Crain’s Chicago Business: The Chicago-based consulting firm stunned the financial community…
The Chicago Tribune: Investors dumped shares of Chicago-based Huron Consulting Group Inc. on Monday, concerned by the firm’s disclosure of accounting errors that forced the departure of Chief Executive Gary Holdren. Huron’s stock plunged $30.66, or 69 percent…
The Wall Street Journal: Shares of Huron Consulting Group Inc. (HURN) plummeted to an all-time low Monday after the company late Friday made a myriad of negative announcements including that its chairman and chief executive has stepped down and the company will be restating the last three years of financial results.
Bloomberg: Blowing Up Your Company Gets Raised to Art Form: Jonathan Weil: It almost wouldn’t be fair to say we should have known that Chicago-based Huron Consulting Group Inc. was destined to implode. It is tempting to say it, though…Today, Huron is better known as the forensic-accounting shop that couldn’t keep its own books straight, and blew up its business model in the process.
The headlines give one the impression that a sudden cataclysmic event triggered an unfortunate deluge of unanticipated but not necessarily undeserved negative consequences. The schadenfreude is palpable. In Chicago, anti-Andersen commentary is flying fast and furious alongside Andersen apologists trying to get their words in between.
The Huron Consulting Audit Committee of the Board of Directors “finds out” (From whom? A whistleblower? Internal audit? An angry exec who hadn’t received one of the “kickbacks”) about some payments to executives as a result of acquisitions that had not been accounted for properly and the result is a long list of “complex matters that demand extraordinary combinations of financial, technical, and industry expertise”:
- An announcement of restatements of several years of financial statements with a significant impact to net income,
- The resignation of the CEO, CFO and Chief Accounting Officer,
- An unprecedented one day drop in stock price,
- The filing of several class action lawsuits,
- The disclosure of an SEC inquiry on another serious accounting issue, revenue recognition,
- Concerns voiced by analyst regarding the ability of the company to continue as a “going concern.”
The restatement “bombshell” Huron’s management dropped on Monday was a shocker indeed…Granted, the audit committee was right to spill the gruel (better late than never), but why now and where the hell was the board? More importantly, were there any clues in the financial statements leading up to this fiasco which might have flashed warning flags to investors?…much of the current hubbub involves the treatment of “misreported” costs related to acquisitions. With that in mind, let’s start with Goodwill.
Goodwill is an intangible asset and subject to annual impairment testing. Determining the value of goodwill is hazy at best, when you consider it’s inclusive to patents, brand names, etc. above and beyond book value. Thus, consider goodwill as the cost of an investment in excess of book value…In Huron’s case, goodwill as a % of total assets (March 2008 through March 2009) averaged 50%. This is red-flag #1. Goodwill as a % of shareholder equity during the similar period averaged 137%, also a huge red flag.
Huron announced late Friday that it was restating earnings for 2006, 2007, 2008 and the first quarter of 2009 because of incorrect accounting related to the acquisition of four businesses between 2005 and 2007…The company said certain Huron employees received some of the payments made to the selling shareholders of the acquired businesses.
“The employee payments were not ‘kickbacks’ to Huron management.” Rather, the people who received payments were “client-serving and administrative employees” of the acquired companies or workers hired by those companies after the acquisitions, Huron said.
Huron said the selling shareholders had received payments at the time of the acquisition and, in some cases, when their companies hit certain financial targets. Huron had recorded these payments as goodwill on its balance sheets. But under generally accepted accounting principles, when such payments are made to company employees who are not selling shareholders, they must be recorded as a “non-cash compensation expense.”
PwC may have been the wrong “experts” to ask about classification of expenses related of paying off employees after an acquisition. Maybe there is no right way to record a wrong transaction. But if there were, there are others equally qualified as PwC they could have asked. Unfortunately, companies like FRA (also ex-Andersen) and FTI (ex-PwC) are competitors of Huron’s and share the same pedigree as Huron and PwC.
PwC is their enabler.
PwC is inspected by the PCAOB every year. The 2006 report issued in October of 2007 cites a deficient audit (out of six cited) where,
“the Firm failed to sufficiently test certain assumptions that management used in its goodwill impairment test…there was no evidence in the audit documentation, and no persuasive other evidence, that the Firm had evaluated the appropriateness of the projections, other than by making inquiries of management.”
Again in the 2007 report, issued in June of 2008, six deficiencies were cited. One faulted PwC for failing to test the underlying data and the calculation of an award allocation related to a goodwill impairment analysis.
“The Firm also failed to assess whether the methodology was applied consistently from year to year and whether the incorporation of the award allocation into the [goodwill impairment] analysis was appropriate.”
In another deficiency cited in the 2007 report, PwC
“…failed to test certain of management’s key assumptions supporting an assertion that payments following the modification of contingent consideration after a significant acquisition represented additional purchase price rather than employment compensation to the sellers or other current-period expense. They also failed to identify and address that the modification rendered the issuer’s disclosure of the agreement inaccurate.”
In the report for 2008, all of the deficiencies cited were as a result of inadequate evidence to support opinions related to goodwill impairment.
“…In some cases, the deficiencies identified were of such significance that it appeared to the inspection team that the Firm, at the time it issued its audit report, had not obtained sufficient competent evidential matter to support its opinion on the issuer’s financial statements. The deficiencies that reached this degree of significance are described below, on an audit-by-audit basis, with the exception of similar deficiencies that were observed in multiple audits and are therefore grouped together…In four audits, due to deficiencies in its testing of goodwill for possible impairment, the Firm failed to obtain sufficient competent evidential matter to support its audit opinion.”
In December of 2008, the PCAOB issued their Report on the PCAOB’s 2004, 2005, 2006, and 2007 Inspections of Domestic Annually Inspected Firms (KPMG US, PwC US, Deloitte US, EY US and KPMG Canada.) Goodwill impairment issues makes it to the “Top Ten” list of repeated deficiencies.
“GAAP requires that certain assets and liabilities, such as certain investments in debt and equity securities, derivatives, and assets acquired and liabilities assumed in a business combination, be recorded in financial statements at their fair value. Certain assets need to be evaluated annually (or, depending on the nature of the asset, when events or changes in circumstances warrant) to determine whether their fair value is less than their recorded amount, and their recorded value needs to be reduced.
Inspection teams observed instances of inadequate testing by firms of fair value estimates in connection with firms’ evaluation of the possible impairment of goodwill and other long-lived assets. The inspectors observed instances where firms had not tested the reasonableness of management’s significant assumptions and the underlying data that the issuers had used in valuation models. As a result, the auditors did not have sufficient evidence to conclude on the issuers’ estimates of fair value…Inspection teams also observed instances where firms had not challenged management’s conclusions that assets did not need to be tested for impairment, despite evidence of impairment indicators.”
I asked the PCAOB if any of the deficiencies cited in PwC’s inspection reports were related to their client, Huron Consulting.
PCAOB Spokesperson Colleen Brennan:
“We can’t identify issuers…The nonpublic portion of any report is not available to the public. For additional information, please see the Board’s Statement Concerning the Issuance of Audit Reports, PCAOB Release No. 104-2004-001, and Process for Board Determinations Regarding Firms’ Efforts to Address Quality Control Criticisms in Inspection Reports, PCAOB Release No. 104-2006-077, both available at www.pcaobus.org/Inspections.”
Maybe one of the class action lawsuits naming PwC can push this issue a bit more. They’ll find out if PwC was negligent, complicit, or just plain incorrigibly incompetent about the “errors” at Huron Consulting. Revenue recognition deficiencies are the subject of an additional SEC inquiry at Huron. Interestingly enough, allocation of chargeable hours, or revenue recognition issues, were the downfall of another PwC consulting firm client, BearingPoint. For professional services firms like Huron that also sell proprietary software, the issues multiply. Revenue recognition is probably one of the Top 3 deficiencies cited in PwC’s PCAOB inspections in the last few years.
Image Source: Matt Damon and Ben Affleck accepting their Oscars for Good Will Hunting.