David Duncan sat in the Houston courtroom and answered a question put to him by the federal prosecutor. His face appeared strained. On any other day, Duncan would have been in his office at Arthur Andersen, the prestigious accounting firm, or on site at Enron. He would have been checking emails, holding a staff meeting with his audit team, or making important calls to senior partners at Andersen’s worldwide headquarters. But on this day, he faced a judge in a federal courtroom. His usual flamboyance had been set aside for the conservative dark suit expected of an Andersen partner.

No one from the small Texas town of Beaumont could have dreamed that the quiet, studious boy they had known would end up in federal court. But Duncan had begun to change once he went away to college. At Texas A&M, he did well in his accounting classes, joined a fraternity, and learned to play golf.^[1] He became competitive and ambitious. After graduation, he was recruited by the accounting giant Arthur Andersen.

Andersen was considered one of the top five accounting firms in the world. It had built its reputation on high-quality work by skilled, dedicated people. Duncan did well at Andersen and, at 35, he was elected to the Andersen partnership. Only two years later, he was asked to lead the large audit team at Enron.

At Enron, Duncan really came into his own, with the help of his close friend, Richard Causey, a former Andersen employee. The two were virtually inseparable. They worked together, went to lunch together, and played golf together. Their families even went on vacations together.^[2]

Duncan took pride in his rapid rise to the top. But nothing had prepared him for his appearance in court. The courtroom remained quiet, waiting for Duncan to begin. For just an instant, David Duncan looked down at his folded hands resting on the table in front of him as though watching his career slip through his fingers. He took a breath, and people leaned forward as he began to explain his version of what had gone wrong.

“It did not particularly go well,” he explained about the morning of October 23, 2001. At that time, Duncan had been the lead auditor examining the books of the Houston-based energy giant, Enron. That morning, he and several senior members of his accounting team had been invited to Enron’s executive conference room to listen in on a call between several Wall Street stock analysts and Enron top executives. Enron’s stock was in a downward spiral. “There were many pointed questions asked,” he explained to the court. Questions were asked about Enron’s audit reports and restatements.^[3]

Enron was collapsing. The Securities and Exchange Commission (SEC) was starting an informal investigation. Something had to be done and quickly. Duncan called his team together in Conference Room 37C1 of the Enron building in Houston, where the Andersen audit team was located. On a good day, you can see the Gulf of Mexico from the wide plate glass windows on the 37th floor but, on that day in October, everyone was too busy to look.

Duncan told his staff they needed to start complying with Andersen’s new policy on handling audit documents. The policy had been created a year and a half earlier, partly to make sure the firm’s extraneous paperwork could not be used in a court case. Although the document retention policy required that paperwork supporting the firm’s opinions and audit be retained, it allowed a broad category of secondary documents to be destroyed. Stunned, everybody in the room remained silent for a moment, then began racing to do what he or she had been told to do. No one asked Duncan to explain further, he testified. None of the staff asked whether what they were doing was wrong. No one questioned whether what he or she were doing might be seen as an obstruction of justice. Andersen staff just reacted, following orders without question. They were complying with a firm policy.

At Enron’s offices and at Andersen’s offices in Houston, Portland, Chicago, and London, the massive effort to shred files was underway. The shredders whirred steadily and noisily. The task was enormous, and both Andersen and Enron staffers worked together through the night in the days that followed. The document purge was in full swing when Andersen’s own fraud investigator, David Stulb, arrived at Enron’s offices in Houston. Duncan was in his office going through his email and deleting files.

“We need to get rid of this,” Duncan told Stulb, pointing to his computer screen. Stulb was horrified. “Dave, you really need to keep this information,” he told him. “There is a strong likelihood we will need this information.” Leaving Duncan’s office, Stulb made a frantic call to his boss in Andersen’s New York office to let him know just how bad things were. “Dave Duncan needs some guidance on document retention,” he warned.^[4]

Duncan paused in his testimony, perhaps reflecting on the events he was describing. He began again. Duncan told the court that he decided to stop the shredding on November 8, after learning that the firm had received a subpoena. On that day, Duncan’s assistant hurried into his office with documents marked for shredding still in her hands. This time, Duncan told his assistant, “No, you are not to shred anymore. Who’s asking you to shred?” His aide stopped in her tracks, turned and headed back to her computer, where she sent an urgent email to Duncan’s team. “Per Dave: no more shredding,” it read. Then, she went to the office shredder, “No more shredding,” she scrawled in large letters across a piece of paper and taped it to the top of the machine.^[5] On November 9, the day after the SEC issued a subpoena to Andersen,^[6] the shredding finally stopped.

It was too late. More than a ton of documents had already been destroyed, and over 30,000 emails and computer files, allegedly confidential to Enron, had been deleted. Evidence had been destroyed under Duncan’s watch—evidence that was needed for an SEC investigation of Enron. According to Andersen’s legal defense, the shredding was business as usual. The lawyers claimed that the shredding was just part of Andersen’s standard practice to eliminate unnecessary files. To the SEC, it appeared to be the start of a deep cover-up operation. But, by the time Duncan appeared in court, these arguments didn’t matter any more.

Duncan swayed on his feet^[7] as the court told him he faced a possible jail sentence. His career was over. And with him, he would take down one of the five biggest accounting firms in the world—Arthur Andersen.

There is, in Andersen, a parallel to the Titanic. Both consisted of compartmentalized units so independent that the whole was considered unsinkable. Just as the Titanic should have continued to float with some compartments flooded, Andersen employees felt the firm was designed so that the entire organization could survive, even if some of its offices were closed or if some of its partners were convicted of wrongdoing. That one office of the firm could sink the firm was unthinkable.

After all, Andersen was one of the Big Five—the top five accounting firms in the world—along with Deloitte Touche Tohmatsu, KPMG, PricewaterhouseCoopers, and Ernst & Young. By 2002, a reputation for quality services had helped Andersen grow to almost 350 offices in major cities throughout 84 countries, with 85,000 worldwide employees serving 100,000 clients, including governments and multinational corporations. Along with traditional accounting and auditing services, and tax advice, Andersen had evolved into a multidisciplinary professional services partnership offering a range of business consulting and information technology services.

Andersen had more than once been number one among the giants in the accounting industry. In the 1980s, the eight firms dominating the accounting profession were jokingly referred to as “Arthur Andersen and the Seven Dwarfs.” Andersen was number one among the Big Five until its split with Andersen Consulting sent Arthur Andersen into fifth place. In 2000, Andersen Consulting became an independent public corporation known as Accenture. But Arthur Andersen seemed unsinkable and was rebounding after Andersen Consulting broke loose from the parent firm. How could one of its local office compartments sink such a ship of commerce?

To understand why Arthur Andersen was brought down, you first have to understand what Enron did wrong. Until it was brought to the public’s attention for its mishandling of funds, Enron was not a household name, nor was Arthur Andersen. Not many utilities ever reach that level of public visibility. Within energy circles, however, it was well known as one of the few companies to successfully integrate energy exploration, transmission, and selling. At its peak, Enron’s service companies included Florida Gas Transmission, Midwestern Gas Transmission, New Power Company, Northern Border Pipeline, Portland General Electric, Transwestern Pipe, and Enron South America, in addition to Enron Energy Services, Enron Wholesale, and EnronOnline, among others.^[8]

Enron had been created in 1985 by the merger of two gas pipeline companies: Houston Natural Gas and InterNorth. Ken Lay, a native of rural Missouri, was CEO of Houston Natural Gas. From his early beginnings as the son of a small-time farmer, Lay had managed to work his way through school to earn a Ph.D. in economics. Although Lay was never a strong manager, according to the people who worked for him,^[9] he had developed into a clever strategist. He quickly saw the potential in gas deregulation and engineered the merger. Enron became an important lobbyist for energy deregulation.

In 1985, the same year that Enron was created, the U.S. federal government issued new regulations that supported a market pricing system in the natural gas industry, based on supply and demand. This meant that the price of natural gas would depend on how many people wanted to buy it. If supply was low and lots of people wanted natural gas, the price would go up. If supply was high or no one wanted to buy, the price would drop.

Under deregulation, prices began to fluctuate. Buyers and sellers of energy realized that they could no longer predict the price of natural gas. Once again, Ken Lay saw opportunity in this fluctuation and, with the advice of Enron executive Jeffrey Skilling, a Harvard MBA, Enron became a broker for trading energy.^[10]

Enron offered buyers and sellers an innovative strategy for pricing stability through long-term contracts in which the value of energy in the contract was calculated using formulas that extended the current market price and market predictions into the future. This seemed fair. But everyone soon found out that setting a market value for energy to be purchased as far as ten or more years in the future is not easy. Enron’s customer contracts were difficult to value because no one could truly predict future market value of the energy that was being bought and sold in the contracts. Enron had to produce figures for its accountants and ultimately for its stockholders to show that the company was making a profit.

To predict the future price of the energy in these long-term contracts, Enron used computer models designed to forecast energy needs and prices. The computer models predicted strong demand for energy in the future. Strong demand meant that the future market value of the energy in the long-term contracts Enron held would be high. This suggested high future profits for Enron. In the late 1980s and early 1990s, Enron found that it was making money buying and selling the natural gas contracts themselves. Next, Ken Lay and Jeffrey Skilling decided to try their hands at electricity. Enron began to corner the electricity market by buying up electricity-generation facilities and securing long-term electricity contracts similar to those it had negotiated for gas. Again, this was a great success and a big money-maker for Enron, which was becoming a very powerful utility company.

By the mid 1990s, Enron had a commanding place in the energy industry as one of the largest energy dealers in the United States. The company’s success in gas and electricity encouraged it to branch out even more. Enron used the profits from its successful energy businesses to get into other commodity markets, such as paper and chemicals, where it had less expertise. The company also began to speculate in the high-risk high-tech sector, at that time a favorite of stockbrokers and a money-maker. In 1998 alone, Enron’s stock had risen an extraordinary 89 percent. In 1999, it gained another 58 percent.

Enron’s belief in itself, its misleading accounting practices, and its strong connections to Wall Street firms sustained Enron’s stock until the very end. Even as evidence of fraud was amassing and the stock price was plummeting, stock analysts were recommending the company’s stock to investors. If any analyst or auditor challenged their methods, Enron executives would explain that there was nothing wrong with their “new economy” models. In fact, the Enron executives could be downright rude to anyone who challenged the wisdom of their models, suggesting that those questioning might not have the brainpower to understand. But those models were flawed, and Enron’s arrogance was a cover-up for inconsistencies in Enron’s financial situation.

Enron’s success story began to unravel in April 2001 when it made public its first-quarter earnings for that year. While the company reported an 18 percent increase in revenue, the detailed accounting behind this number did not support the earnings claim. Instead of profits, the numbers suggested that the company might actually be losing money. Enron’s stock slid from $80 a share to $60 as the news of its potential losses was released to the public. It continued to slide when, on October 16, 2001, Enron took a one-time charge of just over $1 billion and admitted to losses of $618 million.^[11] To ease the fears of stockholders, Enron executives explained that the charges would be one-time and nonrecurring. This explanation was more a hope than a guarantee. Concerned that describing the charges as nonrecurring was misleading, Andersen’s auditors advised Enron’s managers against this characterization.^[12]

Andersen’s auditors were right. Less than one month later, on November 8, 2001, Enron restated financial reports for 1997, 1998, 1999, 2000, and the first three quarters of 2001. Altogether, Enron added $2.59 billion of debt to its books and wiped out about 20 percent of its earnings for the previous five years. By the end of November 2001, Enron’s stock had fallen so low that it was considered worthless. Enron declared bankruptcy in December 2001.

Enron had been able to obscure its losses by manipulating its financial relationships with numerous partner companies, called Special-Purpose Entities (SPEs). It is not illegal or even unusual to set up such “off-the-books” partnerships to improve the bottom line, raise cash, or manage debts. The profits or losses of an SPE do not have to show up on the books of a parent company if the SPE is independently owned. To be classified as a legitimate SPE for Enron, the company had to meet three criteria:

Enron created as many as 3,500 SPEs^[13] with names such as Chewco, Raptor, JEDI, and Merlin. Later, SEC investigations determined that some of the SPEs did not qualify as independent partners. For example, Michael Kopper, an Enron employee, headed Chewco. The case should have been made that Enron controlled Chewco because one of Enron’s employees ran the company. It wasn’t. In another case, it turned out that Enron owned all but 1.5 percent of JEDI stock. JEDI debt should have shown up on Enron’s accounting books. It didn’t.

Some Enron employees were starting to get worried. Margaret Ceconi, a one-time Enron Energy Services employee, became suspicious of the way Enron was manipulating some of the SPEs. Although she had an accounting degree, she was not an accountant at Enron. To validate her suspicions without causing a stir, she wrote to the SEC, using her personal email account. In her email, she laid out a simple hypothetical example, describing what she had observed. “Say you have a food company that makes both hot dogs and ice cream. The hot dog stand is making money, and the ice cream stand is losing money. So the company puts the ice cream losses on the profitable hot dog books.” Then she asked, “Since both the ice cream stand and the hot dog stand have the same owner, is this legal?” A member of the SEC replied to the email that the practices described in Ceconi’s example misrepresented the performance of each of the food stands. However, they would have to know the exact circumstances to determine illegal activity with certainty.^[14]

Using accounting practices similar to those described in the hot dog and ice cream stand switch, Enron hid its losses and boosted its earning figures. One of the four Raptor SPEs, hid Enron debt of over $1 billion alone. To avoid showing debt, Enron used a second trick.

The company manipulated the computer-generated values assigned to the energy contracts it held to show greater potential earnings than the company really had. Enron then sold these contracts to investment bankers. In return, Enron agreed to buy back the energy in the contracts. In effect, these clever deals amounted to disguised loans. It looked like Enron had made a profitable sale. Instead, it had really borrowed money based on the value of the contract with a promise to pay it back—a loan. None of this was reported accurately in Enron’s quarterly reports. By the time Enron’s deceptive practices were revealed, investors with funds in Enron lost an estimated $60 billion.

The sheer size of the case is overwhelming. How could a company like Enron hide its true level of debt unnoticed by the Andersen auditors who had been overseeing Enron’s books since its creation in 1985?

Enron was a very important client for Arthur Andersen. It was as Enron’s auditor, Arthur Andersen found itself at the center of one of the biggest bankruptcies in U.S. history.

For 89 years, Arthur Andersen was a mainstay of the accounting profession holding a reputation for honesty and trustworthiness. Over time, Arthur Andersen had also developed a reputation for experience and reliability in the utility industries, and some of the first Andersen clients had been Midwestern utilities. Andersen had specialized in handling companies such as Enron. The firm had been InterNorth’s auditor and continued to be retained by Enron after the merger of InterNorth and Houston Natural Gas in 1985. Andersen was the logical choice to conduct Enron’s federally required independent audit.

By March 2002, facing a felony charge for obstructing a federal investigation of Enron, Andersen’s reputation was lost. Once the firm was indicted, Andersen rapidly lost its audit clients. The core of its business was in ruins.^[15] On Saturday, August 31, 2002, Arthur Andersen ceased to be an auditing firm of publicly traded companies.

With its strong background in auditing utilities and its long history with InterNorth and Enron, Andersen auditors should have uncovered wrongdoing at Enron as soon as it occurred. Perhaps.

A review of the accountant’s job may help to clarify why the Andersen auditors did not report Enron’s questionable dealings and losses earlier. Typically, companies employ their own accountants to handle their financial reporting. External auditors are independent accountants hired by the company’s board of directors, usually with input from the chief financial officer or management team, to check the work of the company’s internal financial managers and accountants. Federal regulations implemented in 1933 and 1934 require all U.S. publicly traded corporations to have an external audit once a year to protect the people who own the company from mismanagement of funds and fraud. The federal government felt the regulation was necessary because the speculative investment in publicly traded companies during America’s Roaring Twenties had encouraged managers and owners to inflate stock prices. The 1929 market crash had triggered a decade-long economic depression. The external auditors are hired to verify that the internal accountants have done their work accurately.

Everyone who owns stock in a company or that has a retirement plan or mutual fund that is invested in stock is an owner and receives an annual financial report based, in part, on an audit of internal records by independent accountants. These audited reports are generally long, complicated appendices to the annual reports. The auditors must come to an opinion about whether the financial statements made by the company are accurate and based on Generally Accepted Accounting Practices (GAAP) and Generally Accepted Accounting Standards (GAAS). The audit reports often appear with qualifying statements containing information critical to assessing a company’s financial condition. Although not required to be auditor-certified, companies also file quarterly reports with the SEC.

It is important to bear in mind that most auditors are not trained in criminal investigation. They don’t conduct audits as though they are on a crime scene. Most of the time, their work is pretty routine. Auditors look at accounts receivable and at expenditures. They check to see whether the methods for recording transactions are appropriate and consistent. But they don’t look at everything. They certainly don’t spend much time looking for evidence against the very people who hired them. They don’t bug people’s phones. They don’t hide in the corporate basement until nightfall, then sneak upstairs to look for hidden files. They can’t. Even with the help of computers, the typical large company has so many transactions that a team of auditors cannot cover all of them in detail. Instead, they may take a sampling of transactions or check the accounting processes and the information technology (IT) systems. If the sample is okay and the systems appear sound, most auditors will conclude that the company’s financial accounting is fine. As one former employee of Andersen explained, auditors look at financial systems maintained by the company and see whether the system is secure.

Even though an auditor might conclude that a company’s financial system and reports seem appropriate and accurate, there is plenty of flexibility for differences of opinion. Accountants often have several options about how they calculate and report corporate finances. Indeed, the more complex corporate finances become, the more options will present themselves. The Financial Accounting Standards Board (FASB) guidelines that provide generally accepted accounting standards contain over 100,000 pages of rules. Matching a potential problem with the applicable rule can be a lengthy and interpretive process. Although the guidelines are cumbersome to use, the big accounting firms, including Andersen, lobbied to keep the status quo. They fought tough new reforms because their audit clients liked the flexibility.

The Andersen auditors looking at Enron’s books did find irregularities in how Enron reported or did not report losses. In particular, they were concerned about Enron’s SPEs. By 1999, Andersen auditors clearly stated to Enron’s board of directors that Enron’s manipulation of funds through its SPEs was suspect. David Duncan himself warned the Enron board of directors that, “...many [of the SPEs] push limits and have a high risk profile.” But Duncan did not indicate that he thought this was a big concern.^[16] The SPEs were high risk, but were they illegal? That was up to interpretation, based on the facts the auditors had at the time. Later, in court, Duncan claimed that none of the Andersen auditors had all the information to interpret accurately whether rules had been broken.^[17]

Although it may have been true that Andersen auditors did not have all the information concerning the full extent of Enron’s transactions, Duncan could not say that he was entirely unaware. Andersen’s Professional Standards Group (PSG) had advised against going along with some of Enron’s deals. As far back as May 1999, Benjamin Neuhausen, a member of the PSG, wrote Duncan, saying, “Setting aside the accounting, [the] idea of a venture entity managed by [Enron’s] CFO is terrible from a business point of view [with] conflicts of interest galore. Why would any director in his or her right mind ever approve such a scheme?” Numerous memos objecting to Enron transactions were also written by Carl Bass, another member of the PSG.^[18]

On February 5, 2001, just before Enron’s business practices were questioned publicly in April, 13 Andersen partners held a routine annual risk assessment meeting to decide whether to retain Enron as a client. The discussion raised issues about possible conflicts of interest associated with Enron’s SPEs. Duncan gave his fellow partners reassuring explanations. Despite ongoing warnings from the PSG, the partners were reassured and the decision was made to stick with Enron. Later, Michael Jones, one of the Andersen partners who attended the meeting, wrote, “It appeared that we [Andersen] had the appropriate people and processes in place to serve Enron and manage our engagement risks.”^[19] The Andersen partners put their confidence in David Duncan and the auditors on his team.

Given the arrogant and aggressive nature of Enron’s corporate culture, one must wonder whether the Andersen team was equipped to stand up to Enron executives. A warning of possible wrongdoing from Arthur Andersen traditionally carried enough weight to convince a reluctant client. It was in the client’s own interest. But Enron’s leaders thought they knew better. They were also prepared to “strong-arm” Andersen’s hapless auditors to get their way. In one account, Enron managers were said to have cornered an Andersen auditor in a small conference room where they demanded an opinion letter that would support a claim for $270 million in tax credits. When the Andersen auditor resisted being rushed to deliver an opinion, one of the Enron managers shoved a chair under the doorknob while another explained, “Nobody leaves until I get that opinion letter.” After 30 minutes of badgering by the Enron managers, the Andersen auditor agreed to provide the opinion that afternoon in exchange for his release.^[20]

While Andersen’s senior partners might have withstood any client’s intimidation tactics, Andersen’s younger and more inexperienced auditors were definitely not yet strong enough to stand alone. Some partners privately worried that Duncan was too young and inexperienced to handle such an aggressive client. Although the once-quiet Duncan had developed a self-confident Texas bravado at Enron, it seemed to be more of a show than real change.

Even Enron employees, including Sherron Watkins, an ex-Andersen accountant who suspected trouble, had to proceed cautiously. Watkins had worked for Enron for eight years. By the late 1990s, she was assigned to work on some of the SPEs’ off-the-books deals. When she realized what was happening, she sent an anonymous, one-page letter to Enron’s CEO, Ken Lay, about what she had observed while working with one of the four Raptor SPEs. She pointed out the “funny accounting” and warned, “I am incredibly nervous that we [Enron] will implode in a wave of accounting scandals.”^[21]

Her fears were well founded. In a painful twist of fate, it was the later publication of Watkins’ own memo that convicted Enron and Andersen in the court of public opinion, if not the federal courts.

Everybody was still in shock from the tragic events of September 11th. Private and institutional investors were losing billions. Pensions were being eroded and, in some cases, wiped out. Americans everywhere had also watched as the Western states fought against energy companies that were manipulating energy supplies and imposing exorbitant prices on their customers to generate quick cash. Meanwhile, SEC investigators were uncovering a host of self-serving alliances between brokers, bankers, lawyers, venture capitalists, analysts, and corporate executives. It became easier to think that most of the money these people made came from a coordinated effort to push a company into the public market, grab stock, and cash in by selling their own stock to unsuspecting public investors just before the stock crashed. People wondered what other corporations had misleading—or just plain incorrect—financial reports. Together, Enron and Andersen became examples of seemingly pervasive corporate collusion that made Americans doubt the companies they invested in. Enron’s financial scandal was depressing the stock market. Enron employees and all the other folks who had invested in Enron stock were feeling the effects.

The SEC had already opened an informal investigation based on the October 16 financial report, and by October 31, 2001, the SEC had upgraded its investigation from informal to formal. Now, with the November 8 restatement, they became more dubious. The SEC suspicions concentrated on Enron’s complex financial partnerships—the SPEs—and the appropriateness of practices Enron used to keep certain transactions off the books and out of sight. Investigators were searching for accounting rules that had been broken.

The press began to build up the drama in the months before the Andersen trial actually began in May of 2002. In January 2002, the Wall Street Journal declared “the scandal is not quite here yet but the elements are all there.”^[22] An ABC television news program reported that Enron and Andersen staff had kept shredding documents even after a company directive was issued to stop. The Wall Street Journal painted a vivid picture of shredding, describing a conveyor belt whisking “confidential files of major law and consulting firms, investment banks, and other businesses into rows of gnashing blades, which slice them into tangled ribbons...then get recycled into toilet tissue.”^[23]

After Enron’s bankruptcy proceedings began, evidence of the extent and nature of Enron’s financial transgressions began to mount. On January 23, 2002, Kenneth Lay, Enron’s CEO, resigned as chairman and chief executive of Enron. By January 31, 2002, both the SEC and the House Committee on Energy and Commerce were asking questions about Enron’s many complex partnership deals. Media attention now turned from Andersen to its client, Enron. The idea of a shredding machine churning paper into pulp had been an image that the media could dramatize. Now it was old news.

Andersen’s guilt may have seemed clear to the public but jurors hearing the federal court proceedings had a much more difficult time coming to a judgment.

On May 13, 2002, David Duncan, the lead Andersen auditor on the Enron account, confessed to ordering the shredding of Enron files. In so doing, “I obstructed justice,” he admitted.^[24] Even though David Duncan finally admitted to obstruction of justice, the shredding, which attracted so much media attention, turned out to be unimportant. Important documents had not been shredded or were reconstructed with Andersen’s help. The evidence was too flimsy for the jury to determine whether there had been criminal intent. The business of the shredding was “superficial and largely circumstantial, and it had a lot to do with Andersen just tidying up their files,” Oscar Criner, foreman of the jury, related after the event.^[25]

Also in Andersen and Duncan’s favor was the fact that, by November 8, 2001, Andersen’s auditors had helped revise Enron statements for the previous five years to reflect reductions in previously reported net income and report debt accurately. The restatement reduced the earnings for that period and put $2.59 billion of debt on Enron’s books. Corporations do not like restatements of earnings, which tend to disclose unpleasant financial realities. Although Andersen did advise Enron to make the restatement, it was not a popular move for Andersen or for Enron. It made them both look incompetent at best. The earnings restatements revealed serious financial shortfalls. By December 2, 2001, Enron had filed for bankruptcy.

It was clear that Andersen had failed to keep Enron on track. But it was still not clear that Andersen had committed the obstruction of justice felony. In its public defense, Andersen executives told the Senate Permanent Subcommittee on Investigations that Enron had withheld crucial data about its finances. Eventually, the Department of Justice was left with little against Andersen. It finally indicted the firm on one charge of obstruction of justice because the company had allegedly withheld, altered, and destroyed evidence the SEC needed to investigate Enron. Andersen’s trial began on May 17, 2002 and ran until June 16.

Before sending the jury to deliberate, the trial judge, Melinda Harmon, gave the jury a particularly long and detailed set of instructions about how to carry out its duties. She warned them that the evidence provided by David Duncan, who had agreed to testify for the prosecution in exchange for leniency in his sentencing, was to be treated with special care. The jury soon recognized that they would not be able to agree on whether Duncan was telling the whole truth. When the jury started its deliberations on June 5, they were divided 50–50. “Some of us believed him and some of us didn’t,” foreman Oscar Criner said afterward. Whatever the truth, it was clear that Duncan had a lot of baggage. On June 8, the jury was still split 9–3 but now more of the jurors were in favor of conviction.^[26]

By June 12, the jury was still deadlocked, and it looked as though a mistrial would have to be declared. Judge Harmon told the jury to go back and try once again to reach a unanimous verdict. The jurors had taken hundreds of pages of notes, and they consulted them again. They could not come to a unanimous decision about who the wrongdoer was. They asked the judge whether they could come to a verdict if they were convinced that wrong had been done but were not sure by whom. Judge Harmon ruled that they could. The incriminating evidence that the jurors finally settled on came from a memo written by an Andersen in-house attorney based in Chicago and not from Duncan’s confession. At the trial, Andersen lawyers argued that key records associated with the Enron audit had been carefully maintained and not shredded, as alleged by the prosecution. Andersen then produced these documents to demonstrate its claim and assisted in reconstructing the documents that had been shredded and deleted. Not everything had been shredded. Duncan had kept detailed records about Enron’s audits, including memos about his own handling of sensitive issues, such as Enron’s need to restate third-quarter earnings for the previous year.

The audit records documented that Enron had accumulated $618 million in losses by 2000 and needed to take just over $1 billion in write-offs. Enron wanted these write-offs to be characterized as “nonrecurring” and wanted Andersen to back it up. As a one-time event, the information could be portrayed to stockholders as an unusual occurrence. It would never happen again, Enron could assure everyone. A memo written by Duncan clearly showed that he had disagreed with Enron and thought these statements were inaccurate. Taking a new direction in the prosecution, the federal attorneys had introduced an email written by Andersen attorney, Nancy Temple. Temple, who had worked for the firm only 18 months, had suggested that Duncan’s memo be altered to change the word misleading in a description of Enron’s accounting practices, as the memo originally stated. Temple asked for the change after the fact to make it appear that Andersen had not failed to report its objections to the “nonrecurring” characterization, which an auditor had a duty to do. Also, Temple requested that her name be removed from the email.^[27] To the jury, this looked like a cover-up. It was in this email that the jury found evidence of intentional corruption. They convicted the firm on this single memo from Andersen’s in-house attorney, Nancy Temple, to David Duncan and not because of shredded documents or deleted emails.

Andersen employees worldwide were stunned. The indictment itself had already condemned Andersen, even though employees felt that the damages should be limited to the Houston office and David Duncan. According to common understandings of the basic partnership agreement, the Houston office employees were empowered to make their own decisions and run the office the way they saw fit, as long as the office maintained professional accounting standards and followed Andersen’s quality assurance processes. Each partner was expected to abide by the terms of the partnership agreement and decisions that the entire partnership made. David Duncan and the Houston office had shown poor judgment, making questionable decisions that did not accurately reflect the firm or the position it took on some of Enron’s transactions. Even if an Andersen partner was found guilty of wrongdoing, the entire firm should not be branded as criminal.

As far away as the city of Taipei in Taiwan, Andersen protesters carried “scapegoat” placards in the streets. In Washington, DC, freshly scrubbed junior staff members embarking on their audit careers marched, wearing their sweatshirts with the Andersen logo. They were hurt and angered, too. Despite the conviction, they did not feel guilty of any crime, even by association, and they wanted people to know it.

The protesters were not ready to accept liability. Andersen was a limited liability partnership (LLP) and could be indicted and convicted in its entirety. Andersen had used the LLP organizational type to legally avoid unlimited individual liability that general partnerships faced. Although the LLP organization limits the personal financial liability for members of the partnership, the partnership could still bear civil and criminal liability. In Andersen’s case, if the Houston office was guilty, all offices across America could be found guilty, too. The inherent legal consequence of the partnership structure and the effect of the obstruction-of-justice conviction on those who had no direct connection with the crime made it hard for anyone associated with the Andersen name. Everyone in the company would share the burden of guilt.

With Andersen’s conviction, the public was satisfied that justice had been served. It took longer for the deeper consequences to be felt. The disgrace of Arthur Andersen and Enron affected large and small investors alike. Confidence in audit reports was lost. People began pulling out of the stock market, already shaky after the failure of so many dot-com companies. The markets slumped further. And, in the wake of Enron and the Andersen conviction, many corporations found a need to restate their earnings. They correctly feared further withdrawal of investments if they did not. The Justice Department began a series of indictments against analysts, CEOs, CFOs, and other officers of companies.

There were other substantial effects, most of which are still developing. The head of the SEC, Harvey Pitt, resigned. He had been criticized because his own associations with accounting firms, legal firms, and brokerages might suggest conflicts of interest. When he suggested a choice for the head of a new public oversight body whose ethics turned out to be seriously flawed, it was the last straw, and he stepped down.

The federal government and accounting associations initiated their own reviews of accounting practices and standards. The CEOs and CFOs of nearly 200 companies that were registered in the U.S. were forced by the SEC to assume personal liability for the accuracy of their company’s reports. Government regulators, the media, and professional investors alike began taking a close look at the seemingly pervasive conflicts of interest between corporate managers, boards, auditors, investment bankers, stock analysts, brokers, and lawyers.

Most people prefer quick and easy answers whenever corporate scandals occur. Arguments focusing on a “culture of greed” or “poor management,” “difficult clients,” “immorality,” and “governmental incompetence” are all convenient abstractions that tell us that the people or institutions involved were corrupt or incompetent. The media blamed the “culture of greed” for the bad corporate behavior at Enron and at Andersen. But what does that really mean?

During the entire investigation and trial, no one even suggested that Andersen employees were involved in personal gain. Duncan was reported to be making between $600,000 and $1 million a year. In contrast, his friend Richard Causey, Enron’s Chief Accounting Officer, cashed in over $13 million in stock options between 1998 and 2001. Enron stock options and bonuses did not end up in the pockets of Andersen employees.

Although the desire to be rich is a powerful motivator, it obscures far more important lessons that could help Americans avoid catastrophic business failures in the future. And, of course, Andersen auditors had resisted the temptation of personal gain in hundreds of thousands of cases over its nine decades in business. The SEC, the accounting profession, and the giant accounting firms, including Andersen, were built on the assumption that businesses are accountable to stockholders and the public at large, should abide by the laws of the land, and should be independently monitored. No one knew better than Andersen employees that accounting professionals are often exposed to what one partner referred to as “skullduggery.”^[28] It’s always been the auditor’s job to make sure that this does not affect investors.

Although more complex explanations or explanations with more than one cause can be difficult to understand, the deepest insights often come from explanations that recognize several factors. Greed could certainly have been a factor in Andersen’s decision to continue auditing Enron—clearly a challenging client. As one of Andersen’s biggest clients, Enron paid them over $52 million in fees in 2000, and fees were expected to shoot up to $100 million soon. Was it the fees that motivated Duncan and the partnership to keep Enron as a client, even though it was considered high risk? A senior member of the firm noted sadly that Andersen would have walked away from such a risky client 10 years earlier. What changed in the firm’s culture and in the U.S. business environment that encouraged Andersen partners to compromise their founding values?

There is more to the explanation than simply greed. As you go through the pages that follow in this book, you will have an opportunity to form your own conclusions about the end of Andersen. Is the story a tragedy about a great many people who were hurt by a few bad apples? Or, as some believe, is the heart of the story about the government doing the wrong thing in going after Andersen, the firm, instead of limiting its attack to specific individuals in the company?

We hope you will find that the theme is not simply a picture of greed that overwhelmed corporate values. Rather, the real story is about a firm that changed in a way that inadvertently created the seeds of its own destruction. This is a multigenerational saga that will take you from the early years of the firm to its final days. From Arthur E. Andersen’s original partnership, a new firm evolved that became a dynamic, sprawling, more aggressive giant, with clients willing to skate ever closer to the edge of acceptable business and legal risk.

You will see that each generation of Andersen employees was faced with crucial choices about Andersen’s direction. In the beginning, Andersen became successful because it followed clear guidelines and molded first-rate accountants. However, following the death of Arthur Andersen, the firm grew far larger than Arthur Andersen thought was wise by increasingly offering clients consulting services in addition to audit. Together, growth and drift from core services challenged accountability and leadership. The decisions the firm’s leaders made at each point sent the firm down an ever more tangled path and, ultimately, to the firm’s collapse. You will explore the stages of change that led to an evolved complex structure, and you will consider the external and internal factors that led to the changes. Most important of all, you may find that those factors and changes are not too different from those affecting companies all across the country and the world.

The firm ceased auditing publicly traded companies on August 31, 2001. “They killed us,” an Andersen partner told reporters after the trial, “for no good reason.”^[29]

These are only the bare facts of an American business tragedy. What follows will let you share in the in-depth details of what led to the unraveling of one of the five biggest accounting firms in the world.