September 30, 2022
Ernst & Young’s move to split up its auditing and consulting businesses will help the firm more easily avoid conflicts of interests—and the inevitable problems they lead to—says Cohen Milstein Sellers & Toll’s Laura H. Posner.
Earlier this month, Ernst & Young LLP announced an industry-first split of their auditing and consulting functions, dubbed “Project Everest,” a radical move that could completely transform the business model for accounting firms. The split still needs final approval from EY Partners, with a vote slated for later this year.
The announcement has ignited a fiery debate from the global accounting and business community, with many praising EY for its bold, first-mover split and the potential windfall for EY’s advisory businesses. Others speculate that Everest may be too ambitious a climb and harm EY’s brand.
If it becomes official, the division will separate EY’s accountants who audit companies such as Amazon.com Inc., Salesforce.com Inc., Alphabet, Inc. and more, from its faster-rising—and typically more profitable—consulting business. The company’s split would also mark the biggest shake-up in the sector since the 2002 collapse of Arthur Andersen, the auditor that was mired in the Enron scandal and whose downfall reduced the Big Five to the Big Four.
The Big Four accounting firms—EY, Deloitte LLP, KPMG LLP, and PricewaterhouseCoopers LLC—have been under regulatory scrutiny for years over concerns that their advisory services undermine their ability to conduct independent reviews. As reported in the Wall Street Journal in March, the SEC sent letters to them and other accounting firms in late 2021 seeking information about its audit clients and auditor practices. UK auditing and accounting regulator, the Financial Reporting Council, went a step further and asked the Big Four in 2020 to separate auditing as a standalone business in Britain by June 2024.
While details are still being hammered out, accounting insiders speculate that the move to separate the two operations will, in effect, stop newer EY recruits from pursuing cross-practice advancement of audit, tax, and advisory work as their more experienced colleagues have.
Nevertheless, from an investor protection perspective, the move should be a big win. Over the years, serious conflicts of interests have arisen due to accounting firms conducting both audit and consulting work for the same or related companies. Such conflicts frequently lead to corporate misstatements, breaches of fiduciary duties, and in some cases, fraud—which inevitably erodes investor confidence and results in securities class actions and regulatory actions.
By splitting the two businesses, these conflicts of interest, and the inevitable problems they lead to, could more easily be avoided. For example, EY recently agreed to pay the SEC $10 million for their work with Sealed Air—a packaging company known for its brands, Cryovac food packaging, and bubble wrap cushioning packaging—related to charges of auditor independence misconduct perpetrated by several partners to secure Sealed Air as a client.
This past April, in the UK, EY was hit with a $2.5 billion suit for its auditor negligence in NMC Health, which filed for bankruptcy in 2020 after billions of dollars of undisclosed debt was unearthed.
All eyes are watching. As if sending a warning shot across EY’s bow, the SEC’s acting chief accountant, Paul Munter, issued a statement in August reminding accounting firms that “it is paramount that the accounting firm fully understands its responsibility for maintaining auditor independence and it discloses such requirements to the non-accounting firm investors involved” while exploring audit firm restructurings and other complex transactions.
Although EY’s proposal will continue to spark heated debates across the industry, the move will most likely limit conflicts of interest and better protect investors moving forward, meaning EY could avoid some costly securities litigation and SEC regulatory actions in the future as well.
EY’s first-mover split is bold. Hopefully, Deloitte, KPMG, and PwC will take note as they consider the future of splitting up their own consulting and auditing arms and keeping the interests and protection of their auditing clients’ investors top of mind.
Laura H. Posner is a partner in Cohen Milstein Sellers & Toll PLLC’s securities litigation and investor protection practice, as well as its ethics and fiduciary counseling practice. Prior to joining the firm in 2017, she was the bureau chief for the New Jersey Bureau of Securities.
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