Last August, Daniel Cargile, president and chief executive officer of Tehama County Bank, based in Red Bluff, Calif., took a call from a partner at Ernst & Young, a Big Six accounting firm that had been auditing the bank's books. Cargile thought he had little to worry about. His bank was doing fine and had lots of excess capital, which was why he was startled to learn the reason for the call. E&Y didn't want to audit the bank anymore. "As we say around here, our accountants fired us," Cargile says.
Cargile and his bank handily survived the rejection, which E&Y won't discuss as a matter of policy. But lots of banks are getting phone calls similar to Cargile's. With growing regularity, major public accounting firms are turning their backs on many smaller banks, thrifts, and fledgling companies. Deloitte & Touche, for one, declined to audit about 60 companies trying to go public last year, more than half the 103 initial public offerings they actually evaluated.
There's no mystery about the reason. In recent years, accounting firms have been forced to fork over hundreds of millions of dollars to settle lawsuits brought by investors, the government, and others claiming a company's auditors were negligent. Just last November, Ernst & Young agreed to pay the government $400 million to settle claims that its audits of hundreds of thrifts had been inadequate. And accountants are almost routinely sued when they're involved with an IPO that goes sour. "Liability risk has gone so far, it's not worth the risk to audit some small companies, real estate ventures, financial services companies, IPOs, and small banks," says Lawrence A. Weinbach, CEO of Arthur Andersen & Co. "The risk-reward trade-off is out of whack."
DEEP POCKETS. Accountants are doubly nervous because of the laws on joint and several liability. Those laws say any one defendant may be liable for the entire loss sustained by the plaintiff in a court case, even though other defendants contributed to the loss. Accountants usually bear a small portion of the blame but often have to pony up the biggest slice of the damages because they typically have deeper pockets than other defendants. Even worse, since the Big Six firms are private partnerships, an individual partner is personally liable for all debts and legal judgements incurred during his or her stay at a firm.
Becoming choosier may make sense for auditors, but it's often hard on companies. Daniel Cargile says he is pleased with his new auditors. Other companies, though, may find they have to deal with smaller firms less used to assessing their industry and may not be getting audits of the caliber that they--and their investors--need. It's also embarrassing for companies to lose their accountants, because it suggests something may be wrong with the books. And companies trying to go public may have a tougher time of it, since Wall Street likes the imprimatur of a major CPA firm. "I don't think the public is served well by this," says Robert L. Gray, executive director of the New York State Society of CPAs.
The current attitude of the Big Six is a radical change from the 1980s, when they fell all over themselves to land clients, big and small. At Deloitte & Touche, the word went out last June that audits of IPOs had to be O. K.'d by the firm's head office. "Our aversion to risk is greater than our appetite for growth," says J. Michael Cook, CEO of Deloitte & Touche. KPMG Peat Marwick partner Jeffrey J. Sands says his firm looks for more references from attorneys, bankers, and investors and conducts more background checks before it will take on a new client. "If we thought twice before about taking on a new client, we'd think three times now. You'd prefer not to be the accountant when the thing goes over the edge."
Even when accountants agree to work with a company, they may charge more to audit companies in potentially hazardous industries, in part because the audits take more time. "There is a premium to risk," says Enrique M. Tejerina, a partner at KPMG Peat Marwick. "There are more requirements the bank and thrift clients have to fill with our help." Higher prices sometimes drive away business. Condev Land Growth Funds in Winter Park, Fla., says it left KPMG Peat Marwick when it found an Orlando accounting firm willing to do the same work for 35% less.
NEW RULES. Some clients are taking more aggressive steps. Codenoff Technology Corp. in Yonkers, N. Y., actually fired KPMG Peat Marwick in December because, it says, the firm was charging too much--$67,000 for an $8 million company. A KPMG Peat Marwick spokeswoman says the firm does not comment on individual clients, but adds that many variables affect audit pricing. Industry sources say some companies have sued auditors that dropped them as clients.
New federal regulations being drafted for bank and thrift audits could exacerbate the problem. In addition to normal audit work, accountants will have to evaluate managers' assessments of their banks' internal controls and compliance with laws on bank safety and soundness. "They're frustrated because it's increasing their liability," says Donna Fisher, manager of accounting policy for the American Bankers Assn. "Any time they do additional work, there's the risk they'll be held liable."
Thrift audits have already become more elaborate. "Our auditing costs go up every year because the Office of Thrift Supervision asks for more," says the president of one New Jersey S&L. Even though her company has several times as much capital as the thrift regulations require, she is concerned about being left out in the cold: "I wouldn't want to be having to look for an auditor now, I'll tell you that."
With the bean counters looking out more for themselves than their clients these days, her worries are likely to become even more widespread.
WHY ACCOUNTANTS ARE BOWING OUT: FEAR OF LAWSUITS Accounting firms auditing small banks, fledgling companies planning public offerings, and other popular litigation targets have had to pay hundreds of millions of dollars to settle claims alleging that their audits didn't uncover financial problems LOW PROFITS Though such clients require unusually intense scrutiny, they are often unable to pay accounting firms enough to make the business worthwhile REGULATORY REQUIREMENTS Under new rules covering bank audits, accountants must conduct much more detailed examinations DATA: BW