VideoPrologue: Back in the early 1970s, the accounting profession was a gentlemanly affair. Work hard, make a decent salary, and play golf on Saturday with your clients. Auditors were like bankers: conservative, straightforward, and ethical to a fault. Indeed, accountants routinely topped the lists of most-admired professionals.
"I was CFO at two companies in the '70s," recalls Robert Howell, now distinguished visiting professor of business administration at the Tuck School of Business at Dartmouth College. "When my accountant said, 'You ought not do that,' that was it. Things have gone 180 degrees out of phase since then."
The shift can be traced to 1978, when the American Institute of Certified Public Accountants (AICPA), under pressure from the Department of Justice, lifted the ban on advertising and solicitation. The end of that prohibition triggered a land grab in the accounting industry, and a big push into consulting services.
The ensuing conflicts of interest culminated in a string of now-infamous accounting scandals and the dismantling of Arthur Andersen. Many observers believed the downfall of Andersen, the passage of the Sarbanes-Oxley Act of 2002 (Sarbox), and the establishment of the Public Company Accounting Oversight Board (PCAOB) would curb the excesses of the previous decade. The tough talk of the PCAOB's chairman, William McDonough, only reinforced that notion. In a press conference in October, he noted that the Big Four accountancies "have a high interest in restoring confidence [in public-company accounting]. If they don't do it themselves, we will do it for them. And it will be painful."
But recent events suggest McDonough will have his work cut out for him. In June, public-interest groups, including Common Cause and Consumers Union, charged that Ernst&Young was advising audit clients to "rubber stamp" the purchase of nonaudit services, a seeming violation of the spirit of Sarbox, if not the law. Soon after, news broke that three of the Big Four (excluding Deloitte Touche Tohmatsu) were being sued by a single client for allegedly padding travel expenses. Then, in September, a former senior partner at E&Y's San Francisco office was charged with destroying documents related to a government investigation of a failed dot-com called NextCard. To some industry watchers, the three incidents suggest that the Big Four are still finding their way in a post-Sarbox world. Barbara Roper, director of investor protection at the Consumer Federation of America, is harsher: "I don't see a lot of evidence that the Big Four firms have seen the light."
Rope-a-Dope
You can't really blame the Big Four for not owning up to any past mistakes. Any admission that previous audits were not as rigorous as they might have been could expose the firms to shareholder lawsuits. Publicly, the four firms have expressed general concern over the tarnishing of the audit profession. PricewaterhouseCoopers vice chairman John O'Connor concedes that he was embarrassed by the accounting scandals of the past few years: "We asked ourselves, 'Have we lost our nobility?'" Even before the scandals hit, the accountancy had instituted PwC University, a five-day seminar to help employees deal with the kinds of stresses auditors experience.
Nevertheless, O'Connor asserts that PwC's biggest mistake during the past few years was that it simply lost sight of the value of its core audit service: "We had underinvested in some of our services, including audit."
Sarbox was intended, in part, to refocus audit firms on auditing. To some extent, it has, by prohibiting auditors from offering certain consulting services altogether and allowing them to offer others only to nonaudit clients. In addition, auditors are meeting more often with corporate audit committees, which are now empowered to hire and fire the firms. That's a definite power shift. "Audit committees are our clients now," notes Susan Frieden, Americas vice chair of quality and risk management at E&Y.
CFOs say engagement partners have become more conservative in the wake of Sarbox as well. At a recent conference at MIT's Sloan School of Management, Howard Smith, CFO of insurer AIG, noted that the amount of time spent getting feedback from the company's auditors has "grown tremendously" for complicated accounting issues. At the same conference, John Millerick, CFO of Analogic, said bluntly: "There are no quick answers [from our auditors] anymore."
Others argue that Sarbox could have gone further. "Sarbox was just triage," asserts Cynthia Smith, a lecturer at Ohio State University and co-author of Inside Arthur Andersen. "It addressed a number of obvious things." Under Section 203 of the act, for example, firms are required to rotate lead audit partners every five years. But critics say legislators should have required companies to change firms every five years (a stipulation E&Y vice chairman Beth Brooke labels "a horrible idea").
What's more, Andersen's downfall has actually proven to be a windfall for the remaining top-tier firms, which picked up the disgraced firms' clients. E&Y, for one, reported revenues of $13.1 billion for its fiscal year 2003, a 30 percent rise from the previous year. And PwC's aggregated net revenue for its fiscal year 2003 was $14.7 billion, a jump of nearly $1 billion.
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