What Is the Andersen Effect?
The Andersen Effect is a reference to auditors performing even more due diligence than recently required to prevent the sorts of financial accounting errors and setbacks that encouraged Enron's collapse in 2001.
The Andersen Effect gets its name from former Chicago-based accounting firm Arthur Andersen LLP. By 2001, Arthur Andersen had developed into one of the Big 5 accounting firms, joining any semblance of PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst and Young, and KPMG. At its pinnacle, Arthur Andersen employed almost 28,000 individuals in the U.S., and 85,000 worldwide. The firm was known around the world for its ability to convey specialists universally to exhort multinational organizations across its auditing, tax, and counseling practices.
From a "Big 5" to Collapse
By 2002, the entirety of the trust and greatness came tumbling down. That June, Andersen was sentenced for obstacle of justice for shredding reports connected with its audit of Enron, bringing about what notoriously became known as the Enron scandal. Even the Securities and Exchange Commission (SEC) did not arise sound. Many blamed the oversight commission for being "sleeping at the worst possible time." But beside Enron, the up to that point exceptionally legitimate and regarded Arthur Andersen stood the most to lose, and it did.
More defective audits for the benefit of Arthur Andersen were found in the course of the Enron prosecution and investigation. Big-name accounting scandals linked to Arthur Andersen proceeded to incorporate Waste Management, Sunbeam, and WorldCom.
The subsequent bankruptcy of WorldCom, which immediately outperformed Enron as the biggest bankruptcy in history around then, brought about a classic cascading type of influence of accounting and corporate scandals. The business' reaction was a swift endeavor to keep away from the Andersen Effect by utilizing strong corporate governance and uplifting accounting controls.
In response to the series of accounting scandals set off by Arthur Andersen, the U.S. Congress passed the Sarbanes-Oxley Act of 2002 (SOX). The federal law laid out new or expanded requirements for all U.S. public company boards, management, and public accounting firms. A startling extra positive outcome of SOX is that this extra level of examination has brought about companies repeating their earnings even in the event that they have not really intentionally distorted accounting data.
The Bottom Line
Even probably the biggest, generally very much regarded, and most trustworthy accounting firms can collapse due to mismanagement or slips up taken in the interest of a client. Sarbanes-Oxley was passed to safeguard the client or investor. Yet, while not generally recognized, the additional investigation likewise safeguards companies and public accounting firms from committing the sorts of errors that could at last add to their demise.
- The Sarbanes-Oxley Act of 2002 was passed by Congress to lay out new or expanded Federal requirements for all U.S. public companies, management, and public accounting firms to prevent another Enron and Andersen Effect.
- The Andersen Effect gets its name from the former Chicago-based accounting firm Arthur Andersen LLP and its association with what became known as the Enron scandal.
- By 2002, everything came tumbling down for Arthur Andersen as additional broken audits were found in the course of the Enron prosecution and investigation.