Arthur Andersen

Arthur Andersen LLP was one of the world’s largest accounting firms and served as Enron’s external auditor from 1985 until the company’s collapse in 2001. At its peak, Andersen employed approximately 85,000 people across 84 countries and generated revenues exceeding $9 billion annually, making it one of the “Big Five” professional services firms alongside Deloitte, Ernst & Young, KPMG, and PricewaterhouseCoopers. The firm earned $52 million from Enron in 2000 alone, split between audit fees ($25 million) and consulting fees ($27 million), creating significant conflicts of interest as it simultaneously audited and advised on the same complex financial structures.

Following Enron’s bankruptcy, Arthur Andersen was indicted and convicted of obstruction of justice for ordering the mass destruction of Enron-related documents during October and November 2001. The conviction, handed down on June 15, 2002, effectively destroyed the 89-year-old firm. Andersen surrendered its CPA license on August 31, 2002, and 85,000 employees lost their jobs worldwide. Although the U.S. Supreme Court unanimously reversed the conviction in May 2005, the ruling came too late to save the firm or restore the careers of those who had worked there. Arthur Andersen is mentioned in approximately 1,160 messages across 46 different employee mailboxes in the Enron email corpus, documenting the extensive relationship between auditor and client during the critical period leading up to both companies’ demise.

The Audit Relationship

Arthur Andersen’s relationship with Enron exemplified the conflicts of interest that pervaded public accounting during the late 1990s and early 2000s. The firm’s Houston office billed Enron approximately $1 million per week for combined auditing and consulting services. In 2000, consulting fees of $27 million actually exceeded audit fees of $25 million, raising serious questions about the firm’s independence. As former SEC Chairman Arthur Levitt observed, conflicts of interest “inevitably occur when a company pays an accounting firm consulting fees that far outweigh the audit fee.”

Beyond standard audit work, Andersen earned substantial fees for structuring advice on the very transactions it was supposed to independently evaluate. The firm billed Enron $5.7 million specifically for advice in connection with the LJM and Chewco transactions, structures that proved central to Enron’s fraud. In virtually all of Enron’s special purpose entity transactions, accounting treatment was determined with extensive participation and structuring advice from Andersen. The firm was effectively auditing its own work, creating obvious incentives to overlook problems in structures it had helped design.

Andersen personnel maintained close operational ties with Enron’s internal teams. Email correspondence from the period shows Andersen employees directly copied on valuation discussions and internal deliberations about accounting treatment. For instance, when Vince Kaminski, head of Enron’s Research Group, refused to sign off on LJM-related valuations without seeing full legal documentation, his email declining to approve the analysis was copied to an Andersen employee at [email protected].

David Duncan and the Houston Engagement

David Duncan served as Arthur Andersen’s global engagement partner for the Enron account, having been assigned as lead partner in 1997. In this role, Duncan bore ultimate responsibility for determining whether unqualified audit opinions should be issued. He signed unqualified opinions for Enron’s financial statements for fiscal years 1998 through 2000, certifying that the audits were conducted according to Generally Accepted Auditing Standards (GAAS) and that Enron’s financial statements were presented in accordance with Generally Accepted Accounting Principles (GAAP).

Internal Andersen documentation painted a different picture than the clean audit opinions suggested. Fraud Risk Assessment questionnaires completed by the engagement team documented that Enron used “highly aggressive accounting practices” and entered into “unusual” year-end transactions. These internal documents specifically noted that Enron’s use of complex “form over substance” and related party transactions created an “extreme” or “very significant” financial reporting risk. Despite these documented concerns, Duncan continued to sign clean audit opinions.

The SEC later alleged that Duncan was “reckless in not knowing that the unqualified audit reports he signed were materially false and misleading.” Specifically, the SEC found that Duncan failed to ensure the engagement team properly audited certain transactions known as the Prepays, Nahanni, and the Raptors in accordance with GAAS, and failed to ensure that Enron properly presented and disclosed these transactions in its financial statements.

Duncan appears in only three email messages in the Enron corpus, suggesting he conducted most of his business with Enron executives through phone calls or in-person meetings rather than written correspondence. One substantive reference, from an email in Ken Lay’s mailbox dated January 20, 2002, notes: “Both ACCF and some members of its board have been mentioned in the press around the country in connection with Enron, David Duncan (one of our directors), and you.”

Audit Failures on Special Purpose Entities

Arthur Andersen’s most consequential failures involved its approval of accounting treatment for Enron’s special purpose entities, the off-balance-sheet structures that concealed billions in debt and losses from investors. The firm explicitly signed off on the accounting treatment and valuations for these vehicles, including the Raptor structures that were central to the eventual fraud.

An October 9, 2001 email from Gordon McKillop, found in Rick Buy’s mailbox, demonstrates the depth of Andersen’s involvement: “The quarterly valuations for the assets hedged in the Raptor structure were valued through the normal quarterly revaluation process. The business units, RAC and Arthur Andersen all signed off on the initial valuations for the assets hedged in Raptor. All the investments in Raptor were on the MPR and were monitored by the business units and we prepared the Raptor position report based upon this information.” This email shows that Andersen was not a passive observer performing after-the-fact audits but an active participant approving valuations as they were established.

The LJM partnerships created by Andrew Fastow presented similar failures. In 2001, Enron and Andersen belatedly concluded that Chewco, one of the LJM-related entities, lacked sufficient outside equity at risk to qualify for non-consolidation under accounting rules. They also determined that the LJM1 SPE in the Rhythms transaction failed the same threshold accounting requirement. These were not subtle judgment calls; the SEC characterized them as “clearly wrong, apparently the result of mistakes either in structuring the transactions or in basic accounting.”

The dual role problem was evident throughout. Andersen had earned substantial fees advising on the very structures whose accounting treatment it was supposed to independently verify. When problems emerged, the firm faced the prospect of admitting that it had approved flawed accounting for vehicles it had helped design, implicating itself in any restatement.

Internal Enron correspondence reveals that employees understood the auditor relationship could be managed. An October 4, 2001 email from Louise Kitchen’s mailbox includes the statement: “Sorry, I think my fault. I have spoken w/ Wes and Georganne to pull back out and need to get Mike to redo contracts to be dated in 4Q to survive any potential Arthur Andersen review.” This suggests employees believed transaction timing could be adjusted to affect audit outcomes.

Prior Warning Signs

Arthur Andersen’s troubles at Enron did not occur in isolation. Just months before the Enron scandal broke, in June 2001, the firm paid a record $7 million civil penalty to the SEC for its role in a $1.43 billion accounting fraud at Waste Management, another Houston-based corporation. The Waste Management restatement, announced in February 1998, was the largest in SEC history at that time. The fine was the largest civil penalty ever imposed on a Big Five accounting firm by the SEC.

Enron employees were aware of this history. On October 22, 2001, just three weeks before Enron announced its $618 million third-quarter loss and five-year restatement, an employee posted a question on the company’s internal eSpeak forum directly addressing Andersen’s credibility:

“Mr. Lay- Enron has been aggressive in the use of SPV’s collateralizing future cash flows for the sake of present earnings. I couldn’t help but notice our auditor, Arthur Andersen of Houston, recently admitted guilt and paid the largest fine ever for criminal falsifications related to SPV’s on behalf of another large Houston corporation. You are a man of integrity, so my ‘question’ is a chance for you to so reassure us we have no such problems here at Enron.”

Ken Lay responded with a full-throated defense of both Enron’s practices and Arthur Andersen’s competence: “To begin with, I can assure you that I or the Board of Directors, would not approve the use of any SPVs or other types of financial vehicles unless we were convinced both by all of our internal officers as well as our external auditor and counsel, that they were legal and totally appropriate. That is the standard that we have used for as long as I have been with Enron, and we will continue to use. In many cases, not only has the local Arthur Anderson office approved these vehicles, but they have also been approved at Arthur Anderson’s headquarter office from some of the world’s leading experts on these types of financing.”

Within weeks, both claims would be proved false.

Document Destruction

As Enron’s situation deteriorated in October 2001, Arthur Andersen initiated a campaign of document destruction that destroyed the firm. According to the subsequent indictment, the destruction initiative began on or about October 10, 2001, as Andersen foresaw imminent government investigations and civil litigation.

The peak period of shredding occurred between October 23 and November 9, 2001. David Duncan ordered Andersen staff to destroy over a ton of Enron-related papers and delete substantial electronic records. The destruction continued even as the SEC began making informal inquiries into Enron’s accounting practices.

By November 16, 2001, Arthur Andersen was named as a defendant alongside Enron executives in federal securities class action lawsuits. An email circulated that day stated: “As you may have become aware, the company received notice yesterday that you have been named as defendants (along with Enron Corp., Ken Lay, Jeff Skilling, Andy Fastow, and Arthur Andersen) in one of the federal securities class actions.”

Criminal Prosecution and Conviction

Arthur Andersen was indicted on March 14, 2002, on one count of obstruction of justice for destroying documents related to the Enron investigation. The indictment represented an existential threat to the firm, as a conviction would bar it from auditing public companies.

David Duncan was fired from Andersen in January 2002 and pleaded guilty on April 9, 2002, to one count of obstruction of justice. In his plea, Duncan admitted that he “knowingly, intentionally and corruptly persuade and attempt to persuade other persons … to withhold records, documents and other objects from an official proceeding, namely an investigation by the Securities and Exchange Commission.”

The firm went to trial and was convicted on June 15, 2002. Deputy Attorney General Larry Thompson stated following the verdict: “The guilty verdict shows that the evidence demonstrated Andersen intentionally interfered with an official investigation concerning Enron Corporation when it destroyed tons of papers documents and a large quantity of electronic information.”

Collapse of the Firm

The conviction proved fatal. Arthur Andersen surrendered its CPA license on August 31, 2002, effectively ceasing to exist as an operating entity. Approximately 85,000 employees worldwide lost their jobs. Clients had already been fleeing since the indictment, recognizing that retaining an auditor facing criminal conviction created untenable risks for their own financial reporting.

The collapse was remarkably swift. Within a matter of months, one of the world’s leading professional services firms went from employing 85,000 people across 84 countries and generating $9 billion in annual revenue to being little more than a legal entity defending against remaining lawsuits. The firm’s name became synonymous with audit failure and corporate scandal, joining Enron itself in the lexicon of business disasters.

Supreme Court Reversal

On May 31, 2005, nearly three years after the conviction, the U.S. Supreme Court unanimously reversed Arthur Andersen’s obstruction of justice conviction in Arthur Andersen LLP v. United States, 544 U.S. 696. Chief Justice William Rehnquist, writing for the Court, found that the jury instructions had not properly portrayed the law.

The critical error concerned the intent required for conviction. The jury had been told that “even if petitioner honestly and sincerely believed its conduct was lawful, the jury could convict.” The Supreme Court held that this instruction was wrong: “Federal law requires consciousness of wrongdoing for conviction under the statute.” Without proper instructions requiring the jury to find that Andersen knew its conduct was illegal, the conviction could not stand.

Following the Supreme Court’s decision, David Duncan withdrew his guilty plea, as the legal basis for the underlying charge had been invalidated.

The reversal came too late to matter commercially. By 2005, Arthur Andersen’s clients had long since departed, its employees had found other positions, and its reputation was irretrievably destroyed. The firm remained technically in existence primarily to manage the wind-down of remaining legal matters but would never again practice public accounting.

Legacy

Arthur Andersen’s collapse accelerated reforms that were already being debated following Enron’s bankruptcy. The Sarbanes-Oxley Act of 2002 imposed new requirements on public company audits, enhanced penalties for securities fraud, and created the Public Company Accounting Oversight Board to regulate auditors. The legislation also restricted the consulting services that audit firms could provide to their audit clients, directly addressing the conflict of interest that had characterized the Andersen-Enron relationship.

The “Big Five” accounting firms became the “Big Four” with Andersen’s demise. The remaining firms absorbed most of Andersen’s practice, hiring former employees and acquiring client relationships. The consolidation further concentrated the market for large public company audits among a small number of firms, a structural issue that continues to concern regulators.

For the 85,000 Andersen employees who lost their jobs, the Supreme Court’s vindication provided little practical relief. Many had built careers at the firm and faced significant professional disruption regardless of the ultimate legal outcome. The Enron scandal and Andersen’s collapse marked the end of an era in public accounting, demonstrating that even the most established institutions could be destroyed by failures of professional judgment and integrity.

References

This article draws on approximately 1,160 email messages mentioning Arthur Andersen across 46 employee mailboxes in the Enron corpus, spanning primarily the October-November 2001 period when the relationship between auditor and client was under greatest stress. Secondary sources include U.S. Department of Justice press releases and legal documents, SEC enforcement actions against David Duncan and Arthur Andersen, the U.S. Supreme Court decision in Arthur Andersen LLP v. United States (544 U.S. 696), and contemporary news reports from PBS, NPR, and CBS News.