By Carrie Johnson
Washington Post Staff Writer
Friday, March 9, 2007
The future of the accounting industry may depend on the answer to a single question: With only four major firms left in the business, are there too few to let any fail?
Five years after the indictment and collapse of accounting giant Arthur Andersen, the government remains skittish about how much to punish audit firms for misdeeds. The firms and their Washington allies warn that the companies are vulnerable to big verdicts that could steer them out of business, leaving clients with few choices, driving up costs, and throwing investors and markets into disarray.
Even as the industry profits from a spike in accounting fees after the scandals at Enron and WorldCom, it is launching a bid to win relief from high-stakes court judgments that insiders say could spiral one or all of the firms into bankruptcy. To spread the word, the top firms recently launched a public policy center and are turning to the Securities and Exchange Commission for help.
SEC officials are meeting with outside experts to consider ways to create safe harbors that would shield auditors from legal liability. Regulators also continue to assess whether to give their blessing to a strategy that would compel companies to bring disputes with auditors to an arbitration panel rather than a jury, according to sources briefed on the issue.
But the issue of how much leeway to grant auditors remains something of a hot potato just a few years after a series of corporate blowups devastated investor confidence and tarnished the reputation of the accounting profession, which failed to detect widespread fraud.
Debate is raging even as PricewaterhouseCoopers is attempting to stave off possible charges by Russian authorities over its work for oil giant Yukos, as Deloitte & Touche last month settled a claim involving its failed audit of Parmalat for $149 million, and as KPMG and Ernst & Young continue to battle lawsuits from clients who bought improper tax shelters.
KPMG narrowly escaped indictment over its marketing of abusive tax shelters in 2005, agreeing to pay the government $456 million and avoid a possible "death sentence." Ernst remains the subject of a tax investigation by federal prosecutors in New York.
The effort to limit auditors' liability has gained traction within the European Commission, but sentiment remains strong in certain quarters . When Conrad Hewitt, the SEC's chief accountant, mused publicly about restricting liability for audit firms at a conference last month, consumer advocates howled.
Under their view, the threat of liability prompts auditors to do better work -- and it is the only real leverage that remains, given prosecutors' reluctance to bring criminal charges against another accounting firm.
Moreover, Bevis Longstreth, a former securities and exchange commissioner, said accounting firms -- insular partnerships that do not release detailed financial information and that govern and insure themselves -- have failed to make a case that they cannot afford big legal judgments.
"It's just unacceptable to cap liability and not even look at profit," said Longstreth, who served during the Reagan administration. "No one knows what the profits are because there is no transparency."
In an interview last week, Hewitt said that only Congress could pass monetary caps on liability for auditors and encouraged the industry to present a plan to lawmakers. But behind the scenes, aides to the SEC's general counsel and its chief accountant are mulling steps that regulators might take to ease the burden on audit firms, according to sources briefed on the issues who spoke on condition of anonymity because the process is in its early stages.
Many industry officials worry as much about the impact of regulatory crackdowns on auditors as they do about liability claims, they said.
As a member of Congress in the mid-1990s, Christopher Cox, now the SEC chairman, championed a measure that narrowed the ability of investors to sue in securities class-action cases. Among his advisers was lawyer Michael J. Halloran, a lawyer who joined the SEC staff last year as deputy chief of staff and counselor to Cox.
The agency is the linchpin in the audit firms' effort because they think a Democratic Congress is unlikely to carve out special exemptions for the accounting industry, which has profited handsomely by charging higher audit fees for intense reviews of corporate books.
Cox said that the agency was not considering "any specific proposal" but that staff members were conducting at all times "intellectual research and development." He added that the SEC is concerned about limited competition in the industry but said that the agency will punish wrongdoing wherever it occurs.
Big-ticket lawsuits have captured the concern of broader deregulatory forces. In a December report, a panel created with the blessing of Treasury Secretary Henry M. Paulson Jr. concluded that criminal indictments of companies should be a "last resort," in light of the Andersen experience. The Committee on Capital Markets Regulation noted that European Union officials are considering liability caps and urged U.S. authorities to do the same. The chief executives of two of the Big Four accounting firms, Samuel A. DiPiazza Jr. of PricewaterhouseCoopers and William Parrett of Deloitte, served on the panel.
Next week, Treasury officials plan to host a day-long roundtable at Georgetown University where auditor liability will again be on the agenda. On Wednesday, the U.S. Chamber of Commerce will issue its own report on the state of regulation. The chamber report is expected to call for liability changes for accounting firms, according to people who have been briefed on its contents. Wednesday will be the fifth anniversary of the Andersen indictment related to its work for Enron. The investigation and ultimate indictment induced clients to flee and pushed the 89-year-old audit firm out of business.
The campaign for relief comes even as the number of lawsuits against auditors has declined since 2002. In 2005, only nine cases cited accounting firms. In recent memory, only one big firm, Laventhal & Horwath, sank because of legal liability. Laventhal was burdened with court cases in the late 1980s over its work for clients during the savings-and-loan crisis.
Most of the time, legal experts say, it is difficult for investors to sue audit firms because the companies that hire them have primary responsibility for their own financial reports. Over the years, courts and Congress generally have forced investors to prove that auditors took part in fraudulent conduct in order to prevail in court.
For the vast majority of accounting-firm partners, officials who did not engage in misconduct generally are protected from having their personal assets seized. Big firm partners earn well into the six figures, if not more, and typically receive pensions of about $300,000 a year for life after they retire.
But accounting firms say that the current law isn't enough to insulate themselves from disaster.
"The issue is not routine litigation but the multibillion-dollar case that could cause a firm to close its doors," said Robert J. Kueppers, deputy chief executive of Deloitte, of the auditor liability discussion, which he said is still in early stages. "We just don't want to be put out of business."