CASE 1.6

NEXTCARD, INC.

Synopsis

In November 2001, Arthur Andersen & Co. employees in that firm’s Houston office shredded certain Enron audit workpapers during the midst of a federal investigation of the large energy company. The decision to destroy those workpapers ultimately proved to be the undoing of the prominent accounting firm. A few years later, a felony conviction for obstruction of justice would effectively put Andersen out of business. Ironically, at the same time that the Andersen personnel were shredding Enron workpapers, three senior members of the NextCard, Inc., audit engagement team were altering the fiscal 2000 audit workpapers of that San Francisco-based company. NextCard was founded during the late 1990s by Jeremy Lent, the former chief financial officer of the large financial services company, Providian Financial Corporation. Lent’s business model was simple: use a massive Internet-based marketing campaign to quickly grab a large market share of the intensely competitive credit card industry. By 2000, NextCard, which by then was a public company, had signed up one million credit card customers. Unfortunately, NextCard’s customers tended to be high credit risks, which resulted in the company absorbing much higher than normal bad debt losses. When the company’s management team attempted to conceal those large credit losses, the SEC and other federal regulatory authorities uncovered the scam. By 2003, the once high-flying Internet company was bankrupt and its former officers were facing a litany of federal charges. The San Francisco office of Ernst & Young audited NextCard’s periodic financial statements. When the news of the federal investigations of NextCard became public in the fall of 2001, Robert Trauger, the NextCard audit engagement partner, made a poor decision. That decision was to alter the fiscal 2000 audit