PwC To Acquire Booz But Broader Not Better For Integrity Of Global Capital Markets

PwC and global strategic consulting Booz & Company have signed a conditional merger agreement. Announced on October 30, 2013, the proposed transaction depends on approval by Booz & Company partners, the receipt of required regulatory approvals and tying up any last minute details that may arise.

Mark O’Connor at Monadnock Research says Booz partners may still have second thoughts.

The Booz partner vote is anticipated to take place in December, with a more detailed announcement on deal terms to occur before year-end. The “merger” is by no means assured, however, for two reasons. Given the history of Booz partners rejecting the proposed A.T. Kearney merger in its final stages, it is clear that Booz leaders have a history of not speaking with a single voice despite giving preliminary approval.

The second obstacle to a transaction is regulatory approvals, and more specifically, the reasons regulators may block a transaction. Regulators in Europe and the US have considered forcing the Big Four to divest their interest in providers of consulting services, like those of Booz&Co. And New York regulators appear poised to take action themselves if Federal regulators don’t intervene with meaningful regulatory restrictions and oversight.

Why bother? Dennis Nally, Chairman of PricewaterhouseCoopers International, focuses in the firm’s press release on the desirability of vertically integrated, seamless, end-to-end service delivery to multinationals.

“In particular it would give CEOs the opportunity to work with a global consulting team that could provide services from strategy development right through to execution.”

But Mark O’Connor tells us what’s really motivating PwC:

“With stagnating growth in audit, and with PwC being displaced again as the largest global professional services firm in fiscal 2013 by Deloitte, adding $1 billion in revenues will likely again put PwC on top in fiscal 2014. So while $1 billion may not seem material to member firm combined revenues, it is significant in the context of PwC’s competition with Deloitte.”

What’s in it for Booz? Cesare R. Mainardi, CEO of Booz & Company:

“This potential combination would not only deliver on this innovative value proposition but would also help reinvent management consulting for the next century.”

Almost every news report about the proposed acquisition mentioned the potential auditor independence conflicts that will inevitably occur when Booz consulting partners fold engagements with PwC audit clients into the new combined firm. Those conflicts will happen because it’s highly likely many Booz consulting clients are audited by PwC. After all, PwC has the largest audit practice of all the global firms even if it trades largest firm honors with Deloitte every other year.

Former Securities and Exchange Chairman Arthur Levitt was dramatic about the dangers to investors of the auditor independence conflicts. (Levitt’s been singing this song forever, bless his heart! Me, too.)

Levitt told Bloomberg News, “We are slipping back.”  He would know. Here’s Bloomberg/BusinessWeek:

Levitt, who is on the board of Bloomberg LP, the parent of both Bloomberg News and Bloomberg Businessweek, clearly isn’t a fan of such moves: “As the accounting profession becomes more committed to consulting, their audit activities have got to be questioned.”

The New York Times DealBook says “no problem”.

PricewaterhouseCoopers and Booz & Company have taken steps to quell any concerns, according to people briefed on the matter. The two companies are expected to review client matters, with Booz partners expected to drop consulting assignments that conflict with existing auditing clients.

DealBook’s Kevin Allison reported the next day that, “Sarbanes-Oxley’s restrictions on cross-selling audit and advisory services are still in place — auditing clients can’t be consulting clients, and vice versa.”

That’s not accurate. Strictly speaking, auditors of US listed companies are not legally prohibited from providing “strategy consulting” to audit clients and audit firms don’t think they are restricted from providing highly lucrative consulting services to audit clients such as tax avoidance services, operational risk and internal control assessments and fixes, M&A accounting and tax advice, and governance/risk/compliance work.

The Economist explains:

A significant number of Booz’s clients would immediately be in doubt because PwC audits them—strategy consulting for audit clients is banned in many countries, and even where it is legal it is frowned upon (not least in America).

In the US the “independent” Audit Committees are charged with gut-checking strategy work performed by auditors and reviewing the other grey-area audit-related, tax and “other” activities. It’s done on a kind of “honor” system since there has never been, in my memory, any criticism, let alone regulatory action against an Audit Committee for a too-generous interpretation of the rules or for any of the obvious violations I’ve pointed out in the last few years.

SEC rules to insure auditor independence existed before the Sarbanes-Oxley Act of 2002 confirmed nine more prohibited services. Legacy restrictions guarded mostly against audit partner financial interests in audit clients, other prohibited business relationships and alliances between auditors and their clients, and activities where auditors would clearly be perceived by the investing public as not objective because they were auditing their own work.

The last big push by audit firms into consulting, pre-Enron, was focused primarily on information technology consulting. Whether the auditors were thinking about strategy consulting or not, regulators and legislators post-Enron were more concerned with conflicts arising from software development and implementation consulting, internal audit co-sourcing, and clear conflicts such as valuation services, bookkeeping, broker-dealer services, and tax advocacy.

Enforcement of auditor independence rules regarding prohibited services and business relationships has been non-existent since the Sarbanes-Oxley Act was passed. Concerns about the lack of enforcement are not new. The auditors’ push back into consulting isn’t new, either.

Mark O’Connor at Monadnock Research:

Deloitte alone confirms that it made 30 strategic acquisitions in fiscal 2013, and plans to continue in acquisition mode during fiscal 2014. Deloitte purchased strategy specialist, Monitor Group Company, out of bankruptcy in January 2013. Deloitte also made two attempts to purchase strategy specialist Roland Berger. The first attempt failed in November 2010 and the most recent talks initiated in the first quarter of 2013. Deloitte also purchased significant portions of the BearingPoint public sector consulting operations out of bankruptcy.

PwC closed on its acquisition of digital media strategy consultancy, BGT, and reached an agreement to acquire HR performance management and analytics advisor, HumanR, both in the last few weeks. It purchased Ant’s Eye View, a social media strategy consultancy a year ago, after acquiring Logan Todd & Co., a European operations consultancy in March 2012.

PwC also acquired one of the world’s preeminent operations consulting firms, PRTM, in August 2011, and acquired Diamond Management and Technology Consultants in November 2010. PwC made several smaller operations consulting acquisitions that included Alaris and Paragon Consulting Group in late 2009, and purchased a large portion of BearingPoint’s commercial consulting operations out of bankruptcy in 2009.

KPMG has focused on smaller strategic acquisitions, with a particular emphasis on IT strategy and outsourcing. It acquired certain portions of the IT consulting practice of Hackett Group in March 2013. The predecessor entity to Hackett, Answerthink, was a consultancy formed in 1997 by a group of former KPMG partners that left the firm before BearingPoint was split-off.

KPMG acquired UK-based strategic IT advisor Xanus in November 2012, and Canadian strategy and operations firm, Secor, in July 2012. It acquired German operations advisor, BrainNet, in June 2012. KPMG also acquired strategic outsourcing advisor, EquaTerra, in February 2011.

Late last year Ernst & Young acquired Brazil’s Axa Value Chain, a consultancy that focuses primarily on strategy and operations consulting. It has also acquired performance management and analytics firm, ISA Consulting in Philadelphia. EY has made mostly smaller focused acquisitions in the past, and has stayed away from large transactions with firms that have a large global presence. But that may change.

Last November the NYU Stern School of Business held a Ross Roundtable on the reemergence of consulting practices in the major audit firms. I participated on the panel that included Bob Herz (a former FASB Chairman and current audit committee and PCAOB SAG member), former Fed Chairman Paul Volcker, professors from Stern, and Christopher Davies of Wilmer Hale who represents PwC and Ernst & Young in auditor liability matters and who pinch-hit for PwC’s Brendan Dougher who canceled at the last minute.

I mentioned at the forum that I had documented several examples of auditor independence violations that did not result in fines or sanctions.

So have others.

There are numerous examples of audit firms still earning at least as much of their fees from audit clients, or multiples of their audit fees, from what were, in my mind, supposed to be prohibited services to those companies. For example, auditors provide non-audit related advice on GAAP and SEC reporting for specific transactions and get paid extra for it. Who goes back to check and see if they audited their own advice?

I wrote in March of 2011 about KPMG and its “secondment” of tax staff to audit client GE to help with their returns for a few months every year.  This had been going on for a while, for $10 million extra per year. Less than a year after I wrote about it, the engagement stopped. There were reports of the beginning of an investigation. An order to preserve documents referring to the “loaned staff” was circulated. But we’ve not heard anything from the PCAOB or SEC about any disciplinary actions or sanctions for this clear violation of Section 201 auditor independence rules.

Wal-Mart and News Corp use their auditor, Ernst & Young, for tons of tax services. They’re in big trouble for bribery, an illegal act, but we didn’t hear about it from Ernst & Young. If Ernst & Young knew at some point about the alleged illegal acts, did the firm file a Securities and Exchange Act Section 10A report with the SEC when it was obvious those companies weren’t stopping on their own or self-reporting but instead covering them up?

The SEC and PCAOB have not even minimally enforced the Sarbanes-Oxley Section 201 auditor prohibited services rules against the Big Four and have stopped enforcing compliance with existing rules against inappropriate financial interests and strategic alliances. When was the last time you heard about an independence violation by one of the Big Four other than the insider trading scandals? Clearly they are occurring. But it’s wildly unpopular for regulators to even suggest they may force companies to cut off a favored vendor – the one you can “work” with – as we have seen whenever the subject of auditor rotation comes up.

The New York Times DealBook reassures us that regulators all over the world will be on the ball this time, scrutinizing the match-up given heightened concerns in the US and abroad about anti-competitiveness as well as auditor independence.

“…the union of the two firms is likely to bring scrutiny from regulatory agencies around the world as it again raises the issue of an accounting firm’s buildup of a consulting business that could pose conflicts of interest…

A spokesman for the Public Company Accounting Oversight Board, which oversees auditors, said in a statement that the board “does not need to approve the transaction, although we have an interest in it, partly because of the independence issues it raises.”

Another factor that may have an impact on the deal is an inquiry into PricewaterhouseCoopers by the New York State Department of Financial Services, which is investigating ties between consultancies and banking clients. Depositions are being scheduled for as soon as next month, according to a person briefed on the matter.

(Superintendent of Financial Services for the State of New York Ben Lawsky recently subpoenaed PwC and Promontory over potential conflicts with other bank monitoring assignments similar to Deloitte’s Standard Chartered screw-up.)

In my opinion, there is absolutely no reason for you to think there will be any regulatory scrutiny in the US of this transaction and its conflicted aftermath. The PCAOB clearly says it has no authority to approve or disapprove of the transaction, in spite of being the US audit industry regulator. Neither the PCAOB nor the SEC takes responsibility for regulating the consulting arms of the audit firms. Jim Kroeker, former SEC Chief Accountant and Jim Doty, Chairman of the PCAOB, testified to Congress that consulting activities of the audit firms were out of their jurisdiction unless the independence violation occurs between an auditor and its audit client.

Their testimony, on March 28, 2012, was given in response to specific questions about the clear auditor independence conflicts presented by Deloitte’s role as an OCC/Fed appointed foreclosure reviewer, a consulting engagement, for JP Morgan Chase.

Why, you might ask, did Congressman Brad Miller of North Carolina ask PCAOB Chairman Jim Doty and SEC Chief Accountant Jim Kroeker about my column? You thought I left town after the PCAOB two-day hearings on auditor independence and auditor rotation!

Not so fast! Congressman Miller wanted to know if they knew about Deloitte’s assignment to review their own work at JP Morgan Chase.

The Deloitte partner in charge of the JPMorgan engagement, Ann Kenyon, was a partner on Deloitte’s audit of Washington Mutual. So it would not be in her interest for Deloitte’s consultants to turn up any auditing errors the firm made with that mortgage originator, particularly since Deloitte is a defendant in shareholder litigation related to Washington Mutual’s collapse. In addition, Deloitte audited Bear Stearns, and is going to trial as a defendant in Bear Stearns investor litigation related, in large part, to EMC. So the consultants wouldn’t have a strong incentive to find any auditing goofs there, either.

If that’s not enough conflict to disqualify a firm, I don’t know what is.

Doty seemed a little surprised to hear my name and Kroeker said that it’s not his job. Not good answers. (I’ve whispered in both sets of ears since to try to help them recover from what I think is a big problem – the perception they left that the consulting side of the audit firms is unregulated.)

You can listen for yourself here. My name and my work is mentioned starting at the 1:14:00 mark.

Here’s the text of that exchange:

Mr. Miller of North Carolina:

Thank you, Mr. Chairman. There has already been some discussion of concerns about a lack of independence for conflicts of interest by auditors. That is the reasoning behind the proposed requirement of retaining auditors. But that seems to be a recurring concern. It was a concern in Enron and those other scandals during that period. And the biggest auditing firms, the big four accounting firms, still have consulting firms that are affiliated that are as large, and as possible, as the accounting firm. I know that there are some not some limitations on how much overlap there can be between the–consulting firms and the auditing firms. But right now, the OCC and the Fed are both doing reviews of foreclosure practices by the bigger servicers that are all affiliates of the biggest banks. And both essentially have allowed the servicing firms to pick their own reviewers. It appears from the engagement letters that had they made public that most of the reviews are being done by the consulting firms that are affiliated with auditing firms. And it certainly has raised some questions about conflict of interest.

Most notably for JPMorgan Chase, their affiliates that did servicing, they picked Deloitte. And a big part of their review will be mortgages that came to JPMorgan from Bear Stearns, which they acquired, and from Washington Mutual, which JPMorgan  Chase acquired. Deloitte was the auditor for Bear. And they are in fact a defendant in investor litigation for what went on at Bear and mortgage securitization. They are a defendant with Washington Mutual, also for the mortgages originated by Washington Mutual.

It seems like there is an ample disincentive for the  auditing firm to find large problems with the mortgages  originated by JPMorgan Chase, or now liabilities assumed by  JPMorgan Chase, when they bought Bear and when they bought  Washington Mutual.

There was an article in the American Banker earlier this month by Francine McKenna raising those questions. She has concerns about conflict, or certainly the appearance of conflict, or the lack of distance. I have those concerns as well. Do you all have those concerns? And should this have happened? How should the rules be changed, if you think so? Yes, sir?

Mr. Doty. Congressman, first of all, you have highlighted the scope and complexity of the independence question. Independence and skepticism are a state of mind. And part of the exercise that we are engaged in is to try to understand  as much as we can about that.     I would have to say that with respect to the issue you put your finger on, it is an issue of another regulator’s area of  expertise and jurisdiction. It is not part of our jurisdiction. It is part of the jurisdiction of the Federal banking regulators.

And I think in the McKenna article you are referring to, the appropriate official of the Office of the Comptroller of the Currency speaks to it, and speaks to the issue. But I really would have nothing to add or nothing to comment on there. It is not my responsibility or the Board’s responsibility to confront that issue in this particular case.

Mr. Miller of North Carolina. I understand. I have heard that it is not my job response many times. But it seems like it should be your job if an affiliate of an accounting firm is undertaking an investigation that may  look at the work of the accounting firm with which they are  affiliated. Why is that not something that some of you will look at? Would any of you look at that?

Mr. Doty. We would in inspecting an engagement of any accounting firm. We would be concerned about business relationships with the affiliates of the accounting firm and the registrant or the issuer. And we do look at, as I was saying to Congressman Sherman,  the relative contribution of non-audit fees to the revenue of  the firm when we do our annual inspection of the 10 largest  firms.

Mr. Miller of North Carolina. Anybody else? Mr. Kroeker, you have your hand on your button. Was it just a nervous twitch?

Mr. Kroeker. No, no, no.  As it relates to the independence of the financial statement auditor, which is really the jurisdiction that we have for registered public companies, we would certainly be taking a look at that issue. It is a tenet of the independence rules that you can’t audit your own work, and a tenet of the independence rules  follows that you can’t be independent if you have less than an  objective sense of mind–that is, you are incented to come to a  particular outcome. So as it related to the financial statement audit, that would be squarely within our responsibility. As it relates to any work that is done under a consent decree for the OCC or others, I don’t believe it would fall within our jurisdiction.

Superintendent Lawsky of the New York Department of Financial Services picked up this regulatory black hole—audit firms consulting for non-audit clients— and ran with it. His decisive and independent action to fine and ban Deloitte for “misconduct, violations of law, and lack of autonomy during its consulting work” at Standard Chartered Bank on those anti-money laundering (AML) issues was prompted by the realization that no one regulates the Big Four consulting practices.

The Boston Globe:

“What we realized as we were starting to look not only at Standard Chartered but at other banks who have especially anti-money-laundering problems, what we realized is consultants they were hiring to try and clean this up and to try and expose what went wrong were often almost as compromised as the banks themselves,” Lawsky said.

They found nobody was regulating the consultants, but he said Department of Financial Services lawyers unearthed a century-old New York banking statute that requires department approval for consultants to access confidential bank information.

“We held the keys to the kingdom as to whether the consultant could go in and work at particular banks. We held the power to drive reform in the industry,” he said.

Other regulators around the country can probably do the same for the banks they oversee, he said.

Booz partners will never willingly give up consulting engagements because of supposed PwC auditor independence conflicts. The Booz partners will opt out of the PwC agreement instead. How do I know this? Recall which US regulator made sure no ongoing Diamond Consulting clients were not also PwC audit clients.

Can’t recall? That’s because no regulator took up the issue.

Try to recall which regulator made sure BearingPoint IT strategy and implementation engagements were shed or stopped to prevent auditor independence conflicts when PwC and Deloitte split that firm up after its bankruptcy.

Yup. No US regulator addressed the issue.

I wrote at the time, March 2009:

PwC will have to shed 1/2 to 2/3 of BearingPoint’s commercial clients because of independence issues. With a business already struggling to close and keep engagements, you’re going to tell clients, “Thanks, but no thanks, we have to resign in the middle of your SAP implementation.” And BearingPoint has to resign these engagements before PwC closes the deal. PwC can not benefit from “selling” the contract to someone else.

And then there’s the contracts where BearingPoint is a subcontractor and the prime contractor or a material other subcontractor is a PwC audit client. This is a distinct possibility when looking at the Federal, state and local government contracts which are almost 30% of BearingPoint’s revenue and their largest and most valuable practice.

In some cases, defense contractors (since Department of Defense make up the biggest portion of the Federal Services contracts) are the prime contractors. PwC will have to review each and every one to make sure no parties to these contracts, and there are often many, are audit clients or otherwise conflicted. And hey PCAOB! We know how good PwC is at working with lots of contracts and data…Those conflicted engagements will have to be resigned too.

And then there’s the alliances. Oh, PwC folks reading, some of you know this is one of my favorite subjects. If only you had listened when you had the chance…

From BearingPoint’s 2007 annual report:

Oracle (Auditor is EY)

Microsoft (Auditor is Deloitte)

SAP AG (Auditor is KPMG)

Hewlett-Packard (Auditor is EY)

IBM (Auditor is PwC)

Fortunately for PwC, they would likely only have to limit activities from the largest alliance relationships, per independence requirements, with IBM. But what competitive disadvantages result?

Alliances are tricky things. BearingPoint has hundreds, if not thousands, of strategic partnerships and alliances with other firms, including large defense contractors and specialized software firms that could cause an independence conflict for PwC. Gone.

But how to extricate the firm from valid contracts and engagements that involve conflicted parties? Those contracts were not written, like some of PwC’s own newer alliance contracts hopefully were, with an “independence conflict” escape clause.

Independence was the driving reason three of the Big 4 shed their consulting arms after Sarbanes-Oxley. It’s the reason BearingPoint spun off from KPMG in the first place – to be free of these restrictions. Have you forgotten that BearingPoint was originally KPMG Consulting and still rents space from KPMG in some locations! That irony, in and of itself, would be a bad consulting joke if the transaction took place.

Which federal regulator will make sure that the audit firms’ surging interest in strategic consulting firms does not destroy the last hope investors may have of auditor independence?

The SEC won’t. The PCAOB won’t.

That leaves whom? Federal and state banking regulators, the CFPB, state attorneys general, state consumer advocates?

Not exactly how everyone thinks post-Sarbanes-Oxley audit firm regulation works.

8 replies
  1. Daniel Reynolds
    Daniel Reynolds says:

    Excellent column. I agree that U.S. regulators are unlikely to have much of an impact on this transaction. Perhaps the U.K. willl step up?

  2. Francine
    Francine says:

    @Daniel Reynolds

    What will be interesting is the patchwork of Booz firms that will and won’t join up based on individual partner interests. The Booz partners will look at each PwC partnership in each country and make a decision whether to join up or go it alone. Just like BearingPoint…

  3. OnePoundOne
    OnePoundOne says:

    great piece.

    Why don’t regulators and other affected parties try to spread the work around to non Big 4 firms. In comparison to Big 4 these firms seem small, etc, but in reality they are national firms with thousands of practitioners, including many former Big 4 employees with all kinds of capabilities. As a valuation guy, when we worked with Big 4 firms, the only reason we deferred to them was b/c of their name, not b/c of any perceived stronger experience or skill set. In fact, many times the opposite. There are sooo many audit/consulting firms of so many sizes, you can wipe out independence issues and conflicts forever by spreading the work around. Not that the 2nd tier firms like BDO, McGladrey, etc aren’t massively conflicted right now either.

  4. Francine
    Francine says:


    I agree. There is talent everywhere. But digging beyond Big Four too hard—for corporate CFOs raised on Big Four and for regulators who have to use the firms to support their work such as in TARP. You go with what you know.

  5. Anon
    Anon says:


    I found your comment about market eunuchs bemusing, I am an audit partner in a Big 4 firm. Recently I called out a number of internal control issues identified during my audit of a regulated institution. The Board subsequently requested that management engage me to advise on the required remediation. This is not because I am cosy but because I know exactly what the issues and problems are and the necessary steps required to raise standards to the appropriate level.

    In my following audit, I called out that management had not made the required improvements and I consequently had to perform more work to satisfy myself on the integrity if the financial statements.

    The ‘consulting’ work I performed did not impair my judgement, it gave me a stronger position in relation to my primary role as auditor. On another client I was fired for questioning certain management practices and the Board decided to trust management over me.

    I am therefore of the view that your drive in this area is incomplete in focusing on the firms alone. The types of truly questionable relationships result when Boards / Audit Committees do not set the appropriate expectations from management that the auditors perspective matters and should be acted upon. Consulting impairs independence when the Audit Committee and the auditor are wedged by management.

    It’s about time regulators focus on governance too. Your energy on this space would be of great service to audit integrity.

  6. Francine
    Francine says:


    Thanks for your comments. Without knowing exactly how far you went in your “consulting” it’s hard to say if this extra work, for which you were undoubtedly paid extra—was it part of audit fee, audit related or “other”—would be considered prohibited services. Will the audit team go back and audit your “remediation? Did you design an implement new and improved controls that your firm’s audit team will pass judgment on for ICFR? If so you should not have been allowed to do so by the Audit Committee it but I understand why you and the firm would want to.

    I agree that management and Audit Committees are not setting appropriate expectations and when Audit Committees, in particular, are not making an independent assessment of auditor independence when retaining auditors and deciding on other service engagements. Yesterday at the PCAOB SAG a member from BlackRock said his firm depends on its auditor to decide if it is independent. That’s abdication and why the problem continues to exist.

    So, yes, I will criticize others who allow the auditors to bill more for consulting and tax that is prohibited. I wrote about the attitude of these others in the company corporate governance role towards auditors in another post this week called the “Chilling Effect”.


  7. Anon
    Anon says:


    Thanks for your response. I believe the regulators should target Audit Committee behaviour to change practices regarding oversight and this should get as much focus as auditors themselves. The example you mention is interesting. In some jurisdictions it is a criminal offence for an auditor to provide an independence clearance to a board that is knowingly false or wilful. I’m aware from peers this standard has an impact.

    I’d like to see regulators push companies harder. Interestingly I think this will help the firms.

    PS. Auditors should only ever provide advice on controls – gaps, options and opinions – as only management should ever design and implement controls. I went back to evaluate what management had ultimately done (hence the comment re having to call it out again). The point is, i think the word consulting is used too laterally and some care is needed. It means different things to different people.

  8. Big 4 Guru
    Big 4 Guru says:

    The best comment I heard in the whole Booz acquisition was, “Nobody’s paid this much for booz since the prohibition”. But in all seriousness, great post!

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