The Enron effect
The sudden collapse in late 2001 of Houston, Texas-based energy company Enron had a profound effect on the accounting industry. Enron engaged in accounting practices designed to hide the true liabilities of the company accounting practices that were approved by its auditor, Arthur Andersen. Chicago, Ill.-based Arthur Anderson, a pioneer in the industry, was convicted on a federal obstruction of justice charge for destroying evidence related to its Enron engagement, eliminating the firm as a major player in the auditing industry. The subsequent collapse of telecom giant WorldCom, also audited by Andersen, in late 2002, only underscored this conclusion. But the Enron scandal had other effects, including increased scrutiny on the accounting and professional services industry.
The unfortunate results of the Enron affair are dramatic and far-reaching: one of the largest bankruptcies in U.S. history, $32 billion lost in market capitalization, $1 billion lost in employee retirement accounts, and the first ever felony conviction of a public accounting firm. Furthermore, the scandal, along with other recent, high-profile audit failures at companies from Waste Management and Cendant to more recent scandals involving Italian dairy company Parmalat, to SEC settlements involving companies such as Bristol-Myers Squibb and Qwest, to current investigations into mortgage investment giant Fannie Mae, has damaged the integrity and credibility of the public accounting profession in the eyes of senior executives and the public at large. And it’s not just Arthur Andersen that has suffered in light of these developments; three of the Big Four accounting firms have endured similar investigations by the SEC in the past couple of years, with numerous questionable tactics being descried by authorities. KPMG was recently charged with unprofessional conduct in a scandal involving audits of Gemstar, and agreed to pay $10 million in fines. PricewaterhouseCoopers paid $5 million to the SEC in 2002, formerly the largest fine for any infractions. Ernst & Young is currently under investigation for alleged violations.
How will these events affect the future of the accounting profession? A number of reforms have been proposed, including: the creation of a private sector oversight board independent of public accountants to monitor audit quality and enforce auditor discipline; the mandate of a timed rotation of auditors; the implementation of limits on auditor moves to client positions; reform of audit committees; and a reassessment of certain accounting rules.
The most significant change thus far has come in the form of the Sarbanes-Oxley act of 2002, which established an expansive set of rules meant to prevent the kind of accounting fraud evidenced at places like Enron and Tyco. And these kinds of reforms have even come into play at the academic level, as colleges and other accounting programs have begun to address the ethical aspect of the profession throughout their curriculum.
No More Consulting?
Chief among the reforms is the ban on consulting services. In recent years, the large professional services firms have been divesting their management consulting practices, a trend underscored by then volatile, highly publicized split between Arthur Andersen and Andersen Consulting (now known as Accenture) in 2000. Arguably, these divestitures were more a result of internal revenue-sharing disputes between auditors and consultants (consulting work generally commands significantly higher margins than audit work) and attempts to realize the value of such consulting practices via initial public offerings than a desire to secure greater auditor independence. But critics of the industry have long been skeptical about accounting firms’ financial dependence on their consulting arms, pointing out the inherent difficulty in auditors’ maintaining any sense of objectivity while their firms are so beholden to clients for consulting revenue. In early 2002, PricewaterhouseCoopers and Deloitte Touche Tohmatsu, the last professional services firms to offer management consulting as part of their primary service portfolios, agreed to split off the consulting practices to appease those who fretted about the potential conflicts of interest.
While there formerly was no general proscription by either the SEC or the AICPA against performing non-auditing services for audit clients, Congressional action has changed this. A number of congressional subcommittees have looked at the issue of auditor independence, and there already is legislation that limits auditing firms from providing both audit and consulting services to the same client. In fact, a number of states are considering legislation which will ban this practice entirely going forward.
The Sarbanes-Oxley Act (or Sarbox), along with the PCAOB (Public Company Accounting Oversight Board) has already restricted the non-auditing services that public accountants (which include the Big Four) can provide to clients; if they audit a client’s financial statements, the same firm is not allowed to offer advice in the areas of human resources, technology, investment banking, or legal matters, although accountants may still advise on tax issues. Accountants may still advise other clients in these areas, or may give advice within their own firm. The effects of this ban can still vary, depending on the specific definition of consulting services, but as legislation continues to evolve, there are sure to be further changes down the road. Besides shareholders and employees, the Enron scandal also took as a victim one of the most prominent firms in the accounting profession. After it was revealed that Arthur Andersen approved Enron’s complicated and illegal offshore partnerships, government investigators began looking at Andersen. The firm admitted in early 2002 that it shredded documents related to Enron, even after the government obtained a subpoena for the information. The Justice Department began seeking an indictment of Andersen, wrecking the firm’s reputation. Clients were defecting in droves, and staff and partners domestically and worldwide were leaving. In an 11th-hour bid to save the firm, former Fed chairman Paul Volcker outlined a plan to create a seven member management board that would, among other things, divest Andersen of its consulting businesses and make it the model for proper accounting and audit procedure. Unfortunately, Volcker’s plan was contingent upon an improbable confluence of events: the Justice Department dropping its investigation, shareholders settling lawsuits and partners committing themselves to stay and salvage the firm. None of those things happened, and the firm hoped to salvage itself through a merger with a competitor.
Again, no luck. Arthur Andersen was tried for obstruction of justice in federal court; in June 2002, in a rare event, a major corporation was found guilty of a felony in a jury trial. Andersen surrendered its audit license in August 2002, leaving a hole in the industry to be filled by the Big Four (nee Big Five) and smaller audit firms. And the Big Four have certainly prospered at the hands of Andersen’s demise-by mid-fall 2002, Ernst & Young had picked up more than 200 ex-Andersen clients, while the other Big Four firms had picked up in excess of 100 each. And that doesn’t even account for the fact that in some cases, these firms have acquired entire formerly Andersen offices; in some cases, teams of former Andersen accountants have migrated to these other firms, bringing rosters of clients with them.
Even before Enron, the accounting profession witnessed a significant decrease in new membership. According to the AICPA, the number of students graduating with accounting degrees fell 23 percent between 1996 and 2000, as students turned increasingly to careers in finance, information technology, and other business disciplines. The taint from the scandal could further deter students from pursuing an accounting career. However, the increased emphasis on the quality of accounting and auditing could make the profession more attractive to students seeking challenging, meaningful assignments and high levels of responsibility. However, the increased emphasis on the quality of accounting and auditing could make the profession more attractive to students seeking challenging, meaningful assignments and high levels of responsibility. And a number of accounting programs are now incorporating increased ethics-related material into their curriculum, and the Big Four, the American Accounting Association, the AICPA, and the Institute of Management Accountants have all joined universities to help develop this aspect of curricula. Ethics-related changes to the CPA exam may follow. And ultimately, according to the Bureau of Labor Statistics, accounting and accounting-related jobs are forecasted to grow on average through 2010. And aside from an increase in the number of businesses who will need auditing services, the changing financial laws and regulations and the increased scrutiny of company finances in today’s culture will only power the drive the growth of accountants and auditors.
Accounting, Technology And Globalization
The Big Four firms in particular are increasingly stewards in technological advancement, and are among the most shrewd and aggressive of all businesses in their embrace of intranets, extranets and e-commerce technology. In addition, there is a movement throughout the field towards adoption of international accounting rules. Though this issue is still evolving, there is no question that international accounting organizations, such as the International Federation of Accountants (IFAC) and the International Accounting Standards Committee (IASC), will wield more influence in the future.
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