Q&A: Where Does Andersen Go from Here?

With the Mar. 13 announcements that neither Deloitte Touche Tohmatsu International Group Ltd. nor Ernst & Young International has been able to come to terms on a purchase of Arthur Andersen, the accounting world and Corporate America now face a new reality. Andersen either quickly finds another global partner or is left to struggle--and probably die--on its own. One way or the other, the odds are good that we will see an ignominious end for the 89-year-old firm that was long a role model for the profession. Here's what the ground-shifting developments mean:

Q: Why did Deloitte Touche back away from buying Andersen?

A: No one seems willing to buy the firm unless Andersen negotiates a limit to its potential Enron litigation liabilities. Earlier, Ernst & Young also broke off merger talks because litigation matters were unresolved. But if Andersen can negotiate a cap on liabilities with plaintiffs' attorneys and the Securities & Exchange Commission--$750 million is the figure most cited--a buyer could acquire the firm by assuming that liability. Some of the cash would come from insurance and the rest from future revenues. But Deloitte ultimately felt it couldn't protect its partners from the risk that they would have to pay for Andersen's mistakes.

Q: What did Deloitte and others see in Andersen?

A: The appeal was the firm's $4 billion U.S. business, including 28,000 U.S. staffers with much expertise and many contacts and at least some of the firm's $5 billion in foreign business--an alluring prospect. Without a sale, the business and staff would be dispersed among Andersen's rivals.

Q: Why can't Andersen survive on its own?

A: After defections by such big clients as Kerr-McGee, Freddie Mac, Federal Express, Merck, and Delta, many more of the firm's 2,300 audit clients are likely to go elsewhere. Partners, managers, and staff will probably leave, too, rather than accept sharply reduced earnings and the prospect of little growth. What's more, if Andersen is indicted or pleads guilty to criminal charges of obstructing justice, regulators could bar it from the auditing business. Even if they don't, the taint would drive out more business.

Q: Would a sale be good for Enron shareholders and ex-staffers?

A: Yes, as long as the deal guarantees that they get paid. Without a sale, chances are high that Andersen will disappear, leaving no source of revenues to pay future claims. Once the insurance money runs out, claimants will have to pursue partners individually, a dicey prospect. The risks that they'll be left high and dry after a few years are much greater without a sale that guarantees a payout.

Q: Doesn't Paul Volcker, Andersen's recently appointed overseer, think Andersen could survive independently?

A: Volcker, brought in by Andersen Chief Executive Joseph Berardino, wants a top-to-bottom overhaul that would turn a reformed Andersen into a role model for the accounting profession. The problem is the firm would likely collapse in a heap of litigation before his plan could be implemented.

Q: What about Volcker's proposed reforms?

A: Volcker would separate all audit work from consulting. Staffers who work in areas such as tax consulting and executive recruitment would become independent of audit staffers and supervisors. No longer would individual partners handle--and be paid for--all the work that their clients generate, removing any incentive to go soft on audits to get consulting business. He would also mandate the rotation of auditors at least every five years and would establish a "cooling-off" period before a partner could seek a job with a client. He would also bar firms from doing certain work for audit clients: Included in the ban would be internal auditing and tax consulting.

Q: Are these changes needed in the profession?

A: Absolutely. Any buyer should have to accept these conditions--and Congress and the SEC ought to consider making them the rule in the profession. Ideally, a buyer should even bring Volcker on board to make sure his recommendations are followed. As the former Fed chairman told BusinessWeek: "The auditing firms have shown a remarkable capability for resisting reforms." The price for snapping up Andersen should include taking on both Volcker's regimen and oversight.

Q: Would these moves eliminate auditing failures, preventing another crisis?

A: No. As long as corrupt managers try to hide information--as was alleged at Enron--auditors can be duped. Poor financial reports can't be eliminated. But such moves would reduce the odds of an Enron II. Just as there will always be criminals, there will always be some questionable financial reporting. But improving the procedures for ferreting out criminality or simple negligence has to help.

Q: Won't a buyer balk at accepting the Volcker reforms?

A: Yes. Deloitte groused about some of the recommendations, arguing that consulting-auditing conflicts are more perception than reality, for instance. None of the firms wants radical reforms, but the one that does accept them would have powerful bragging rights. It could claim to be the ethical leader of the profession, which might even draw clients. But with Deloitte, the most promising partner, backing away from a merger, a quick deal is looking less and less likely. Bankruptcy now looms as an option.

By Joseph Weber

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