Business Economics: Arthur Anderson LLP - Assignment Example

Topic: Business Economics Pages: 7 Sources a) Suppose you were the top partner at a major accounting firm at that time of Andersen's collapse. What actions, if any would you take in response Explain. The ultimate reasons for the demise of Arthur Anderson LLP can be broadly subdivided on the following few factors: 1. Lack of 2nd line of regulation: Enron turned out to be the final act of wrong doing for Arthur Anderson LLP, but it was not certainly the first. Arthur Anderson has been forced to settle over a dozen cases of financial and accounting irregularities over the previous 25 years. This list of 12 cases include Colonial Realty in 19993, Sunbeam Corporation in late 1990s and Baptist Foundation of Arizona in 1998, and the total payout for case settlement was well in excess of $500 million. Despite these tell tale signs of irregularities and frauds, the firm did not put in place a 2nd line of internal regulation in place. As a top partner at an accounting firm, I would put in place a high powered internal team that would have sweeping powers and would be responsible to study past failures, recommend and implement changes and more importantly, conduct a random or systematic 2nd round of auditing on team/partners/clients. (The Demise of Arthur Andersen, 2002) 2. Forbid team members and partners to work with clients with insider connection: Another major factor that was responsible for the lapse in adhering to the accounting standards was the fact that one/multiple members of the auditing team had professional and/or personal interests in Colonial Realty. This seriously diminished the willingness of the auditor to evaluate the financial reports with strict objectivity. 3. Closely monitor clients that are taking accounting as well as consulting services: Accounting firm offering consulting services derive significant synergies from the consulting services. Among others, cross selling of services helps accounting firms increase their revenues and profits. Additionally, rapid change in business environment resulted in new forms of transactions, and hence an auditing firm needed more than just accountants - they needed computer professionals, lawyers and management professional to understand and audit these transactions. However, offering both the services had one critical drawback- expected conflict of interests. In effect, this turned into a case where one arm of a company, the auditing arm, would evaluate the other arm of the same company- the consulting services. This arrangement poses significant conflict of interest. So, as a partner, I would propose to set up an independent team within the organization that will closely monitor deals where the client is offered both consulting as well as auditing services to minimize breach of regulations. b) In 2000, the Securities and Exchange Commission proposed new regulations that limit consulting work by accounting firms. This proposal was not passed by Congress. Do you think that the legislators were trying to act in the public interest when they failed to pass this proposal Explain. The traditional accounting firms in general and Arthur Anderson LLP in particular had a fledging consulting business arm by 1990s. These consulting divisions traced their evolution to auditing teams that helped clients increase their operational efficiency and technical control. However, these consulting services, then, were largely perceived as a small component of the overall auditing services offered by the accounting firms. However, the advent of computer and subsequent adoption of computer by companies resulted in new business dynamics. These fast paced, growth oriented business dynamics offered more stand-alone consulting opportunities. Additionally, the process of auditing shifted from a stand, generalized auditing process to highly complex processes that required, in addition to traditional accountants, management professionals, computer engineers and strategists. In short, consulting became an integral part of most of the accounting firms. (Wyatt A.R., August 2003) However, this also led to situations where there were conflict of interests between the consulting and accounting services. Given that consulting business activities that helped clients grow rapidly generated higher revenues & profits and experienced higher growth rates than accounting business, erstwhile accounting firms with high professional standards became more amenable to demands of the consulting business divisions to be softer while bookkeeping. The Securities and Exchange Commission proposed new regulations, also known as "Sarbanes Oxley act" that limited consulting work by accounting firms. The underlying assumption was to eliminate possible scenarios dissociating consulting with accounting activities. However, there are some inherent problems in this arrangement. 1. In the present business scenario, an auditing activity requires a multifaceted team consisting of auditors, accountants, computer engineers and management professionals. If the accounting firms are restricted from offering consulting service, then there will be a flight of these talents from auditing firms, thereby drastically impeding these firms from offer proper auditing services. 2. If the auditing firms are not allowed to offer consulting services, then these firms will be totally dependent on auditing services for revenue. In this scenario, the auditing firms, especially the smaller ones, may be forced to adopt softer accounting principles just to ensure they do not lose clients. So, the basic aim of making the auditing service independent may be compromised. 3. A large number of auditing firms, especially the smaller ones, were critically dependent on revenue from consulting arms for existence and growth. Without the consulting service, the very existence of these firms might be in danger. (Melancon B., October 2000) Restricting auditing firms from offering consulting services could have led to a major churn in the industry. So, the Congress was partially justified in not passing the new regulations that would have limited/restricted accounting firms from offering consulting services. (Powerful auditor-consultants are the targets of Arthur Levitt's crusade, SEPTEMBER 25, 2000) b) The American Institute of Certified Public Accountants (AICPA) is the primary professional association for certified public accountants (CPAs). It has developed a Code of Professional Conduct that sets the standards of conduct for CPAs. People can file complaints about the ethical conduct of a CPA with the AICPA, which can levy sanctions and other penalties against its members. Do you think that the unethical conduct at Andersen (and possibly other accounting firms) was the fault of the AICPA for not setting and enforcing higher ethical standards among its members Explain. The auditing and accounting industry in US has largely been regulated by self or peer imposed regulations. However, these regulations, as mentioned, were self or peer imposed, and hence did not have legal bindings on various consulting firms. Additionally, the auditing industry is highly polarized, and the erstwhile big 5 auditing firms could influence the industry standards. The AICPA had in place various self-regulatory bodies like the POB and ISB. POB or the Public Oversight Board was founded in 1979 and was an AIPAC body that was in charge of overseeing different components of self-regulation in the accounting and auditing industry. However, it increasingly lost its importance as the most important and biggest of the accounting firms ignored the POB. Subsequently, the POB voted to dissolve itself in Jan 2002 as it was rendered redundant when the erstwhile big 5 accounting firms, APICA and the SEC- essentially the power centers of the accounting and the auditing industry designed and developed a new regulatory structure without consulting the POB. Similar has been the history of ISB, the Independence Service board. "The ISB was created in 1997 through an agreement between the SEC and the AICPA to initiate research, develop standards, and engage in a public analysis and debate of auditor independence issues." (Independence Standards Board to cease operations after making major contributions to the resolution of difficult and longstanding auditor independence issues, July 2001) However, ISB was dissolved in July 2001 by SEC and AIPCA as SEC was concerned about the lack in speed in creation of standards. SEC then went on to create its own set of independent and standard rules. Hence, it was perhaps the inability and not the fault of AICPA that it could not enforce higher and tougher ethical standards among its members. d) The Sarbanes-Oxley Act of 2002 established a new five-person board to oversee financial accounting in publicly traded corporations. The board is appointed by the Securities and Exchange Commission. Prior to the creation of this board, the industry relied primarily on self-regulations through the AICPA. Do you think the establishment of the new oversight board was a good idea or should the profession have continued to be self-regulated Explain. The Sarbanes Oxley law was instituted in 2002 and was aimed at enforcing higher level of accountability for corporate accountants. This law tried to ensure that accountants and auditors are held accountable without exception. According to this law, the auditing and accounting services would be monitored and regulated by an independent board where the members would be appointed by the Securities and Exchange Commission. However, this board was not totally independent and autonomous. This board was completely dependent on the SEC. The members of this board, called, PCAOB, were to be appointed by the SEC. PCOAB was to be totally funded by the SEC, and SEC could all actions by the PCOAB was supposed to be subject to change or rejection by the SEC. Additionally SEC had the power to dissolve the board. All these provisions made the board particularly vulnerable. However, the defining characteristic of this independent board was the fact that 3 out of the 5 members were to be industry outsiders. In other words, there would be no conflict of interest between the decision makers and the objective of the board. Additionally, this board will be under the jurisdiction of the SEC, and not the AIPCA. This gave the board a much better chance if introducing sweeping changes in the accounting and auditing industry as compared to the other self-regulatory bodies that have historically failed to make a perceptible impact. e) According to the Independent (Nigel Thorpe, "Greenspan Cautions on Over-Regulation, Thursday, September 26, 2002), Alan Greenspan, the (former) chairman of the Federal Reserve, warned against over-regulation in financial markets despite corporate scandals such as Enron and WorldCom. In his testimony before the Committee of Government Oversight and Reform, on October 23, 2008 he revised some of his beliefs. Do you think that financial markets and, in particular, rating agencies should rely on self-regulation Explain. The debate over self-regulation in the financial industry, especially for the rating agencies, has been quite an old one. Alan Greenspan actively championed the case of self-regulation of the free market in 1990s. Self-regulation has a number of advantages associated with it. Self-regulation also means that policy/framework designers have better and insider understanding of the market and prevailing issues. Self-regulation is also characterized by lower monitoring costs. On the flipside, self-regulation also means various degrees of biasness. External regulation, on the other hand is often created and monitored by people external to the industry, and hence the chances of people unaware of internal dynamics of the industry creating the framework. Additionally, monitoring the entire financial industry involves considerable operational challenges. Among advantages, external regulation is characterized a considerably lower degree of biasness for or against any section/party. While self-regulation represents efficiency/cost benefit, external regulation ensures that there is no biasness or conflict of interest. However, self-regulation also means lenient application and under enforcement of the framework. Historically, self-regulation has failed to achieve its desired results. Attempts like ISB and POB failed, or were dissolved due to slow speed of progress. (Andrews E.L., October 2008) Due to various operational and logical problems, it is unlikely that regulation will be entirely self-imposed, or outsider enforced. Regulation has been, and will always be a suitable mix of self and external regulation. So, in the ideal scenario, regulation should be a judicious mix of self and external regulation, supported by a strong and neutral third party monitoring system. Reference: Andrews E.L., (October 2008), Greenspan Concedes Error on Regulation, retrieved December 2, 2008, from http://www.nytimes.com/2008/10/24/business/economy/24panel.htmladxnnl=1&adxnnlx=1228220227-fg1YddDd778Mr9d8Opj6kw Independence Standards Board to cease operations after making major contributions to the resolution of difficult and longstanding auditor independence issues, (July 2001), retrieved December 2, 2008, from http://www.404.gov/news/press/2001-72.txt Melancon B., (October 2000), The Proposed SEC Rule on Auditor Independence and Its Consequences, retrieved December 2, 2008, from http://www.journalofaccountancy.com/Issues/2000/Oct/TheProposedSecRuleOnAuditorIndependenceAndItsConsequences.htm Powerful auditor-consultants are the targets of Arthur Levitt's crusade, (SEPTEMBER 2000), Business Week, retrieved December 2, 2008, from http://www.businessweek.com/2000/00_39/b3700001.htm The Demise of Arthur Andersen, (2002), retrieved December 2, 2008, from utminers.utep.edu/lacarrera/May%20Arthur%20Andersen%20Paper.doc Wyatt A.R., (August 2003), Accounting Professionalism - They Just Don't Get It!, retrieved December 2, 2008, from http://aaahq.org/AM2003/WyattSpeech.pdf Read More