Quiz 1: Comprehensive Cases
There were many parties who had responsibility in the Enron fraud: • Enron Management : Played a significant role not only for orchestrating the fraud, but also in having an active role in trying to influence the auditors, and their independence. • Arthur Andersen's Senior Management : The accounting firm did not appear to have sufficient checks and balances on the work and potential conflicts of its outside offices. In addition, when several senior partners raised potential concerns about Enron, Andersen's senior management had a responsibility to investigate these concerns (in essence audit the work of its own auditors), as well as to raise its concerns with Enron's Board of Directors and its audit committee. • Local Arthur Anderson Auditors : While the vast majority of the local office may have been delegated at times to the Enron account (from an audit and/or consulting role), local members of Andersen's team had a duty to raise concerns not only with Enron's audit committee, and board of directors, but also with senior management at Arthur Andersen (outside their local office). Their lack of effort to maintain independence creates concerns about the profession as a whole. • Regulators : Regulators could have taken a larger role in limiting management's ability to influence the auditing process. • Investment Bankers/Bankers : Just as in the recent financial crisis, those who underwrote and/or traded Enron securities had a responsibility to their clients to conduct additional due diligence on any securities they underwrote particularly as Enron sought to do more exotic securities and partnerships. • Academics/Accounting Industry Trade Groups : This group might have played a larger role in preparing auditors to deal with such situations and provide a way to help bring potential issues to the light. The trade groups might also have played a larger role in understanding how the special purpose entities could be used and abused in a proactive (rather than retroactive) way.
Audit firms are now prohibited from providing certain consulting services to their publicly traded audit clients. Among these services are the following: • Financial information systems design : This covers the computer software and processes used in the financial reporting process. By providing such services to an audit client, an auditor might be unduly influenced by the high fees for consulting/building such a system. In addition, the auditor might not be able to provide an unbiased opinion as to the effectiveness of the company's financial controls. • Bookkeeping or other recordkeeping services : In this instance the auditor would be too close to the data gathering process. The auditor's firm might be less rigorous in its assessment of the client's bookkeeping, and/or might simply use a default system that is easy to audit rather than truly effective. • Broker/Dealer, Investment advisory : In some ways accounting firms are well positioned to provide investment advisory to clients. They have a deep understanding of an audit client's business and finances, and likely have deep industry knowledge as well. Investment advisory services create a conflict of interest for the auditing firm not only in terms of potential fees, but also in terms of being able to be unbiased in their assessment of a firm's finances from an auditing standpoint. • Legal services : Accounting firms may be well positioned to help audit clients identify sources of legal services, but as the Enron example demonstrated, the opportunity for fee generation from legal services may create situations where legal counsel takes a less rigorous (conservative) interpretation of rules.
The text lists a number of examples from the Powers Report (Exhibit 3), describing what was seen as significant conflicts in Andersen's involvement in Enron's special purpose entity (SPE) transactions, and potential violations of professional auditing standards. Generally Accepted Auditing Standards (GAAS) are standards used to judge the quality of audits. GAAS covers broad issues such as auditor proficiency, and also require that auditors maintain independence (in face and appearance) in all matters related to the audit. In addition, the auditor is expected to be diligent in performing the audit, and in reporting and misleading statements. Using the statements in the Powers Report, it is reasonable to conclude that Andersen violated a number of GAAS: • Independence: In setting up and advising on special purpose entities (SPEs ) as well as day-to-day accounting decisions (as evidenced by email correspondence), Andersen's auditors may have lost some degree of objectivity when they had to review those decisions as part of an audit. • Internal Control Evaluation: Enron's Board of Directors appears to have relied on Andersen's assessment of Enron's internal controls; however, some of the evidence in the Powers report suggests that many of the SPE disclosures approved by Andersen and others were somewhat vague; suggesting that the auditors and others did not adequately understand Enron's financial structures and controls. • Sufficient Competent Evidential Matter : As Andersen played a large role in creating and structuring Enron's financial reporting, and accounting systems, Andersen may have taken the path of least resistance is gathering data to support or refute statements as to the condition of Enron's finances and controls. • Planning and Supervision : The audit should have identified situations (such as SPEs) where Andersen was too involved in structuring deals or financial reporting. • Reporting: Under GAAS , Andersen was obligated to issue a disclaimer of opinion if it could not reasonably maintain independence during the audit process. Undue influence from Enron's management, in addition to complacency at the local office level, should have triggered these concerns.
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