What Did Arthur Andersen Do Wrong, Exactly?

[I found this in my drafts folder, written October 20, 2011 but never published.]

In July 2002, a jury found Arthur Andersen guilty of obstruction of justice after it had destroyed documents related to Enron Corp. Andersen claimed that the documents were destroyed as part of its housekeeping duties and not as a ruse to keep Enron documents away from the regulators.

After the guilty verdict, government lawyer Andrew Weissmann crowed, “When you expect the police, don’t destroy evidence.” “For Andersen, the police was the [Securities and Exchange Commission].”

Leslie Caldwell, head of the Enron Task Force, also led the investigation into Arthur Andersen. She said ominously after the guilty verdict, “We are not finished with Arthur Andersen.”

Actually, they were indeed finished with Arthur Andersen — but Arthur Andersen wasn’t finished with them. When Arthur Andersen took the case to the Supreme Court, the Supremes unanimously reversed the conviction due to flaws with jury instructions.

The Court found that the instructions were worded in such a way that Andersen could have been convicted without any proof that the firm knew it had broken the law or that there had been a link to any official proceeding that prohibited the destruction of documents. Chief Justice William Rehnquist wrote that “jury instructions at issue simply failed to convey the requisite consciousness of wrongdoing…Indeed, it is striking how little culpability the instructions required.”

Chief Justice William Rehnquist was also highly skeptical of the government’s concept of “corrupt persuasion”—persuading someone to engage in an act with an improper purpose even without knowing an act is unlawful.”

It was a pyrrhic victory. Having relinquished its right to act as CPAs, the company was effectively dead. It went away much like Enron, and the case was closed, and people moved on.

This was the official story – the one that was spoon-fed by CNN and the DOJ. But it isn’t the complete story.

Despite Weissman’s statement that one shouldn’t destroy documents when the police are on the way, the government did not charge Andersen with obstruction of justice for destroying documents during the relevant time period because no official proceeding of the SEC was pending. AA’s Supreme Court brief says:

It is plain as day that the Government did not charge Andersen with obstruction of justice for discarding documents during the relevant time period because no official proceeding of the SEC was pending. This Court has held for more than a century that “a person lacking knowledge of a pending proceeding necessarily lack[s] the
evil intent to obstruct.” United States v. Aguilar, 515 U.S. 593, 599 (1995) (citing Pettibone v. United States, 148 U.S. 197, 207 (1893)).

The United States attempted to evade that settled law by instead charging Andersen with “witness tampering,” on the remarkable theory that although it was perfectly lawful for Andersen to have a document retention policy that preserved only the final audit work papers, and perfectly lawful for Andersen’s employees and professionals to follow that policy, it was somehow a serious felony for Andersen’s in-house attorney and supervisors to remind its employees of the policy.

The government argued that Nancy Temple’s proposed edits to David Duncan’s draft memorandum constituted criminal “witness tampering,” because in its hindsight view the SEC would have wanted to see Duncan’s first draft. It invoked 18 U.S.C. § 1512(b)(2)(A), which criminalizes killing, intimidating, threatening, and “knowingly … corruptly persuad[ing]” any person with the intent to make evidence unavailable to an official proceeding.

Yet there is nothing inherently “corrupt” about an intent to impede future government fact-finding within the bounds of the law. Any defendant engages in a wide range of conduct to limit information; that is one of the reasons that our legal system is frequently described as “adversary” and not “Hello Kitty and Barbie Play A Happy Game Of Prosecution and Rainbows.”

The Court has recognized that there is nothing “obviously evil” or “inevitably nefarious” about acting “for the specific purpose of depriving the Government of … information”. (Ratzlaf v. United States).

Furthermore, 18 U.S.C. § 1512(b)(2)(A) applies only when the defendant intended to make documents or testimony unavailable to a particular official proceeding, defined as a judicial proceeding, “a proceeding before the Congress,” or “a proceeding before a Federal Government agency which is authorized by law.” Interference with the fact-finding ability of law enforcement or preliminary agency investigations is not sufficient. Neither is an abstract desire not to retain documents because they might be relevant to some possible future proceeding.

The theory of this prosecution criminalized conduct commonly understood to be lawful, including the document retention policies in place at almost every American corporation or professional firm of any size. And the jury may well have rested its verdict on an email from Nancy Temple which “offered such common legal advice that the chairman of the American Corporate Counsel Association wrote in a letter to his members: ‘Who amongst us has not thought: There but for the grace of God go I.’

All of Nancy Temple’s and David Duncan’s actions took place entirely in the open. Neither attempted to hide what they – or anyone else – was doing. The destruction of documents was never intended to be a conspiracy to keep information from the SEC. No witness at trial said they were told by the company that the purpose was to keep materials from the SEC.

No one at Andersen had the “evil-meaning mind” necessary to justify criminal punishment. This conviction was secured by creative lawyering on the part of government prosecutors, at the expense of sound statutory interpretation and the basic goals and values of the criminal law. It did a great injustice to the tens of thousands of Andersen partners and employees who were permanently harmed by the firm’s destruction.

Results of Carl Bass’ Appeal With The Texas Board of Public Accountancy

I haven’t read it yet but the opinion can be found here.

Enron’s Audit Fees Entertain Professor

Everybody is ramping up their Enron coverage in time for the anniversary. This USA Today article states:

Enron’s collapse gave professor Jonathan Stanley of Auburn University the inspiration to pay more attention to auditing fees.

Just as everyone points to the Hindenburg when talking about zeppelin safety, Enron is the poster child for corporate implosion. But very few people realized that Enron was going belly up until it was too late.

But there was a warning: The year before the stock collapsed, Enron paid $25 million in auditing fees, more than all but one company in the Dow Jones industrial average. Intrigued, professor Stanley looked to see if there was any correlation between big auditor fees and stock performance.

And cut.

The article doesn’t mention who the other company is, and whether it too collapsed. My instinct – based on my general mistrust of the media – is that the company is still alive and thriving somewhere, but that would destroy his stupid little theory so nobody is going to mention that inconvenient fact.

I don’t believe Enron’s auditing fees were indicative of anything other than Enron’s usual money-is-nothing attitude about spending. Enron spent millions on McKinsey studies, millions on Aeron chairs, millions on fancy art. I would not be shocked to learn that Enron also spent millions on auditing fees. In fact, if you told me that Enron was quite frugal and paid lower than industry average, I would definitely be suspicious.

But this is Enron we’re talking. ENRON! The company didn’t worry its pretty little over head over auditing fees. And this professor shouldn’t worry his pretty little head either.

Arthur Andersen Suspends Document Destruction Policy

Arthur Anderson email halting destruction of documents.

Thomas Bauer’s Memo Re: Chewco Investigation

This document is a memo drafted by Anderson auditor Thomas Bauer about the investigation into Chewco. I think the very last diagram (last page) is very good.

Arthur Andersen and LJM

This is a Washington Post article from February 2002.

Anderson and LJM

Thomas Bauer Congressional Testimony

Subcommittee on Oversight and Investigations
February 7, 2002
10:00 AM
2322 Rayburn House Office Building

Mr. Thomas H. Bauer
Partner
Andersen LLP
555 12th Street, NW
Washington, DC, 20004

Good morning, Chairman Greenwood, Representative Deutsch, Chairman Tauzin, Representative Dingell, and members of the Subcommittee and full Committee. I am Tom Bauer. I am a partner at Andersen, where I have worked since 1974. I am appearing today at the request of the Subcommittee to discuss the accounting issues associated with the Chewco transaction.

By way of background, I grew up in Western Pennsylvania and attended college at Indiana University of Pennsylvania, where I received a bachelor’s degree with a major in accounting in 1974. After graduating from college, I began my career with Andersen and have been with the firm ever since. I became a partner in 1986. In 1995, I joined the Enron audit engagement.

I understand this hearing will focus on several transactions involving Special Purpose Entities. This morning I will discuss the Chewco transaction, with which I am familiar.

It recently has become clear that, in 1997, when the Chewco transaction was conceived, Enron withheld information from and misled me on the accounting issues related to Chewco. I knew nothing of this at the time. I was told I had been provided with all relevant documentation in Enron’s possession. Had the information that was withheld been timely provided to me in 1997, when I requested it, the accounting advice and opinion of Andersen would have been different and the major part of the restatement that occurred in November 2001 would have been unnecessary.

Let me describe the background. In 1993, an Enron subsidiary and CalPERS formed a partnership known as Joint Energy Development Investments. It was called JEDI for short. JEDI invested in energy-related securities and other investments. It was a very successful investment. Because JEDI was a 50-50 partnership between Enron and CalPERS, Enron appropriately did not consolidate JEDI for financial reporting purposes. These events occurred before I became involved with auditing Enron.

In late 1997, Ben Glisan, the Enron transaction support employee with principal responsibility for accounting matters in the Chewco transaction, contacted me to discuss the accounting for a transaction that Enron was entering into. Mr. Glisan is an able accountant, who at the time was thoroughly familiar with the accounting rules governing Special Purpose Entities. He told me CalPERS’ limited partnership interest in JEDI would be acquired for approximately $300 million by an entity called Chewco Investments, LLP. In our discussion, Mr. Glisan told me that Chewco would be structured as a Special Purpose Entity so that it would qualify for non-consolidation. Mr. Glisan also told me that an Enron employee, who I later learned was Michael Kopper, would have a very small interest in Chewco. He also said Enron was considering guaranteeing a loan that would finance a substantial portion of the transaction.

I reminded Mr. Glisan that for Chewco to qualify for non-consolidation, as he proposed, two tests had to be met. First, at least 3 percent of its capitalization had to be at-risk and attributable to entities independent of Enron. Second, neither Enron nor a related party of Enron, such as an employee, could control Chewco. I confirmed this advice with Andersen’s Professional Standards Group in Chicago. Mr. Glisan assured me that Chewco would have 3 percent independent equity and would not be controlled by Enron or an Enron employee.

As the transaction unfolded, Mr. Glisan told me that Chewco’s independent equity would come from two sources. First, he said that a large financial institution independent of Enron would make a large equity contribution. I later understood this large financial institution to be Barclays. According to Mr. Glisan, the second component of Chewco’s third party equity would come from wealthy individual investors, who, with the exception of Mr. Kopper, would be independent of Enron.

I requested that Mr. Glisan provide Andersen with all documentation in its possession relating to the transaction. He told me he would do so and he thereafter provided pertinent documents to me. Enron senior officials also confirmed in writing that I had been given all documentation they had. In this connection, I reviewed:

minutes of Enron’s Executive Committee of the Board of Directors approving the transaction;

the $132 million loan agreement between JEDI and Chewco;

Enron’s guarantee agreement of a $240 million loan from Barclays to Chewco;

the amended JEDI partnership agreement; and

a representation letter from Enron and a representation letter from JEDI, each of which stated that related party transactions had been disclosed and that all financial records and related data had been made available to Andersen.

I also requested that I be provided documents relating to Chewco’s formation and structure. Mr. Glisan told me that Enron did not have these documents and could not obtain them because Chewco was a third party with its own legal counsel and ownership independent of Enron. I did not view this as unusual. Quite frequently an auditor does not receive documents from a third party who is represented as being independent. Andersen did send and received a confirmation regarding the loan agreement from the Chewco representative.

The transaction documents and Enron board minutes I reviewed relating to Chewco corroborated the representations I had received from Mr. Glisan and Enron. The documents described an $11.4 million independent equity infusion into Chewco, which represented 3 percent of Chewco’s capitalization. Also, the documents described and represented that Chewco was “not affiliated” with Enron. Thus, in 1997, based on what I was told and what I reviewed, Chewco appeared to meet the criteria for a non-consolidated Special Purpose Entity.

Roughly four years later, on October 26, 2001, two Enron accounting employees called me to discuss concerns that had recently arisen about the sufficiency of Chewco’s independent equity. On November 2, 2001, Andersen received a set of Chewco documents gathered by the Special Committee of Enron’s Board of Directors. When I reviewed these materials, I was appalled to discover a document I had never seen before – a two-page Side Agreement between JEDI and Chewco amending their 1997 loan agreement. The Side Agreement was dated December 30, 1997, the very same day that the loan agreement between JEDI and Chewco was signed. As I mentioned previously, Enron showed me and gave me the loan agreement during the 1997 audit. They did not show me or tell me about or reveal the existence of the contemporaneous Side Agreement. The same individuals who signed the loan agreement also signed the Side Agreement.

The Side Agreement materially altered the accounting treatment of Chewco. By itself, it caused Chewco to fail to qualify as an unconsolidated Special Purpose Entity. Under the Side Agreement, JEDI was directed to deposit $6.58 million into reserve accounts created for Barclays’ benefit at entities known as Big River and Little River. Barclays’ $11.4 million equity infusion in Chewco appears to be conditioned upon the receipt of the $6.58 million from JEDI. This means that the independent at-risk equity in Chewco was not $11.4 million as represented, but rather much less, and significantly below the 3 percent necessary for non-consolidation.

The undisclosed Side Agreement meant that Chewco’s and JEDI’s financial statements should have been consolidated with Enron’s since 1997. I do not know why this critical Side Agreement was withheld from me in 1997. I do not know who made the apparent decision to mislead Andersen and me. Had Andersen, in 1997, been provided the materials that I received in November 2001, there is no way I would have permitted Chewco to be treated as an unconsolidated Special Purpose Entity, and a significant portion of the November 2001 restatement would have been avoided.

In addition, other documents provided to me for the first time in November 2001 raised other accounting issues. Had I known this information in 1997, I also would have modified my conclusions and opinions relating to Chewco.

Mr. Chairman, I hope the information I have provided is helpful to the Committee’s inquiry. I am here to answer any questions that the Committee may have.

Carl Bass Fights To Remain CPA

On Christmas Day, an interesting article about Carl Bass was published in the northern Ohio “Morning Journal” via AP:

To many in the accounting world, Carl Bass is a hero. Long before Enron became a worldwide symbol of scandal, Bass told his supervisors at Arthur Andersen LLP that something was amiss with the Houston energy giant.

But the Texas state board that licenses accountants sees Bass differently — as unfit to continue in his profession.

Nearly a decade after Enron collapsed and took Arthur Andersen with it, the work of Bass and another former Andersen partner, Thomas Bauer, as Enron auditors is still being debated in a highly contentious and costly proceeding.

The Texas State Board of Public Accountancy has stripped Bass and Bauer of their CPA licenses after determining they violated professional standards in their audits. But the pair has pushed back with a legal challenge that led a judge to rule that the license revocations should be voided because the board violated the Texas Open Meetings Act.

The revocations remain in effect while the matter is under appeal, which could take at least a year.

The upshot is a standoff playing out after most of the figures in the Enron scandal have had their days in court and raising questions about a little-known state agency that doesn’t rely on the Legislature for funding.

William Treacy, the board’s executive director, said it’s in the public interest for Bass and Bauer to be barred from working as CPAs. He cited the depth of the Enron scandal, which led to more than $60 million in lost company stock value and more than $2 billion in losses from employee pension plans.

“There’s a lot more than two licenses at stake,” Treacy said. “Let’s not forget the thousands of people who lost their life savings, their jobs and their pensions.”

The board argues that Bass and Bauer should have their licenses revoked because they failed to follow accepted accounting practices in conducting Enron audits in 1997 and 1998.

But some observers believe the case is more one of overzealousness by the agency than insufficient audits.

Wayne Shaw, a professor of corporate governance at SMU’s Cox School of Business in Dallas, said it’s unusual to see licenses revoked because of flawed audits unless the accountants were complicit or showed total disregard for accepted procedures. That’s particularly true for audits like those involved with Enron, he said.

So Bleeding Edge Current, It Will Make You Weep

Today I got pulled into a meeting in the conference room. Several people were on the phone with a rep from Hoovers. We are evaluating the software before deciding whether to shell out money for a full license. We were asking questions about the quality of the data, and the lady was talking about how great this information was, how everything is updated every three months and how there was simply nobody better for real-time information about companies both domestic and international.

My boss clicked on a random link for an oil company, and up popped this “current” information. I was rather surprised to see their auditor is Arthur Andersen. I unabashedly got up, took a picture, and sat down like nothing had happened:

As we were walking out, somebody said, “We should have searched for Enron.”

I turned to go back inside but my boss grabbed my sleeve and asked me to do something. But I am dying to get my hands on that database. I suspect Enron is in it. I will take pictures when I confirm it.

Interview With Nancy Temple

The BBC has an interview with Arthur Andersen exec Nancy Temple. I haven’t listened to it yet but I’m sure it will be time well spent to listen.

An Enron Quiz That Went Horribly Right

Sometimes it is fun to laugh at stupid people. Now is one of those times.

This is an actual exhibit used during two Enron trials. It’s an Enron Quiz and it was used by defense attorneys to demonstrate how pervasive the media coverage was here in Houston when the defendants were attempting to get a fair trial.

Whoever took the quiz got most of the answers wrong (SPE=Special Perk or Enticement? Really?) but the most outrageous and yet hilariously stupid thing is that whoever took this quiz answered “C” to number 13.

That would have been so awesome if it was true. Alas.

A more frightening thought: what if the person who took this quiz was actually a juror?!

Geeking Out With Arthur Andersen Shirts

Thank God I’m not someone who would actually wear these; even if they were Enron shirts, they are far too ugly for me to wear (and one is a man’s shirt but that is beside the point when you’re talking about sport piping.) But these anachronisms are interesting, I think.

Austin Suicide Rants About Enron/Arthur Andersen In Goodbye Letter

Many of us, particularly here in Texas, were appalled to wake up to the news that a plane had flown into the FBI building in Austin. Within hours, CNN connected the dots: it was a suicide, the man who had flown into the building was targeting the IRS (not the FBI), and he had set fire to his house before he boarded his small plane.

The suicide letter can be found here. I was amused (yes, amused by a suicide letter) to read a passage about Enron and Arthur Andersen:

He then goes on to explain that Section 1706 basically screwed him over. But I wonder how he got it in his head that Arthur Andersen had anything at all to do with that exception. AA was an auditing firm who, no doubt, did some lobbying, but AA would not directly benefit from that section. Indeed it seems to benefit individuals, not companies. In any case, the guy was seriously upset with AA for its perceived support of this section of the tax code.

Sidebar: CNN censored the word “shit” in the letter; as in “they don’t give a shit about…” I feel like that is incomplete reportage, and it condescends to its readers.

In any case, it seems strange to me that Enron and Arthur Andersen, which existed to do good – and did do good – is seen as the boogeyman not only for politicians, but for a lone wack who flew a plane into a building.