Arthur Andersen And Other Accounting Failures
The accounting profession, which is largely self-regulated, has suffered through a series of fiascoes since the late 1990s, resulting in a call for major changes in accounting standards. The Financial Accounting Standards Board (FASB) has served since 1973 as one of the organizations responsible for establishing standards of financial accounting and reporting. Although the FASB is a private organization, its standards are recognized as authoritative by the SECURITIES AND EXCHANGE COMMISSION (SEC) and the American Institute of Certified Public Accountants. In the late 1990s and early 2000s, debacles involving major accounting firms required the FASB and the SEC, as well as other regulatory organizations, to consider new rules designed to improve financial reporting. Between 1996 and 2002, investors lost an estimated $200 billion in earnings restatements and stock meltdowns following failures in auditing processes. A number of high-profile auditing failures decreased confidence in the accounting profession. Among these failures were incidents involving such companies as Bausch and Lomb, Rite Aid, Cendant, Sunbeam, Waste Management, Superior Bank, and Dollar General.
One of the most highly publicized accounting failures in this period involved Houston-based Enron Corporation and its accountant, Arthur Andersen, L.L.P. Enron suffered a collapse in the third quarter of 2001 that resulted in the largest BANKRUPTCY in U.S. history and numerous lawsuits alleging violations of federal SECURITIES laws. Thousands of Enron employees lost 401(k) retirement plans that held company stock. The controversy extended to Arthur Andersen, which was accused of overlooking significant sums of money that had not been represented on Enron's books. Arthur Andersen was later found guilty on federal charges that it obstructed justice by destroying thousands of Enron documents. Enron reported annual revenues of about $101 billion between 1985 and 2000. On December 18, 2000, Enron's stock sold for $84.87 per share. Stock prices fell throughout 2001, however, and on October 16, 2001, the company reported losses of $638 million in the third quarter alone. During the next six weeks, company stock continued to fall, and by December 2, 2001, Enron stock dropped to below $1 per share after the largest single day trading volume for any stock listed on either the New York Stock Exchange or the NASDAQ.
Initial allegations focused upon the role of Arthur Andersen. The company was one of the "Big Five" accounting firms in the United States, and it had served as Enron's auditor for sixteen years. Arthur Andersen also served as a consultant to Enron, thus raising serious questions regarding conflicts of interests between the two companies. According to court documents, Enron and Arthur Andersen had improperly categorized hundreds of millions of dollars as increases in shareholder equity, thereby misrepresenting the true value of the corporation. Arthur Andersen also did not follow generally accepted accounting principles (GAAP) when it considered Enron's dealings with related partnerships. These dealings, in part, allowed Enron to conceal some of its losses.
Arthur Andersen was also accused of destroying thousands of Enron documents that included not only physical documents but also computer files and E-MAIL files. After investigation by the U.S. JUSTICE DEPARTMENT, the firm was indicted on OBSTRUCTION OF JUSTICE charges in March 2002. After a six-week trial, Arthur Andersen was found guilty on June 16, 2002. The company was placed on PROBATION for five years and was required to pay a $500,000 fine. Some analysts also questioned whether the company could survive after this series of incidents.
The accounting issues in the Enron case extended beyond Enron and Arthur Andersen. Prior to this case and since 1977, the accounting field was supervised considerably by the Public Oversight Board (POB). When SEC chairman Harvey L. Pitt in 2002 made a series of inquiries about the system of self-regulation in the accounting profession, he did not consult the POB. The POB voted to disband, effective May 1, 2002. After the Enron case, the FASB emerged in the public spotlight as the leader of the system of self-regulation and has taken a significant role in the reform of accounting rules. In January 2003, the FASB announced new accounting rules designed to force U.S. companies to move billions of dollars from off-balance-sheet entities into the companies' balance sheets. The SEC has also stepped up its oversight of company accounting.