Embattled Ernst & Young rings in big changes

Barely a year ago Ernst & Young, like its peers, was racing to pick up the pieces left behind by Andersen's collapse, enjoying the windfall of new clients and talent.

Since then, though, the picture has grown darker. Negative publicity from its involvement in a string of controversies has taken a toll on Ernst & Young.

After a wave of corporate scandals that undermined confidence in auditors, Ernst says it has ushered in sweeping changes to the way it does business, instituting reforms that go beyond those required by a new federal law.

Ernst has spent much of this year in the spotlight, first for setting up dubious tax shelters for Sprint Corp. executives that are now under scrutiny from the Internal Revenue Service. Then it came under more scrutiny for its role as auditor of HealthSouth Corp., the chain of rehabilitation and surgical centers that has been ensnared in a accounting scandal.

Most worrisome is the specter of a penalty the Securities and Exchange Commission is seeking — a six-month ban on accepting new clients. The proposed ban stems from a case in which the SEC accused Ernst of lacking enough independence when it audited the books of its former client PeopleSoft Inc.

Amid all this, Ernst says it is instituting internal reforms.

“Ultimately, investors have to believe that credibility is being restored,” Beth Brooke, an Ernst & Young global vice chair, told Reuters. “For our profession to sit silent, investors are never going to believe and trust … that we're making the right effort. Silence is just not an option.”

Like other accounting firms, Ernst is bound by the stricter rules stemming from last year's passage of the Sarbanes-Oxley law aimed at deterring corporate fraud. But the firm says its own reforms go beyond those mandated by law.

For example, the firm is rotating staffers who have worked on one audit client for more than 10 years, even though the new law requires only that the lead partner be moved to another assignment after five years, Brooke said.

Ernst recently issued a new code of conduct and started an ethics hotline in March last year, she said. It has also reevaluated its process for accepting new clients and keeps an eye out for lavish lifestyles led by CEOs.

It also says it has changed how it evaluates and compensates its partners so they are not judged by the amount of non-audit business they bring into the firm — a concern voiced by critics after the Enron Corp. scandal.

Ernst says an in-house survey recently showed that morale among its employees remains high. But whether the reforms can restore potential clients' faith remains to be seen.

Some experts, such as Roman Weil, an accounting professor at the University of Chicago, say a review of recent accounting cases would show that all the top accounting firms have their share of the blame.

“Each year, every six-month period has its own favorite Big Four accounting firm and their problems,” Weil said.

Others, such as Mark Cheffers, who runs the Web site and tracks legal liability faced by accountants, say the negative publicity could mean a sizable hit to Ernst's bottom line, since companies are more willing than ever to switch auditors in the post-Enron world.

The SEC's proposed six-month ban on new clients could scare away potential customers, he said.

According to Auditor Trak, which tracks auditor changes, Ernst & Young gained only five new public audit clients since May 29, when news of the SEC's demand surfaced in the mainstream media. During the same period, PricewaterhouseCoopers gained 10 new clients, KPMG added nine and Deloitte scooped up eight.

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