The Little Guys Doing Large Audits

Cheaper, more attentive second-tier firms are scoring clients off the Big Four

When the board of directors of Hercules Inc. (HPC ), a $2 billion Wilmington (Del.) chemicals company, decided earlier this year to reconsider who should audit their books, they took bids from three of the Big Four accounting firms. The incumbent auditor, PricewaterhouseCoopers (PWC), was among those competing. That the big firms would be in the running for Hercules' account is not a surprise. It has operations scattered throughout the U.S., Europe, and Asia.

But when the bidding ended, the winner was a name you might not expect: BDO Seidman. One of the "Tier Two" accounting firms, BDO booked just $365 million in U.S. revenue in 2004, vs. PWC's $6 billion. And with 25,000 employees around the world, compared with PWC's 112,000-person network, it can't match its rival's manpower. Still, BDO convinced Hercules' board that it could make decisions faster and that its chemical industry experience would help it do a good job at a good price. "There was a sense that we would be important to BDO, that there will be top management attention if we have problems," says John K. Wulff, Hercules' nonexecutive chairman.

For years, the big international accounting firms -- PWC, Ernst & Young, Deloitte & Touche, and KPMG -- had a lock on companies with $1 billion in sales or more. But more and more of these companies are now eyeing the four second-tier firms, especially Grant Thornton, the fifth largest with more than $700 million in revenue last year, and BDO at No. 6. Reasons vary. Many companies, like Hercules, initiate a shift in a search for better service, a lower bill, or both.

In other cases, though, big accounting firms are resigning because they need their manpower to focus on their largest, most profitable clients. The requirements of the Sarbanes-Oxley Act have increased the number of hours required for a typical audit by more than 30%, and there is a shortage of qualified auditors to take up the slack. The Big Four, says Jonathan Hamilton, editor of the Public Accounting Report, "had to shed clients that in a perfect world they would like to keep."

The result: According to proxy advisory firm Glass, Lewis & Co., 238 companies with revenues of $100 million-plus switched auditors in 2004, up from 115 in 2003. The winners have been the second-tier firms. But within that group, none has outdone BDO. According to Glass Lewis, BDO gained 71 new clients in 2004, after factoring in gains and defections. Grant Thornton, McGladrey & Pullen (No. 7), and Crowe Group (No. 8) gained 46 such clients combined.

All of the Big Four, meanwhile, posted significant net losses in their client rosters. Not every company, of course, is a good candidate for a second-tier auditor. Companies with worldwide operations still need the Big Four's unparalleled geographical coverage. "That's why General Motors is not in the picture for us," says BDO Chief Executive Jack Weisbaum.

Among the second-tier, what sets BDO apart? For one thing, the firm has deep expertise in areas such as shipping, retail, and apparel. That has helped it do a better job of holding onto existing clients than other second-tier firms. BDO gained 109 new clients and lost 38 last year, while Grant Thornton gained 80 and lost 63.


Both BDO and Grant Thornton are growing well. On Aug. 15, BDO will report $440 million in U.S. revenue for its fiscal year ended June 30, a 21% increase over last year's $365 million. Grant Thornton's revenue climbed more than 30% last year and is likely to be up close to 30% again in 2005. Edward E. Nusbaum, Grant's CEO, says the firm has won 50 new public company clients so far this year.

Historically, one of the top reasons the BDOs of the world could never capture the large-cap market was the objections of analysts and investment bankers who argued that a Big Four auditor was important to investor confidence. So when Hercules made its move, Chairman Wulff says that managers worried they might hear boos from Wall Street. But that hasn't happened. One cheerleader is Deutsche Bank (DB ) analyst David Begleiter, who raves that "it's positive, actually. It's saving a lot of money."

By Nanette Byrnes in New York

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