct transparent accounting practices (Agrawal & Chadha, 2005). The Enron scandal became one of the largest accounting scandals in history, a situation that created a turning point for Anderson which was then faced with a series of legal suits regarding the sub-standard audit. The case study analyses all the scandals associated with Andersen and what should have been done differently to prevent the accounting fraud practices to take place. In addition, the paper will offer recommendations on accounting audit best practices to prevent similar scandals from taking place (Brown, 2005).
Relevant Facts
According to Agrawal & Chadha, (2005) most of the accounting scandals attributed to Andersen began in 1996 when the company was actively engaged in several audit practices with the business community and other auditing firms. However, the interpretation given for the lack of Andersen to fit effectively into the audit community is that there was a less strict regulatory framework by the government which was introduced in the 1930s and was still being used at the time. While the Security Exchange Commission was in the process of ratifying the older laws in relation to audit procedures, the major accounting firms were in constant conflict with the political elite of the government. Andersen itself was embroiled in various conflict with the SEC and was put under investigation over accounting fraud.
One of the major scandal to occur was the Waste Management Systems and that of Sunbeam. Between the two scandals, the Waste Management Systems is believed to be the most damaging to the firm’s reputation. Waste Management System which was one of the leading clients of Andersen did an audit after the actual audit had been taken by Andersen. However, the revised audit report indicated an overestimation of $1.4 billion over a period exceeding three years. This overestimation is considered as one of the largest restatement in the entire American history. “However, this restatement would second the Enron scandal that was found to have a restatement of almost double of what Waste Management Systems had” (Unerman & O’Dwyer, 2004).
Root of the Problem
A subsequent investigation by the Securities Exchange Commission indicated a massive cover up at Andersen which clearly laid the blame on Andersen. Andersen was able to resist investigations by invoking the document retention policy where it was decided that the company could retain some of the crucial documents that would have assisted with the investigations. The company would later use the same strategy to deny Enron scandal investigators crucial documents that would have otherwise shed some light to what had transpired in one of the largest accounting fraud in U.S history. Sunbean also insisted that there was restatement of its annual earnings over a range of two years at the time that Andresen was the accounting firm. Agrawal & Chadha (2005) are of the opinion that despite not being found guilty of any wrongdoing, it was evident that the company had engaged in a number of accounting fraud.
Problem Components
Another major occurrence that happened as Andersen is that its consultancy services split with the affiliated firm to form an independent firm in 2000. This happened after a lengthy arbitration process despite the split being attributed to the fading reputation of Andersen. The consulting firm that was affiliated to Andersen later formed an independent firm and named itself Accenture (Agrawal & Chadha, 2005). The company spent huge sums of money to try and reinvent itself from the shadows of Andersen. In fact, the company went ahead to install computers at General Electric making it one of the first company to do so. Despite the numerous setbacks and endless squabbles with its partners, Andersen was still a major firm in the accounting field. Petrick & Scherer (2003) state that Andersen would yet experience a wave of negative reputation owing to the sting of scandals attributed to the company.
Alternatives
With no one to lay the blame on, the partners and clients met to decide on the fate of the company’s management. Petrick & Scherer, (2003) indicate that the Security Exchange Commission was in the process of acquiring subpoena files from Andersen regarding the Enron case. This was after it was discovered that the accounting had overestimated the figures of Enron to a maximum historical figure that had never been experienced in the accounting field. Not only was Andersen under probation by the Securities Exchange Commission but the firm was also receiving a lot of attention from the media. It would be hard to try and repair Andresen’s reputation amidst growing criticism from key industrial players (Brown, 2005). So what really happened at Andersen and was the firm guilty of what it was being accused of?
In the cases involving Andersen, the government takes the greater share of the blame. At the time that Andersen was formed, there were weak legal structure governing not just accounting professionals but the entire financial sector. This might explain the near collapse of the country’s financial sector. Secondly, the Securities Exchange Commission concentrated in licensing firms without conducting due diligence on their credibility. Having been reported in previous scandals, what the SEC should have done is suspend the operations of Andersen until the issue was resolved in the cases involving Waste Management Systems and Sunbean.
Alternative Evaluation
Most of the scandals remained unsolved and the firm continued with its operations until another scandal would come up. “The Enron scandal is defined as one of the greatest scandal involving major firms in U.S history” (Nelson et al., 2008). The scandal which received a lot of media attention led to the infamy and bankruptcy of senior company executives, loss of reputation of Andersen and an overall financial effect on both the firms executives and thousands of investors. However, the case was a case of greed in the financing and banking sector which continues to draw legal battles up to date.
The senior executives of Enron and Anderson continue to claim their innocence stating that their actions in relation to the scandals were sanctioned by the respective company boards. While this has never been clarified, it was clear that there were major auditing malpractices involving senior managers at Andersen as well as Enron. Nelson et al observe that even before the scandal, Arthur Andersen who at the time headed the firm continued to write numerous report on the media stating that Enron’s accounts were accurate (2008). However, it would later be discovered that there was a massive overstatement of Enron’s accounts and at the time, Andersen was the auditing firm which can only imply that this was done with their knowledge.
Alternative Choice
The restatement of Enron’s income statements and balance sheets showed an abrupt discrepancy of no auditing having been taken for a long period of time. Enron had already paid Arthur Andersen approximately $50 million to undertake auditing at the firm. This figure is exclusive the figures paid the legal firms representing both firms in the transactions made. This implies that all those who participated in the scandal felt that they were well covered by the system and the chances of being detected were very minimal. Despite this assumption, the burden of responsibility was on Andersen who had clearly indicated that they lacked ethical accounting procedures as observed from previous scandals. So how can just one firm be involved in so many scandals and yet try to prove its innocence. In trying to avoid investigations, Andersen invoked the possession of documents clause. Brown (2005) observes that the documents relating to Enron’s case were later destroyed and Andersen was later sued for obstruction of justice.
Action Plan
Just like in the previous cases involving Sunbean, Water Management System, Enron and Baptist Foundation, there were traces of accounting fraud in almost all the cases. How Andersen was able to justify the audit process is still unexplained. Today, there are tighter regulations coming in the wake of uncertain economic times. The Securities Exchange Commission has more control over financing and banking institutions providing some legal foothold on some of the processes that take place in these institutions. Unerman, & O’Dwyer advice that the fall of Enron and the string of scandals involving Andersen should provide major lessons for the future (2004). It is assumed that the parties involved in the scandals were well aware of what was happening while those not aware involuntarily participated in the scandals (Petrick & Scherer, 2003).
To prevent the same from happening in the future, the pressure is on the federal government and the Securities Exchange Commission to formulate laws that cushion unsuspecting investors from company malpractices. “Some of the factors that influence various scandals is that investors create a perception that companies which appear to have a winning strategy should have their stocks overpriced” (Unerman, & O’Dwyer, 2004). Poor performers from an economic perspective have their stocks plunging down. This is exactly what was happening when Andersen was overstating the income statements and the balance sheets of the companies there were auditing. The stock prices of the said companies would automatically go up and this would appear to be a lucrative venture for the unsuspecting investors.
Alternative Choice
So what happens when the investors discover that they were duped about how much a company is profitable? The overstatement at Enron is one of the greatest in the U.S history. This means that probably, the company might have been worth a lot less of what it was thought to be. Unsuspecting investors however knew that they were buying stocks from a leading firm and thus they were willing to buy the overpriced stocks at whatever cost. Agrawal & Chadha (2005) are of the opinion that this was a lesson that appropriate measures should be put in place to ensure that companies’ audit should not be manipulated otherwise the nation will be staring at another near collapse of the financing and banking industry should another major scandal occur in the future.
References
Agrawal, A., & Chadha, S. (2005). Corporate governance and accounting scandals*. Journal of law and economics, 48(2), 371-406.
Brown, R. E. (2005). Enron/Andersen: Crisis in US accounting and lessons for government. Public Budgeting & Finance, 25(3), 20-32.
Nelson, K. K., Price, R. A., & Rountree, B. R. (2008). The market reaction to Arthur Andersen’s role in the Enron scandal: Loss of reputation or confounding effects? Journal of Accounting and Economics, 46(2), 279-293.
Petrick, J. A., & Scherer, R. F. (2003). The Enron scandal and the neglect of management integrity capacity. American Journal of Business, 18(1), 37-50.
Unerman, J., & O’Dwyer, B. (2004). Enron, WorldCom, Andersen et al.: a challenge to modernity. Critical Perspectives on Accounting, 15(6), 971-993.
