THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 223

CHAPTER FYI An Economic Analysis of Financial Structure 191 The Demise of Arthur Andersen In 1913, Arthur Andersen, a young accountant who had denounced the slipshod and deceptive practices that enabled companies to fool the investing public, founded his own firm Up until the early 1980s, auditing was the most important source of profits within this firm However, by the late 1980s, the consulting part of the business experienced high revenue growth with high profit margins, while audit profits slumped in a more competitive market Consulting partners began to assert more power within the firm, and the resulting internal conflicts split the firm in two Arthur Andersen (the auditing service) and Andersen Consulting were established as separate companies in 2000 During the period of increasing conflict before the split, Andersen s audit partners had been under increasing pressure to focus on boosting revenue and profits from audit services Many of Arthur Andersen s clients that later went bust Enron, WorldCom, Qwest, and Global Crossing were also the largest clients in Arthur Andersen s regional offices The combination of intense pressure to generate revenue and profits from auditing and the fact that some clients dominated regional offices translated into tremendous incentives for regional office managers to provide favourable audit stances for these large clients The loss of a client like Enron or WorldCom would have been devastating for a regional office and its partners, even if that client contributed only a small fraction of the overall revenue and profits of Arthur Andersen The Houston office of Arthur Andersen, for example, ignored problems in Enron s reporting Arthur Andersen was indicted in March 2002 and then convicted in June 2002 for obstruction of justice for impeding the SEC s investigation of the Enron collapse Its conviction the first ever against a major accounting firm barred Arthur Andersen from conducting audits of publicly traded firms This development contributed to the firm s demise The second major policy measure arose out of a lawsuit brought by New York Attorney General Eliot Spitzer against the ten largest investment banks (Bear Stearns, Credit Suisse First Boston, Deutsche Bank, Goldman Sachs, J.P Morgan, Lehman Brothers, Merrill Lynch, Morgan Stanley, Salomon Smith Barney, and UBS Warburg) A global settlement was reached on December 20, 2002, with these investment banks by the SEC, the New York Attorney General, NASD, NASAA, NYSE, and state regulators Like SarbanesOxley, this settlement directly reduced conflicts of interest: GLOBAL LEGAL SETTLEMENT OF 2002 It required investment banks to sever the links between research and securities underwriting It banned spinning The Global Legal Settlement also provided incentives for investment banks not to exploit conflicts of interest: It imposed US$1.4 billion in fines on the accused investment banks