The Lessons of Andersen

Enron Convictions – An Ex-Andersen Perspective

Friday, May 26, the Chicago newspapers, like many across the country, were running a number of stories about the convictions of Enron executives Lay and Skilling. But, here in the Chicago area, the stories are also heavy on the Andersen angle as this is where Andersen was headquartered and where its worldwide training center was located.

   

For many years of my career, my business cards identified me as a Management Information Consulting Division employee of Arthur Andersen & Co. When I entered the partnership, I was a member of both Andersen Consulting and of the overarching partnership Arthur Andersen & Co. Societe Cooperative (later called Andersen Worldwide). 

   

I made partner during a fascinating time in these companies as Andersen Consulting was battling for market share with its Audit and Tax brethren and their new consulting practice. Worse, the combined companies were having leadership issues driven by a growing disparity in income between Andersen Consulting and Arthur Andersen partners.   

   

Money does strange things but it really is at the heart of Andersen and Enron issues. At Andersen Consulting (AC), the staff to partner pyramid was 50:1 or so but maybe 18:1 in Arthur Andersen (AA). Smaller pyramids generally throw off smaller partner unit earnings. AA partners also received an additional chunk of change each year from Andersen Consulting as the “transfer payment”. This sum provided monies to one group of partners if the other group had a sort of ‘excess profits’. AC was always paying this as its earnings per partner were considerably stronger.   

 

The transfer payment was a princely sum and the fact that AA was building a competing consulting business while being paid by AC was perceived to be unfair by many AC partners.   

 

Overseeing all this activity was a joint CEO who may have abdicated responsibility and allowed this behavior to continue. He could have rebuked AA management, halted expansion, etc. but didn’t. While I continued to remain friends with many within AA, I soon grew to resent their management and their short-sighted ways.   

 

 

It was AA’s decision to go after consulting aggressively that produced the kind of scenario where consulting fees overrode those of auditors on engagements. In Enron, the consulting work was apparently much bigger than the audit fee and AA partners were encouraged to grow the size of their consulting sales.   

 

If ever there was a proof point for “People do what they’re rewarded to do” this was it. 

 

Prior to 1989, the AA I knew was fiercely independent and focused on providing quality advice and counsel to clients. Even when it had to give tough love advice (and maybe lose the client) it did it. Personally, I remember taking the Office Managing Partner (an auditor) and the lead Tax Partner to a lunch meeting with a prospective new consulting client. This prospect was an S&L that, as it turns out, was shopping for a new suite of service providers. The problem was, as I learned at lunch, that they needed an auditor who would take a liberal interpretation of asset valuation (i.e., loans and non-performing loans). The partners I brought clearly stated the firm’s prohibition against this and we walked away from the prospect as friends. I saw similar events unfold frequently in my early career.   

 

After 1989, management within AC and AA changed as part of the separation of the two business units. My personal opinion is that AC got superior leadership and that AA didn’t.    

 

Politics and power were coloring the big decisions. AA had more partners even though it diluted per partner earnings for them. AC moved upstream serving fewer but bigger clients. AA felt AC wasn’t serving its clientele and that AA should develop its own consulting force to do so. However, consulting firms will always move up-market and even AA’s consulting group was not content to serve just small businesses.   

 

That then set up the clashes between AC and AA in the consulting market.   

 

In retrospect, the following should have happened:

-          AA management would have rolled their consulting business into AC

-          AA management would have abided by many promises made to AC to limit its marketplace incursions into consulting

-          AC would have continued to share its earnings

-          AA would never have let audit integrity take a back seat to consulting fees

-          Both business entities would have partnered in the marketplace to further enrich each other’s businesses

-          Sunbeam, Waste Management, Enron and other troubled audits wouldn’t have happened

-          AA would still be here today   

 

But they did happen and they did because:

-          Internecine fighting got personal and the monetary stakes were very high

-          Trust between the business units was replaced with competition

-          The combined firm CEO appears to have failed to provide long-range insight into the evolving problems and let matters spiral to a devastating conclusion

-          Money pitted partners against partners   

 

An arbitrator had to get called in to sort things out and eventually concluded that AC should go its own way. But, it makes you wonder how things could get so bad that 1100+ partners would actively want a divorce. 

   

Today, many AC (now Accenture) partners are sure glad there isn’t any economic interest tying them to AA. 

 

But, on the AA side, some serious self-examination still remains to be done. The partners that used to be within that firm need to explore how Enron happened, why their firm let it occur, how did it foster the schism with AC, etc.   

 

There are clearly several business case studies to be developed from this sad chapter in business but we cannot let these lessons be lost. I’ve blown the whistle on unethical behavior before in my career. I know I did the right thing for the firm and sometimes I paid for that for a period of time. Nonetheless, I know I did the right thing and I can sleep with that knowledge. I’m not sure the same can be said for many of those involved in this episode. Some should be most uncomfortable in their roles, some will be contemplating their roles in jail and some, amazingly enough, will go to their graves in full denial. It’s for the latter group and for executives to follow that this episode should be used as a teaching tool for decades to come. The Enron/Andersen lesson is one history lesson we should not be doomed to repeat.

Comments

[Graham Salmon]

What is surprising to me is how long it took for the final legal split to take place - from 1989 to mid 2000.Once mutual trust has gone in any organisation a swift termination is required, no matter what the short term financial penalty. Your name and professional standing is everything in this situation.
I knew quite a few of the AA guys in the UK in the 70's - people of my age. They represented their firm very well and were clearly some of the best of their generation in the profession. The UK arm had an enviable track record of attracting clients and choosing who they would act for,and who they wouldn't. The blame for the demise of AA has to lie at the very top in my opinion.The divergence from general accounting services by AA was lunacy and must have harmed the Andersen brand name right from the start.
I remember seeing an article by Ian Hay Davison (a long retired managing partner of AA UK) a few months ago and he was clearly deeply affected by destruction of the firm that he had been associated with since the mid 60's.
Greed won in the end.And everybody still at AA lost.

[David Maister]

Bravo, Brian. I’m not an insider, but everything you say echoes what others insiders told me. It’s a simple lesson: when you switch from “let’s make money by adhering to high standards” to “let’s make money any way we can” decay and rot has set in. It might not show up immediately but (to change the metaphor) the fatal poison has been taken. You don’t explain Enron (or Andersen’s) demise by what happened at the end, but, as Brian has brilliantly laid out, by trying to understand the path they had been on for awhile, and what led them to take that path.

[Dennis Howlett]

Graham's comments resonate well with my own experience. AA Leeds was spectacular in its service and deserved every bit of its success in the late 70s/80s.

A tragedy.

A pity the same cannot be said for the Big Four of today. They seem well short of the standards AA represented.

[vinnie mirchandani]

Andersen was top notch, but having competed with them while at PwC (as you and I frequently joust about) their own worst enemy. Their economics and frequent steamrolling of client middle management lost them a number of client fans - and them a number of deals they technically should have won. Clients have the same praise/complaint about Accenture - so they are right to decouple from AA, but in a number of ways may not have made a complete image redefinition...