The Great Deception of Enron

In the late 1990’s and early 2000’s, the turbulence of the global economy caused Fortune 500 firms to be more sensitive to the value of their reputations. Financial institutions regularly evaluated the reputation and internal credibility by publicly traded companies when making decisions that would impact their customers and the future of their businesses. As Enron’s stock price soared in 1999 and 2000, the ‘efficient’ market was put into question despite the irrational reliance on Arthur Andersen’s compromised services. When the government sought the moderately reputable firm Arthur Andersen to audit and monitor the internal finances of Enron, growing a mind-boggling 57% in sales YoY for five years, Andersen provided professional services in auditing, consulting, and accounting.

Although Enron circumnavigated the GAAP and GAAS laws to blind Andersen, the external auditor’s purpose was to practice ethical and sophisticated auditing services to benefit the public markets. Therefore, it was not ethical for Arthur Andersen to provide non-audit services to Enron while still acting as their external auditor.

Andersen conspired to hide accurate accounting data from the public and did not attempt to create true independence between financial services, effectively exposing the government’s negligence to surveil the public markets and allow Mark-to-Market accounting.

Arthur Andersen’s decision to hide Enron’s accounting data from the public and not differentiate between Andersen Accounting and Andersen Consulting allowed Enron to continue the malpractice of Mark-to-Market Accounting. In July of 2000, Enron signed a long-term contract with Blockbuster Video to introduce and provide on-demand entertainment in multiple US cities by the end of the year.

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Based on the projected revenues from the pilot projects, Enron recognized estimated profits of more than $110M from their Blockbuster deal. Although the market demand was there, the technical viability to fulfill the deal remained in question from competing media firms. Since Andersen did not mediate the estimated profits of the long-term contract, Enron began bolstering their balance sheets and appeared as a unicorn to the public. This collusion was not the first time that accounting firms had trouble committing to audit independence. In fact, accounting standards have fallen since the 1980’s when consultancy practices proved to be more profitable.

As Enron acquired more pipelines and extended their natural gas model into becoming a market maker in new fuel industries, the trading of assets and joint ventures became very controversial. Andersen Consulting advised it while Andersen Accounting turned an eye to it. In 1997, Enron wanted to buy out a stake in one of its many joint ventures from one of its own partners. Enron did not want to show the debts from the financing of the acquisition, so they acquired the partner’s stake through a special purpose entity controlled by yet another Enron executive. Enron guaranteed to raise the debts for this special purpose entity, but the transaction was structured so that the debt of the joint venture did not need to be consolidated financial statements. Red lights should have been flashing in front of the Andersen executives in charge of the Enron account as they learned more about their client’s malpractices.

Instead, they accepted Enron’s payment of more than fifty million dollars. As a strategic advisor, consultant, and auditor, Arthur Andersen was integrated into Enron’s financial department to achieve quality financial reporting and oversight of Enron’s diversification strategy. Ironically, Andersen Consulting encouraged Enron to reach beyond its pipeline business and become more involved in natural gas trading while Andersen Accounting was found guilty of obstruction of justice for destroying potential evidence on Enron’s trading of specialty purpose assets. The accusation created skepticism around the entire Arthur Andersen firm and their ‘justification’ that they were uninformed of Enron’s poor business ventures.

Arthur Andersen accomplished “spectacular” frauds by skewing discretionary accrual results as the external auditor for Enron, which led to the demise of both unethical, selfish entities. Nevertheless, Enron was a client of Arthur Andersen and Andersen was fulfilling their duty by providing Enron both auditing and consulting services. This may be a straw man argument considering how easy it is for a business to deny service to a customer, yet Andersen was going through an internal cultural shift from seasoned executives to young, aggressive partners. This shift from founder Arthur Andersen’s beliefs in integrity and serving the client to young, money-crazed MBA graduates caused Andersen to pursue their second most lucrative account, Enron. As this shift occurred in the late 1990’s and early 2000’s, Andersen was undergoing a peer-review by Deloitte Touche after experiencing a culmination in sliding standards and audit fraud with clients Waste Management, Inc. and WorldCom.

Andersen was somehow given a clean “bill” of health by Deloitte Touche after providing non-auditing services to Waste Management and WorldCom while also providing external audit services. Finally, the head of the SEC, Harvey Pitt, began discussing the lack of enforcement of the existing accounting rules and alluded to the importance of accurate peer reviews by other accounting firms. Even though Andersen decided to continue feeding and fulfilling Enron’s requests as a client before fulfilling their fiduciary responsibility, Andersen’s transparent accounting decisions of negative influence and condemnation led to one of the most significant accounting reforms in history: the Sarbanes-Oxley Act of 2002 or SOX.

After the investigation of Enron by the SEC became public, Arthur Andersen began shredding documents to cover up imperfections in their audit of Enron and consequently fell subject to hiding accounting data from the public. When David Duncan, a partner at Andersen and head of the Enron audit, arranged the data destruction, he knew that Enron’s faulty transactions had caught up to them, and Andersen needed to hide their role in the fraudulent activity. Duncan knew that Enron was able to create contracts and ventures that satisfied governmental laws, but breached the intent of accurate financial statements proving Arthur Andersen and the government’s inability to enforce regulations. The destruction of all Enron related documents by Andersen after federal prosecutors requested various information further demonstrates the collusion and conspiracies conjured by Andersen to manipulate the rules of the public market in favor of Enron’s balance sheet.

This learning lesson for lawmakers led to the creation of the Sarbanes-Oxley Act of 2002 that established new auditing and financial regulations for public companies. More importantly, it established a new legislation that would protect shareholders, employees, and the public markets from fraudulent financial errors. Furthermore, the collusion between Enron and Andersen shows the government’s inability to enforce GAAP and GAAS principles which exposed the government’s grip, or lack thereof, over the public markets.

It was unethical for Andersen to provide non-audit services to Enron while being their government-mandated auditor despite the evidence that Enron was manipulating GAAP and GAAS regulations before Andersen could analyze the full Enron account. Enron did this by bolstering their balance sheet with inflated asset values and dispersing their liabilities to subsidiaries that they did not consolidate: Mark-to-Market accounting. As explained earlier, Enron did not include the debts of these companies in their financial statements at year end. Unfortunately, Enron robbed Andersen of its best judgement by short-circuiting Andersen’s system of checks and balances and overriding their internal technical staff.

The confirmation of these signals was suspiciously circular: Enron would tell its employees that Andersen had approved the deals while Andersen would tell its staff that Enron’s executives had also approved them (Benston). This reflects the pressured atmosphere that Enron forced Andersen into, constantly demanding that Andersen auditors sign off on various transactions as internal Enron accountants hid debts in specialty purpose assets.

Enron and Andersen engaged in a saga of error shredding documents, restating earnings, avoiding regulatory investigations, and failing to fulfill their responsibilities in the merger with Houston Natural Gas. Although Enron instigated the practice of unethical financial accounting, it rubbed off on Andersen when it did not regulate the uncharted growth of Enron or bring attention to the conflict of interest between Enron and its executives to the Audit and Compliance Committee. After Arthur Andersen’s continuous errors, it did not remain independent in both fact and appearance, which has resulted in new accounting and auditing principles to prevent any future fraud or collusion event.