If you’ve been reading me for a while, you know that I pretty much stick to discussing the largest 4 audit/accounting firms. This is for practical reasons – keeping my sanity in dealing with so much information – and to be realistic. Put the three next tier firms in the US together and they don’t equal either the critical mass in terms of experience and infrastructure nor the client/revenue base of any one of the Big 4. They will never, either individually or collectively, be able to step up and absorb the detritus from another Big 4 firm failure, either in the US or out.
That doesn’t mean the next tier don’t serve the clients they have well. Mostly. Just means that the next tier are not ready to play in the same pitch as Cristiano Ronaldo. (Front page photo/Portuguese.)
And this conclusion is drawn before you consider the considerable litigation threats each one faces. RSM and Grant Thornton both have Madoff exposure and Grant Thornton also has Refco. And BDO, well, in addition to Madoff exposure, there’s the BDO International litigation and the judgement against BDO Seidman US for Banco Espirito Santo. You’ve heard of zombie banks? Well, BDO in the US, at least, and potentially overall if the case against BDO International is also won, is a zombie audit firm.
So I’m constantly amazed to find Grant Thornton’s CEO Ed Nusbaum acting as the designated spokesboy for the accounting industry. He probably drew the short straw at the last Center For Audit Quality back room with cigars and cognac pow-wow. And I’m incredulous to see Jeremy Newman of BDO International still huffing and puffing a seemingly progressive and transparent patter with whomever will interview him.
Now, that’s no slight to my friend Dennis Howlett. I was genuinely chuffed to see Newman post a comment to Dennis’ blog. Dennis blogged about Newman’s “candid” admissions in his Huffington Post blog post regarding the auditors and mark-to-market accounting.
“It is easy to look at the details of the accounts with hindsight and see how banks results were boosted by certain transactions. The transparency required by current accounting standards ensures we can see how banks were affected by increases in the market values of financial assets. However, it seems no-one realized the fragility of the markets in such securities. When problems first emerged in the sub-prime debt market, no-one was prepared to recognize the scale of the impact. In reality, we all looked for reasons why the problem would not be contagious.
Should accountants and auditors have identified these issues? Should regulators have realized the vulnerability of banks’ capital and reserves? Should governments have recognized that a problem in one bank would affect others? The answer to all these questions is “probably.” We believed that real value was being created by these new financial instruments and wanted to believe that the “good times” were here to stay…”
My comment in Dennis’ original post responds to this Pollyanna-ish pronouncement.
“Unfortunately, I don’t agree that any of the Big 6 firms are “recovering” from the intoxication with good times at all. All you have to do is observe closely, which I am, all the reductions in force and other cost cutting moves they’re making because of the way they say they indulged themselves with too many resources and overhead during the good times.
Although I value the candour exhibited by that emphatic “probably,” I’m less ecstatic about the firms’ complicity in the creative accounting we are seeing at Citigroup, for example…
Inspired by Mr. Newman’s seeming desire for a conversation, Dennis grabbed the bull by the horns, or the CA by the short-hairs, and asked for a meeting. And he got it.
I helped him draw up some questions and was excited for him.
On May 15th Dennis interviewed Mr. Newman in London and tells us he spent two hours shooting the bull with Newman, a man he already admired for his candor. His post, Jeremy Newman, The Cautious Maverick, begins with some flattery.
“I also had the sense I’d be meeting a person willing to speak with passion for a profession that I and others believe needs to change. It is perhaps a reflection of the liveliness of our discussion that what was meant to be a one hour meeting turned into nearly two hours of debate that only ended because we each had other things to conclude that day…”
To Dennis’ credit, his first question is the toughest one: What of the BDO franchise?
In light of the crippling Banco Espirito Santo judgement against their US firm and the impending trial for BDO International to determine their culpability in this case, I’ve said BDO US is already dead.
“He was unequivocal: “It will be dealt with and we’ll move on. And no, we’re not at any risk.” I have no reason to disbelieve him…”
Well, I have 521 million reasons to disbelieve him. That’s the number of millions BDO has to pay. It’s already been adjudicated in the BDO Seidman vs. Banco Espirito Santo case. They lost. They’re hanging on by the thread of a desperate appeal. At the time of the judgement in August of 2007, a mere two years ago, mandatory discovery revealed that they could not pay it. It would break them.
Jury Awards Rise Against BDO Seidman
“A jury on Tuesday ordered the accounting firm BDO Seidman to pay more than $351 million in punitive damages in a negligence case, bringing BDO’s potential liability in the case to roughly $521 million, an amount the chief executive said threatens its operations.
The Florida jury had found BDO negligent for failing to find extensive fraud in its audits of a financial services company backed by a Portuguese bank. The amount will be added to the same jury’s award of $170 million in compensation to the bank, Banco Espírito Santo.”
““The big problem is a single case can bring down a big firm,” University of Georgia Professor Dennis Beresford said. Firms such as BDO Seidman typically distribute most of their profit to partners each year, leaving little in reserve for large legal judgments, said Beresford, a former chairman of the Financial Accounting Standards Board. ”
So what’s changed in two years? Has BDO, in this period of pre-recession and recession, sold enough profitable services, asked partners for more capital, and begged, borrowed, or worse enough to cover the judgement if they lose on appeal? Given the lack of transparency of all the audit firms with regard to actual profits and reserves for such contingencies, it’s hard to know for sure.
In the year ending June 30, 2008, BDO’s US firm had revenues of $659 million and claims 81 percent cumulative growth over the past three years (2005-2008). But how much profit? The profit margin for the year ended 2007 was 30%. If the numbers are accurate, how much could they have set aside since? Would you lend money to an accounting firm to pay a judgement?
“Jurors were given financial statements indicating Chicago-based BDO made a $176 million profit last year after collecting $526 million in revenue, up 25 percent over the previous year.
BDO chief executive officer Jack Weisbaum testified the firm has about 2,800 employees and its 250 partners made $131 million in total compensation last year.
“The company couldn’t pay punitive damages. We certainly wouldn’t look the way we do now,” he said.
Back in February, after being granted the umpteenth BDO International requested delay in the case which is due to start May 26th in Miami, Mr. Newman was much less effusive:
BDO International’s defence has always centred on the fact that the umbrella body only has 10 employees and the audits conducted by member firms are done independently. BDO International has said it has no control over its audits and should therefore not be held responsible.
Jeremy Newman the CEO of BDO International would not comment on the issue.
Mr. Newman: I dare say, you’re bluffing.
Jeremy Newman the CEO of BDO International would not comment on the issue.