So how did Andersen get themselves into so much trouble over Enron?
Andersen was Enron’s auditor when the company filed for bankruptcy on 2 December with estimated debts of around $80bn. Andersen’s chief executive Joe Berardino then went on to make a series stunning public admissions.
Lordy, just what exactly did Berardino admit, accountants are not known for publicly confessing their mistakes?
True. The profession appears to train its practitioners to be inherently conservative but Berardino’s strategy seemed to be to come clean, and do it quick so he could begin rebuilding the reputation of his firm.
Okay, okay. But what did he say?
Before the US House of Representatives Committee on Financial Services on 13 December Berardino said: ‘We now believe, based on a second look, that our team made an error in judgment. An honest error, but an error nonetheless.’
Crikey! An accounting altercation with one of the Big Five taking their eye off the ball. In simple terms, and I mean in very simple terms, just what went wrong?
Well, Berardino says two things happened, both involving special purpose vehicles.
The SPVs were set up as a means of allowing Enron to raise debt but without it being consolidated into Enron’s accounts and affecting the company’s bottom line.
But, the accounts avoid consolidation only if they adhere to one essential rule – that 3% of the SPVs assets be held in hands completely unrelated to the parent company, in this case Enron.
Come on, get to the point.
Alright here’s where it apparently went wrong for Andersen.In 1997 Andersen audited an SPV called Chewco. At that time Andersen found $11.4m of Chewco had come from a bank – which met the 3% rule so everything was rosy.Unfortunately, by a means not explained by Berardino, Andersen discovered some time in October last year that half the bank’s stake was provided by Enron. The 3% rule had been breached and on 2 November Andersen went to Enron’s audit committee with the news that ‘possible illegal acts’ had taken place. That is the auditors had not been informed.
What should have happened then, smart arse?
The accounts should, after all, have been consolidated. And indeed it would lead to a restatement of Enron’s accounts. Berardino said it was not clear why the information was kept from the auditor.
But Andersen suffered a second problem while examining an SPV called LMJ1. In short in 1999 Andersen thought LMJ1 met the 3% test and would not have to be consolidated. During a review in October 2001 the firm changed its mind. It had made an error, mainly over the valuation of certain assets, and LMJ1 would have to be consolidated into the Enron accounts.
And the problem was?
The problems led to a restatement of Enron accounts to the tune of about £500m.
Heavens! Was that the end of it?
Oh no. Berardino then had to return to Congress and reveal that Andersen staff had shredded a wagon load of documents relating to Enron even after official investigations had begun.
Blimey! How much was Andersen being paid for all of this?
That’s an interesting one. Incredibly Andersen bagged $25m for the Enron audit and another $27m for other services. Not peanuts.
So, who else has their finger in the pie?
Virtually everyone, it would seem. PwC is acting as administrator for the European side of the Enron empire, but had also carried out valuation work for at least two of the ‘special purpose vehicles’ at the centre of the collapse in the US. KPMG, not wanting to be left out, was the auditor for two of those vehicles, LJM1 and LJM2. Deloitte & Touche of course carried out a ‘peer review’ of Andersen’s audit work, but contrary to earlier belief, this did not look specifically at the Enron audit, though it did investigate the workings of Andersen’s Houston office.
Of course, the senior partners of all the Big Five were summonsed to appear before Harvey Pitt and told to put out a joint statement saying they were going to put the profession’s house in order – which has now been overtaken by events.
Andersen is no stranger to controversy, is it?
Quite. Back in 1982 it failed to spot the fraudulent activities at DeLorean, the Belfast car manufacturer, and was effectively blacklisted from government work until 1997. That was after Labour came to power, hence the accusations now being thrown around about links between the two. But in the US it has had to pay out for its work at Waste Management Inc and down under it is in deep trouble over its audit of collapsed insurer HIH.
Is this a disaster for the profession?
Yes and no. Yes in that it raises all sorts of questions over auditor independence and self regulation, but no if it is shown that Andersen employees knowingly colluded in a fraud. If this turns out to be the case, then Andersen could be hung out to dry while the rest of the profession feeds on its carcass.