'World has changed' for accounting firm Ernst & Young

August 4, 2003

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A year ago, the Sarbanes-Oxley Act created an entirely new system for regulating accountants, an attempt to transform them into better watchdogs who could prevent the kind of massive financial scandals that pummeled investors in recent years.

Stunned by the public outcry against auditors and the flurry of shareholder lawsuits and regulatory probes, major accounting firms have been struggling since then to reshape themselves. They have improved training for auditors, backed away from some types of businesses and started to craft new kinds of relationships with clients.

A look into the operations of one of the influential Big Four accounting firms, Ernst & Young, illustrates that a number of changes in the audit process are working as lawmakers had hoped. Ernst partners say that in disputes with clients, the partners have more clout with client boards of directors. Some partners say corporate executives are more willing to share details about complex deals than in the past. And most clients have agreed to pay for more extensive audits.

Ernst's experience also reflects how difficult it can be to try to shift gears in a mammoth company at a time when new rules are not yet written, key court cases have not been decided and scandals keep erupting. One partner said the ongoing news coverage of Ernst's troubles makes him sick to his stomach. Others resent that the firm has to give up business they consider legitimate, because of negative publicity.

Ernst partners are braced for the news to get worse. Congressional hearings in September will examine Ernst's audit of troubled HealthSouth, and the SEC staff is trying to get Ernst barred from accepting new public clients for six months because of its relationship with a software company in the 1990s.

Meanwhile, partners say that as audits get tougher, more problems will be uncovered, and they fear the accounting profession will get the blame for not catching the problems sooner rather than the credit for catching them now. Auditors have come to be seen as “silent accomplices” because they failed to uncover corporate fraud, investor advocate Patrick McGurn said. The nation's other three major accounting firms, PricewaterhouseCoopers, KPMG and Deloitte & Touche, are also under scrutiny for at least one high-profile audit failure each.

“Investors right now are having a tough time putting a wall between the past and what's going forward,” said Beth Brooke, vice chairman of Ernst. “What's problematic is, for the next 12 months probably we're going to see more cleansing in the marketplace.”

Clients, meanwhile, are jittery, making frequent calls to their auditors. In the past, accountants generally reviewed financial records a few times each year to prepare the annual report and filings with the Securities and Exchange Commission. Ernst partner Jim Logothetis said he now hears from directors and corporate managers who want to run practically everything with numbers past him — quarterly reports, press releases and documents prepared for important meetings.

Working for a major accounting firm these days feels like being a piñata, said Mark Weinberger, the head of Ernst's tax practice and a former Treasury Department official. He tries to reassure rattled younger employees that this will pass, that Ernst is just the current “flavor of the month.”

But some Ernst partners remember how Arthur Andersen officials assumed that the firm's problems were temporary until a federal indictment last year sent its clients fleeing and caused the accounting powerhouse to quickly collapse.

Some partners said they think often about Andersen's fate. They said they were amazed that during Andersen's criminal trial, prosecutors pointed to the fact that top Andersen auditors accompanied Enron leaders on golf outings and trips to sunny conference spots as supposed proof the auditors were too cozy with their clients.

One Ernst partner said he started worrying that if he were ever deposed, a plaintiff's lawyer might look at his appointment book and point to weeks of lunches with a client. He wondered if a jury would see that as evidence that he failed to be a tough auditor. He has started insisting that he split the lunch check with his clients.

“In the old days you used to think it'd be great to be so experienced, knowing the client's business,” said Susan Frieden, Ernst vice chairman for quality. “It used to be terrific to have a good relationship with your client, so they would talk to you and tell you a lot of things. The world has changed. Perceptions have changed.”