For much of the last century, the consulting arms of the global accounting firms dominated the profession's landscape. They were large, fast-growing cash machines. But then, in a very short period of time, much of their capabilities were spun off. So, why were the then Big Five so fast to divest them?
The story arguably begins with a yearlong Securities and Exchange Commission investigation, which culminated with a report handed down in January 2000. To prevent real or perceived conflicts of interest, the law states that auditors, and their immediate families, cannot have a financial stake in the companies they audit.
While the principal makes sense, the decades-old law meant that it was a violation for a tax partner's spouse to have a 401(k) account that owns a small stake in hundreds of companies, one of which was being audited by a partner elsewhere inside the spouse's firm. The likelihood of a violation was compounded by the consolidation of the global accounting firms and the rise in popularity of IPOs by e-startups, many of whom hired Big Five accounting firms.
The SEC began investigating these ownership violations following the 1998 merger of Price Waterhouse and Coopers & Lybrand, the biggest combination in the history of the accounting profession. Without an automated system to check one's stock portfolio against that of the newly combined firm's ever-changing client roster, violations were rampant.
The SEC report found more than 8,000 violations, including more than 77 percent of all of the firm's partners, including six of the 11 partners at the senior management level who oversaw PwC's independence program. PwC was not alone. Following the report, fingers were pointed at all of the other firms.
In June 2000, the SEC agreed to relax the stock ownership rules by allowing partners and professionals to own stock in audit clients as long as they do not work in the office in which the audit is being performed or have the ability to influence the audit, and do not own more than 5 percent of the company. But the SEC wanted something in exchange.
As a tradeoff for loosening the reins on investments, SEC Chairman Arthur Levitt pushed for an end of the practice of selling consulting services to audit clients. The argument was that the consulting work to audit clients was so lucrative that it might create the perception of a conflict.
According to a report filed with the American Institute of CPAs, the Big Five generated between eight percent and 15 percent of their global revenue from consulting work sold to public audit clients. PwC alone generated more than $1 billion in consulting fees from their public audit clients.
Ernst & Young Sells First
In March of that year, the SEC gained a valuable ally in its fight to split the accounting and consulting arms of these giant firms when Cap Gemini offered a stunning $11.1 billion for the bulk of Ernst & Young's $4 billion consulting practice. Many E&Y partners have privately admitted that it was the size of Cap Gemini's offer, and not SEC pressure, that led to their decision to sell. But, not wanting to be the only accounting giant without a significant consulting capability, E&Y began to lobby alongside the SEC to encourage the other Big Five to divest as well.
In May 2000, KPMG Consulting, which has subsequently been renamed BearingPoint, announced it would be the next to spin off. It chose to take the firm public and sold about 20 percent of its shares to Cisco. In August, Andersen Consulting won its arbitrated divorce from its parent company. (The remaining consulting practice was redistributed when the firm collapsed following the Enron accounting scandal in 2002.)
In September 2000, Hewlett-Packard announced it was in talks to buy PricewaterhouseCoopers Consulting for about $18 billion in a cash-and-stock deal. HP's stock price fell by more than 35 percent after the acquisition talks were announced. The lower stock price killed the deal. For two years, PwC looked for other options. It tried to find other buyers. It even tried to go public, announcing plans in May of 2002 that it was going to change its name to Monday and file for an IPO. But before those plans were implemented, IBM offered $3.5 billion for the practice. The deal closed in October 2002.
Deloitte remained the only Big Five firm not to divest, but not for a lack of trying. It split off its consulting arm from the rest of the firm to prepare for a management buyout. It even changed the name of the consulting unit to Braxton. But in 2002, with the economy reeling, funds were harder to raise than anticipated. Ironically, by not divesting, Deloitte is now the largest and arguably best positioned of the global accounting firms.
The Paths Almost Taken
These transactions redistributed more than $21 billion in consulting revenue. But at several steps during the last decade, other deals almost happened. How strong would HP have been today if it had acquired PwCC as it planned to in 2000. Would it have still acquired EDS, making it a true IT juggernaut? Would IBM be as strong today without the PwCC acquisition?
In the days before IBM finally acquired PwC Consulting, there were other suitors. EDS, an Indian outsourcer and two venture capital firms hired consultants to work up quick valuations of the consulting business. If any of those buyers had offered more than IBM, the landscape could have been considerably different.
And what if Andersen Consulting hadn't been allowed to walk away from its parent company without a more significant payment? Looking back, the fear of losing the potential payday from spinning off one's consulting practices, every bit as much as SEC pressure, was also pushing firm leaders to divest.
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