This is the era of the global firm, whether in finance or industry. A firm like Toyota or Citigroup may have its headquarters in one city, but it has operations all over the world and gets capital from a similarly broad base. When Citi ran into difficulties, it turned to Abu Dhabi.
And then there is accounting.
At first glance, it appears that there is also a handful of global accounting firms -- the Big Four and a couple of others -- but that is not the reality.
Those firms are formally organized as a series of partnerships, each of them relying for capital on its own partners rather than on outside sources of capital. And while they may market themselves as unified organizations with worldwide abilities, a very different view is presented when someone sues over a failed audit.
Then the firms disclaim any responsibility for actions of a firm with a similar name in another country. It is as if Toyota in Japan insisted it had nothing to do with Corollas made in California.
The accounting firms do that in large part to limit their liability. A single bad audit may have brought in a fee of less than US$1 million -- but a liability of US$500 million. The partners in Britain have no desire to share in the liability of the US or Brazilian affiliate.
But that may have to change. Some courts are cutting through the legal barriers -- as one appeals court did in Florida this week -- even as the big auditing firms find it necessary to impose controls and international coordination on their various affiliates. The firms need to ensure that international accounting rules are interpreted the same way in London as they are in Frankfurt and Tokyo, no matter how many legally separate partnerships are involved.
In the Florida case, the lawyer for BDO International, which is the coordinating entity for BDO's international network of firms, persuaded a judge to rule that the international firm, which is based in the Netherlands, had no responsibility for a bad audit performed by BDO Seidman, the US affiliate. BDO Seidman lost the case at trial and was ordered to pay damages of US$521 million.
In a hearing before an appellate court, BDO International's lawyer dismissed as "puffery," not reality, the claims by his client that it exercised strict management and control over its affiliates. The appeals judges were not impressed, and this week ruled that a jury should consider whether BDO Seidman was an agent of the international firm, making the international firm liable for the bad audit. (BDO Seidman's appeal of the case is pending.)
It is not clear just where BDO International would get the money even if it eventually loses the case -- an official testified it has only 10 employees -- but the plaintiffs hope they could go after other BDO affiliates.
Eventually, the need for capital may force accounting firms to find ways to change local rules and seek capital from a wide variety of sources, much as Wall Street firms did a generation ago when they began to incorporate and sell stock to investors.
Paul Boyle, chief executive of the Financial Reporting Council, the British accounting regulator, has suggested that such a change may be needed to ensure an adequate number of competitors, an issue of concern in many countries since the collapse of Arthur Andersen reduced the Big Five to what some called the Final Four.
"Outside capital has the potential to facilitate either a new entrant of scale to the industry, or to accelerate the growth rate of some of the smaller existing firms," he said in an interview on Thursday.
As it is, regulators fear taking too harsh action against any one of the survivors. One reason the Justice Department shied away from seeking a conviction of KPMG for its tax shelter promotions was a concern that such a move could kill the firm.
One fear of all accounting firms is that a big legal verdict could be fatal, and that has led to what may be the counterproductive effort to legally insulate each national partnership -- leaving each of them poorly capitalized and vulnerable. If they feel vulnerable, they are more tempted to settle cases that they might win, and that itself can drive up costs.
The BDO network is not as large as that of the Big Four, but it stretches around the world. The case that threatens it was brought by a Portuguese bank, Banco Espirito Santo International, that had lent US$170 million to a Florida company whose audited financial statements showed it had US$225 million in accounts receivable. It turned out the real number was US$5 million and that fraud had been going on for years. Some of those involved went to prison, and the bank sued BDO Seidman and BDO International.
"They advertise to the world, `We are all one firm; we have strict quality controls,'" said Steven Thomas, a partner in Thomas Alexander & Forrester, who represented Banco Espirito Santo. "Then when they are sued, they say, `No, we are all separate firms and have nothing to do with each other.'"
The appeals court ruling pointed to BDO annual reports advertising its "strict quality control" over member firms, including BDO Seidman.
That kind of control may really be needed in the globalized world we live in, with companies operating across continents. But firms that really have such control are going to need much more capital than any local firm can have, both to withstand the results of errors and to put in place the controls that will reduce their number.
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