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As courts consider how liability should be parceled out in the Enron debacle, what will become of Arthur Andersen LLP is one of the biggest questions. A federal court in Texas is considering a securities fraud suit brought by shareholders against the Houston-based energy company. Even without figuring in the loss of business and diminished reputation that are already flowing from the fiasco, the Chicago-based accounting and consulting firm could be facing anything from a slap on the wrist to a potentially bankrupting judgment, depending on how the court rules. Even with the protections afforded it as a limited liability partnership, Andersen is a juicy target for trial lawyers seeking a big payout from the Enron collapse. Enron itself has filed for Chapter 11 bankruptcy protection, a move that shields it from shareholder lawsuits. But Andersen, which audited Enron’s books yet failed to flag the partnerships the company used to hide $7 billion in debt, is seen as a potential deep-pocket defendant, with an estimated $500 million in liability insurance and billions in other assets. Trial lawyers are already taking aim at Andersen. The firm is the only company listed in New York-based Milberg Weiss Bershad Hynes & Lerach’s class action on behalf of Enron shareholders, along with 29 individual Enron directors and officers as co-defendants. The suit was filed Dec. 4 in Houston with the U.S. District Court for the Southern District of Texas. No damages have been requested in the suit yet, but attorneys at Milberg Weiss have said the total liability from Enron could be as high as $25 billion. A spokeswoman for Milberg Weiss declined to comment for this story, saying the firm has been asked not to speak with the press until the court names lead counsel in the case. [Editor's note: Milberg Weiss has since been named lead counsel in the case, by order dated Feb. 15, 2002.] Experts are divided on how much Andersen may have to pay. And their opinions depend very much on their perception of the facts that have emerged. At the center of the Enron meltdown are several limited partnerships that operated between late 1997 and early 2001, including Chewco Investments LP, LJM1 and LJM2. These partnerships, which accountants call “special-purpose entities,” did two things: They let Enron engage in transactions that normally would have been too risky for the firm and they kept some liabilities off Enron’s balance sheet. These partnerships are not unusual, and ordinarily, they are perfectly legal under Securities and Exchange Commission and generally accepted accounting rules. In fact, Enron had a long history of setting up SPEs. From 1993 to 1996, Enron and the California Public Employees’ Retirement System ran a similar partnership called Joint Energy Development Investment LP. JEDI did not show up on Enron’s books, but its accounting treatment was not questioned. But the Chewco and LJM partnerships were structured incorrectly. To avoid showing up on Enron’s financial statements, the partnerships had to involve an outside party. That wasn’t the case with Chewco and LJM. These partnerships were between Enron and its own officers, who had borrowed from Enron the money needed to pay for their shares. As a result, Enron itself bore all of the risk if the partnerships failed, and under the accounting rules, that meant the partnerships — and all of their losses and liabilities — should have been included on Enron’s financial statements. There is little disagreement that Enron broke the accounting rules with Chewco and LJM. What is in doubt is Andersen’s role. Andersen representatives did not return calls for this article, but the firm claims that it had not been aware that Enron financed the SPEs for the benefit of its senior officers. And because it did not know this, the firm had no reason to think that partnerships should be included on Enron’s financial statements. But according to a report issued by Enron, Andersen’s accountants helped structure the partnerships. It also says the firm collected $5.7 million in fees just for setting up Chewco. That would suggest Andersen was aware of the limited partnerships — and their illegal nature — when it approved Enron’s financial statements, said Charles Elson, a professor at the University of Delaware’s Center for Corporate Governance. “If we accept [the report] as true, there is going to be a lot of liability for Andersen.” Andersen’s strategy has been to portray itself as an unwitting dupe in the Enron meltdown — as much a victim of senior officers’ greed as the company’s investors. That line may not reflect well on the firm as an auditor, but it might prove to be a sound legal strategy, legal experts said. Accountants can only be held liable for securities law violations if they behave recklessly — that is, ignore or conceal facts that would indicate its audit was flawed. But Andersen seems to be saying that its auditors were only negligent because they did not find out the truth about Enron’s partnership. The difference between “recklessness” and “negligence” may not sound like much, but makes a world of difference in securities law. “Enron could sue Andersen on a negligence standard,” said one securities lawyer who works with the Big Five accounting firms. “But shareholders have to prove that Andersen was reckless, and that’s a step beyond negligence.” The only way to prove auditor recklessness is to look at the documents themselves. Ordinarily, this is no small task. Many of the work papers produced in an audit are confidential, and accounting firms rarely surrender them without a court order. And once they do get them, plaintiffs’ lawyers must sift through thousands of documents to find the papers that will prove that auditors were out of line. But in this case, the information needed to prove recklessness seems to be surfacing unusually quickly. For instance, the disclosure that Andersen was involved in structuring the limited partnerships is important, said Robert Prentice, a professor of business law at the University of Texas, because it establishes that at least some within Andersen had knowledge of them. “They may not have been told everything, but they had access to everything, and for them not to notice … I think I can sell that as recklessness when I get to a jury,” he said. There is a history of Big Five firms having to pay large sums for accounting failures. In 1992, Ernst & Young LLP agreed to pay the government $400 million for mistakes it made in the audits of more than 300 failed savings and loan associates. The amount is the biggest amount ever paid out to settle a suit related to bad auditing. The government is not the only plaintiff to have won big; attorneys representing shareholders have also wrested major awards from the accounting firms. In 1999, Ernst & Young paid $335 million to investors in Cendant Corp. for failing to catch a massive accounting fraud. And just last year, Andersen agreed to pay $110 million to Sunbeam Corp.’s shareholders. Those three cases probably understate the risk to Andersen in the Enron case, legal experts said. The Enron bankruptcy is the largest in U.S. history, dwarfing the Cendant and Sunbeam cases. And the political clamor surrounding Enron is every bit as loud as that following the S&L collapse. “This one is going to be a big one because it involves a Fortune 10 company, and it’s become a political issue,” Elson said. “It’s attracted that much more interest.” Andersen is likely to be asked to pay even more in the Enron case, said Mark Cheffers, chief executive of AccountingMalpractice.com, a Manchaug, Mass., firm that advises accountants on malpractice claims. Cheffers estimated that Andersen’s total exposure to liability from Enron is $10 billion to $20 billion, but he predicted that Andersen will be able to settle for $2 billion to $3 billion in damages. “It seems unlikely that [Andersen] will be able to come up with more than that,” Cheffers said. The law itself also increases Andersen’s potential liability. A provision of the bankruptcy code stipulates that, if one defendant is bankrupt, all other defendants’ liability can increase by up to 50 percent more. That is one reason for the high awards in the Cendant, Sunbeam and S&L accounting cases. Of course, theoretically, Andersen could avoid paying anything, if a court determines that it was not reckless in the Enron audit. But the firm is all but certain to be forced to pay out something, legal experts said. In the Cendant, Sunbeam and S&L suits, the accounting firms in question settled rather than risk a larger judgment in court. Andersen would be foolish to do otherwise. But the wrath of Enron’s shareholders is not the danger facing Andersen. The company’s reputation has already been dragged through the mud, as investors and politicians have questioned the firm’s fitness to perform audits. “The biggest risk to Andersen is not losing a judgment, but what happens to its business,” said Kenneth Klee, a professor of bankruptcy law at the UCLA law school. Last week, Atlanta-based SunTrust Banks Inc. ended its 60-year-old relationship with Andersen and hired PricewaterhouseCoopers as its auditor. SunTrust has denied that the Enron collapse motivated its decision, but the company is one of the first to switch auditors since Enron filed for bankruptcy. Before that, Hard Rock Hotel, a casino company based in Las Vegas, also dropped Andersen. And Enron is not the only potential accounting scandal facing Andersen. The firm was also the auditor for Global Crossing Ltd., the Bermuda-based telecommunications company that filed for bankruptcy in late January. The SEC is investigating Global Crossing’s revenue-booking practices. Even professional football is piling on: Lawyers for the Oakland Raiders reportedly are charging that Andersen destroyed documents that could have affected a suit by team boss Al Davis contending that projected ticket sales were inflated. The team says those numbers brought the Raiders back to Oakland; Andersen provided the data. It is unclear how well Andersen is set up to weather the storm. The firm is certain to carry insurance to protect itself against malpractice suits, but because Andersen is private, it will not say how much coverage it has. The sum is reportedly about $500 million. If that is not enough, bankruptcy would seem particularly attractive to the firm. To see why, it is important to know a bit about the structure of Arthur Andersen LLP, the U.S. accounting arm of Andersen Worldwide SC and the firm specifically named in the Milberg Weiss suit. (None of Andersen’s other businesses, including its international units, are named in the suit, and they are shielded from liability because they are organized as separate entities.) The important part of the firm’s name is “LLP,” which stands for limited liability partnership. The LLP — or “double L.P.,” as it is sometimes called — is relatively new; in fact, it did not exist at all until 1991, when Texas became the first state to pass the laws allowing for their creation. Others quickly followed, and by 1998, all 50 states had laws allowing companies to organize as LLPs. They would seem to have been created for just this occasion. Under the old liability law, every partner could have been held personally liable for the Enron meltdown — even if they had nothing whatsoever to do with the audits in question. But as an LLP, the only people who can be held liable for the breakdown of Enron are Arthur Andersen itself, the accountants who were directly involved with Enron and their supervisors. “Anyone who is an actor can be held liable for their actions,” said Matthew J. Barrett, an associate professor of law at Notre Dame University. “The firm can be held liable, as can all the partners involved.” That could turn out to be quite a lot of people. Besides the auditors in Andersen’s Houston office, a court could rule that those auditors’ supervisors were reckless in not exercising better oversight. And then there are those supervisors’ supervisors, and so on through the chain of command to Andersen’s senior ranks in Chicago. But the LLP structure clearly shields most of Andersen’s partners from any liability whatsoever, and that could also have ramifications. If it appears that Andersen will be asked to pay out a massive amount to Enron shareholders, the firm’s partners could, in effect, dissolve the firm and pay out the firm’s most liquid assets, such as accounts receivable, ahead of the court judgment. If the process is done correctly, much of that money could be shielded from a court’s judgment. But doing that reduces the resources Andersen will have on hand to fight shareholder lawsuits. “They’ve got some very, very difficult decisions ahead,” said Lynn LoPucki, also a professor of bankruptcy law at UCLA. “They’ve got to do two very different things, and those decisions will become visible very soon.” What will Andersen do? There is no way to know for certain, as so many questions still hang over the firm and its actions. The firm’s defenders note that the very allegations that have damaged Andersen’s reputation the most — that it was structuring the limited partnerships at the same time it was performing audits and that those partnerships seemed to have been created solely to make Enron look like it was performing better financially than it actually was — are perfectly acceptable under current securities law and accounting rules. “My experience is that Arthur Andersen is a first-class entity,” said Thomas Hyland, a partner at New York-based Wilson, Elser, Moskowitz, Edelman & Dicker who often represents accountants in malpractice cases. “These guys are not schlocks. I want to see the evidence against them that they blew the auditing.” But with the Enron meltdown already ranking as one of the biggest accounting scandals ever, many experts believe Andersen will take a tremendous blow. “I heard one of Andersen’s partners recently say that they are not that worried, but financial statements were their responsibility,” Prentice said. “Andersen’s problem is going to be how much they were on the scene.” Copyright (c)2002 TDD, LLC. All rights reserved.

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