How to Save Your Business Your People & Yourself

Ross Murakami and KMH rise out of the ashes of Arthur Andersen

February, 2007

Ross Murakami first heard about the Arthur Andersen accounting scandal in November 2001 from an unexpected but reliable source: his mom. Mrs. Margie Kanemitsu called her accountant son from her home in Hilo, after watching a CNN broadcast.

“Ross, did you hear what happened to one of your clients, Enron?” she asked.

The younger Murakami was a partner at Arthur Andersen’s thriving 42-person Honolulu office. The large international accounting firm served as the financial auditor of Enron, a giant energy trading company based in Houston. That morning, Arthur Andersen had announced a restatement of an earlier audit of its client.

“Don’t worry, Mom. We’ll be fine,” he said.

Mothers can be like that. Worry, worry, worry. But, then again, you know what they say about a mother knowing best.

Within days, through a seemingly never-ending series of news reports, Murakami, his staff and the rest of the country watched Enron implode, sucking its staff, subsidiaries and investors down an irresistible vortex. Curiously, one of the first down the financial and political black hole was the auditor, 88-year-old Arthur Andersen, not only its Houston office, but nearly everyone else, including the people in far-off Honolulu.

Their ordeal—a sort of financial purgatory of watching and waiting—lasted for more than six months. Then, in a matter of weeks, they built a new firm while still running the terminal Arthur Andersen. The whole saga was a harrowing crash course in how to save a business, how to build a business and how to do the right thing.

“It was emotional. It was exhausting,” says Murakami of his office’s sudden fall and eventual rise. “It was also extremely rewarding.”

THE YOUNG PARTNER

The year 2001 was promising to be a good one for Murakami. Hawaii’s economy was continuing its steady recovery from a decade-long slowdown, which meant a busy year for service businesses like accounting firms. In addition, in the fall, the then-37-year-old accountant made partner at Arthur Andersen. Having joined the company 14 years before, straight out of the University of Hawaii at Manoa, Murakami was the first partner in the Honolulu office to have begun his career at the Honolulu office.

Murakami started his new position at Arthur Andersen on Sept. 1st.

“Here I am a new partner, and, 10 days later, we are hit by one of the most tragic events in U.S. history, which, among other things, had a big impact on business in general,” says Murakami. “Then, two months after that, Enron. Kaboom!”

Even though his once promising year was beginning to look nightmarish, when Murakami put down the phone after speaking with his mother on that November morning, he was confident that the scandal would pass. After all, every one of the big five accounting firms had had a questionable audit at one time or another in their histories. Some of them had even been sanctioned by the Securities and Exchange Commission for their indiscretions. But they all had weathered their respective storms. It seemed highly unlikely to Murakami that the actions of a few people in his company’s Houston office could reverberate all the way to Honolulu.

Around the office, he reassured his staff: This, too, shall pass. Corporate was tight-lipped about the growing scandal, preferring to wait for the legal and political dust to settle. Murakami and Honolulu office managing partner Randy Karns met with their local public relations consultant, who advised that they do the same. People wouldn’t appreciate public protests or protestations of innocence, they were told. Especially if they were protesting their own innocence. It would be bad form, especially in Hawaii.

Corporate sent representatives to reassure the Honolulu staff that the accounting irregularities were part of an isolated situation in Houston. They pointed to the firm’s vast capital base. Again, there was nothing to be alarmed about.

However, in the first quarter of 2002, as news reports announced one legal development (and lost client) after another, tensions were running high in the office. To relieve the anxiety, Murakami and his staff scheduled visits to members of Hawaii’s congressional delegation and met with Gov. Ben Cayetano. The sessions were gut-wrenching and emotional. “How could this be happening to us?” “Why was Arthur Andersen being made a scapegoat?” they asked. “We haven’t done anything wrong,” they insisited.

The leaders listened patiently and offered their sympathies and support.

“We knew they [Hawaii’s congressional delegation and the governor] wouldn’t be able to do much for us. How could they? It would be like stepping in front of a speeding truck,” says Murakami. “But we needed an outlet for all the anxiety, anger and emotion. We needed to vent.”

In Arthur Andersen’s 29th-floor office in the Pacific Guardian Life Center, the staff continued to vent with management’s full support and participation. Someone began writing encouraging messages with a Magic Marker on a Plexiglas wall off the reception area. People began writing words of support, inspirational quotes from leaders like Gandhi, or words of anger and defiance. They even had lighthearted activities in which they took out their frustrations on certain Department of Justice officials.

“You had this pride about working for Arthur Andersen and then there was this outrage that all this was going down and no one could do anything about it,” says Harvey Rackmil, chief financial officer for HONBLUE, who was the senior member of Arthur Andersen’s tax department from 1998 to 2002. “We were outraged at the government. We made ‘I am Arthur Andersen’ T-shirts for ourselves, and we went downstairs and took photos of each other. Arthur Andersen for the longest time didn’t fight back. They thought that we would get through it. Then the indictment was handed down and that was that.”

THE OLD PARTNER

In the fall of 2001, Randy Karns was quietly planning a second career away from public accounting. The 50-something Karns, who had opened Arthur Andersen’s Honolulu office nearly 20 years before, had been offered an early retirement package from the corporate office—mandatory retirement, actually. That was fine, because he had recently been offered his dream job. Today, Karns won’t disclose what the dream position was, or with whom. He does say that it was with an organization for which he had a passion, and that the position was both prestigious and lucrative.

Karns, who had conducted audits of Hawaii companies since the late ’60s, had spent his entire career with Arthur Andersen, starting out in the firm’s Los Angeles office. He was extremely proud of his company and the quality of work it had done, so 2002, had promised to be not only a sweet beginning to a new career, but a sweet ending, as well. However, as the feeding frenzy around the accounting scandal grew, the senior partner knew that his work at Arthur Andersen wasn’t done. He asked his potential new employers if he could have a little more time to decide about the position. They agreed.

“My first two thoughts were: What’s going to happen to our people? And what’s going to happen to our clients?” says Karns. “This was more than just an economic contract. There is a real responsibility when you are developing people or serving them.”

Karns began an options analysis, studying the feasibility of joining another firm, shutting down, or starting a new one. Early findings confirmed what he and Murakami already knew. None of the other big-four accounting firms were interested in purchasing the Honolulu practice, especially with so many lucrative Arthur Andersen offices ripe for the picking on the Mainland. Other firms in town were interested in Arthur Andersen Honolulu’s individual clients and personnel, but not the office as a whole.

On March 14, 2002, a federal grand jury in Houston indicted Arthur Andersen on one count of obstructing a Department of Justice investigation by destroying documents. After the announcement, Karns and his management team kicked things into high gear, calling an office-wide meeting in which Karns laid all the options on the table, including his recent job offer. No one was going to abandon ship, he assured his staff.

Subsequent informational meetings, held in a common area, spilled out into the halls. The meetings were held every two weeks, then weekly. Sometimes there was an agenda, like when Karns outlined what had happened with Enron. Sometimes it was just to talk story.

“We had meetings whether we had something to say or not. You would be surprised. You always have something to talk about,” says Karns. “Our staff wanted to know if Ross and I had heard anything, and if we hadn’t, did that change our thinking, if that makes sense. Even knowing that there is nothing new can be comforting.”

“Randy was a great leader,” says Rackmil. “He was the guy delivering the message, fireside-chat style. You knew he was going to do everything in his power to help. He had been here a long time and had a lot of loyalty in the community. As long as the clients stayed, we would be OK.”

All along Karns offered his options analysis and assessment without interjecting a prejudgment one way or another. This was a decision for the employees, not him. He was still considering his dream job.

Then, one day, he accidentally walked in on a small group of staff who were working on a gift of gratitude to the senior partner. Karns realized that he already had his dream job.

“I came home and told my wife that we were going forward. That [other] job would have been a lot of fun to do. But it [his decision] really wasn’t about money or prestige,” says Karns. “They felt so strongly about the firm, its mission, its clients and its people. They were doing all of this on top of dealing with all the stress of getting their jobs done. I felt privileged to be a part of them.”

THE NEW PLAN

Of course, Murakami’s mother wasn’t the only one outside the firm who called him about Enron and the future of Arthur Andersen. “I started fielding calls from clients, who would say: ‘Eh, Ross, how come you didn’t let me do all those things?’ I told them that I didn’t know why they did that,” says Murakami. “I told them we don’t do that. That’s not how business is done. We had a very solid client base. They knew us, and they knew we had always been very honest and open with them.”

Early in the crisis, Murakami and Karns hit Bishop Street hard, meeting with as many of their clients as they could. Sometimes, as at the gatherings with their staff, the two partners had little new information to impart to their anxious clients. There were a lot of uncomfortable discussions, some in front of boards of directors. But every client was contacted and spoken to face to face if possible. After Andersen’s indictment in March, the meetings got more urgent, going from heart-felt reassurances to the beginnings of a plan for a new firm.

“We kept them [our clients] informed and we told them that we were trying to pull something off that would be a stand-alone entity,” says Murakami. “We said we couldn’t tell them right now if it was going to be successful or not. We couldn’t wait till we were solid to let them know. It wasn’t about us. It was about them.”

At first glance, the partners’ plan, which they would appropriately name “Project Phoenix,” seemed simple. They, along with Peter Hanashiro, who was slated to be named partner at Arthur Andersen before the crisis, would buy the firm from corporate. They would continue to provide the same good service that they always had, except the new firm would no longer audit large publicly traded companies. But the new firm would be free from a rigid corporate fee structure and nimble enough to respond to changes in the local marketplace.

That none of the national firms were interested in picking up Arthur Andersen Honolulu only confirmed to the partners that Hawaii was no longer a strategic location for the national firms (see sidebar on page 32), and that, Enron or not, Arthur Andersen would have left Honolulu, probably sooner than later.

However, Karns, Murakami and Hanashiro weren’t just starting a new firm. They were also running an existing one, with a client base they needed to preserve. In addition, they only had weeks, not years or months, to set up their new firm. New networks and telephone systems would have to be installed. Amazingly, they didn’t know exactly when the switch over would happen.

The partners called a meeting of the staff and unveiled Project Phoenix. They told the gathering they were confident that the firm, KMH LLP, would work in the changing marketplace, but they could only give the staff one assurance: one guaranteed paycheck as employees of the new firm. The staff overwhelmingly agreed to form a new company. The meeting would be their last fireside chat.

In June, Arthur Andersen corporate pulled its offices’ licenses; the dissolution of the firm was finally under way. The Honolulu office was the only one of Arthur Andersen’s more than 80 offices nationwide that was staying in tact. Therefore, it was a relatively small purchase, an office of 42 people, with two partners. In fact, it was one of the smallest of the more than 4,000 financial dealings that the firm transacted as it dissolved its assets.

“We were talking to Andersen to let us move on. It was traumatic to be hanging on and waiting to be cut loose,” says Murakami. “But they couldn’t do it because they had to go through a particular process.

One month passed. Then another. KMH had one, two and then three false starts. Then the sale finally went through, one of the last transacted by Arthur Andersen. On the evening of July 31, 2002, Murakami turned off the lights on Arthur Andersen’s offices. The next morning, he came back to Suite 2900 and flipped the switch on KMH LLP.

FLIGHT OF THE PHOENIX

Murakami made that August’s payroll, and has made every one since. But KMH has done more than just deliver paychecks on time. According to Murakami, the firm’s revenues have doubled since he switched off the lights on Arthur Andersen, with 20 percent growth for four years in a row. The staff has also doubled, growing from 42 to 85 in late 2006.

Throughout the ordeal, KMH lost only two or three tax clients and a handful of national and international clients, several of whom later rehired the firm in other capacities. KMH’s vision of a locally owned firm with a local focus along with national expertise has taken hold. Coincidently, it was also one that had been floating around in the heads of many experienced accountants in town.

“Even before Andersen imploded, we had discussed the possibility of creating a local firm with national ties. That is the way the market is moving,” says Wilcox Choy, partner at KMH and former partner at big four accounting firm, Grant Thornton. “But there just wasn’t enough critical mass to do that. Then Andersen went down and after talking with them, we realized we were on the same page.”

KMH started with three partners (Karns, Murakami and Hanashiro) and now has six. Alan Yee joined the firm from Grant Thornton’s Honolulu office in 2002 and Al Fernandez from Ernst and Young in 2003. Both run KMH’s tax practices. Alton Ohira, former head of KPMG Honolulu’s insurance and audit practice, came on board in 2003 and Wilcox Choy, once in charge of Thornton’s audit practice, also in 2003.

Murakami says the firm’s spectacular growth should be credited to the new partners and the business they have brought in. He also points out that none of it would have been possible without the faith, hard work and understanding of Arthur Andersen’s/KMH’s staff and clients. “The business people here are really very caring, and they were really concerned if we were going to make it or not,” says Murakami. “At first, we didn’t have a lot to tell them, and then, when we did have a plan, we asked them to believe in us. And they did. They also helped out in some very important ways. For instance, they started to pay their bills early.

“Also, our people were so patient and understanding while they were working so hard,” continues Murakami. “We kept asking them to hold on, just hold on. And they did.”

Karns is retired now. He still has an office at KMH and comes in several times a week. The dream job offered to him four years ago went to another candidate, who Karns says has done a far better job than he could have done. Considering what Karns did for his own company, that remains a debatable point. But the retired partner will have none of that. He, instead, deflects all credit to his colleagues, staff and clients.

“I wish I could tell you that it was all brilliantly staged, but it was almost like I didn’t have a choice. It was the right thing to do,” says Karns. “It was the character of our people and our clients. Those are the people who you should build the statues of, not me.”

 

Timeline: The Fall of Arthur Andersen

Aug. 15, 2001
Enron vice president for corporate development Sherron Watkins writes a seven-page letter to her boss, CEO Kenneth Lay, warning of accounting irregularities at the oil and natural gas trader. “The business world will consider the past successes as nothing but an elaborate accounting hoax,” she writes.

Nov. 8, 2001
Enron revises its financial statements for the previous five years. Instead of showing huge profits, the company now says that it actually lost $586 million.

Jan. 10, 2002
Arthur Andersen acknowledges that it destroyed Enron documents.

Jan. 15, 2002
Arthur Andersen fires chief Enron auditor David B. Duncan.

March 15, 2002
Arthur Andersen is indicted by a federal grand jury in Houston on one count of obstruction of justice for shredding documents and deleting computer files regarding Enron.

March 26, 2002
Arthur Andersen CEO Joseph F. Berardino steps down amid an exodus of clients and overseas partners.

June 15, 2002
After a six-week trial, Arthur Andersen is convicted of obstruction of justice for destroying documents while on notice of a federal investigation.

May 31, 2005
The U.S. Supreme Court overturns the Arthur Andersen conviction. The justices unanimously agree that the Houston jury was given overly broad instructions by the federal judge presiding over the case. At issue is a memo from an Arthur Andersen in-house attorney detailing the company’s document retention policy.

Nov. 23, 2005
The Justice Department announces that it will not pursue the criminal case against Arthur Andersen in wake of the Supreme Court decision handed down earlier that year.

 

BALANCING THE BOOKS

On Monday, Oct. 16, 2006, the day after Hawaii’s statewide earthquake, accounting firm Accuity LLP opened for business. Just days before, the firm had served as the Honolulu office of accounting giant PricewaterhouseCoopers (PWC), which had decided earlier that year to pull out of the Hawaii market.

“I got a call from a friend that first day, who said: ‘PWC pulls out and the earth shakes,’” says Kent Tsukamoto, the former PWC managing partner and now Accuity’s managing partner. “You might say that we started off with a bang.”

While the circumstances surrounding Accuity’s transition from international juggernaut to locally owned big business weren’t as catastrophic as Arthur Andersen’s end and KMH’s beginning, Tsukamoto and his partners, Wendell Lee and Dennis Tsuhako, were essentially dealing with the same issue: How do you sustain a business while building another business?

However, a larger, more earth-shaking issue probably extends far beyond Accuity, KMH and the rest of the Islands’ accounting industry: How important is Hawaii to businesses with a global, or national reach? The answer is: maybe not much anymore.

According to Accuity’s tax partner, Wendell Lee, PWC’s decision to leave Hawaii and pursue larger markets on the Mainland was initially shocking, but not surprising in the end. “PWC has more than 15,000 clients in the U.S. Only about 200 of them account for 80 percent of the company’s revenue. On average, that’s about $54 million to $100 million per client, per year,” says Lee. “That leaves the Hawaii market off the scale, because, at the very bottom of the food chain, they were looking for at least $1.5 million in revenue per client. At PWC, our largest Hawaii client provided about $1 million.”

With PWC’s exit and Arthur Andersen’s demise in 2002, Hawaii is home to three of the big-four accounting firms. Tsukamoto believes that number may shrink over the next several years.

“The size of a public accounting firm is a function of the size of the services rendered. Accounting follows the organizations,” says Warren Wee, associate professor of accounting at Hawaii Pacific University. “Just look at the corporations that were based in Hawaii 10 or 20 years ago. It’s not rocket science to see what’s happening, really basic economics.”

“Ten or 15 years ago, you saw a lot of mergers of the large, national firms, going from the big eight to the big five. Now, of course, after Andersen’s implosion, it’s down to four,” adds Wilcox Choy, partner at KMH and former partner at big-four accounting firm Grant Thornton. “Everything’s bigger and bigger businesses need bigger profits.”

In other words, follow the money, and while the big money is on the Mainland, there is still more than enough business to be found in the Islands. Accuity has retained a vast majority of its staff and about 95 percent of its revenue since leaving PWC. Tsukamoto expects about 5 percent growth in 2007.

Local ownership has a plethora of benefits. Now, Accuity is no longer saddled with post-Enron, corporate office-imposed procedures, which had very little relevance to Hawaii’s small-scale businesses. (According to Tsukamoto, about 60 percent of Accuity’s clients are family-owned businesses.) Also gone is the constant pressure from the head office to increase fees by 20 percent to 30 percent, rates more in line with those charged in New York and Los Angeles. In addition, when Tsukamoto needs to make a decision, he just walks down the hall to talk with his partners.

Some of the advantages of local ownership can’t be accounted for on a balance sheet: “PWC offered us [the partners] positions on the Mainland, where we would have done well,” says Lee. “But that wouldn’t have been the right thing to do. We have 80 people who are our family, who in turn have families that they have to take care of. We couldn’t abandon them in the market like that. This is Hawaii. This is what you do. You take care.” — DKC

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