Too Few Auditors to Go Around?

U.S. General Accounting Office looks into consolidation and competition among public accounting firms. Also: Execs unimpressed with Sarbanes-Oxley; resignations at Impath amid accounting probe; SEC settles with former Andersen partner; and more.

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The U.S. General Accounting Office has found no evidence of impaired competition in the audit market for public companies — not yet.

The downsizing of the Big Eight into the Big Four, however, is among a number of factors that “may have implications for competition and public company choice, especially in the future.”

On Wednesday the GAO published “Public Accounting Firms: Mandated Study on Consolidation and Competition.” The report — made to the Senate Committee on Banking, Housing, and Urban Affairs and the House Committee on Financial Services — was required by the Sarbanes-Oxley Act of 2002. Sarbanes-Oxley mandated that the GAO should study:

  • factors contributing to the mergers among the largest audit firms in the 1980s and 1990s;
  • implications of consolidation on competition and client choice, audit fees, audit quality, and auditor independence;
  • the impact of consolidation on capital formation and securities markets; and
  • barriers to entry faced by smaller accounting firms in competing with the Big Four for large public company audits.

The GAO recognized that the “audit market for large public companies is an oligopoly, with the largest firms auditing the vast majority of public companies and smaller firms facing significant barriers to entry into the market.” According to the agency, the Big Four accounting firms now audit over 78 percent of U.S. public companies and 99 percent of public company sales. Use of the Hirschman-Herfindahl Index — a measure of industry concentration commonly used in antitrust analysis, according to the GAO — also indicates that “the largest firms have the potential for significant market power.”

Research into audit fees, however, “did not conclusively identify a direct correlation with consolidation.” The GAO’s research into audit quality, auditor independence, and capital formation were also inconclusive, although the agency “did observe potential impacts for some smaller companies seeking to raise capital.” Noting the “unprecedented changes in the audit market,” however, the GAO also observed that “past behavior may not be indicative of future behavior,” which may warrant further study into “preventing further consolidation and maintaining competition.”

Are any accounting firms in the second tier (as we discussed in our special report) primed to join the Big Four? Probably not, says the GAO, which maintains that “lack of staff, industry and technical expertise, capital formation, global reach, and reputation” are among the market forces that make an expansion of the Big Four unlikely.”

A final note: The GAO provided a draft of the report to the Securities and Exchange Commission, the Department of Justice, the Public Company Accounting Oversight Board, and the American Institute of Certified Public Accountants. The SEC, the DOJ, and the AICPA each provided technical comments that were incorporated into the final report where appropriate, notes the GAO. But perhaps as befits a younger organization that’s still finding its sea legs, the PCAOB had no comments.

A Year Later, Executives Unimpressed with Sarbanes-Oxley

One year after the passage of the Sarbanes-Oxley Act, senior corporate executives do not seem to believe that much has changed as a result — except their personal legal vulnerability.

According to a recent survey of nearly 200 CFOs, CEOs, and other C-level executives recently conducted by law firm Foley & Lardner, 74 percent believe they are personally exposed to increased liability as a result of the act.

Respondents to the survey, however, haven’t been impressed with the law’s ability to clean up corporate misdeeds. Nearly 73 percent do, in fact, believe that the continued emphasis on corporate governance by regulators has been appropriate. However, nearly 60 percent believe that corporate governance reform has gone too far.

Specifically, 54 percent do not believe that Sarbanes-Oxley has made investors more confident in the integrity of their financial and other public reporting, and more than 56 percent do not believe the SEC has been effective in developing the rules mandated by the act. And fully 94 percent expect further increases in costs as a result of doing business under Sarbanes-Oxley.

When asked about the effectiveness of their board of directors one year after the passage of the act, however, 63 percent of respondents said they believe their board is equally effective — and nearly 34 percent conceded that their board is more effective.

The lack of celebration on the first anniversary of the Sarbanes-Oxley Act echoes the unfavorable opinions reported a week ago in the most recent PricewaterhouseCoopers “Management Barometer” survey.

Impath Finance Executives Resign Amid Accounting Probe

Impath Inc. said that its audit committee has launched an investigation into possible accounting irregularities involving its accounts receivable, which the company believes have been overstated.

The company, which offers diagnostic data to oncologists, also said its vice president of finance and its corporate controller have resigned, effective immediately.

The company added that it believes the financial impact will be material. “This investigation will likely lead to a restatement of results from prior periods and prior years, and the continued evaluation of assets may result in one-time charges for the second quarter, contributing to an overall net loss for the year,” said the company in a press release.

Impath added that in the process of reviewing the carrying value of its GeneBank asset, the company discovered discrepancies relating to the amounts capitalized to date on that asset. Impath’s audit committee intends to retain independent counsel and an independent forensic accounting group to conduct the investigation.

Dow Jones noted that the company’s web site listed Karin Gardner as corporate controller and Peter Torres as vice president of finance, but those names appeared to have been removed by midday Wednesday.

“As we have said in the past, the company has a zero tolerance policy on these matters at every level in the organization,” said Carter H. Eckert, chairman and chief executive officer, in a statement. “We are taking swift and decisive actions to assess the situation, determine the nature and extent of the financial impact and implement the appropriate remedial steps and controls to ensure that we provide financial reports that are accurate and reliable.”

SEC Settles with Former Andersen Partner

The Securities and Exchange Commission settled charges against John J. Canepa, a former audit partner at Arthur Andersen LLP, in connection with the improper recognition of revenue by Anika Therapeutics Inc.

Without admitting or denying the commission’s findings, Canepa consented to the entry of a cease-and-desist order.

In related proceedings, the commission settled cease-and-desist proceedings on January 13 of this year against Anika and two of its former officers — chairman, chief executive, and president J. Melville Engle, and chief financial officer Sean F. Moran.

The commission found that Canepa was a cause of Anika’s improper recognition of about $1.3 million in revenue from 1998 and 1999 “bill-and-hold” transactions involving the sale of its product, Orthovisc, to a distributor, in violation of generally accepted accounting principles.

According to the order, Anika prematurely recorded on its books and records and reported in periodic filings with the commission revenue from three bill-and-hold transactions with the distributor at the time of invoicing and prior to actual shipment and delivery of the product to the distributor.

The order found that Canepa reviewed and concurred with Anika’s premature recognition of revenue from the bill-and-hold transactions in 1999. Furthermore, in March 2000 Canepa caused Anika to improperly recognize $342,980 in revenue from a 1998 bill-and-hold transaction in its restatement of revenue, alleges the SEC.

The company filed a second restatement in September 2001. As a result, Canepa was a cause of Anika’s violations, adds the commission.

Short Takes

  • Outsourcing in the health care industry is expected to grow to 22 percent of the industry’s budget in 2003, according to business intelligence firm Cutting Edge Information. The most outsourced health-care processes include hospital support services (30 percent), information technology (22 percent), finance/capital functions (20 percent), and clinical operations (11 percent).
  • The expected price range for the initial public offering of 7 million shares by Netgear Inc., a maker of computer networking products, has been raised to $12-$14 from $10-$12, according to Reuters, citing underwriter Lehman Brothers. Under the new range, Netgear would raise about $91 million.
  • Cigna Corp. has hired Goldman Sachs Group Inc. to help arrange the sale of its pension business for as much as $2 billion, according to Bloomberg, citing people familiar with the situation.
  • 8 of the 12 regional Federal Reserve banks reported “somewhat stronger growth” during the past six weeks, according to the Fed’s most recent survey of regional economies, also known as the beige book. The survey found “generally more positive assessments of current economic activity” and “increased optimism about economic prospects in coming months.”

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