This paper examines the ethical and legal failures that led to the collapse of Arthur Andersen LLP, once one of the "Big Five" accounting firms in the United States. The paper reviews the mandated requirements for legal compliance and applies them to Arthur Andersen's conduct, including its failure to protect consumers and its role in the Enron financial scandal. It analyzes how the Sarbanes-Oxley Act of 2002, had it existed earlier, might have prevented the firm's misconduct. The paper also explores the elements of ethical decision-making — particularly ethical leadership — and considers how strong ethical leaders could have preserved the firm's integrity and prevented its ultimate downfall.
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The paper demonstrates applied ethical analysis: it takes an established ethical decision-making framework (ethical leadership qualities from Ferrell et al.) and systematically applies each element to a real corporate case. This "framework-to-case" method shows how academic theory translates into practical judgment about organizational behavior.
The paper opens with historical context before moving into four numbered analytical sections: (1) legal compliance requirements and how Arthur Andersen violated them; (2) the Sarbanes-Oxley Act and its hypothetical preventive effect; (3) the ethical decision-making framework elements relevant to the case; and (4) a counterfactual discussion of how ethical leadership could have changed outcomes. A brief conclusion synthesizes the lessons learned.
Arthur Andersen LLP was founded in 1913, and for over 90 years it grew to become one of the largest accounting and auditing firms in the United States, holding a reputation comparable to PricewaterhouseCoopers, Deloitte & Touche, KPMG, and Ernst & Young. By the 1980s, the Arthur Andersen name was synonymous with integrity, trust, and ethics — values critical to the success of any firm charged with auditing and confirming the accuracy of a company's financial statements, since that accuracy generally influences investors' decisions (Ferrell & Linda, 2012).
In the 1990s, Arthur Andersen became one of the fastest-growing accounting and auditing firms in the United States and achieved significant financial success. However, beginning in 2001, the company faced a series of lawsuits for accounting irregularities. In May 2001, "the company paid $110 million to settle claims brought by Sunbeam shareholders for accounting irregularities and $100 million to settle Waste Management shareholders over similar charges a month later" (Ferrell & Linda, 2012, p. 365).
This paper reviews the mandated requirements for legal compliance and determines how those requirements apply to the Arthur Andersen case.
Among the mandated legal requirements applicable to businesses are: laws regulating competition; laws protecting consumers; laws promoting equity and safety; laws protecting the environment; protection of workers within an organization; measures to reduce risk and promote an ethical culture within an organization; and incentives to encourage organizations to respect compliance programs.
One of the most directly relevant mandated legal requirements in the Arthur Andersen case is consumer protection law. Laws relating to consumer protection require businesses to deliver accurate information about their products and services and to follow applicable safety standards. For example, the Consumer Product Safety Act of 1972 "created the Consumer Product Safety Commission to establish safety standards and regulations for consumer products" (Ferrell & Linda, 2012, p. 98).
Arthur Andersen failed to protect its consumers with respect to the accounting services it delivered. In 2001, Sunbeam shareholders filed a case against the firm for accounting irregularities, forcing it to settle for $110 million. A month later, the company settled for $100 million on behalf of Waste Management shareholders over similar charges. With multiple cases filed against Arthur Andersen, it became clear that the firm had failed to protect those who relied on its services (McGlynn, 2010).
Mandated legal requirements also stipulate that private and public organizations must prepare accounting and financial statements in accordance with Generally Accepted Accounting Principles (GAAP), and that auditing and accounting firms must deliver objective opinions on the fairness of an organization's financial statements — including its income statement, balance sheet, and statement of cash flows. An accounting firm should express its opinion on whether its client's financial statements conform to GAAP (McGlynn, 2010).
Arthur Andersen failed to protect consumer interests, and many of the firm's business practices were unethical, ultimately contributing to its collapse. Enron Corporation was one of Arthur Andersen's largest clients, and "on November 8, 2001, Enron was forced to restate five years' worth of financial statements that Andersen had signed off on, accounting for $586 million in losses. Within a month, Enron had filed for bankruptcy" (Ferrell & Linda, 2012, p. 367).
The U.S. government enacted the Sarbanes-Oxley (SOX) Act in 2002 following the collapse of Enron, which shook the U.S. financial community. The SOX Act established new direction and guidelines that the corporate community must follow with regard to corporate and accounting responsibility. The act was specifically created to combat the accounting and securities frauds that rocked the U.S. corporate community in the early 2000s.
Had the SOX Act been enacted in 1999, it would likely have prevented Arthur Andersen from engaging in many of its unethical practices in the late 1990s and early 2000s. For example, Section 104 of the SOX Act would have required Arthur Andersen to properly verify the accuracy of its clients' financial statements. Section 104 prohibits illegal and questionable accounting practices and would have prevented Arthur Andersen from approving the improper financial statements of Enron Corporation and other similar companies. By adhering to the rules and regulations set by SOX, Arthur Andersen could have avoided the numerous cases that forced the company to pay damages running into hundreds of millions of dollars. Furthermore, SOX Section 204 would have prevented the companies whose financial statements Arthur Andersen audited from publishing misleading financial information.
This paper reviews the case of ethical scandal that emerged in 2001. The case reveals that Arthur Andersen participated in several unethical behaviors that ultimately led to the collapse of the company. The SOX Act of 2002 was enacted to prevent the type of unethical behaviors that disrupted the business community in the United States in the early 2000s. A key lesson from the Arthur Andersen case is that ethical conduct is not only morally necessary but also essential to long-term business survival.
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