Ethical Challenges Faced by Arthur Andersen LLP

Arthur Andersen
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Arthur Andersen
Background
Arthur Andersen LLP was an American accounting firm providing auditing, consulting, and tax services to large corporations. In the 1990s, the public accounting firm was one of the “Big Five” accounting firms with more than 85,000 staff and offices spread all over the globe. However, accounting scandals of the late 1990s and early 2000s would cause irreversible damage to the multinational corporation’s reputation and ultimately lead to the firm voluntarily losing its CPA license to practice. Towards the end of the 1990s, Arthur Andersen found it increasingly difficult to balance its commitment to audit independence and its aspiration to expand its consultancy services. At the same time, the company was struggling to maintain its fidelity to accounting standards and its clients’ wishes to maximize profits.
These conflicts of interest would see the company become embroiled in several accounting and auditing scandals, including the Waste Management Inc. and Sunbeam Products cases in the early 2000s. However, the infamous Enron case would become its biggest accounting scandal and lead to the demise of the company. Arthur Andersen was found guilty of failing to detect, ignore, and approve accounting frauds for Enron Corporation, an American energy company that was involved in extensive accounting and corporate fraud for four years (Connell, 2002). The public accounting firm failed to fulfill its professional responsibilities when auditing Enron's financial statements, over and above, obstructed justice by destroying evidence of its misconduct by shredding documents related to Enron. This essay will focus on the Enron scandal and the ethical issues that contributed to one of the largest corporate bankruptcies in America.
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After Congress approved the deregulation of the sale of natural gas, the resulting markets allowed energy companies like Enron to capitalize on gas contracts by selling energy at exorbitant prices and generating large revenues. In an attempt to diversify, the company owned and operated various assets, including electricity plants, broadband services, and paper and water plants all over the world. This expansion strategy would see Enron become one the fastest rising companies and was widely hailed as the most innovative company in America. However, the company was banking on the flourishing dot-com bubble by selling exaggerated internet stocks to trading partners through its electronic trading website (Albeksh, 2016). When the dot-com trend started waning in the early 2000s, most of Enron's speculative business ventures proved disastrous. In order to indicate good performance, the energy company began using market-to-market accounting to conceal financial losses.
The lax regulatory environment in the stock market, as well as the corporation's complex business model and corporate governance, ensured that most investors remained oblivious of the unethical practices used by Enron to continue attracting investors through its exorbitantly priced stocks. These fraudulent corporate and accounting practices would continue until the eventual burst of the dot-com bubble, when the company's stocks started falling. Serious concerns began emerging about Enron's possible bankruptcy and manipulation of standard accounting practices to hide its history of financial losses (Reitenga et al., 2010). Even though Enron employed several CPAs to identify loopholes that would allow it to conceal billions of dollars in debt from its failed projects, the SEC investigation revealed gross violations of accounting practices both inside and outside the company.
The main ethical challenge that was faced in the Enron scandal is that of conflicts arising when CPAs receive lucrative fees and perform dual roles for one client. Arthur Andersen was Enron’s auditor since the early 1980s when the energy company made the switch from a pipeline operator to an energy trader. As an external auditor, Arthur Andersen had a responsibility to provide a judicious guarantee that audited financial reporting for Enron was devoid of any material misstatement and that all financial, as well as accounting records, were truthful and fairly presented. In order to do so, the external auditor must be independent and free of any conflicts of interest in the audit client. However, this was not the case since Arthur Andersen was performing the dual roles of auditor and consultant, for which it received large sums of money as fees. It is established that the public accounting firm was paid $27 million for consulting services and $25 million for audit work. Moreover, the company's lead auditor had a yearly performance target of 20% growth in sales, and therefore there was every incentive to ignore Enron’s high-risk accounting practices and accounting manipulations (Boyd, 2004).
The economic bond between Arthur Andersen and Enron impaired the former’s capacity to be impartial and fulfill its auditing duties reasonably. Hefty payments may have affected the quality of the company’s audit work as the company’s leadership sought to generate more revenue for its consultancy service. Arthur Andersen’s management was willing to risk its reputation by overlooking Enron’s fraudulent off-books financial entities, over and above, employing strategic incompetence to avoid uncovering extremely sophisticated financial vehicles designed by its client to hide financial losses and corporate fraud. The SAS guidelines before 1997 did not oblige auditors to look for fraud actively but only to report it if they happened to discover the same. Arthur Andersen could still claim ignorance of Enron‘s corporate and financial misrepresentations. The company’s management also instructed the shredding of Enron’s documents amidst an impending SEC investigation to hide its complicity in the widespread fraud (Healy & Palepu, 2003). One of the firm’s lead accountants and lawyer orchestrated a campaign to obstruct justice by instructing the audit team to use the document-retention policy to destroy all incriminating documents.
As Enron’s accounting came under government scrutiny, Duncan sent emails with an Internet link to the document-retention policy to several branches in Houston, Portland, London, Chicago, and London as a signal to begin destroying all Enron records that would implicate the accounting firm’s participation in the fraud. According to court proceedings, the wholesale destruction of Enron documents started more than two weeks before Enron was subpoenaed by SEC. Fortunately, the firm’s attempt at obstructing justice was later revealed, thereby proving that the firm’s leadership was indeed aware of Enron’s financial misrepresentations but overlooked the fraudulent activities of its clients because of the lucrative fees it was receiving. The firm was found guilty of not fulfilling its professional obligations in relation to its audits of Enron’s financial statements but was only convicted of obstructing justice by destroying Enron documents while aware of an ongoing federal investigation. Arthur Andersen was fined the maximum penalty of $500,000 and five years of probation (Healy & Palepu, 2003).
In order to prevent similar ethical violations, the government enforced stricter corporate governance laws by passing the Sarbanes-Oxley Act, which resulted in the creation of the Public Company Accounting Oversight Board (PCAOB). The autonomous, non-governmental entity was tasked with instituting auditing standards and monitoring CPAs that audit the financial statements of publicly held companies. Before the Sarbanes-Oxley Act, the auditing profession enjoyed a self-regulatory process where peer reviews performed the quality control function for audits performed by external auditors for SEC-registered companies. Under the new arrangement, a...