Accountants fight to keep cash cows

By Roger Trapp

By Roger Trapp

13 September 2000

As a former university boxer Graham Ward knows a thing or two about bruising encounters. But the president of the Institute of Chartered Accountants in England & Wales will need to come up with a special punch for today's bout with the Securities and Exchange Commission in New York.

The venue - one of the city's college campuses - is not exactly Madison Square Gardens, so Mr Ward will have to balance his heavyweight instincts with his famous charm, and the fast footwork of a flyweight. But, equally, he cannot afford not to make clear his opposition to the mighty US financial regulator's proposal to force accounting firms to stop providing their audit clients with consulting services.

His few minutes of testimony will constitute only a small part of a lengthy inquiry that has some time to run. But the stakes are high. At issue is the future of the world of accountancy as we know it today.

On the face of it, the SEC is seeking a sharp divide between audit and consultancy work. But leading accountants say the proposed rulings would also prohibit the big firms from providing services in such areas as internal audit, actuarial services, legal services and even providing expert witnesses.

Mr Ward is more aware of the ramifications than most. His own firm, PricewaterhouseCoopers, is on the verge of selling its consulting business to the computer company Hewlett-Packard for £10bn to £15bn. Such a move, if successful, would follows similar steps by other Big Five firms. Ernst & Young has sold its consulting arm to Cap Gemini and KPMG has sold a 20-per-cent stake in its US consultancy practice to Cisco Systems while also applying to float the business.

And PwC is felt to have helped cause the situation because a US investigation several months ago found thousands of violations by its partners of the rules governing ownership of shares in audit clients.

Mr Ward is too much of a diplomat to be drawn into personalities. Instead, he says, he will be using his appearance at the hearings to state "the virtues of the framework approach". By this, he means that Britain and other European countries operate a regulatory regime on the basis of principles rather than rules. He will say this is more workable and more likely to win support. He also claims such an approach is "transportable" because it can reflect conditions in different countries rather than being applied unilaterally.

But many in the accounting profession talk darkly of the matter being something of a crusade by the SEC's chairman, Arthur Levitt. Publication of the proposed ruling at the end of June with a comment period of only 75 days indicated he was keen to rush the matter through ahead of the US Presidential election and the possible end of his term of office.

And the issue of auditor impartiality being threatened by their firms' consulting activities may be more of an issue for the SEC than the investors it is trying to protect.

Neil Lerner, head of European risk management at KPMG, says the SEC has "quite unreasonably" taken the view that provision of extra services compromises the independence of the auditor. "The SEC admits it has no evidence to support its hypothesis but claims what is important is the 'perception' of lack of auditor independence," he adds.

Others say the SEC proposal will have the opposite of the intended effect. James Copeland, chief executive of Deloitte & Touche, says on the firm's website that - allowing for "occasional irregularities, and even frauds" - the firms' audit record has been good. And one reason for this "is that firms like ours employ the very experts the SEC proposal would discourage from joining us". These are the people expert in such areas as information technology, risk management and actuarial science - and auditors need them to help guide through the complexities of modern businesses, he claims.

From this it is a small jump to "the war for talent", the subject supposedly uppermost in the minds of every employer these days. If working for a top accounting firm is going to mean just doing dull audits, the best and the brightest are not going to want to work for such organisations, goes the argument. And the result would be a decline in audit quality.

Whatever the merits of such arguments, the accountants seem to have at least two problems. First, this issue has been in the background for some time and they have only belatedly started to respond to it. Second, they are at least partly disadvantaged by the seeming divide within their ranks. Some take a tough line, and others - notably Ernst & Young - are more conciliatory.

But, while the talking goes on, the firms are positioning themselves for the future. Even the ones who have not yet announced changes to their structure are said to be considering options. Each firm that changed the ownership of their consulting businesses claims different motivations, but clearly the SEC's growing concern about auditor independence has been a key factor. After all, such divestments fly in the face of the consolidation trend all the rage until a few months ago.

Though Arthur Andersen was already in the early stages of the proceedings that would lead to its recent divorce from Andersen Consulting, other big firms believed they could follow the Andersen model and create giant worldwide firms selling a whole range of professional services. The justification was that their increasingly global clients wanted then to be able to provide advice in whatever territories they were operating, and to be able to make the investments necessary they needed to get much bigger.

Critics suggested the ambitions were more likely a desire to escape the core business of audit, which had become a commodity. The perception was that this had become devalued by the spate of audit failures that gripped Britain in the 1990s and by the feeling that companies saw no value in the work other than to meet statutory requirements.

With more and more fees coming from consulting, there were growing accusations that audit was used as a loss-leader to gain entry to clients who could then be sold much more lucrative additional services. The allegations have always been hotly denied by the firms, but the perception has remained.

These extra services quickly grew beyond pure business consulting into the building of information technology systems and outsourcing or performing such functions as internal auditing that operation companies would previously have done themselves.

More recently, the largest firms have made much of their inroads in corporate finance and the law. Ironically, the corporate finance work has often been gained at the expense of investment banks, now reckoned to be too large to handle small management buyouts and similar transactions at economic rates.

This expansion gave the SEC cause for concern. Lynn Turner, the organisation's chief accountant, is reported to have said: "The firms aren't anything like they were. Quite frankly, there has been no examination of these issues for 25 years."

Though the big firms claim their clients support their stand but do not want to risk antagonising the SEC by going on the record, not every company chief executive is happy about having their choice of auditor limited by the mergers that reduced the Big Eight accounting firms to the Big Six, then the present Big Five. And, also this summer, the accountants received a bloody nose at the hands of their old rivals, the American Bar Association.

The UK Law Society and other lawyer groups around the world have gradually been warming to the idea of allowing the accountants' long-cherished notion of multi-disciplinary partnerships, or firms where lawyers and accountants can share profits. At present, accountancy firms' legal operations are limited in the scope of what they can do or have associations with law firms that keep the two parts at arm's length. Accountants have predictably slammed the American Bar Association's overwhelming vote against such a change in practice as "protectionism" and predicted that lawyers will not be able to buck the market for ever.

Jeffrey Peck, managing director in the office of government affairs at Arthur Andersen, says: "The vote flatly rejected the needs of buyers. I think eventually the marketwill prevail."

He says the vote will not divert firms such as Andersen from their strategy of building up legal services around the globe. But the reason his firm and its rivals devote so much attention to a series of regulatory hearings is that the SEC might.

They must be hoping Mr Ward - or anybody - can deliver a knockout blow before the consultation period closes on 25 September.