Throwing Out the Trash

CFO.Com’s Tim Reason posts on December 26, 2006 08:37am
ACCOUNTING
Civil Matters

“Saturday’s New York Times (12/23, p B1) takes aim at the time-honored practice of describing executives as departing to “pursue other interests” or “spend more time with family.”
Nothing particularly jaded about that. In a recent video interview with me, recruiter Lorraine Hack even made quote marks with her fingers about executive “retirements.” …A more amusing effort at avoiding a disparagement suit comes from Vitesse. Like Broadcom, it announced that unnamed members of management — presumably the CEO, CFO, and a senior VP it fired back in May — had backdated options. What is funny is Vitesse’s Friday “clarification” of why it fired KPMG. The company said last Tuesday that KPMG was let go for a lack of independence — which could have been read as implicating the auditor in the company’s various backdating and accounting woes. Not so, Vitesse explained in a follow-up release. KPMG is no longer independent, the company said, because we will probably sue it for the accounting mess we’ve discovered. KPMG must be so relieved to have its name cleared.”

As was mentioned in previous posts, the Big 4 firms are as tied up in litigation as some of their clients. In some cases they are being sued by their clients, in others they are being sued by their clients’ shareholders along with their clients’ management. In other cases they are being investigated by the SEC, Justice Department and/or foreign regulators for actions related to fraud, restatements and general intentional criminal misconduct on the part of their partners and employees. All of them have a great fear of the impact of heavy litigation and all of them have paid or will pay fines and settlements in the hundreds of millions of dollars, either to the government and/or to claimants.

So it’s a wonder that any one of them can be “independent” with regard to their client as soon as trouble is brewing. It used to be that one of the major reasons a firm would be considered not “independent” is if their client still owed them money for services for the prior year when they came around the following year to do the audit. Now that the auditors are on the job in most large companies almost continuously, it is interesting to guess who holds the upper hand in these types of disputes. It used to be also that the firm would stand behind their client and their partners when anyone questioned their decisions or actions with regard to the audit. But now everyone runs for cover and starts pointing fingers as soon as the feds or the lawyers show up.

And now I digress…

In a partnership such as in the Big 4 firms, all working capital comes from current operations and contributed capital. When speaking of current operations, I also refer to the custom for the firms to have extensive lines of credit with banks in order to pay large litigation settlements or to make other significant investments quickly. The cash flow from normal operations should be sufficient in normal times for payroll and ongoing expenses.

But as we know, the firms must also be “independent” of their banks. So a Big 4 firm that audits financial services institutions, brokerage firms, investment banks, investment company complexes and other typical providers of credit lines and other borrowing facilities has limited choices. They can not be indebted to an organization that they audit. The activities of the Treasury function of any of the Big 4 include constant monitoring of the firm’s client relationships in order to not run afoul of the independence requirements. A desire to do business with Citigroup as an auditee, for example, can significantly affect a firm that had a banking or credit line or receivables securitization agreement with the same institution.

These restrictions also inherently cause the firms to shy away from more “complex” financial arrrangements, but ones that are common for any other global organization such as hedging foreign currency payables and receivables. The Big4 firms often suffer from the “shoemaker’s children” syndrome in such instances in that the strong, technically knowledgeable professionals who know how to execute such transactions correctly, from a process and systems perspective, are not available to the firm’s administrative and support areas but are out billing clients. I don’t know of any Big 4 firm that has a firm handle on their foreign currency exposures or that actively hedge them or, God-forbid, actually look at this exposure as a potentially profitable speculative activity.

Much of the exposure actually comes in the form of receivables and payables to their own foreign affiliates. With the weakness of the dollar against the EURO and Sterling, how many of the firms have lost money because of non-hedging of receivables and payables with their European and UK sister firms. You do know, don’t you, that for example, PwC US pays PwC Germany in EURO via wire transfer after receiving an invoice (and after negotiating a rate that commonly includes a markup compared to the rate assigned if the company had contracted directly with the German affiliate) when they use German local staff to support the audit of a US multinational with activities in Germany? It’s a very arm’s length transaction. Not exactly the picture of a global, seamless service delivery organization.

We all know that such credit facilities take a lot of time and effort to negotiate or to unwind. This is true even with the most creditworthy of organizations. How do banks evaluate the creditworthiness of a Big 4 firm with non-integrated, fairly new integrated financial systems, so much pending litigation and no legal requirement to have audited financial statements or transparency in terms of other potential large liabilities?