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Small Accounting Firms Exit Auditing

Hundreds of small accounting firms in the USA are struggling under tough new auditing rules adopted after a string of corporate scandals and regulatory probes, and several are exiting parts of the business they view as increasingly risky, according to industry experts.

Over the past few months, New York's Grassi & Co. and Citrin Cooperman & Co.; Los Angeles's Good, Swartz, Brown & Berns LLP; and several other accounting firms have severely curtailed or abandoned the business of auditing public companies. Spurred by failures at Enron Corp. and WorldCom Inc., where auditors failed to catch serious accounting problems, Congress last year imposed limits on the kind of work auditors could do and created an industry oversight board to set new professional standards.

Accounting firms that review financial statements for public companies must register by next week with the new oversight board, which can inspect those firms and discipline those found to be in violation of its rules. As of Monday, 88 firms had registered.

“People just didn't want to risk their entire career for one bad audit,” explained Louis C. Grassi, managing partner of the Lake Success, N.Y., firm. Grassi said his firm gave up 40 public clients, worth about $1.5 million in audit fees, and is instead focusing on private clients, taxes, consulting, and other kinds of work that face fewer government restrictions.

The exodus of smaller firms that will perform public company audits raises broader and more serious concerns about competition in the accounting industry, which has consolidated rapidly over the past decade. Last year, Arthur Andersen LLP collapsed after being indicted for obstruction of justice, leaving just four large firms to handle work for more than 75 percent of the nation's biggest public companies, according to a recent General Accounting Office report that called the industry an “oligopoly.”

Chicago-based accounting management consultant Allan D. Koltin said he expects that over the next two years the number of accounting firms reviewing the books of public companies will fall to fewer than 100 from 850. Many of those expected to exit handle the smallest public companies, often the least lucrative clients who cannot afford or have been rejected by accounting's Big Four — PricewaterhouseCoopers, Ernst & Young, Deloitte & Touche and KPMG.

“The types of clients [drawn to small firms] are not strong, powerful, dynamic, cash-rich companies,” said Scott M. Sachs, a partner in the San Fernando Valley office of Good Swartz, a 110-person accounting firm that recently decided to give up about a dozen public audit clients. “They're tiny Nasdaq firms, bulletin board companies, companies with liquidity challenges. . . . That added level of risk, the headaches, from a business standpoint, it wasn't worth it.”

That could make it harder for these kinds of firms to find auditors, although not every accounting firm is rushing to abandon them.

“One man's garbage is another man's antique. Everybody assesses risk differently,” said Jeffrey M. Weiner, managing partner of Marcum & Kliegman LLP in Woodbury, N.Y. Weiner said his firm has picked up more than 40 public audit clients from rivals exiting the business over the past year.

Some accounting firms are waiting for regulators to sketch out more complete oversight and disciplinary plans before deciding whether to stop auditing public firms. Industry insiders said these firms are trying to assess the cost of registering with the oversight board and training staffers on the latest rules and standards, and determine if they have enough revenues from public companies to cover those costs or if they can raise audit fees sufficiently to make the work profitable.

“We're really looking for the regulations to settle in before we delve in too deeply with our resources,” said Kenneth E. Baggett, managing partner of Bethesda's Reznick Fedder & Silverman, which has four offices and about 600 employees. Reznick Fedder audits about nine public companies, according to Baggett. It is the nation's 18th largest public accounting firm, according to industry newsletter Public Accounting Report.

Others firms are already sinking considerable resources into meeting the new rules. At Aronson & Co., a 40-year-old Rockville firm, one of its longtime partners has spent more than 100 hours preparing a registration form for the new accounting oversight board. It even sought advice from an outside lawyer in order to complete parts of the form that asked about any misdemeanor and felony convictions racked up by its accountants. Managing partner Lisa J. Cines said Aronson leaders wanted to be careful about how they questioned employees to avoid violating employment laws.

The Public Company Accounting Oversight Board recently started an outreach program to help small audit firms cope with the onslaught of registration, a nod to the fact that small firms handle work for many entrepreneurial companies that “create most new jobs and many new ideas,” said board chairman William J. McDonough at a public meeting last month.

The new costs extend beyond the registration process. For instance, Aronson had problems getting liability insurance. Only one insurer would draft a policy to cover Aronson's whole practice. Three others wanted to exclude its SEC clients, said Cines. Other mid-sized accounting firms are facing similar problems, according to Mario Lemme of Lemme Insurance Group Inc., a Chicago insurance broker for many accounting and law firms.

Underwriters no longer offer multi-year policies to mid-sized accounting firms that review the books of public companies, and audit firms that do secure insurance often find their rates have doubled, Lemme said.

Despite the added problems, Cines said Aronson decided it needed to continue to audit public companies to maintain the firm's technical skills, to keep the respect of longtime government contracting and real estate clients, and to draw new recruits. Cines said Aronson audits about 12 public companies.

But she said the firm will evolve as the new rules become clearer. “The only thing I'm sure of, is things will be dramatically different than we know them today,” Cines said. “I don't know what we're going to look like three to five years from now.”

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