Crisis In Confidence

For those of us who teach in the Hankamer School of Business, recent daily accounts of scandals such as Enron, WorldCom, Global Crossing and Xerox certainly have given plenty of information for research or classroom assignments to fulfill our "active learning" mission. Unfortunately, a dream for professors has been a nightmare for our current and former students, causing unprecedented financial and personal losses. Poster children for this mess were two entities that were big at Baylor: Arthur Andersen and its flashy client Enron. 
From Oct. 16 to Nov. 8 last year, Enron Corp. issued a series of press releases announcing its first quarterly loss in more than four years, plus earnings and balance sheet misstatements exceeding $1 billion from 1997 through 2000. That began a chain reaction of disclosures of corporate chicanery that eventually led to the downgrading of its debt rating to junk status and its filing for bankruptcy protection on Dec. 1. 
Enron just was beginning to make inroads into recruiting at Baylor, and faculty members had been excited about this "most admired" Fortune 50 company recruiting the best and brightest of our students. News of the company's implosion was both tragic and disillusioning to us at Hankamer. We had grown to admire the company based on its media portrayals as well as on communications with satisfied former students the company had employed. 
Then the media began to focus on Arthur Andersen. It was no secret that Enron was Andersen's second largest client. However, I immediately wrote off news accounts that the company might be in trouble. "They have suffered and survived scandal before and will surely do it again," I told myself. I was wrong.
On a Wednesday in mid-March, I received an e-mail message from Andersen informing me the firm was withdrawing from spring interviews. For the first time in 55 years, Arthur Andersen would not be hiring new employees from our campus, or any other. I walked outside and into the Andersen Student Center, emblazoned with the firm's logo and chronicling the proud history of our relationship with the firm and its people -- a history that spanned my lifetime (see sidebar).
Although I never have been an Arthur Andersen employee, the firm has had an incredible impact on Baylor University, the Hankamer School of Business and on me personally. I recount the hours that Andersen partners and other employees have spent in our classrooms, at no cost to us. I remember the idyllic campus in St. Charles, Ill., where employees from all over the world gathered to receive unparalleled professional training. I remember Rod Holmes, my late department chair, mentor and holder of the Arthur Andersen Professorship, the first of its kind in our School's history. It leaves me with a profound sense of sadness, grief and loss. 
What happened?
The difficulties at Enron and Andersen are symptomatic of a larger problem. The world is changing, and accounting has had difficulty keeping up. Technology enables the production of information in real time, while periodic financial reporting and attestation -- the classical tools of accountants -- lag behind. Accounting principles have evolved from conceptual, reason-based guidelines to form-driven procedures and regulations that substitute what is legal for what is right. Balance sheets, rather than being represented by hard assets with costs that are objective and easy to measure, contain difficult-to-decipher intangibles and derivative instruments, which must be measured at fair value, increasingly allowing more room for manipulation. 
Auditing, once the crown jewel of public accounting practice and its only real franchise, is no longer the highly profitable business it once was. Consult-ing, which does not require independence, has taken its place. Lured by the prospect of ever-increasing profits and astronomical partner salaries, the Big 5 CPA firms have slid down a slippery slope during the past two decades, emphasizing the selling of consulting services concurrent with audits, and giving the appearance to the public that they are sacrificing independence, which is essential in the audit function. 
Officials at Andersen certainly are not without blame. If media accounts are correct, Andersen's apparently "cozy" relationship with Enron raises substantial doubts about the firm's independence, the essential ingredient to professional integrity for accountants. And we cannot forget the terrible record the firm had in 2001, with scandals from Waste Management, Sunbeam and the Arizona Baptist Foundation. 
The strong arm of the law 
The federal indictment handed down on March 22 against Andersen for destruction of documents was unprecedented. In June, when the guilty verdict was delivered, the firm was convicted of a different crime from that mentioned in the indictment. Instead of destruction of documents, it was found guilty of alteration of documents (even when the original document was retained). Instead of a scalpel, the Justice Department used a meat cleaver to cure the ills at Andersen. The firm is appealing, but in reality, that effort is only for the sake of salvaging a fraction of the firm's already tarnished reputation. For all practical purposes, the appeal is a moot point. Ironically, the vast majority of the people who have suffered from the Enron/ Andersen saga have been innocent employees of both entities who had nothing to do with the companies' financial ills. 
The Sarbanes-Oxley Act of 2002
In an election year, Congress and the White House cannot let alleged wrongdoing go unpunished. Corporate scandals were daily news during the spring and summer. For nine days in July, the Dow Jones industrial average lost almost $2 trillion of market value, reflecting loss of investor confidence in the transparency of corporate America's financial reporting structure. In response, on July 25 Congress passed H.R. 3763, the Sarbanes-Oxley Act (see http://thomas.loc.gov/), containing the most sweeping legislative reforms to affect corporate governance since the Depression. The bill contains stringent requirements carrying stiff criminal penalties for corporate executives, boards of directors and the accounting industry. Among other things, the act prohibits CPA firms that audit public companies from concurrently performing eight different types of consulting services for those same companies. In addition, Congress has proposed a study by the comptroller general on the impact of mandatory periodic rotation of auditors among companies. 
In the long run -- and characteristically -- we all will pay for the scandals of the past few years. As a result of the Sarbanes-Oxley Act, the U.S. economy likely will become even more highly regulated than it has been in the past. This will result in higher costs of audits and public oversight that will have to be borne by registered entities and their shareholders, thus increasing the cost of doing business for American companies and consumers. These changes are necessary, however, to restore confidence in American markets. In capitalistic enterprises, there are two very strong motivating factors: greed and fear. For effective control of the unscrupulous few, fear of the consequences of getting caught must outweigh greed for short-term gain. The Sarbanes-Oxley Act raises the price for unscrupulous conduct. It is hoped that in the long run, preventive reform measures spelled out in the act will help restore confidence in U.S. financial markets and in the public accounting profession charged with the responsibility for assuring that confidence. 
At Baylor, we have lost one of the best business partners we ever had in Arthur Andersen. That loss hurts deeply and will be felt not only here but on college campuses throughout the world. In the accounting department, we will not forget Andersen's partnering efforts with Hankamer to help our students become the successful and ethical business professionals they are today. 
 

Editor's Note: To read Dr. Thomas' article "The Rise and Fall of Enron," visit the American Institute of Certified Public Accountants' Web site.