Audits and advice…a conflict? Smaller CPA firms say both hats fit

Edward F. McCrory of Batchelor Frechette<br>worries about SEC ruling.
Edward F. McCrory of Batchelor Frechette
worries about SEC ruling.

Like many accountants, Lawrence Kahn watched the collapse of accounting behemoth Arthur Andersen LLP with sadness, but without surprise. The managing partner of a prominent accounting firm in Rhode Island, Kahn has a jaundiced eye. He figured some of the big guys must cook the books. What goes around comes around.


But Kahn’s sadness turned to dead-serious concern recently, when Congress overwhelmingly passed the most sweeping legislation for the accounting profession since the 1930’s. Kahn and most accountants say the scandal at Arthur Andersen has come unfairly around to affect them.


"Even though we know Arthur Andersen is a CPA firm and we are a CPA firm, we are as different as night and day. But CPAs are like lawyers – we’re all lumped together. The whole profession is painted with the same brush," said Kahn, president and managing director at Kahn Litwin Renza & Co.


The Sarbanes-Oxley Act was approved in a crisis atmosphere on Capital Hill, as accounting discrepancies discovered in large auditing firms and conglomerate corporations like Enron and WorldCom have fueled a loss of investor confidence that has contributed to the biggest losses on Wall Street in decades.


But many accountants here who don’t do business on a national or international level say their industry is completely unlike that of the Big Five accounting firms which audit huge corporations. They fear the reach of the new federal regulations may go too far – hurting the approximately 300 smaller accounting practices in Rhode Island that don’t audit publicly traded companies.


"It’s the rule of unintended consequences. The legislation is directed at SEC-level companies, but the cascading effect that’s anticipated will mean that those regulations will fall upon smaller companies. They’ll be caught up in the web," said Raymond C. Church, executive director of the Rhode Island Society of CPAs. "Regulations designed for mammoth international companies will start being felt by smaller, locally owned businesses."


Among other provisions, the Sarbanes-Oxley Act created a regulatory board to oversee the accounting industry and punish corrupt auditors with long prison terms, and gave broad new protections to corporate whistle-blowers. Because of increased scrutiny, auditors will have to spend more money for outside verification of statements and schedules that their clients provide them.


The measure also leaves crucial details to the discretion of the Securities and Exchange Commission, currently embroiled in politically charged transition. Included in details left to the SEC are potential rules that would limit or restrict the consulting services that auditors can offer their clients. It is yet to be determined whether those restrictions would apply to small accounting firms as well as SEC firms that audit publicly traded companies.


Many small businesses in Rhode Island look to their local auditing firm to provide some consulting services, said Church. To a certain degree, it just makes sense, he said – a small business’s accountant is already knowledgeable of the company’s operating procedures and books, and can easily make strategic recommendations. If smaller accounting firms were forced to curtail their consulting practices, it would be a big blow.


"There really isn’t a conflict of interest," said Edward M. Mazze, dean of the College of Business Administration at the University of Rhode Island. "The small and medium-sized accounting firms that … serve in a business-advising role in addition to accounting have really grown up with their clients. It’s a very different type of relationship. If the small were held to the same standard, it would be an extraordinary expense for people who didn’t do anything wrong."


For that reason, CPAs at Batchelor, Frechette, McCrory, Michael & Co. are nervously waiting to see what decision the SEC will make regarding consulting. The Providence-based firm is a heavy audit firm with an accounting staff of 30. The firm doesn’t have any publicly traded companies for clients – instead, their bread and butter is family-owned businesses in Rhode Island, typically with $10 to $20 million in total revenue, said Edward F. McCrory, principal at Batchelor, Frechette. Providing business consulting to those clients generates 25 percent of the firm’s revenue, he said.


"Immediately, the pendulum swings too far the other way before coming to the point where it should be," said McCrory. "It’s just such a different level when you’re dealing with an Enron or a WorldCom than when you’re dealing with who we deal with in the state."


Additionally, McCrory said the due-diligence measures now required are already spreading panic and paranoia in the local banking industry.


"Even the banking community is starting to feel it. I have a friend at a local bank saying that no one knows where accountability stops anymore. He called to ask me about a CPA firm that a customer of his was using that he didn’t know about," said McCrory.


Business and accounting industry lobbyists had tried in recent days to limit the potential reach of the measure, but they got nowhere. The Rhode Island Society of CPAs Board of Directors recently established a study group to look into the consequences of the new regulations for local firms, said Church.


One ray of hope for Kahn is that the regulations will finally allow the law to recognize the difference between a minnow and a shark. Ultimately, he sees large firms that do SEC-level work and middle-market firms and individuals as working in two separate professions.

No posts to display