The Fallout of Arthur Andersen and Enron on the Legal Landscape of American Accounting

It may have been a decade ago, but the fallout of the accounting scandals of the late 1990's and early 2000's continue to resonate through both of the accounting and legal professions. The largely self-regulated accounting profession has enacted numerous changes that continue to evolve in response to the scandals and pressure from government agencies and the public.

While the Arthur Andersen/Enron scandal is probably the most memorable of these controversies, similar accounting failures occurred at Bausch and Lomb, Rite Aid, Cendant, Sunbeam, Waste Management, Superior Bank, and Dollar General.

The Financial Accounting Standards Board (FASB) has existed since 1973. It is one of the most widely recognized organizations responsible for establishing standards of financial accounting and reporting. Although the FASB is a private organization, its standards are generally recognized as authoritative by the Securities and Exchange Commission (SEC) and the American Institute of Certified Public Accountants. After the Arthur Andersen/Enron scandal (and all of the others that occurred around the same time period) 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.

Public outcry from these scandals was understandable, given that between 1996 and 2002, investors lost an estimated $200 billion as a result of accounting and auditing irregularities. A number of high-profile auditing failures decreased confidence in the accounting profession. Among these failures were incidents involving such companies as

The Arthur Andersen/Enron case came to light when Enron suffered a collapse in the third quarter of 2001 that resulted in the largest Bankruptcy to that point in US 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 documents related to Enron.

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, 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 on 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 16 years. 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 helped 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 US 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 legacy of Enron/Arthur Andersen live on in various changes to the profession. While prior to this case the accounting field had been supervised considerably by the Public Oversight Board (POB), after this case came to light SEC Chairman, Harvey L. Pitt, in 2002 made a series of inquiries about the system of self-regulation in the accounting profession without consulting the POB. This ultimately led to the POB voting to disband in May, 2002. As a result, 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 US companies to move billions of dollars from off-balance-sheet entities into the companies' balance sheets. The SEC has enhanced its oversight of the profession, as well.

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Disclaimer: Every effort has been made to ensure the accuracy of this publication at the time it was written. It is not intended to provide legal advice or suggest a guaranteed outcome as individual situations will differ and the law may have changed since publication. Readers considering legal action should consult with an experienced lawyer to understand current laws they may affect a case.

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