Company Fading From Big 5 Picture

The U.S. accounting industry is expected to undergo a major transformation in the months ahead in the wake of Arthur Andersen’s conviction of obstruction of justice.

Already, industry power is consolidating into an oligarchy of four giant firms--Ernst & Young, PricewaterhouseCoopers, Deloitte & Touche and KPMG International. What used to be called the Big Five is shaping up as the Big Four.

Firms that previously were small players in specific industries such as energy and gaming will gain new clout as they pick up pieces of Andersen’s crumbling empire.

And the gap between the largest of the Big Four (PricewaterhouseCoopers) and the smallest (KPMG) will narrow as PricewaterhouseCoopers and Deloitte & Touche divest themselves of their consulting businesses.

Last year, PricewaterhouseCoopers collected about $9.3 billion in U.S. revenue, $5 billion more than KPMG. A year from now, analysts expect that difference to shrink to $2.5 billion or less.

Before Enron Corp.’s debacle, Andersen had 26,000 staff members, nearly 2,000 partners and annual U.S. revenue of $4 billion. It was noted for its expertise in the energy, hotel, casino, airline and natural resources industries, as well as its tax work.

Spokesman Patrick Dorton said the firm now has about 10,000 employees.

Client defections began in January with the disclosure that Andersen shredded Enron audit documents, and accelerated with the unsealing of an indictment March 14 charging Andersen with one count of obstruction of justice. The firm’s conviction Saturday is widely seen as a mortal wound.

A compilation by The Times of auditor-change filings with the Securities and Exchange Commission and other public documents shows Andersen has lost more than 720 of its 2,300 public-company clients. That represents almost $1.3 billion in business.

But Dorton said the firm is shrinking faster than the records show. On Saturday, the firm notified the SEC that it will cease auditing public companies Aug. 31.

Ernst & Young looks to be the biggest winner from Andersen’s meltdown, gaining 189 former Andersen clients, or more than a quarter of the business that has defected from the troubled accounting firm. Combined, they made up $300 million of Andersen’s $4 billion in U.S. revenue last year.

The firm also has aggressively courted Andersen’s partners, reaching agreements to hire about 200 partners and at least 1,000 staff members in many regions, including important business centers such as New York and Los Angeles and small markets such as Baltimore; Richmond, Va.; and Nashville.

Overseas, Ernst & Young has signed 54 of the 83 overseas partnerships that once made up the Andersen Worldwide confederation, a move that greatly expands its international reach and will feed multinational business back to its U.S. offices.

The sale of Ernst & Young’s consulting practice two years ago paved the way for the growth the firm is seeing this year, allowing it to invest in sectors such as technology, entertainment, real estate and hospitality, said Tony Anderson, managing partner for Ernst & Young’s Pacific Southwest Area.

Nowhere are Ernst & Young’s gains from Andersen’s fall more evident than in the hotel industry. Before this year, Ernst & Young’s biggest hotel client was the Six Continents Hotel Group, a British company best known for its Holiday Inn chain.

Over the last several months, Ernst & Young has won the business of former Andersen clients Hilton Hotels Corp., Marriott International Inc., Westin Hotels and Starwood Hotels & Resorts Worldwide Inc., and now audits hotel companies that combined account for more than $4 out of every $10 collected by U.S.-based hospitality companies, said Jonathan Hamilton, who publishes the Public Accounting Report, an industry newsletter.

In real estate, Ernst & Young has picked up about half the clients that abandoned Andersen, including Centex Corp., the big Dallas-based home builder, and real estate investment trusts such as Nationwide Health Properties Inc. of Newport Beach.

Deloitte & Touche also benefited from Andersen’s troubles, becoming the dominant accounting firm in the gaming industry by hiring two of Andersen’s top partners in its casino practice and winning a number of important clients, including Trump Hotels & Casino Resorts Inc., Harrah’s Entertainment Inc. and MGM Mirage.

Deloitte, long the No. 2 player in the business, now audits 70% of the publicly traded U.S. gaming companies, Hamilton said.

The firm also has made a big move in the airline industry, now auditing two of the three largest U.S. airlines after capturing longtime Andersen audit clients UAL Corp. and Delta Air Lines Inc.

Moreover, Deloitte, which previously had not been in the top echelon in the tax business, became a major player by hiring 2,000 Andersen tax staff members, including 200 partners, said Allan Koltin, a Chicago accounting industry consultant.

Andersen’s energy practice is being divvied up among the major accounting firms, with each picking up significant clients.

KPMG and PricewaterhouseCoopers each has gained more than $200 million of former Andersen business by winning major clients.

Art Bowman, editor of Bowman’s Accounting Report, an industry newsletter, said he believes that the surviving Big Four will gain from Andersen’s demise through strategic moves that solidify their positions in specific industries or regions. Each will be able to increase its U.S. business by $500 million or more.

“The only difference is in how much they have won,” Bowman said.

Although most of Andersen’s major accounts have been spoken for, Bowman thinks the accounting industry is headed for several years of turmoil as many former Andersen clients make multiple switches in auditors.

“These clients have to find somebody this year, but then they will look for the firm that has the most expertise in their industry,” Bowman said.

The conviction Saturday in federal court in Houston isn’t the end of Andersen’s woes. Andersen still faces an SEC investigation into its work for Enron.

Moreover, Andersen is being sued by investors who lost billions of dollars in Enron’s collapse, and it faces hundreds of millions of dollars in liability.

Andersen has hired bankruptcy and reorganization specialist Bryan Marsal to oversee the downsizing of the firm. Bowman expects the firm ultimately to declare bankruptcy and dissolve this fall or winter.

One question that remains unanswered is whether any of the firms winning Andersen’s business or hiring its partners will find themselves targets of angry Enron plaintiffs and creditors that had hoped to collect damages from Andersen.

Attorneys for these groups are examining the issue of “successor liability” for the firms that wind up with Andersen staff and offices and have sought more information about the deals.

A federal bankruptcy judge in New York recently rejected an effort by Enron creditors to force Andersen to provide more information about its finances and practice sales, but he left the door open for the creditors to get the information at a later date.

But attorneys seeking damages from an accounting firm that has taken over an Andersen practice will be venturing into new legal territory, said John C. Coffee Jr., a Columbia University law professor.

Attorneys usually have a clear target--the so-called successor company that assumes the business of a failed company. But in the case of Andersen, three or four could be seen as successors, Coffee said, and there is no legal precedent for this situation.

Anderson of Ernst & Young said he believes that the firm’s dealings with Andersen will be clear of liability.

“We did not acquire offices of firms,” he said. “We hired people, and you can’t stop somebody from hiring people, regardless of what firm they came from.”

“At the end of the day, there is not a clear answer as to whether there will be a successor liability issue, but certainly there are question marks,” said Dennis Nally, PricewaterhouseCoopers’ senior U.S. partner.

PricewaterhouseCoopers, concerned that it could be dragged into protracted litigation over the issue, has taken a different approach, trying to win clients through the traditional proposal, or bidding, process. Nally said accounts won this way are less likely to face a successor liability challenge since the business is won on merits and not through a purchase or the hiring of a particular partner.

Nally also believes that the method provides a more orderly way to acquire business. His firm only recently regained its equilibrium after its creation through the merger of Pricewaterhouse and Coopers & Lybrand International four years ago.

Acquiring more offices and partners from Andersen would create another difficult transition that PricewaterhouseCoopers plans to avoid.

“Anyone who says integrating large accounting firms is an easy task is fooling themselves,” Nally said.

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The Andersen Ripple Effect

The rapid erosion of accounting firm Arthur Andersen has altered the power structure in the accounting world. Here are some of the significant changes in the industry.

The Big Five

Before this year, five giant firms dominated the accounting industry. Andersen, regardless of whether it survives, will fall out of the top ranks, leaving the industry controlled by four firms.

Overseas

Of the 83 overseas partnerships that once made up the Andersen Worldwide confederation, 54 have gone to Ernst & Young.

Airlines

By picking up UAL Corp. and Delta Air Lines Inc. as clients from Andersen, Deloitte audits two of the three largest U.S. airlines and is well positioned to pick up more aviation business.

Hotels

Ernst & Young has won former Andersen clients Hilton Hotels Corp., Marriott International Inc., Westin Hotels and Starwood Hotels & Resorts Worldwide Inc.

Gaming

Deloitte hired two of Andersen’s top partners in its casino practice and has won a series of high-profile clients, including Trump Hotels & Casino Resorts Inc., Harrah’s Entertainment Inc. and MGM Mirage.

Source: Times research, Public Accounting Report

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Where Have the Clients Gone?

Accounting firm Arthur Andersen has lost 722 clients and $1.3 billion in business since it became embroiled in the Enron Corp. bankruptcy case last year. Hereeithers a breakdown of where the business has gone. Dollars Firm Clients Percent (millions) Percent

Deloitte 140 19% $333 26% E&Y; 189 26 300 23 KPMG 159 22 296 23 PWC 121 17 215 17 Other 55 8 68 5 Undecided58 8 80 6

Total 722 100 1,292 100 Source: Times research