SEC and Andersen Reach Record Settlement in Audit Fraud Case

On June 19, the SEC announced its finding that Andersen’s audit reports on financial statements for Waste Management, Inc., were materially false and misleading and that the Big Five firm had engaged in improper professional conduct. Without admitting or denying the allegations or findings, Andersen agreed to the first antifraud injunction in more than 20 years and the largest civil penalty ever in an SEC enforcement action against a Big Five firm—$7 million. Andersen further agreed to be censured under the SEC’s rules of practice.

The SEC had alleged and subsequently found that Andersen had knowingly or recklessly issued materially false and misleading audit reports on Waste Management’s annual financial statements from 1992 to 1996. According to the SEC’s statement, Andersen’s audit reports on Waste Management falsely stated that the financial statements were presented fairly and in conformity with GAAP and falsely stated that Andersen’s audits were conducted in accordance with GAAS. According to the SEC, Andersen overstated Waste Management’s pre-tax income by more than $1 billion. Andersen had issued unqualified or “clean” opinions.

Three Andersen partners consented to entry of antifraud injunctions and monetary penalties and consented to settle related administrative proceedings. A fourth partner, a regional practice director, settled administrative proceedings for improper professional conduct and agreed to a bar from appearing or practicing before the SEC, with the right to request reinstatement after one year. Without admitting or denying the allegations, each of the three partners agreed to the entry of an antifraud injunction, to the payment of a civil penalty, and to a bar from appearing or practicing before the SEC as an accountant—one with the right to request reinstatement after five years and two with the right to request reinstatement after three years.

“Arthur Andersen and its partners failed to stand up to company management and thereby betrayed their ultimate allegiance to Waste Management’s shareholders and the investing public,” said SEC Director of Enforcement Richard H. Walker. “Given the positions held by these partners and the duration and gravity of the misconduct, the firm itself must be held responsible for the false and misleading audit reports issued in its name. … Accountants play a critical role in providing access to our capital markets. We will not shy away from pursuing accountants and accounting firms when they fail to live up to their responsibilities to ensure the integrity of the financial reporting process.”

In connection with the audit of Waste Management’s 1993 financial statements, Andersen proposed a series of “action steps” that would change the company’s improper accounting practices in future periods and to write off its prior misstatements over a five- to seven-year period, rather than immediately correcting them in accordance with GAAP. Andersen also allowed Waste Management to, in Andersen’s own words, “bury” certain charges by improperly netting them against unrelated, one-time gains. Andersen told Waste Management that its use of netting was an “area of SEC exposure” but nonetheless allowed it to occur. When the misstatements were ultimately revealed, Waste Management announced the largest restatement in American corporate history. In issuing an unqualified audit report on the restated financial statements, Andersen acknowledged that the financial statements it had originally audited were materially misstated.

Although the SEC’s complaint and its settlement action with Andersen made no mention of auditor independence violations, acting SEC Chairman Laura Unger commented in a June 26 Wall Street Journal article that the SEC now had a “smoking gun” illustrating a clear instance where an auditor’s independence was compromised. In the course of the SEC’s independence rulemaking project last year, many critics said that no evidence could be presented that providing audit clients with nonaudit services compromised auditor independence. “[Andersen and Waste Management] is at least one significant case that we can point to,” Unger said.

The Wall Street Journal quoted Andersen spokesperson David Tabolt as criticizing Unger’s comments: “It’s regrettable that the SEC is making serious allegations that were never made in the complaint and that weren’t part of any settlement discussion. … The fact of the matter is there was no independence violation and the SEC had no case to make one.” According to the Wall Street Journal article, when asked why the SEC’s complaint didn’t formally accuse Andersen of auditor independence violations, Unger replied, “Because it was a settled action.” She then declined to comment on whether dropping allegations of auditor independence was part of the settlement negotiations between the SEC and Andersen.

Broader Implications for the CPA Profession?

Commenting on the SEC-Andersen settlement, Rona L. Cherno, chair of the NYSSCPA Professional Ethics Committee, said, “The Andersen case is only one case, and you really can’t generalize. [The committee is] working to create a reenergized climate for focusing on accounting standards. As professionals we need to be more aware of the demanding role of reporting on our clients and of serving the public and readers of financial statements.”

CPA Journal editorial board member and “SEC Advisor” editor Gary Illiano, partner and northeast regional director of professional standards at Grant Thornton, sees the settlement as “an indication of the SEC expanding its ‘auditing-the-auditor’ role. We’ve started to see the SEC coming in and asking auditor-type questions at the capital-raising phase. They’ve definitely stepped up their scrutiny of auditors, and as we see in the Andersen settlement, gone after four individuals, including one national office partner.

“All of this paints an unjust picture of the profession,” said Illiano. “It makes it seem like auditors are a bunch of knuckleheads. I don’t think the profession can do much directly to counteract the ‘black eye’ that this type of news gives us. Firms will probably look at this and ask themselves, ‘Are we executing audits properly, and generally doing self-evaluations to make sure we’re doing the right thing?’ The vast majority of auditors are trying to do the right thing, and they suffer along with the bad ones.”

The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.