Top-tier auditors dumping smaller clients
But lately, it seems you've been drifting apart. He can't do as much for you as he used to, even if he wanted to, and you can't support him in the style to which he's become accustomed. Maybe now you're both looking for different things.
Yep, it can be tough when accounting firms dump their clients.
In recent months, top-tier auditors have dropped dozens of small- and mid-sized public companies — many in the tech sector — from their client rosters. The purge began last year, in response to the greater scrutiny and added workload mandated by the Sarbanes-Oxley corporate reform legislation, and has picked up speed this year.
As the Big Four accounting firms try to minimize risk and maximize their fees per client, new opportunities have opened up for smaller national or regional firms. The snubbed companies, though, can suffer bouts of fiscal separation anxiety.
"You're always somewhat disappointed to find out you're no longer wanted as a customer," said David Mickelson, chief financial officer of Redhook Ale Brewery. The Woodinville-based brewer learned in July that Ernst & Young, which had audited Redhook's books for its entire 23-year corporate history, was resigning the account.
"There were no hard feelings at all, but it's never fun," Mickelson said of the seven weeks it took to line up Moss Adams as Redhook's new audit firm.
As of last week, the Big Four (Deloitte & Touche, Ernst & Young, KPMG and PricewaterhouseCoopers) had resigned this year from 152 corporate audit accounts nationwide, according to Seattle Times examination of data from Audit Analytics, a Massachusetts-based market-research firm. At this point last year, the Big Four had resigned from just 103 accounts.
Other Northwest-based companies to lose auditors this summer include Cell Therapeutics, Insightful and Loudeye (all of Seattle), Portland-based Rentrak, and Extended Systems of Boise, Idaho.
Sarbanes-Oxley is spur
Resignations jumped in the wake of the Sarbanes-Oxley Act of 2002. The landmark statute, passed after the Enron fiasco and financial scandals at several other big companies, rewrote much of American securities law and changed the auditor-client relationship in several ways.
Auditors were barred from providing many kinds of consulting services to their audit clients; other non-audit services were allowed, but only with prior approval of the audit committee of the client's board of directors. In many cases those non-audit services — information-systems consulting, tax advice and the like — had been far more lucrative than the audits themselves.
Auditors also were given increased responsibilities for reviewing clients' internal financial controls, and they now report primarily to the boards' audit committees, not to top management.
Big Four accountants and industry observers say Sarbanes-Oxley — along with the stunning collapse two years ago of Arthur Andersen, after massive fraud was uncovered at its client Enron — has forced firms to take a harder look at which clients are worth keeping.
"Firms are trying to reduce their risk profile," said Gary Sundem, an accounting professor at the University of Washington Business School. A given client, he said, "may be profitable up front, but there's a probability of a huge payout down the road if something goes wrong,"
Dan Hollingshead, managing partner in the Seattle office of PricewaterhouseCoopers, said his firm and others hold their clients to higher standards than before.
"Some of the resignations you see around the country are directly concerned with the willingness of [a client company's] management and directors to respond to the public-company environment we're in today," Hollingshead said. "If companies choose not to respond appropriately, we don't want them as clients."
Accountants, like lawyers, seldom talk publicly about their clients. But sometimes regulatory filings hint at why a company might resign an account.
In June, Ernst & Young quit as the auditor for Insightful, a small software company. While Ernst cited no disagreements with Insightful on accounting principles, in SEC filings the company disclosed that Ernst had "observed deficiencies in the design or operation of our internal controls" that, if not corrected, could raise doubts about the accuracy and completeness of Insightful's financial reports.
Four days after Ernst resigned, so did Insightful's chief financial officer. The company missed the SEC's deadline for reporting its second-quarter results and, until it hired a new CFO and retained Moss Adams as its new audit firm, was briefly threatened with delisting from the Nasdaq. (Both Insightful and Ernst declined to comment for this story.)
The training ground
No such turmoil accompanied Ernst's departure as Redhook's auditor. But Mickelson, the brewer's CFO, said he had noticed a lot of turnover in the Ernst auditors assigned to Redhook. ("You have to train people somewhere," he said.)
He also noted that the international firm — whose fiscal 2003 net revenue was $5.3 billion — got just $97,500 for auditing Redhook's books: "I know our annual billings weren't that material compared to some of their larger clients."
The major accounting firms are much more likely to walk out on smaller clients than big ones, according to data from Auditor+Trak, a research firm in Atlanta.
"It doesn't mean they're bad clients," said Julie Lindy, editor of Inside Public Accounting, an industry journal. "It just means they're not on the Big Four's priority list right now. They're putting much more resources into their core market, which is the Fortune 1000 companies."
Of the Northwest companies whose auditors dropped them this summer, only one, Cell Therapeutics, had total audit and non-audit fees exceeding $1 million last year. By contrast, Boeing paid Deloitte & Touche $21.7 million last year — $16.3 million of that for auditing services alone.
"There's a much stronger emphasis on profitability across the board," Lindy said.
That's particularly true given that resources at accounting firms have been stretched thin by the new rules.
"What was a 5,000-hour audit this year might be a 7,000-hour audit next year because of Sarbanes-Oxley," said Art King, managing partner of Moss Adams' Seattle office.
Regulators concerned
If Big Four firms have to trim their client rosters, Lindy said, it's not surprising that they'd concentrate on their larger clients — especially since firms no longer can rely on fat consulting contracts to bulk up their revenues.
However, the sharp rise in resignations this year has drawn concern from federal regulators.
Last month Donald Nicolaisen, chief accountant for the Securities and Exchange Commission, told Bloomberg News that Sarbanes-Oxley "should not be a convenient tool for (audit firms) to manage their business."
"I've expressed my view to the CEOs of the big firms that I think it is their responsibility not to run away from the marketplace," Nicolaisen said in the interview. "They do have a responsibility in the public trust."
Drew DeSilver: 206-464-3145 or ddesilver@seattletimes.com