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This is old news but as Pinnacle Towers approaches bankruptcy I thought people at FR would be interested in Pinnacles background and events leading up to this Enron like company.

August 25, 2000

SEC Probes Andersen For Conflict of Interest

By MICHAEL SCHROEDER Staff Reporter of THE WALL STREET JOURNAL

WASHINGTON -- Among companies rocked by accounting scandals, Waste Management Inc. stands out. After a board-led probe turned up years of questionable accounting, the company took a $3.5 billion charge in 1998, and since then the trash hauler and its outside auditor, Arthur Andersen LLP, agreed to pay $220 million to settle shareholder litigation in the matter.

Now, Waste Management's accounting headache may turn out to be notable in another way.

At the same time that Arthur Andersen was conducting the audits that failed to halt the questionable accounting, the firm was pocketing big fees for consulting services it provided Waste Management. The Securities and Exchange Commission is currently probing whether the consulting fees may have compromised the independence of Arthur Andersen's auditing work, according to several people familiar with the case.

As a result, the case is shaping up as a possible centerpiece of a campaign by the SEC to demonstrate that conflicts of interest can be caused by the proliferation of consulting and other nonauditing services that numerous accounting firms routinely offer, the knowledgeable people said.

From 1991 to 1997, Arthur Andersen received about $50 million in fees for consulting services at Waste Management sites world-wide, dwarfing the $10 million in audit payments during the same period, according to the knowledgeable people. The SEC, which declines to comment, is trying to determine if auditors looked the other way to keep consulting fees flowing.

David Barrett, an outside attorney for Arthur Andersen, said in an interview, "We're outraged someone leaked highly confidential information. Apparently it's being done to influence the SEC's rule making." He said that gross fee numbers can be highly misleading, but declined to comment further. Waste Management didn't immediately have a comment Thursday.

The general existence of a probe into Arthur Andersen's handling of Waste Management's financial statements has been known since April 1998, when the trash hauler, fresh from adopting more conservative accounting practices that increased truck-depreciation and other income-statement expenses, revealed the inquiry in an SEC filing.

At the time, an Andersen official termed it routine, saying an auditor's work is usually reviewed after a client restates earnings. The SEC, meanwhile, termed it "standard operating procedure in cases of alleged improprieties in financial statements to examine the accounting treatment that the statements received."

But since then, the SEC and some of the nation's biggest accounting firms have locked horns over the potential conflicts of interest that have arisen as revenue from consulting has dramatically run ahead of audit fees for the nation's biggest accounting firms. To the SEC, the desire of accounting firms to keep the consulting fees flowing threatens auditor independence by possibly prompting the accountants to overlook worrisome and too-aggressive bookkeeping practices. In June, the SEC proposed rules to significantly limit consulting services that auditors can offer corporate clients.

But public accountants, led by the American Institute of Certified Public Accountants, Arthur Andersen, KPMG LLP and Deloitte & Touche LLP, have mounted an aggressive counter-attack, arguing that there is no justification for new limits and that the regulation would actually hurt audit quality by reducing an accounting firm's scope of knowledge about client companies.

"There's never been a case where an audit failure in any way related to nonaudit services," said Shaun O'Malley, retired chairman of the former Price Waterhouse LLP, citing a recent audit-effectiveness study sponsored by the Public Oversight Board, an accounting self-regulatory group.

Historically, however, the SEC has steered clear of the high-risk legal strategy of trying to prove an auditor was conflicted by the consulting side of the business. The goal generally has been to establish that the auditors acted recklessly in failing to uncover fraud. Between 1994 and late 1999, the SEC has brought 676 enforcement cases that included alleged accounting violations, ranging from bookkeeping problems to fraud.

"It's very difficult, if not impossible to prove" an independence violation in a blown audit, said SEC Chief Accountant Lynn Turner: "You'd have to get into the auditor's head."

In the Waste Management case, according to one of the knowledgeable people, the SEC believes that it may have "smoking-gun documents." Among particulars of the situation, a big chunk of Arthur Andersen's consulting work was on the trash hauler's centralized computer system, the people familiar with the matter said. Information technology is one of the areas that the SEC has proposed banning as a cross-sold service to audit clients.

While the SEC is assessing the link between the trash hauler's accounting woes and the consulting services, the regulators are pursuing other avenues as well.

Earlier this month, for instance, Pinnacle Holdings Inc., a fledgling real-estate investment trust that owns and operates antenna towers, revealed in an SEC filing that the agency is probing allegations that its auditor may have violated independence rules. In a recent conference call with Wall Street analysts, Steven Day, the company's chief operating officer, said the SEC was given a tip that it examine Pinnacle's accounting last year for its $254 million acquisition of an antenna business from Motorola Corp.

The inquiry is in preliminary stages and the SEC has alleged no wrongdoing; an SEC spokesman declined to comment. A spokesman for PricewaterhouseCoopers, the Pinnacle auditors, said: "Our independence with respect to Pinnacle has never been impaired. All of the services provided to Pinnacle were appropriate and allowable under existing SEC standards." Pinnacle's Mr. Day added: "We're no criminals here. There are no accounting issues. We've done our accounting appropriately."

In Pinnacle's case, the SEC is looking at whether Pinnacle can justify how it valued the Motorola assets, as well as how it tallied acquisition-related expenses, according to a person with knowledge of the probe. According to an SEC filing, Pinnacle recorded the unit's current assets at $271.7 million. The SEC also is examining Pinnacle's $28 million in acquisition expenses: such things as legal, consulting and accounting fees, the person familiar with the probe said. If some of the figures of that type are on the high side, they could work to increase earnings going forward, accounting experts said.

In addition to auditing, PricewaterhouseCoopers has advised Pinnacle on possible deals, including "due diligence" work on possible targets -- about $3.7 million alone in consulting fees for work on the Motorola deal -- and it has consulted for the board on executive compensation, according to company executives. "We pay a lot of fees to our auditor's consulting side," Mr. Day said in the conference call, but declined to provide details.

The SEC, he said, "looked at that relationship and said, 'If you're paying a lot of fees, maybe [the auditors] let you have your way on accounting and maybe you can do whatever you want do.' That's their position and their fear."

Pinnacle has other close ties to its auditor. Mr. Day was a PricewaterhouseCoopers partner in the mergers-and-acquisitions group from 1986 until he joined Pinnacle as chief financial officer in 1997. When Mr. Day became Pinnacle's chief operating officer in July, he was replaced by Jeffrey Card, who had worked as a PricewaterhouseCoopers acquisitions partner since 1991.

The SEC's aggressiveness on the auditor-independence front follows years in which it spotted disturbing circumstantial evidence of fraudulent financials that might have been approved by a conflicted auditor. An example: the $500 million accounting fraud at Phar-Mor Inc., Youngstown, Ohio, which led the drugstore chain to seek bankruptcy-court protection in 1992. (It emerged from the bankruptcy proceedings in 1995.) In 1996, a federal jury in Pittsburgh hearing a shareholder suit found Coopers & Lybrand LLP liable under a fraud claim for signing off on financials recklessly without regard to whether they were true or false.

The audit partner viewed Phar-Mor as a "constant source of new business," plaintiff's attorneys argued in the case.

For their part, the accounting firms say the AICPA is an effective regulatory body. In addition to a policy-making role, it has a disciplinary panel and a full-time staff of 14 to investigate alleged violations. The SEC is "scratching in the mud everywhere they can to find an example, as if a single case would prove there's a significant risk to the economy," said Robert Elliott, AICPA chairman.

But the panel doesn't have the tools or authority to police the industry aggressively. It probes allegations made in SEC cases and in civil-shareholder lawsuits. But the panel has authority to investigate only its own members and doesn't have subpoena power to demand documents.

The AICPA has or is investigating 117 of the 676 SEC cases, so far resulting in 31 violations. Penalties range from public-auditing suspensions to reprimand letters. The big accounting firms note that board audit committees also exist to identify and handle potential problems.

Write to Michael Schroeder at mike.schroeder@wsj.com1