Financial overhaul

Some accounting, auditing firms say last year’s Sarbanes-Oxley Act created welcome opportunities

BY DAVID SPEAKMAN

Once considered boring or the harmless butts of bad business jokes, accountants shed that image after the record-breaking bankruptcies of Enron Corp. and WorldCom Inc. showed what can happen when bean-counters go bad.

In the aftermath of the Enron scandal and the implosion of “Big Five” accounting firm Arthur Anderson LLP, Congress passed the Sarbanes-Oxley Act of 2002, which overhauled the way public companies handle their internal accounting and public financial statements.

Enforced by the U.S. Securities and Exchange Commission, the law went into effect eight months ago and takes a multipronged approach to overhauling the corporate financial reporting process for public companies. It focuses on two areas: enforcing corporate accountability and eliminating the conflict of interest of accounting firms that provide financial audits as well as provide other services such as accounting and consulting.

Under new corporate accountability laws, if a company commits accounting fraud, the boss faces jail time.

“What people saw right away were the CEO and CFO certifications of the financial statements,” says Rick Barraza, senior vice president of investor relations at Calpine Corp., a San Jose-based power provider (see sidebar). “In our eyes this was nothing new. The accounting for this company has been certified for the last 17 years that I’ve been here. It’s just tighter control and more restrictions on directors and officers.”

Another part of Sarbanes-Oxley is the legal requirement that companies prohibit the accounting firm that does its internal audits to also handle its valuation for federal financial reporting.

“It’s really changed the go-to market strategy of the accounting firms,” says Bill Tulin, a Bay Area-based partner at Ernst & Young LLP. “Our future growth will really be driven in a large part because of Sarbanes-Oxley.”

Companies are much more likely to go out and hire somebody other than their financial reporting auditor to do internal audits, he says.

Citing new SEC regulations on how companies report financial numbers, Tulin says E&Y sees Sarbanes-Oxley as a way to develop a relationship with a company that previously turned to one of E&Y’s competitors.

In the past, some public companies have been criticized because they hired their auditor for other, strategic purposes such as tax planning or acquisition due diligence.

“Companies are embarrassed by the fact that they sometimes pay their auditors fees that are greater for the non-audit services than for the audit,” Tulin says, explaining why more companies are turning to other accounting firms for services traditionally handled by their financial disclosure auditor to avoid any appearance of conflict of interest — whether required by law or not.

He says the accounting industry woke up and smelled opportunity.

“Companies are forced to find a different auditor to provide certain services,” he explains. “In the case of valuation, they have to; in the case of due diligence, they don’t have to, but a lot of them prefer to do so.”

Sarbanes-Oxley also may be loosening the stranglehold the remaining “Big Four” accounting firms have on their market as more companies turn to a second accounting firm to handle strategic planning budgets and other internal auditing functions.

“We’re seeing an increased awareness of the need for strong internal audit programs,” says Bud Genovese, president & CEO of San Jose-based AuditOne LLC.

AuditOne focuses on the financial services market, including many of Silicon Valley’s independent banks. As a result of Sarbanes-Oxley, Genovese says his company has more opportunities.

“We see more attention to the adequacy of the coverage for internal audits. In the past, it may have been seen as an unnecessary expense or an expense companies could delay — and that’s not so now,” he says.

Genovese says a small and nimble company like his has advantages over its larger competitors.

“Some of the national firms may audit a semiconductor chip company one day and a potato chip company the next day,” he says. “We just focus on the financial institutions.”

E&Y’s Tulin agrees the opportunities are not limited to the “Big Four” accounting firms.

“What you’re seeing is this two-firm provider mentality that many companies have adopted,” Tulin says. “It’s created a different type of relationship among the accounting firms because now you may get referred into an opportunity by a competitor whereas in the past, you weren’t. That’s a really interesting dynamic shift in the accounting profession.”

Tulin says tax law attorneys also are benefiting.

“A lot of law firms have looked at Sarbanes-Oxley as a plus for [tax attorneys] because companies may not want to use their auditors to do certain tax planning work,” Tulin says

But is the new law working after its first eight months?

“There’s been a desire and need from investors for more information, more disclosure,” says Calpine’s Barraza. “The power sector has come under a lot of pressure going back to the PG&E and Enron bankruptcies in 2001.”

Calpine has been trying to distance itself from its more troubled competitors by presenting transparent financial disclosures.

“I think we’ve been doing a pretty good job of being more open with Wall Street to give them more insight into our business and a lot of that has come about from Sarbanes-Oxley,” Barraza says.

E&Y’s Tulin says it will take time to allow the public and Wall Street to once again trust accounting firms after the Enron/
Arthur Anderson meltdown.

“We’re going to have to wait a little bit for the situation to bake further in terms of companies implementing Sarbanes-Oxley,” Tulin says. “Once that starts to happen, people will have a sense that companies are doing a better job and gradually you’ll see a restored confidence in capital markets.”