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Sunday, August 11, 2002

By Pamela R. Winnick, Post-Gazette Staff Writer

In days of old, the imprimatur on an audited financial statement signed by a Big Eight firm -- the biggest of the nation's public accounting firms, whose ranks have dwindled to half that number -- was like the Good Housekeeping seal of approval. It assured shareholders that all was well with their investments and that they could sleep soundly, knowing their nest eggs were protected -- or, at the least, that the situation as laid out in a company's financial statements accurately portrayed its condition.

	(Illustrated by Anita Dufalla, Post-Gazette)

"For decades, society has expected auditors to ferret out fraud," said Ed Ketz, professor of accounting at Penn State's Smeal College of Business.

Not anymore. That image of flinty-eyed auditors scouring every detail of a company's balance sheet and income statement for discrepancies was shattered last year with the collapse of Enron.

Investors were outraged to learn that accounting firm Arthur Andersen had signed off on the energy trader's financial statements even though it appeared to know they grossly misstated Enron's revenues and financial condition. Part of the problem was the dual role played by Andersen, which acted both as a consultant to Enron and as its outside auditor.

The Enron deception was followed by other major scandals, mostly recently WorldCom, which recently filed for bankruptcy and stands accused of artificially inflating profits by concealing nearly $4 billion in expenses and shifting around more than $3 billion in reserves outside of accepted accounting practices.

In the wake of these scandals, President Bush recently signed sweeping legislation aimed at clamping down on corporate and accounting fraud. Among other things, the law establishes a regulatory body to oversee the audit of public companies and adopts standards for auditors.

But what remains unclear is what all this is going to mean for the business of accounting.

Ketz is among those who predict a massive industry shakeup as accounting firms scramble to rid themselves of their sexier consulting practices that advised clients on business practices and strategies and focus, once again, on their more mundane audit functions.

Indeed, just as President Bush was signing the new law, PricewaterhouseCoopers, one of the Big Four, announced that it was selling its consulting practice to IBM for $3.5 billion in cash and stock.

The transaction "will unleash the consulting unit from the regulatory restraints of our industry and will allow the business to reach its full potential," Samuel A. DiPiazza, Jr., chief executive officer of PricewaterhouseCoopers, said in announcing the deal. What he didn't say is that it also will allow the accounting firm to maintain, if not restore, creditability damaged by its dual role.

Deloitte & Touche, another of the Big Four, still maintains a consulting and audit practice but plans to spin off what remains of its consulting practice in the near future, said Patricia Silverman, a spokeswoman at the firm's Downtown office.

A. Lee Shull, Jr., a managing director at Resource Connection's Pittsburgh office, notes that the company was once a spinoff of Deloitte & Touche. However the firm is now totally independent from Deloitte and provides accounting and finance, informattional technology and human resource services. (Matt Freed, Post-Gazette)

Deloitte already had spun off much of its consulting business in 1996, forming Resources Connection, which opened its Pittsburgh office in 1999. The firm provides companies with experienced professionals in accounting and finance, informational technology and human resources. Deloitte initially maintained a minority stake in the venture, but Resources Connection became entirely independent when it went public in December 2000.

Will less-well-known accounting firms grab up some of the auditing business now that the Big Four have come under fire, either directly or by guilt through association?

Ketz thinks not. Fortune 500 companies, he said, likely will continue to use the Big Four because of their geographic reach and prestige.

At least one smaller-name accounting firm, Jefferson Wells International, is experiencing a surge in business in the wake of the accounting scandals, said Joseph Perozich, managing director of the Pittsburgh office.

Jefferson Wells for years has done internal audit work for bigger accounting firms, which would go on to perform and put their name on the outside audit work that's filed with regulators. Indeed, the firm was formed in 1995 for this very purpose, doing the internal audits for companies whose independent accountants would source out the work.

"What our founder saw was that there was an independence issue because they were also doing external audits," Perozich said of the Big Four's growing use of smaller firms to do the internal reviews for them. The bigger firms outsourced the work in part to focus on the more lucrative consulting business.

Despite the recent scandals, Ken McCrory, a partner at Downtown accounting firm McCrory & McDowell, does not expect to attract Fortune 500 clients.

Nor does he expect much additional governmental scrutiny since his firm performs audit and informal consulting services to private companies primarily in the construction industry. Regulators are focusing on auditors of public companies who sell stock to the public, he said.

	Joseph Perozich, managing director of the Pittsburgh office of Jefferson Wells International, says there has been a surge in business in the wake of the accounting scandals. (John Beale, Post-Gazette)

But McCrory does believe companies that use the bigger-name accountants may have to be prepared to pay more. That's because with the more profitable consulting practices gone, the Big Four will have to charge more for audit services, which once served as a so-called "loss leader" that allowed them to get their foot in the door and sell other, more profitable services.

"Audits will be priced more fairly," McCrory said.

The higher prices may be worth it, Penn State's Ketz said, because "the public is going to demand that audited statements be more truthful."

Perozich attributes recent accounting abuses to the general excesses of the 1990s, particularly to the Internet boom, which encouraged corporations and their auditors to emphasize revenue rather than profit.

"Stock prices were driven by revenues and expectations of profits," he said. "None [of the Internet companies] were making profits, only revenues.

"That fed over into everything else."

Pamela R. Winnick can be reached at pwinnick@post-gazette.com or 412-263-1928.