After the Global Financial Crisis almost a decade and a half ago, many were calling for a restructuring of the obviously conflicted auditing profession. But as so often happens in such matters, lobbyists for the status quo ensured this sensible idea got buried in committees.
Now, partly through costly exposure for its partners to fraud at Steinhoff and Tongaat, the suggestion of a split is being considered by Deloitte. The exclusive report below by our partners at the WSJ suggests the firm could follow fellow Big Four member EY by hiving off its audit practice.
Whether that would solve the real problem is a moot point. While firms still rely for payment from those they audit, the obvious conflict will remain. For instance, Steinhoff’s fraud was due to Deloitte’s inability to spot the real reason why CEO Markus Jooste insisted a small German firm audited the European operations.
___STEADY_PAYWALL___Jooste argued that as this firm had worked for founder Bruno Steinhoff since the company’s inception, if Deloitte insisted on changing that, it would be the one to go. Until Deloitte Europe got involved after Steinhoff’s Frankfurt listing, the firm played ball. Just like other fee-seeking auditors have done for decades. And, until their remuneration is restructured, are sure to do continue doing in future.
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WSJ Exclusive: Deloitte Explores Splitting Auditing, Consulting Arms, Following EY
Deloitte would be second Big Four firm to divide the businesses, potentially spinning off consulting arm
By Jean Eaglesham and Corrie Driebusch of The Wall Street Journal
Deloitte is exploring a plan to split its global audit and consulting practices, following an effort by fellow Big Four accounting firm Ernst & Young to potentially spin off its consulting arm, according to people familiar with the matter.
The moves would mark the biggest shake-up in the accounting industry in decades, handing windfalls to tens of thousands of the firmsâ partners and creating two new consulting giants and two stripped-down auditing firms.
Deloitte reached out to investment bankers at Goldman Sachs Group Inc. after news broke of rival EYâs potential world-wide split, the people familiar with the matter said. Goldman and JPMorgan Chase & Co. are advising EY on its possible restructuring, the people said.
The Deloitte talks are still at a very early, exploratory stage, according to one of the people familiar with the matter.
After the initial publication of this article, a Deloitte spokesman denied the firm was exploring a plan to split. âWe remain committed to our current business model,â the spokesman added.
EY believes a split would allow its rapidly growing consulting side to more easily acquire new clients, without the constraints that restrict the ability of the firms to sell consulting services to their auditing clients.
Regulators world-wide have been increasingly concerned about conflicts of interestâwhether auditors, which are supposed to scrutinize a companyâs books, will go easy on clients that buy lucrative consulting services from them. In the U.S., the Securities and Exchange Commission is investigating potential breaches of independence rules by the Big Four, The Wall Street Journal has previously reported.
The remaining EY mostly audit business, which would likely remain as a partnership, would be freed of at least some of these potential conflicts. But it would be a smaller, slower-growing business, potentially leaving it vulnerable to lawsuits and making hiring tougher.
KPMG and PricewaterhouseCoopers, the other members of the Big Four, say they will stick to their existing approach of offering consulting and tax services alongside the bread-and-butter audit work. A KPMG spokesman said in a statement the firm remains âcommitted to our multidisciplinary modelâ and hasnât talked to banks about a split-up. PwC last month said that it had âno plans to change courseâ from its current approach.
Any Big Four shake-up wonât happen fast.
EY expects it will take at least another 18 months or so to complete any spinoff of its consulting arm, as it scrambles to finalize its strategy for a possible world-wide split following an early leak of its plans, according to people familiar with the matter.
The firm intends to put a formal proposal by mid- to late summer to its roughly 12,000 partners, who own the firm and will need to vote to approve the selloff, the people familiar with the matter said.
If EY does decide to split, the most likely option is an initial public offering of its consulting arm, according to people familiar with the matter. The firm hasnât ruled out the alternative of a private sale. But the scale of the businessâcombined consulting and tax revenue of $26 billion in its last financial yearâputs it out of the reach of most private-equity firms, the people familiar with the matter said.
Deloitteâs consulting side is bigger still. The firmâs consulting and tax businesses between them generated close to $40 billion of revenue globally in the year that ended in May 2021, compared with $10.5 billion from its audit work. Deloitte sold its U.K. restructuring business to consulting firm Teneo Holdings LLC last year.
âThe biggest question is âhow much money would this deal put in the pockets of the remaining audit partners?â If they canât sell the consulting arm for enough to generate sufficient cash for the partners, theyâre not going to vote to approve it, itâs as simple as that.â
â Lynn Turner, former SEC chief accountant
To gain approval for its plans, EY needs to win over most of its partners in each of the roughly 140 countries that make up the firmâs international network.
Its ability to do that may rest on the size of the price it can get for the consulting business, which will support the payouts it can offer to partners, accounting industry observers said. The size of those windfalls is expected to vary depending on partner seniority, with those closest to retirement likely to get the most.
âThe biggest question is âhow much money would this deal put in the pockets of the remaining audit partners?ââ said Lynn Turner, a former SEC chief accountant. âIf they canât sell the consulting arm for enough to generate sufficient cash for the partners, theyâre not going to vote to approve it, itâs as simple as that.â
As well as getting partners in different business lines and locations on board, EY will need to negotiate the split with regulators world-wide that oversee the audit industry, according to the people familiar with the matter. The last time EY spun off its consulting arm, with its sale to Cap Gemini Group SA of France for 11 billion euros, worth about $10.8 billion at the time, in the early 2000s, it took about a year to get SEC approval, according to a person familiar with the matter.
Regulators will want assurance the selloff wouldnât make EY more vulnerable to an Arthur Andersen-style implosion, should the firm be hit by a massive lawsuit.
A mostly audit firm could be financially viable, said Derryck Coleman, director of research analytics at data provider Audit Analytics. Strict independence rules in the U.S. and many other parts of the world mean the big accounting firms no longer appear to be subsidizing their audit fees from the consulting side, he said. âThe audit practices of each of the Big Four should be able to stand on their own,â Mr. Coleman added.
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