Andersen's Collapse May Be Boon to Survivors
Industry Officials Predict More Clients, Higher Fees for Remaining Big Accounting Firm
By David S. Hilzenrath
Washington Post Staff Writer
Saturday, August 24, 2002; Page E01
It might seem like the worst of times for accounting firms: Accounting scandals dominate the news. Congress last month passed a law to regulate auditors more strictly. Arthur Andersen LLP, convicted of a crime, has virtually disintegrated.
However, for the remaining big accounting firms, the business outlook may be rosy, industry officials say.
The collapse of Andersen, which was the nation's fifth-largest accounting firm, has created a windfall for Big Five survivors, which have taken on most of Andersen's former clients.
Furthermore, the parade of accounting horrors at companies such as Enron Corp., WorldCom Inc., Xerox Corp. and Qwest Communications International Inc. has sensitized corporate boards to the dangers of lax audits. As a result, companies have asked their auditors to do more work and are likely to go along with higher audit fees, auditing specialists say.
The Sarbanes-Oxley Act, which Congress passed in July in response to the accounting scandals, limits the consulting work accounting firms can perform for companies they audit. But one big accounting firm's loss might be another's gain, industry analysts say. For example, Deloitte & Touche LLP may pick up business that Ernst & Young LLP loses, and vice versa.
The law also requires auditors to perform additional services -- such as examinations of companies' internal controls -- which are likely to translate into additional revenue.
"If anything, we're being elevated in this whole process," said Richard Kilgust, global public policy leader of PricewaterhouseCoopers LLP. "I look at it as being a plus for our business, for the auditing business. . . . It's hard for me to see that this is a negative.
"I think revenues will definitely be higher," he said. "There is some possibility also that [profit] margins will be higher."
It's too early to know how the new law, overall, will affect practices in the accounting industry, many observers say. The Securities and Exchange Commission has yet to translate the legislation into detailed rules, and key provisions may not take effect at least until the fall of 2003.
The law, which governs audits of companies listed on stock exchanges, prohibits auditors from providing several types of services to audit clients. But most of those activities already were banned under SEC rules adopted in 2000.
An exception involves information technology consulting. The new law for the first time prohibits auditors from designing or implementing computer systems that generate financial data they are responsible for auditing. But such work represents only a small portion of auditors' revenue, and big accounting firms have been getting out of that business anyway.
Over the past year, 9 percent of the fees that companies paid their audit firms were for information technology services, down from 12 percent the year before, according to a recent study by the Investor Responsibility Research Center.
Ernst & Young and KPMG LLP have already sold the units that did their information technology consulting, Deloitte & Touche's consulting arm was taken private by its partners and renamed Braxton, and PricewaterhouseCoopers has announced plans to sell most of its consulting practice to International Business Machines Corp.
Another exception involves internal auditing. The Sarbanes-Oxley Act bans outside auditors from doubling as internal auditors, as Andersen did with Enron. The new law goes beyond the SEC rules from 2002, which are taking effect just this month. The SEC rules prohibit outside auditors from doing more than 40 percent of the internal audit work at companies with more than $200 million of assets.
Companies are going outside the circle of big accounting firms for some of the restricted services. Businesses that specialize in internal auditing, such as consulting firms HarborView Partners LLC and Jefferson Wells International Inc., say they are in increasing demand.
Big accounting firms have teamed with Jefferson Wells to present joint bids in which the accounting firm solicits the outside audit and Jefferson Wells pursues the internal work, Jefferson Wells chief executive Don A. Bobo said. By teaming with Jefferson Wells, the big accounting firms may prevent a direct competitor from winning the business and getting close to one of their clients, Bobo said.
Under the Sarbanes-Oxley Act, audit firms can continue to provide a variety of lucrative consulting services, but only with prior approval from the audit committees of corporate boards of directors. If committees grant approval, it must be disclosed in public reports. Services permitted with prior approval include such staples of the accounting business as preparing corporate tax returns and helping companies minimize their taxes.
One of the biggest questions looming over the industry is how audit committees will exercise their discretion.
Some investors, analysts and board members say the recent scandals will make board members much less inclined to use the auditors for consulting. The changes could hurt consulting firms, say some experts, but new rules could also result mainly in a reshuffling, with business moving from one big accounting firm to another.
The recent study by the Investor Responsibility Research Center, which looked at more than 1,200 companies with revenue of at least $10 million, illustrates how much business could be up for grabs. Last year, 72 percent of the fees those companies paid their audit firms were for non-audit services. That was unchanged from the year before.
In 2001, Deloitte & Touche billed Nextel Communications Inc. $38.5 million overall, of which $35.9 million was for services other than auditing. PricewaterhouseCoopers billed Marathon Oil Corp. $50 million overall, of which $47.4 million was for services other than auditing. PricewaterhouseCoopers billed Bristol-Myers Squibb Co. $41.3 million overall, of which $38.6 million was for services other than auditing.
For the most part, the study's statistics describe the state of affairs before Enron collapsed late last year. But the study hinted at a trend. Companies whose fiscal years ended after Dec. 31 made relatively less use of their auditors for non-audit services. Among those companies, non-audit services represented 66 percent of the audit firms' total fees.
Bristol-Myers Squibb said in its proxy report filed with the Securities and Exchange Commission in April that PricewaterhouseCoopers will not be retained for any new management consulting projects.
Accounting firms face "some short-term costs of dislocation as they adapt to the new world," but over the long run, "I think they're going to thrive," said Rajib Doogar, who teaches accounting at the University of Illinois at Urbana-Champaign.
A financial wild card in the accounting industry's future is the liability that firms could face for past audits, some of which are the subject of litigation.
At least until memories of Enron and WorldCom fade, one of the key changes for accounting firms is that companies may attach greater value to their audit work.
In the past, corporations approached audits as commodities differentiated mainly by price. They pressed accounting firms to keep the cost down.
Accounting firms used audits as a way to gain entree to potential consulting clients. Audits were often underpriced, audit work was largely focused on areas the auditors perceived as posing the greatest risks, and relatively young, inexperienced employees did much of the work, industry veterans say.
"If audits were a loss leader before, they're not going to be a loss leader going forward," said Patrick S. McGurn, vice president of Institutional Shareholder Services, which monitors corporate governance for institutional investors. "The audit committees are going to demand greater service from the firms, and so as a result, they're going to pay more for it."
Dennis Fusco, chairman of the board of the accounting firm BDO Seidman LLP, predicted that audit fees will increase at least 25 percent over the next year.
Industry sources said BDO Seidman recently won the competition to become auditor of a new client even though its bid included a higher fee than its rivals' bid.
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