Sarbox Pendulum Starts to Swing the Other Way, Just a Little

Mark Olson, Chairman of the Public Company Accounting Oversight Board (Peekabo) recently made a speech where he laid out four key principles to reduce the burden of Sarbanes Oxley on US public companies.

It should be noted that Andersen, one of the Big 5 at that time had an important part in the saga that eventually led to the Sarbanes-Oxley Act to restore investor confidence and address serious gaps in the U.S. regulatory framework. What this meant was that an increased need to bolster internal controls over financial reporting...essentially ensure that company managers told the truth. Also corporate governance responsibilities for boards of directors, external auditors increased.

Another Sarbanes-Oxley fallout: the end of self-regulation by public auditors and institution of PCAOB as an independent oversight body, which has registered more than 1,700 accounting firms since Jan 2003.

And of course, the infamous Section 404, requires public companies annually to provide investors an assessment of their internal control over financial reporting (or ICFR) with quarterly management certifications, annual management assessments of controls, and independent auditor attestations

Has Section 404 worked? Certainly it has. Very few large corporations have gone bankrupt since Enron for fraudulent financials and fewer CEOs have gone to jail. Bolstered by this set of events, the pendulum seems to be swinging the other way just a little: too much perceived costs (fattening auditors, Sarbox consultants, IT implementers et al) and perhaps less than equivalent benefit.

So the PCAOB decided on May 17, 2006, to amend their standards. According to Olsen, these are the guiding principles:

First, the PCAOB plans to propose changes to make the standard simpler to read, easier to understand and more clearly scalable to companies of any size. At the same time, by emphasizing core principles, the new proposal is expected to focus auditors on the areas of greatest importance.

Second, the PCAOB is critically evaluating every area of the audit to determine whether the existing standard encourages auditors to perform procedures that are not necessary to achieve the intended benefits of the audit.

Third, the PCAOB plans to propose changes that would make explicit in the standard the PCAOB’s past guidance on how to make internal control audits as efficient as possible.

Fourth, the proposal should emphasize the importance of a company’s control environment, and how it can impact the risk of financial reporting fraud or other material failure, in order to focus auditors on what really matters, which is identifying material weaknesses in a company’s system of internal control before those weaknesses result in material misstatements in the company’s published financial statements.

Practicality, simplicity and cost control are becoming the guiding principles for the new standards: companies should focus on the higher-risk elements and need not spend a bundle of cash to be in compliance.

Take for example the increased number of new IPO listings outside the US to avoid Sarbox compliance costs. PCAOB claims that this trends stems from the new listings of state-owned enterprises which are naturally non-US and prefer to list in their home jurisdictions.

We believe that we are now settling into a new, perhaps more relaxed regime of corporate governance since the penalties for malfeasance are extraordinarily high (take a look at the recent option scandal, where many CEOs lost their jobs). Companies take reporting and governance seriously and may need less over-the-top in-my-face standards and likely incorporate the moral code in their DNA and thus need lesser cost-heavy regulation but a softer hand with a heavy stick.

Mr. Mark Olson's speech is available here http://www.pcaobus.org/News_and_Events/Events/2006/Speech/10-17_Olson.aspx

Cap Gemini SA (EPA:CAP) PreAnnounces Q3-2006, Buys KanBay

Cap gemini SA (EPA:CAP) announced today that its Q3-2006 revenues of 1.881 billion Euros grew 13.5% over the same quarter last year Q3-2005 (1.674 billion), but 1.9% lower than the previous quarter Q2-2006 (1.915 billion Euros).

Outsourcing boomed at 20% growth and Consulting grew 9.4%, indicating the Cap Gemini' SAs recent push into outsourcing is paying off and customer demand continues strong.

Europe and Asia Pacific grew 15.4% while North America grew 5.4%. UK and Ireland grew at a stunning 29.2%

Clearly the good times are rolling for Cap Gemini SA (EPA:CAP) .

Cap Gemini SA (EPA:CAP) also announced a $1.25 billion purchase of Chicago-based Kanbay (NASDAQ:KBAY) paying a 15% premium and securing 7,000 IT professionals. The combined company will have 16,000 professionals in India.

Markets did not care much for this news, sending the Cap Gemini SA (EPA:CAP) stock down 4.4% in trading. Kanbay went to $28.60 per share, rising 14%.

Andersen's Nemesis, Jeff Skilling is Served Due Justice

The wheels of justice grind slowly, but they meted out a just sentence on Jeff Skilling, the former Enron CEO, one of the few people responsible for Andersen's dramatic collapse and foreever changing the accounting firm landscape by reducing the Big 5 to the Big 4.

Jeff Skilling was sentenced Monday to more than 24 years in prison. The U.S. District Judge Sim Lake, in handing out the harshest sentence yet in the Enron saga, said Skilling's crimes "have imposed on hundreds if not thousands of people a lifetime of poverty."

He allowed Skilling to remain out of jail, but mostly confined to his home with an electronic monitor on his ankle. Skilling also has to pay $45 million in restitution to Enron investors. Skilling, was "disappointed" by the verdict but would appeal the 19 criminal counts against him.

In his comments, Skilling was remorseful for what happened at Enron, but maintained he had committed no crime. "The company did not have enough dry powder to deal with it. That, in sum and substance, is what happened in Enron," he said.

Enron and Andersen employees were severely affected.

So now Skilling can serve the Big 24, and repent his wrondoings.

Grant Thornton Revenue Up 22%, Double the Big4 Rate

Grant Thornton LLP (GT), the U.S. member firm of Grant Thornton International, says that its US revenues climbed 22% from $726 million to $886 million in the fiscal year ending July 31, 2006. This follows a 29% increase from $562 million in 2004 to $726 million in 2005.

GT has a full 10% higher than the annual sales increase of Deloitte and Touche LLP (12.5%) and Ernst and Young LLP (10%). In 2005, GT ranked 7 out of 100 in Accounting Today's list of Top 100 firms.

The firm also landed 3,400 projects and 200 new clients in addition to starting a new Recovery and Reorganization practice, a Healthcare practice and acquiring Stout Risius Ross Inc. of Farmington Hills, MI. The client base grew from 1,800 to 2,000, so the volume contributed by new clients is approximately 11% of the 22% sales growth, the balance 11% is likely additional services provided to existing clients.

Surprisingly, GT provided NO further financial details on its release, but highlighted some qualitative achievements. We understand that accounting partnerships are by nature quite tight lipped and reluctant to provide any information beyond the bare minimum. DT and EY at least told us where the overall growth was along service lines, practices and geographies. But this total lack of detail does not allow for any comparison with other firms on any dimensions.

All we can say is that GT grew much faster than its larger competitors, which indicates that they are getting proportionately a lot more business this year than the Big4. The gap between GT and the smallest of the Big4 is billions of dollars, so there is no impending threat for the mega firms. But, GT is clearly capitalizing on opportunities that the Big 4 are either not seeing or do not prefer to see. Companies are slowly widening their horizons beyond the Big Four and the large number of new clients which GT has acquired is indicative of this trend. Two years of 20% + growth are catapulting this mid-level firm with revenues of ~$500 million very rapidly to a ~$1 billion dollar regional powerhouse in 2007 if current trends continue.

Some notable achievements....

SEC proposed Section 404 changes --GT believes that these provisions should be given a chance to work through collaborative fine-tuning. In the process of "getting it right," it is vital to make sure that new guidelines protect investors without unduly burdening companies with excessive costs.

Increased transparency in reporting auditor change -- GT urged the SEC to revise 8-K rules to require reasons for all company dismissals of auditors, for all auditor resignations and for all instances in which the auditor chooses not to stand for reappointment.

Section 199 -- GT submitted comments to the United States Treasury Department and the Internal Revenue Service on the Section 199 Proposed Regulations.

Working Mother 100 Best Company -- The 100 Best recognizes Grant Thornton for creating a corporate culture that encourages the retention and advancement of women.

BusinessWeek 50 Best Places to Launch a Career -- GT landed the No. 34 spot

IDG's Computerworld -- Named Grant Thornton LLP as the No.5 Best Place to Work in Information Technology.

Etc. Etc.

Deloitte and Touche LLP Revenue Up 12.5% in 2006

Following strong results from Ernst and Young LLP, Deloitte and Touche LLP also announced solid performance with growth across services, sectors and practices.

Deloitte Touche Tohmatsu Worldwide Member Firms recently reported US$20 billion aggregate member firm revenues for fiscal year 2006, up 11.5% from 2005.

Financial advisory grew 20%, consulting grew 17% and tax was up 12%.

Financial services industry grew 21%, consumer business grew 20% and manufacturing grew 16%.

According to Deloitte, FY2006 was the fourth consecutive year of double-digit revenue growth and the 13th consecutive year of growth.

North America grew 12.5%, Central and South America grew 24.1%, Europe grew 10%, CIS was up 63% and Asia Pacific/Japan grew 11%

For 2007, Deloitte predicted even stronger revenue growth of 12.5%

Deloitte expects more consolidation and change within professional services is likely as mid-sized firms strengthen their capability and capacity, so as to expand their base of globalizing clients.

New Accounting Networks: Can They Compete with the Big4?

Baker Tilly USA

If you have never heard of this firm, it may begin to crop up shortly in US corporate circles. Baker Tilly is one of the top 10 accounting firms in the UK, and now making news by creating Baker Tilly USA with a new business model.

Baker Tilly USA will be a national network of 22 mid-size accounting firms aiming to act as a single firm and trying to effectively compete with the Big4. The network plans to offer tax, audit and consulting services under one name and 8,000 employees.

Clearly the Big4 firms dominate the accounting space, especially all the top public companies in the US, who have traditionally chosen these firms for their name, capabilities and international scope. Firms like Grant Thornton, McGladrey Pullen and
BDO Seidman make up the rear-guard behind the Big Four, taking mid-size regional clients who are not interested or fall off the Big Four radar screen.

Will Baker Tilly work?

The incumbent Big Four firms have formidable positions having been trusted advisors for years and can win just by sheer size. That’s not to say that companies are not switching audit firms, but typically from one firm to another. These network firms, if they can effectively combine processes, cultures and capabilities can present one single face to the client, they at least have some chance of winning. Even the second-tier firms have had a tough going getting marquee companies to switch away from Big Four.

The proof will of course be in the pudding. If a large public company switches out of the Big Four and goes to a network firm, then that is a clear victory, and if this happens more than often, we could call the networks a good competitor to the Big Four. Or perhaps they will become tough players against the second-tier.

Is there more to come?

According to the Washington Post, three other accounting firm networks are preparing to introduce alternatives: Moores Rowland North America, the Leading Edge Alliance and Moore Stephens North America

New landscape

All said, we think we are seeing the beginnings of a new trend in the accounting industry. Consolidations, mergers and partnership mash-ups are going to show up in larger numbers and accelerate as well. The landscape is going to rapidly change and these will begin to take more mind-share of financial news and the growing attention of media. We will be reporting more of this as it happens and the impacts on the industry

How do the Big 4 Firms Rank in the Fortune 500?

Accenture (NYSE: ACN) came out 379th in the recent international Fortune 500 2006 ranking. In 2005, Accenture just made the cut with a rank of 455 out of 500.

Accenture's (NYSE: ACN) revenue of $17.1 billion and profit of $940 million makes it rank 3rd in the Computer Services and Software industry behind Microsoft and Electronic Data Systems.

Accenture (NYSE: ACN) is sandwiched between Hindustan Petroleum (rank 378) and Lear Corporation (rank 380)

Where would the Big Four firms place on the Fortune List based on their revenue? We estimate their ranking as below. PwC would come out in the 300s with over $20 billion, followed by Deloitte and Touche at rank 323 and Ernst and Young at rank 352 and Accenture at 379. The last one making the cut is KPMG at rank 430. The others did not even make the cut...

PricewaterhouseCoopers
2005 revenue: $20.2 billion
Rank: 321

Deloitte and Touche
2006 revenue: $20.0 billion
Rank: 323

Ernst and Young
2006 revenue: $18.4 billion
Rank: 352

Accenture (NYSE: ACN)
2006 revenue: $17.1 billion
Rank: 379

KPMG
2005 revenue: $15.7 billion
Rank: 430

CapGemini
2006 revenue: $9.8 billion estimated
Rank: Not in Fortune 500 Ranking

BearingPoint (NYSE: BE)
2005 revenue: $3.6 billion approx
Rank: Not in Fortune 500 Ranking

Andersen Alum Moves to Top of UnitedHealth Group, Inc. (NYSE: UNH)

The options scandal has made astonishing inroads into Corporate America affecting tons of executives and toppling CEOs. Companies which have backdated options to benefit senior managers have become investor targets, subject to SEC investigations and generally become poster childs for how hidden white collar crime is rampant in public corporations.

One such company is UnitedHealth Group, Inc. (NYSE: UNH) where Bill McGuire, the CEO resigned today in face of intense criticism and pressure.

Coming to the CEO position is Stephen Hemsley, the current Chief Operating Officer, an Arthur Andersen alum and ex CFO of the accounting firm. Corporate life takes bizzare turns and now a Big 4 alum has become the leader of a Fortune 50 firm, actually 37 in the Fortune 500 with $45 billion in sales.

UnitedHealth Group, Inc. (NYSE: UNH) stock is at the lowest level of the year, and now we have to see what Mr. Helmsley can do with the company...we will be watching!

From the UnitedHealth Group, Inc. website, here is a brief bio of Mr. Helmsley:

Mr. Hemsley previously was managing partner, strategy and planning, for Arthur Andersen and Company and headed the firm's technology activities and knowledge initiatives. He was a member of the Andersen Worldwide and Arthur Andersen Executive Committee and Executive Council, the Chairman's Advisory Council and Partner Income Committee. In addition, Mr. Hemsley served as chief financial officer for Arthur Andersen. He had been with that organization for 23 years.

Should BearingPoint Remain Public?

Credit ratings agency Moody's recently downgraded BearingPoint (NYSE: BE)'s ratings from B1 to B2, and put them on watch for further potential downgrade. The agency took note of
the firm's year-to-date cash outflows, due to finance and accounting systems costs and of course the inordinate delays in filing its 10-K and last but not least the huge employee turnover seen in Q2 -2006. These ratings are considered speculative.

As we said before, BearingPoint (NYSE: BE) will be further delaying filing its financials and estimated performance far below previous projections.

Now not only investors but also creditors will be on watch, and if performance does not match expectations not only will the stock take a hit but its debt costs will continue to increase.

BearingPoint's troubles are not over yet, and it is facing the worst situation for a public company: disappointed investors and creditors. The turnaround is taking longer than anticipated and there is a constant stream of tough news, including a recent suit from bondholders.

We ask a difficult question: Should BearingPoint continue as a public company? Can it handle all the pressures of periodic reporting, stakeholder scrutiny and continue to operate without transparent financials? Can we speculate that the private equity boom will impact BearingPoint (NYSE:BE), make a tender offer for the entire company and take it private? Away from the public eye, the firm can focus on the longer-term and fix its situation with bolder moves. Operations appear to be strong and there are contracts still flowing in, so the situation is not desperate but fixable. We will wait and see what develops, but conjecture that something like this has a good possibility to occur.

KPMG Europe LLC: New Entity for a New Pan European Landscape

The European Commission’s Eighth Directive legislation (the EU's effort to increase investor confidence, like the US Sarbox) , which allows cross-country ownerships in accountancy firms had its first impact today. KPMG becomes the first to take advantage among firms representing global accounting networks.

KPMG LLP reported today that it UK and Germany member firms will be merging into a single entity, KPMG Europe LLP, which will remain a member firm of KPMG International and have revenues of £2 billion - the largest fully integrated accountancy firm in Europe. The firm will be a new UK registered LLP with 17,000 partners and staff in 44 UK and German offices and HQ in Frankfurt.

Why is KPMG LLP doing this? It appears to be a part of a mega-plan to create a fully integrated KPMG LLP member firm in Europe with the hope that other KPMG member firms in Europe will soon join this behemoth.

KPMG Europe LLP will be chaired jointly by John Griffith-Jones, currently Chairman of KPMG LLP (UK), and Prof. Rolf Nonnenmacher, currently Chairman of the Managing Board, KPMG Deutsche Treuhand-Gesellschaft AG. Both UK and German boards have blessed the merger, now pending ratification from UK and German partners in December 2006.

Clearly this "innovative and ground-breaking move" was done both in response to changing external environments and the need to be proactive in face of increasing regulation in Europe.

First, size creates strength, and ability to withstand monetary shocks and regulatory retributions. Consider that KPMG is reeling under a $456 million fine in the US for inappropriate tax shelters, the pain is lessened over a larger number of partners.

Second, clients, investors and capital markets may benefit as Euro-spanning companies can engage a single firm in UK and Germany.

Third, Europe is increasingly becoming the exchange of choice to list for many companies which do not wish to deal with onerous Sarbanes Oxley measures in the US, and the larger public companies may prefer larger Euro audit firms with pan-European presence.

Most importantly, KPMG is reacting quickly to massive European regulatory changes. The European Commission’s Eighth Directive legislation clarifies the duty of statutory auditors and sets out certain principles to help ensure their objectivity so that investors and other interested parties can rely on the accuracy of audited accounts. Europe is quickly going the way of the SEC and PCAOB with increasing oversight, and financial fines on misbehaving firms.

The rest of the press release is just motherhood: increased strength, more opportunities for their people, increased investor confidence etc. etc.

Clearly, this is a first shot in Europe and is bound to set off a wide variety of large and small scale mergers across the Big Four firms, and we will soon begin to see rumblings or actual actions from the other audit firms: DT, EY and PwC. We shall be watching the changing landscape as it quickly changes from the current state.

The 8th Directive is available here: http://eur-lex.europa.eu/LexUriServ/site/en/oj/2006/l_157/l_15720060609en00870107.pdf

Ernst & Young LLP Financial Results: Strong Growth in Emerging Economies

Ernst & Young LLP recently released its 2005/2006 fiscal year results (year ending June 30, 2006) worldwide revenues rose 10% in local currency terms to a total of $18.4 billion. E&Y is the first among the private accounting firms to report results, and it does appear that times remain good and growth is rampant in areas outside North America and Western Europe. We will look for other accounting firms to report in the next few months and watch how they differ from these results.

Transaction Advisory Services (TAS) led the charge, growing at 16% and reflecting the boom in global Mergers and Acquisitions activity.

Assurance and Advisory Business Services (AABS), the traditional public audit services grew 11%, driven by continuing demand for Sarbox, internal audit and specifically risk services.

Tax Services grew only 6% "against a background of continuing regulatory and legislative reform". This is surprising as Tax has always been a strong growth leader and reflects the challenges and fallouts from the ongoing KPMG litigation on use of inappropriate tax shelters.

The global picture shows that emerging economies' revenues surged, especially in Asia, Pacific and Indian SubContinent. Growth in developed countries was below the global average, here are the numbers:

9% in the Americas
19% in Northern Europe, Middle East, India and Africa
6% in Central Europe
7% in Continental Western Europe
14% in the Far East, Oceania and Japan

Ernst & Young LLP also said, "While our "mature" markets continued to perform well, we achieved stellar growth, of between 25% and 55%, in the emerging-market economies in which we have made strategic investments,"

China Aims for Big Ten in Ten Years

We hear that the Chinese finance ministry wants to develop at least 10 full-fledged accountancy firms in the next ten years. The policy: “bigger, stronger, self-reliant”. The goal: be capable of providing comprehensive audit services of world standards in order to reduce reliance on foreign firms, especially the Big 4. These 10 firms would be able to operate internationally and support local Chinese companies which plan to internationalize. Further, 100 medium-size firms would concentrate on the domestic market…..current firms are actively encouraged to merge to create economies of scale.

All this in a draft policy paper recently released for industry comment by the Chinese Institute of Chartered Accountants (CICPA). Concerns abound that any weakness in domestic accounting infrastructure and issues with reliability of corporate accounts may impede effective formation of deep capital markets. Currently the Big 4 firms dominate the Chinese companies listed overseas, and only about 70 of China's more than 5,000 accounting firms are even permitted to audit listed companies.

"Any problems encountered . . . must be promptly and effectively resolved," the policy says. Further, it shows up the lack of experienced accountants and issues a need for for the development of 1,000 "senior professionals able to handle globalised services".

Another example of how the Chinese government is setting policy, deciding industry structure and dictating how the market should behave. It has been very successful in other sectors, so we would expect full compliance in the accounting area too. If this were to materialize, the Big4 are going to have a tough run for their Remimbi in the future.