With the demise of Lehman Brothers, Ernst & Young’s $31 million annual fee just went out the window. It’s a tiny amount in the scheme of things when you think that EYs last year’s global revenue came in at $21.1 billion. The bigger problem will be the lawsuit PwC’s advisors Linklaters are almost certain to dump in the firm’s lap. Here’s why.
It has now become routine for insolvency advisors to sue the incumbent audit firm at distressed companies. In EY’s case, there is plenty of collateral evidence in the firm’s 2007 global review that EY set its stall out as a firm that not only understands the world of capital markets, but is assiduous in its pursuit of conservative asset valuation policies. It doesn’t take a $1,000 an hour lawyer to work out that those claims are so far removed from reality as to be tantamount to misrepresentation of the most egregious kind. At least that’s what I would expect lawyers to say. Check out these statements:
We’re bringing the right level of financial skepticism to critical areas such as fair-value determinations, reserving, off balance sheet structures, and liquidity. We’re requiring consultation without professional practice leaders on significant of unusual matters. We’re focusing attention on events that occur in these volatile markets subsequent to the date of financial statement. And we’re carefully reviewing client disclosures for timeliness and transparency. (Chairman’s Q&A page1)
As a profession we are very aware that when we are performing an audit we are working for the owners of the business – the investors – and not the management. And so we see it as our responsibility to engage with out stakeholders , and to speak out and provides leadership on important public policy natters affecting the capital markets. Chairman and CEO Jim Turley (Chairman’s Q&A page 6)
Curiously of all the Big 4, EY is the least transparent. Apart from top line revenue, it is nigh on impossible to discover how many partners the firm has. Neither is it possible to accurately estimate profit per partner. The closest we can get on the profit front goes back to 2000 and a NYT article which disclosed partner share at around $400,000 based on revenues of $10 billion. A simple doubling up doesn’t work.
On the people and revenue front, the Big Four Alumni blog estimates:
Ernst and Young does not appear to report the breakdown of these by ranks. Our estimate for Ernst indicates that its partner ranks grew by 7.1% and professional staff grew by 16.4%. It seems that Ernst was certainly more active than the other firms in the labor marketplace and more likely to extend offers.
Revenues per partner for the Big Four firms also increased substantially as partner ranks increased much slower than revenues. Each partner sold on the average $2.81 million in 2007.
Taking an average profit margin of 35%, that puts average industry partner profit at something around $983,000. How much of that is held back in reserve is another matter. None of these figures gets us close to the EY reality but they serve as vague waymarks. Francine McKenna has some market data but the picture remains cloudy for individual firms. What we do know however is the way EY is organized. From the same article by Francine:
All partners participate in a single pool of earnings.
Turning to the question of litigation and once again, per Francine who quotes from the FT in 2007:
“…audit firms have limited resources and have rarely settled lawsuits for more than $200m.”
Earlier today, US legislators were arguing the toss over a financial services rescue package amounting to $700 billion. Lehman’s third quarter losses alone were reported at $3.8 billion. It is now in a firesale situation.
Given all of the above, I can see lawyers going after EY globally. You participate in a single pool – that means everyone gets hammered when the lawsuits start flying. I hate to say it but when Francine predicted that one of the Big 4 might collapse it seemed plausible but deeply worrying. At the time, Francine and I discussed this issue in considerable depth, concluding that it would take a catastrophic event to bring another of the Big 4 down. In August, James Peterson declared in reference to the ostrich posturing among the Big 4 that:
It will take courage beyond that shown so far, for a Big Four chief executive to inform his partners that their business model is broken, and requires replacement for the sake of future survival.
If not, hindsight will charge the profession’s current leaders, whose state of public denial still avoids that difficult step, with a dereliction of their stewardship obligations to their younger generation. Because nobody else is going to rise to the occasion, the question is whether it matters enough today that they will.
Given the scale of investor losses and anti-government sentiment over bailouts, I believe we are witnessing the first act in a play that will be looked upon as the catastrophic trigger event that changed the profession forever. That is if it is not annihilated by lawsuits first. Just as the US investment banking community has been rendered extinct.
The closing question must be however, why pick on EY? Simple. They’re an easy target for a business that is now in the toilet.
Related articles by Zemanta
- Prem Sikka: Accounting for the auditors in a financial meltdown
- CFOs drive growth strategies as banks alter finance models: Ernst & Young
- Jobs for graduates at Ernst & Young put on hold
- Auditors protest requirments for IFRS specialists
- Auditors dismiss limited liability link with low fees
- E&Y; in court again over fraud failures
- Banks: Nomura poised to save 6,000 Lehman jobs
![Reblog this post [with Zemanta]](http://img.zemanta.com/reblog_e.png?x-id=6f97e0ad-3890-44a1-9066-9a47cbcd0f16)
loading...
loading...
