Did the Waste Management audit failures signal lower firm-wide audit quality at Arthur Andersen?

Abstract

We examine Arthur Andersen’s audit quality in the 10 years before the collapse of Enron. During this period, Andersen was involved in a series of deficient audits, including Colonial Realty, Sunbeam, Waste Management, and the Baptist Foundation of Arizona. Andersen paid $512 million to settle lawsuits related to these audits, and each of the settlements were among the largest ever made by an audit firm in the pre-Enron period (Hawkins and Cohen 2003). 1 As Ball (2009) suggests, Andersen’s reputation had started to suffer even before Enron. Andersen’s involvement in the Waste Management audit was particularly damaging. In 1998, Waste Management restated its 1992–1996 pretax earnings by $1.43 billion, at the time the largest restatement in the Securities and Exchange Commission’s (SEC) history. As Waste Management’s long-time auditor, Andersen was sued by the SEC for securities fraud. The SEC accused Andersen of issuing false and misleading audit reports and for acquiescing to managers at Waste Management. It was the first time the SEC had sued a major accounting firm because of a failed audit (Brickey 2004). Admitting no wrongdoing, Andersen settled the suit on June 19, 2001, by paying a then-record civil penalty of $7 million and agreeing to a permanent injunction that prohibited it from further violating securities laws.