What Is the Andersen Effect?
The Andersen Effect is a reference to auditors performing even more due diligence than previously required in order to prevent the kinds of financial accounting errors and mishaps that precipitated Enron's collapse in 2001.
The Andersen Effect gets its name from former Chicago-based accounting firm Arthur Andersen LLP. By 2001, Arthur Andersen had grown into one of the Big 5 accounting firms, joining the likes of PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst & Young, and KPMG. At its peak, Arthur Andersen employed nearly 28,000 people in the U.S., and 85,000 worldwide. The firm was known globally for its ability to deploy experts internationally to advise multinational businesses across its auditing, tax, and consulting practices.
Key Takeaways
- The Andersen Effect gets its name from the former Chicago-based accounting firm Arthur Andersen LLP and its connection to what became known as the Enron scandal.
- By 2002, it all came tumbling down for Arthur Andersen as more faulty audits were discovered in the course of the Enron indictment and investigation.
- The Sarbanes-Oxley Act of 2002 was passed by Congress to establish new or expanded Federal requirements for all U.S. public companies, management, and public accounting firms to prevent another Enron and Andersen Effect.
From a "Big 5" to Collapse
By 2002, all of the trust and glory came tumbling down. That June, Andersen was convicted of obstruction of justice for shredding documents related to its audit of Enron, resulting in what infamously became known as the Enron scandal. Even the Securities and Exchange Commission (SEC) did not emerge unscathed. Many accused the oversight commission of being "asleep at the wheel." But aside from Enron, the up-until-then highly reputable and respected Arthur Andersen stood the most to lose, and it did.
More faulty audits on behalf of Arthur Andersen were discovered in the course of the Enron indictment and investigation. Big-name accounting scandals linked to Arthur Andersen went on to include Waste Management, Sunbeam, and WorldCom.
Sarbanes-Oxley
The subsequent bankruptcy of WorldCom, which quickly surpassed Enron as the biggest bankruptcy in history at that time, resulted in a classic domino effect of accounting and corporate scandals. The industry's reaction was a swift attempt to avoid the Andersen Effect by employing strong corporate governance and heightening accounting controls.
In response to the series of accounting scandals set off by Arthur Andersen, the U.S. Congress passed the Sarbanes–Oxley Act of 2002 (SOX). The federal law established new or expanded requirements for all U.S. public company boards, management, and public accounting firms. An unexpected additional positive outcome of SOX is that this extra level of scrutiny has resulted in companies restating their earnings even if they have not necessarily intentionally misrepresented accounting information.
The Bottom Line
Even some of the biggest, most well respected, and most trustworthy accounting firms can collapse due to mismanagement or missteps taken on behalf of a client. Sarbanes-Oxley was passed to protect the client or investor. But while not always acknowledged, the added scrutiny also protects companies and public accounting firms from making the kinds of mistakes that could ultimately contribute to their undoing.
FAQs
The Andersen Effect is a reference to auditors performing even more due diligence than previously required in order to prevent the kinds of financial accounting errors and mishaps that precipitated Enron's collapse in 2001. The Andersen Effect gets its name from former Chicago-based accounting firm Arthur Andersen LLP.
How was Arthur Andersen involved in the Enron scandal? ›
Andersen had two major audit failures just a few years apart and just a short time before Enron filed bankruptcy. In 1996, Waste Management�s audit reports from Andersen were materially false and misleading resulting in an inflation of income by over $1 billion dollars between 1992 and 1996.
What were the effects of the Enron scandal? ›
It has since been surpassed by the bankruptcies of Lehman Brothers, Washington Mutual, WorldCom, and General Motors. The Enron scandal drew attention to accounting and corporate fraud, as shareholders lost $74 billion in the four years leading up to its bankruptcy, and its employees lost billions in pension benefits.
Why was Arthur Andersen accused of obstructing justice when the SEC started to investigate Enron? ›
Subsequently, Enron declared bankruptcy. convicted in a US federal court of the crime of obstructing justice by shredding working papers related to Enron audits because Andersen personnel knew that the papers would be evidence in a SEC investigation.
What was the conflict of interest in Enron's relationship with Arthur Andersen? ›
Arthur Andersen activities:Arthur Andersen was providing both auditing and consulting services to Enron. This arises as a conflict of interest because Arthur Andersen was basically auditing its own work. Arthur Andersen shredded every Enron document and later was dissolved.
What is the Andersen effect? ›
What Is the Andersen Effect? The Andersen Effect is a reference to auditors performing even more due diligence than previously required in order to prevent the kinds of financial accounting errors and mishaps that precipitated Enron's collapse in 2001.
What did Arthur Andersen do that was unethical? ›
Soon after Volcker came on board, however, Andersen was indicted for obstruction of justice in connection with the shredding of Enron documents. During the investigations, Andersen had been trying to negotiate merger deals for its international partnerships and salvage what was left of its U.S operations.
What was Arthur Andersen guilty of? ›
On June 15, 2002, Andersen was convicted of obstruction of justice for shredding documents related to its audit of Enron. Although the Supreme Court reversed the firm's conviction, the impact of the scandal combined with the findings of criminal complicity ultimately destroyed the firm.
How did Arthur Andersen destroy Enron documents? ›
Two days later Andersen launched a "wholesale destruction" of documents at the firm's offices in Houston, where Enron is headquartered. According to the indictment, shredding machines worked around the clock from Oct. 22 until Nov. 8 - the day Enron was subpoenaed by the SEC.
Why was Arthur Andersen found criminally liable? ›
Following a jury trial in the United States District Court for the Southern District of Texas, petitioner was convicted of corruptly persuading its employees to destroy documents with an intent to impair their availability in a United States Securities and Exchange Commission (SEC) investigation, in violation of 18 ...
Enron paid Andersen $25 million for the year 2000 audit, a figure higher than all but one of the companies in the Dow Jones industrials that reported their audit fees. The average charge among the blue chips was just $9 million, according to a review of such fees by The Times.
What are the two main lessons learned from the Enron scandal? ›
This scandal demonstrates the need for significant reforms in accounting and corporate governance in the United States, as well as for a close look at the ethical quality of the culture of business generally and of business corporations in the United States.
What crime was Arthur Andersen convicted of in relation to its work on Enron? ›
United States, 544 U.S. 696 (2005), was a United States Supreme Court case in which the Court unanimously overturned accounting firm Arthur Andersen's conviction of obstruction of justice in the fraudulent activities and subsequent collapse of Enron.
Who was most responsible for Enron scandal? ›
Several key executive team members are often noted as being responsible for the fall of Enron. The executives include Kenneth Lay (founder and former Chief Executive Officer), Jeffrey Skilling (former Chief Executive officer replacing Lay), and Andrew Fastow (former Chief Financial Officer).
Who was the mastermind behind Enron scandal? ›
Jeffrey Keith Skilling (born November 25, 1953) is an American businessman who in 2006 was convicted of federal felony charges relating the Enron scandal. Skilling, who was CEO of Enron during the company's collapse, was eventually sentenced to 24 years in prison, of which he served 12 after multiple appeals.
