Andersen sinks further into the Enron shredder

"The first Name in Financial Services", proclaim the orange and yellow banners in the entrance hall of Andersen's imposing headquarters in down-town Chicago. Today however, a firm that was an emblem of old-fashioned Midwestern probity and caution is a famous name for all the wrong reasons.

As auditor of the failed energy giant Enron, Andersen is at the centre of a lurid tale of collusion, sleight-of-hand book-keeping and document shredding that could lead to criminal charges – and, some fear, to the demise of an 89-year-old doyen of the international accounting industry.

Even before its astounding disclosures of recent days, Andersen's reputation for competence had been massively dented by its certification of accounts that were little more than a fiction, omitting private partnerships run by senior Enron executives, which shielded hundreds of millions of dollars of undisclosed debt. Ignorance or oversight is one thing. Wholesale destruction of audit documents last summer and autumn, as Enron unravelled, is quite another.

For Enron, the red flag was first raised in late August by Sherron Watkins, a vice-president of the energy group with a reputation for speaking her mind. In a letter to Enron's chairman, Kenneth Lay, she compared the situation with Andersen's audit of another Houston company, Waste Management, which was later found to have overstated its income by $1bn (£694m). Then, Andersen, until recently known as Arthur Andersen, paid part of a $220m settlement of lawsuits brought by disgruntled shareholders. It also paid $7m under a deal with the SEC, in which it neither admitted nor denied accusations of fraud.

Enron risked being consumed by scandal, Ms Watkins wrote. "Our past successes" would be considered "an elaborate accounting hoax". Mr Lay passed the warning on to the Houston law firm, Vinson and Elkins, which acted for Enron.

The answer from Vinson and Elkins was reassuring; the use of partnerships to keep debt off the parent company's balance sheet was "creative and aggressive" but not – to use that overworked euphemism of an adjective, not "inappropriate" from a technical point of view. "All the material facts" about the partnerships "appeared to have been disclosed to, and reviewed by, AA [Arthur Andersen]," Vinson's report said.

Within six weeks that comforting judgement was in tatters. On 16 October, 2001, Enron reported a $618m third-quarter loss, and a $1.2bn reduction in shareholder equity, largely stemming from the partnerships, and six weeks later the company became the largest bankruptcy case in US history.

But the onset of the present agony for Andersen, run by chief executive, Joseph Berardino, may be dated to 12 October. That day Nancy Temple, an in-house lawyer at its head office in Chicago, e-mailed David Duncan, the lead partner at Andersen's Houston office who was heading the Enron audit, to remind him of company policy on documents. This apparently calls for destruction of records in certain circumstances but their retention in cases involving the threat of litigation. Ten days later, on 22 October, Enron admitted that the SEC had begun an investigation into a possible conflict of interest relating to the partnerships. According to Andersen, Mr Duncan, upon learning of the SEC inquiry, called an urgent meeting at which he ordered staff to speed up the destruction of Enron documents.

This happened, says Andersen, without consultation with colleagues, and "in violation of Andersen's policies and reasonable good judgement". Most of the shredding took place in the fortnight or so between October 23 and November 9, the day after Andersen itself received a subpoena from the SEC, when an e-mail went out from Mr Duncan's assistant to other secretaries to "stop the shredding".

Mr Duncan's side of the story is very different. He denies wrongdoing, saying he was merely acting on instructions from the Andersen high command in Chicago – in other words the memo sent out on 12 October. Andersen denies that Ms Temple's e-mail encouraged destruction of any documents. However, through his lawyers, Mr Duncan insists that he is being made a scapegoat for decisions taken by his seniors.

For six weeks after the bankruptcy, the saga of the documents remained secret. Andersen's admission on 10 January that "thousands" had been destroyed was a bombshell. On Tuesday came news of Mr Duncan's dismissal. Three other partners, Debra Cash, Roger Willard and Thomas Bauer, were suspended. The turmoil has taken a heavy toll on morale in the Houston offices. "The mood is sombre," one employee said. "People are trying to go on with their business, some are worried about what is going to happen to the company."

What exactly was Andersen's policy, outlined in the 12 October memo, over the handling of documents? Did its top people in Chicago know or suspect the great deception at the heart of the Enron case, or were events limited to Houston?

Half a dozen committees on Capitol Hill are pursuing the Enron collapse; countless congressman and senators and their smart young aides are hoping to make their names from the case.

Meanwhile, a venerable old accounting firm fights for its life. Andersen is at the epicentre of America's biggest financial scandal in a decade. Its reputation is in shreds. It faces the certain prospect of a torrent of lawsuits from disgruntled, and in some cases ruined shareholders. The sacrifice of the Houston office may not be enough to save it.