The Decline and Fall of Arthur Andersen

Unlike Edward Gibbon's "The History of the Decline and Fall of the Roman Empire" describing how centuries of invasion by barbaric tribes, gradual loss of civic virtue and the growth of Christianity led to the dissipation of the mighty Roman Empire, accounting giant Arthur Andersen's decline came in less than nine months.

Solid Foundation

Founded in 1913 by Arthur Edward Andersen, orphaned as a boy in Chicago and later named the youngest CPA in the state of Illinois in 1908 at the age of 23, with his partner Clarence DeLany, the firm was initially Andersen, DeLany & Co.

With the ratification of the Revenue Act and Federal Reserve Act in 1913, demand for audit and accounting services was created as "The Great War" raged in Europe and in the aftermath.

After the departure of DeLany in 1918, the firm became Arthur Anderson & Co. with the Joseph Schlitz Brewing Company of Milwaukee as it's first client.

Trust and integrity being of vital importance to a business based on accountability, Andersen built his firm on a strong set of moral and ethical values.

Once, when threatened by the executive of a local rail utility client to sign-off on some shady documents or face losing the account, Andersen refused to do so, stating that there was "... not enough money in the city of Chicago ..." to make him do that.

The firm adopted the motto -

"Think straight, talk straight."

Rise to Prominence

Adhering to a rigid set of principles and standards, Andersen's client base grew steadily throughout the 1920s. Growing specialized in the gas and electric industry, half of it's clientele consisted of mid-west utilities companies and the firm became known as a "utility firm".

As they became licensed in many states, six offices were opened around the country including New York, Kansas City and Los Angeles.

In 1932, the firm was selected because of it's honest and reliable reputation by a group of east-coast banks to audit Commonwealth Edison, the energy empire of Samuel Insull, creator of the concept of the "holding company". Andersen was involved throughout the investigation and subsequent trial as charges of fraudulent management and misreporting of earnings by inflating stock values were brought against Insull, resulting in disastrous losses to investors. After fleeing to Europe, Insull was brought back to Chicago to face justice, but was eventually acquitted. Though the ordeal gained favorable national exposure for the firm, it was an eerie foreshadowing of events that would transpire seven decades later.

Arthur Andersen, 1944 - by exclusive permission.
Arthur Andersen, 1944 - by exclusive permission. | Source

Arthur Andersen's personal success peaked during the Second World War with growing esteem within professional and academic communities for his voluminous accounting publications. He was awarded honorary degrees from St. Olaf College and Luther College for his work in the preservation of Norwegian history and from Northwestern University in recognition of his endeavors as President of the Board of Trustees and as staff member in the accounting department.

He continued to serve as the managing partner of the firm until his death in 1947 when Leonard Spacek took over the helm. Spacek's leadership spanned 26 years, a period of phenomenal growth for the firm that saw it reach international proportions.

New Horizons

With the dawn of the computer age, consulting was introduced as a service to accompany the tax and audit departments, and grew at a telescopic pace into the 1970s.

When Spacek retired in 1973, Arthur Andersen & Co, maintaining its headquarters in Chicago, had expanded to over 16 offices in the US and 25 offices in foreign countries, becoming one of the largest accounting firms in the world.

Spacek's successor, Harvey Kapnick, aggressively pursued the consulting market, which by 1979 was producing 20 percent of the firm's revenue. Kapnick foresaw the opportunities in consulting and proposed splitting the company into two distinct parts, accounting and consulting, but was voted down by the partners. Kapnick resigned in 1979 and was replaced by Duane Kullberg, who had joined the firm as an auditor in 1954.

The "Big Eight"

Rank by revenue as of March, 1985.

  1. Arthur Andersen
  2. Peat, Marwick, Mitchell & Co.
  3. Ernst & Whinney
  4. Coopers & Lybrand
  5. Price Waterhouse
  6. Arthur Young & Co.
  7. Deloitte, Haskins & Sells
  8. Touche Ross

Andersen Consulting

Arthur Andersen & Co. is credited with the creation of "Management Consulting" and by 1988, 40 percent of it's revenue was attributed to the consulting practice. As the importance of the consulting side threatened to overshadow the audit and tax departments, internal friction developed.

As tensions continued to mount, Kullberg finally agreed to restructure the firm and Andersen Consulting separated from Arthur Andersen & Co. with both remaining under the international "umbrella" entity, Andersen Worldwide Société Coopérative (AWSC).

Kullberg was replaced in 1989 by partner Lawrence A. Weinbach, whose skill at diplomacy quelled the quarreling and directed the focus back to business. With Weinbach as CEO, the firm grew to nearly $5.6 billion in revenue by 1992, an increase of almost 50 percent in four years, with consulting business showing the largest percentage of growth

Growing Pains

In addition to monumental growth that pushed Andersen to the very top of all international accounting firms, the 1980s also brought periods of distress as legal battles ensued against DeLorean Motors Company, Financial Corporation of American (American Savings & Loan), Drysdale Government Securities, and other clients. Between 1980 and 1985, Andersen partners paid $137 million in settlements.

Troubles of this kind were experienced by competitors as well with Peat, Marwick, Mitchell paying out over $19 million, Ernst & Whinney over $6 million and Deloitte Haskins & Sells around $5 million, during the same period.

As computerized automation increasingly influenced business processes during the 1980s, the rigid standards that served Arthur Anderson & Co. so well over the years, began showing signs of faltering.

The Big Eight
The Big Eight

Provides an inside look at eight of the most influential accounting firms in the United States, examining their pivotal roles in the world of national and international finance.

 

Mergers & Acquistions

By 1986, the world's eight largest accounting firms were initiating major changes.

Peat, Marwick, Mitchell & Company combined with the German firm Klynveld Main Goerdelor (KMG) to become KPMG Peat Marwick, establishing a larger global presence by uniting KMG's 80 percent business from abroad with Peat's 80 percent North American ratio.

Andersen and Price Waterhouse had begun talks of a merger in 1989, but negotiations stalled over cultural differences, conflicts of interest regarding certain large accounts (namely IBM) and the funding of partner pensions.

By the early 1990s, several mergers were taking place among the eight firms. Ernst & Whinney joined with Arthur Young to become Ernst & Young, Delloitte, Haskins & Sells combined with Touche Ross forming Delloitte Touche, and in 1998, Price Waterhouse merged with Cooper's & Lybrand to became Pricewaterhouse Cooper's (PWC).

By the end of the millennium, the "Big Eight" had become the "Big Five".

As the fallout from the Savings & Loan crisis of the 1980s extended into the 1990s, Arthur Anderson became involved in a number of thrift failure lawsuits, the most prominent being the government's Resolution Trust Corporation case in 1992 claiming negligence in the audit of the failed Ben Franklin Savings & Trust. As in the past, Andersen partners settled the case in 1993 with minimal repercussion, but becoming far more cautious in their future endeavors.

By 1998, the discord between Andersen Consulting, Arthur Andersen & Co. and Andersen Worldwide Société Coopérative had escalated to the point of Andersen Consulting filing a breach of contract suit, ultimately becoming a completely separate company, Accenture Ltd.

At Their Peak

By 2002, with clients including Halliburton, General Dynamics, Delta Airlines, Edison International, Freddie Mac, FedEx, International Paper, and Hilton Hotels, Arthur Anderson & Co.'s annual revenue had cleared $9.3 billion.

Arthur Andersen & Co. revenue per year in million U.S. dollars.
Arthur Andersen & Co. revenue per year in million U.S. dollars. | Source

Extending their influence into the federal government, two out of the last three Comptrollers General of the US General Accounting Office were top Andersen executives.

Also by this time, however, came allegations of fraudulent accounting and auditing of a number of clients, including Sunbeam Products, Waste Management, Inc, Asia Pulp & Paper, and the Baptist Foundation of Arizona.

Then came Enron and the subsequent "coup de grâce", WorldCom.

Enron

Enron Corporation, an energy trading company headquartered in Houston, Texas, was created In 1985 from the $2.3 billion merger of Houston Natural Gas (HNG) and InterNorth energy company with Samuel Segnar as it's original CEO. After only six months, Segnar left to be replaced by HNG CEO, Kenneth Lay.

In 1990, Enron's COO, Jeffrey Skilling, hired Jerry Fastow for his expertise in energy deregulation. By 1993, Enron was acquiring numerous deregulated entities and shifting liabilities, resulting in misrepresentation of stated values.

Enron was named "America's Most Innovative Company" by Fortune magazine six consecutive years from 1996 to 2001, but while being lauded as innovative, was actually using deceit in many fashions to disguise it's financial health, bringing the term "cook the books" back into everyday vernacular.

In 2000, Enron reported over $110 billion in revenues, the seventh largest among US companies by revenue. By the end of 2001, it had declared bankruptcy.

Exit Arthur Andersen
Exit Arthur Andersen | Source

In October of 2001, the Securities and Exchange Commission started an investigation into the financial workings of Enron as well as it's auditor, Arthur Andersen & Co. As Andersen Worldwide CEO Joseph Berardino was testifying before congress in December, Enron filed Chapter 11.

In January of 2002, the firm admitted to the shredding of sensitive Enron documents leading to an obstruction of justice indictment.

In charge of the Enron account since 1997 was David Duncan, an auditor with Andersen for twenty years. Duncan had directed the shredding of documents by Andersen employees "according to Andersen policy" to prevent examination by the SEC, resulting in the "obstruction of justice" charges leveled against he and the firm. In April of 2002, Duncan entered a plea of "guilty" in exchange for a lighter sentence and worked with the prosecution against his former employer.

Arthur Andersen was convicted of obstruction of justice on June 15, 2002.

WorldCom

Within two weeks of being convicted of obstruction of justice for the shredding of Enron documents, another Andersen client, telecommunications giant WorldCom, disclosed that it misrepresented $3.8 billion in expenses and by the next month, had filed for bankruptcy.

Listing over $107 billion in assets, far exceeding that of Enron, made the WorldCom filing the largest bankruptcy in US history.

Andersen, fired as WorldCom's auditor earlier that year due to the Enron allegations, was asked how it could have missed such a huge oversight. Andersen responded that they where never consulted about it and information on the accounting "was withheld from Andersen auditors by the chief financial officer at WorldCom." The WorldCom CFO was Scott Sullivan who was fired within days of the accounting disclosure in June.

Though Andersen was not formally accused of wrongdoing, they were severely criticized for their oversights, especially in light of their legal problems over the previous twenty years with Sunbeam, Waste Management and most recently with Enron.

And You Thought Accountants Were Boring
And You Thought Accountants Were Boring

Ingenuity. Indictments. Injustice. Arthur Anderson: an innovative accounting firm brought down by governmental false accusations. Political fodder in the government's prosecution of Enron, the company was unjustly dismantled for its supposed connections to the corruption. The company was later vindicated by a 9 - 0 supreme court ruling, but it was too late. The impact was devastating. Thousands of employees were suddenly tarnished by the Arthur Andersen name, left reeling in the aftershock. Meet one of them: Larry Katzen. An honorable, hardworking man who devoted his life to Arthur Andersen, Larry was there from the company's meteoric rise to its unjust demise. This is his story.

 

Finality

On August 31, 2002, Arthur Andersen surrendered it's CPA license, as ordered by the court, and 85,000 employees lost their jobs.

In 2004, an appeal was denied and the conviction stood.

Supreme Court Reversal

Though Andersen's conviction was reversed by the Supreme Court in 2005 due to "technicalities", the damage done to the firm's reputation had long since been irreparable.

On December 12, 2005, following the overturning of the conviction, the prosecution's key witness David Duncan, changed his plea to "not guilty".

Out of the Ashes?

Since the demise of the firm, a skeleton staff has remained in place to handle pending legalities, but in 2014, several former Andersen tax partners attempted to resurrect the prestige the firm once knew, much to the incredulity of many.

As of September 2, 2014, San Francisco tax consultancy WTAC LLP has gone by the name AndersenTax.

Final Accounting: Ambition, Greed and the Fall of Arthur Andersen
Final Accounting: Ambition, Greed and the Fall of Arthur Andersen

A withering exposé of the unethical practices that triggered the indictment and collapse of the legendary accounting firm.

 

Conclusion

The WorldCom affair put final emphasis on the worst corporate melt-down in US history until 2008 with the even larger scandals, occurring only days apart, with Lehman Brothers and Washington Mutual, .

Greed and poor decision making, in conjunction with its becoming too large to adequately govern itself, caused the demise of the accounting giant, and in the end, paralleled many of the circumstances which befell the great Roman Empire.

It is ironic that by deviating from the founding principles that originally built the firm to its high standing, earning it a reputation as an "international policeman" of accounting principles, essentially caused its downfall.

If indeed the dead turn in their graves, Arthur Edward Andersen certainly did in his.

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