Legal Liability

06/04/2010

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Legal Liability
I usually spend two class periods discussing auditors’ legal liability. On the first day, I explain through lecture and examples the auditor’s liability to clients and third parties under common law and statutory law. On the second day, we discuss a specific lawsuit against an auditor. For several years, I assigned my students to read Cottrell & Glover’s CPA Journal article describing the Phar-Mor suit because it provides the best analysis I have found of an actual jury trial. The article outlines the legal issues in dispute, the evidence offered by the shareholder plaintiffs, and the defenses attempted by Coopers & Lybrand. More recently, I have assigned the Heilig-Meyers case, which requires students to analyze a lawsuit filed by shareholders against Deloitte & Touche following Heilig-Meyers’ bankruptcy.

I like to spend the last 20 minutes of the second day discussing proposals to limit auditors’ legal liability. Stephen Taub’s CFO.com article describes one such proposal. Rob Lewis’s AccountingWeb.com article suggests that some sort of cap is necessary if the big accounting firms are to survive. Geiger et al.’s JAAP article warns that limiting auditors’ liability may hurt audit quality.

Articles:
“Auditors Beware: Key Factors Can Lead to Lawsuits,” James H. Thompson and Earnestine S. Quinn, Business Forum (Summer/Fall 1996): 22-28. This article provides a good overview of auditor liability to clients and third parties under common law and statutory law.

“The Harder They Fall: Will the Big Four Survive the Credit Crunch?” Rob Lewis, AccountingWeb.com (October 1, 2008). The six largest accounting firms face 27 outstanding lawsuits seeking damages in excess of $1 billion, including 7 suits exceeding $10 billion.

“SEC’s Hewitt: Indemnify the Big Four,” Stephen Taub, CFO.com (January 26, 2007). SEC chief accountant Conrad Hewitt wants Congress to limit auditors’ liability to investors and creditors; fears losing one or more of the Big Four through litigation.

“Audit Engagement Provisions Raise Queries,” David Reilly, Wall Street Journal (March 6, 2006): C1+C3. Accounting firms ask clients to sign engagement contracts promising to forego punitive damages and settle disputes through arbitration rather than litigation. Some critics argue that such provisions impair auditor independence.

“Finding Auditors Liable for Fraud: What the Jury Heard in the Phar-Mor Case,” David Cottrell & Steven Glover, CPA Journal (July 1997): 14-21. Investors and creditors of failed retail giant Phar-Mor sued Coopers & Lybrand claiming the auditors violated Section 10(b) of the Securities Exchange Act of 1934. This article summarizes the plaintiffs’ allegations and the defendants’ defenses.

Cases:
“The Rise and Fall of Heilig-Meyers,” Paul Clikeman, Journal of Accounting Education (December 2005): 215-231. The second part of this two-part case requires students to analyze a lawsuit filed by shareholders against Deloitte & Touche following Heilig-Meyers’ bankruptcy.

“Brodnax Minerals Company: A Case Study on Auditors’ Responsibilities,” John Reisch, Issues in Accounting Education (November 1999): 589-612. Students conduct a mock trial to resolve litigation between external auditors and shareholders who lost billions of dollars as a result of a massive fraud.

Research Studies:
“Using Financial and Market Information to Identify Pre-Engagement Factors Associated With Lawsuits Against Auditors,” J.D. Stice, Accounting Review (July 1991): 516-533. Lawsuits against auditors are more frequent when: inventory and accounts receivable are high as percentage of total assets, the client’s financial condition is poor, the market value of the client’s stock is high, and the variance of the client’s abnormal stock returns is high.

“The Effects of Client Characteristics on Auditor Litigation Risk Judgments, Required Audit Evidence, and Recommended Audit Fees,” Jamie Pratt & J.D. Stice, Accounting Review (October 1994): 639-656. Auditors appear to gather more evidence when they perceive a high risk of litigation. And auditors appear to charge a “premium” for high-risk audits over and above the cost of performing additional audit procedures.

“Auditor Decision-Making in Different Litigation Environments,” Marshall Geiger, K. Raghunandan & D.V. Rama, Journal of Accounting and Public Policy (May/June 2006): 332-353. The legal protections provided by the Private Securities Litigation Reform Act of 1995 appear to have made Big Six auditors less conservative in their going concern reporting decisions.
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Competitive Environment

06/04/2010

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Competitive Environment
I like to spend some time talking about the market for audit services because many people believe the competitive environment affects audit quality. There is wide disagreement, however, about whether the current market for large company audits is too competitive or not competitive enough.

Some critics complain that audit quality suffers because of cutthroat competition among the big accounting firms. Partners are afraid to stand up to clients for fear of being replaced. Clients engage in “opinion shopping” to find the most permissive auditor. Auditors submit “low-ball” bids to win new clients and then reduce testing to make a profit.

Other critics complain that audit quality suffers because the “Final Four” auditing firms comprise a collusive oligopoly. Clients, especially those in specialized industries or located in smaller cities, have difficulty replacing a deficient auditor. The remaining firms have become “too big to fail” and no longer fear indictment from a Justice department that does not want to create a “Big Three.” PCAOB chairman William McDonough once called the question of splitting up the Big 4 “the single most difficult issue in public policy in this area” (“SEC Weighs a Big Three World,” Wall Street Journal, 6/22/05).

Articles:
“Advisory Services Rise Again at Large Audit Firms,” R. Mithu Dey, Ashok Robin & Daniel Tessoni, CPA Journal (August 2012).  The Big Four are rebuilding their consulting divisions, selling services to private-equity firms and non-audit clients.

“Second-Tier Auditing Firms: Developments and Prospects,” R. Mithu Dey & Ashok Robin, CPA Journal (June 2011). This article discusses the revenues, growth, productivity, and industry specialization strategies of second-tier firms Grant Thornton, BDO Seidman, Crowe Horwath, and McGladrey & Pullen.

“Financial Reform and the Big 4 Audit Firms,” Bernard Ascher & Albert Foer, American Antitrust Institute Working Paper No. 10-01 (January 2010). Because of their importance to the capital markets, the Big 4 have become “too big to fail.” This paper describes how structured divestitures could be used to reduce industry concentration.

“Audit Committees Rubber-Stamp Management Choice,” Edward Teach, CFO.com (October 24, 2007). Interviews with 30 Big Four managers and partners reveal that client management – not the audit committee – is the “driving force” in appointing and dismissing auditors.

“Firms’ Auditor Choices Dwindle,” Diya Gullapalli, Wall Street Journal (June 21, 2005): C1+C3. More than half of large corporations employ two or more of the Big Four accounting firms. Clients in smaller cities or specialized industries have difficulty switching auditors.

“We Need More Than the Big Four,” Edward Nusbaum, Wall Street Journal (January 25, 2005): B2. Chief executive of Grant Thornton discusses the dangers of industry concentration in public accounting.

“Small Firms Exit Auditing,” Carrie Johnson, Washington Post (August 27, 2003): E1. Small accounting firms resign from public clients rather than comply with Sarbanes-Oxley.

“GAO Warns on Future Problems From Audit-Industry Mergers,” C. Bryan-Low & J. Weil, Wall Street Journal (July 31, 2003): C11. GAO report warns that industry consolidation could limit clients’ choices and lead to higher audit fees. Difficult to discipline accounting firms without hurting clients.

“Big Accounting Firms, Striving to Cut Costs, Irritate Small Clients,” Lee Berton, Wall Street Journal (April 21, 1994): A1-A5. This article is a bit dated, but provides a good reminder that public accounting is a service business and auditors must keep the client happy.
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Marketing

06/04/2010

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Marketing
My students, who have been exposed to 8 gazillion advertisements since infancy, cannot comprehend that there was ever a controversy about allowing public accounting firms to advertise. They don't understand why Lee Berton thinks advertising is unprofessional (Chicago Sun-Times, 1/13/03). And they just look puzzled when I tell them I was deeply ashamed when my former firm, Deloitte, published full-page ads bashing Arthur Andersen (Wall Street Journal, 2/26/98). I try to explain that there is nothing inherently unethical about advertising, but accountants need to exercise restraint to avoid undermining their own credibility as mudslinging politicians and victim-trolling lawyers have done.
 
Articles:
“Revitalizing Your Firm’s Marketing Strategy,” Gordon Andrew, Journal of Accountancy (July 2011): 40-44. This article offers advice for developing and implementing a strategic marketing plan.

“Marketing and Advertising for CPAs: Leading-Edge Strategies,” Mary Kay Copeland, CPA Journal (August 2010): 58-62. This article offers advice for websites, social networking, customer relationship management, blogs, seminars, direct mail, and media advertising.

“Deloitte Tries a Different Sales Pitch for Women,” Erin White, Wall Street Journal (October 8, 2007): B1+B6. Deloitte & Touche trains its employees to sell services to female clients.

“Grant Thornton Battles Its Image,” Diya Dullapalli, Wall Street Journal (June 6, 2005): C1+C2. Grant Thornton picked up 1,000 new clients and increased revenue 30 percent, but cannot break into the Fortune 500.

“Accounting Firms Face Backlash Over the Tax Shelters They Sold,” Cassell Bryan-Low, Wall Street Journal (February 7, 2003): A1+A7. Accounting firms had elite sales groups who targeted wealthy clients. Partners faced “pressure to sell things that would be in your best interest rather than the client’s.”

“Advertising Has Hurt Accounting’s Ethics,” Lee Berton, Chicago Sun Times (January 13, 2003). Accounting firms spend $100 million per year on advertising. Critics fear that the “business side” of accounting firms has taken over the “professional side.”

“Deloitte Stops Pulling Punches in Assault on Consulting Rivals,” Sally Goll Beatty, Wall Street Journal (February 26, 1998). Deloitte received heavy criticism for publishing full-page advertisements reading, “Andersen Consulting: Distracted by Infighting. Deloitte Consulting: Focused on our Clients.”


Research Studies:
“Professional Accounting Services: Types of Marketing Communications Used by CPAs,” Kenneth Heischmidt, John Elfrink & Betsy Mays, Services Marketing Quarterly (2002): 63-72. A study of CPA firm advertising practices finds that accountants favor print advertisements and web pages over other forms of advertising.

“Public Accounting: Marketing a Changing Profession,” Dee Ann Ellingson, Arthur Hilter, Dennis Elbert & John Gillett, Services Marketing Quarterly (2001): 63-79. This article describes changes in accounting firms’ marketing practices since 1993.

 
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Audit Fees

06/04/2010

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Audit Fees
Audit fees pose a no-win dilemma for public accountants. When fees are high, critics worry that auditors lack the backbone to stand up to their lucrative clients. When fees are low, critics complain that auditors can’t possibly be spending enough time to perform a proper audit (“Fannie Paid Little for Audits,” Wall Street Journal, 10/6/04).

Sarbanes-Oxley, passed in response to numerous alleged audit failures, had the unintended consequence of enriching the nation’s auditing firms. Ten years later, clients are using the fee disclosures mandated by the SEC in 2000 to comparison shop and negotiate price concessions from their auditors (“Auditing Your Auditor,” CFO, April 2010).

Articles:
“Auditing Your Auditor,” Tim Reason, CFO (April 2010): 26-42. Audit fees are down in 2007/2008. Proxy statement disclosures enable clients to benchmark fees. 82% of auditor changes are initiated by the client.

“Ups and Downs of Audit Fees Since the Sarbanes-Oxley Act,” J.T. Ciesielski & T.R. Weirich, CPA Journal (October 2006): 28-35. Examines changes in S&P 500 audit fees between 2001 and 2004.

“Audit Fees Are on Rise as Companies Pony Up,” Diya Gullapalli, Wall Street Journal (March 25, 2005): C3. Big clients paid 40% more for audits in 2004.

“Fannie Paid Little for Its Audits,” Jonathan Weil, Wall Street Journal (October 6, 2004): C1. KPMG received only $2.7 million for Fannie Mae’s 2003 audit. Low audit fees raise questions about whether auditors are performing sufficient testing.

“Audit Fees Swell After Scandals, New Law,” M. Krantz, USA Today (May 6, 2003): B1. S&P 500 audit fees rose 27% in 2002. The increase was attributed to reduced competition after Arthur Andersen’s demise and more hours required to comply with Sarbanes-Oxley.

Research:
“Corporate Audit Fees Up? Beware of Trouble Ahead,” Nanette Byrnes, Reuters.com (October 9, 2011). Three academic studies find that audit fees substantially higher than those paid by competitors of similar size are strongly associated with future operating declines, stock price drops, and credit rating downgrades.



 
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Public Accounting Careers

06/04/2010

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Public Accounting Careers
About 75 percent of my students begin their careers in public accounting. Students are quick to perceive (or imagine) bias, so I try to talk about public accounting in general without mentioning specific firms. Dale Marxen’s Accounting Horizons article is 15 years old, but I think it contains some good insights that are still appropriate for people entering public accounting today.

I encourage all students planning to begin their careers in public accounting to explore the web sites and blogs listed in the Links section of this website and pick a couple to read at least weekly.

Articles:
“The Factors that Affect Accountants’ Decisions to Seek Careers in Big 4 versus Non-Big 4 Accounting Firms,” Penelope Bagley, Derek Dalton & Marc Ortegren, Accounting Horizons (June 2012): 239-264. Accounting students who plan to seek jobs with Big 4 firms place higher value on firm prestige. Those who plan to seek jobs with non-Big 4 firms place more emphasis on firm atmosphere and work-life balance.

“Flex Time Flourishes in Accounting Industry,” Steven Greenhouse, New York Times (January 7, 2011). Public accounting firms provide work-life balance and flexible schedules for their employees.

“PwC Pays for Priority,” Joe Walker, Wall Street Journal (October 4, 2010). All the Big Four firms use social networking sites to recruit employees. PwC pays LinkedIn millions of dollars to get top billing in job listings.

“Campus Recruiting: What Local and Regional Accounting Firms Look for in New Hires,” George Violette & Douglas Chene, CPA Journal (December 2008): 66-68. This article describes the campus recruiting process and claims that local and regional accounting firms look for candidates who demonstrate leadership potential, strong communication skills, and high levels of enthusiasm and motivation.

“Accounting for Good People,” The Economist (July 21, 2007): 68-70. Big Four firms are trying to reduce turnover so they can grow despite shortage of new accountants. More programs to retain women and maintain good relations with alumni.

“S-Ox Creates Special Demand,” Sarah Needleman, Wall Street Journal (May 16, 2006): B8. Demand is growing for information-technology auditors. Salaries are increasing and more candidates are taking the Certified Information Systems Auditor (CISA) exam.

“Take This Job and … File It,” Diya Gullapalli, Wall Street Journal (May 4, 2005): C1+C6. Audit firms have much more work because of Sarbanes-Oxley. Employees are leaving because of overwork.

“The Big 6 Experience: A Retrospective Account by Alumni,” Dale Marxen, Accounting Horizons (June 1996): 73-87. This article, which presents data gathered from structured telephone interviews with 121 Big 6 alumni, is dated but still provides a few valuable insights for people entering public accounting. Respondents report what they liked and disliked and what they would do differently if they were beginning their careers over again.

“What Does It Take to Be an Auditor?” William D. Hall, Journal of Accountancy (January 1988): 72-80. A timeless essay that is still worth reading even though it was written before today’s students were born. Emphasizes that auditors need more than technical knowledge of accounting and auditing standards.
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