For partners and professionals in Arthur Andersen's Houston office, there was one sure way to move up: Figure out new ways to make Enron Corp. happy. More than 100 staffers were devoted to the office's largest account, which by Enron's calculation was worth more than $50 million a year.
Perhaps it was inevitable, then, that as the energy-trading giant rose to prominence in the '90s, Andersen's green-eyeshade legions came to bask in Enron's glow. If a top partner in the Houston office got a call from ex-Enron CEO Jeffrey K. Skilling, it "made his day," says an ex-Andersen exec. Enron only enhanced Andersen's reputation as the leading auditing firm for the oil-and-gas business. "They were the best. They were always viewed as the firm to go to in Houston," says Stephen D. Newton, managing director at executive recruiter Russell Reynolds Associates Inc. A client-service team working out of Andersen's marketing department met regularly with David B. Duncan, the lead partner on the Enron account, to figure out what new tax advice or risk-management product they could sell to the energy giant. Several top Enron execs, including its chief accounting officer, had come from Andersen. Andersen even cut a deal to handle some of the "internal" auditing work for Enron along with vetting its public reports for the trading firm's audit committee.
It is now clear that Andersen will pay dearly for that chummy relationship. Its Houston office is at the center of a growing scandal that could cost Andersen and its partners billions and, ultimately, may lead to the demise of the firm. On Jan. 15, Andersen dismissed Duncan for directing what it describes as a frantic two-week effort to destroy "thousands" of e-mail messages and documents related to its audit of Enron. It also put three Houston partners on leave and relieved four others, including D. Stephen Goddard Jr., managing partner who ran the Houston office, of management responsibilities. "This was a painful decision, but it was absolutely the right thing to do," said Andersen CEO Joseph F. Berardino in a statement. "We are prepared to take all appropriate steps necessary to maintain confidence in the integrity of our firm." An attorney for Duncan did not return phone calls. And Goddard could not be reached.
But will those moves be enough? Berardino faces the real prospect that daily revelations about Andersen's involvement in the accounting scandal have permanently damaged its reputation--and could eventually lead to criminal charges, such as obstruction of justice. From his statements about the firing of Duncan and other steps taken in Houston, it's clear that Berardino would like to contain the damage to that office. But investigators are looking closely at broader questions involving Andersen's role in Enron's collapse. For instance, what did Andersen know about the problems with off-balance-sheet partnerships that inflated Enron's income? Congressional investigators say that in addition to warning Enron Chairman and CEO Kenneth L. Lay about that accounting in a memo last August, Enron executive Sherron S. Watkins also followed up with a phone call to an Andersen partner.
Already, some talent is trying to jump ship: A Houston-area headhunter says his firm has gotten 1,000 resumes from top Andersen people in one week. Some industry observers figure that Andersen's fall, perhaps through a sale or merger, could come within a year. For Andersen to survive, says professional-services consultant Dean McMann, "they'd really have to land some very large accounts in a market where accounts don't change very often." Losing accounts is also possible. Already, the audit committee at one longtime client, R.R. Donnelley & Sons Co., is planning to review its use of the firm.
Other energy companies will be watching closely as the drama plays out. While it is the smallest of the Big Five, Andersen dominated in Houston. Long before Enron, the firm was known as a pioneer for innovations such as a way to expense dry holes over the life of an oil field, says I.T. "Tex" Corley, an ex-Andersen partner who now runs a glass-recycling business. Every year, Andersen hosts Houston's premier energy conference at a glitzy hotel, bringing in foreign oil ministers, Washington officials, and top executives. It had 70% of the city's oil-and-gas clients, says a former exec.
Holding Andersen together through the storm will be a monumental job. The firm is already the big-pockets defendant in some 40 shareholder lawsuits in which plaintiffs' lawyers are claiming damages of more than $32 billion. Enron, the primary defendant, is all but immune to the actions because of its bankruptcy filing. Bill Lerach, managing partner at Milberg Weiss Bershad Hynes & Lerach LLP, a firm handling one of the shareholder suits, says: "I don't think you ever want to see large entities go out of business because of litigation, but our clients have to be appropriately compensated for what happened here."
Fighting the legal battles--along with struggling with no fewer than eight separate congressional probes--is bound to take a heavy toll on Berardino and many of his 3,000 partners. If they decide to settle the lawsuits, it will cost them dearly--almost certainly more than the $110 million they paid to settle shareholder litigation in the liquidation of Sunbeam Corp. (SOC) or their unspecified share of a $220 million settlement of the earlier Waste Management Inc. (WMI) case. Andersen won't say how much insurance it has, but another settlement of hundreds of millions of dollars could be devastating. And if fraud is found, much of the cost won't be covered.
Of course, Andersen's fate will turn on how culpable it proves to be in the collapse of Enron. Until mid-January, Berardino had admitted that his firm made only one professional misjudgment in auditing, which, he says, accounts for a relatively small part of Enron's earnings restatements. And, he says, the firm was not given certain crucial information in another Enron partnership it was auditing, which also led to restatements. But revelations of document destruction could prove far more damning if Justice Dept. investigators decide that they amount to obstruction of justice. And Watkins' warning raises questions as to whether Andersen had a more active role in setting up the partnerships than it has conceded.
Comparisons have arisen between Andersen's woes and the fall of Laventhol & Horwath in 1990. Although far smaller, L&H faced a rash of shareholder lawsuits over problematic audits, a nasty client bankruptcy, and a loss of confidence. The 350 L&H partners, suffering multimillion-dollar legal settlements, voted to dissolve. "The partners just wanted to get away from the pain," recalls ex-L&H CEO Robert N. Levine, now a consultant in Mill Valley, Calif. Unless Berardino can reassure staffers, clients, and a slew of investigators that Enron was an isolated affair in which Andersen played a bit part, he may find himself in a similar spot. By Joseph Weber in Chicago, with Christopher Palmeri in Los Angeles, Louis Lavelle and Nanette Byrnes in New York, and Wendy Zellner in Dallas