What Caused Arthur Andersen to Abandon its Limited Liability Protection?
The fact that limited liability partnerships and companies’ owners are not liable for debts and obligations of the business is the most significant benefit of being an owner in a limited liability partnership or company, as opposed to other kinds of businesses, such as a sole proprietorship. The limited liability clause grants the owners of the company protection that is enjoyed by the shareholders (Schneeman, 2013). Though most owners of a company offer personal guarantee to secure funds in the initial years of the company, the members are still protected by the limited liability clause and can therefore not be held liable for the company’s debts. The limited liability companies were only recently introduced in the early 1980 is as hybrid companies formed as a mixed character of corporations and partnerships (Bevans, 2007). It was designed with the intention of keeping the favorable features of a limited partnership while discarding the unfavourable features of a limited partnership. With such great benefits enjoyed by the owners of a limited liability company, the question remains why a firm would abandon its limited liability protection. Arthur Andersen, a limited liability partnership (LLP), is an example of a firm whose partners enjoyed protection from personal liability until its demise in the Enron accounting scandal. This paper will focus on Arthur Andersen limited liability partnership that abandoned its limited liability protection. In addition, the paper will discuss in detail the prior and subsequent events that led to the firm taking such a step.
Arthur Andersen and the Enron Scandal
Formerly considered as a ‘big five’ accounting firm, Arthur Andersen in the last decade has reduced to a company that no longer exist though it actually still exists. In the wake of 2002, the company voluntarily submitted its practicing license as Certified Public Accountants in the U.S after it was found guilty of intentionally mishandling the audit of Enron. The damage caused by the criminal charges has made the company to remain on its knees for the last ten years with subsequent events of bad reputation preventing it from recovering its business operations.
The Enron accounting scandal involved Arthur Andersen giving unqualified opinions on the annual financial reports of Enron (Markham, 2015). The audit report was of the opinion that Enron’s financial statement had been prepared in accordance with the GAAP (generally accepted accounting principles), and the Arthur Andersen had not detected material flaws in Enron’s accounting systems and procedures. At the time, Arthur Andersen was among the big audit firms in the world and therefore questions were raised why such a firm could compromise its integrity by failing to blow the whistle of Enron’s accounting manipulations. As a result, Arthur Anderson became subject to unending lawsuits and government investigation on all of its clients. The scandal is one of the major financial scandals of the 21st century. The scandal was a big contradiction to the principles of its founder Arthur Andersen who was known as a man of integrity, and did not condone fraud or dishonesty (Brooks and Dunn, 2010). Arthur Andersen once forego a big client who wanted him to sign fraudulent documents.
Though the company committed audit fraud, the major reason behind its disintegration was the destruction of audit documents, which was an obstruction of justice (Brooks and Dunn, 2010). Due to the criminal charges filed against the company, the Securities and Exchange Commission (SEC) withdrew the company’s certificate to audit companies registered with SEC. That was not the first time Arthur Anderson had found itself in audit scandals. Earlier cases similar to the Enron case had taken place in the audit of Waste Management and Sunbeam (Brooks and Dunn, 2010). While commenting on the Waste management scandal, SEC opined that, “not only did Andersen knowingly and recklessly issued materially false and misleading statements, but also failed to enforce its own guidelines to bring the company in line with minimally accepted accounting standards” (cited in Brooks and Dunn, 2010). The SEC was therefore irked by the new scandal involving Enron after the chances it had given Arthur Andersen by only fining them, which Andersen had not honored.
Prior to the conviction of Arthur Anderson, its major clients who were mostly big multinational companies had already transferred their businesses to other big audit firms (Markham, 2015). According to most CEO’s, the company’s reputation was so damaged that they did not want any association with the company, which would affect their reputation and ability to attract investors and financing at low interest rates from banks (Brooks and Dunn, 2010). The firm was greatly affected by loss of business that it eliminated 28,000 employees in US alone and 85,000 worldwide (Markham, 2015). The company not only damaged its business but also caused harm on Enron’s business by affecting investors (Markham, 2008). Though Enron also contributed to its demise by continuously manipulating its financial statements to reflect a positive earnings, it was the responsibility of Arthur Andersen LLP as the auditors to blow the whistle instead of qualifying the financial statements of Enron.
Arthur and Anderson’s numerous cases and fines due to obstruction of justice led to a financial fallout in its business. Due to the company damaging Enron’s investment, it proposed to settle for $ 750 million, which were to be paid in installments using future revenues though the amount was reduced to $375 (Markham, 2015). Its insurer made its financial position worse, which was not in the position to cover most of the losses in a previous settlement. Arthur and Anderson therefore decided to pay part of the settlement using its own funds. In a limited partnership, partners are protected from personal liability in the event of business losses to the extent of their investment (Bevans, 2007). Limited partners cannot be sued for business debts or personally held liable for actions that were executed by the business. They are shielded by the limited liability agreement and therefore should be made to be personally liable of losses that were solely caused by the actions undertaken by the business. According to the American Bar Organization (2003), despite this protection from liability, Arthur Andersen partners were likely to be subjected to settling creditors’ dues out of their capital contributions. Some former partners also lost benefits and pension as a result of the firm bankruptcy. The company therefore abandoned its limited liability protection in order to clear debts using partners’ funds that were held by the company.
Arthur Andersen demise is still considered among the greatest financial scandals of the century. The firm’s reputation was damaged resulting in loss of clients and business. Its major clients who were large companies withdrew their businesses from the firm due to fear of loss of investors and funds at low interests from banks due to credibility. Moreover, the company was forced to surrender its license as Certified Public Accountants, and lost the opportunity to audit the financial statements of companies registered with SEC. The company is considered defunct though it is still in operation and its business scope is very narrow. The company has not been able to get back on its feet and chances are it will never go back to the prestigious position it used to operate in.
Limited liability partnerships are considered protective vehicles that prevent partners from being held personally liable in the event the business is in debt. However, it seems the vehicle is not as secure as it seems when the agreement was being drafted. This is because the partners of Arthur Anderson, a limited liability, lost their funds after the company abandoned its limited liability protection clause that protected partners from business debts. The company had no choice but to abandon the clause due to its numerous financial obligations on creditors who included Enron’s former employees. Moreover, its insurer was not in a position to help clear previous owed debts and therefore the firm’s losses magnified. This is a wakeup call for all limited liability partnerships in existence. The Arthur Andersen case implies that partners in limited liability partnership are not as safe as they perceive. Therefore, all the partners involved in a limited liability partnership should always do things right and work hard to avoid any challenges that might harm their activities.
Bevans, N. R. (2007). Business organizations and corporate law. Clifton Park, NY: Thomson Delmar Learning. Retrieved from https://books.google.co.ke/books?id=87G4yWVkehAC&printsec=frontcover&dq=Business+organizations+and+corporate+law&hl=en&sa=X&ei=0SRBVazRFcj_UtKWgbAI&ved=0CBwQ6AEwAA#v=onepage&q=Business%20organizations%20and%20corporate%20law&f=false
Brooks, L. J., & Dunn, P. (2010). Business & professional ethics for directors, executives, & accountants. Mason, OH: South Western Cengage Learning. Retrieved from https://books.google.co.ke/books?id=9x5Yj3nApN4C&pg=PR19&dq=Business+%26+professional+ethics+for+directors,+executives,+%26+accountants.&hl=en&sa=X&ei=nyRBVYXmLcfmaOvPgNAG&ved=0CBwQ6AEwAA#v=onepage&q=Business%20%26%20professional%20ethics%20for%20directors%2C%20executives%2C%20%26%20accountants.&f=false
Markham,J.W. (2015). A Financial History of Modern U.S Corporate Scandals: From Enron to Reform. Routledge. Retrieved from https://books.google.co.ke/books?id=6KJsBgAAQBAJ&pg=PA201&dq=Arthur+Andersen+scandal&hl=en&sa=X&ei=8yNBVersJ8TUarqLgZgE&redir_esc=y#v=onepage&q=Arthur%20Andersen%20scandal&f=false.