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Charting a New Course

Financial services companies are re-assessing their relationships with Big-Five IT-consulting units as fallout from the Arthur Andersen-Enron accounting scandal raises questions about paying lucrative consulting fees to auditors that perform a dual role.

As pressure mounts from the Arthur Andersen/Enron scandal to split auditing from consulting, financial-services companies are reevaluating their IT consulting relationships with Big-Five IT audit and consulting firms.

A number of banks, asset-management companies and at least one exchange have severed their audit relationships with Arthur Andersen, including The Chicago Mercantile Exchange, Freddie Mac, Northern Trust Corporation, AMVESCAP (parent of mutual-fund company INVESCO), Hartford Financial Services Group and SunTrust Banks Inc. Neuberger Berman Inc. has publicly stated that it's reviewing its auditing contract with Arthur Andersen as well.

The California Public Employees Retirement System (Calpers) - which selected Deloitte Consulting for a $5 million multi-year straight-through-processing design project last spring - is monitoring the situation closely because Deloitte & Touche is also the pension fund's auditor. "The Board has engaged with both firms to understand their intention to separate completely," says Denise Arend, division chief and director of the STP project for the investment side of Calpers.

"Financial-services firms are definitely re-evaluating their consulting relationships and Big-Five firms are re-evaluating their consulting businesses - big time," says a source with one of the Big-Five consultants which still has ties to its audit-parent.

"Firms have to analyze what they're using Big-Five consulting firms for and just be sure whether the results are objective," says Larry Tabb, vice president, securities and investments, TowerGroup. "God forbid if something happens and they don't go through this vetting process, it will certainly be a stock-holder lawsuit," he cautions.

Meanwhile, there has been a tremendous fall off in business because of the Andersen/Enron situation. "Everyone has cut back and it's very difficult to win new work," says the Big-Five partner.

One reason is that some financial institutions are turning to in-house development and using less consulting. Even though the CME dropped Arthur Andersen as its auditor, chief information officer Scott Johnston says, "We didn't have any other relationship (for technology) with Andersen."

When asked if the auditor/consultant independence issue would affect the CME's work with other Big-Five consultants, Johnston says: "It's an added consideration, but because of the way that we use consulting firms, it's unlikely right now" to affect the CME. "In the past, we may have been more passive buyers of technology. But over the past two years we've turned ourselves more into aggressive developers," says Johnston. "We wanted to continue to build expertise in full-time people in intellectual property within the CME ... The problem with consultants is they tend to walk out the door at the end of the job."

These are tough times for the consulting arms of Big-Five audit firms that are being forced to separate by regulators and corporate clients. Big-Five IT consultants are hurting from a slump in IT-consulting revenues, fee pressures and brisk competition from smaller rivals. Not only that, the Andersen accounting fiasco has tarnished the image of Big-Five audit firms that pocket lucrative consulting fees.

"It always seemed to me the intertwining of the audit and consulting function (appears) problematic," comments Paul Stevens, global head of technology for Barclays Global Investors. "You need audit for a specific job, which often times has a regulatory dimension to it. The consulting tasks are much more discretionary. The thought that you use one provider, if it was considered feasible, will be much less so."

Underscoring the serious economic impact of the Enron situation is the fact that the securities industry has cut back on IT-consulting expenditures. Over the past year and a half, "The securities firms have reduced their use of external-service providers," says Tabb.

TowerGroup estimates that somewhere around 30 percent of their external IT-service budget has been cut. In North America, TowerGroup expects the securities industry to spend $7.4 billion on external professional services, which includes consulting plus outsourcing. If outsourcing is subtracted, that still leaves a hefty $6.2 billion.

Still, "The KPMGs and PwCCs (PwC Consulting) of this world are very actively bidding on financial-services projects, including STP and T+1 initiatives and wealth management," says Tabb.

Yet, the postponement of the U.S. T+1 deadline for a shorter settlement cycle and the delay of the Basel Accord for capital adequacy, have denied revenues to consulting firms that were anticipated. "If those sort of industry-wide initiatives falter or are delayed or possibly suspended or canceled, then, again, I imagine that the consulting firms will see that source of their income dry up," says Stevens.

To avoid any perception of conflict of interests, several financial-services customers are scrutinizing the amount of business they allocate to Big-Five firms.

"You have companies like Goldman Sachs that are completely truncating the (consulting) work that they do with the firms that audit them," says Alan Paris, a partner with Capco, a technology- and management-consulting firm that focuses exclusively on financial services. "They're capping the relationships, they're saying, 'You're not going to do more consulting work than you do audit work,'" adds Paris.

Major financial firms are saying they will not give any more consulting work to Big-Five firms until the consulting business is spun off from its audit-parent, confirms a source close to PwC Consulting.

JPMorgan Chase is limiting its work with PricewaterhouseCoopers Consulting, which is also the bank's auditor. PwCC won the project-management merger-office work for the J.P. Morgan-Chase merger.

According to the bank's 2001 proxy statement, JPMorgan Chase paid PwC at least four times more for non-audit services than audit services. Of the $104 million total paid to PwC in 2001, $18.4 million was for core audit fees of its financial statements. But the aggregate fees billed by PwC for "other professional services" were $75 million of which $28.8 million was for audit-related services, $13 million for tax services, and $33.2 millios for "other consulting," performed by PwCC, which were primarily related to assistance with merger-related integration and securities-law-compliance activities.

PwCC also charged $10.9 million for financial-information systems' design and implementation services. In the proxy, the audit committee states it "does not believe that such work has compromised PwC's independence but has nevertheless adopted a policy not to commence any new engagements of PwC, other than for tax advice and for audit-related services. Accordingly, the firm will not engage its independent auditor for any new consulting services of the nature provided by its consulting affiliate, PwCC."

Moshe Katri, analyst with SG Cowen Securities Corp., who covers the computer-services sector, says, "This is why you will see these companies separating. You will see the separation process going through pretty quickly and, in a way, that will enable these consulting firms to stop the erosion in their business."

For Big-Five consulting firms with ties to large audit practices - Andersen, PwCC and Deloitte & Touche - spinning off their businesses into independent units is a matter of survival. Three of the Big-Five audit firms have already spun off their consulting arms: Ernst & Young sold its consulting business to CapGemini, KPMG Consulting went public about a year ago, while Accenture - formerly known as Andersen Consulting - was spun off from Arthur Andersen in a bitter dispute.

Three remaining Big-Five consultants are in various stages of divorcing: Arthur Andersen - which rebuilt a consulting business to compete with Accenture - is selling that business and both PwCC and Deloitte & Touche have said they are committed to separating their audit and consulting businesses.

"It's something that we have to do to maintain a viable business," says the source close to PwCC. PwC has announced that it intends to spin off its consulting practice, PwCC, through an initial public offering. It plans to file its S1-registration statement in either May or June, says the source close to PwCC. "The feeling of the firm is extremely optimistic. The partners and consultants are looking forward to independence and the ability it will provide us to enhance the service levels to our clients," comments Evelyn Fuhrer, PwCC partner, Financial Services. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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