The Andersen accounting firm’s handling of Enron’s books has Congress, investigators and the public all wanting to know whatever happened to the old reliable green-eyeshade set.
The answer lies in a trend that defined big accounting firms throughout the nation’s recent economic boom: expanding services far beyond their traditional job of signing off on financial statements.
“Arthur Andersen ran this like I was going to Macy’s. I went in to buy some curtains, and the salesman says, `Oh, you need a new sofa,'” too, said Paul Zane Pilzer, a former real estate developer and Andersen client. “That works wonderfully in Macy’s. But it doesn’t work when one of those partners is supposed to be an impartial auditor.”
That was in the 1980s. “It’s even worse today,” he said, “because all these firms have realized consulting is the place to make money. … It disgraced the accounting profession.”
Pilzer’s one-stop-shopping experience at Andersen was no aberration. It was, in fact, an example of the driving strategy behind the firm and its chief executive, Joseph Berardino.
Although Berardino did not become Andersen’s CEO until early last year, he got there by being one of its top auditors and aggressively selling a range of services anchored by its auditing and tax business.
Berardino played a key role in pushing Andersen to rebuild its consulting services after its divorce two years ago from Andersen Consulting, now Accenture. He is credited with helping to prevent the Securities and Exchange Commission from enacting rules limiting consulting work by accounting firms.
As Congress and federal regulators consider how best to prevent another collapse similar to Enron, the way Berardino and Andersen did business has come under scrutiny.
Internal Andersen documents and interviews with former clients and accounting veterans show how the Chicago-based firm cross-markets its services, in ways many critics say exemplify the industry’s conflict-of-interest problems. The documents and interviews also point to how the public’s faith might be restored in those keeping Corporate America’s books.
Industry vows reforms
Some of the Big Five accounting firms have vowed to limit the consulting services they do for audit customers, even though some argue that doing so gives auditors a better idea of how a company works. And the industry’s trade group, the American Institute of Certified Public Accountants, has sought to repair public confidence–and forestall tougher laws–by agreeing that audit firms should not consult for their publicly traded audit clients.
But the potential remains for conflicts of interest, critics say. Accounting firms still will offer tax advice and other services. While the other Big Five firms have either spun off or vowed to separate from their consulting businesses, Andersen has said it will retain its operations.
Paul Volcker, the former Federal Reserve chairman chosen to head an Andersen oversight board, has expressed concerns about such arrangements.
“Large and profitable consulting assignments may, even subconsciously, affect auditor judgment,” he recently told the Senate Banking Committee.
Andersen says Volcker’s oversight board will work with the firm to in making “fundamental changes in its audit practice.”
“We’ve made a number of strong changes to the way we do business,” said Patrick Dorton, a company spokesman. “Andersen auditors take the independence rules very seriously and abide by all of the SEC and [AICPA] requirements in this area.”
Dorton also said Andersen plans to work with its more-than 2,300 publicly traded U.S. audit clients to determine the acceptable scope and level of fees for non-audit services that the firm will continue to provide. It also has promised to set up a new Office of Audit Quality.
No such office existed when Pilzer was an Andersen client. Now an entrepreneur and author, he made millions in the 1980s buying bank headquarters and leasing them back to their original owners.
It was a time when Andersen was establishing itself as the leading accounting firm for the energy industry–and when accountants were figuring out just how lucrative it could be to consult for their audit clients.
Despite his partner’s objections, Pilzer always insisted on hiring Andersen as a consultant rather than a purebred consulting firm such as Booz Allen or McKinsey. But he had a reason for doing so.
“I would never let my partner argue that consulting fee,” Pilzer said, because “the more consulting business we did with them, the more companies they would refer to me and the easier their audit partners would be in approving the deals.”
The one-stop shopping did not end there, though. Andersen also “would introduce us to the banks,” he recalled. “They’d say, `Hey, we have a bank who’s a customer, they’re looking to sell their building.”‘
Pilzer, in turn, needed wealthy individuals to buy into the deal. “The first place I went to get those people was the tax department at Arthur Andersen,” he said.
To Andersen’s top executives, such arrangements were simply synergy. As head of the firm’s audit and assurance division in 1999, Berardino was unapologetic in pressing Andersen partners to help sell services to the “Global 1000,” a list featuring Enron, Microsoft and others.
In Andersen’s 1999 annual report to partners, Berardino told audit partners to “leverage” the division’s services across the firm to create “multidisciplinary” solutions for clients.
The message was one echoed throughout the company, as other senior executives extolled the virtues of cross-selling services. Tax division head Richard Spivak told his partners in the 1999 annual report to “aggressively package” solutions “across service lines, service categories and industries.”
The strategy worked well, according to the latest figures for the rebirth of Andersen’s consulting business. For fiscal year 2001, auditing made up 43 percent of the firm’s domestic net revenue, said Jonathan Hamilton, editor of the Public Accounting Report. Tax services provided 31 percent of net revenue, while consulting made up the remaining 26 percent.
Consulting as a cash cow
Of the 2,311 publicly registered companies Andersen audited in 2001, 98 companies paid more for consulting services than they did for accounting work, according to SEC filings. For another 140 companies, consulting work was worth between 26 percent and 100 percent of the amount of Andersen’s audit business.
Andersen’s relationship with Enron riled some customers. In a lawsuit filed in 1996, Dow Hydrocarbons and Resources accused the auditing firm of favoring Enron at the expense of another client, a Dow subsidiary.
“Acting in these dual roles as the voice of [Enron] management as well as the voice of so-called `independence,’ Andersen violated the most fundamental standards required of external auditors to ensure objectivity,” the lawsuit alleged.
A judge dismissed the case against Andersen because the statute of limitations had taken effect. “The fact that the statute of limitations was allowed to expire tells you they didn’t have any confidence in the basis of their allegations,” said company spokesman Charlie Leonard.
At a news conference last week, Volcker said his oversight board would review another potential conflict: the way big accounting firms pay their partners. By sharing overall profits, critics contend, partners have an incentive to bring in as many types of business as possible, even if it is not in the client’s best interest.
Some say such potential conflicts could be blunted by changing who hires the auditors. One idea being floated is to have the stock exchanges, rather than individual companies, do so.
“That way, the auditor isn’t afraid if they’re too tough with a company’s audit,” said Dave Cotton, an outspoken CPA in Alexandria, Va., whose firm specializes in audits of government organizations and programs.
If auditors worked for the stock exchanges, proponents say, accounting firms would not risk the appearance that they were blessing the books just to keep their fees coming.
Even Andersen has acknowledged that senior partners debated that dilemma a year ago in the case of Enron. Andersen said the partners talked about how the prospect of Enron paying as much as $100 million a year in fees “could be misperceived as affecting independence.”
Andersen, which made $47.5 million in fees from Houston-based energy company in 2000, nevertheless decided to keep Enron as a client. More than $20 million of that money came from consulting and tax services for Enron, whose books Andersen audited from the energy trader’s inception in 1985 until being fired on Jan. 17.
To have Andersen provide a range of services is typical for such a sprawling firm, and some observers think that’s not necessarily bad. “Some people would say that’s networking among the affluent, except their networking is all internal,” said Arthur Bowman, editor of the trade newsletter Bowman’s Accounting Report. “I guess it comes back to the integrity of everybody involved.”
Others say the system breeds an unhealthy coziness between big corporations and their accountants. “You tend to lose sight of the fact that your underlying responsibility is to the potential investors and shareholders in that company,” Cotton said.
Pressure from client cited
He knows what that pressure feels like. Cotton’s firm once audited a grant program for what he would only describe as “a mid-Atlantic state government.” His review found that the state had failed to properly verify half of the $28 million given to help low-income residents pay their energy bills.
The secretary of the agency called in Cotton, who held his ground. So the official “stood up, reached across the table and grabbed me by my necktie. He pulled me to the center of the table, stuck his nose right up next to mine and said, `You can issue that report, and it will never see the light of day.”‘
Cotton’s firm did issue the report and hasn’t “done a bit of business with that state since.”
Despite all the attention on Andersen’s relationship with Enron, the accounting industry trade group contends that separating auditing and consulting would not have prevented Enron’s collapse. “But we are committed to restoring faith in the accounting profession, which has been around for over 100 years. And if this helps, we’re in favor of it,” said Joel Allegretti, spokesman for the AICPA.
The association is concerned enough about the industry’s battered image that it plans to start a print and radio advertising campaign March 18. The message will be: “Don’t paint the entire profession with the same brush simply because of the possible failure of just a handful of auditors.”
One major question still unanswered is who will audit the auditors. Until recently, part of that role fell to the Public Oversight Board, a peer review group created in 1977 and funded by the AICPA members who audit public companies.
When SEC Chairman Harvey Pitt recommended a new watchdog dominated by members outside the accounting profession, the oversight board disbanded in protest.
Bowman supports a new oversight body that would have teeth “to bring felony charges against any management executive or accounting firm professional who has violated the trust that comes with their jobs.”
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Cashing in on consulting
Some top accounting firms derive a significant percentage of their revenue from consulting services.
Ranked by U.S net revenue for fiscal year 2001 and revenue sources
Consulting
Audit services
Tax services
Other
PricewaterhouseCoopers
$8.1 billion
Consulting: 31%
Audit services: 35%
Tax services: 20%
Other: 14%
Deloitte & Touche
$6.1 billion
Consulting: 35%
Audit services: 33%
Tax services: 21%
Other: 11%
Ernst & Young
$4.5 billion
Audit services: 58%
Tax services: 39%
Other: 3%
Andersen
$4.3 billion
Consulting: 26%
Audit services: 43%
Tax services: 31%
KPMG
$3.2 billion
Audit services: 62%
Tax services: 38%
Source: Public Accounting Report
Chicago Tribune
