THE BIG SIX ARE IN BIG TROUBLE
Recently, a financial-services company planning to go public approached KPMG Peat Marwick, one of the Big Six accounting firms, about doing an audit. As a precaution, Peat's own investigators checked the company out. When they discovered an outside investor in the concern had served jail time for violating securities laws 17 years earlier--a detail underwriters had missed--Peat turned the company down.
These days, accountants can't be too careful. Their firms--indeed, the entire profession--are under siege. As the dragnet for culprits in the financial debacles of the 1980s continues, accountants face claims of more than $2 billion in damages, and regulators are preparing lawsuits demanding millions more. Private litigants are suing, too. Most of the Big Six firms face or have settled cases involving major financial hits (table). The impact of these actions could extend to Corporate America: Some companies may be unable to get a competent auditor.
CHOSEN FEW. Accountants are not the only litigation targets. Government regulators shocked lawyers recently by extracting $41 million from the prestigious New York law firm of Kaye, Scholer, Fierman, Hays & Handler for its role in the $2.6 billion failure of Lincoln Savings & Loan Assn. But the actions against accountants could be far more devastating. While thrift failures involved hundreds of law firms, most of these institutions were audited by one of the Big Six.
The ability of these firms to take blow after blow is in question. Insurance premiums for the Big Six have soared tenfold since 1985, while maximum coverage has been cut in half. Settlements in the range of $20 million to $30 million, which are common, are not fully covered by insurance. For some firms, premiums and legal costs eat up to 25% of what would otherwise go to partners.
Some experts believe that one or more Big Six firms could fall in the next few years. In 1990, Laventhol & Horwath, a second-tier firm facing $2 billion in claims, went out of business. "This is the biggest crisis the profession has faced in its history," declares John W. Hill, assistant professor of accounting at Indiana University.
SUIT FITS. In response, firms are trying to guard against future shocks. Sources say Ernst & Young will audit only banks that receive regulators' highest ratings. Another major firm will not take on government-securities dealers. Others avoid or carefully screen small companies, which are often the target of lawsuits when they fail to meet investors' expectations. Firms are especially leery of companies that have fired auditors. Warns Peat Marwick partner Michael Conway: "There will be some companies that cannot get an audit at any price."
If the ranks of accounting continue to shrink, and if the profession shies away from new audits, it would raise profound questions about the system of independent auditing that the Securities & Exchange Commission and investors have relied on for nearly six decades. The alternative would be government auditors--a prospect that nearly everyone dreads. "It's in the best interest of shareholders that we have a viable accounting profession," says James A. Kaitz, a vice-president of the Financial Executives Institute, which represents financial officers of 7,000 companies. "A weakened accounting profession is not to anyone's advantage."
Critics contend that many of the profession's wounds are self-inflicted. When the buyout-and-merger craze of the 1980s shrank the client pool, critics say, Big Six firms sometimes turned a blind eye to questionable activity to hold on to business. "Accountants didn't cause the S&L crisis," acknowledges Representative Ron Wyden (D-Ore.). "But had they sounded enough alarms for regulators, taxpayer losses could have been significantly less."
Accountants respond they are being used as scapegoats by bureaucrats trying to shift the blame away from regulatory lapses and by investors searching for deep pockets to cover their losses. Auditors say they must rely on information from management, which is sometimes faulty. When there is fraud, "auditors are as much the victim as the public," says Wayne W. Smith, a partner at Gibson, Dunn & Crutcher, a Los Angeles law firm that represents Deloitte & Touche. But, he concedes, "people are not very forgiving of auditors."
BIT PLAYERS. To fend off future litigation, accountants are lobbying state legislatures for laws limiting plaintiffs to suing partners only in the office where an audit was performed. And they are pushing Congress for a law to limit liability to a firm's degree of responsibility. Now, auditors may have to foot the entire bill, even if they were bit players when their client folded. Deloitte &Touche is part of a group that is being sued for $200 million by Lincoln S&L's bondholders, although Deloitte came aboard only five months before regulators seized Lincoln and had not conducted an audit.
Accountants are also trying to get their own house in order. Last year, the 300,000-member American Institute of Certified Public Accountants voted to require auditors to state unambiguously whether they had "substantial doubts" about whether a client could continue as a going concern for the following 12 months. And last summer, the group banned members from accepting loans from financial institutions they were auditing. That move came weeks after the SEC filed a complaint against Ernst & Young alleging that it had filed misleading audits for Dallas' RepublicBank. The action claimed the firm was compromised by $21.8 million in loans the bank had made to Ernst partners.
Housecleaning may help forestall future claims. But the Big Six will have their hands full for some time dealing with nasty allegations from the past.A BARRAGE OF BIG HITS
COOPERS & LYBRAND One defendant in $300 million lawsuit by Florida regulators
alleging Coopers, as auditor for Guarantee Security Life Insurance Co., failed
to detect "phantom" transactions. Coopers is contesting the charges
ERNST & YOUNG Defendant in an SEC complaint asserting that predecessor firm
Arthur Young filed misleading audits at Texas-based RepublicBank. The SEC says
Young compromised its independence. Ernst & Young is disputing the suit
ARTHUR ANDERSEN Agreed to pay up to $30 million to settle investor claims from
the collapse of Lincoln Savings & Loan Assn. Andersen last year settled similar
federal charges that could cost up to $25 million
DELOITTE & TOUCHE One defendant in a California insurance regulators' suit
charging fraud and negligence in the audit of Executive Life Insurance Co.,
which collapsed from junk bond investments. Deloitte is contesting the charges
KPMG PEAT MARWICK Target of a $100 million suit by Resolution Trust Corp.
alleging misleading audits of failed Pennsylvania thrift, Hill Financial
Savings Assn. Peat says its 1988 audit cited problems with Hill's financial
Dean Foust with Tim Smart in Washington