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    Involvement of Enron & Anderson

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    Enron and Anderson

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    Venkatesh K
    Involvement of Enron & Anderson

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    © All Rights Reserved
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    Enron and Andersen—What Went Wrong and Why Similar Audit Failures Could Happen Again ‘Matthew J. Barrett* Years may pass before the public finds out exactly why Andersen's audits of Enron failed to uncover the pervasive accounting fraud at che company, bur several factors likely concribuced to the audit failure. Unconscious biss, compounded by organiza tional flaws and a culture at Andersen that emphasized marketing non-audlit services to audit clients in an effort to boost profits; significant conflicts of interest and self- interest; and greed all help explain why Andersen did not (1) catch the problems at Enron, and (2) cell che war'd thac such problems existed. Although Congress attempted to address some of the perceived problems in the Sarbanes-Oxley Acc of 2002 (*SOx"), several significant gaps remain because che reforms do not adequately address uncon- scious bias. Arent audits supposed to be sign-off on the appropriateness of a company’ financial statements? Not exactly. Before we examine what wenc wrong in Andersen's audits, we should clarify whae an audit hopes to accomplish. In an audi, the auditor evaluaces the various representations that an enterpris’s management asserts in the financial statements and related notes about the firm’ assets and liabilities ac specific date and cuansactions during a particular accounting period so chat the auditor can render a seport on (and almost always express an opinion about) those financial starements and accompanying disclosures. Ulimately, the auditor seeks to express an opinion as to whether the Financial scarements present fairly, in all material respects, che enterprises financial condition, results of operations, and cash flows in conformicy with generally accepted accounting principles. If che examination of the entiy’s procedures and ac counting records allows the auditor to reach an affirmative conclusion, then the audi- tor will sue an unqualified or “clean” opinion. Even an unqualified opinion, however, “Professor of Law, Notre Dame Law School. The author gratefully acknowledges valuable research ssiance from John J. Barber, 2 memisr of te class of 2005 and an Arthur Andersen alum, and helpful ‘comments and suggestions fiom David R, Herwiez. Copyright © 2003 Matihew J. Barret 155 156 EnRON: CORPORATE FIASCOS AND THEIR IMPLICATIONS does nor guarantee the accuracy of financial statements; such an opinion provides only “reasonable assurance” that che financial statements fairly present, in all macerial re- spects, the enterprise's financial condition, results of operations, and cash flows in conformiry with generally accepted accounting principles." Differing perceptions exist becween the assurance that investors and other users of financial statements expect and thar which audivors provide? An important study during the early 1990s revealed thac almost half of che investors surveyed believed that audited financial statements provide absolute assurance against errors or unintentional misstatements, In chat same survey, more chan seventy percent expressed a belief that audited financial starements provide absolute assurance against fraud or intentional misstatements. Unforcunately, even in a properly planned and executed audit, fraud can more easily avoid detection chan unintentional errors. As result, investors set a higher standard for auditors co uncover fraud than co discover errors and their expec- tations exceed the assurance actually provided. The accounting profession has labeled these misconceptions as the “expectation gap." To reiterate, an audit provides only rearonable assurance against material misstate- ments, whether intentional or unintentional, in the financial starements, In ceality, an audic does nor guarantee chat error of fraud has not affected the financial starements, Similarly, even an unqualified report does not offer any assurance that the enterprise presents a safe investment opportunity or will not fail. At the same time, however, then-existing generally accepted auditing standards required an auditor to assess che risk that errors and fraud may cause the financial statements to contain 2 material ‘misstatement. In addition, the auditor faced a professional obligation to design the audi to provide reasonable assurance that che examination would detect material er- rors and misstatements, to exercise professional skepticism, and co perform and evalu- are audit procedures to attain che required assurance.* Didnt a jury convict Andersen for fraud in its audits of Enron? No. Although David Duncan, Andersen's former lead zudie partner on the Enron account, pleaded guilty to " See genealy Davio R. HERWITZ & MATTHEW J. BARRETT, MATERIALS ON ACCOUNTING FOR Lawre8 180-82, 200-04, 215-17, 233-40 (3d ed. 20) 2 td 3227-38. 2 Mare J. Epstein & Manshall A. Giger, Zamenor View of dnt Assurances Reet Evidence of the Expectation Gap, J. ACCT, Jn, 1994, 3660. ‘Ser CONSIDERATION OF FRAUD IN A FINANCIAL STATEMENT AUDIT, Statement on Audicing Sean- sands No, 82 (America lst. of Cenifed Pub. Accountants 1997) (‘SAS No, 82"); ao HERWz & BARRETT, yp note 1a 231-33. ERecivefor audi of financial terns or periods beginning on or alter Dec. 15,2002, SAS No, 98, Gnsdertien of Frei a Finecial Suteret Audit, iperdes SAS No, 82, CONSIDERATION OF FRAUD IN a FINANCIAL STATEMENT AUDIT, Statement on Auditing Sram dards No. 99 (American Inst. of Certified ub. Accountants 2002). In adicon o previous expecacion SAS No. 99 now requires an auivor wo excend the exercise of profesional skeptic wo the possiliy thc faud may causea materia statement. In pancular, auditors wus evaluate specifi aud raksand document te plan and procedures use o evaluate those ess. ENRON AND ANDERSEN 157 obstruction of justice during the SEC’ inquiry into Enron's collapse and a federal jury convicted Andersen on one felony count of obstructing justice, those crimes did not relate to the audits themselves.® As to those audits, however, Andersen has acknowledged that its audits failed to require Enron to include ewo special purpose entities (“SPEs’) in the company’s con- solidaced financial statements as generally accepted accounting principles required.® Shortly before its bankruptcy filing, Enron restated ics financial statements back to 1997 to include those wo SPEs.’ During his Congressional testimony in December 2001, then-Andersen Chief Executive Officer Joseph F Berardino blamed Enron for withholding “critical information” about the larger SPE, an entity called Cheweo. He candidly admitted that Andersen attributed the incorrect accounting on the smaller SPE, a subsidiary of the entity known as LJMI, co “an error in judgmenc.”> Ar chat time, financial accounting rules required that, among other things, unrelated parties ‘own an investment equal to at least three percent of the fair value of an SPES assets to avoid consolidation.” (Accounting rule-makers subsequently adjusced thac threshold upwards co ten percent,'° and they continue to study the consolidation requirements." Those rule-makers also now refer to SPEs as “variable interest entities,” ot VIES.)" In 1999, alter reaching some conclusions on valuation issues involving various assets and liabilities, Andersen's audit tam originally determined that unrelated parties held more than chree percent of the subsidiary’ residual equity, thereby meeting che required Flynn MeRobers eral A Final Acauning: Repent ofender ges tiff jie, CH. TRIB, Sept. 4, 2002, a1, avilable at 2002 WI. 26771271, For a discussion ofthe Andersen criminal case ee Aron Burton & John S. Drienleousi, dis dao a 689-782. ° Before the nse Commitee on Fiancal Serves, 107th Cong. (Dec. 12,2001) (sarementof Joseph F Berandino, Managing Partnes-Chief Executive Officer, Andesen), avaiable arhep:/inewsfindav.con hdoesdocsfenron/andersen!2120 ese pa (hereinafter Berardi testimony * See BRON Cone, FORM &-K, CURRENT REPOHT PURSUANT TO SECTION 13 Of 15(@) OF THE SECURITIES EXCHANGE ACT OF 1934 (fled Nox. 8, 2001) (disclosing required restatement of previously issued Financial statements), avsitable at hecp:/lwww.sec-goviArchivesledgar/dara/1024401/ {900095012901503835/49183 eee se aha Jonathan Wel, Etro iors Debaed Parineip Loses Andere Mewes how That the Acountants Knew of Raptor Stats, WALL. ST. J Apr. 3, 2002, at Cl, ‘nslable at 2002 WL-NIS} 3390542, * Berardi testimony, supra noe 6. 2 William We Bratton, Enron and the Dark Side of Sharcalder Vue, 76°TUt be REV. 1275, 1306, 0 118 (2002) (explaining the origin and history of the three percent test sealer Gordon Housworth, Enon & Arshur Andersen: to comply is nor enoygh, CRITICALEYE, Aug, 2002, a 21-25, available ut hup:fiwwwcemeaconsulting.com/Crtical_Eye/Critcal EYE_aug_2002.pil. ™ ConsoLIDATION OF VARIABLE INTEREST ENTITIES, FASB Interpretation No. 46, $$ 9, C21-25 (Financial Aecouneing Standards Bd, 2003), avalable ae hespliwww fab or/incerp6 pd 4 BINANCIAL ACCOUNTING STANDARDS BOARD, Projet Updates Consolidations Policy and Prce- days (Ape 8, 2003), avilable at heel ewwetsb.oegpojeeiconsol.sheml (ast visited June 13, 2003). " CONSOLIDATION OF VARIABLE INTEREST ENTITIES, sypr note 10, at $ 6, 158 ENRON: CORPORATE FIASCOS ARD THER IMPLICATIONS threshold for non-consolidation. In reviewing che transaction in October 2001, Andersen determined chat the audic eeam reached its initial judgmenc in error and advised Enron to correct the error," Based upon testimony ac Anders is criminal tril, internal documents that Con- gressional investigators obtained, and a report hy a special committee on Enron's board, an article in The Wall Street Journal immediately after Andersen's conviction high- lighted inaclequate disclosures, questionable transactions with ocher SPEs, che prema- ture recognition of revenue, and the failure to insist chat Enron record adjustments iu recommended in previous audits as other potential deficiencies in Andersen's audits. Governmental investigations of Andersen's audits presumably continue, and civil lit gation remains pending.'* So why did Andersen fil o cauch rhe problems at Enron? Although numerous con- flices of interests permeated the relationship between Andersen and Enron, uncon- scious bias—the propensity co interpret data in accordance wich our desires—best ‘explains why Andersen's audits failed. Other explanations include the culeure and or- ganizacional flaws at Andersen. Unconscious bias. A recent Harvard Business Review article entided “Why Good Accountants Do Bad Audits” argues that unconsciously biased judgments, rather than criminal collusion between auditors and management, often cause audit failures.'° ‘Two recent experiments, one with business students and the other with professional auditors, demonstrated that even the suggestion ofa hypothetical relationship wich a client distorts an auditor's judgments. Long-sranding relationships involving millions of dollars in ongoing revenues can only magnify the results, The article posits that three structural aspects of the accounting industry—ambiguicy, attachment, and ap- proval—create significant opportunities for bias to influence auditing judgments. In addition, the article highlights chree aspects of human nacure—familiaricy, discount- ing, and escalation—thar amplify auditors’ unconscious biases." Ambiguity, Accounting remains an art, nota science, which requires enterprises, and their auditors, ro exercise professional judgment in preparing and auditing financial statements. Although we often hear accountants refered co as "bean countets” and may believe that accounting provides clear-cut answers to all questions, financial account ing requires various estimates chat affect the amounts shown in the financial state~ "Bernd estimony, pra note 6 Ken Brown, Aden Staff Works to Tie Up Lane End Andere Might Face More Legal Problems ‘Begone Guy Vers, NEAL S.J June 17, 2002, a C1 ule at 2002 WLS) 3397879. 3d "© Mar H. Bazerman, George Loewenstein & Don A. Moore, Why Good Accountant Do Bad Anat, aay. BUS. REV., New. 2002, 2 96, "ad ENON AND ANDERSEN 159 mens, including the reported amounts of assets liabilities, revenues, and expenses, In addition, generally accepted accounting principles often allow alternative treatments for the same transaction or events and may not address a particular sicuation because business transactions evolve more rapidly than accounting principles. Witness the Internet’ recent emergence and Enron's eransformation from a regional natural gas company to a global energy and commodities trader.'® Given the various accounting escimates and permissible choices in accounting methods, a typical business enterprise could potentially select from more than a million possible “bottom lines.”” To illus- trate, the fast-food chain Wendy's once advertised chat its customers could order a hamburger 256 different ways. Wendy's offered eight different toppings and condi- ‘ments, such as leetuce, tomato, cheese, ketchup, and mustard, which customers could request. Either selecting or omitting those individual extras translated ro 256 options, a number that grew exponentially with each extra. For public companies today, gener- ally accepted accounting principles allow even more choices. In this regard, entities ‘must decide when to recognize revenue; estimate sales returns and allowances, warranty costs, useful lives, and salvage values; select inventory and depreciation methods; and decide whether or not to expense stock options. Bias thrives in such an environment.” Attachment, The auditor's business interests in fostering a long-term relationship with a clienc’s management encourage auditors to render “clean” audic opinions in an cffort to retain any existing engagements and to secure furure business. Auditors that issue anything bur an unqualified opinion frequently get replaced.” During che late 1990s, che largest public accounting firms—frst the Big Six and then the Big Five (now che Final Four)—increasingly provided non-audit services, such as consulting, internal auditing, and tax advising, often to the very enterprises they audited.” Dur- ing 2000, Enron paid $52 million to Andersen—$25 million for auditing services, and an additional $27 million for non-auditing services, including $3.5 million for taxwork—and ranked as Andersen's second-largest client.*® Perhaps more significantly, aan internal Andersen memo in February 2001 regarding the retention of Enron as an audie cliene refers to $100 million a year in potential revenies from Enron.” Even if Sie genenaly Mache J. Bacee, Enron, Accounting, and Lawes, NOTRE DAME LAWYER, Summer 12002, at 14,15, available ae hep lard eclal-ndaw/slumnidadlawyerfoarer pd Hoenn & BARRETT, sypra nots 1, a 173 (citing RJ. Chambers Financial Information aed the Securities Market, ADACUS3, 13-16 (1963), printed in RJ, CHAMBERS, ACCOUNTING FINANCE AND 2 Bazerman, Lowenstein & Moore, supra noce 16, at 98-98, "id a9. ENRON Conn, SCHEDULE 4A, PROXY STATEMENT PURSUANT TO SECTION 14(a) OF THE SECU- JTS EXCHANGE ACT OF 1934 (led Mas 27, 2001), avilable a hepllwwwsee-gow Archived -data/1024401/ 090095012901 001 669/0000950129-01-001669.cxy; see abu Barrect supra note 18, at 16. 3 Berandine testimony prs note 6 (dletsiling non-audie Fes tha Enron paid to Andersen in 2001). Tom Hamburger & Ken Brown, Andeen Kaew of Enron Woes a Yeor Age, WALA. St. J Jan. 17, 2002, at A3, auilale at 2002 WL WS} 3383224, 160 ENRON: CORPORATE FIASCOS AND THEIR IMPLICATIONS Andersen could absorb the loss of Enron as a client, individual careers and che Hous- ton office depended upon retaining the Enron engagement. As the audit partner for the firm's second-largest client, David B, Duncan enjoyed clout nor only in the Hous- ton office, but throughout Andersen.” Like the remaining Final Four accounting firms, Andersen encouraged its employ- ees, especially those nor likely ro become partners, co take jobs with clients or potential clients when they left the firm. The resulting “revolving door” between Andersen and Enron only enhanced the financial attachment. From 1989-2001, eighty-six people left Andersen to worlk for Enron.” Andersen alumni at Enron included Richard A. Causey, its chief accounting officer and a former Andersen audit manager; Jeff McMahon, Enron's treasurer; and Sherron Smith Watkins, the vice president who unsuccessfully cried to blow che whistle on Enron's aggressive accounting.”” Employ- ees at Enron often referred to Andersen as “Enron Prep." In the “up or out” environ- ment at Andersen, everyone who worked on the Enron account had subtle incentives to keep both their bosses and che people at Enron happy. ‘The so-called “integrated audic” that Andersen employed at Enron and then sought co marker more widely to other clients also documents attachment. Under this model, Andersen sought to combine its role as external auditor wich internal auditing, the process whereby an enterprise checks its own books.” Paralleling and sometimes over- lapping outside or independent audits, internal audits seek to ensure that an enterprise follows its procedures, safeguards its assets, anc operates efficiendy.™ Under a ive~ year, $18 million contract that soughe to create an “integrated audit,” Andersen tole over Enron's internal auditing in 1994, transforming dozens of Enron staffers into Andersen employees"! The Wall Street Journal reported that before Enron's collapse, 2% Flynn McRoberts ec al Final Accounting: Tiesto Eira blinded Andenen, CH. TRIB, Sepe. 3 2002, 361, anil at 2002 Wl, 26770980, * Peer Behe Bc April Wit, Concerns Grow Aid Conf, Wasi, Post, July 30, 2002, ac AL, au able at 2002 WL. 24824440, 2 ENRON AND BEYOND: TECHNICAL ANALYSIS OF ACCOUNTING, CORPORATE GOYERNANCE. AND Scum Issuts 156 QuliaK. Brazel 8¢ Janice L. Ammons, ed, 2002) (herenafer ENRON aND BEYOND]: se alo John R. Wilke, Anita Raghavan & Alexei Barionuevo, U.S. Will Aree dndenen Krew of Misteps, Proscors Marsa Evidence Abou Role in Flawed Enron Wonk, Wats. SJ, May 7, 2002, 2¢ CA, available a: 2002 WL-WS} 3393942: ee abo Alexei Barionuevo 8¢ Jonathan Weil, Duncan Knew Enron Papers Would be Low, WALL ST. J May 14,2002, at Cl, amiable t 2002. WLWS) 3394753, % Behe de Win, supra note 26 Alexei Barronuevo & Jonathan Wel, Perener Wanted Ardher Andersen On Enron Audit, WALLS} May 9, 2002, ¢ C1, available at 2002 WL-WS] 3394352; se abo Barrionuevo &°Weil, pra noe 26 (*Aderien held out Enron asthe prime example af es inegrated’ audit approach. ...") 9 HERTZ & BARRETT, pre nore 1, a 202-06 2 McRobers era, spr noe 25; Alexei Bartionuevo, Quetonng th Boos Cour Docsment Shaw Andes Ties Wi Ean Were Growing in Early 90s, Wats ST. J Fb, 26, 2002, a 6, aniable a 2002 ‘WLWs} 5386907, ENRON AND ANDERSEN tol ‘more than 100 Andersen employees worked in leased space inside Enron's headquar- ters in Houston. In videotapes that Andersen filmed to marker the “integrated au- dit,” people ac boch Andersen and Enron described how intertwined their operations had become. In one segment, Jeffry Skilling, then Enron's president, commenced: “L think over time we and Arthur Andersen will probably mesh our systems and processes ‘even more so that they are more seamless between the two organizations.”"* Coupled with che inherent ambiguity in financial statements, such actachment can influence auditors to accept the “clients” interpretation and application of generally accepted accounting principles. Approval. Nianagement has historically selected the accounting principles and esti- sates that an enterprise uses to prepare its financial statements.” An audit essentially endorses or rejects the accounting choices that the client's management has made.** Research has shown that selfserving biases become even stronger when people are endorsing someone else's judgments, provided those judgments align wich their own biases, chan when they are asked to make original judgments chemselves, This research suggests that unconscious bizs can cause auditors to accept more aggressive accounting treatments than the audicor might propose independently.” Familiarity People are less willing to harm individuals chac they know relative co surangers. People are even less willing to harm paying elients, or individuals they con- sider paying clients, with whom they enjoy ongoing relationships."* Like lawyers for corporations, who represent the entity and nor the officer who hited chem, auditors’ xeal responsibilisies Flow co the investing public, not the manager or individual who retained chem.” An auditor who suspects errors or misstatements, whether intentional 6 not, must choose, peshaps unconsciously, between harming a known individual, and likely the auditor's own self-interest, by questioning the accounting, ot injuring Faceless others by failing co object to the possibly incorrect numbers. Such biases only grow stronger as personal relationships with che client's management, somerimes former auditing colleagues, deepen. David Duncan and Rick Causey often vacationed to- gether, annually leading 2 group of Andersen and Enron “co-workers” on golfing trips toclite courses around the county."" The “revolving door” between Andersen and Enron Tanthe Jeanne Dugan, Dennis Berman 8 Alexe Bartionuevo, Ou Caren, FeopleatAudersen, Enen Tl How Close They Wee, WALL ST J Apr. 15, 2002, at C1 avilable at 2002 WL-WS] 3391766, 3d » Banerman, Lowenstein & Moore, supra nore 16, 3¢ 99-100. HeRWITz Be BARRETT, suprn note 1, at 173, % Bozerman, Lowenstein & Moore, pa note 16, 2¢ 99-100. * Fae 100-01 % dae 100. 2 HERWIT2 & BARRETT, supra nove 1 at 182-83. Bozerman, Lowenstein & Moore, supra noe 16, a 100. © MeRobers er ly supra nowe 25. 162 ENRON: ConPoRATE FIASCOS AND THEIR IMPLICRTIONS and the “integrated aude" model also strengthened che familiarity. As a result of familiaciy, auditors likely will believe assertions of managers with whom they have worked in the past because a relationship of familiarity and trust erodes the audicor's Discounting. Immediate consequences influence behavior more than delayed ones, ‘especially when uncertainty accompanies the future costs. This tendency appeals to che propensity to place more emphasis on the short-term effect of decisions than their long-term ramifications. Immediate adverse consequences, including damage to the relationships with the client and its management, possible loss of che engagement, and potential unemployment, may dissuade auditors from issuing anything other than an ‘unqualified opinion. By comparison, che costs arising from an audit failure, namely civil lawouits, disciplinary proceedings, and reputacional losses, appear distane and tuncertain, or even unlikely." Afier an earlier audit failure ac Waste Management, for which Andersen agreed to the largest fine ever against an auditor, the firm did not fire the audit partners whom the SEC sanctioned." Ironically, one of those audivors wrote the document retention policy featured in Andersen's criminal trial for obstructing justice in the Enron investigation.** The internal Andersen memo regarding the deci- sion ro retain Enron as a client documents Enron's aggressive accounting practices and potential conflices of interest by then-Enron chief Financial officer Andrew Fastow. Nevertheless, Andersen executives decided co retain Enron as 2 client because “we [have] the appropriate people and processes in place co serve Enron and manage our engagement rsks."*” As toral audit and other fees from Enron grew to $52 million in 2000, Andersen willingly assumed increasing engagement risks for a client that che firm believed could potentially generate $100 million in revenues annually.® Ezcalation. People often hide or explain away minor mistakes, often without realiz- ing what they are doing. Unconscious biases may cause an auditor to accept small imperfections in a client's financial statements.” Over time, such misstatements can become maceril. Ac that point, correcting the sisuation may require admicting previ- ‘ous errors or biases, restating the financial statements, or even resigning. Rather than take those actions, the auditor may uy to conceal the problem, thereby escalating unconscious bias into fraud.” For example, after Andersen approved che non-cons ‘See supra notes 26-34 and accompanying tx. “® Berman, Lowenstein 8 Moore, sup note 16,2100 Aid 4 Fiyon McRoberts et al A Final Accunting: Ciil war spin Anderen, CH, Tb, Sept. 2, 2002, st 1 auilble ae 2002 WL 26770609, Wid © Hamburger 8 Brown, supra nove 24 * Seid ° Bazerman, Lowenstein & Moore, sypra note 16, a 100 Sie ENRON AND ANDERSE 163 dated accounting for various SPEs, the audicors later adopted an interpretation that enabled Enson to avoid recognizing losses for declines in the value of underlying in- ‘vestments in certain entities known as the Raptors.*' At Andersen's criminal trial, pros- See generally John C. Coffe, Je Undesanding Enron: eh Abou he Gaeherpers Stupid, 14-16 (ly 30, 2002), arailabe ar hep Isr comfabstrat_ids325240; ois doo at 125-143. i, we 16,22 I, upra note 7. 164 ENRON: CORPORATE FIASCOS ANB THEIR IMPLICATIONS frontline exee ss closest ro the companies they audit—to overrule the experts,” and Andersen's Enron andic team did so on at least four occasions, allowing Enron to hide debt and inflave reported earnings.” Equally troubling, Andersen honored Enron's request to remove Carl E. Bass, then a member of the Professional Scandards Group from char ceam, because his accounting stances were too conservative. Significant conflicts of interest and self-interest. As previously mentioned, among the services that Andersen sold to Enron and other audit clients were internal auditing services.*! In essence, Andersen's outside auditors were evaluating the firm's consult- ing services Recall also that Enron paid Andersen $27 million for non-auditing services during 2000. When non-auidit fees comprise a significant part of an auditor's income from the audit client, those fees might easily tempt an auditor to overlook an enterprise's “aggressive” accounting, simply ro retain the client’s non-audit business. At a mi mum, those fees paid to Andersen call the appearance of Andersen's independence into question. To repeat, even if Andersen could absorb the loss of a client like Enron, individual careers and offices that depended upon keeping Enron as a client would cercainly suffer. Finally, che ‘revolving door” between Andersen and Enron created additional in- centives for audicors interested in employment at Enron to ty to keep Enron's man- agement happy: Hew does Sarbanes-Oxley address these problems? SOx Section 301 required the SEC to prescribe rules thac direct che national securities exchanges and national securities associations, such as the New York Stock Exchange and The Nasdaq Stock Market, Inc, to prohibie the listing of any company that does not place in an audit commit- tee—a committee of independent directors presumably better able to protect the company's interests—the responsbilicy for hiring, compensating, and firing the audi- tor In April 2003, the SEC issued rules that require each national securicies ex change and national securities association to submit proposed amendments to their listing rules chat comply with the SEC rules by July 15, 2003. The rules set Decem- ® Mike McNamee, Out of Control a Andersen, BUS. WEEK, Ape: 8, 2002, 2632. Hm Seesypra notes 29-34 and accompanying tex. © MeRoberts ex ala rupn ne 4. Barre, sup note 18,2016 See supra noses 23-25 and secompanying tex. © Ser upra moves 26-28, Sarbanes-Oxley Act of 2002, Pub. L. No, 107-204, § 301, 116 Ste. 745, 775-77 (eel ae 15 USCA. § 78-1 (West. Supp. 2003)), © Standards Relating wo Listed Company Audit Commitecs, 68 Fed. Reg. 18,78 2003). ENRON AND ANDERSEN 165 ber 1, 2003 as the deadline to obtain final approval. Under the SECS rules, most domestic companies must comply with the new listing rules by the earlier of (1) their first annual shareholders meeting after January 15, 2004, or (2) October 31, 2004." In the meantime, most publicly traded companies have given their audic commictee the exclusive power to hire, compensate, and fire the firm's auditor. SOx and new final SEC rules also strengthen statutory and administrative require ments regarding auditor independence. SOx Section 201 lists various services outside the scope of the practice of auditors, including bookkeeping services, financial infor- mation systems design and implementation, appraisal or valuation services, Fairness opinions, internal audit outsourcing services, management or human resources func- tions, and legal services, as "prohibited activities.” Although auditors can no longer peeform internal auditing and many other consulting services for their audit clients, the SEC's new final rules issued in January 2003 reiterate its long-standing position that an accounting firm can render certain tax services to audit clients without impair- ing the firm's independence.”® SOx Section 202, however, requires che audit commic- tee to preapprove all audit and most non-audic services.”" SOx Section 203 provides that most accounting firms may nor provide audit services, to a publicly craded company, usually referred to as an issuer, if the lead audit partner or the reviewing audit partner has performed audic services for the issuer in each of the issuer's previous five fiscal years.”* Section 206 prevents an auditing firm from auditing an issuer that employs in certain high-level positions an individual who served on the audic team during the past year.” The SEC’: new regulations, which (subject to various, transitional rules) became effective May 6, 2003, specify that the receipt of compensa- tion by an “audit partner” based upon procuring engagements with the audit lienc for services other than audit, review, and attest services destroys independence.” The SEC rules also require a one-year “cooling off” period prior to the commencement of audit procedures if certain members of an audit client’ senior management have served as members ofthe fms audit team.” Fall, he rules generally equine the roration of the lead and concurting partners on an audit team every five years.” Od a 18,817. © Sarvanes

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