Andersen's Pain Will Strengthen System

By James Flanigan

March 24, 2002 12 AM PT

The demise of the Andersen accounting firm, whether through merger or dissolution and bankruptcy, won’t be the simple banishment of an errant company.

Instead, the resolution of the troubles of the fourth-largest global accounting firm, with about 64,000 employees and $9.3 billion in 2001 revenue, will set off trends both negative and positive. Among them:

* Accounting costs will rise sharply for U.S. and overseas businesses, in part because of liability issues raised by the scandal.

* Many of Andersen’s accountants will be hired by other companies.

* Reforms growing out of the Andersen-Enron debacle will strengthen U.S. accounting practices, which “must remain the standard for the world,” says Iwao Tomita, co-founder of Japan’s Tohmatsu & Co. that became the global firm Deloitte Touche Tohmatsu in the 1970s.

First the costs. The federal indictment of Andersen was very broad--too broad, say Paul Volcker, who heads Andersen’s oversight panel, along with some accounting experts and thousands of Andersen employees who protested last week in demonstrations from Los Angeles to Atlanta. The indictment made it practically impossible for other firms to acquire Andersen, because they fear inheriting its liabilities.

So Andersen apparently will continue to lose business, as some of its clients cancel its services and seek other accounting firms to do their audits. More than 50 of Andersen’s 2,300 clients have defected so far.

That is a very costly way to go, says Mark DeFond, professor of accounting at USC. Other large accounting firms--the Big Four of PricewaterhouseCoopers, KPMG, Deloitte Touche Tohmatsu and Ernst & Young--will have to grow very rapidly to handle the flood of new work.

Undoubtedly they will have to hire Andersen auditors to do the same work for clients they are doing now. But the process will involve disruption and costs.

A big-company audit is a huge undertaking involving hundreds of accountants. The average audit fee for U.S. business is about $2million a year, but typical fees at large firms run much higher when tax services, management and information consulting are taken into account.

Lucent Technologies, for example, paid $54 million in audit and consulting fees last year to PricewaterhouseCoopers. Enron, in 2000, paid about $52 million to Andersen.

When a company switches auditors, it can expect the new auditor to add 50% to the work hours involved in the job. New audits done in today’s crisis atmosphere could double the tally, adding as much as $10 billion to accounting costs for U.S. business.

Costs will rise for other reasons as well. Regulations being proposed in Washington would decree that a firm use different accounting firms for general business auditing and for tax services.

“That will hit small and medium-sized companies hard,” says DeFond, because they are used to getting a break on the cost of tax work from the auditor who does their general accounting. Large companies that maintain their own tax departments will be hurt less by regulatory changes.

Andersen employees will be hired to do new audits at their old client firms because there is a shortage of qualified auditing talent today.

The highflying 1990s economy lured math-adept young people away from the profession, accounting experts explain, even though accounting jobs start at $40,000 to $45,000 a year and the pay traditionally doubles every five years.

But Andersen partners--the senior members who have equity investments in the firm--stand to lose heavily as the firm is driven into or near bankruptcy by settlements of lawsuits filed by Enron shareholders. Andersen’s initial offer of $750 million to settle such lawsuits has been rejected by plaintiffs’ lawyers.

All accounting firms face rising costs from potential lawsuits that target accountants for not warning of financial troubles in companies they audit, even where such troubles could not be foreseen.

In the last 12 months Andersen has paid more than $350 million to settle shareholder lawsuits. A few years ago, Ernst & Young paid $335million to settle suits over its accounting of Cendant Corp.

These threats of rising liabilities are going to produce changes in the profession, says accountant Richard Weisinger, who heads his own firm in Glendale. Fees will have to rise to realistically cover risks, he argues.

New services will be introduced, such as a forensic audits to guard against wrongdoing--and protect boards of directors from lawsuits, predicts Jonathan Hamilton, editor of the Public Accounting Report, an Atlanta-based newsletter, raising costs even more.

It will be necessary to restore credibility to the vital function of accounting and to keep liability lawsuits from getting out of hand. The government oversight board being proposed by Securities and Exchange Commission Chairman Harvey Pitt could provide government protection for the profession.

And the accounting profession warrants protection because it is crucial to the functioning of global financial markets and all business transactions.

Much of the world has been moving toward rigorous, SEC-approved accounting standards in recent years, because international capital markets demand such standards, which give a clear picture of a company’s business.

Economies that do not follow rigorous accounting standards, including Japan’s, do not succeed in today’s world economy, says Tomita, who founded the first audit company in Japan in 1968.

Before Tohmatsu & Co., Japan’s Ministry of Finance supervised the accounts of Japan’s companies, often by signing off on flawed balance sheets, and ultimately adding to Japan’s current financial problems.

But Tomita, who is 78 and retired from active management of his firm, made his clients follow SEC-approved accounting standards. As a result, Deloitte Touche Tohmatsu grew by getting the international accounting business of Japan’s multinational companies and U.S. companies operating in Japan. Tomita was eager for Deloitte Touche to bid for Andersen’s customer base, until the indictment made the potential liability too uncertain.

In Japan, Andersen’s accounting firm affiliates are joining KPMG, although some of the firm’s clients are coming to Deloitte Touche Tohmatsu.

For all its safeguards, the U.S. system too became lax in the investment boom of the 1990s. Enron’s obfuscation of accounts, and Andersen’s approval of them, did not occur in isolation. Today’s investigations in the Enron-Andersen case are necessary to correct that era’s laxity.

The painful process of Andersen’s demise will help restore credibility to investment markets and ultimately make the U.S. system stronger.

James Flanigan can be reached at jim.flanigan@latimes.com

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Biggest Firms

Largest accounting firms based on worldwide professional staff:

Worldwide

professional

Company staff

Pricewaterhouse-Coopers 135,295

KPMG 79,000

Deloitte Touche Tohmatsu 76,534

Andersen 63,806