Big Audit Leaves Russia – Or Does It?

Ties were severed with an ease, and speed, that suggests auditor global networks may be more fragile than advertised.

We’ll only know with the judgment of history whether the large global accounting networks’ readiness to separate from their member firms in Russia had any impact whatsoever on the political and economic outcome of Russia’s invasion of Ukraine. For now, as Churchill described the actions of Russia in 1939, “it is a riddle wrapped in a mystery inside an enigma.”

Two weeks into the increasingly bloody morass of Vladimir Putin’s “special military operation,” however, there can be these observations:

  • The largest six networks (as of this writing) have acted to join an ever-expanding list of firms and companies, public and private, choosing the right side of history by withdrawing from Russia.

  • Which said, the accounting networks’ structures and the nature of the Big Audit model –- both differing fundamentally from those of the world’s largest corporations and the lawyers, consultants and other professional service providers – mean that in actual practice the impact is likely to be minimal.

  • Once beyond the immediate optics and a modest amount of house-keeping, the ease and speed with which these amputations were carried out suggest that future distress scenarios should be seen as dire.[1]  

Grant Thornton led on March 1, and then the terminations came raining down –- PwC and KPMG, EY, Deloitte as the last of the Big Four, and BDO on March 9. The pack of red cards lagged business cessation announcements by McKinsey, Apple, Nike, and a partial but growing list of the large law firms, although ahead of giants in the consumer sector — McDonalds, Coca-Cola and Starbucks — and lately even bankers Goldman Sachs and JP Morgan Chase.

Their public face was one of collegial amiability; if couched as divorces, they would anticipate future reconciliation or re-engagement. EY’s press release offered comfort that the “EY global organization assured that it would provide assistance to Russian employees.” PwC Russia put it that, “This transition is expected to be smooth and the PwC Global leadership team has stressed that it would make every effort to support our Russian colleagues and firm through the process.”  

Looking ahead, the tone of the announcements fairly brimmed with confidence:

  • PwC stated that, “The principles and rules of working with clients in Russia will remain unchanged.”

  • Over at EY, “EY Russian practice is providing and will continue to provide services to all its clients in accordance with high quality standards based on international methodologies developed by the global organization, which will continue to provide methodological support to Russian practice.”  

The basic organization of the large networks portended the up-beat tone. As well enough known but seldom scrutinized, they are assemblages of distinct and separate legal entities, organized and providing client services at the local country level to comply with the local nature of the profession’s regulation. They are, for the most part, various types of private partnerships, owned by their local partners who share profits and losses at that level. They do not have outside third-party capital, a corporate “parent,” or a top-level “holding company,” although most have some form of non-practicing administrative entity that is inserted into a complex web of inter-firm contractual agreements to facilitate the handling of intellectual property, methodology sharing, quality oversight, personnel transfers and the like.

Very little need change to maintain the status quo. Daily life at both the newly-outcast Russian firms and their quondam colleagues ex-Russia will evolve in ways that are both marginal and limited. That’s especially as compared to the disruption being caused by outside forces, as the array of Western sanctions on companies and individuals both Russia-based and doing business there looks expansive, targeted, and significant.

Those effects, however, would befall the accounting networks and firms whether the Russian members were in or out.

  • Employees of the newly-isolated Russian firms will continue to work the same jobs, at the same locations and under the same leaders as before.

  • The fortunes of the Russian partners will continue to depend on their on-going local practices –- although as noted, impacted by Western sanctions –- but not radically different from under the large networks’ localized compensation ethos of “eat-what-you-kill.”

  • Change management will be trivial. Clients and other interested parties will have received the news of the Russian firms’ status almost instantaneously. With marginal effect in the marketplace, the firms’ publicity resources will be occupied briefly with revised branding announcements, re-labelled publications, website re-designs and the issuance of new business cards.

Nor is there any reason to doubt the limited nature and scope of the impact on the execution of Big Audit engagements. For these, there are two aspects:

  • An audit firm in Russia, engaged by a client based there and having international operations, would always have relied on its collegial network member firms to perform any necessary non-Russia work. That need will continue, although under the global-level assurances of on-going cross-border amity, it will be uninhibited by the cosmetics of separation (while, as noted, very possibly affected by the sanctions regimes).

  • Symmetrically, the auditor of a non-Russia company with operations in Russia will have relied traditionally on its member firm there to audit and report on the local results. Again, going forward (and noting that the audits of companies exiting or halting their Russian business may now have to address the accounting for operating losses or discontinued operations), the local Russian firm would presumably be available to be engaged at arm’s-length — deploying its personnel and relying on the non-Russia referring firm to provide technical consultation and methodology guidance, just as a large network has always done to secure services in a country where it might not have its own network member.          

So far, very likely all well and good, if lacking in drama — save for this: when the violence has ended, and the dust of the Russo-Ukrainian conflict has settled, both literal and figurative, a dark and subtle message lurks beneath the surface.

Consider that the large audit networks have thrived on messages emphasizing the scope and strength of their international structures, and their capacity at scale to deliver seamless and efficient services to the participants in the global capital markets.

Those messages have persisted, despite an emphatic signal delivered in 2002, when the Arthur Andersen network collapsed in a matter of weeks. This occurred even though it was the most profitable and tightly-organized, with its partners enjoying the only globally integrated results-sharing model in the profession’s entire history. 

Which is to say — the largest six networks have now shown the capacity to surgically excise their Russian member firms, voluntarily and in a matter of days. That suggests — under-cutting the messaging of network unification as robust and tightly-bound (and shifting metaphors) — that the “ties that bind” may only be attached with slip-knots, or are spun of gossamer, able to being broken or snipped in an eye-blink by the scissors of exigent events.

I have long argued that the under-appreciated lesson in Andersen’s precipitous fall was that, far from being “too big to fail”, the surviving Big Four tetrapoly is “too fragile to survive.”[2]

That every one of these large networks was able to cut loose a member firm of significant size, swiftly and without obvious discord or repercussions, does not inspire confidence that a similar fate would not befall an organization under the stress of a government sanction or a litigation judgment at a level — easily foreseeable, given the size of recent well-known corporate failures — that would threaten the limited depth of its capital structure and its individual partners’ resources.

Modifying network structures that have included Russian member firms, over to on-going relationships with now free-standing Russian local firms, should work smoothly enough, considering the size of the Russian economy in an overall global context. Tightly knit as are the activities of the companies and the sources of capital that make up the large western economies, however, the case would be far different should a large network be forced to lose a local firm in, say, a G-7 country or a handful of others.  

That prospect is worthy of a discussion, when a post-wartime context allows, that deserves to be held explicitly and in full public view.

[1] By way of disclosure, my legal practice has for five decades been focused on the accountants. I was a partner in the Arthur Andersen worldwide organization and a senior member of its in-house legal group until the spring of 2001, and continue with on-going relationships both personal and professional.

[2] Please see, for example, my book, “Count Down: The Past, Present and Uncertain Future of the Big Four Accounting Firms” (Emerald Books 2d ed. 2017, pp. 45-64).

This is a guest entry from Jim Peterson, an American lawyer whose practice focuses on financial and accountancy related issues, and who is a 19-year veteran of Arthur Andersen’s in-house legal group. He launched his column, “Balance Sheet” in the business section of the International Herald Tribune in 2002 – evolving to his blog, “Re:Balance”.  

For more about this subject see an excellent summary of the issues, “Why the Big Four’s Russia Pullout Isn’t a Clean Break: Explained,” by Amanda Iacone and Michael Kapoor.

© Francine McKenna, The Digging Company LLC, 2022

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