The increasing reliance of the Big Four accounting firms on their consulting and advisory practices may threaten the independence of their accounting practices, according to some accounting experts.
A roundtable discussion Monday at New York University’s Stern School of Business on the re-emergence of consulting practices at major accounting firms featured a panel of influential accounting watchdogs. They included former Federal Reserve chairman Paul Volcker, former Financial Accounting Standards Board chairman Bob Herz, NYU professors Sy Jones and Stanley Siegel, journalist Francine McKenna, and attorney Christopher Davies of the law firm WilmerHale.
Volcker, who chaired the Fed during both the Carter and Reagan administrations, noted that the question of who pays the accounting firms or can be a serious problem. “It’s very hard to get an independent review from somebody who gets paid,” he said. “During my days as a bank regulator, when we found something wrong or questionable with a bank, they would say, ‘We’ll investigate it. We’ll have our law firm or accounting firms do a thorough investigation and find out who is responsible.’ Not once did the in-house accounting firms or legal firm find out who was responsible. Somehow it was the Immaculate Conception. But when you had an outside accounting firms or an outside lawyer, you got voluminous reports that you could aggressively pursue.”
Volcker noted that in 1990, his investment banking firm had the job of mediating a dispute between the accounting firms or and consultants at Arthur Andersen. “They had a longstanding reputation for being the most disciplined accounting or,” he said. “This was a very proud firm being torn apart. We were able to reach a harmonious resolution of this struggle, but later it was a very expensive divorce.”
Volcker attributed Andersen’s later problems with clients like Enron to a desire to rebuild the consulting practice after shedding Andersen Consulting, which became Accenture. “They’d gotten rid of the consulting business, but they immediately made a huge investment in rebuilding a consulting practice, thinking that somehow this rebuilt practice was vital to the future of the firm,” he said. “They had the same difficulties that they had in the first place. In fact, it weakened the firm in making such a very large investment in a consulting practice, which exploded on them with Enron.”
Volcker was later involved in helping craft the Sarbanes-Oxley legislation, which still allowed accounting firms to provide both accounting and tax services to the same clients.
“Arthur Andersen had been put out of business, and nobody wanted to put another accounting firms out of business,” said Volcker. But he noted that putting accounting and consulting practices in the same firm could lead to problems.
“I will say, from all my observations, there is no doubt that putting these two functions in the same firm has an impact on the culture,” he said. “You are in effect subsidizing the Accounting function. The tension was palpable in that once great firm of Arthur Andersen. It was enormously frustrating and in the end unproductive.” Volcker believes that if Andersen had not been indicted and ultimately gone out of business, it would have been a much different firm and might have survived as an accounting-only firm.
Accounting firms Committee Involvement
Former FASB chairman Herz noted that the quality, credibility and trustworthiness of financial information that goes to investors is essential to the efficient functioning of the capital markets and therefore to the economy. “Accounting is one key aspect of that,” he said. “Whenever it comes to these kinds of issues, I don’t think about it in terms of accounting independence per se. I think about it in terms of Accounting quality, both in terms of the actual quality of the accounting firms and the perceived quality and credibility of the accounting function, and whether people believe the numbers that are accounting, that somebody has been actually having a good look at it and you can have some trust in those numbers. We saw a decade ago when there were a number of those cases, there was a real question about whether or not you could rely upon the numbers at all, and that led to Sarbanes-Oxley and a lot of the other actions pursuant to that. I personally think that was necessary at the time to restore both accounting quality and the perception in the market that you could rely upon the numbers because it would be a threat to one of the crown jewels of our country, the capital markets. The elements going into accounting firms quality are competence and objectivity. You need somebody who can do a good accounting, and you need somebody who is inclined to do a rigorous, objective accounting.”
Herz noted that Sarbanes-Oxley created the Public Company Accounting Oversight Board to oversee the inspections of accounting firms and strengthened the responsibilities of the accounting firms committees. “I am on the Accounting committees of some large companies,” he added. “The accounting firms are now responsible to the accounting committees and not to management. That is what happens, at least best practices. The Accounting committees make sure that the accounting firms, from the partner on down, understand that the client is the Accounting committee, and the accounting committees, if they’re good accounting committees, their interests are to have a good accounting done. The issue at the whole firm level, or maybe the whole industry level, is where do the investment dollars go? If I’m the head of one of the big accounting firms and I want to make an investment, is the investment allocated first to growing consulting services, buying consulting firms, or is it allocated towards training of the accounting firms, improving the accounting methodologies and the like. There are no bright lines here, but you can see what the allocation of investment resources is.”
Another important issue, Herz observed, is how the accounting firms feel about their position in the firm. “I’m a firm believer that a quality accounting is job one of any accounting firms that has a license to do accounting, particularly of public companies, and therefore as an Accounting firms you ought to feel like you’re doing job number one,” he said. “The question would be the culture. Does the culture treat them as the most important people or at least as equal, or is it kind of you’re over there in this regulated business, and the glamor part of the business is over there growing the non-Accounting services. I think over time that can have an impact on the whole culture of a firm. It can have an impact on the quality of the resources eventually choosing to go into the Accounting profession.”
It’s not a question of delivering services or independence. It’s a question of what is the service supposed to be and how is it supposed to be communicated to the market. If you want to change that, however, you can’t just amplify the obligation on the accounting firms.