Arthur Andersen's role in the Enron scandal and audit reform

Enron and Arthur Andersen
1.  The parties most responsible for the crises were first and foremost the FASB—the Financial Accounting Standards Board. The FASB had permitted the 3% rule for SPEs and essentially provided companies like Enron with a legalistic loophole for hiding losses. Had the FASB been more stringent, the Enron debacle could have been avoided. However, Andersen also bears some responsibility because it, like other accounting firms, had gotten greedy and overextended itself by offering consulting services where it should have been only offering accounting services. Acting as a consultant on how to set up SPEs, the firm was remiss in auditing those same SPEs. However, the failure starts at the top. If there is going to be a regulatory body like the FASB then it should be regulated—but it was not doing its part.

2.  Consulting services audit firms are from prohibiting from providing clients that are public companies include: 1) consultation on big-fee financial information systems design and implementation of or information on IT—the risk being that the audit firm will look the other way at issues that should be made public; 2) internal audit outsourcing—the risk being that the company lacks controls; and 3) expert services—the risk being that the audit firm stops auditing altogether.

3.  The Powers Report showed that the audit firm failed to think and speak clearly. It should have clarified anything obtuse and if the client was unwilling to do so, the client should have been dropped. The audit firm also should have brought irregularities to the attention of the Board and the audit committee. Andersen also was engaged in a conflict of interest by providing consulting on SPEs at the same time it was supposed to be auditing these.

4.  Working papers are the property of the auditor. They should show that there was a clear auditing objective, i.e., an audit assertion; they should also show when the audit was completed (year and date) so as to provide accurate documentation of the audit; the extent of the audit test, i.e., what was tested and how the number was determined, which will allow future auditors to assess the sufficiency of the audit; whether another working paper was referenced and, if so, where that working paper can be found; what the results were, free of bias.

5.  Five recommendations made to strengthen the independent audit function following the Enron scandal would be: 1) eliminate all consultation services—consultation presents a conflict of interest and should be avoided; 2) all irregularities should be reported to the board/audit committee—this is the responsible/ethical course of action; 3) the outsourcing of the internal audit function should not be permitted—this suggests a lack of internal controls; 4) the audit firm should not be facilitating the structuring of SPEs but should rather be auditing them—this ensures the integrity of the audit; and 5) the result should reflect the reality—i.e., think straight and speak straight. Of the five recommendations, the ones implemented were that consulting services were limited by Sarbanes-Oxley and that internal controls have to be implemented.

6.  There has not been a significant shift or evolution over the past several decades in the concept of professionalism as it relates to the public accounting discipline. If anything, it has only been backsliding more and more over the years. Beginning with the Nixon Shock of the 1970s, the idea of credibility and responsibility basically went out the window. Everyone became all about gaming the system in whatever way they could at that point. Regulations were seen more as obstacles to overcome rather than as principles to abide by. Faking the data became acceptable since the FASB itself seemed open to the idea with its 3% rule. The name of the game was making money however possible and if one could double one’s revenues by “consulting” then that was what one should do. The world became a business and the business became all about subterfuge and trickery, deceiving bagholders down the line and not worrying about whether one was being honest or deceitful. The FASB is to blame for part of this, but firms like Andersen and companies like Enron should also have known better: they were actively engaged in defrauding the public and that is never acceptable.

7.  Audit firms give a degree of authority and security to investors by auditing quarterly reports. If they are not involved in the process, investors have no way of knowing if the company is reporting the facts or not. Quarterly reports should be audited—why not? A public company has a responsibility to its shareholders, and if shareholders are going to be abused because there is no law governing the matter, they should not be invested in the company in the first place. Audited quarterly financials would give shareholders a better sense of what is going in with the company’s statements and practices versus waiting for the year-end audit. It would also put more pressure on the company to actively monitor internal controls to make sure they are being implemented.