THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 223

CHAPTER 8

FYI

An Economic Analysis of Financial Structure

191

The Demise of Arthur Andersen

In 1913, Arthur Andersen, a young accountant who had denounced the slipshod and
deceptive practices that enabled companies
to fool the investing public, founded his own
firm. Up until the early 1980s, auditing was
the most important source of profits within
this firm. However, by the late 1980s, the
consulting part of the business experienced
high revenue growth with high profit margins, while audit profits slumped in a more
competitive market. Consulting partners
began to assert more power within the firm,
and the resulting internal conflicts split the
firm in two. Arthur Andersen (the auditing
service) and Andersen Consulting were
established as separate companies in 2000.
During the period of increasing conflict
before the split, Andersen s audit partners
had been under increasing pressure to focus
on boosting revenue and profits from audit
services. Many of Arthur Andersen s clients
that later went bust Enron, WorldCom,
Qwest, and Global Crossing were also the

largest clients in Arthur Andersen s regional

offices. The combination of intense pressure
to generate revenue and profits from auditing and the fact that some clients dominated
regional offices translated into tremendous
incentives for regional office managers to
provide favourable audit stances for these
large clients. The loss of a client like Enron
or WorldCom would have been devastating
for a regional office and its partners, even if
that client contributed only a small fraction of
the overall revenue and profits of Arthur
Andersen.
The Houston office of Arthur Andersen,
for example, ignored problems in Enron s
reporting. Arthur Andersen was indicted in
March 2002 and then convicted in June 2002
for obstruction of justice for impeding the
SEC s investigation of the Enron collapse. Its
conviction the first ever against a major
accounting firm barred Arthur Andersen
from conducting audits of publicly traded
firms. This development contributed to the
firm s demise.

The second major policy measure arose
out of a lawsuit brought by New York Attorney General Eliot Spitzer against the
ten largest investment banks (Bear Stearns, Credit Suisse First Boston, Deutsche
Bank, Goldman Sachs, J.P. Morgan, Lehman Brothers, Merrill Lynch, Morgan
Stanley, Salomon Smith Barney, and UBS Warburg). A global settlement was

reached on December 20, 2002, with these investment banks by the SEC, the New
York Attorney General, NASD, NASAA, NYSE, and state regulators. Like SarbanesOxley, this settlement directly reduced conflicts of interest:

GLOBAL LEGAL SETTLEMENT OF 2002

It required investment banks to sever the links between research and securities underwriting.
It banned spinning.
The Global Legal Settlement also provided incentives for investment banks not to
exploit conflicts of interest:
It imposed US$1.4 billion in fines on the accused investment banks.