Not so long ago, Dennis Howlett and I went public with a bet:
Which Big 4 audit firm is the next to fail?
This may seem like a dead pool – a quite depressing and morbid fascination with something that will add pain and misfortune to so many. I have been accused of being so totally negative that I strain credibility. After all, isn’t there anything good to say about any of the firms?
Isn’t some audit failure natural? Isn’t some error and omission in the audit process the result of a rational cost/benefit formula at work – one that determines how much more testing, sampling, investigation, questioning, and verification work should be done to reduce risk of material misstatement to an “acceptable” level?
Isn’t everyone cutting staff in this recession? Why can’t the audit firms run a business like any other capitalist and make a profit? Why are auditors any more responsible for the public interest than lawyers?
Aren’t plaintiffs’ lawyers too aggressive and going after audit firms only because they have “deep pockets” ? Aren’t auditors responsible only for certifying based on what management tells them? Can anyone hold them responsible if they were “duped” by bad guys?
The litany of crybaby defenses goes on and on.
Frankly, it’s getting a little tedious.
Even before the conviction this week of four current and former partners of Ernst & Young for criminal tax fraud involving tax shelters, EY had a bundle of other trouble. They were the auditors of Lehman Brothers and are being sued for their role in that failure. They have Madoff exposure. They are also co-auditors for Societe Generale and auditor for UBS – two problem children, for sure. There is speculation about EY in other quarters, and although I don’t agree with their reasoning, the conclusion is the same.
Dennis believes that I’m betting on PwC as next to fail. I don’t honestly remember committing to that, but I’m willing to go with it for the sake of argument. This is in spite of the fact that the other Big 4 have plenty to worry about and the next tier firms are in no way ready for prime time. Wishful thinking that BDO can somehow win their appeal in the Banco Espiritu Santo case, that Grant Thornton won’t get hurt by Refco, or that McGladrey is innocent in the Sentinel case is trumped by the fact all have additional exposure to Madoff.
Deloitte, well, too many to count. And the Parmalat case is a potential model changer. And a very embarrassing insider trading scandal. Then there’s the loser consulting gigs and a declining demand for consulting, all of which makes for never ending cuts and a not so rosy outlook.
And yet, for my money, PwC is still the closest to the precipice, if only now because of Satyam.
Think about it. It’s their third strike (at least that we know of) internationally after Japan and Moscow. Two of their Indian partners, for God’s sake, are still in jail – thrown to the prosecutorial sharks by the Indian Central Bureau of Investigations. The Chairman (soon to be retired ) of Pricewaterhouse International Limited, Sam DiPiazza, has pulled out all stops in investigating what occurred in India, sending US and other professionals to “assist” colleagues in India with comprehensive audit quality reviews, and personally meeting with Indian government officials and others worldwide to try to repair the “lost trust.”
And then there’s PwC’s Madoff exposure.
And the lawsuit for wage and hour violations in California that they’ve already lost on the facts but are vigorously appealing. They completely flubbed the administrative responsibility test in this case and will lose the licensing argument. Why? Because the fear mongering they’re trying to stir up through proxies (there have been friend of the court briefs filed by business organizations sympathetic to PwC) are just that. Empty threats. The law firms have nothing to be afraid of if audit firms are required to pay overtime to not-yet-licensed associates. The law firms exposure is minimal. After all, you pass the bar and are a licensed attorney in most states by late fall of the year you graduate. Most law firms don’t tolerate a delay or a failure to pass the bar the first try, especially for top graduates. Contrast this to the audit firms. You can work for five to seven years, eighty hours a week during busy season, before making Manager level, the typical cutoff for future promotions without a CPA.
And there are still questions lingering over their role in Northern Rock. And their forays into gambling audit have not been so successful all the while they’re advising the US to open up online gambling in order to reap the tax revenues.
The rumbling has also started in the comments on this blog over PwC’s stealth “reductions in force” and their broken promises over start dates and starting salaries to graduates. It’s fully expected that additional staff cuts will come soon and be of such a volume that it will be hard to hide behind the “didn’t fit with our performance culture” excuse.
Finally, there’s the strategically disastrous purchase of BearingPoint’s Commercial Services practice. Sources tell me due diligence has been non-existent, it’s solely an ego-trip for current leadership, and there’s a shell game going on in public statements regarding their interest in full blown systems integration services. The probability that integration of the operations, financials, staff and infrastructure will be smooth and trouble-free is in the low single digits.
Yep. Of the Big 4, my bet is with PwC US to fail in the next twenty-four months.