To: Casey W. Baker, J.D.
From: Sixuan Long
Date: November 15, 2018
Subject: Module 5 – Fiduciary and Professional Liability – Accounting Firm Failures
This memo is for responding to reflection question regarding the ways that society can use to improve compliance with the legal and ethical duties imposed upon professionals and whether the current regulatory system offers sufficient protection to the interested parties or not. It will analyze the ethical and professional failures of two high profile accounting firms, Laventhol & Horwath and Arthur Andersen, then discuss some of the duties created by the existence of professional relationships. In my opinion, I deem that improving the related law, strengthening moral education and increasing the independence of auditors can help raise awareness among professionals in compliance with the legal and ethical duties imposed upon them. Moreover, I also believe that although there is still room for improvement in the current regulatory system, regulators continue to improve the current regulatory system to maximize the protection of the interests of all parties.
Fact
• Laventhol & Horwath
Laventhol and Horwath (L&H) were the seventh largest accounting firm in the United States before the failure in November 1990. Before the bankruptcy, it has expanded rapidly, with an average annual growth of 30%. L&H became the largest and most expensive partnership in American history. There are two reasons for failure: litigation and improper management policies regarding the dangers of litigation. L&H is self-insured and adopts a proactive litigation policy that is more inclined to court litigation and resolution. In the last year of 1990, a lawsuit was settled at $10.5 million, and in the Westheimer case a $73 million judgment, the cost of litigation was about $1 million per month. Another large, sensational lawsuit is pending: televangelist Jim Bakker and the PTL Ministry. At the partner meeting in Dallas on November 16, 1990, partners faced two choices: either to invest $15 million from their own assets or to file for bankruptcy. The company filed for bankruptcy on November 19, 1990. It has had a huge impact on employees, retirees, partners, customers, creditors, professional and financial markets. Due to the failure of L&H, lobbying efforts to pass legislation to limit the responsibilities of partners. Therefore, most states eventually allowed the establishment of new commercial entities, limited liability partnerships (LLPs). The second lobbying action was a lobbying effort to curb class-action litigation. After the controversial debate and the initial presidential veto, the U.S. Congress passed the Private Securities Litigation Reform Act of 1995. (Stiner Jr, F. M., 2010).
• Arthur Andersen
Arthur Andersen LLP is located in Chicago. The company provides audit, tax, and advisory services to large companies. By 2001, it had become one of the largest multinational companies in the world. However, in 2002, the company voluntarily waived its license to practice in the United States after being found guilty of criminal charges related to the company's audit of Enron (Wikipedia contributors, 2018). One difference between Arthur Andersen & Co. and its competitors was its “one-Firm” concept, which emphasizes a unified organization around the world that provides consistent service to its customers while maintaining the company's independence. The company is organized around a central authority because it tries to speak with one voice. As a result, the company’s potential to deviate from its established culture ultimately led to its demise. The failure of local offices to maintain centralized corporate principles has led to a lack of protection for the public interest, as well as certain partner customer relationships and important non-audit services revenues (such as Enron’s income) leading to perceived lack of independence and loss of public trust has played a role (Niece, J. M., & Trompeter, G. M., 2004).
• The Private Securities Litigation Reform Act
“PSLRA – is a piece of legislation passed by Congress in 1995 to stem the filing of frivolous or unwarranted securities lawsuits. The PSLRA increased the amount of evidence that plaintiffs are required to present before filing a securities fraud case with the federal courts. It also changed the way securities class action lawsuits are handled by giving judges the authority to determine plaintiffs and to take other actions to reduce legal system abuses. The purpose of the Private Securities Litigation Reform Act was to prevent unwarranted, flimsy, or fraudulent lawsuits from being filed, which can be expensive and tie up the efficiency of the legal system. It also reduced litigation risk for certain companies who faced these types of lawsuits on a regular basis” (Investopedia, 2018).
Reflection Question
In what ways can society improve compliance with the legal and ethical duties imposed upon professionals? Does the current regulatory system offer sufficient protection to the interested parties?
Analysis
Frederic M. Stiner, Jr. points that there is a difference between what the auditor said when performing the audit and what the public thinks the auditor is doing. This is called the “expectation gap.” L&H failures indicate that the profession cannot overcome the expected gap. It has apparently failed to try to educate the financial public about what the auditors have done over the years. Instead, the profession began to turn to politics. CPA firms have conducted large-scale lobbying activities in two areas. One is to restrict auditor responsibility in most states through legislation, allowing the establishment of new commercial entities, limited liability partnerships (LLPs). The second lobbying operation was a large-scale lobbying activity to curb class-action lawsuits (Stiner Jr, F. M., 2010).
For another case, Arthur Andersen was once a leader in the accounting profession, but as the administrative services became Andersen Consulting, the company seemed to have difficulty maintaining control because freer consultants began to generate growth in the company's total revenue. In order to keep up with the pace, more traditional audit practices have begun to focus more on the generation of non-audit services. This may result in a reduced emphasis on the importance of audit quality, as evidenced by projects such as waste management. In addition, the company's decision from internal CAPAP depends on generally accepted accounting principles and is supported by Leonard Spacek, which may be overturned by line personnel. This departure from the one-Firm concept may be a decisive factor in Anderson’s death. In essence, the company no longer speaks with one voice. Moreover, the Enron scandal is also an important factor in Anderson's failure (Niece, J. M., & Trompeter, G. M., 2004).
What are the legal duties imposed upon professionals? Felix I. Lessambo (2014) says that, “auditors are liable both civilly and criminally. Civilly, an auditor can be found liable either under the common law or a statutory law liability. Common law liability arises from negligence, breach of contract, and fraud. Statutory law liability is the obligation that comes from a certain statute or a law which is applied to society.” Additionally, for ethical duties, the professional responsibilities of companies and accounting professionals serving the public are determined by studying the legal functions that professionals perform in the economy. However, Andersen and other accountants in scandals were motivated to abandon the responsibilities of pursuing their correct goals and fall into the trap of accumulating wealth. The author believes that the ultimate responsibility of the internal auditor is to develop a statement that provides a reasonable and fair picture of the financial situation to any user who has the knowledge claim. Moreover, the main duties of the external auditor are: First, the use of the public is responsible for attesting to fairness, assessing the financial statements and declaring that they represent a fair picture of the company's financial situation, followed by becoming a regulator of financial markets and question the irregular practice that might distort these images. This due professional care requires auditors to exercise “professional skepticism”: this attitude includes challenge and critical evaluation of audit evidence (Duska, R., 2005).
In my opinion, society can improve compliance with the legal and ethical responsibilities of professionals in improving law, strengthening education and increasing the independence of auditors. First, without a sense of moral responsibility, the only deterrent to the accumulator is legal sanctions. Similarly, when pursuing money and commissions is the main driver of accounting firms, the company forgets its responsibility and mission to produce goods and services, and only strives to maximize profits, regardless of ethics and values. When wealth accumulation is the only driver, there is inevitably a lack of moral responsibility (Duska, R., 2005). Therefore, continuous improvement and enhancing implementation of the law and strengthening of supervision will help professionals understand and comply with legal and ethical responsibilities. In addition, strengthening relevant education can also increase auditors' moral requirements for themselves and gain public trust. Increasing the independence of auditors should also be an important aspect of helping auditors comply with laws and ethics.
Although the current system still has room for improvement, regulators continue to improve the regulatory system to maximize the protection of the interests of all parties. Audits can also be divided internally or externally, depending on the interrelationships between the participants. Internal audits are performed by the organization's employees. External auditing is performed by an external agent. Internal audits are often referred to as first-party audits, while external audits can be either second-party audits or third-party audits (What Is Auditing? n.d.). Because of the failure of these company, the regulatory proposed the Private Securities Litigation Reform Act and the provisions of the law regarding fraud write into law the standards that the AICPA promulgated regarding audit scope and illegal acts. Moreover, the legislation allows the development of legislation that permits limited liability partnerships (LLPs) and limited liability companies (LLCs) (Stiner Jr, F. M., 2010).
Conclusion
Based on the above facts and analysis, improving relevant laws and regulations and strengthening supervision, as well as strengthening the moral education of professionals and increasing the independence of auditors, will help them improve their ethical requirements and awareness and compliance with relevant laws and regulations. Although there is still room for improvement in the regulatory system, the failure of accounting firms and a series of audit scandals have led regulators to continuously improve their regulatory system to maximize the protection of all parties, such as setting up LLPs.