Arthur Andersen: audit work for Enron, prosecution and settlements

analysisArthur Andersen LLP audited Enron’s publicly filed financial statements and also provided internal audit and consulting services to Enron. David Duncan, the firm’s worldwide engagement partner for Enron from 1997, headed its Enron engagement team. Andersen’s March 2002 indictment stated that Enron had retained the firm as auditor for 16 years until the December 2001 bankruptcy, that Enron was among its largest clients worldwide and its largest in the Gulf Coast region, and that the work was done mainly in Houston, with staff also in Chicago, Portland and London. Enron’s 2001 proxy statement records that the board, on the recommendation of its Audit and Compliance Committee, appointed Andersen to audit Enron’s consolidated financial statements for the year ending December 31, 2001 and asked shareholders to ratify the appointment at the annual meeting of May 1, 2001, which an Andersen representative was expected to attend. ^{1 2 3 4}

analysisEnron’s 2001 proxy statement disclosed that during 2000 Enron paid Andersen, its principal auditor, $25 million in audit fees and $27 million in all other fees, which related mainly to business process and risk management consulting, tax work, due diligence and other audits. The U.S. Senate Permanent Subcommittee on Investigations put Enron’s 2000 payments to Andersen at about $52 million, or $1 million a week, and found that Andersen’s consulting fees at Enron first exceeded its audit fees in 1999. The Powers Committee, the special investigative committee of Enron’s board, stated in its report of February 1, 2002, which is not a court finding, that Enron’s records showed Andersen billed Enron $5.7 million above its regular audit fees for advice on the LJM and Chewco transactions alone, for work performed from 1997 to 2001. As quoted by the Subcommittee, the same report put Andersen’s bill for work on the Raptor vehicles at approximately $1.3 million. ^{3 4 5}

analysisIn an opinion signed in Houston and dated February 23, 2001, filed with Enron’s 2000 annual report, Arthur Andersen LLP stated without qualification that the consolidated financial statements of Enron Corp. and subsidiaries as of December 31, 2000 and 1999, and for the three years ended December 31, 2000, presented fairly, in all material respects, the company’s financial position and results in conformity with U.S. generally accepted accounting principles. On November 8, 2001, Enron announced that it would restate its 1997–2000 financial statements and that those statements and the audit reports covering them should not be relied upon. Enron directors interviewed by the Senate Permanent Subcommittee on Investigations for its July 2002 report pointed out that Andersen had given Enron a clean audit opinion each year, and none recalled Andersen ever objecting to a particular transaction or accounting practice; the Subcommittee, in its own assessment, cited evidence that, internally, concerns about Enron’s accounting were commonplace at Andersen. ^{6 7 3}

analysisIn its July 2002 report the Senate Permanent Subcommittee on Investigations described internal Andersen documents showing that the firm’s 1999 and 2000 client risk analyses placed Enron in its “Maximum” risk category, the 2000 analysis being signed by David Duncan and four other partners. According to an internal Andersen e-mail of February 6, 2001 cited by the Subcommittee, 14 senior Andersen partners had met the previous day to decide whether to retain Enron, discussed among other things Andrew Fastow’s conflicts of interest as CFO and manager of the LJM funds, and decided to keep Enron as a client. Enron’s directors told the Subcommittee that they had not been informed of a February 2001 visit by the head of Andersen to Enron’s headquarters, nor that shortly afterwards, in March 2001, a senior Andersen partner was removed from his Enron oversight role at Enron’s request. These are a congressional report’s accounts, not court findings. Andersen remained Enron’s auditor until Enron discharged it on January 17, 2002; two days earlier Andersen had dismissed David Duncan, its lead partner on the Enron account. ^{1 2 3}

analysisThe Powers Committee concluded in its report of February 1, 2002 that Andersen did not fulfil its professional responsibilities in auditing Enron’s financial statements or its obligation to raise with the board concerns about controls over related-party transactions; this is a board committee’s finding, not a court finding. The report stated that Andersen had admitted erring on the Rhythms structure, which forced the restatement of 1999 and 2000 results; that Andersen helped structure the Raptors yet failed to provide objective accounting judgment; and that in September 2001 Andersen required Enron to reverse the equity accounting it had applied, leading to the $1.2 billion equity reduction. The report also noted that Andersen apparently disputed Enron accountants’ account that it had reviewed and approved the recording of additional equity in March 2001, and that in congressional testimony Andersen’s chief executive had explained that the firm had simply been wrong in 1999 when it concluded that the LJM1 special purpose entity in the Rhythms transaction satisfied the non-consolidation requirements. ¹

analysisThe record of the criminal case adds two accounts of the engagement team’s advice on special purpose entities (SPEs). In a background footnote to its May 31, 2005 opinion in Arthur Andersen LLP v. United States, citing the government’s brief rather than stating a holding, the U.S. Supreme Court noted that Andersen’s engagement team had allowed Enron to “aggregate” the Raptor SPEs for accounting purposes so that they reflected a positive return, which Andersen’s own experts called a “black-and-white” violation of generally accepted accounting principles. The federal grand jury indictment of March 7, 2002 also alleged that the audit team had, in the spring of 2001, advised Enron that it could use a favourable accounting method for its SPEs, contrary to the methodology approved by the firm’s own Professional Standards Group, and that an internal review in 2000 had rated the Enron audit team only a “2” on a scale of one to five; these were allegations, not proven at trial as separate facts. ^{2 3}

analysisThe U.S. Supreme Court recorded that in June 2001, before Enron’s collapse, Arthur Andersen LLP entered into a settlement with the SEC over its audit work for Waste Management, Inc., under which the firm paid a fine, was censured and was enjoined from further violations of the securities laws. That settlement resolved the SEC’s Waste Management matter against Andersen. ¹

analysisAfter Enron’s October 16, 2001 results and the SEC’s inquiry, Andersen’s Enron engagement team destroyed large quantities of Enron-related paper and electronic records from October 23, 2001. The U.S. Supreme Court, reciting facts from the trial record in its opinion of May 31, 2005, stated that David Duncan met engagement partners and staff, distributed the firm’s document policy and told everyone to comply, and that the shredding stopped on November 9, 2001, after SEC subpoenas were served. The federal indictment of March 7, 2002 alleged that documents were also destroyed in Portland, Chicago and London. The conviction resting on these facts was reversed by the Supreme Court on May 31, 2005. Duncan pleaded guilty in April 2002 to obstructing justice and agreed to serve as a government witness, and in January 2008 the SEC filed a settled civil action against him in connection with the Enron audits. ^{1 2 3 4}

analysisOn March 7, 2002, a federal grand jury in the Southern District of Texas indicted Arthur Andersen LLP on one count of obstruction of justice under 18 U.S.C. § 1512(b)(2), charging that between October 10 and November 9, 2001 the firm, through its partners and others, corruptly persuaded its employees to withhold, alter and destroy documents for use in regulatory and criminal proceedings. A Congressional Research Service chronology records that on March 15, 2002 the General Services Administration suspended Enron Corp., related entities, several former Enron officials, Arthur Andersen LLP and a former Andersen official from conducting new business with the federal government, for 12 months for all parties except Andersen, whose suspension was to last for the duration of its indictment. A jury convicted the firm in June 2002; the U.S. Supreme Court reversed the conviction on May 31, 2005. ^{1 2 3}

analysisAt the trial in Houston the jury deliberated for seven days, declared itself deadlocked and, after an Allen charge and three more days, found Arthur Andersen LLP guilty of obstruction of justice. In a statement dated June 15, 2002, the SEC said that, in light of the verdict, Andersen had informed it that it would cease practising before the Commission by August 31, 2002; Andersen itself acknowledged that the verdict would effectively end the firm’s audit practice as early as that date, depending on the time needed to brief and argue post-trial motions. On October 16, 2002, U.S. District Judge Melinda Harmon sentenced the firm to the maximum punishment of five years’ probation and a $500,000 fine for altering its Enron-related documents, according to a Congressional Research Service chronology. Andersen contested the verdict: the district court denied its motion for a judgment of acquittal, the firm appealed and the Fifth Circuit affirmed, and the U.S. Supreme Court then granted review and reversed the conviction on May 31, 2005. ^{1 5 3}

analysisOn May 31, 2005, in Arthur Andersen LLP v. United States (No. 04-368), the U.S. Supreme Court held that the jury instructions failed to convey properly the elements of “corrupt persuasion” under 18 U.S.C. § 1512(b). It reversed the Fifth Circuit’s judgment affirming Andersen’s conviction and remanded the case for further proceedings. ¹

analysisAndersen dismissed David B. Duncan, its lead partner on the Enron account, on January 15, 2002. At a House Energy and Commerce subcommittee hearing in January 2002 on the destruction of Enron-related documents by Andersen personnel, Duncan invoked his Fifth Amendment right against self-incrimination and the hearing was postponed indefinitely. On April 10, 2002, according to a Congressional Research Service chronology, Duncan pleaded guilty to a single felony count of obstructing justice and agreed to serve as a government witness; the Justice Department described the 2002 plea as one to obstructing an SEC investigation into Enron. The available records do not show the later course of the criminal case after the plea. On January 28, 2008, the SEC filed a settled civil action against Duncan in connection with the audits of Enron’s financial statements (SEC v. David B. Duncan, Litigation Release No. 20441, AAER No. 2777), and on January 30, 2008 it issued an administrative proceeding release concerning him as a certified public accountant (AAER No. 2778); the settlement terms are not in the available records. ^{3 6 4}

analysisNeal Batson, the court-appointed bankruptcy examiner, concluded in his final report of November 4, 2003 that there was sufficient evidence for a fact-finder to conclude that Andersen committed professional negligence in its accounting services to Enron and aided and abetted certain Enron officers in breaching their fiduciary duties by causing Enron to enter into special purpose entity (SPE) transactions designed to manipulate its financial statements. This is an examiner’s conclusion, not a court judgment. The examiner noted that, because Enron’s officers took part in the conduct, Andersen may argue that their actions are imputed to Enron and that Enron’s claims should be barred or reduced under comparative fault rules. ¹

analysisIn the same final report of November 4, 2003, the examiner also concluded that there was sufficient evidence for a fact-finder to conclude that Enron’s outside law firms, Vinson & Elkins L.L.P. and Andrews & Kurth L.L.P., committed legal malpractice in advising on the SPE transactions or aided and abetted certain Enron officers in breaching their fiduciary duties; this too is an examiner’s conclusion, not a court judgment. He noted that the firms may argue that the officers’ conduct should be imputed to Enron, that Vinson & Elkins had offered opinions of law school professors and practitioners on several matters on which he took testimony, and that a professional defendant might produce a qualified expert giving an opinion contrary to the plaintiff’s expert. ¹

analysisAndersen was among more than fifteen defendants in the consolidated Enron securities class action, Newby v. Enron Corp. (S.D. Tex.), according to a co-defendant’s submission recorded in a February 7, 2007 order; the others included Vinson & Elkins and former Enron executives. In January 2007 the court granted the lead plaintiffs’ request to drop Vinson & Elkins, among others, according to a press report summarized by a class-action case database. Lead plaintiffs’ counsel announced on September 27, 2005 that the lead plaintiff, the Regents of the University of California, had obtained $32 million from Andersen Worldwide SC, among recoveries for investors then exceeding $7 billion; the terms are as stated by the plaintiffs’ side. A class-action case database instead gives the Andersen Worldwide settlement as $40 million and separately records a $40 million cash settlement fund under an Arthur Andersen settlement agreement described in a partial-settlement notice of July 24, 2003; the available records do not explain the difference. According to a September 2006 press report, the university agreed to a $72.5 million settlement from Arthur Andersen, its spokesman saying that the firm, despite its obvious financial limitations, was capable of paying it. ^{1 2 3}