August 2003

Inside Arthur Andersen: Shifting Values, Unexpected Consequences

By Susan E. Squires, Cynthia J. Smith, LornaMcDougall, and William R. Yeack

Financial Times Prentice Hall; 208 pages; $24.95;
ISBN: 0131408968
Reviewed by Francis T. Nusspickel

This book provides insight into the changes that took place within Arthur Andersen and which the authors conclude led to the firm’s demise in 2002. The authors, four ex-Andersen employees, attempt to apply the lessons learned from the fate that befell Andersen to the future of the accounting “industry” and a commentary on the Sarbanes-Oxley Act of 2002.

The first half of the book, after briefly recapping the Andersen trial and the Enron story, summarizes the history of Arthur Andersen & Co, mostly taken from the firm’s own publications. It highlights the legacy left to the firm by its founder, Arthur E. Andersen: one of integrity, high quality of work, and an unwavering commitment to “Think straight and talk straight,” the principle on which he built his accounting practice.

The authors present the theory that a cultural change within the firm resulted in a conflict of interest that compromised its obligation to protect the public interest. Citing internal and external pressures, they claim that Andersen adopted a “sales culture” that demanded and rewarded the generation of fees. This change, combined with rapid growth that increased the independence of local offices, resulted in higher levels of risk. The authors also put forth the popular belief that this quest for fees focused on the fast-growing consulting markets, creating a conflict of interest with audit clients that generated substantial consulting fees.

Considering the authors’ backgrounds, for the book to focus on Andersen’s sales culture is understandable. But the problem is probably not that simple. The demise of Arthur Andersen is far more complex, with many factors contributing to its downfall, only some of which the firm could control, although conflicts of interest plus poor risk management was clearly a formula for disaster. This confluence of factors resembles the perfect storm: Individually, these factors could possibly have been handled effectively; collectively, they proved insoluble problems.

The book overlooks the entire area of the quality of the practice. During the 1990s, Arthur Andersen and other large firms constantly reviewed their audit methodologies in light of the changing world of business. The “new economy,” with its rapidly expanding technologies and global operations, caused companies to become more complex and difficult to audit. Audits had to focus more on processes and controls, areas of perceived risk, and unusual transactions, because the volume of transactions made traditional audit techniques inadequate. Implementing these revised audit methodologies required audit staffs to have more extensive training and a higher level of experience. The authors do not address the adequacy of the audit practice. Were the new audit procedures adequate, and if so, were they effectively implemented? Or did the business world get ahead of the auditors? With many apparent audit failures over the past years by many firms, this point deserves attention.

They also fail to address the widely held view that politics contributed to Andersen’s demise. Were the SEC and the Justice Department waiting for the chance to make an example of a major accounting firm? If so, was it just unlucky for Andersen that one of its clients, Enron, was the first to provide such an opportunity? Was the Justice Department motivated to proceed against Andersen by the media circus surrounding the Congressional hearings of December 2001 and January 2002, or by White House efforts to divert attention from its connections with Enron officials?

Nor does the book address the prior litigation involving Andersen clients. The authors mention the Baptist Foundation of Arizona, Waste Management, Sunbeam, and others, but they focus on the firm’s sales culture and its apparent unwillingness to stand up to clients. They also ignore several important questions: What actions did firm management take to learn from past experiences? Were those actions, if any, adequate? Were the firm’s procedures to ensure audit quality sufficient to preclude situations like Enron, or were those procedures, adequate as they may have been, not followed by certain individuals?

Clearly the accounting profession must determine what is needed to regain the public trust. Its public image as a “trade” or “industry” and the audit fee conflict of interest are part of the problem. Even in situations where only audit services are provided to a client, the client still pays the fees. If this itself is it a conflict of interest, the alternative may be for auditor selection and payment to be the responsibility of the government or an independent agency, but this alternative has drawbacks as well.

The Sarbanes-Oxley Act attempts to address issues such as scope of practice, auditor rotation, employment of prior auditors, audit committee responsibility and makeup, and corporate officer responsibilities. Some provisions are more useful than others. A more basic issue is the body of accounting principles followed in the United States known as GAAP, which some people say should be replaced by a more conceptual body of principles, similar to the existing International Accounting Standards (IAS).

The answers to the accounting profession’s ills are not simple matters, nor are they covered in this book. It may already be too late for the accounting profession to take the lead in cleaning its own house, because someone else may be doing it for us.

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