Andersen: The Whistle Not Blown

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No taste for accounting: Arthur Andersen HQ

The way it's supposed to be, a CEO gets a little nervous when he hires an Arthur Andersen to go over his company's books. After all, an outside auditor's seal of approval — this company's balance sheet is what the company says it is — means he keeps the confidence of investors, and on Wall Street confidence is everything. But if he gets a bad report — like the dreaded "accounting irregularities" — he's sunk. Investigators come running; investors just run.

In this world, investors know which companies are shooting them straight at earnings time and which ones aren't; which ones have dangerous levels of debt and which ones don't; which ones are making money and which ones aren't. Which is critical. The rise and fall of Enron may have been merely part of "the genius of capitalism," as Paul O'Neill put it, but the genius of investor-based capitalism — that'd be our system — also depends on disclosure, on transparency, on every investor knowing what Ken Lay knew about Enron's financial habits when Ken Lay knew it.

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But that only works if the outside auditor isn't in-house, and Arthur Andersen was half in bed with Enron from the start. In a proportion common to the Big Five accounting firms, half the $52 million a year Arthur Andersen collected from Enron was for its accounting services, and half was for its consulting business. And much like Wall Street analysts have become loss-leaders for the investment banking operation down the hall, accountants — outside auditors — have become a way to get the firm's consultants, who make the big profits, in the door. Relationships get formed. Hands wash each other. And for an auditor, offending a big client with uncomfortable scrutiny quickly becomes a company no-no. After all, everybody's on the same team.

Two years ago, Andersen CEO Joseph Berardino, arguing that the Big Five could police themselves, led the squawking that ultimately got former SEC chairman Arthur Levitt to back down from proposals to forbid accounting forms from doing consulting work. When the current scandal first started to bloom, Berardino insisted to Congress that 70-year-old accounting rules don't give auditors the tools to flag the kind of risky behaviors that got Enron in trouble — and that it's the laws governing client disclosure that are toothless, allowing an Enron to hide its shadiest deals from the poor auditors trying to uncover them.

But these days, Arthur Andersen doesn't look much like an accounting firm that didn't know enough. "Enron whistle-blower" Sherron Wadkins didn't just tell Lay in August about her fears that their company would "implode in a wave of accounting scandals" — she told a top man at Andersen, who then told three Andersen partners, including the recently disavowed David Duncan, who was overseeing the Enron audit.

It remains to be seen whether Duncan was covering his own trail (as Andersen declared Wednesday when it fired him and handed the feds his scalp as a peace offering) or just taking an obvious hint from a destruction-policy memo from an Andersen lawyer, which was the story Duncan was telling congressional investigators deep into Wednesday night. But he sure knew enough to go on a shredding-and-deleting rampage that, the firm says, lasted from Oct. 23 to "shortly after" Nov. 9, the day the SEC sent over its subpoena.

Luckily, the business world is not without a sense of karma, and full disclosure does eventually come to those who wait. Enron's debt-concealing, off-the-balance-sheet partnerships (which Enron's pet law firm says were "creative and aggressive" but not illegal) and warped revenue yardsticks eventually brought it down, and now we all know about them. Arthur Andersen's reputation as an honest accountant is now permanently tarred, and it will suffer at Wall Street's hands for devaluing its auditor's seal of approval. (As a consultant, though, you've got to love the way they go that extra mile.)

As for the punishments of the legal variety, with their pick of Wadkins, Duncan, Andersen's now-suspended Houston management team and disgruntled employees of both sinking ships, federal and congressional investigators have their pick of potential squealers. Despite — or because of — the political largesse of both companies (Andersen's own campaign checkbook graced 94 of 100 U.S. Senators), the political heat will be turned up high, and Justice's own little bedfellow problem (Andersen is helping them reorganize the FBI) shouldn't prevent them from collecting plenty of arrests in the name of George W. Bush's integrity. For the wrongdoers at these two companies, the jig does appear to be up.

But it's not the reputations and fortunes of Andersen or Enron that policy people at say, the Treasury Department are worried about — it's that of accounting, and investing, in general. Speaking to (and well beyond) a group of life insurers Wednesday, Treasury undersecretary Peter Fisher bemoaned that the science of making gobs of money had advanced well beyond the science of telling investors "the riskiness of that firm's activities" — just how, exactly, a company was making those gobs of money.

"I fear that the financial catastrophes of recent years will continue to haunt our financial markets and questions will continue to be raised about our system of investor-based capitalism on which our economy depends," Fisher said. And closing that "disclosure gap" — not preventing the next corporate implosion, but making sure investors get the warning signs as promptly as possible — with accounting- and disclosure-rules reform is now Washington policymakers' most important job.

Because while Sherron Wadkins certainly seems to have been a conscientious employee with a sharp eye for trouble, whistle-blowing isn't whistle-blowing if only Ken Lay and some Arthur Andersen partners — who probably didn't need the advice and certainly didn't follow it — heard the noise. Blowing the whistle on Enron's creative accounting, however, wasn't Wadkins' job. It was the job of the certified public accountants — the outside auditors — at Arthur Andersen LLP.

And they evidently swallowed the darn thing.