Remember Enron and its auditors Anderson?

Now might be a useful time to recall what happened to high-riding Enron and its auditors Anderson. It goes to show that we cannot always trust the auditors, even if they happen to be big reputable ones.

After all, who pays their fees? The client. So are the external auditors really independent? You tell me.

Moreover, external auditors aren’t really able to tell you if their clients’ transactions make good business sense. After all, they are not experts in their various clients’ businesses or industries.

The auditors are just mandated to assure stakeholders that their clients’ financial records reflect a true and fair view of the business transactions.

In a regular audit, the external auditors don’t go in with the objective of conducting a thorough, indepth anti-corruption or anti-money laundering investigation – though in some obvious or suspicious situations (e.g. frequent change of auditors) they should be on the alert to spot the alarm bells ringing and red lights flashing.

Still, auditors do have a duty to verify that the assets of the businesses are for real and are not inflated and that creditors are not understated. They have to verify that cash in the bank or other liquid assets really exist and are not fictitious or paper assets.

Unfortunately, in some cases, less scrupulous external auditors can be complicit in their clients’ shady dealings, advising them on dubious matters and even closing an eye to their clients’ shady dealings.

So don’t tell us that such-and-such company’s accounts have been signed off by a ‘reputable’ external audit firm, therefore everything must be above board with the company.

To detect corruption, money laundering or the siphoning of funds, an in-depth and thorough probe by a really independent commission, staffed by those familiar with all aspects of the business, is required.

This is from Wikipedia:

Following the 2001 scandal in which $100bn in revenue from energy giant Enron was found to have sustained itself by means of institutional and systematic accounting fraud, Andersen’s performance and alleged complicity as an auditor came under intense scrutiny. The Powers Committee (appointed by Enron’s board to look into the firm’s accounting in October 2001) came to the following assessment: “The evidence available to us suggests that Andersen did not fulfill its professional responsibilities in connection with its audits of Enron’s financial statements, or its obligation to bring to the attention of Enron’s Board (or the Audit and Compliance Committee) concerns about Enron’s internal contracts over the related-party transactions”.[12]

On June 15, 2002, Andersen was convicted of obstruction of justice for shredding documents related to its audit of Enron, resulting in the Enron scandas. Although the conviction was later reversed by the Supreme Court, the impact of the scandal combined with the findings of criminal complicity ultimately destroyed the firm. Nancy Temple (Andersen Legal Dept.) and David Duncan (Lead Partner for the Enron account) were cited as the responsible managers in this scandal as they had given the order to shred relevant documents. Since the U.S. Securities and Exchange Commission cannot accept audits from convicted felons, the firm agreed to surrender its CPA licenses and its right to practice before the SEC on August 31, 2002—effectively putting the firm out of business. It had already started winding down its American operations after the indictment, and many of its accountants joined other firms. The firm sold most of its American operations to KPMG, Deloitte & Touche, Ernst & Young and Grant Thornton LLP. The damage to Andersen’s reputation also destroyed the viability of the firm’s international practices. Most of them were taken over by the local firms of the other major international accounting firms.

The Andersen indictment also put a spotlight on its faulty audits of other companies, most notably Waste Management, Sunbeam, the Baptist Foundation of Arizona and WorldCom. The subsequent bankruptcy of WorldCom, which quickly surpassed Enron as the then biggest bankruptcy in history (and has since been passed by the bankruptcies of Lehman Brothers and WaMu in the 2008 financial crisis) led to a domino effect of accounting and like corporate scandals that continue to tarnish American business practices.

On May 31, 2005, in the case Arthur Andersen LLP v. United States, the Supreme Court of the United States unanimously reversed Andersen’s conviction due to what it saw as serious flaws in the jury instructions.[13] In the court’s view, the instructions were far too vague to allow a jury to find obstruction of justice had really occurred. The court found that the instructions were worded in such a way that Andersen could have been convicted without any proof that the firm knew it had broken the law or that there had been a link to any official proceeding that prohibited the destruction of documents. The opinion, written by Chief Justice William Rehnquist, was also highly skeptical of the government’s concept of “corrupt persuasion”—persuading someone to engage in an act with an improper purpose even without knowing an act is unlawful.

Ah, there’s an interesting twist to all this: in 2000, a young undergraduate at Wharton, “Taek Jho Low”, chose Enron as his ‘stock pick’. His ‘hot tip’ was published in the Wharton Journal under the heading ‘Enron boasts top growth’.

Conveniently, this published piece can no longer be found on the Wharton Journal website (too embarrassing for all concerned?) – but fret not, you can still see it archived here.