Auditing & Ethics: Arthur Andersen's Debacle

Ethics is the core of all auditing.

How Arthur Andersen fell apart…

October 12, 2001:
4 days before Enron disclosed a $618 million loss for the third quarter (this being their first public disclosure of financial problems) – workers at Andersen received a memo to destroy all audit material, except for the most basic “work papers.” RED FLAG?

November 8, 2001:
The first Security and Exchange Commission subpoenas were issued on this date. Supervisors kept reminding employees their destruction responsibilities in the weeks leading up to this date.

At the time, there was no rule for how long accounting firms must hold on to papers, but its standard was to hold many of them for several years.

"Anyone who destroyed records out of stupidity should be fired," said committee chairman Billy Tauzin, a Louisiana Republican. "Anyone who destroyed records to try to circumvent our investigation should be prosecuted."

Ethics definitely comes into play here. There comes a time (especially in auditing) when you have to take a good look around you and decide if what you are doing is right. The statement above is true, but how do you choose who was just blindly following the pack and who knew what they were doing?

In 2002, Anderson was convicted of witness tampering for shredding documents related to its audit of Enron. The firm agreed to surrender its license and its right to practice.

In 2006, The Supreme Court unanimously overturned Andersen’s conviction due to flaws in the jury instructions. According to the court’s view the instructions allowed the jury to convict Anderson without having proof that the firm KNEW it broke the law. Also, there was no proof that there was a link of any official proceeding that prohibited the destruction of documents. This is where the Sarbanes-Oxley Act comes into play.

The Sarbanes-Oxley Act (Also known as SOX) is the direct result from the Enron and Anderson scandal.

There is now an established law that requires you to hold onto documentation for a secure amount of time.

Sec. 802(a)(1) "Any accountant who conducts an audit of an issuer of securities to which section 10A(a) of the Securities Exchange Act of 1934 (15 U.S.C 78j-1(a)) applies, shall maintain all audit or review workpapers for a period of 5 years from the end of the fiscal period in which the audit or review was concluded."

Another law is directly related to the destruction of documents.

Sec. 802(a) "Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both."

Aftermath:
So Andersen is no longer convicted…does it all go back to normal?

No. Reputation is key in auditing. Although they may have been deemed innocent, they in no way APPEARED innocent, which is just as important.

The firm had lost nearly all its clients when it was indicted, and they couldn’t climb out of that hole. They still have a few employees left but the majority of their work is dealing with numerous lawsuits.