Arthur Andersen, Andersen Consulting Must Split Up

AN INTERNATIONAL ARBITRATOR split up the accounting firm Arthur Andersen and its sister consulting firm, Andersen Consulting, ending a nasty battle that goes back nearly a decade.

Colombian arbitrator Guillermo Gamba placed the blame for the breakup on the parent company of the two firms, Andersen Worldwide, saying it hadn't lived up to its obligations to run the organization.

However, he charted a middle ground between the two warring parties, providing a decision that appeared to allow for the breakup with as little pain as possible on both sides.

The decision, which has been eagerly anticipated by the firms, will force Andersen Consulting to give up the Andersen name and require it to pay about $1 billion to the partners at Arthur Andersen. That money, which consists of regularly scheduled payments between the firms, has been held in escrow since the arbitration began in December 1997.

The arbitrator also ruled that Andersen Consulting must give back any technology jointly held by the firms, but Andersen Consulting avoided a potentially devastating $14 billion payment that could have been awarded under the contract between the two firms.

Andersen Consulting filed the arbitration case in an effort to break away from Arthur Andersen and Andersen Worldwide, the holding company that oversees the two firms. An arrangement created in 1989 split up the firm into its auditing and consulting practices, but several years later, Arthur Andersen started a consulting unit that began to compete with Andersen Consulting.

At the same time, Andersen Consulting was making hundreds of millions of dollars in payments to Arthur Andersen under the corporate arrangement. Fed up with the situation, Andersen Consulting filed for arbitration, seeking to break off from the company without making the payments, which could have totaled $14 billion. Jim Wadia, the world-wide managing partner at Arthur Andersen, called the decision a victory.

"My whole philosophy on this was to prove that Andersen Consulting shouldn't be allowed to go for free," Wadia said.

The decision was released by the International Court of Arbitration in Paris and faxed to the two firms in New York, where dozens of officials gathered in the predawn hours awaiting their fate. The arbitrator submitted his confidential ruling to the International Court of Arbitration, which released it to the companies simultaneously at its headquarters in Paris.

The decision, which can't be appealed, applies only to the two Andersens and carries no broader implications for the accounting or consulting industries. But in some ways, tumultuous changes in the auditing and consulting industries already have forced the Andersen sister companies to rethink how they do business and, in years to come, could force still more change there and at their rivals.

Arthur Andersen could be forced to deal with new rules from the U.S. Securities and Exchange Commission that would dramatically cut the ability of accounting firms to do consulting work, on the theory that doing other work for an audit client could compromise the integrity of the audits. Those proposed rules could force Arthur Andersen to divest itself of its own consulting unit, the very operation that has been the cause of this corporate grief.

Arthur Andersen strongly opposes the SEC proposal, maintaining that its audits are of the highest integrity. But two of its Big Five accounting-firm rivals have or are planning to split their consulting operations from their auditing functions. Ironically, that's just what the Andersens did when they split up more than a decade earlier.

"I think they were ahead of their time by accident," said Max H. Bazerman, a professor at the Kellogg Graduate School of Management at Northwestern University. But, he added, "Obviously this creates other issues in terms of who gets the goodies."

Meanwhile, Andersen Consulting has been forced to adapt its business to the Web and has seen its core strength — helping companies install huge enterprise software packages from companies such as SAP (SAP) — weaken as that sector slows down. The rise of the Internet also has cost the firm several key employees including George Shaheen, who quit as chief executive last fall to run Webvan (WBVN), an Internet grocer. In fact, the strong-willed Shaheen led the effort to split the companies, and his departure raised the specter of a settlement between the sister companies. But that never happened.

Andersen Consulting executives, while denying that they were distracted by the breakup, have battled back. The company is now intensely focused on the Web, taking ownership stakes in and offering services to young Internet companies and teaming up with big tech names such as Microsoft (MSFT). Growth, the company says, has picked up again.

Gamba submitted his decision to the International Court of Arbitration more than two weeks before his July 31 deadline, which had been extended once already. The two firms have been on high alert for the past few weeks waiting for the court to release the decision. The ruling was delayed a week because the judges in Paris decided that Gamba's faxed signature wasn't good enough, so they shipped the ruling back to Bogota for his real signature.

Here's how the two firms, which make their money selling their problem-solving expertise, let their dispute get to the point that their fate rested in the hands of a single Colombian lawyer: Arthur Andersen got into the consulting business back in the 1950s, as companies began computerizing their bookkeeping operations. The consulting business grew rapidly, but remained under the control of the auditors who ran the firm, raising the wrath of many consultants. Then in 1989, the partners at Arthur Andersen agreed to reorganize the company. The accountants stayed at Arthur Andersen, the consultants moved to Andersen Consulting, and the firm created Geneva-based Andersen Worldwide to oversee both units, which operated independently.

But none of the partners on either side wanted to give up their claims on the firm's earnings. So they set up an arrangement under which the more profitable firm paid the lesser profitable one a portion of its revenue, capped at 15% of its total revenue. But the payments, which have totaled nearly $1 billion since 1989, have nearly all gone one way, from the consultants to the accountants.

Another key part of the deal was a boundary line the two sides drew around their markets. Andersen Consulting was supposed to focus on big companies, while Arthur Andersen would be allowed to do consulting work, but only for small firms, or those with less than $175 million in annual revenue.

By the mid 1990s, the sniping had resumed. Arthur Andersen accused its sister company of refusing to do consulting work for its small and midsize auditing clients. So in 1994, Arthur Andersen began seeking consulting contracts from midsize companies, nudging closer to Andersen Consulting's core business just at the time when the consultants' payments to the accounts started growing dramatically. Arthur Andersen executives admit they encroached on Andersen Consulting's turf, but they say their violations weren't serious enough to warrant the breakup of the company.

The feud came to a head in 1997, when the head of Andersen Worldwide stepped down. Jim Wadia, now head of Arthur Andersen, and Shaheen, who had led Andersen Consulting since the reorganization, both ran for the office, but neither could muster the two-thirds majority they needed among the partners. An acting CEO was named, and he still nominally runs the company. Later that year, Andersen Consulting's partners voted to take their grievances to an arbitrator, effectively leaving the two firms connected in name only.

The two sides deluged Gamba with evidence, much of it entirely contradictory. Andersen Consulting tried to show that Arthur Andersen was competing against it for the consulting business of big global companies. And while the two sides were fighting for business, Andersen Consulting was writing checks totaling hundreds of millions of dollars to Arthur Andersen's partners.

To make its case, Andersen Consulting produced a three-inch thick loose-leaf binder filled with about 700 Arthur Andersen bids to do consulting work for big companies, just the ones that Andersen Consulting serves. Across the front of each one, Andersen Consulting stamped in big red letters the annual revenues of the company receiving the pitch, proving beyond a doubt that these were big companies.

Arthur Andersen countered that in only eight of those cases, Andersen Consulting had actually submitted a bid and, of those, Arthur Andersen won just one contract. Arthur Andersen hired the former secretary general of the International Chamber of Commerce, which oversees the International Court of Arbitration, to help defend itself and convinced a disgruntled former Andersen Consulting partner to testify on their behalf. In an electronic mail to Arthur Andersen partners, Wadia said Andersen Consulting's case "relied on manufactured 'proof' that fell apart when we examined the facts behind the story."