Andersen/Enron Affair Precipitates "Big Five" Divorces




Event Summary

In early February, while the public was riveted to TV broadcasts by congressional inquiries into Enron and while many former Enron executives and Andersen partners resorted to the safe heaven of the Fifth Amendment, behind the scene, the entire accounting industry was left grappling with an unparalleled array of challenges. Pressure has mounted on the accounting and consulting services industries to reform their practices following the collapse of Enron and the subsequent speculations about the role of its auditor, Arthur Andersen.

In the wake of the Enron scandal, the last two of the Big Five accounting firms have caved in and said they would sever ties between their accounting and consulting businesses. According to Reuters, Deloitte Touche Tohmatsu, the second-largest accounting firm, on February 5 reversed the hard stance it had long adamantly maintained that it could better service its clients by keeping the two operations together. While it was still viable, the firm, which is still known by the name Deloitte & Touche in the US, had kept its consultancy arm Deloitte Consulting as an integral part of the group. The memo sent to Deloitte staff said that the options to separate its consulting division included an initial public offering (IPO), a merger with another firm or the creation of a separate consulting company owned by the partners. Another option includes creating a strong "firewall" between Deloitte Consulting and Deloitte & Touche. A time frame for the move has also reportedly not been finalized.

On the same day, Ernst & Young, which sold its consulting practice to Cap Gemini in 2000 (see Meiosis, Mitosis: Cap Gemini's Mating with Ernst & Young) also said it would stop selling IT services to the companies it audits and will no longer act as both internal accountant and external auditor for a single customer. These moves came only a day after tormented Arthur Andersen said it would take preliminary steps to at least partially separate its own consulting business.

A week earlier, the largest accounting firm, PricewaterhouseCoopers (PwC), said it would launch an IPO for its consulting division. The move is aimed at avoiding the mushrooming perception of a conflict of interest, and comes as the only viable solution given a dearth of buyers with cash needed for a transaction of that magnitude and given the lack of capital within PwC Consulting. Much earlier, in November 2000, the company had to abort its attempt to sell its consulting business to computer giant Hewlett-Packard.

Some accounting firms have pursued similar options in the past, particularly after former Securities and Exchange Commission (SEC) Chairman, Arthur Levitt, unsuccessfully sought several years ago to clamp down on auditors providing management and IT consulting services to their clients. To that end, KPMG might have got a head start on its competitors after launching KPMG Consulting as a public company in February 2001. As mentioned above, Cap Gemini bought the consulting arm of Ernst & Young (E&Y) resulting with Cap Gemini Ernst & Young (CGE&Y), while Arthur Andersen split in 2000 from its sister firm Andersen Consulting, now known as Accenture (see Now Andersen, Tomorrow Accenture, They've got a lot of Selling to do). Consequently, all Big Five firms seem to have finally succumbed to renewed calls for prohibiting accounting firms from providing their audit clients consulting services, a move regulators had unsuccessfully pursued a few years ago.

Market Impact

While the biggest corporate collapse and the ensuing scandal in history will have an immense impact on the future of Andersen and the auditing industry, life will never be the same either for the other members of the "Big Five" dynasty and for the general management and IT consulting industry in general. Although the lawsuits and/or charges of failure due to alleged incompetence have happened many times before in the IT consulting market (see Business Software Firms Sued Over Implementation - Lawsuits Bring ERP Problems to Light), as well as in tax & audit services (see Heads Roll at Consulting Giant in Wake of SEC Investigation), the usual practice of spinning the bad press, settling the matter quietly inside or outside the court, and/or recovering over time will not be good enough any longer owing to the avalanche effect the Enron case has created. It has apparently triggered all Big Five firms to quickly respond to new investor, customer, and public demands.

Using the same firm for both auditing and consulting services, although frowned upon by some, was once accepted nonetheless, but it will no longer be the case. Accounting experts and other critics have, particularly since Enron, been shouting the blue murder that earning lucrative fees from offering consulting services and then auditing (or vice versa) the same client risks impairing the auditor's or the consultant's impartiality.

While Andersen, which is accused or at least suspected of everything from incompetence to deliberate collusion, is indisputably in the hottest spot, as there will be inevitable litigations whose punitive damages alone may destroy the giant. This will not happen any time soon though, which is a sort of blessing in disguise for the firm. In any event, the possible implication of Andersen's incompetence or its role as Enron's accomplice (whichever is worse of two evils) has badly scarred its reputation and has caused many of its customers to question whether they should be retaining it as auditors and/or consultants.

Companies are concerned that employing Andersen might affect their shareholders' trust in the company's accounting bill of health. Potential loss of customers and possible employees departure, while painful, should not necessarily mean Andersen's demise as such, but its long-term viability will remain questionable and will hover over many minds. In any case, whether Big Five will become the Big Four some time down the track is less important than the fact that the business model of these will have changed forever.

There has long been a trend (or at least it was not that unusual) for large global corporations to have one of the Big Five firms audit their accounts, and to also consult them on their business strategy. One thing led to the other, and it was then the systems integration consulting division of the same Big Five that would undertake the major IT contracts such as the business process reengineering (BPR), the installation of ERP software, the implementation of other e-business components, or managed (hosted) services. This cozy setup for the Big Fives is now been living on borrowed time, despite the fact that many auditors have in the past tried to preserve their objectivity in light of their fellow consultants' engagement.

It is also very likely that many customers have felt comfortable with a 'one stop shop' service from a long-term, trusting partner. Although some may have even touted synergy as the knowledge gained about the customer in auditing may help in subsequent consulting assignments, regulators and the public have long grumbled about "conflicts of interest" long before Enron. The case has reheated the debate that has made the above separations inevitable.

What Happens Now?

After the initial agony over deciding which new auditor/consultant to engage, customers may realize benefits in the long run. A fair competitive environment should put pressure on all the bidders and their value proposition, and should reduce the risk that the auditor would assume an approach only to lead to a lucrative follow-up consulting engagement. Some customers will also be relieved by the fact that not any more the same company that consults them is eyeing their books as well.

Those Big Five that have already exercised some kind of separation, like in case of Accenture and KPMG Consulting, might not be affected much. In addition to preempting pressure from the SEC, their motive for separation was also to capitalize on the success of their management consulting and systems integration operations. Further, consulting partners might even have felt relieved (as they will, from now on), to be accountable and liable only for their own consulting projects. They no longer have to share the liability occasioned by audit litigations, which was the case before.

Therefore, Accenture, CGE&Y, and KPMG Consulting, which have already invested efforts into separating their businesses, might, in the short term at least, have an advantage over their belated counterparts. However, all the Big Fives should be in a conundrum how to adjust to the business after the separation. Corporate life is much less congenial and more hierarchical than a partnership with a typical matrix organizational structure. The business plans of new organizations should, at least, streamline offerings, restructure the reporting and control structure, and identify areas for serious focus and investment. Having been cut from their auditors' lead opportunity creation, these newborn consultancies will also have to increase their marketing campaigns in order to create brand recognition (particularly in the case of a name change to allay any bad association) and demand during the sluggish market.

As the Enron fallout is likely to prompt many companies ensuring that there is no possible conflict of interest, this will likely present opportunities to established systems integrators and outsourcing firms like IBM Global Services, EDS, Computer Sciences Corporation (CSC), ICL, AnswerThink, CMG, to name some. In addition to these and the above mentioned pure professional service divisions of former Big Fives, some smaller but reliable and renowned IT service providers, as well as resellers and direct consulting organizations of applications vendors may benefit from the current situation.

However, due diligence, doubt and skepticism will be the watchwords for professional services buying for some time to come, which will not bypass any player. As an echo effect, customers might become quite wary of even pure consultancies' recommendations (e.g., software selection) that would lead to more follow-up work for them (e.g., implementation of the selected solution). Discerning service providers will therefore make sure to nurture the notion of impartiality as to differentiate them in the market. The winners will also embed the auditing of financial reporting and processes as an intrinsic part of the acceptance-testing phase of any systems implementation project.

User Recommendations

Customers should realize that as changes take place inside the Big Five, their approach to business will irrevocably change as well, to the customers' delight. As you are in a driver's seat now, the methods of engagement and value propositions should differ from those in the past.

If you are happy and comfortable with your current auditor, there is no reason for a radical change. However, use the current profusion of renowned professional services providers to your advantage both in terms of quality and price. At least, ensure that future consulting engagements are bid in a fair and competitive atmosphere, while challenging the current service provider to prove its competency at designing robust and easily audited processes.

Be aggressive during negotiating risk allocations, price parity and general terms and conditions. Fixed project prices (as opposed to time and material pricing), milestone payment schedules linked to deliverables, and penalty clause for late deliveries (as well as the profit sharing incentive for early completions) should be a matter of course. Also, it might not hurt to consider reviewing your current processes and systems as to find any still undetected malfunctioning practice in accounting and/or financial reporting.

 
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