bigger than enron
homelessonswatchdogspoliticsaccounting warsdiscussion
photo of joseph berardino
Interview: Joseph Berardino

A longtime partner with Arthur Andersen, Berardino became CEO of Andersen Worldwide in January 2001 and stepped down in March 2002 after the firm was indicted for obstruction of justice in the Enron investigation. He tells FRONTLINE that he believes the accounting profession is misunderstood by the general public, and that a new conceptual framework is needed if auditors are to communciate more effectively with investors. He answers questions about Andersen's conduct as Enron's auditor, and he speaks about the issues surrounding Andersen's role as both auditor and consultant; about the decision to invite Paul Volcker, the former Federal Reserve chairman, to head an oversight panel in an attempt to restructure Andersen as an audit-only firm; and about the timing of his own decision to step down. This interview was conducted by FRONTLINE correspondent Hedrick Smith on May 1, 2002.

You wrote an op-ed piece for The Wall Street Journal and the headline was something like, "Enron Wake-Up Call."...

That piece was written in early December. Even in those relatively early days in absorbing what happened at Enron when this huge company collapsed, one thing was clear to me and that is, as the facts started coming in on Enron, we would see that this was a parable of the 1990s. This was a story that would call into question, not just the accounting or auditing related to Enron, but some of the broader corporate governance issues, as well as the issues of our accounting model and what could be used, what we learned from it. ...

This was a big collapse, and it has certainly proven to be a very big story. And the question is what have we learned?

What do you think is at stake here? At one point, you used some phrases about "trust in the marketplace," and so forth. Why is this important? Why should ordinary investors care? Why does this matter to the economy as a whole?

... I travel all over the world. I see capital market systems all over the world. One thing I will say at the beginning is we've got the best model. Others try to emulate it and learn from it, maybe even try to improve upon it, but we do have the best model ... and ones that people trust.

When I stepped down, I said on national TV that the ultimate tragedy of Enron would be that we donšt learn. I'm not real optimistic.

However, whenever you have a washout like we have had with Enron, it destroys people's confidence in the system. And the question becomes what is that system, and how do you improve it?

But the lack of trust and confidence, I think is fundamental to what we are talking about today. As auditors, we are in place to give that investor confidence, and this is all about what's good for the investor. When you lose that trust, you can second-guess everything you do. We need to come up with new ideas that could help govern our profession ... to re-engage the investor and improve their confidence. ...

So my basic posture on this is that, if you want to focus on accounting and auditing, we can do that. Extremely important. But if you look at how you're trying to protect the investor, think of it like a manufacturing process. There is a whole pipeline of activities, starting with management running the business, to a manager communicating to the shareholders. A lot of stuff is happening, and at the end of that pipeline [there's] the auditor, if you will, the inspector at the end of the assembly line.

What we're going to do, looking at Enron, is look at Inspector Number 103, and what he or she could have done differently. I'd say that's fair game. But it's not the whole story. I need to look at the whole pipeline. The board, the analysts, the bankers, the investors themselves -- how do they behave, why do they behave that way, and what can we learn from that behavior in terms of education, changing the system and so forth? ...

You spoke in one forum of your profession being in crisis. ... What did you mean when you said your profession is in crisis?

I believe our profession has been in crisis for some time, and we've referred to this from the profession standpoint as the "expectation gap." What we do is very different from what people think we do. We don't guarantee the financial condition of the company. But whenever a company fails, people ask, "Where were the auditors?"

What we do is test the systems that go into the company's calculating, reporting on its earnings. Based on those tasks, we do form an opinion as to whether those fairly presented results. But whenever a company goes under, everyone expects the auditor to have been able to predict it.

We live in a risky world. We ought to encourage entrepreneurs to take risks, and investors to get rewarded for taking risks. Obviously, when they succeed, they profit handsomely, but when they fail, we can't be suing Inspector Number 103, because we've now gone from eight to five firms; we'll probably go to four. When do you run out of auditors?

So I think there is a fundamental crisis of confidence, of understanding. We need to cure it, because the investor deserves to know what they can count on, who they can count on, and what degree of comfort they should take away from this whole process. ...

What do you do about the firms that wouldn't produce totally honest [books]?

Well, that's where you have audits for companies that either don't know how to get it right -- a competence issue -- or want to skirt the rules, let's say, or get by with the bare minimum of disclosure, the least conservative accounting, the best earnings per share. The dilemma we're in as auditors is, at the end of the day, you give your client a pass or a fail grade. So the client that barely gets by gets the same opinion as that client who is more fulsome in their disclosure and more conservative in their accounting. So you need to ask yourself a question: Is that right?

As auditors, one of our challenges is [that] we don't write the financial statements, management does. So we can encourage more disclosure. We can encourage more complete discussion. We can encourage more conservative accounting. At the end of the day, some clients will look you in the eye and say, "This is it. Accept it or reject it." If we accept it, they get the same opinion as the client who is more fulsome. So ... the auditor has a lot more knowledge than they are able to express in this standard opinion.

Yes, we can discuss our findings with the board, we can discuss it with management. But we don't have a direct pipeline to the shareholders, to the ultimate investors. ...

So one idea I've put on the table that needs a lot of thought, and perhaps some structure, is what if an auditor could grade their opinion and distinguish between those two clients at different ends of the spectrum? Or it could discuss or insist that there be some discussing of the risks of the business, so the shareholder could have a more complete understanding of what could go wrong or how conservatively the accounting is or not? I think there's an incomplete conversation today between all the information the auditor has, and what the investor might want.

Talk for a moment about the 1990s. ... Were the pressures on accountants more intense? ... If you go back 20, 25 years, a CEO or a top management team of a company would feel good if they had a successful year, they made income, they employed a certain number of people, their products were known, their services were known for high quality. And yes, they want to see their share price go up. But it was one of a bunch of indicators. But by the time you get into the 1990s, more and more it's the stock price ... which becomes the yardstick by which everybody is measured. At that point, I'm wondering, if you're the accountant and, as you said, there's a certain fudge factor, or there are lots of judgment calls and estimates that go into earnings per share, which affects stock price. How much is the pressure increased on you to say, "That's immaterial, that's not too important. We need those extra 33 cents per share to make our earnings to keep our stock price going up?"

There's no question there's more pressure on management. Not only was management chasing "beating last year's numbers," the discussion we started getting into was "How do we beat Wall Street's estimates?" ... And yes, like I say, indirectly the auditor felt that. ...

So it's pressure, and also different ideas of what people feel they need to make an investment. The auditor is in the middle of that conversation. If something goes wrong, he'll be the first to get criticized.

Add to that -- back to this crisis of confidence -- in the 1990s the SEC got a lot more aggressive. They got aggressive in two areas. One is they challenged existing audited financial statements, and there was an unprecedented number of these restatements of those financial statements. One can get into whether those restatements were material or not material. In some cases, they were very material. In some cases, they weren't, quite frankly. But as a result of those restatements -- there were some 400 in the last three years -- it undermined the confidence investors had on their financial statements.

It's important that you have an aggressive SEC, keeping everybody honest. On the other hand, people will say that some of those restatements were not material. There are areas where there were honest disagreements as well as right and wrong. All I'm saying is, collectively, when people looked at the quantum leap in the number of restatements, it undermined confidence in the auditing profession. It's one reason we are where we are today.

But you would attribute the growth from something like three corporate restatements in 1981 to 150 per year in the late 1990s entirely to the activity of the SEC? There's no problem with the companies pushing the envelope? There's no problem with auditors missing it? It's all the SEC?

Well, of course not. It's all the above. There are also that many more registrants, that many more public companies. All I'm saying is, regardless of whether you look at the cause of the restatements, the restatements themselves and the quantity of them have caused an undermining of the confidence of the investors. ...

I think one of the things that people applaud most about your final, most difficult period here at Andersen was bringing in Paul Volcker and trying to deal with the future. We've been talking about where we go in the future, and not so much about the past. Why did you do that, and what do you think of Paul Volcker's strategy?

I want to say at the outset, I'd never met Paul Volcker in January 2002. I approached him because he is a man of unquestioned integrity. He's a man who understands in the broader context the capital markets, had a specific interest in the accounting piece to the broader picture.

As a firm, we needed two things: we needed some credibility coming out of this crisis, and we needed some new ideas, so that we could go to the market and say we're a different kind of firm. Before Mr. Volcker would come on board, he asked me a lot of good questions. I gave him certain assurances. Both those questions and assurances all were on the issue of, what could the future look like for the accounting profession, and would we, would I be in a position to change the model?

I would suggest to you that a lot of the ideas Mr. Volcker came up with were ideas that we generally work with a lot, because I felt we needed to give the marketplace a different kind of firm. Not because I was 100 percent convinced that this quote-unquote "pure-audit firm" we were talking about would be a market leader, but because we needed to test the system. Getting back to my point earlier about the expectation gap, we needed to find a way to bridge that gap. I felt there was some very unhelpful conversations out there. For example, this issue of consulting fees that auditors incur. ...

Why would you push for an audit-only firm?

I think there were a couple of reasons. One was that, given all the criticism of our firm at the time, strategically we wanted to be and needed to be a different market offering. Point two, the market was asking for and questioning this whole issue of auditors doing consulting work for their clients. So we were prepared to take that issue off the table, and give those investors the confidence that there could not possibly be that quote-unquote "conflict of interest." We were bringing Mr. Volcker in to help us think through how to do that; the credible offer, but also a viable firm that would actually attract clients.

So am I understanding you correctly that you, in Andersen, had the idea of becoming an audit-only firm before you called in Paul Volcker?

The short answer to that is yes. As part of our conversations with Paul Volcker, we told him we were prepared to move in that direction. We needed his thinking as to whether that was a smart thing to do. We needed his wisdom in terms of how to do it. That's what attracted him, frankly, to working with our firm.

When you were approaching the idea of an audit-only firm, were you looking to put a new model out for the accounting industry from Andersen?

I was looking to survive -- with Andersen. That was my most significant objective. Then, yes, I was challenging my profession, because I do think we need to make fundamental changes. ...

In retrospect, do you regret having fought [former SEC Chairman] Arthur Levitt when he was trying to separate the bulk of consulting from auditing [in 2000]?

I regret fighting anybody. On the other hand, I do believe the market is a better place than the government in deciding how the market should be formed. Among other things I disagreed with at the time is that the government was forcing the whole profession to a certain model. What I said to him, and I'd still say, is ... "Give the marketplace some options. Give them some alternatives, and the better model will win." I didn't know what the best model was two years ago. I don't know what the best model is today. Let the marketplace decide. So that is the first reason I disagreed at the time.

The second is that I do not feel that there is any evidence that consulting fees cause auditors to restrict the conclusions on their older clients. But given all the noise that's existent, particularly in this last year, I've given up on that discussion. The market just doesn't buy it, and so we should respond to the market. That's what we were going to do with Anderson. And yes, I regret fighting, but only because I think we should be able to work these things out. ...

You talk about this politicization of accounting issues, and the intrusion or involvement, depending upon how you feel about it, of outsiders. One of the first examples of that was the fight over expensing stock options in the early 1990s. Was that good to get Congress as deeply involved in that?

No, no, I don't think it is. Back to the crisis of the accounting profession, I think it undermines the confidence. Everybody feels they can lobby, and their opinions, no matter what answer you end up with, the profession suffers because it's being questioned. I think it's all fair in democracy. It's all fair to criticize, comment, et cetera. But when you're constantly getting hit from all different directions, people are going to look at you differently. In some of these cases, the accounting issues are very difficult, and no one of us has the ultimate wisdom. ...

So let's take stock options, still a hot debate. One point of view, no less than Alan Greenspan and Warren Buffet have expressed, is that of course stock options are given to an executive as compensation. Let's account for it as compensation. I agree, but let me just quickly add that it's very, very hard to calculate that number. You could put five accountants, five businessmen, five economists in a room, give them the same set of facts -- and you're asking them to value, evaluate or value the financial instrument that has a 3-, 5-, 10-year life -- evaluation depends on the discount rate you might want to use, what stock appreciation might occur for that company. ...

So the point is this is really hard. Honest people can have intellectually different points of view, and in our system, in our open democracy, politicians will weigh in, businessmen will weigh in, Congress will weigh in. ...

Let me ask you about another issue that's come up. That is the whole question of stockholder suits, the degree to which the accounting profession and other professions are at risk. What others have told us is that the savings and loan experience, the scandal and the collapse of a number of stockholders coming out of that, were extremely painful financially to the accounting profession. ... To what extent was that important in the eagerness with which the accounting profession wanted to get the tort law reform bill passed in 1995? ... What were you trying to do? What did you want tort reform to do for you?

Tort reform was important to get some proportionality to whatever damages were assessed against an accounting firm, so that, for example, if company ABC failed and stockholders lost, let's say, a hundred million dollars, and nobody else was around with any money but the auditors, that the auditors were meant to pick up the whole bill. They said if they were 10 percent culpable, they'd pick up 10 percent and no more. So it was an attempt to at least rein in or limit the damages so accounting firms wouldn't go out of business. ...

Did you feel as though the aggressiveness, the combative relationship that you mentioned before with the SEC -- did you feel that Harvey Pitt's arrival at the SEC might change things?

Yes, I was very concerned about the combative role we had with the SEC. ... You like to work with your government, not fight it. So I thought Harvey Pitt's outreach to the profession after he was confirmed by the Senate, was constructive. I certainly received it as constructive.

Frankly -- and I've told both Levitt this and I've told Harvey Pitt this -- I want a strong SEC. I'm an auditor, but it helps me to know that we've got a tough rigorous enforcement agency. There is no question in my mind, then or now, that Harvey Pitt ... will be tough in enforcing the rules.

What they will do, or say that they will do differently, is reach out, so we can try to get a consensual view of the changes that need to be made, rather than a more combative approach. I think it's a question of style. It's a style I'm very comfortable with, and I'll be more than happy to participate in. ...

You've said that, after the Waste Management case, you wanted to communicate certain things within your own firm, that you wanted to have a dialogue and a discussion about certain issues. What was it you were trying to communicate to others coming out of the Waste Management case?

We had had a couple of tough cases. We were facing the hangover from the 1990s. Valuations were still very high, companies were failing, and in my view, stock prices were going to come down. I thought that we'd have a couple of tough years in terms of stock price valuations; the multiples were crazy.

I just wanted to be sure our partners understood that quality was number one, not growth. Quality was number one at our audit practice. We needed to have the right clients; we valued what we did. I wanted the partners to know that if they needed to fire a client or give the client news that the client didn't want to hear, that they'd be rewarded for that. Those are the messages I gave our partners. ...

Talk to me for a moment about the way accounting firms operate. ... You have a professional standards group, or technical experts, or as some people call them, "Keepers of the Holy Grail." ... You were talking about the need to protect quality, and quality comes first, and so forth. How do you organize your work in order to ensure quality?

First and foremost, we have partners assigned to each client. They are the ones who, at the end of the day, sign the firm's name. We also have what we call a professional standards group. This is a group largely located in Chicago whose job is to respond to an audit partner's question about, [let's say], "This rule's 800 pages long. Explain to me paragraph 79C and how this might relate to a specific client situation."

Those people are compensated based on their ability to give first-rate accounting advice to our practitioners. They're outside the local office, so they're not at all influenced by whether this office or that office makes money or doesn't make money, or keeps a client or doesn't keep a client.

We also have what we call practice directors. Practice directors are, if you will, our risk managers. They look at our portfolio of clients, the risk they provide us, whether we have the right people assigned. When there are conversations between the technical experts and the line partners, they help take the theoretical answer and make sure it makes sense in the practical situation we're dealing with.

In a partnership, we operate through consensus. So if everyone agrees with the answer, life is easy. If there are disagreements, those disagreements are supposed to bubble up in the organization either on a case-by-case basis --we're discussing this accounting issue with that accounting issue -- or when we decide whether or not we're going to retain a client. All this is intended to give our line partner, who serves the client in the field, the best answers as quickly as possible in some very highly complex situations. ...

Is there an appeals process? What we were told by another one of your partners was that if there was a disagreement between the field people, the client servers and the technical experts, the Keepers of the Holy Grail, there was an appeal process; it went up to the CEO. Is that accurate? Is that how it works?

... Yes, if there's a disagreement, it would go up through our hierarchy in the firm. We have a leadership in each office. We have a leadership in the country. The two kinds of disagreements would be either in a specific accounting issue or should we keep this client. At the end of the day, frankly, we are able to reach consensus. That's how we've tried to do it. ...

There were very few issues that would not get resolved at fairly immediate levels, close to the team, very few appeals. I'd say, in my mind, there would always be a heavy burden of proof required to get me past what technical guys would say.

In other words, if your technical guys had an objection, you'd be inclined to side with them?

Yes.

... There was a fellow named Carl Bass. He was in your technical services group. What would the function of a Carl Bass be?

He was in our professional standards group, so-called "Keeper of the Holy Grail," in your term.

So he would be the one who was reviewing, helping, advising, and perhaps challenging?

Uh, huh.

There are a bunch of his memos that are now out in the public record through congressional websites and so on and so forth, in which, time after time, from 1999 through 2001, Bass is saying there's no substance to the partnerships that Enron is setting up off-books. These are his phrases: "There is no substance. I can find no substance to this partnership." ... Is that something that would come to you, and if it comes to you, would that not have been an alarm for quite a period of time? This happened not once, but it happened multiple times.

Well, it didn't come to me. I've not read those memos. I've heard about them. There were disagreements. At the end of the day, what has happened is, if you look at the restatements that we agreed to on Enron, there were two restatements of some $500 million of earnings over a five-year period. In one instance, representing about 80 percent of that restatement. Frankly, we didn't have all the facts. Whether it was withheld from us purposefully or not, we didn't have all the facts. In the second instance -- roughly 20 percent of the restatement -- we did have the facts, and we made a bad judgement call.

What does that mean?

It means that at the time, at the end of October, when we were presented, when we reviewed the transaction, we realized our people had the information they needed to make a judgement call and they made the wrong call.

They approved something they shouldn't have approved?

Yes. As soon as that was reviewed, we went to our client and said, "This piece has to be restated, as well as the other piece where we didn't have all the information." What I don't know -- and I just don't know, on these Carl Bass memos -- is to what extent those were included in those restatements; to what extent there were other factors that caused those memos to be superceded. But it is not unusual that there'd be these debates back and forth. What is supposed to happen is that there is to be an agreement, and if any partner is uncomfortable with advice we're giving a client, I expect them to keep going up the chain until they get comfortable. In that instance, I certainly was not aware of these disagreements.

Well, what also came out, again in memos that have come out ... Enron management was upset with the questions Carl Bass was raising, went to David Duncan and said, "Could you get Carl Bass taken off the Enron account?" David Duncan appealed to higher authorities, I don't know whether to you or Mr. Kutsenda or somebody else, but appealed to higher authorities and Carl Bass was removed. Why would you remove the technical guy, who's the protector of your integrity, at the request of a client?

Well, it's very unusual that we would remove somebody. I was not consulted on that decision, I don't know all the factors that went into it. But at times, frankly, we have people who don't perform, and at times we have people who do perform, and clients object to both. You've got to make a judgement call.

At the end of the day, and they'd alter the relationship to some extent, although it's a skeptical relationship, you do rely on trust in each other. The client wants to feel that you're understanding their business problem, that you're understanding what they're trying to accomplish with their accounting for business transactions. If you have people that either don't have the bedside manner, don't have the capability, don't have the expertise to get in a client's shoes to understand it, clients react negatively. OK? Then we've got to make a judgement call as to whether they're objecting to that service for the right reason or the wrong reasons. It's very rare that we remove somebody. Obviously, this was one of those rare situations.

So you regret, maybe, not having listened to Carl Bass earlier?

I never talked to Carl Bass.

Do you regret, as a firm, not having listened to Carl Bass?

There's been so much pain that's coming out of this Enron situation: stockholders, their employees, and now our employees. People are making value judgements all the time. How do you come up with a foolproof method for 85,000 people making judgements? They're often judgements; they're not black and white. If they were black and white, they'd be easy. Making judgements on the fly every day -- because I travel the world, people always ask me, "How do you sleep at night?" And I'd say two things. One is, "I sleep like a baby. I wake up every two hours and cry."

What I was crying about is people are making judgements. As we're sitting here today, people are out there making judgements, and [hopefully you] put in place the culture, the support mechanisms so that when you're getting out there in a tough situation, they'll go for help, and that you'll provide them the right help to get to the right answer.

Every time I made a new partner -- and one of the happiest days of my life is when I congratulate a new partner -- I give them one piece of advice, and I've done this for the twelve years I've been in management roles in this firm. After all the congratulations, I said, "Look, you're a partner. You represent this firm. You are going to be in a tough situation. Make sure the whole firm shares that problem with you. Get help. We're here to support you." As a leader, I thought that was my job. As a CEO, I was giving those same messages soon after I took over, because of the environment there.

I can sympathize with you. You've got a very difficult job. You got people out on the line all the time, as you say, making judgements. You've got to delegate that authority and it's spread all over the world. I guess that's one reason why the Carl Bass thing, to me, is such an interesting and important story; because he's in place so that you can sleep at night.

I understand.

I don't know this business, and I acknowledge that. As a layman looking at it, as an investor counting on you and your colleagues looking at it, it would seem to me as though when the firm comes and wants to remove the very guy that's asking the difficult questions, that's a red flag. To me, as a Washington bureau chief, if I've that kind of stuff going on among my reporters and something like that happens, I immediately am concerned. It would seem to me that that's where the maximum protection [comes in], that lets you sleep maybe three hours or four hours instead of waking up every two hours. And that's why that's puzzling -- how that would happen.

Well, hindsight's a wonderful thing. We have very smart people in these roles, and supervising people in these roles, so we make the right judgements. Now, as I said earlier, I wasn't consulted on that. I didn't have the detailed knowledge of the plusses and minuses of that decision.

This is not an issue that Rick Causey raised with you ever, or Enron raised with you?

I met with Enron, with Rick Causey, in February or so of 2001, as I did with many of my clients as I was visiting them. The one issue Rick and I did discuss was Enron's need for the best accounting advice as quickly as possible because, as you well know, they were doing lots of transactions, and very complex transactions.

But we never discussed any individuals per se, so we didn't ever discuss Carl Bass. This was an issue we were always working on and frankly, we had added more people into our professional standards group because more and more of our clients were dealing with more and more of these complex issues and wanted what Enron wanted: the right answer as quickly as possible.

Sure. ... This meeting that was held by phone among the Enron partners on Feb. 5, 2001 is recorded in the memo written by Michael Jones the next day. The principal subject, and a lot of concern, but I gather one of the principal subjects was the off-let partnerships run by Andy Fastow, and whether or not he had a conflict of interest. Does something like that get kicked up the line? It looks like a moment when, I gather, Andersen partners were debating whether or not to retain Enron as a client. The memo makes that pretty clear. Is that an unusual situation? Again, to an outsider, that seems like a fairly acute moment.

The answer is yes and no.

Well, let me put it this way. Take me back to February 2001. You're just taking over. What's going on when Andersen partners are having this kind of a debate? Just take me back there and kind of walk me through it.

Let me take you through our processes and how this would fit into those processes. First of all, I was the CEO of Andersen Worldwide, which is, if you will, a holding company, or coordinating entity for partnerships in 84 countries. Our job was to set policy and to make sure people followed them.

One of those policies in our audit practice was to review each client and decide whether or not we want to retain them as a client. So we would evaluate the risk of that client. We'd evaluate the economic viability of the client. We'd evaluate whether we had the right people on the account. We'd evaluate their accounting principles. The process was that this was to be done, of course, with the cooperation of the engagement partner responsible for the account, but was to be done by the firm management in that country. In the U.S., since we're such a large organization, that would typically be done in the office. Then the biggest clients, as well as the riskiest clients per our subjective formulas, would go up the line with whatever criteria we had in place.

In the case of Enron, given its size and risk, there was a meeting that you referred to which was common. Common in the sense that this was not just Enron, although that meeting was just Enron as I understand it, but we would have other discussions about other clients. That was, if you will, U.S. management's sign-off on retaining that client.

The consensus of those --whether it 10 or 15 people on that call -- was we understood the risk, we understood the accounting issues surrounding special purpose entities, and we understood that we needed to consult and get the right people involved as issues went through and people agreed to retain the client.

It was not unusual that there would be questions about accounting or risk. Every business has risk. This was obviously a very high-profile one, which is why you saw a firm leadership in the U.S. Typically, at least in my experience as CEO, those conversations stopped at the country level, where there was always consensus in terms of retaining that client, going forward. The purpose of that meeting was not to review specific transactions, but just to review the client relationship to make sure we had the right people involved, the right level of knowledge, and we were communicating effectively with our client at the management level and at the audit committee level.

And there was also a discussion in that Enron has the potential of becoming a $100 million-a-year client?

Yeah.

Which makes it look as though the value of the client relationship is a factor in the whole consideration.

Well, actually, I happen to have read that memo. The context of that was that that would be seen, as you have seen it, with some suspicion by others. If anything was a red flag to the participants, that we'd need to get this right so that nobody questions that we're giving answers because it's a big client. We're giving answers because we think they're the right answers.

So then two questions coming out of that. Number one, I'm not quite clear why it isn't prima facie evidence of conflict of interest if Fastow was both the CFO and the managing partner of an independent partnership. You don't need to know a lot of accounting to know that's not an independent entity, do you?

No.

So I don't understand why that wasn't flagged.

It was flagged.

I mean with the Enron board.

Well, my understanding, and this has been well reported as well, is that the board waived their ethics policies specifically to allow this to happen. There was disclosure in the proxy statement and in the annual report that these correlated party transactions existed.

So, in that sense, the stockholders were informed?

Yes. And frankly, by definition, related party transactions are not arms-length, the definition. They're not presumed to be arms-length. They're presumed that they're not arms-length. That's why any significant related-party transaction is required under our disclosure rules to be disclosed and just lay out the facts. You can't make a judgement because you know the transaction isn't objective.

Apparently, from what you're saying then, in that meeting, there was no feeling among the Andersen partners that there was anything wrong with Enron's books at that point. Is that correct?

Yes, it seems that that would be a logical implication, yes. Certainly there's no indication of that in the memo. ...

The next thing that comes up that is significant, and of course, is a big thing to the public, is the letter that Sherron Watkins wrote to Ken Lay and then shared with her former colleagues at Andersen a few days later. I think the date's about Aug. 20, 21, 22, somewhere around there. I'm wondering whether or not that was an alarm and a red flag to you all and what was the response to what Sherron Watkins shared with Andersen?

... These so-called "whistle-blower" memos we take extremely seriously. And the first thing we do whenever we find out about them is we satisfy ourselves that top management is aware of the situation and general counsel is aware of the situation, and that there are processes in place to respond to them. My understanding is all that took place. But I think people need to look at the calendar. If you'll look at August, these are obviously very complex questions he's raising. You're not going to answer them overnight.

The combination of Sept. 11 and the distraction it provided a lot of people, and then you quickly ran into the company closing its books through the third quarter where, frankly, a lot of these issues I assume were addressed.

As you well know, there was a billion-dollar write-off of assets in the third quarter as well as a billion-dollar write-off of stockholders' equity. To what extent the issue Sherron Watkins was raising in those memos were dealt with in that third quarter or not, I don't know. But I'd suggest to you that those processes, you know, people just became overcome by events. I can't tell you specifically to what extent she raised a question and it was or wasn't finally answered. ...

To what extent when Enron goes into this strategy of off-book partnerships does Andersen as the accounting and auditing firm get dragged along into a process that looks OK at the start and then becomes a big problem?

This is something we worry about a lot. One of the reasons we have those meetings like the one we just talked about in February is to stand back and say, "OK, where are we?" and have people from outside the account -- not directly servicing the client -- to look at this issue. You have to watch yourself [that] you don't fall the slippery slope of what I call the legalistic approach.

Meaning?

Legalistic. Where is the rule that says I can't say this? So you accept accounting because you have no reason not to accept it. We need to be looking more and more at, does this make sense? But we've got rule makers who are writing more and more of a cookbook approach, which, in my view, will never succeed. It's why I think you'd need to have a conceptual framework.

One of the points that we keep hearing is that, in fact, what's really disturbing about what happened at Enron is not what's illegal, but what was legal -- but misleading to the investing public.

I said early on I wasn't sure what would be worse -- that everyone followed the rules and this company still failed, or that we, or somebody else screwed up and this company failed. So I share that concern. ...

I just wonder whether or not you're disturbed more about what's potentially illegal, or disturbed more about what is potentially legal, but misleading?

Well, I think in the case of the special-purpose entity accounting, you could get accounting that is quote-unquote "legal" that could be misleading. The reason it could be misleading is people don't see those assets, because it's not on the books. Maybe they're buried in a disclosure. Maybe they don't look at the disclosures. It's all these issues we've been talking about.

It's also one of the reasons I come to this idea that's still a pregnant idea in my mind -- it's not well formulated -- on if you find yourself as an auditor in those situations where you really can't say no, but you'd probably rather not say yes, is there a way to rate that opinion to highlight somehow for the investor that you're, you know, "Go look at footnote number seven. There are some real exposures here."

That's why I think this issue of risk management and more disclosure, and in laymen's terms to the investors, about what the risks are, "Guess what, investors, we're investing in all these businesses. We're making big bets and they're different from our historic businesses." That's a hard thing for a company to say that's as successful as Enron was in the early days.

Why did you fire David Duncan?

Well, very simple. We found out in early January that a substantial number of files had been deleted from e-mails and shredded. We'd interviewed enough people to reach a conclusion that at least there was extremely poor judgement. We didn't know -- and I still don't know -- what was discarded. But given the timing of that destruction of documents and anyone looking at what happened, just on the face of it would feel that this was just incredibly poor judgement. I wanted to give a message -- because at the time everyone was looking at me and at us -- that this was not a culture that would stand that kind of behavior.

You indicated in some of your earlier questions about why wasn't this guy fired or that guy fired. There's always a challenge when you listen to your lawyers of why would you fire anyone who's important to your case. I looked at this situation and I said the judgement was just so bad -- and it wasn't just my judgement, the U.S. leadership had reached a similar conclusion -- that we had to give a signal to the market, regardless of what that meant to our legal position, that this was not a culture that would think of that kind of behavior as appropriate. It was totally inappropriate. ...

Do you think that there was any way to have saved Andersen? Do you think there was any way early on -- I'm talking about the period from like December through early February, something like that -- where if Andersen had handled it differently, it either would have survived or been in a lot better shape as it's moving forward?

Let me tell you what we are trying to do and why it didn't work. It was very clear to us after the documents were destroyed that this whole situation was at a completely different, highly more sensitive, explosive situation. We took, I think, two fundamental decisions very early on that I think were the right decisions. Those were we would be cooperating with every agency of the government, whether it be Congress, Department of Justice or SEC, so they could do a rapid investigation.

Really, as part of that, but a second decision, was that I would be out there as a public face to the firm and that every decision we would make would be to say that 99.9 percent of our people do the right thing, make the right judgements. To the extent it became clear that we made errors, people would be able to find them out or we admit them, as we did in the case of the restatement.

So we let Congress -- I think at one point there were 13 committees looking at this thing -- we gave them full access to our files. We went to the Department of Justice and self-reported this document destruction within 24 hours of my first finding out about it. The only reason it took 24 hours is because we were still interviewing people to understand the scope of what we were talking about.

We went to the Department of Justice, the SEC, and when the plaintiffs' groups were formed and said, "Listen, you need to decide if you want us to go through this, because Department of Justice, if you indict the firm or come after the firm, our clients are not going to understand it. Our member firms are not going to understand it. We will go out of business, because we won't have any clients if you indict our firm." We went to the SEC and said, "If you pull our license, we'll go out of business." We went to the plaintiffs and said, "If we go out of business, there ain't no money."

We felt the only way you could have those conversations on an accelerated timeframe was for us to live our values, and for us to be forthcoming and open, whatever the consequences. In my opinion, we would have gotten through this. We would have lost some business. Our reputation had been damaged. But the straw that broke the camel's back was the Department of Justice indictment of the firm. But for that, I think we would have gotten through this.

[Richard] Breeden, the former SEC commissioner, and others have said that one of the differences between your case and the Salomon case after the bond trading episode there was ... that the immediate willingness to plead guilty and immediate sort of change of command, if you will, at the top rank, was critical to the survival of Salomon Brothers at that point. Is that relevant to the Andersen case? Could you have, and should you have agreed, for example, to plead guilty as a firm and not just left it on David Duncan, taken that responsibility? Could that have saved the indictment and done what you were talking about?

I think it was two completely different situations. ...

On the issue of changing management, I'll give you three comments. Number one is, soon as we heard about the document destruction, we self-reported and we brought in Sen. Danforth. That was our signal that says, "Open kimono." We're having somebody who everyone would respect is a straight shooter, help us with our policies and help us think through these issues. Several weeks later, early February, I brought in Paul Volcker. That was also a signal that says, "We're taking this seriously." We're having somebody help us think through these issues. If we say we're going to makes changes, we're going to make changes, because we've got somebody that everyone would respect for those reasons.

We went to the Department of Justice the middle of February, when we had finally finished our own review. Because, remember, I hadn't heard anything on this at the beginning of January. We dealt with Duncan roughly a week or so later, but we said at the time this is a preliminary investigation. ... By around the middle of February, a U.S. manager had done that, and we were prepared to take further actions.

The Department of Justice, I think appropriately, said, "You know what, we're doing our review; would you hold off on that, so it doesn't impinge on our investigation and our interviews of your people?" So we cooperated. We did everything we could to be straight up and to cooperate, because what was weighing very heavily on us was all this uncertainty and we wanted clearance. We wanted the Department of Justice to say, "No, this was not an orchestrated cover-up from the top. Some individuals may have done some bad things. We'll deal with the individuals."

I am told we're the first and only self-reporting entity to be indicted. But we knew the Department of Justice has tremendous discretion, and they exercised it. With the SEC, we helped them by opening up our files to their review and they did what you would want your government to do; they were very tough and very thorough and they understood the urgency. We were progressing that conversation very early on.

So, in retrospect, I don't know what I could have done differently. I really have thought about that. Could I have stepped down earlier? I finally did step down in late March, because we were still hoping the Department of Justice, once they saw what we told them would happen -- clients leaving, member firms leaving, et cetera -- that maybe that would influence them to come up with a different kind of solution, because we had told them we were prepared to take very severe action beyond David Duncan. So I figured I'll offer my -- I was the only bullet I had left at the time. ...

It seems to me from our discussions with people in Washington that one of the reasons why the indictment against the firm was pressed, or there was some feeling that the firm itself had to acknowledge something more than just the partner in the field -- in other words David Duncan and people around him -- was the Waste Management case. It was the Waste Management case that suggested that there was knowledge high up in the firm of Arthur Andersen, and that part of the plea and the settlement in the Waste Management case was, "We'll never do this again." ... The feeling in Washington, specifically in the Department of Justice, was that the firm hadn't gotten the message and wasn't serious about the earlier settlement. It's really that aspect of the Waste Management case ... that has made the Justice Department so vigorous about having the firm acknowledge that something was amiss. I just wonder.

... I understand that point of view. I've heard that point of view. We took Waste Management very seriously. We took every one of our problems very seriously. We pay for them dearly, not just in dollars, but in reputation. We take our jobs as professionals very seriously. In the context of my taking over this firm, I mentioned to you earlier, we were starting to get messages from the top about risk management, client retention, backbone. Maybe not enough, maybe not quick enough, but we were taking some clear steps forward.

My question is, do you kill a firm over this issue? Different people [are] involved, different client, different issues. Is that enough to kill a firm? I have a problem with the proportionality of the indictment and its implications to what we had done. That's where I fall off. That's where 85,000 people took to the streets. I've had hundreds of letters from our people all over the world telling me, "When I tuck my kid in at night, I've got to explain to them that their father's not going to jail or their mother's not guilty of a crime."

I think there's a serious public policy question about, when do you indict an organization? ... So I'm not saying that we couldn't do better. We could do a lot better. I am saying we were taking Waste Management extremely seriously, our risk management very seriously and, by your question, we weren't getting very much credit for that. ...

What are the risks that we will not have learned enough from the Enron debacle to actually make the fixes that are necessary?

When I stepped down, I said on national TV that the ultimate tragedy of Enron would be that we don't learn. I'm not real optimistic. I do think there are some things in place. This one bill sets up this public oversight board, or accountability board. God bless them, I really wish them success.

But why aren't you optimistic?

Because ... all the approaches will be pretty much as they've been in the past. These bills that are being proposed, how you fund the FASB, setting up another oversight board or accountability board -- it's not convincing to me that this will be enough impetus for change. I think you need market-based change.

Now I will say on a positive side, that at least in the near term, the markets have responded to accounting questions. I think that firms will respond in terms of their due diligence. So maybe the marketplace will impose some change. Directors clearly are more engaged. I think one of the things under Arthur Levitt's leadership that has been very positive, and which we were very visible supporters of, was the whole idea of audit committees and empowering them to do more. ...

So to you, the real danger coming out of Enron is that we won't make enough real changes?

I'm concerned we won't make enough of those real changes I talked about; that we won't have a conceptual basis for what we're trying to communicate; that we will not adequately respond to investors' needs, and investors won't perhaps do the homework they need to do.

And why do you fear that?

I think in a case of conceptual framework, it's real hard, and there are very many different views. In the case of investors, they have very short memories. In the case of the auditors, I think the auditor needs to come up with a different product, and my grade-it-all opinion is my contribution, meager as it is, to that debate. But I don't see any of those things moving forward with any aggressiveness. One of the reasons I've agreed to meet with you today is I do think we can't rest until there is more meaningful change.

home + introduction + lessons + politics of enron + accounting wars + watchdogs
questions for investors + interviews + discussion + correspondent's chat + tapes + transcripts
press reaction + credits + privacy policy + FRONTLINE + wgbh + pbsi

web site copyright 1995-2014 WGBH educational foundation

SUPPORT PROVIDED BY

FRONTLINE on

ShopPBS