Arthur Andersen was once known as a “Big Five”, being one of the top accounting firms. These firms and their chartered accountants had solid reputations and were engaged by some of the largest clients to provide audit and attestation services. However, by the end of 2002, Arthur Andersen was facing federal indictments and an irreparably tarnished reputation. How did this prestigious firm of accountants fall from grace so quickly? There were four key mistakes that led to the accounting firm’s downfall.
Over-Focus on Consultation Services
The 1980’s and 1990’s were a time of mergers and acquisitions in many industries. This changing and fast-paced environment created a need for consulting services, which Arthur Andersen stepped up to provide. These consultation engagements were more lucrative than auditing and attestation engagements. The firm began to experience tension between the audit partners and the consulting partners, and the consulting side eventually split away from Arthur Andersen to become its own firm. Audit partners then began to feel pressured to obtain these lucrative consulting engagements, which then led to a focus more on profits than reputation.
Over-Focus on Profits
Arthur Andersen was built on a solid reputation of principles and integrity. Unfortunately this moral foundation began to falter in the 1990’s with the revelation of accounting scandals at a number of Arthur Andersen’s clients, culminating with the fraud perpetrated by Enron. This fraud would be the undoing of not only Enron, but Arthur Andersen as well. Arthur Andersen’s focus on profits and growing its consultation practice began to create a number of conflicts of interests for the firm, leading to even more problems.
Conflicts Of Interest
In addition to the conflicts of interest from providing both consultation and audit services to the same client, additional conflicts of interest were rampant between Arthur Andersen employees and the businesses they were auditing. For example, a large number of Enron managers were former Arthur Andersen employees. Arthur Anderson’s accountants who were on the Enron engagement turned a blind eye to concerns, even going as far as granting Enron’s requests to remove auditors the company did not like or who questioned their accounting practices. It especially didn’t help that Arthur Andersen began shredding important documents when they realized they were going to be investigated.
Arthur Andersen became arrogant, perhaps believing they were too big to fail. Early on, the Justice Department expressed a desire to look at settlement options, but Arthur Anderson refused. Ultimately, the accounting firm was found guilty of obstruction of justice. This conviction precluded Arthur Anderson from auditing public companies, which ultimately resulted in their demise.
The business climate has changed vastly since Arthur Andersen scandal. The scandal, in fact, had much to do with this. Many rules and practices were implemented to help ensure that accounting firms meet their professional and ethical obligation to investors and creditors. US also began shifting from rule based accounting guidelines towards accounting guidelines that rely more on professional judgement such as IFRS.