When The Big Five Accounting Firms Became The Big Four

The Big Five accounting firms are Deloitte, EY, KPMG, PwC, and of course Arthur Andersen. Each year, hopeful accounting students across Yeshiva University submit their applications and eagerly anticipate an offer from one of these five goliaths of the accounting industry. Students sleep easy knowing all it takes is for one out of these five big name firms to connect with their candidacy in order to start their career in the glorious Big Five.

This would have been a great opening paragraph to an article a short fifteen years ago. However, much has happened between now and then. Almost fifteen years ago to this month, scandal and disgrace shook the accounting industry to its core. Once on the “large firm” level with the likes of Deloitte, EY, KPMG and PwC, the great Arthur Andersen crumbled before the eyes of a stunned nation, unable to withstand the tailwind from the financial reporting crimes of mega-client Enron. Here is a look back at arguably the greatest accounting scandal ever perpetrated and how it forever changed the accounting profession.  

Dec. 31, 2000: Enron closes out the year trading at an extraordinary $83.13 a share with a market capitalization exceeding $60 billion. The energy giant is in the top ten of the Fortune 500.

Aug. 15, 2001: Sherron Watkins, an Enron vice president, writes to Enron Chairman and CEO Kenneth Lay expressing concerns about Enron's accounting practices.

Sept. 26: At an employee meeting, Lay tells employees that Enron stock is an "incredible bargain” and the third quarter is “looking great."

Oct. 16: Enron reports a stunning $618 million third-quarter loss.

Oct. 17: The SEC begins an informal probe of Enron. (This would later be upgraded to a formal investigation and amended to include their auditing firm, Arthur Andersen.)

Oct. 23: Arthur Andersen destroys an estimated one ton of Enron documents.

Nov. 8: Enron files documents with the SEC revising its financial statements for the previous five years to account for $586 million in previously undisclosed losses.       

Nov. 9: Enron and Dynegy announce a $7.8 billion merger agreement, forming Dynegy Corp, in which Dynegy would own 64% and Enron 36%.

Nov. 28: Enron stock plunges below $1. Dynegy Inc. aborts its plan to buy its former rival amidst concerns Enron will go bankrupt.

Dec. 2: Enron declares bankruptcy, at the time the largest bankruptcy in U.S. history.

Jan. 17, 2002: Enron terminates its partnership with Arthur Andersen.

Jan. 23: Lay resigns as Enron Chairman and CEO.

June 15: Arthur Andersen is convicted of obstruction of justice for shredding documents related to the audits of Enron. (The conviction would later be overturned by the Supreme Court.) While Arthur Andersen is not implicated in directly assisting Enron in falsifying its books, the firm is found to have been woefully negligent in its role of overseeing and auditing Enron’s financial statements.

Aug. 31: Arthur Andersen surrenders its license to practice accounting in the U.S. $9 billion in annual earnings disappears along with 85,000 jobs.

Oct. 16: Arthur Andersen is sentenced to probation and a $500,000 fine; the firm is already banned from auditing public companies and is left with only a few hundred employees on the payroll following its obstruction of justice conviction.

May 31, 2005: The U.S. Supreme Court overturns the conviction of Arthur Andersen. However, the firm is already decimated and well beyond recovery.

May 25, 2006: Lay is found guilty of six counts of conspiracy and fraud, his principle transgressions presenting false financial statements and making misleading statements at employee meetings.

When all of the carnage had been sorted through, what was left was a large void by Arthur Andersen in the accounting practice and more importantly industry altering rule changes. On July 30, 2002, the Sarbanes-Oxley Act of 2002 (SOX) was enacted, chiefly designed to protect investors from the possibility of fraudulent accounting activities by corporations. Among the primary reasons for the creation of this legislation was to address the Enron scandal as well as other accounting fraud debacles which followed, such as the Tyco and the WorldCom scandals.

SOX features two key provisions. The first is Section 302, which mandates that company senior management certify the accuracy of reported financial statements. This was deemed critically important, as many top managers of these fraud-embroiled companies claimed they had been unaware of the accounting discrepancies. The second is Section 404, which requires that company management and auditors establish internal controls in order to prevent fraud. Additionally, reporting methods must be put in place to assess the adequacy of these controls. SOX also established strict standards to avoid conflicts of interest, prohibiting auditing firms from providing not-audit services, such as tax or advisory work, to companies which they audit.

In spite of regulations such as SOX, the legacy of the Enron scandal and ensuing fall of Arthur Andersen lives on. Though lawmakers will continue to keep a close eye on public companies, investor confidence in the financial statement auditing process may never fully recover following the public disgrace of what was thought to be the sterling reputation of Arthur Andersen. As investing is severely impeded without complete confidence in the information the potential investment is based on, the ramifications on the stock market could be forever lasting. The question is seemingly not if but when the next accounting scandal will shock the business world.