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Plan A for Group B accountancies? In the year of the corporate scandal, pick off as much business as possible from Big Four firms.
Joseph Radigan, CFO.com | US
October 2, 2002
Lee Graul says he's starting to see the door open. Open slightly, mind you, but open nonetheless. And that, he says, is better than having his nose pressed up against the glass.
As director of the SEC practice for accountancy BDO Seidman (SEED-man), Graul helps court new audit clients for the Chicago-based firm. Time was, says Graul, that he rarely made a sales pitch to a Fortune 500 company. Although Seidman audits 300 publicly traded companies, it and the other handful of second-tier accountancies never had the cachet or market clout of the Big Four (nee Big Six) auditors.
In fact, many of these second-tier firms were classified as "Group B" auditors by the accounting industry's leading trade group, the American Institute of Certified Public Accountants. (They're also often referred to as "national" and "regional" firms.) But the last 12 months or so have presented these Group B firms with an A-1 opportunity to pick up major new clients.
The most obvious source of this opportunity: the demise of former accounting stalwart Arthur Andersen. Andersen's inglorious fall from grace left 1,400 publicly traded companies without an independent auditor. And Group B firms have rushed in to fill the void.
According to Arthur Bowman, editor of the Atlanta-based Bowman's Accounting Report, some 500 to 600 of Andersen's former clients have opted to do business with one of the surviving Big Four accountancies. But, he says, Group B firms have picked up at least 81 Andersen accounts — a huge number by past standards.
What's more, roughly one half of Andersen's former clients have not yet announced who their new auditors will be. In this year of front-page accounting scandals, SEC investigations, and revenue restatements, industry watchers say Group B firms will likely scoop up their fair share of ex-AA clients.
Indeed, in the past six months, Graul says he's participated in sales presentations to three multibillion-dollar companies — prospective clients who in years past never would have even looked at a Group B auditor.
This phenomenon isn't just limited to BDO Seidman, the fifth-largest accounting firm in the United States. Ed Nusbaum, CEO of Grant Thornton, says his company has gained at least 200 clients this year at the expense of Big Five firms, half from Andersen. In addition, the Chicago-based Group B firm has hired 60 former partners and 500 other former employees of the now defunct accounting firm. Nusbaum says those Andersen alumni have brought additional clients with them.
Even regional accounting firms, which make up the lion's share of the 1,200 bookkeeping companies listed in the AICPA's SEC Practice Section, have seen an uptick in interest from small-cap clients of Big Four firms.
Says Grant Thornton's Nusbaum, "The situation for accounting firms has changed dramatically in the last six months."
Rules of Engagement
If the accounting landscape is changing, so too are the rules of engagement.
Large-cap companies such as Walt Disney and Apple Computer, for instance, have announced they will no longer purchase non-audit services from their independent auditors. In the past, top-tier accounting firms have been accused of trying to parlay audit contracts into consulting contracts — things like ERP implantations and financial reengineering. And in a number of cases, it appears that the financial rewards from non-audit engagements have outstripped the cash generated from bookkeeping services.
At Disney, for example, the company's independent auditor, PricewaterhouseCoopers, took in $8.7 million in auditing fees from the Magic Kingdom in 2001. By contrast, PwC booked $32 million in non-audit fees from Disney that year.
Critics charge that the lure of greater profits has led some of the larger accountancies to direct more attention to consulting services than audit services. During the pitches he's made to large-cap companies this year, claims Graul of BDO Seidman, prospective clients have repeatedly complained about the level of service they've received from a Big Four auditor.
In addition, he says, those prospective clients also expressed consternation about the bad publicity their current auditors have been receiving lately. "All of them said they were concerned about the number of times their auditors were named in news stories about accounting scandals," insists Graul.
The BDO Seidman director did not offer specific examples to back up his claims. But industry watcher Bowman says it's not uncommon for CEOs and CFOs to gripe about a lack of attention from Big Four auditors. Specifically, he says, some clients feel they rarely see lead audit partners after a contract's been signed. Says Bowman, "I've heard people complain that 'I get shunted off to a senior auditor or a junior associate, and I [end up] spending more time training them' " than actually reviewing the financial statements.
Such complaints tend to emanate from executives at less-sizable companies. "There is so much pressure on the lead auditing partners to generate revenue," explains Bowman. That pressure can leave those auditors little time to devote to individual clients who aren't paying seven-figure fees.
Not surprisingly, Group B firms appear to be playing up the service angle when courting Big Four clients. Still, partners at the top-tier firms dispute the argument that they spread themselves too thin to provide good service to all but the largest of clients.
"What's new in that?" asks Mike Ascolese, a spokesman for PricewaterhouseCoopers. "The smaller firms have been making that argument for years."
A Thinning Out
Maybe so. But this is the first time that second-tier accounting firms have actually made inroads into Big Four territory.
And make no mistake, it's tough turf to crack. According to Bowman, some 97 percent of the 15,000 to 16,000 publicly traded companies and mutual funds registered with the SEC are audited by Big Four firms. Of the remaining 1,200 members in the AICPA's SEC practice section, only two (BDO Seidman and Grant Thornton) audit more than 100 publicly traded companies.
Below the ranks of the ten largest auditors, the number of publicly traded clients thins out. By Bowman's count, the seventh-largest auditing firm in the United States, Minneapolis-based McGladrey & Pullen, has only 95 publicly held companies on its client roster.
What's more, say some current clients of Group B accountancies, there are trade-offs in not using a Big Four firm. Take Memry Corp., which makes shape-memory alloys used in components of medical devices. According to Bob Belcher, CFO at the Bethel, Connecticut-based company, Memry's management has at various times looked at cross-border acquisitions.
Each time, he says, the company's management and board have discussed whether Memry would be better served by a Big Four firm that operates globally. Like other Group B accountancies, McGladrey & Pullen has a very limited international presence.
"We've struggled with that," says Belcher. "And if we buy another firm, we would make that move."
Itzhak Sharav, an accounting professor at Columbia Business School, says the global reach of the marquee accountancies is a big selling part to audit clients — particularly to managers of multinational corporations. "That's where the Big Four have an advantage," Sharav asserts. "That's a handicap to the smaller auditors — and they'll have to overcome it."
They'll also have to overcome a lack of sway on Wall Street. Notes Belcher, "If you're a public company looking to go public, or a public company looking to get sold, there's some perceived value to using a Big Four auditor."
Even Group B auditors readily acknowledge the massive resources available to each of the Big Four auditors — resources that dwarf the capabilities of smaller firms. In fact, admits Nusbaum, partners at Grant Thornton would not even consider bidding for the business of a General Motors or General Electric.
For managers at some publicly traded companies, though, bigger is not necessarily better. In fact, a number of CFOs at midsize public companies — that is, companies with $500 million to $1 billion in annual sales — prefer working with local auditing firms.
Take Freehold, New Jersey-based Foodarama Supermarkets, with $945 million in revenues. In 1996 the grocer switched to Amper Politziner & Mattia, a Edison, New Jersey-based accounting firm. Previously, Foodarama had used a top-tier auditor for most of the company's 50-year existence.
CFO Michael Shapiro explains the move: "We felt we were better off being a big fish in a small pond than being a little fish in a big pond. Otherwise, you don't get the attention you need."
Memry's Belcher has similar feelings. Currently, Memry still has most of its operations in the United States and therefore doesn't require a lead auditor with a large overseas presence. Moreover, he says, the smaller McGladrey & Pullen is a good fit for the company, which recorded sales of $32 million in the fiscal year ending June 30, 2002.
Concedes Belcher, "We would just be a tiny, tiny client of a Big Four firm."