The Securities & Exchange Commission is finally getting around to disciplining the auditors who played supporting roles in some of the biggest corporate disasters in modern time. In mid-August, it banned two PricewaterhouseCoopers accountants from auditing public companies after they failed to follow audit rules in reviewing the books of software company Micro-Strategy Inc. and conglomerate Tyco International (TYC).
But in both cases, key players appear to have dodged the SEC hammer. The agency didn't pursue other senior partners who signed off on the audits. And it hasn't brought charges against PwC itself, despite citing the firm or one of its auditors for improper conduct three times in the past three months. Moreover, a PwC spokesman says the firm continues to employ the Tyco accountant and stands behind the audits he oversaw from 1997 to 2001.
The mild punishment raises a troubling question that has lurked ever since last year's collapse of Arthur Andersen: Are the surviving Big Four accounting firms now too few to be allowed to fail -- and effectively beyond regulators' reach? Any severe, firmwide sanction, such as a one-year ban on auditing public companies, could put an accounting firm out of business. That would only strengthen the ever-growing concentration of the Big Four. Already, their market dominance threatens to make unworkable an idea the SEC is studying to boost auditor independence -- requiring companies to rotate audit firms every five years.
Regulators face a conundrum. They must carry a big stick but not use it to drive any of the remaining big players out of business. The SEC and the new Public Company Accounting Oversight Board (PCAOB), which shares accounting enforcement with the SEC, must foster competition, even if it means asking Congress to open the federal purse to subsidize small firms' expansion.
This doesn't mean SEC officials don't want to be tough. "We can't expect audit firms to correct deficiencies if there's no firmwide penalty after a string of failures," says a top agency official. Yet Andersen's failure shows how carefully they must tread. All but a handful of Andersen clients took their business to one of the remaining four: PwC, Deloitte & Touche, Ernst & Young, and KPMG. A July 30 General Accounting Office report says that businesses audited by the Big Four now account for an astounding 99% of all public-company sales. "It's a national problem," admits SEC Chairman William H. Donaldson. "We're concerned about the long-term implications."
SEC Enforcement Director Stephen M. Cutler won't say what's next in the PwC case but insists he's "determined to pursue firmwide sanctions." If so, he'll need to be creative. Already, the agency is experimenting in a case against Ernst & Young for allegedly violating rules preventing audit firms from going into business with the companies they audit. SEC lawyers are seeking to prevent E&Y from accepting new clients for six months. E&Y is fighting what it considers a draconian punishment. Beyond such temporary suspensions, the agency is also going to have to impose hefty financial penalties for the auditors to feel pain.
Fostering competition will be harder. The Big Four dwarf the rest of the profession: Annual revenues of the 20 next-largest firms combined don't equal the $3.2 billion in U.S. sales of KPMG, the smallest of the Big Four. It could take a decade for one of the second-tier firms to graduate to the bulge bracket by merging, opening new branches, and hiring the staff needed to attract a large corporate client.
To boost competition, the federal government could subsidize overseas expansion of the non-Big Four by awarding them audit contracts at, say, Defense Dept. installations. At the same time, the SEC could encourage large foreign accounting firms to compete for U.S. business, a step that Donaldson says "should be a great opportunity" for them. The sooner he sends out the invitations the better. By Paula Dwyer