A decade ago, when Arthur Andersen began to part ways with its younger and wealthier sibling, Andersen Consulting, the accounting firm’s partners had a mission: to rebuild a lucrative consulting practice.
Andersen’s relationship with Enron Corp. later emerged as a model of how the Chicago-based accountant would do it. As the small Houston energy company swelled into a powerhouse with seemingly huge earnings and a soaring stock price, the consulting and auditing fees Andersen collected from it mirrored Enron’s growth.
Yet just as Enron’s good times reflected favorably on Andersen’s strategy, the energy trader’s stunning collapse has exposed problems in Andersen’s drive to expand as an auditor and a consultant, experts say.
The growing public perception, said Ashish Nanda, an associate professor at Harvard University’s business school, is that “accounting firms care first and foremost about maximizing profits and little about standards that might threaten profits.”
The focus on fees, particularly from consulting, “endangers the respect and autonomy that the profession has long been accorded,” said Nanda, who has studied Andersen’s operations.
Former Andersen partners interviewed by the Tribune assert that the focus on marketing and on winning new clients has come to dominate too much of the firm’s attention.
Among other things, one former partner contends, Andersen diminished its focus on “substantive auditing,” which required reviewing contracts and other specific documents. Rather, the firm–like some others in its industry–moved toward a less intensive audit process that looked at a company’s accounting processes and controls, the former partner said.
Enron’s collapse, he says, has prompted the firm to return to the more rigorous auditing method.
And while the Chicago-based firm often boasted of being the industry’s “maverick” leader, this image, former partners say, masked a layered, excessively complicated management structure that was under pressure on several fronts even before the shocking fall from grace of Enron, one of its most prized clients.
Andersen declined to comment for this article.
Like many of the leading accounting firms, Andersen is a limited liability partnership, quite different in structure from a typical U.S. corporation. It is made up of a complex network of member firms.
“It’s a little bit like democracy,” said retired Andersen chief executive Duane Kullberg. “The worst of all government systems until you try every other one.”
As a result, member firms and the partners that make up Andersen’s leadership are a disparate bunch, with a high degree of independence. Almost every major decision within the roughly 28,000-member U.S. arm of the firm–such as the decision to fire a partner–must be endorsed by a vote of the firm’s equity partners.
The structure, which Kullberg describes as “cumbersome,” encompasses layer upon layer of management, with partners often reporting to several different senior executives.
Even Kullberg now wonders if management took its eye off the ball during a key period between September 1997 and January 2001, when a fractious battle for control within Andersen left the partners unable to agree on a permanent leader.
The three years prior to the appointment of current chief executive Joseph Berardino were “a period of time when somebody could argue that there might have been a lack of [management] focus,” said Kullberg.
At the same time, former partners say, the internal bickering and squabbling over the Andersen Consulting firm’s relationship with Andersen accounting ultimately resulted in a permanent separation in the fall of 2000. At the time, Andersen Consulting accounted for close to 60 percent of the firm’s revenue.
Battle over profits
So profitable was the former consulting arm that it attempted to withhold almost $500 million in fees, two years worth of payments for organizational work carried out by the parent company that it charged was being used to subsidize the accounting half of the practice.
Pressure to keep pace with Andersen Consulting following the split and emerge from its standing as the smallest of the Big 5 accountants also led Andersen to put more emphasis on winning new business.
In purely financial terms, the drive was a success. Andersen’s revenue rose from $3 billion in 1992 to $9.3 billion in 2001, fueled by new lines of business outside of auditing, ranging from treasury management to corporate finance services. Just 42 percent of its fees came from accounting and auditing in 2001.
Investigators are now probing whether the aggressive push into consulting compromised the auditing process. At Enron, for instance, Andersen not only audited the power trader’s books, but also provided tax and business consulting services, as well as supplying internal audit functions.
Partners who were dedicated to the Enron account tended to bill more and thus tended to earn more than other partners, some former partners say.
Along with the rewards came heightened pressure: to audit Enron effectively while keeping fees flowing at an account Andersen partners estimated in February 2001 could soon reach $100 million a year.
The emergence of the Andersen consulting units as profitable, stand-alone businesses in the 1990s underscored broader changes going on in the professional services field.
“It is encouraging to realize how much of our fees come from services that were either in their infancy or did not exist in 1995,” said Steve Samek, the managing partner responsible for the U.S. in the firm’s 1999 annual report. Samek went on to outline the firm’s increasingly aggressive strategy to win even more work from the nation’s top 2,200 corporations.
Berardino himself, before becoming Andersen’s chief executive, urged partners to continue pushing the firm’s risk consulting services.
As head of the audit business in 1999, he told partners that they must keep “leveraging” Andersen’s services to “create a multidisciplinary solution for clients.”
Better pay
As its ability to leverage its services grew, so did compensation among the partners. Allocating compensation of equity partners at Andersen is a “horrendous” process, said Kullberg.
But it is a good example of the inherent complexities of running a huge partnership.
The compensation process is linked to the number of “units” each equity partner has in the firm. The partners usually start off with 300 units and are then evaluated two years later and at regular subsequent intervals to determine whether they deserve a greater share. The evaluation process takes six months to complete, estimated Kullberg.
A partner’s subordinates evaluate their superior’s strengths and weaknesses and the evaluations continue up the company’s chain of command. Numerous factors, from the partner’s ability to mentor employees to the person’s intelligence, factor into the compensation equation, but how much business the partner brings in is also a big factor.
Partners are generally awarded between zero and 65 units after the evaluation. The firm’s profits are then divided up based on the total number of outstanding units.
Before it became taboo, firms like Andersen openly measured how much consulting business they won from auditing clients. That benchmark is still closely watched, but not advertised, said Tom Rodenhauser, a consulting industry analyst.
“It’s the type of thing you really didn’t want to publicize,” Rodenhauser said. “The expectation was if I pass along business that something will come back to me in the end because we all benefit.”
